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Lam Research 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, 1999 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 OF (I.R.S. EMPLOYER IDENTIFICATION NO.)INCORPORATION OR ORGANIZATION) 4281 TECHNOLOGY DRIVE, 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: NONESECURITIES 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, 1999 as reported on the Nasdaq National Market, was approximately$248,780,000. 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 inthat such persons may be deemed to be affiliates. This determination ofaffiliate status is not a conclusive determination for other purposes. As of December 31, 1999, 18,658,919 shares, $.001 par value, of theregistrant's common stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive proxy statement for the registrant's 2000 annual meeting 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 American Xtal Technology, Inc., or AXT designs, develops, manufactures anddistributes high-performance compound semiconductor substrates, laser-diodes,light-emitting diodes, or LEDs and consumer and commercial products utilizinglaser-diodes and LEDs. AXT expanded its markets in 1999 through the acquisition of Lyte Optronics,Inc. (See note 2 to the consolidated financial statements). The Lyte Optronic'sbusiness now operates as two separate divisions of AXT: the visible emitterdivision, focusing on the manufacture of LEDs and laser-diodes, and the consumerproducts division, focusing on the design and marketing of laser-pointing,laser-alignment and LED products. The Substrate division comprises the thirdoperating unit of AXT. BACKGROUND Substrate Division: At our substrate division, we use a proprietary vertical gradient freezetechnique, commonly referred to as "VGF," to produce high-performance compoundsemiconductor substrates which are used in a variety of electronic andopto-electronic applications such as wireless and fiber optictelecommunications, lasers, LEDs, satellite solar cells and consumerelectronics. We primarily manufacture and sell gallium arsenide, called GaAs,substrates. Sales of GaAs substrates accounted for approximately 80.1% ofdivision revenues and 56.3% of company revenues in 1999. We also manufacture andsell indium phosphide, or InP, and germanium, or Ge, substrates and arecurrently developing other high-performance compound substrates includinggallium nitride, or GaN. Recent advances in communications and information technologies have createda growing need for power efficient, high-performance electronic systems thatoperate 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, or multiple elements, which may include: - gallium, - aluminum, - indium, - arsenic, - phosphorus, and - nitrogen. 1 3 Substrates that consist of more than one element are commonly referred toas "compound substrates" and include GaAs, InP, gallium phosphide (GaP) and GaN.GaAs is currently the most widely used compound substrate. In comparison tosilicon, compound substrates have electrical properties that allow semiconductordevices to operate at much higher speeds or at the same speed with lower powerconsumption. For example, electrons move up to five times faster in GaAs than insilicon. Compound substrates also have better opto-electronic characteristicsthan silicon which allow them to convert energy into light and lasers, or todetect light and convert light into electrical energy. The GaAs substrate marketis divided 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-encapsulatedczochralski, 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 1999 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 are incorporated 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. 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, 2 4 technique. With the HB technique, the crystal is grown in a semi-cylindricalcontainer, which results in a semi-circular, or D-shaped, substrate. In order toproduce a round semi-conducting GaAs substrate, the HB technique requires thatthe D-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 that opportunities alsoexist in the markets for other high-performance substrates. For example, webelieve that the markets for InP and GaP substrates, based on 1998 market dataand annual growth rates projected by Dataquest, IDC and Strategies Unlimited,were an aggregate of approximately $150 million in 1998 and we expect that thesemarkets will continue to grow. Semi-insulating InP substrates are used inpower-efficient, high-performance electronic applications such as wireless andhigh-bandwidth communications and semi-conducting InP substrates are used insuch applications as fiber optic communications and lasers. GaP substrates areused by manufacturers of LEDs. The traditional method for growing crystals forInP and GaP substrates has been the LEC, technique. In addition to compoundsubstrates, the market for the element Ge is developing in response to thegrowing demand for solar cells in satellite communications. We believe that themarket for Ge substrates used to manufacture solar cells was approximately $60million in 1998 and we expect that the market will continue to grow in relationto the demand for satellites. This application requires the use of Ge substrateswhich must be manufactured with few defects and minimal breakage. We believe thefurther development of these markets depends on the ability of suppliers tocost-effectively manufacture power-efficient, high-performance compound andsingle-element substrates The AXT Solution. We use a proprietary VGF technique to producehigh-performance GaAs and other substrates for use in a variety of electronicand opto-electronic applications. We believe that our VGF technique, which wehave developed over the past 13 years, provides certain significant advantagesover traditional manufacturing methods for growing crystals used in theproduction of semi-insulating and semi-conducting GaAs substrates. We believethat we are currently the only high-volume supplier of GaAs substratesmanufactured by using the VGF technique and are positioned to become a leadingmanufacturer and supplier 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. In 1999, we shipped over $9million of Ge and InP substrates to customers and qualified our wafers with manymore potential customers. Visible Emitter Division: The Visible Emitter division designs, develops, manufactures and sellsvisible semiconductor laser-diode chips and high brightness visiblelight-emitting diodes, or HBLEDs. Our laser-diode chips are currently soldprimarily into the laser pointer market. Sales of laser-diodes accounted forapproximately 85.8% of division revenues and 19.6% of company revenues in 1999.Our laser-diodes and red, amber and yellow HBLEDs are 3 5 built on our proprietary aluminum indium gallium phosphide, or AlInGaP materialtechnology. The red, amber and yellow HBLEDs are sold as wafers that areprocessed into LED chips and lamps by our customers. Sales of HBLEDs accountedfor approximately 5.1% of division revenues and 1.2% of company revenues in1999. The advancement of the material and device technology for the LEDs made inthe last decade has resulted in increased device efficiency. LEDs withefficiencies higher than incandescent light bulbs are commonly available. TheHBLED is a class of LED that is visible under normal sunlight. In the past,HBLEDs were cost prohibitive in applications requiring large quantities.However, improvements in technology have reduced the cost sufficiently to enablethe HBLEDs to be used in applications such as full color video display signs,back lighting for LCD displays in cell phones and automobile instrument panelsand white LED illumination. Management estimates that the current HBLED marketis approximately $600 million. In the fourth quarter of 1999, we began shipping a blue LED product inpilot quantities. This new 470 nm aluminum indium gallium nitride, orA1InGaN-based high brightness blue LED has approximately 1.5 milliwatt poweroutput at 20 milliamps. The new blue LED builds upon the company's currentoffering of A1InGaP products. The blue LED product will be sold as chips to bepackaged by our customers for use in full color displays, back lighting forcellular phones and automobile panels and general illumination lighting. Weexpect that the blue LED chips will account for an increasing portion ofdivision and company revenues in future periods. Consumer Products Division: The consumer products division designs, develops, manufactures and sellsvisible laser and LED products for consumer, commercial and industrialapplications. Our products utilize laser-diodes made from our GaAs substrates and the LEDs fabricated in other AXT divisions to make premium consumerproducts, alignment and targeting systems and industrial modules. Approximately50% of sales are generated from laser pointers, 40% from laser targeting systemsand 10% from industrial products. We sell laser pointers into the business presentation and office productsmarkets. We utilize 635nm laser-diodes in many of our product lines, whichcontain the highest beams allowable under FDA guidelines. These pointer marketsare becoming mature in terms of the volume of shipments and have experiencedsignificant decreases in average selling prices during the past three years. We also sell laser alignment systems for industrial markets such as thegarment industry. Since laser light is directed in a straight line, companiesuse lasers to increase accuracy in their manufacturing operations. We supplythese companies with customized laser modules for their unique applications. Inaddition, we sell laser-targeting sights for the weapons industry. STRATEGY Substrate Division: 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 throughsubstantial investments in research and development. Our efforts have led tosignificant improvements in the dislocation density, mechanical strength anduniformity of the electrical properties of GaAs substrates. We believe that ourexperience and expertise in VGF technology provides us with a competitiveadvantage over more recent market entrants who are utilizing variations of theVGF technology. We intend to continue to advance our VGF technology throughcontinued investment in research and development and participation in certaingovernment sponsored research programs. 4 6 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 tocontinue to provide high-quality, price-competitive substrates. In addition, inthe semi-insulating GaAs substrate market, we intend to leverage ourdemonstrated success in the epitaxy segment to further penetrate the ionimplantation segment. In the semi-conducting GaAs substrate market, we alsointend to capitalize on our leadership to further penetrate the high-volume,cost-sensitive LED market. Leverage VGF technology to manufacture additional substrates. We believeour VGF technology is a platform that 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 have shipped InP and Ge substrates developedusing our VGF technique to customers. Unlike the more traditional methods ofgrowing crystals, we can use our VGF technology to grow the crystals for theseother substrates without having to make a significant investment in new capitalequipment. Increase manufacturing capacity to target high-volume markets. Weincreased our manufacturing capacity by approximately 30,000 square feet in thefourth quarter of 1998. In addition, in June 1998, we purchased an additional58,000 square foot facility in Fremont, California. In January 1999, weannounced the receipt of a business license for operations in Beijing, China andthe purchase of a 31,000 square foot facility in a major tax-free industrial park in Beijing. We recently announced we have acquired an additional 31,000square foot facility in this same industrial park in Beijing and plan tocommence production by the middle of 2000. We believe that this increasedmanufacturing capacity will enable us to further lower unit production costs andprovide our high-performance substrates at competitive prices for high-volumemarkets such as LEDs. Leverage existing customer relationships. We currently sell our GaAssubstrates to over 200 customers, some of our largest include: - EMCORE - Hewlett Packard - Motorola - NEC - Nortel - Siemens - Sony - TRW We intend to expand our past success by providing high-quality GaAssubstrates to these customers and to supply them additional substrates as theirneeds develop. For example, we have shipped InP substrates to TRW, whichcurrently purchases a significant portion of its GaAs substrates from us. Inaddition, we intend to establish alliances and joint development arrangementswith customers to develop new products, increase manufacturing efficiencies andmore effectively serve our customers' needs. Visible Emitter Division: Our strategy is to become a leading provider of HBLEDs for the full rangeof colors, including red, yellow, amber, blue and green LEDs. Develop high brightness AlInGaP-based red, amber and yellow-green LEDs. Wewill continue to invest in research and development of AlInGaP material anddevice fabrication techniques to further improve LED brightness and performance. Develop AlInGaN-based blue and green HBLEDs. We will continue to invest inAlInGaN material and device fabrication techniques to further improve LEDbrightness and performance. 5 7 Develop a high volume low cost manufacturing model and become the marketleader in the supply of AlInGaN-based HBLEDs. We will continue to invest in ourdomestic production capability and to expand our operations in Xiamen, China toincrease capacity and to lower manufacturing costs. Consumer Products Division: Focus on the premium segment of the laser pointer market. We will continueto manufacture and sell laser-pointing devices primarily to the middle topremium price segments of the marketplace. An agreement with the 3M Corporation,to exclusively distribute and market premium laser pointers to the officeproducts retailers, has solidified our position in this important marketsegment. Develop proprietary new laser and LED-based consumer products. We aredesigning and developing new visible laser and LED products that capitalize onour visible laser and LED technologies. We have announced that we expect to introduce a new home security device inthe second quarter of 2000 that guides people out of a fire with three lasers,named Safe Escape. Most home fires occur late at night and wake people from adeep sleep. After breathing carbon monoxide and waking to the panic of a fire,it is common for even the most athletic individuals to have difficulty findingtheir way out of their own homes. Safe escape activates based on the sound of a smoke detector and projectsthree bright and safe laser arrows to the ground that cut through smoke andguide people to a safe exit. Safe Escape utilizes digital sound activationtechnology to listen for the sound of a smoke detector while discriminatingagainst other common sounds. Another new product we are introducing in the first quarter of 2000 is ourLED flashlight called MiniBrite, which is our first product utilizing superbright LEDs. Offered in five extremely bright colors, this product can be usedas a mini flashlight that attaches to a key chain. This relatively low costproduct has an LED that we believe will last up to ten years of constant use. Establish relationships with key Asian suppliers. We are reducing ourdependence on U.S. based manufacturing and creating alliances with qualityoriented Asian manufacturers. This direction will allow us to reduce labor,overhead and material costs while focusing attention on developing and marketingnew products. CUSTOMERS In 1999, our top ten customers accounted for 36.1% of our total revenues.No customer accounted for more than 10.0% of our total revenues in 1997, 1998and 1999. In 1997, 1998, and 1999, our five largest customers accounted for20.4% and 27.9% and 22.9%, respectively, of our total revenues. Generally, we donot have long-term or other non-cancelable commitments from our customers andusually sell products pursuant to customer purchase orders. The loss of anymajor customer could have a material adverse effect on our business andoperating results. 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." TECHNOLOGY Substrate Division: 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 6 8 traditional techniques. These aspects of the VGF technique enable us to growcrystals that have a relatively low dislocation density and high uniformity. Oneof the benefits of these characteristics is that the crystal, and the substrateinto which the crystal is manufactured, are mechanically strong. The mechanicalstrength often results in substrates with lower breakage rates during acustomer'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 meet a customer's requirements,enables us to produce circular substrates with a minimum amount of discardedmaterial. 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-qualitysubstrates. 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 7 9 limit the ability of the HB technique to be used to cost-effectively producehigh-quality substrates greater than three inches in diameter. Since the HBtechnique uses a quartz crucible during the growth process which can contaminatethe GaAs melt with silicon impurities, the HB technique is also unsuitable formaking semi-insulating GaAs substrates. Visible Emitter Division: Our material technology utilizes a metal-organic chemical vapor deposition,or MOCVD technique to synthesize compound semiconductor thin films on substratessuch as GaAs and sapphire (Al2O3). The thin film, which consists of multiplelayers, is actually where the LED or laser-diode devices are formed. The deviceperformance is closely related to the design of the layered structure and how itis synthesized in the MOCVD process. The same layered structure can be madeunder different process conditions and result in a different device performance. The MOCVD process is a chemical reaction between metal-organic material,such as trimethylgallium (TMGa), and hydride, such as arsine (AsH3). Thechemical reaction takes place on the surface of a heated substrate like GaAs.When TMGa and AsH3 react on a heated GaAs substrate, a thin GaAs film is thendeposited on the GaAs substrate. In theory, many different compounds can bedeposited this way such as aluminum gallium arsenide (AlGaAs), indium galliumarsenide phosphide InGaAsP, and aluminum indium gallium phosphide (AlInGaP). Because it is a relatively low cost production process, MOCVD reactors havebecome the choice of the opto-electronic industry for fabricating thin filmdevices such as LEDs, laser-diodes and high-speed electronic circuits.Commercial MOCVD reactors are now available from more than one vendor. Thesereactors usually can process multiple wafers and some reactors can even do morethan 35 wafers per run. In general, the larger the size of the reactor, the moreeconomic the production cost. However, larger reactor geometry also presentshigher technical challenges for wafer uniformity. The visible emitter divisioncurrently has several multi-wafer MOCVD reactors in operation. Proprietaryprocesses have been developed to grow high quality AlInGaP thin films on GaAsand aluminum indium gallium nitride (AlInGaN) thin films on sapphire. Thedevices fabricated from these materials have demonstrated performance comparableto the high end products on the market. Consumer Products Division: Our laser pointers, targeting systems and industrial products all utilize atype of laser module. A laser module usually consists of a laser-diode,collimating optics or lenses, a tuned control circuit and a protective brass orsteel housing. Often, an additional optic is included to shape the projected dotinto a line, cross or some other pattern. Our visible emitter division suppliesthe laser-diode chips and our consumer products division adds automatic powercontrol circuitry, a collimating lens and assembles the product. Our lensesoften use a proprietary active alignment process to align the beam axis to thehousing. Pattern generating optics are then added where required. We are currently developing digital control circuits for visible laserproducts to control lasers directly from small micro controllers. PRODUCTS Substrate Division: 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. 8 10 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 2,3,4 - Fiber optic communications - Satellite communications - High-performance transistors - Automotive collision avoidance radarsInP semi-conducting 2 - Fiber optic communications - LasersGe 4 - Satellite solar cells Visible Emitter Division: We sell laser-diodes primarily for the pointer industry and we sell LEDproducts for use in displays, traffic lights, back lighting for a variety ofproducts and for general illumination purposes. Both the laser diodes and LEDsmust meet customer specifications. Consumer Products Division: We sell laser pointers, laser alignment and targeting systems andindustrial module products utilizing laser-diodes and LEDs manufactured by ourvisible emitter division. We offer 15 products within our laser pointer lineprimarily directed at the office products and business presentation markets. Weoffer approximately twenty products in our laser alignment line includinglaser-targeting sights for training purposes. In our industrial module business,we offer laser modules for the garment industry and other industrial uses suchas levelers. Our industrial products are sold within the OEM markets. We have announced two new products for shipment in the first half of 2000.Our Safe Escape product, which utilizes lasers to guide people from a burninghouse or building, is expected to ship in the second quarter of 2000. OurMiniBrite LED flashlight, which is a super bright LED personal light, beganshipping in the first quarter of 2000. MANUFACTURING Substrate Division: 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 9 11 through 1999. Because we currently perform all steps in our manufacturingprocess at our Fremont facility, any interruption resulting from earthquake,fire, equipment failures or other causes would have a material adverse effect onour results of operations. For more information regarding the risks relating toour manufacturing 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. In connection with further expanding our manufacturing capacity, wepurchased an additional 58,000 square foot facility in Fremont, California inJune 1998 and a 31,000 square foot facility in Beijing, China in 1998. We haverecently acquired an additional 31,000 square foot facility in Beijing and planto commence production by the middle of 2000. Visible Emitter Division: Our visible emitter division currently operates in three facilities, two inSouthern California and one in China. Our office and device production islocated in Monterey Park, California, our MOCVD wafer production is located inEl Monte, California and most of our laser chip assembly is done in Xiamen,China. We purchased an additional 27,000 square foot facility in El Monte,California in late 1998. This new facility will be used primarily for MOCVDexpansion. Improvements are being planned and we expect the facility to be fullyfunctional by the second half of 2000. This additional space will allow us tomore than double our LED production. MOCVD equipment currently has about a six to nine month lead-time fordelivery and is supplied by two major companies. Our substrate materials or rawwafers are primarily purchased from our substrate division based upon six to tenweek forecasts of production. We are currently developing processes and procedures that comply with ISOstandards and we are working toward ISO certification. Consumer Products Division: Our consumer products division operates a 15,000 square foot manufacturingfacility in Torrance, California. This facility is designed to optimize theproduct flow and minimize material handling. The major manufacturing processesinclude receiving and testing of raw materials, storage of raw materialinventories, product assembly, inspection of finished products, finished goodsstorage and shipping. A number of our products, including laser pointers, arebeing sourced in Asia as we move to reduce product costs and manufacturingoverhead. We have established quality control procedures and personnel in Asiato support this function. We currently have several sources for assembly of ourpointers located in China. We are currently developing processes and procedures that comply with ISOstandards and we anticipate our production facilities will be ISO certified bythe end of 2000. SALES AND MARKETING Substrate Division: We sell our products worldwide through our direct sales force as well as through independent international sales representatives. Our direct sales forceconsists of sales engineers who are knowledgeable in the manufacturing and useof compound and single-element substrates. Our direct sales force operates outof our corporate office in Fremont, California and our Japanese subsidiary. Oursales engineers work with customers during all stages of the substratemanufacturing process, from developing the precise composition of the substratethrough manufacturing and processing the substrate to the customer's exactspecifications. We believe that maintaining a close relationship with customersand providing customers with ongoing technical support improves customersatisfaction and will provide us with a competitive advantage in selling othersubstrates to our customers. 10 12 International sales, excluding Canada, as a percentage of total revenues in1997, 1998, and 1999 were 26.8%, 29.6%, and 45.1%, 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". Visible Emitter Division: The majority of our laser-diode chips are sold in China and elsewhere inAsia. We primarily rely upon independent sales representatives for the sale oflaser-diodes in China and in Asia. We also conduct some sales in Asia on adirect basis. We anticipate the new LED product line to be introduced during 2000 willinitially be sold into lamp packaging manufacturers in Taiwan and China. Weintend to sell products through independent local sales representatives and ourdirect sales force. We also intend to make subsequent sales of our HBLEDs, inparticular our blue LEDs, into U.S. and European markets. We anticipateutilizing our own direct sales force for this sales effort. Consumer Products Division: We currently sell our products through a combination of our own directsales force and independent sales representatives. Our direct sales forceconsists of professionals experienced in all phases of major account saleswithin the consumer products industry. Independent sales representatives areprimarily used for our sighting and alignment products with over 45representatives covering the majority of the United States. The vast majority ofour sales are to customers in the United States. For our international sales of our consumer products, we utilizeindependent agents and expect to increase our reliance on independent agents infuture periods. We also participate in major trade shows and fund cooperativecustomer advertising to promote our products to the end users. RESEARCH AND DEVELOPMENT Our research and development efforts are focused on developing newsubstrates and LEDs and improving the performance of existing products andprocesses, and reducing 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 high purity GaAs epitaxy substrates. Our internally-funded research and development expenses in 1997, 1998, and1999 were $1.3 million, $2.7 million, and $3.1 million respectively. In addition to internally-funded research and development, we have alsofunded a significant portion of our research and development efforts throughcontracts with the U.S. government and customer funded research projects. Underour contracts, we retain rights to the VGF and wafer fabrication technologywhich we develop. The U.S. government retains the rights to utilize thetechnologies we develop for government purposes only. In 1997, 1998, and 1999,we received $2.3 million, $1.8 million, and $1.6 million, respectively, fromU.S. government agencies and customer funded research contracts. Over the sameperiods, we expensed $1.5 million, $.8 million, and $1 million respectively ofexternally-funded research and development proceeds. In future periods, weexpect our government contracts will significantly decline as we shift tointernally-funded research and development projects. 11 13 Our total internally-funded and externally-funded research and developmentcosts for 1997, 1998, and 1999 were $2.8 million, $3.5 million, and $4.1 millionrespectively. We expect to continue to expend substantial resources on research anddevelopment. The development of compound and single-element substrates and LEDsis highly complex. There can be no assurance that we will successfully developand introduce new products in a timely and cost-effective manner or that ourdevelopment efforts will successfully permit our products to meet changingmarket demands. For more information regarding the risks relating to ourresearch and development efforts, see "Factors Affecting Future Results -- Wemust effectively respond to rapid technological changes by continuallyintroducing new products that achieve broad market acceptance." COMPETITION Substrate Division: 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 to face competitive risks similar to those for itsGaAs substrates. Many of our competitors and potential competitors have been inthe business longer than us and have greater manufacturing experience, moreestablished technologies than our VGF technique, broader name recognition andsignificantly greater financial, technical and marketing resources than us. Wecannot assure you that we will compete successfully against these competitors inthe future or that our competitors or potential competitors will not developenhancements to the LEC, HB or VGF techniques that will offer price andperformance features that are superior to ours. Increased competitive pressurecould also lead to intensified price-based competition, resulting in lowerprices and margins, which would materially adversely affect our business,financial condition and results of operations. 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. 12 14 In order to remain competitive, we believe we must invest significantresources in developing new substrates and in maintaining customer satisfactionworldwide. Visible Emitter Division: The LED industry is very competitive. LED manufacturers in Taiwan and Chinahave a competitive pricing advantage due to low overhead and small research anddevelopment investment. In order to remain competitive, we intend to continue toinvest technological advances for our products. Currently, our primarycompetitors include: - Cree Research - Hewlett Packard - Nichia Chemicals - Toyoda Gosei - United Epitaxy - Epistar Many of our competitors or potential competitors have been in businesslonger than we have and have greater manufacturing experience, broader namerecognition and significantly greater financial, technical and marketingresources than we do. In addition, our Asian competitors may have greatersuccess in Asian markets. Consumer Products Division: The pointer market has experienced a reduction in competition due to marketand price erosion for laser-diodes and finished products. We are at risk fromdirect competition with Asian sources. In many instances our products arepurchased directly from Asian companies and repackaged under our product brands.One risk factor for the consumer products division is our customers are able tobuy similar products from the same or other Asian sources at low cost, thuseroding our profit margins. We offer many advantages such as domesticwarranties, FDA required specifications, shorter delivery times and special marketing programs. However, we are at risk from lower cost products. Ourprincipal competitors in the pointer market include: - Mega Power - Transverse - Opcom The targeting sight market has seen an increase in competitors over the pasttwelve months and our principal competitors include: - Alpec - Clear Line - Beam Shot We believe that the primary competitive factors for which our products competeare: - Quality - Price - Product performance - Customer service - Customer satisfaction 13 15 There can be no assurance that any of our products in any of our divisions willcontinue to compete favorably or that we will be successful in the face ofcompetition from existing competitors or new companies entering our targetmarkets. If we fail to compete successfully, our financial condition and resultsof operation would be materially 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 of our development personnel than upon the legal protections afforded our existingtechnologies. 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. We are cooperating with Cal-OSHA in an investigation regarding higher thanpermissible levels of potentially hazardous materials in certain areas of themanufacturing facility in Fremont, California. The Company has put in placeengineering, administrative and personnel protective equipment programs to 14 16 address this issue. No accidents or injuries resulted from this matter and thefacility is in full operation. Civil and criminal charges can be imposed byCal-OSHA, although the current focus is on civil enforcement. 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, 1999, our backlog was approximately $16.6 million. Backlog can fluctuate greatly based upon, among other matters, the timingof orders. In addition, purchase orders in our backlog are subject to changes indelivery schedules or to reduction in size or cancellation at the option of thepurchaser without significant penalty. We have experienced, and may continue toexperience, cancellation, reduction and rescheduled delivery of orders in ourbacklog. Our backlog may vary significantly from time to time depending upon thelevel of capacity available to satisfy unfilled orders. Accordingly, althoughuseful for scheduling production, backlog as of any particular date may not be areliable indicator of sales for any future period. EMPLOYEES As of December 31, 1999, we had 888 full-time employees, of whom 749 wereprincipally engaged in manufacturing, 112 in sales, general and administrationand 27 in research and development. Of these employees, 554 are located in theUS and 326 at our facilities in China. 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. EXECUTIVE OFFICERS As of December 31, 1999, our executive officers and directors were asfollows: NAME AGE POSITION ---- --- -------- Morris S. Young, Ph.D 54 Chairman of the Board of Directors, President and Chief Executive OfficerTheodore S. Young, Ph.D 59 Senior Vice President, Marketing and DirectorDavis Zhang 43 Senior Vice President, ProductionGary S. Young 56 Vice President, SalesGuy D. Atwood 57 Vice President and Chief Financial Officer, Treasurer and SecretaryXiao Gordon Liu 35 Vice President, Engineering and DevelopmentJesse Chen (1)(2) 41 DirectorB.J. Moore (1)(2) 63 DirectorDonald L. Tatzin (1)(2) 47 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. 15 17 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 variouscapacities 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 us from June to September 1995. Mr. Atwood holds aB.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. 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 feet 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 31,000 square foot facility in Beijing, China in 1998. 16 18 The principal operating company properties are included on the followingtable. We consider each facility to be in good operating condition and adequatefor its present use, and believe that each facility has sufficient plantcapacity to meet its current and anticipated operating requirements. SQUARE FEET ---------------LOCATION PROPERTY DESCRIPTION OWNED LEASED-------- ----------------------------- ------ ------ Fremont, CA Production and Administration 58,000Fremont, CA Production 80,000Beijing, China Production 31,000Monterey Park, CA Production and Administration 22,000El Monte, CA Production 27,000El Monte, CA Production 7,000Xiamen, China Production 14,000Torrance, CA Administration 7,000Torrance, CA Production 15,000 ITEM 3. LEGAL PROCEEDINGS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 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 1998 January 1, 1998 through May 19, 1998...................... Not Applicable May 20, 1998 through June 30, 1998........................ $15.000 $10.125 Third Quarter ended September 30, 1998.................... $15.500 $ 7.000 Fourth Quarter ended December 31, 1998.................... $10.813 $ 6.000Fiscal 1999 First Quarter ended March 31, 1999........................ $22.500 $ 9.063 Second Quarter ended June 30, 1999........................ $27.000 $19.375 Third Quarter ended September 30, 1999.................... $35.125 $17.750 Fourth Quarter ended December 31, 1999.................... $23.875 $12.063 As of December 31, 1999, there were 164 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. 17 19 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA YEARS ENDED DECEMBER 31, ----------------------------------------------- 1995(3) 1996(3) 1997(3) 1998(2) 1999(1) ------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA:Revenues..................................... $24,117 $31,272 $43,313 $61,314 $81,521Cost of revenues............................. 14,773 21,037 29,650 38,949 57,369 ------- ------- ------- ------- -------Gross profit................................. 9,344 10,235 13,663 22,365 24,152Operating expenses:Selling, general, and administrative......... 4,774 5,534 9,921 11,538 14,016Research and development..................... 448 592 1,289 2,684 3,086Acquisition costs............................ -- -- -- -- 2,810 ------- ------- ------- ------- ------- Total operating expenses........... 5,222 6,126 11,210 14,222 19,912Income from operations....................... 4,122 4,109 2,453 8,143 4,240Interest expense............................. (12) (170) (793) (1,481) (2,150)Interest and other income (expense).......... 282 (72) (57) 598 729 ------- ------- ------- ------- -------Income before provision for income taxes..... 4,392 3,867 1,603 7,260 2,819Provision for income taxes................... 1,599 1,516 783 2,976 2,139 ------- ------- ------- ------- -------Income before extraordinary item............. 2,793 2,351 820 4,284 680Extraordinary item -- early extinguishment of debt....................................... -- -- -- -- 508 ------- ------- ------- ------- -------Net income................................... $ 2,793 $ 2,351 $ 820 $ 4,284 $ 172 ======= ======= ======= ======= =======Basic net income (loss) per share:Income before extraordinary item............. $ 0.96 $ 0.65 $ 0.22 $ 0.27 $ 0.04Extraordinary item........................... -- -- -- -- (0.03)Net income................................... 0.96 0.65 0.22 0.27 0.01Diluted net income (loss) per share:Income before extraordinary item............. $ 0.23 $ 0.19 $ 0.06 $ 0.26 $ 0.03Extraordinary item........................... -- -- -- -- (0.03)Net income................................... 0.23 0.19 0.06 0.26 $ --Shares used in basic net income per share calculations............................... 2,921 3,595 3,697 16,076 18,655Shares used in diluted net income per share calculations............................... 11,913 12,524 13,598 16,325 19,771 ---------------(1) Includes Substrates, Consumer Products, and Visible Emitters for the full year. (2) Includes Substrates and Consumer Products for the full year, and Visible Emitters for the three months ended December 31, 1998. (3) Includes Substrates and Consumer Products only. 18 20 YEARS ENDED DECEMBER 31, ------------------------------------------------- 1995(2) 1996(2) 1997(2) 1998(1) 1999(1) ------- ------- ------- -------- -------- (IN THOUSANDS) BALANCE SHEET DATA:Cash, cash equivalents, and short-term investments.............................. $ 1,121 $ 1,171 $ 3,199 $ 16,438 $ 6,062Working capital............................ 5,144 6,866 12,612 41,644 40,462Total assets............................... 15,067 23,178 37,796 102,283 115,762Long-term debt, net of current portion..... 2,350 5,833 7,728 19,842 18,501Stockholders' equity....................... 7,869 10,237 17,387 61,164 62,459 ---------------(1) Includes Substrates, Consumer Products, and Visible Emitters (2) Includes Substrates and Consumer Products 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 substrate 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. On May 28, 1999, we completed our acquisition of Lyte Optronics, Inc., aNevada corporation, with operations in Southern California and The People'sRepublic of China. Lyte Optronics is a manufacturer of LED's and laser-diodes.Lyte Optronics also designs and markets laser-pointing and alignment productsfor the consumer, commercial and industrial markets. Lyte Optronics is operatedas two separate divisions of AXT: the visible emitter division, focusing on themanufacture of LED's and laser diodes, and the consumer products division,focusing on the design and marketing of laser-pointing and alignment products.Of the approximately 380 employees of Lyte Optronics retained after theacquisition about 320 are with the visible emitter division, with about 200employees located in China. Under the terms of the acquisition, we issued approximately 2,363,000shares of common stock and 983,000 shares of preferred stock with a $4 millionliquidation preference over common stock, in exchange for all of the issued andoutstanding shares of capital stock of Lyte Optronics. Ten percent of the sharesissuable to the Lyte Optronics' shareholders will be held in escrow for up toone year to satisfy any claims that we may bring under the agreement during thatperiod. The transaction was accounted for as a pooling of interests. Inconnection with the acquisition, we reported a charge of $2.8 million in thesecond quarter of 1999 to reflect transaction costs and other one-time chargesincurred in connection with the acquisition. We have been profitable on an annual basis since 1990. Our total revenueswere $43.3 million for the year ended December 31, 1997, $61.3 million for theyear ended December 31, 1998 and $81.5 million for the year ended December 31,1999. Total revenues primarily consist of product revenues. Product revenues aregenerally recognized upon shipment of products to customers. Historically, asignificant portion of our product 19 21 revenues have been derived from sales of GaAs substrates and laser-pointing andalignment products. In the years ended December 31, 1997, GaAs substratesaccounted for 50.4%, 55.4% in 1998 and 56.3% in 1999 of our total revenues andlaser-pointing and alignment products accounted for 41.5%, 20.0% and 7.5%,respectively. Since October 1998, we have included the sales of products fromour visible emitter division in our financial results. In 1999, sales from ourvisible emitter division generated 22.9% of total revenues. We began selling InP and Ge substrates to our customers in late 1997, GaN substrates in late 1998 andin late 1999 we began selling LED's to our customers. Historically, revenues generated from research and development contractswith U.S. government agencies and customer-funded research projects comprisedmore than 5.0% of our total revenues. We expect our contract revenue to declineto less than 1.0% of our total revenues in future periods as a result of ourshift to internally generated research and development projects from governmentand customer-funded contracts. 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 26.8% of total revenues for the year endedDecember 31, 1997, 29.6% in 1998, and 45.1% in 1999. Except for sales in Japanand some sales in Taiwan, which are denominated in yen, we denominate andcollect our international sales in U.S. dollars. Doing business in Japansubjects us to fluctuations in exchange rates between the U.S. dollar and theJapanese yen. During the year ended December 31, 1997, we incurred foreigntransaction exchange loss of $186,000, a loss of $24,000 in 1998, and a gain of$652,000 in 1999. During the year ended December 31, 1999, we bought foreignexchange contracts to hedge against certain trade accounts receivable inJapanese yen. The outstanding commitments with respect to such foreign exchangecontracts had a total value of approximately $1.9 million as of December 31,1999. From July 1996 to October 1998, we conducted all of our substrateoperations in a 50,000 square foot office and production facility located inFremont, California. Prior to transitioning our manufacturing operations to thisfacility, we leased a 20,000 square foot manufacturing facility in Dublin,California. In late 1998, we expanded the size of our current manufacturingfacility by approximately 30,000 square feet to meet our anticipated futureproduction needs through 2000. In June 1998, we purchased an additional 58,000square foot facility in Fremont, California directly across the street from ourexisting manufacturing 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 until late 2000. InJanuary 1999, we received a business license for operations in Beijing, Chinaand purchased a 31,000 square foot facility in a major tax-free industrial parkin Beijing. This facility became operational during the third quarter of 1999.We intend to expand this facility by another 31,000 square feet beginning in thefirst quarter of 2000. We expect that our proprietary VGF crystal growthoperations will continue to be housed in Fremont, California, and our othermanufacturing operations will be conducted in both Fremont and Beijing. Our consumer product division's operations have been located in Torrance,California since 1998 and consist of a 22,000 square foot office and productionfacility. Prior to 1998, a portion of the consumer products division was locatedin Arizona and a portion in Los Angeles, California. Since 1997, our visibleemitter division has been located in a 22,000 square foot office and productionfacility in Monterey Park, California and a 7,000 square foot productionfacility in El Monte, California. In 1998, we acquired another 27,000 squarefoot facility in El Monte for future production in 2000. In late 1998, weacquired a 14,000 square foot production facility in Xiamen, China forprocessing laser diodes. In connection with the granting of stock options, we recorded aggregatedeferred compensation of $322,000 for the year ending December 31, 1997,$203,000 in 1998 and $0 in 1999, representing the difference between the deemedfair value of the Common Stock for accounting purposes and the option exerciseprice at the date of grant. This deferred compensation will be amortized overthe vesting period of the applicable options of which $102,000 was amortizedduring the year ended December 31, 1997, $96,000 in 1998 and $110,000 in 1999. 20 22 The following table sets forth certain operating data as a percentage oftotal revenues for the periods indicated. YEARS ENDED DECEMBER 31, -------------------------- 1997 1998 1999 ------ ------ ------ Revenues.................................................... 100.0% 100.0% 100.0%Cost of revenues............................................ 68.5% 63.5% 70.4% ----- ----- -----Gross margin................................................ 31.5% 36.5% 29.6%Operating expenses: Selling, general and administrative....................... 22.9% 18.8% 17.2% Research and development.................................. 3.0% 4.4% 3.8% Acquisition costs......................................... 0.0% 0.0% 3.5% ----- ----- ----- Total operating expenses.......................... 25.9% 23.2% 24.5% ----- ----- -----Income from operations...................................... 5.6% 13.3% 5.1%Interest expense............................................ (1.8)% (2.4)% (2.6)%Interest and other income (expense)......................... (0.1)% 1.0)% 0.9% ----- ----- -----Income before provision for income taxes.................... 3.7% 11.9% 3.4%Provision for income taxes.................................. 1.8% 4.9% 2.6% ----- ----- -----Income before extraordinary item............................ 1.9% 7.0% 0.8%Extraordinary item -- early extinguishment of debt.......... 0.0% 0.0% 0.6% ----- ----- -----Net income.................................................. 1.9% 7.0% 0.2% ===== ===== ===== YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1999 Revenues. Revenues increased 33.0%, or $20.2 million from $61.3 millionfor the year ended December 31, 1998 to $81.5 million for the year endedDecember 31, 1999. The increase in revenues resulted primarily from a $13.7million increase in sales of GaAs and InP substrates to existing domestic andinternational customers and the addition of new customers, a $12.7 millionincrease due to the inclusion of the visible emitter division for a full year in1999 compared to only the fourth quarter in 1998, and a $6.0 million decrease inconsumer product sales reflecting declining sales prices for laser pointerproducts, an increase in sales returns due to product quality problems, and achange in government regulations regarding the allowable strength of laserproducts sold to the consumer product market in Europe. International revenues, excluding Canada, increased from 29.5% of totalrevenues, or $18.1 million, for the year ended December 31, 1998, to 45.1% or$36.8 million for the year ended December 31, 1999. The increase ininternational revenues resulted primarily from a $7.3 million increase in GaAsand InP sales to new and existing international customers and a $10.0 millionincrease due to the inclusion of the visible emitter division for a full year in1999 compared to only the fourth quarter in 1998. Gross margin. Gross margins decreased from 36.5% for the year endedDecember 31, 1998, to 29.6% for the year ended December 31, 1999. The grossmargins for substrates decreased slightly from 41.4% to 40.2%, primarily due toa decline in sales prices. The gross margins on products sold by the visibleemitter division that was included for the full year in 1999 compared to onlythe fourth quarter in 1998 was 36.2% in 1998 compared to 11.7% in 1999. Thedecrease in margins at the visible emitter division was primarily due tosignificant sales price decreases for laser diodes, a $1.5 million charge tosettle a patent dispute, and a $2.4 million charge to write down obsoleteinventory. Excluding these charges, the gross margin was 32.6% in 1999. Grossmargins on products sold by the consumer products division decreased from 18.7%in 1998 to (19.3)% in 1999, due to significant sales prices decreases for laserpointer products and a $2.1 million charge to write down obsolete inventory. pointer products and a $2.1 million charge to write down obsolete inventory.Excluding these charges, the gross margin was 14.9% in 1999. Selling, general and administrative expenses. Selling, general andadministrative expenses increased 21.5%, or $2.5 million, from $11.5 million forthe year ended December 31, 1998 to $14.0 million for the year 21 23 ended December 31, 1999. The inclusion of the visible emitter division for thefull year in 1999 compared to only the fourth quarter of 1998 resulted in anincrease of $3.3 million. Substrate division expenses increased $1.2 millionprimarily due to increases in personnel and related expenses required to supportadditional sales volume. These increases were offset by a decrease of $2.0million by the consumer products division as a result of the closing of amanufacturing facility located in Arizona in 1998. Selling, general andadministrative expenses as a percentage of total revenues decreased from 18.8%for the year ended December 31, 1998 to 17.2% for the year ended December 31,1999. This decrease was primarily due to an increase in total revenues. Research and development expenses. Research and development expensesincreased 15.0%, or $402,000, from $2.7 million for the year ended December 31,1998, to $3.1 million for the year ended December 31, 1999. This increaseresulted primarily from the inclusion of the visible emitter division for a fullyear in 1999 compared to only the fourth quarter in 1998. Also, historically theconsumer products division did not separately account for its research anddevelopment expenses which were included as part of its cost of product revenuesand selling, general and administrative expenses and are now classified asresearch and development. Research and development expenses as a percentage oftotal revenues decreased from 4.4% of total revenues for the year ended December31, 1998 to 3.8% of revenues for the year ended December 31, 1999. This decreasewas primarily due to an increase in total revenues. Acquisition cost. As a result of the acquisition of Lyte Optronics in May1999, we incurred a number of one-time expenses associated with the transactionin the approximate amount of $2.8 million. Such expenses include fees paid toour investment bankers, accountants, attorneys, and other outside consultantsand related transaction expenses. Interest expense. Interest expense increased 45.2%, or $669,000 from $1.5million for the year ended December 31, 1998, to $2.2 million for the year endedDecember 31, 1999. This increase was primarily the result of the interestexpense associated with equipment and real estate debt by the inclusion of thevisible emitter division for a full year in 1999 compared to only the fourthquarter in 1998 and increased borrowing on the line of credit. Interest and other income (expense). Interest and other income (expense)increased 21.9%, or $131,000 from $598,000 for the year ended December 31, 1998to $729,000 for the year ended December 31, 1999. The increase was primarily theresult of foreign exchange gains on short-term contracts to hedge againstcertain accounts receivable denominated in Japanese yen. Provision for income taxes. Income tax expense, adjusted for acquisitioncosts of approximately $2.8 million, decreased from 41.0% to 38.0% of incomebefore provision for income taxes for the years ended December 31, 1998 and1999, respectively. Extraordinary item, net of tax benefit. In connection with the acquisitionof Lyte Optronics in May 1999, we incurred fees associated with a loan that werepaid as part of the transaction. YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1998 Revenues. Revenues increased 41.6%, or $18.0 million from $43.3 millionfor the year ended December 31, 1997 to $61.3 million for the year endedDecember 31, 1998. The increase in revenues resulted primarily from a $17.8million increase in the volume of sales of GaAs and InP substrates to existing domestic and international customers, the addition of new customers and theintroduction of Ge substrates in the fourth quarter of 1997. Additionally, therewas a $5.9 million increase due to the inclusion of the visible emitter divisionfor the fourth quarter of 1998, offset by a $5.7 million decrease in revenues atthe consumer products division reflecting declining sales prices for laserpointer products and a change in government regulations reducing the allowablestrength of lasers sold to the consumer market in Europe. International revenues, excluding Canada, increased from 26.8% of totalrevenues for the year ended December 31, 1997, to 29.6% for the year endedDecember 31, 1998. The increase in international revenues resulted primarilyfrom a $3.8 million increase in substrate sales to new and existinginternational customers and a $5.1 million increase due to the inclusion of thevisible emitter division for the fourth quarter of 1998 of which sales areprimarily sold in Asia, offset by a $2.4 million decrease in sales to Europe bythe consumer 22 24 products division caused by governmental regulation changes reducing theallowable strength of lasers sold to the consumer market. Gross margin. Gross margins increased from 31.5% for the year endedDecember 31, 1997, to 36.5% for the year ended December 31, 1998. The grossmargins for substrates increased slightly from 40.6% in 1997 to 40.8% in 1998reflecting higher yields achieved in GaAs and InP production, partially offsetby lower margins on Ge substrates. Total gross margins also benefited from theinclusion of the visible emitter division for the fourth quarter of 1998, whichhad a 36.2% gross margin. Gross margins on products sold by the consumerproducts division decreased slightly from 19.8% in 1997 to 18.7% in 1998 due todeclining prices for laser pointer products. Selling, general and administrative expenses. Selling, general andadministrative expenses increased 16.3%, or $1.6 million, from $9.9 million forthe year ended December 31, 1997 to $11.5 million for the year ended December31, 1998. Substrate division expenses increased $2.1 million primarily due toincreases in personnel and related expenses required to support additional salesvolume. The inclusion of the visible emitter division for the fourth quarter of1998 added $1.0 million. These increases were offset by a $1.4 million decreaseat the consumer products division as a result of closing a manufacturingfacility located in Arizona in 1998. Selling, general and administrativeexpenses as a percentage of total revenues decreased from 22.9% for the yearended December 31,1997 to 18.8% for the year ended December 31, 1998. Thispercentage decrease was primarily due to the 41.6% increase in revenues. Research and development expenses. Research and development expensesincreased 108.2%, or $1.4 million, from $1.3 million for the year ended December31, 1997, to $2.7 million for the year ended December 31, 1998. This increaseresulted primarily from hiring additional engineers and the purchase ofmaterials at the substrate division to develop new products and to enhanceexisting products. Also, historically the consumer products division did notseparately account for its research and development expenses which were includedas part of its cost of product revenues and selling, general and administrativeexpenses and are now classified as research and development. Research anddevelopment expenses as a percentage of total revenues increased from 3.0% forthe year ended December 31, 1997 to 4.4% for the year ended December 31, 1998,primarily as a result of the increase in spending. Interest expense. Interest expense increased 86.8%, or $688,000 from$793,000 for the year ended December 31, 1997, to $1.5 million for the yearended December 31, 1998. This increase was primarily the result of additionalborrowings to finance the purchase and lease of buildings and equipment at thesubstrate and consumer products divisions. Interest and other income (expense). Interest and other income (expense)increased from an expense of $57,000 for the year ended December 31, 1997 to income of $598,000 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 decreased from 48.8% ofincome before provision for income taxes in the year ended December 31, 1997 to41.0% in 1998, due to a decrease in state income taxes caused by the realizationof tax benefits of Lyte Optronics related to operating losses for whichrealization was uncertain prior to the merger. 23 25 SELECTED QUARTERLY RESULTS OF OPERATIONS The following table sets forth unaudited quarterly results in dollars andpercentages for the eight quarters ended December 31, 1999. We believe that allnecessary adjustments, consisting only of normal recurring adjustments, havebeen included in the amounts stated below to present fairly such quarterlyinformation. The operating results for any quarter are not necessarilyindicative of results for any subsequent period. QUARTERS ENDED (IN THOUSANDS) --------------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, 1998(2) 1998(2) 1998(2) 1998(1) 1999(1) 1999(1) 1999(1) 1999(1) -------- -------- --------- -------- -------- -------- --------- -------- Revenues.......................... $13,186 $13,532 $13,942 $20,654 $18,897 $20,783 $20,017 $21,824Cost of revenues.................. 8,144 9,189 8,911 12,705 16,240 13,971 13,077 14,081 ------- ------- ------- ------- ------- ------- ------- -------Gross profit...................... 5,042 4,343 5,031 7,949 2,657 6,812 6,940 7,743Operating expenses: Selling, general and administrative................ 2,460 2,238 2,540 4,300 3,647 3,196 3,113 4,060 Research and development........ 640 714 819 511 662 858 670 896 Acquisition costs............... -- -- -- -- -- 2,810 -- -- ------- ------- ------- ------- ------- ------- ------- ------- Total operating expenses............... 3,100 2,952 3,359 4,811 4,309 6,864 3,783 4,956 ------- ------- ------- ------- ------- ------- ------- -------Income from operations............ 1,942 1,391 1,672 3,138 (1,652) (52) 3,157 2,787Interest expense.................. (238) (274) (325) (644) (53) (730) (752) (615)Interest and other income (expense)....................... 19 (48) 248 379 116 29 235 349 ------- ------- ------- ------- ------- ------- ------- -------Income before provision for income taxes........................... 1,723 1,069 1,595 2,873 (1,589) (753) 2,640 2,521Provision for income taxes........ 707 437 559 1,273 (604) 782 1,003 958 ------- ------- ------- ------- ------- ------- ------- -------Income before extraordinary item............................ 1,016 632 1,036 1,600 (985) (1,535) 1,637 1,563Extraordinary item -- early extinguishment of debt.......... -- -- -- -- -- 508 -- -- ------- ------- ------- ------- ------- ------- ------- -------Net income........................ $ 1,016 $ 632 $ 1,036 $ 1,600 $ (985) $(2,043) $ 1,637 $ 1,563 ======= ======= ======= ======= ======= ======= ======= ======= QUARTERS ENDED -------------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30 DEC. 31, 1998(2) 1998(2) 1998(2) 1998(1) 1999(1) 1999(1) 1999(1) 1999(1) -------- -------- --------- -------- -------- -------- -------- -------- Revenues.......................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Cost of revenues.................. 61.8% 67.9% 63.9% 61.5% 85.9% 67.2% 65.3% 64.5% ----- ----- ----- ----- ----- ----- ----- -----Gross margin...................... 38.2% 32.1% 36.1% 38.5% 14.1% 32.8% 34.7% 35.5%Operating expenses: Selling, general and administrative................ 18.7% 16.5% 18.2% 20.8% 19.3% 15.4% 15.6% 18.6% Research and development........ 4.9% 5.3% 5.9% 2.5% 3.5% 4.1% 3.3% 4.1% Acquisition costs............... 0.0% 0.0% 0.0% 0.0% 0.0% 13.5% 0.0% 0.0% ----- ----- ----- ----- ----- ----- ----- ----- Total operating expenses............... 23.5% 21.8% 24.1% 23.3% 22.8% 33.0% 18.9% 22.7% ----- ----- ----- ----- ----- ----- ----- -----Income from operations............ 14.7% 10.3% 12.0% 15.2% (8.7)% (0.3)% 15.8% 12.8%Interest expense.................. (1.8)% (2.0)% (2.3)% (3.1)% (0.3)% (3.5)% (3.8)% (2.8)%Interest and other income (expense)....................... 0.1% (0.4)% 1.8% 1.8% 0.6% 0.1% 1.2% 1.6% ----- ----- ----- ----- ----- ----- ----- -----Income before provision for income taxes........................... 13.1% 7.9% 11.4% 13.9% (8.4)% (3.6)% 13.2% 11.6% Provision for income taxes........ 5.4% 3.2% 4.0% 6.2% (3.2)% 3.8% 5.0% 4.4% ----- ----- ----- ----- ----- ----- ----- -----Income before extraordinary item............................ 7.7% 4.7% 7.4% 7.7% (5.2)% (7.4)% 8.2% 7.2%Extraordinary item -- early extinguishment of debt.......... -- -- -- -- -- 2.4% -- -- ----- ----- ----- ----- ----- ----- ----- -----Net income........................ 7.7% 4.7% 7.4% 7.7% (5.2)% (9.8)% 8.2% 7.2% ===== ===== ===== ===== ===== ===== ===== ===== ---------------(1) Includes Substrates, Visible Emitters and Consumer Products(2) Includes Substrates and Consumer Products only 24 26 The following table sets forth the restatement of the first three quartersof 1999 related to adjustments of account balances at Lyte Optronics, Inc. (IN THOUSANDS) -------------------------------------------------------------------- Q1 Q1 Q2 Q2 Q3 Q3 REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED -------- -------- -------- -------- -------- -------- Revenue............................. 19,023 18,897 21,025 20,783 21,389 20,017Net income (loss)................... 1,259 (985) (538) (2,043) 2,818 1,637 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, 1999, we had working capital of$40.5 million, including cash and cash equivalents of $6.1 million, compared toworking capital at December 31, 1998 of $41.6 million, including cash of $16.4million. During the year ended December 31, 1997, net cash used in operations of$2.1 million was due primarily to increases in inventory of $5.6 million andaccounts receivable of $2.0 million, offset by net income of $820,000,depreciation of $1.3 million and an increase in accounts payable and accruedliabilities of $4.1 million. The increases in inventory, accounts receivable,accounts payable and accrued liabilities were primarily the result of a 38.5%increase in revenues from the prior year. The inventory turnover ratio decreasedfrom 3.9 turns per year at December 31, 1996 to 3.3 turns per year at December31, 1997 primarily due to an increase Ge inventory. Days sales outstandingdecreased slightly from 56 days at December 31, 1996 to 55 days at December 31,1997. During the year ended December 31, 1998, net cash used in operations of$8.7 million was primarily due to increases in inventory of $11.1 million,accounts receivable of $4.2 million, prepaid assets of $1.6 million, anddeferred income taxes of $1.1 million, offset by net income of $4.3 million,depreciation of $3.0 million and an increase in accounts payable and accruedliabilities of $2.1 million. The increases in inventory, accounts receivable,prepaid assets, accounts payable and accrued liabilities were primarily theresult of the 41.6% increase in revenues from the prior year. Additionally, theincrease in accounts receivable was in part due to increased international salesthat generally have longer payment cycles. International sales were 26.8% ofrevenues in 1997 compared to 29.6% of revenues in 1998. The increase in deferredtaxes was the result of recognizing a tax benefit for prior year losses of LyteOptronics as a result of the acquisition. The inventory turnover ratio declinedfrom 3.3 turns per year at December 31, 1997 to 2.1 turns per year at December31, 1998 primarily due to our decision to maintain the Ge substrates productionline during the fourth quarter of 1998 in anticipation of large orders, although shipments to a large customer had been deferred. Days sales outstandingincreased from 55 days at December 31, 1997 to 61 days at December 31, 1998. During the year ended December 31, 1999, net cash used in operations of$7.8 million was primarily due to increases in inventory of $10.1 million,accounts receivable of $4,4 million and prepaid expenses of $5.7 million, offsetin part by net income of $172,000, depreciation and amortization of $6.2million, and increases in accounts payable and accrued liabilities of $4.4million. The increases in inventory, accounts receivable, accounts payable andaccrued liabilities were primarily the result of the 33.0% increase in totalrevenues from the prior year. Additionally, the increase in accounts receivablewas in part due as a result of increased international sales that generally havelonger payment cycles. International sales were 29.6% of revenues in 1998compared to 45.1% of revenues in 1999. The increase in prepaid expenses wasprimarily due to an increase in income tax receivables as a result of currentyear operating losses at the visible emitter and consumer products divisions.The inventory turnover ratio decreased slightly from 2.1 turns per year atDecember 31, 1998 to 1.9 turns per year at December 31, 1999. Days salesoutstanding increased from 61 days at December 31, 1998 to 69 days at December31, 1999. Net cash used in investing activities was $5.2 million, $16.6 million, and$7.5 million for the years ended December 31, 1997, 1998 and 1999, respectively,which amounts were attributed in each period to the purchase of property, plantand equipment. For the year ended December 31, 1998, the property acquired 25 27 included our new 58,000 square foot building at a cost of $9.0 million and the30,000 square foot addition in Fremont for $2.0 million. Net cash provided by financing activities was $9.4 million for the yearended December 31, 1997, $38.3 million for 1998 and $7.9 million for 1999. Forthe year ended December 31, 1997, net cash provided by financing activitiesresulted primarily from the issuance of $5.9 million of preferred stock and $2.7million for long-term bank borrowings. For the year ended December 31, 1998, netcash provided by financing activities consisted primarily of net proceeds of$25.8 million from our initial public offering and long-term net borrowings of$13.1 million, offset by repayments of short-term borrowings of $2.3 million.Long-term net borrowings primarily reflected the issuance of $11.6 million intaxable variable rate revenue bonds in November 1998 and repayment of existinglong-term debt in the amount of $5.6 million. Long-term borrowings wereprimarily used for the purchase of the new 58,000 square foot facility, forconstruction of the additional 30,000 square foot manufacturing space andrelated equipment in Fremont. For the year ended December 31, 1999, net cashprovided by financing activities resulted primarily from short-term bankborrowings that were used to finance inventories and receivables, deposits forequipment orders, and to pay off high interest long-term debt acquired in theacquisition of Lyte Optronics. 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, most of which were repaid by the taxable variable rate revenue bondsin 1998. The taxable variable rate revenue bonds have a term of 25 years andmature in 2023 with an interest rate at 200 basis points below the prime rateand are traded in the public market. Repayment of principal and interest underthe 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, 1999, $11.1 million was outstanding under thetaxable variable rate revenue bonds. 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 May2000. This line of credit is subject to certain financial covenants regarding current 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, 1999, $8.8 million 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 During 1999, we successfully completed our program to achieve year 2000readiness. "Year 2000 ready" meant that the performance or functionality of ourinternal systems would not be significantly affected by the dates prior to,during, and after the year 2000, to include leap year calculations and specificday-of-the-week calculations. As expected, we have not experienced a materialadverse impact on our business, products, results of operations, or financialcondition as a result of the year 2000 issue. 26 28 Costs directly attributed to our internal year 2000 initiative were in linewith the original estimate of approximately $400,000. These costs were expensedas incurred and were comprised primarily of the costs of hardware and softwarerequired to complete year 2000 testing within the enterprise and consultingfees. We will continue to monitor our critical processes, and those ofsignificant suppliers, third-party external interface suppliers, and utilityorganizations that are critical to our operations, for potential year2000-related problems. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standard No 133, "Accounting for Derivative Instruments andHedging 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. FACTORS AFFECTING FUTURE RESULTS In addition to the other information in this report, the following factorsshould be considered carefully in evaluating our business before purchasing shares of our stock. RISKS RELATING OUR ACQUISITION OF LYTE OPTRONICS, INC. Our success depends on our ability to assume and integrate the operationsof Lyte Optronics with our operations. The success of our acquisition of LyteOptronics depends in substantial part on our ability to assume and integrate theoperations of Lyte Optronics in an efficient and effective manner. Theassumption of a new business will require the dedication of managementresources, which may temporarily distract attention from our day-to-dayoperations. We cannot assure you that we will be able to integrate the businessoperations of Lyte Optronics smoothly or successfully. Our inability to do socould hurt the performance of our business, which may cause the price of ourstock to decline. The success of our acquisition of Lyte Optronics depends in part on ourability to retain Lyte Optronics' current customers. We cannot guarantee thatthe current customers of Lyte Optronics will continue to seek our services nowthat the acquisition is completed. If a substantial number of Lyte Optronics'customers elect not to seek our services, our operating results will suffer. We incurred substantial costs in connection with our acquisition of LyteOptronics, including the assumption of approximately $11.0 million of debt, muchof which has had to be repaid or renegotiated, resulting in a decline of cashavailable. We incurred one-time charges and merger-related expenses of $2.8million and the extraordinary item of $508,000 in the quarter ended June 30,1999as a result of the acquisition. We may incur additional unanticipated expensesrelated to our assumption of Lyte Optronics' business. If these expenses aresubstantial, they may adversely affect our operating results and cause our stockprice to fall. RISKS RELATING TO OUR OPERATIONS 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, we believe that period-to-periodcomparisons of our operating results cannot be relied upon as an indicator ofour future performance. It is likely that in some future quarter, our operatingresults may be below the expectations of public market analysts or investors. Ifthis occurs, the price of our common stock would likely decrease. For moreinformation regarding our results, see "Management's Discussion and Analysis ofFinancial Condition and Results of Operations." 27 29 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: - our recent acquisition of Lyte Optronics and the integration of its business and separate operations and facilities with our operations; - fluctuations in demand for our substrates due to reduction in the value on Asian currencies and the turmoil in the Asian financial markets; - fluctuations in demand for laser pointing and alignment products and decreases in the prices of these products; - 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 and the assumption, integration and operation of the Chinese operations of Lyte Optronics; - 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 Discussion andAnalysis of Financial Condition and Results of Operations." We acquired Lyte Optronics in May 1999, as part of our business strategy,and we may engage in future acquisitions. These acquisitions must besuccessfully integrated into our business and may dilute our stockholders andcause us to assume contingent liabilities. As part of our business strategy, wemay in the future review acquisition prospects that would complement our currentproduct offerings, augment our market coverage or enhance our technicalcapabilities, or that may otherwise offer growth opportunities. In the event ofany future acquisitions, we could: - issue equity securities which would dilute current stockholders' percentage ownership; - incur substantial debt; or - assume contingent liabilities. Any of these actions could materially adversely affect our operatingresults and/or the price of our common stock. Any future acquisitions createsrisks 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, distract ourmanagement and employees and increase our expenses. We may not be able tosuccessfully integrate any businesses, products, technologies or 28 30 personnel that we might acquire in the future, and our failure to do so couldmaterially adversely affect our operating results. 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. Our GaAs substrates typically have a lengthysales cycle, ranging from three months to a year or more. During this time, wemay expend substantial funds and sales, marketing and management efforts while the potential customer evaluates our substrates. However, there is a significantrisk that these expenditures may not result in sales. 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. In addition, 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. We anticipate that sales of any future products under developmentwill have similar 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 fora substantial portion of our revenues. We expect that a significant portion ofour future sales will be due to a limited number of customers. Our top fivecustomers accounted for approximately 20.4%, 27.9% and 22.9% of our revenues inthe years ended December 31, 1997, 1998 and 1999, respectively. If any of thesemajor customers reduces, delays or cancels its orders with us, our revenues willdecline, which will likely cause our stock price to fall. Our customers are not obligated to purchase any specified quantity ofproducts or to provide us with binding forecasts of product purchases. Inaddition, our customers may reduce, delay or cancel orders at any time withoutany significant penalty. For example, we recently announced the suspension ofour Ge substrates from a major customer who had excess inventories and wasexperiencing a slow down in business. 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, however, we believe that one ofour competitors has recently begun shipping, in low volume, GaAs substrateswhich utilize a similar technology. We cannot assure you that our currentcustomers will continue to use our VGF-produced substrates or that additionalcompanies will purchase our products manufactured from the VGF technique.Failure to gain increased market acceptance of our VGF technique by eithercurrent or prospective customers could materially adversely affect our operatingresults, which in turn could cause our stock price to fall. A significant portion of our prospective customers for our substrates arewireless communications manufacturers, fiber optic communications manufacturersand manufacturers of other high-speed semiconductor devices that are producedfrom GaAs substrates using either the LEC or HB techniques. To establish the VGFtechnique as a preferred process for producing substrates for these prospectivecustomers, we must offer products with superior prices and performance on atimely basis and in sufficient volumes. We must also overcome the reluctance ofthese customers to purchase our GaAs substrates due to possible perceptions ofrisks relating to concerns about the quality and cost-effectiveness of our GaAssubstrates when compared to substrates produced by the traditional LEC or HBtechniques. In addition, potential GaAs substrate customers may be reluctant torely on a relatively small company for critical materials used to manufacturetheir semiconductor devices. If we do not achieve acceptable yields of crystals and the successful andtimely production of substrates, the shipment of our products will be delayedand our revenues will decline. The highly complex processes of growing crystalsas well as other steps involved in manufacturing substrates that we engage incan be adversely affected by the following factors: - chemical or physical defects in the crystals; - contamination of the manufacturing environment; 29 31 - substrate breakage; - equipment failure; and - performance of personnel involved in the manufacturing process. Our operating results have been adversely affected in the past due to theoccurrence of a combination of these factors, which resulted in product shipmentdelays and adversely affected our business. A significant portion of our manufacturing costs are fixed. As a result, wemust increase the production volume of substrates and improve yields in order toreduce unit costs, increase margins and maintain and improve our results ofoperations. Any significant decrease in production volume and yields couldmaterially harm our business. In the past, we have sometimes manufactured substrates that have not metthe manufacturing process requirements of our customers. We have fixed theseoccurrences through minor changes to the substrates or the manufacturingprocess. Recurrence of these problems and our inability to solve them maymaterially hurt our performance. In 1997, we began producing and shipping Ge and InP substrates incommercial volume. We also understand that we must achieve the samemanufacturing capability for six inch GaAs wafers. We cannot assure you that wewill be able to manufacture the larger GaAs substrate in commercial volumes withacceptable yields. Our business and results of operations will be materiallyadversely affected if we experience low yields of these successfully developedsubstrates. Because substantially all of our revenues of our AXT substrate division arederived from sales of our GaAs substrates, we are dependent on widespread marketacceptance of these products. We currently derive substantially all of oursubstrate revenues from sales of our GaAs substrates. If there is a decrease ondemand for GaAs substrates by semiconductor device manufacturers or if ourcompetitors introduce new substrates for electronics applications, such aswireless communications, fiber optic communications and other high-speedsemiconductor devices, and opto-electronic applications, such as lasers andLEDs, our revenues may decline and our business will be materially adverselyaffected. We expect that revenues from GaAs substrates will account for asignificant majority of our revenues for the next several years. 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 andsemiconductor device manufacturers adopt them, demand for GaAs substrates coulddecrease. This development could cause our revenues to fall. To be successful, we must develop and introduce in a timely manner newsubstrates and continue to improve our current substrates to address customerrequirements and compete effectively on the basis of price and performance. Wemust also continue to develop our light-emitting and laser diode products, anddevelop new markets for this technology, as well as for our laser pointing andalignment products. We cannot assure you that our product development effortswill be successful or that our new products will achieve market acceptance. Tothe extent that product improvements and new product introductions do notachieve market acceptance, our business will be materially adversely affected.In 1997, we began commercial shipments of Ge and InP substrates and arecurrently developing other substrates, including galliumnitride and siliconcarbide. Factors that may affect the success of product improvements and productintroductions include the development of markets for such improvements andsubstrates, achievement of acceptable yields, price and market acceptance. Manyof these factors are beyond our control. 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 30 32 where the laws may not protect our proprietary rights as fully as in 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. To date, we have been issued one U.S. patent, which relates to the VGFtechnique, and have two U.S. patent applications pending, one that relates tothe VGF technique. Additionally, we have one pending application for a Japanesepatent but no issued foreign patents. We do not have any patents on our light-emitting or laser diode technology, although we do have six patents relating toour laser pointing and alignment products. 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. 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 our attentionand could cause product delays. In addition, if we discovered we violated otherthird party rights, we could be required to enter into costly royalty orlicensing agreements as a result of those claims. These royalty or licensingagreements 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. We are cooperatingwith Cal-OSHA in an investigation regarding higher than permissible levels ofpotentially hazardous materials in certain areas of the manufacturing facility in Fremont, California. Although no accidents or injuries have resulted fromthis matter and the facility is in full operation, civil and criminal penaltiescould be imposed against us by Cal-OSHA. 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, except for Ge, with anyof our suppliers, and we currently purchase raw materials required to growcrystals from single or a limited number of suppliers. For example, we purchasea majority of the gallium we use from GEO Gallium. Due to our reliance on a limited group of suppliers, we are exposed toseveral risks including the potential inability to obtain adequate supply ofmaterials, reduced control overpricing 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 ofmaterials and as a result be subject to higher costs. If we are unable toreceive adequate and timely deliveries of critical raw materials, relationshipswith current and future customers could be harmed, which could cause ourrevenues to decline. 31 33 We are subject to additional risks as a result of our recent acquisition ofnew manufacturing facilities. In connection with further expanding ourmanufacturing capacity, we purchased an additional 58,000 square foot facilityin Fremont, California and a 31,000 square foot facility in Beijing, China, in1998. These new facilities 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, our operations at the new facilities would beadversely affected, which may cause our sales to decline and the price of ourstock to fall. The additional fixed operating expenses associated with the new facilitiesmay only be offset by sufficient increases in product revenues. We cannot assureyou that the demand for our products will grow as we currently expect, and ifthis does not occur, we may not be able to offset the costs of operating the newfacilities, which may materially adversely affect our results of operations. We currently only have two machines (MOCVD's) capable of producinglight-emitting diode wafers. Damage to or failure of these machines could causeproduction to stop or delay while repairs or replacements are being made. We donot keep substantial inventory of LED wafers to enable production to continuewhile the MOCVD machine is being repaired. Any delay in production of the LEDwafers while the MOCVD is being repaired could result in loss of revenue. 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 effectively on the basis of quality, price and performance. Our success in the light-emitting and laser diode markets depends in part upon our ability to further ourdevelopment of this technology and develop additional markets and uses for theproducts. If we are unable to timely develop new, economically viable productsthat meet market demands, our revenues will decline, which could adverselyaffect our results of operation and cause the 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 future.Any significant delays could harm our business. For example, our introduction ofInP substrates was delayed approximately six months as a result of delays in thefinalization of the manufacturing process for these substrates. If we are unable to introduce reliable quality products, we could sufferfrom reduced orders, higher manufacturing costs, product returns and additionalservice expenses, all of which could result in lower revenues. Our substrates are typically one of many components used in semiconductordevices that our customers produce. 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. 32 34 If, as a result of any of these factors, demand for our products declines, ourbusiness will suffer. Intense competition in the market for GaAs substrates could prevent us fromincreasing revenues and sustaining profitability. The market for GaAssubstrates is intensely competitive. If we cannot successfully compete in thismarket, our operating results will be harmed. In the semi-insulating GaAssubstrates market, our principal competitors 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; - 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, which would result in lower pricesand reduced margins. The market for laser-pointing and alignment devices is highly competitiveand subject to pressure to decrease the price at which the devices are sold.Lyte Optronics has opened a manufacturing facility in China enabling productionof components at reduced cost; however this facility has only recently begunoperating and may not be able to handle the volume production that may berequired to meet customer demand. In addition, while we continue to remaincompetitive in our pricing structure of laser pointing and alignment devices, ifprices continue to fall, we may not be able to produce and sell these productsat a profit. We derive a significant portion of our revenues from international salesand our ability to sustain and increase our international sales involvessignificant 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. Our failure to successfully expand ourinternational operations may cause our revenues not to grow as much as weanticipate, which could cause our stock price to fall. International sales, excluding Canada, represented 29.6% and 45.1% of ourtotal revenues in the years ended December 31, 1998 and December 31, 1999,respectively. Sales to customers located in Japan and other Asian countriesrepresented 22.3% and 34.9% of our total revenues in the years ended December31, 1998 and December 31, 1999. We expect that sales to customers outside theUnited States, including device manufacturers located in Japan and other Asiancountries that sell their products worldwide, will continue to represent asignificant 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; 33 35 - 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 to our Japanese and Taiwanese customers, aredenominated in U.S. dollars. Thus, increases in the value of the dollar couldincrease the price of our products in non-U.S. markets and make our productsmore expensive than competitors' products in such markets. For example, doingbusiness in Japan subjects us to fluctuations in the exchange rates between theU.S. dollar and the Japanese yen. In the year ended December 31 1998, weincurred foreign exchange losses of $24,000, and a foreign exchange gain of$652,000 in the year ended December 31, 1999. If we do not effectively managethe risks associated with international sales, our business and financialcondition could be materially adversely affected. To minimize our foreignexchange risk, we have purchased foreign exchange contracts to hedge against certain trade accounts receivable in Japanese yen. Because we currentlydenominate sales in U.S. dollars except in Japan and Taiwan, we do notanticipate that the adoption of the Euro as a functional legal currency ofcertain European countries will materially affect our business. If we lose 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, including any of the key personnel from our acquisition ofLyte Optronics. 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 we cannot assure youthat we will be successful in attracting and retaining new personnel. The lossof the services of any of our key personnel, the inability to attract or retainqualified personnel in the future or delays in hiring required personnel,particularly engineers, could make it difficult for us to manage our businessand meet key objectives, including the introduction of new products on time. Continued rapid growth may strain our operations. In addition to ourrecent acquisition of Lyte Optronics, we have recently experienced a period ofrapid growth and expansion that has placed, and continues to place, asignificant strain on our operations. To accommodate this anticipated growth, wewill 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. If we are not able to install adequate control systems in an efficient andtimely manner, or if our current or planned personnel systems, procedures andcontrols are not adequate to support our future operations, our sales may notgrow and our business will suffer. We are in the process of installing a newmanagement information system; however, the functionality of this new system hasnot been fully implemented. The difficulties associated with installing andimplementing these new systems, procedures and controls has placed and willcontinue to place a significant burden on our management and our internalresources. In addition, international growth will require expansion of ourworldwide operations and enhance our communications infrastructure. Any delay inthe implementation of these new or enhanced systems, products and controls, orany disruption in the transition to these new or enhanced systems, products andcontrols, could adversely affect 34 36 our ability to accurately forecast sales demand, manage manufacturing,purchasing and inventory levels, and record and report financial and managementinformation on a timely and accurate basis. Our inability to manage growtheffectively could affect our revenues and adversely impact our profitability. In addition, Lyte Optronics maintains separate operational and financialsystems, procedures and controls that must be integrated with or replaced by oursystems. This integration will take time and divert management attention andresources. If we are unable to timely integrate or replace these systems, we maybe unable to accurately forecast sales demand, manage manufacturing,purchasing and inventory levels for the two divisions acquired with LyteOptronics, nor record and report financial and management information on atimely basis for these divisions, which could adversely affect our ability totimely produce consolidated financial information. 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. If cash from future operations isinsufficient, or if cash is used for acquisitions or other currentlyunanticipated uses, we may need additional capital. To the extent that we raiseadditional capital through the sale of equity or convertible debt securities,the issuance of such securities could result in dilution to existingstockholders. In December 1998, we raised approximately $11.6 million by issuing variablerate taxable demand revenue bonds series 1998 for: - the purchase of a commercial building and to finance tenant improvements at 4281 Technology Drive, Fremont, California; - the refinance an existing loan and to finance tenant improvements on our principal offices; and - the permanent financing for an existing bank construction loan. These debt securities have rights, preferences and privileges that aresenior to holders of common stock. We cannot assure you that if we requiredadditional capital, it will be available on acceptable terms, or at all. If weare unable to obtain additional capital, we may be required to reduce the scopeof our planned product development and marketing efforts, which would materiallyadversely affect 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 19% of our common stock andare able to significantly influence matters requiring stockholderapproval. Executive officers, directors and entities affiliated with themcurrently own approximately 19% of our outstanding common stock. Thesestockholders, if acting together, are able to significantly influence allmatters requiring our stockholder approval, including the election of directorsand the approval of mergers or other business combination transactions. Thisconcentration of ownership could delay or prevent a change of control of AXT andcould reduce the likelihood of an acquisition of AXT at a premium price. Provisions in our charter or agreements may delay or prevent a change ofcontrol. Provisions in our amended and restated certificate of incorporationand bylaws may have the effect of delaying or preventing a merger or acquisitionor a change of control or changes in our management. These provisions include: - 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. 35 37 Furthermore, because we are incorporated in Delaware, we are subject to theprovisions of section 203 of the Delaware General Corporation Law. Theseprovisions prohibit large stockholders, in particular those owning 15% or moreof the outstanding voting stock, from consummating a merger or combination witha 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 fluctuated significantly sincewe began trading on the Nasdaq National Market. For the fiscal year endedDecember 31, 1999, our stock price closed as low as $9.063 and as high as$35.125. Various factors could cause the price of our common stock to continueto 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. In addition, the stock market in general has experienced extreme volatilitythat often has been unrelated to the operating performance of particularcompanies. 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, 1999, our outstanding commitments with respectto the foreign exchange contracts had a total value of approximately $1.9million 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 AND FINANCIAL DISCLOSURES None. PART III The SEC allows us to include information required in this report byreferring to other documents or reports we have already or will soon be filing.This is called "Incorporation by Reference." We intend to file our definitiveproxy statement pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report, and certain information therein isincorporated in this report by reference. 36 38 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"Security Ownership 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." 37 39 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........................... 39-40Consolidated Balance Sheets as of December 31, 1998 and 1999...................................................... 41Consolidated Income Statements for the Years Ended December 31, 1997, 1998, and 1999.................................. 42Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1997, 1998 and 1999.............. 43Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1998, and 1999......................... 44Notes to Consolidated Financial Statements.................. 45 (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 59 hereof. The exhibits listed in the accompanying Index to Exhibits are filed as part of this report. (b) Reports on Form 8-K None 38 40 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directorsand Shareholders ofAmerican Xtal Technology, Inc. In our opinion, based on our audits and the report of other auditors, theaccompanying consolidated balance sheets and the related consolidated statementsof income, of shareholders' equity and of cash flows present fairly, in allmaterial respects, the financial position of American Xtal Technology, Inc. andits subsidiaries at December 31, 1999 and 1998, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 1999 in conformity with accounting principles generally accepted inthe United States. These financial statements are the responsibility of theCompany's management; our responsibility is to express an opinion on thesefinancial statements based on our audits. The consolidated financial statementsgive retroactive effect to the merger of Lyte Optronics, Inc. on May 28, 1999 ina transaction accounted for as a pooling of interests, as described in Note 2 tothe consolidated financial statements. We did not audit the financial statementsof Lyte Optronics, Inc. at December 31, 1998 and the results of its operationsand its cash flows for each of the two years in the period ended December 31,1998, which statements reflect total assets of $25,435,000 as of December 31,1998 and total revenues of $17,978,000 and $18,137,000 for each of the two yearsin the period ended December 31, 1998. Those statements were audited by otherauditors whose report thereon has been furnished to us, and our opinionexpressed herein, insofar as it relates to the amounts included for LyteOptronics, Inc., is based solely on the report of the other auditors. Weconducted our audits of these statements in accordance with auditing standardsgenerally accepted in the United States, which require that we plan and performthe audit to obtain reasonable assurance about whether the financial statementsare free of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements,assessing the accounting principles used and significant estimates made bymanagement, and evaluating the overall financial statement presentation. Webelieve that our audits and the report of other auditors provide a reasonablebasis for the opinion expressed above. PricewaterhouseCoopers LLP San Jose, CaliforniaMarch 20, 2000 39 41 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors of Lyte Optronics, Inc.: We have audited the consolidated balance sheet of Lyte Optronics, Inc. (aNevada corporation) and Subsidiaries as of December 31, 1998, and the relatedconsolidated statements of operations, stockholders' investment and cash flowsfor the two years in the period ended December 31, 1998 (not presented herein).These financial statements are the responsibility of the Company's management.Our responsibility is to express an opinion on these financial statements basedon our audits. We conducted our audits in accordance with auditing standards generallyaccepted in the United States. Those standards require that we plan and performthe audit to obtain reasonable assurance about whether the financial statementsare free of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion. In our opinion, the financial statements referred to above present fairly,in all material respects, the financial position of Lyte Optronics, Inc. andSubsidiaries as of December 31, 1998, and the results of their operations andtheir cash flows for the two years in the period ended December 31, 1998 inconformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Los Angeles, CaliforniaMay 27, 1999 40 42 AMERICAN XTAL TECHNOLOGY, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) DECEMBER 31, ------------------------ 1998 1999 ------------ -------- ASSETSCurrent assets Cash and cash equivalents................................. $ 16,438 $ 6,062 Accounts receivable, net of allowance for doubtful accounts of $948 and $728.............................. 13,128 17,561 Inventories............................................... 25,300 35,470 Prepaid expenses and other current assets................. 3,271 8,945 Deferred income taxes..................................... 2,452 3,210 -------- -------- Total current assets.............................. 60,589 71,248Property, plant and equipment, net.......................... 37,624 40,865Receivable from officers and stockholders................... 369 596Other assets................................................ 1,558 809Goodwill, net............................................... 2,843 2,244 -------- -------- Total assets...................................... $102,983 $115,762 ======== ========LIABILITIES AND STOCKHOLDERS' EQUITYCurrent liabilities Short-term bank borrowing................................. $ 1,191 $ 8,798 Accounts payable.......................................... 8,587 10,794 Accrued liabilities....................................... 5,242 7,464 Current portion of long-term debt......................... 3,044 2,550 Current portion of capital lease obligation............... 881 1,180 -------- -------- -------- -------- Total current liabilities......................... 18,945 30,786Long-term debt, net of current portion...................... 19,842 18,501Long-term capital lease, net of current portion............. 2,428 3,606Note payable to officers and stockholders................... 604 410 -------- -------- Total liabilities................................. 41,819 53,303 -------- -------- Contingencies (Note 11)Stockholders' equity: Preferred stock, $.001 par value per share; 1,000,000 shares authorized; 980,655 shares issued and outstanding.................. 1 1 Additional paid-in capital............................. 3,999 3,989 Common stock, $.001 par value per share; 100,000,000 shares authorized; 18,393,113 and 18,658,919 shares issued and outstanding, respectively............................. 18 19 Additional paid-in capital............................. 45,248 46,321 Deferred compensation..................................... (327) (217) Retained earnings......................................... 12,198 12,370 Cumulative translation adjustments........................ 27 (24) -------- -------- Total stockholders' equity........................ 61,164 62,459 -------- -------- Total liabilities and stockholders' equity........ $102,983 $115,762 ======== ======== The accompanying notes are an integral part of these consolidated financial statements. 41 43 AMERICAN XTAL TECHNOLOGY, INC. CONSOLIDATED INCOME STATEMENTS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) YEARS ENDED DECEMBER 31, ----------------------------- 1997 1998 1999 ------- ------- ------- Revenues.................................................... $43,313 $61,314 $81,521Cost of revenues............................................ 29,650 38,949 57,369 ------- ------- -------Gross profit................................................ 13,663 22,365 24,152Operating expenses: Selling, general and administrative....................... 9,921 11,538 14,016 Research and development.................................. 1,289 2,684 3,086 Acquisition costs......................................... -- -- 2,810 ------- ------- ------- Total operating expenses.......................... 11,210 14,222 19,912 ------- ------- -------Income from operations...................................... 2,453 8,143 4,240Interest expense............................................ (793) (1,481) (2,150)Interest and other income................................... (57) 598 729 ------- ------- -------Income before provision for income taxes.................... 1,603 7,260 2,819Provision for income taxes.................................. 783 2,976 2,139 ------- ------- -------Income before extraordinary item............................ 820 4,284 680Extraordinary item, net of tax benefits..................... -- -- 508 ------- ------- -------Net income.................................................. $ 820 $ 4,284 $ 172 ======= ======= =======Basic income per share: Income before extraordinary item.......................... $ 0.22 $ 0.27 $ 0.04 Extraordinary item........................................ -- -- (0.03) Net income................................................ 0.22 0.27 0.01 Net income................................................ 0.22 0.27 0.01Diluted income per share: Income before extraordinary item.......................... $ 0.06 $ 0.26 $ 0.03 Extraordinary item........................................ -- -- (0.03) Net income................................................ 0.06 0.26 0.01Shares used in net income per share calculations: Basic..................................................... 3,697 16,076 18,655 Diluted................................................... 13,598 16,325 19,771 The accompanying notes are an integral part of these consolidated financial statements. 42 44 AMERICAN XTAL TECHNOLOGY, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA) ACCUMULATED OTHER PREFERRED STOCK COMMON STOCK COMPREHENSIVE INCOME -------------------- -------------------- DEFERRED RETAINED CUMULATIVE TRANSLATION SHARES AMOUNT SHARES AMOUNT COMPENSATION EARNINGS ADJUSTMENTS ----------- ------ ---------- ------- ------------ -------- ---------------------- Balance at January 1, 1997......... 8,928,737 $2,618 3,648,315 $ 629 $ -- $ 7,094 $(104)Common stock options exercised..... 84,825 154Issuance of Series C convertible preferred stock.................. 1,200,000 5,935Issuance of Employee Stock Purchase Plan stock....................... 67,000 232Deferred compensation.............. 322 (322)Amortization of deferred compensation..................... 102Comprehensive income Net income....................... 820 Other comprehensive income Currency translation adjustment................... (93) ----------- ------ ---------- ------- ----- ------- -----Balance at December 31, 1997....... 10,128,737 $8,553 3,800,140 $ 1,337 $(220) $ 7,914 $(197)Common stock options exercised..... 71,407 138Issuance of common stock........... 123,153 724Issuance of common stock and Series A preferred stock in connection with the acquisition of Alpha Photonics, Inc................... 980,655 4,000 1,266,464 7,500Issuance of common stock as settlement of trade payables..... 4,105 25Reacquisition and retirement of common stock..................... (60,689)Issuance of common stock in connection with financing........ 184,796 994Conversion of Series C convertible preferred stock to common stock............................ (10,128,737) (8,553) 10,128,737 8,553Issuance of common stock upon initial public offering.......... 2,875,000 25,792Deferred compensation.............. 203 (203)Amortization of deferred compensation..................... 96Comprehensive income Net income....................... 4,284 Other comprehensive income Currency translation adjustment................... 224 ----------- ------ ---------- ------- ----- ------- -----Balance at December 31, 1998....... 980,655 $4,000 18,393,113 $45,266 $(327) $12,198 $ 27Common stock options exercised..... 200,679 648Repurchase of shares of common stock in connection with the early extinguishment of debt..... (21,064) (211)Acquisition costs paid by shareholders..................... (10) (139)Issuance of Employee Stock Purchase Plan stock....................... 86,191 776Deferred compensation.............. --Amortization of deferred compensation..................... 110Comprehensive income Net income....................... 172 Other comprehensive income Currency translation adjustment................... (51) ----------- ------ ---------- ------- ----- ------- -----Balance at December 31, 1999....... 980,655 $3,990 18,658,919 $46,340 $(217) $12,370 $ (24) =========== ====== ========== ======= ===== ======= ===== COMPREHENSIVE TOTAL INCOME ------- ------------- Balance at January 1, 1997......... $10,237Common stock options exercised..... 154Issuance of Series C convertible preferred stock.................. 5,935Issuance of Employee Stock Purchase Plan stock....................... 232Deferred compensation.............. --Amortization of deferred compensation..................... 102Comprehensive income Net income....................... 820 $ 820 Other comprehensive income Currency translation adjustment................... (93) (93) ------- ------Balance at December 31, 1997....... $17,387 $ 727 ======Common stock options exercised..... 138Issuance of common stock........... 724Issuance of common stock and Series A preferred stock in connection with the acquisition of Alpha Photonics, Inc................... 11,500Issuance of common stock as settlement of trade payables..... 25Reacquisition and retirement of common stock..................... --Issuance of common stock in connection with financing........ 994Conversion of Series C convertible preferred stock to common stock............................ --Issuance of common stock upon initial public offering.......... 25,792Deferred compensation.............. --Amortization of deferred compensation..................... 96Comprehensive income Net income....................... 4,284 4,284 Other comprehensive income Currency translation adjustment................... 224 224 ------- ------Balance at December 31, 1998....... $61,164 $4,508 ======Common stock options exercised..... 648Repurchase of shares of common stock in connection with the early extinguishment of debt..... (211)Acquisition costs paid by shareholders..................... (149)Issuance of Employee Stock Purchase Plan stock....................... 776Deferred compensation.............. --Amortization of deferred compensation..................... 110Comprehensive income Net income....................... 172 172 Other comprehensive income Currency translation adjustment................... (51) (51) ------- ------Balance at December 31, 1999....... $62,459 $ 121 ======= ====== The accompanying notes are an integral part of these consolidated financial statements. 43 45 AMERICAN XTAL TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) YEARS ENDED DECEMBER 31, ------------------------------- 1997 1998 1999 ------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income................................................ $ 820 $ 4,284 $ 172 Adjustments to reconcile net income to cash provided by (used in) operations: Depreciation............................................ 1,341 2,959 5,616 Deferred income taxes................................... (518) (1,126) 758 Amortization of goodwill................................ 149 599 Stock compensation...................................... 102 96 110 Other................................................... 94 5 -- Changes in assets and liabilities: Accounts receivable................................... (1,984) (4,192) (4,433) Inventories........................................... (5,616) (11,074) (10,170) Prepaid expenses...................................... (435) (1,610) (5,674) Other assets.......................................... (49) (248) 749 Accounts payable...................................... 1,928 1,540 2,207 Accrued liabilities................................... 2,168 533 2,222 ------- -------- -------- Net cash provided by (used in) operating activities....................................... (2,149) (8,684) (7,844) activities....................................... (2,149) (8,684) (7,844) ------- -------- --------CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment................ (5,227) (17,175) (7,527) Net cash received in connection with purchase of Alpha.... 539 -- ------- -------- -------- Net cash used in investing activities.............. (5,227) (16,636) (7,527) ------- -------- --------CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from (payments of): Issuance of common stock................................ 386 27,648 1,074 Issuance of convertible preferred stock................. 5,935 -- -- Capital leases.......................................... (33) (263) (1,379) Long-term debt borrowings................................. 2,654 18,739 3,072 Long-term debt borrowings............................... (5,574) (4,907) Line of credit.......................................... 779 (2,320) 7,607 Notes payable to officers and shareholders.............. (252) 110 (421) ------- -------- -------- Net cash provided by financing activities.......... 9,469 38,340 5,046 ------- -------- --------Effect of exchange rate changes............................. (65) 219 (51) ------- -------- --------Net increase in cash and cash equivalents................... 2,028 13,239 (10,376)Cash and cash equivalents at the beginning of the period.... 1,171 3,199 16,438 ------- -------- --------Cash and cash equivalents at the end of the period.......... $ 3,199 $ 16,438 $ 6,062 ======= ======== ========Non cash activity: Purchase of property, plant and equipment through capital leases.................................................. $ -- $ -- $ 2,856 ======= ======== ========SUPPLEMENTAL DISCLOSURES: Interest paid............................................. $ 802 $ 1,481 $ 2,288 ======= ======== ======== Income taxes paid......................................... $ 1,814 $ 4,338 $ 6,268 ======= ======== ======== The accompanying notes are an integral part of these consolidated financial statements. 44 46 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. THE COMPANY AND SUMMARY OF ACCOUNTING POLICIES The Company American Xtal Technology, Inc., or AXT designs, develops, manufactures anddistributes high-performance compound semiconductor substrates, laser-diodes,light-emitting diodes, or LEDs and consumer and commercial products utilizinglaser-diodes and LEDs. AXT expanded its markets in 1999 through the acquisition of Lyte Optronics,Inc. (See note 2). The Lyte Optronic's business now operates as two separatedivisions of AXT: the Visible Emitter Division, focusing on manufacturing LEDsand laser-diodes, and the Consumer Products division, focusing on designing andmarketing of laser-pointing, laser-alignment and LED products. The Substratedivision comprises the third operating unit of AXT. 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 other than the local currencies for the subsidiaries are included inthe results 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. We provide anallowance for estimated returns at the time revenue is recognized. Contractrevenues are recognized under the percentage of completion method based on costsincurred relative to total contract costs. Concentration of Credit Risk The Company manufactures and distributes GaAs, InP and Ge substrates,visible semiconductor laser diode chips, light emitting diodes, laser pointerproducts and performs services under research and development contracts.Financial instruments which potentially subject the Company to concentration ofcredit risk consist primarily of trade accounts receivable. The Company investsprimarily in money market accounts and commercial paper instruments. Cashequivalents are maintained with high quality institutions and their compositionand maturities are regularly monitored by management. 45 47 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company performs ongoing credit evaluations of our customers' financialcondition, and limit the amount of credit extended when deemed necessary, butgenerally do not require collateral. No customer represented greater than 10% of product revenues in fiscal year1997, 1998 or 1999. No customer accounted for 10% or more of the trade accounts receivablebalance as of December 31, 1998, and 1999. 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 accumulated depreciation 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, equipment and goodwill as of December31, 1999. 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. 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 46 48 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) comprehensive income for the Company relates to foreign currency translationadjustments. Comprehensive income for the years ended December 31, 1997, 1998,and 1999 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. Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standard No. 133, "Accounting for Derivative Instruments and 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. NOTE 2. ACQUISITION On May 28, 1999, the Company completed a merger with Lyte Optronics, Inc.,a Nevada corporation and all of its subsidiaries, including Alpha Photonics,Inc., Lyte Optronics Ltd. (a United Kingdom company) and Advanced Semiconductor(a Xiamen, Peoples Republic of China company). Lyte Optronics, Inc. and itssubsidiaries manufacture and distribute visible semiconductor laser diode chips,high brightness visible light emitting diodes and laser pointers. Under the terms of the merger agreement, the Company issued approximately2,363,000 shares of our common stock in exchange for all the outstanding sharesof Lyte's common stock as well as the outstanding shares of Lyte's Series Apreferred stock. The Company also issued approximately 983,000 shares of SeriesA preferred stock in exchange for all the outstanding shares of Lyte's Series Bpreferred stock. In addition, the Company assumed and converted Lyte's optionsand warrants representing 115,000 shares of the Company's common stock. The merger has been accounted for as a pooling of interests; accordingly,all prior period consolidated financial statements have been restated to includethe combined results of operations, financial position, and cash flows of LyteOptronics, Inc. The Company incurred costs of approximately $2,810,000 associated with themerger, which was charged to operations during the quarter ended June 30, 1999,the period in which the merger was consummated. See Note 9 for selected financial information by business segments. 47 49 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3. BALANCE SHEET DETAIL DECEMBER 31, ------------------ 1998 1999 ------- ------- (IN THOUSANDS) Inventories: Raw materials............................................. $ 9,928 $13,503 Work in process........................................... 13,171 16,151 Finished goods............................................ 2,201 5,816 ------- ------- $25,300 $35,470 ======= =======Prepaid expenses: Income taxes.............................................. $ 312 $ 4,013 Other..................................................... 2,959 4,932 ------- ------- $ 3,271 $ 8,945 ======= =======Property, plant and equipment: Land...................................................... $ 2,446 $ 2,447 Building.................................................. 17,429 18,507 Machinery and equipment................................... 23,544 31,058 Leasehold improvements.................................... 476 2,704 Construction in progress.................................. 3,144 1,008 ------- ------- 47,039 55,724 Less: Accumulated depreciation and amortization........... (9,415) (14,859) ------- ------- $37,624 $40,865 ======= =======Accrued liabilities: Accrued compensation and other............................ $ 934 $ 1,019 Allowance for sales returns............................... 1,036 264 Others.................................................... 3,272 6,181 ------- ------- $ 5,242 $ 7,464 ======= ======= NOTE 4. DEBT In March 1998, the Company obtained a $15.0 million line of credit, or LOCwhich expires in May 2000. The LOC is secured by the Company's business assets,excluding equipment. Borrowings under the LOC bear interest at the bank's primeinterest rate plus .5%. The LOC is subject to certain financial covenantsregarding current financial ratios and cash flow requirements which have allbeen met as of December 31, 1999. At December 31, 1998 and 1999, the balancesoutstanding under the LOC were 0 and $8.8 million respectively. 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 48 50 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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, 1998 and 1999, $0.9 million and $0.9 million was outstanding under this debenture loan, respectively. The Company obtained equipment loans from several different banks throughtwo financing companies to finance the purchase of new manufacturing equipment.These loans have a maturity of five years with interest rates ranging from 6.0%to 9.0% per annum. These loans are secured by the machinery and equipmentpurchased with the loans. As of December 31, 1998 and 1999, $5.5 million and$7.2 million was outstanding under these loans, respectively. 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 of 25 years, bear interest at 200 basis points below prime. Repayment of principaland interest under the bonds is by installment payment on a quarterly basis. TheCompany has an option to redeem in whole or in part of the bonds during the termof the bonds. As of December 31, 1998 and 1999, $11.6 million and $11.1 millionwas outstanding under these loans, respectively. The Company obtained various notes from banks. The notes bearing interestat rates of prime rate plus 0.5% to 0.75% were secured by assets of the Company.As of December 31, 1998 and 1999, $3.3 million and $1.8 million was outstandingunder these loans, respectively. In 1998, the Company also obtained a note from a financing institution inconnection with common stock issuance. As of December 31, 1998, the outstandingbalance of the note was $1.5 million, with a face value of $2.6 million, net of$1.1 million of unamortized discount. In June 1999, the Company repaid the note.The repayment resulted in an extraordinary loss in the amount of $508,000, netof tax benefit of $311,000. The aggregate future repayments of long-term debt outstanding at December31, 1999 are $2.5 million in 2000, $2.8 million in 2001, $2.6 million in 2002,$3.5 million in 2003, $865,000 in 2004 and $8.7 million thereafter. Following the merger with Lyte, the Company repaid Lyte debt that had beenobtained at an unfavorable interest rate. The repayment resulted in anextraordinary loss in the amount of $508,000, net of tax benefits. NOTE 5. INCOME TAXES The components of the provision for income taxes were as follows: YEARS ENDED DECEMBER 31, --------------------------- 1997 1998 1999 ------ ------- ------ (IN THOUSANDS) Current: Federal............................................. $1,571 $ 3,774 $2,274 State............................................... 79 442 376 Foreign............................................. 84 51 247 ------ ------- ------ Total current 1,734 4,267 2,897Deferred: Federal............................................. (808) (1,097) (663) State............................................... (143) (194) (95) ------ ------- ------ Total deferred.............................. (951) (1,291) (758) ------ ------- ------ Total provision............................. $ 783 $ 2,976 $2,139 ====== ======= ====== 49 51 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, -------------------- 1997 1998 1999 ---- ---- ---- Statutory federal income tax rate........................... 34.0% 34.0% 34.0%State income taxes, net of federal tax benefits............. 13.5% 2.6% 5.4%Foreign sales corporation benefit........................... (5.6)% (3.2)% (4.8)%Foreign income taxed at higher rate......................... 4.2% 0.8% 0.0%Acquisition costs........................................... 0.0% 0.0% 33.9%Other....................................................... 2.7% 6.9% 7.3% ---- ---- ----Effective tax rate.......................................... 48.8% 41.1% 75.8% ==== ==== ==== Deferred tax assets (liabilities) are summarized as follows: DECEMBER 31, ---------------- 1998 1999 ------ ------ (IN THOUSANDS) Deferred tax assets: Accruals and reserves not yet deductible.................. $1,635 $2,935 State taxes............................................... 137 98 Other..................................................... 772 724 Net operating loss........................................ 925 925 Credits................................................... -- 128 ------ ------ 3,469 4,810Deferred tax liabilities: Depreciation.............................................. (1,017) (1,600) ------ ------ Net deferred tax asset................................. $2,452 $3,210 ====== ====== NOTE 6. 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, ------------------------------------------------------------------------------ 1997 1998 1999 ------------------------ ------------------------ ------------------------ PER PER PER NET SHARE NET SHARE NET SHARE INCOME SHARES AMOUNT INCOME SHARES AMOUNT INCOME SHARES AMOUNT ------ ------ ------ ------ ------ ------ ------ ------ ------ (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Basic EPS calculation............... $820 3,697 $0.22 $4,284 16,076 $0.27 $172 18,655 $0.01Effect of dilutive securities Common stock options.............. 72 249 1,116 Convertible preferred stock....... 9,829 -- --Diluted EPS calculation............. 13,598 $0.06 16,325 $0.26 19,771 $ -- NOTE 7. COMMON STOCK AND PREFERRED STOCK 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 50 52 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) received cash of approximately $25,792,000 net of underwriting discounts,commissions and IPO expenses. Upon the closing of the IPO, all outstandingshares of the Company's then convertible preferred stock were automaticallyconverted into shares of common stock. On May 28, 1999, the Company completed its acquisition of Lyte Optronics,Inc. Under the terms of the acquisition, the Company issued approximately2,363,000 shares of common stock and 983,000 shares of nonvoting preferred stockwith a 5 percent annual dividend rate and $4 million liquidation preference overcommon stock, in exchange for all of the issued and outstanding shares ofcapital stock of Lyte Optronics. Ten percent of the shares issuable to the LyteOptronics' shareholders will be held in escrow for up to one year to satisfy anyclaims that the Company may bring under the agreement during that period. NOTE 8. EMPLOYEE BENEFIT 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, 1999. 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,3,800,000 shares of common stock have been reserved for issuance as of December31, 1999. 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. 51 53 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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, 1997, 1998, and 1999: SHARES OPTIONS WEIGHTED AVERAGE AVAILABLE OUTSTANDING OPTION PRICE ---------- ----------- ---------------- Balance at December 31, 1996........................ 322,594 209,202 $ 1.59 Additional shares authorized...................... 1,367,000 -- -- Granted........................................... (1,246,951) 1,246,951 5.06 Exercised......................................... (84,825) 1.59 Cancelled......................................... 27,701 (27,701) 3.30 ---------- --------- ------Balance at December 31, 1997........................ 470,344 1,343,627 $ 4.78 Additional shares authorized...................... 1,500,000 -- -- Granted........................................... (320,599) 320,599 17.95 Exercised......................................... -- (71,407) 1.94 Cancelled......................................... 64,268 (64,268) 5.39 ---------- --------- ------ Balance at December 31, 1998........................ 1,714,013 1,528,551 $ 5.45 Additional shares authorized...................... 1,000,000 -- -- Granted........................................... (1,547,360) 1,547,360 18.33 Exercised......................................... -- (200,679) 4.64 Cancelled......................................... 289,793 (289,793) 10.25 ---------- --------- ------Balance at December 31, 1999........................ 1,456,446 2,585,439 $12.68 ========== ========= ====== At December 31, 1997, 1998, and 1999, options for 461,089, 869,710 and1,021,725 shares, respectively, were vested. During the years ended December 31, 1997, 1998, and 1999, the Companygranted options for the purchase of 1,246,951 shares, 320,599 shares, and1,547,360 shares, respectively, of common stock to employees at a weightedaverage exercise price of $5.06 per share, $17.95 per share, and $18.33 pershare, respectively. Management calculated deferred compensation of $322,000, $203,000, and $0related to options granted during the years ended December 31, 1997, 1998, and1999, respectively. Such deferred compensation is amortized over the vestingperiod relating to these options of which approximately $102,000, $96,000, and$110,000 was amortized during the years ended December 31, 1997, 1998, and 1999,respectively. 52 54 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Information relating to stock options outstanding under the 1993 Plan andthe 1997 Plan at December 31, 1999 is as follows: OPTIONS OUTSTANDING ------------------------------------ WEIGHTED AVERAGE WEIGHTED REMAINING AVERAGE RANGE OF NUMBER CONTRACTUAL EXERCISEEXERCISE PRICES: OUTSTANDING LIFE PRICE---------------- ----------- ----------- -------- $ 1.20 - $ 1.90 5,850 0.83 $ 1.90$ 5.00 - $ 5.00 762,934 7.64 5.00$ 5.50 - $ 7.50 265,190 7.90 6.50$ 7.63 - $ 9.13 344,004 7.35 8.79$10.04 - $17.44 182,161 9.07 12.89$17.75 - $21.19 755,200 9.51 20.73$22.69 - $24.96 270,100 9.63 22.98 --------- ---- ------ 2,585,439 8.47 $12.68 ========= ==== ====== OPTIONS VESTED ------------------------- WEIGHTED AVERAGE RANGE OF NUMBER EXERCISEEXERCISE PRICES: VESTED PRICE---------------- ------- -------- $1.20 - $17.44 601,202 $5.56 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, 1998 and 1999(no options were granted during the year ended December 31, 1996) was $0.49,$4.57 and $13.09, respectively. Had compensation cost for the Company's optionsbeen determined based on the fair value at the grant dates, as prescribed inSFAS 123, the Company's pro forma net income and net income per share would havebeen as follows: YEARS ENDED DECEMBER 31, -------------------------- 1997 1998 1999 ----- ------ ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net income: As reported............................................... $ 820 $4,284 $ 172 Pro forma net income...................................... $ 760 $3,936 $(2,747)Net income per share: As reported: Basic.................................................. $0.22 $ 0.27 $ 0.01 Diluted................................................ $0.06 $ 0.26 $ -- Pro forma net income: Basic.................................................. $0.21 $ 0.24 $ (0.15) Diluted................................................ $0.06 $ 0.24 $ (0.14) 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, 1998, and1999; dividend yield of 0.0% for all periods; risk-free interest rates of 6.1%, 53 55 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 5.2%, and 5.6% for options granted during the years ended December 31, 1997,1998, and 1999 respectively; expected lives of 4.5, 5.0, and 5.0 years foroptions granted during the years ended December 31, 1997, 1998, and 1999respectively; and volatility of 0%, 75%, and 96% for the years ended December31, 1997, 1998, and 1999, respectively. 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. 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. A total of 86,000 shares were purchased as of December 31, 1999. The 1998 Purchase Plan permitseligible employees to acquire shares of the Company's common stock throughpayroll deductions. The common stock purchase price is determined as 85% of thelower of the market price of the common stock at the purchase date or the dateof offer to the employee. 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, 1997, 1998, and 1999 were $87,000, $101,000, and $146,000respectively. NOTE 9. SEGMENT AND FOREIGN OPERATIONS INFORMATION The Company has three reportable segments: 1) Substrates 2) VisibleEmitters and 3) Consumer Products. 54 56 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Selected financial information by business segment for the years endedDecember 31, 1997, 1998, and 1999, is as follows: YEAR ENDED DECEMBER 31, ----------------------------- 1997(3) 1998(2) 1999(1) ------- ------- ------- (IN THOUSANDS) Subtrates Net revenues from external customers...................... $25,335 $43,177 $56,732 Operating income (loss)................................... 5,860 10,416 12,275 Identifiable assets....................................... 31,395 75,805 88,579 Depreciation expense...................................... 1,164 2,048 3,616 Capital expenditures...................................... 4,856 16,385 5,572Visible emitters Net revenues from external customers...................... -- 5,897 18,640 Operating income (loss)................................... -- 1,132 (2,775) Identifiable assets....................................... -- 18,917 23,423 Depreciation expense...................................... -- 686 1,671 Capital expenditures...................................... -- 633 4,096Consumer Products Net revenues from external customers...................... 17,978 12,240 6,149 Operating income (loss)................................... (3,407) (3,405) (5,260) Identifiable assets....................................... 6,401 7,561 3,760 Depreciation expense...................................... 177 225 329 Capital expenditures...................................... 371 157 --Total Net revenues from external customers...................... 43,313 61,314 81,521 Operating income (loss)................................... 2,453 8,143 4,240 Identifiable assets....................................... 37,014 102,283 115,762 Depreciation expense...................................... 1,341 2,959 5,616 Capital expenditures...................................... 5,227 17,175 8,857 The Company sells its substrates in the United States and in other parts ofthe world. Also, the Company has operations in Japan and China. Revenues bygeographic location based on the country of the customer were as follows: YEAR ENDED DECEMBER 31, ----------------------------- 1997(3) 1998(2) 1999(1) ------- ------- ------- (IN THOUSANDS) Net revenues: United States............................................. $30,676 $41,902 $42,531 Europe.................................................... 5,452 4,469 8,290 Canada.................................................... 1,034 1,356 3,221 Japan Asia Pacific and other.............................. 6,151 13,587 28,479 ------- ------- ------- Consolidated.............................................. $43,313 $61,314 $81,521 ======= ======= ======= 55 57 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 10. RELATED PARTY TRANSACTIONS During the years ended December 31, 1997, 1998, and 1999, the Companypurchased $1,540,000, $3,681,000, and $3,559,000, respectively, of raw materialsand manufactured quartz from a supplier which is owned by a family member of anofficer. NOTE 11. COMMITMENTS AND 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. The Company leases certain office space, manufacturing facilities, andproperty and equipment under long-term operating leases expiring at variousdates through December, 2006. Total rent expense under these operating leaseswas approximately $398,000 in 1999. Included in property and equipment is approximately $5,167,000 of equipmentwhich is leased under non-cancellable leases accounted for as capital leases.These leases expire at various dates through 2004. Total minimum lease payments under the above leases as of December 31,1999, are as follows: CAPITAL OPERATING LEASES LEASES TOTAL ------- --------- ------ YEAR ENDING DECEMBER 31, 2000...................................................... $ 1,523 $ 381 $1,904 2001...................................................... 1,493 328 1,821 2002...................................................... 1,497 293 1,790 2003...................................................... 1,315 186 1,501 2004...................................................... 371 82 453 Thereafter................................................ -- -- -- ------- ------ ------ 6,199 $1,270 $7,469 ====== ======Less amounts representing interest at 8.25 to 22.8 per cent...................................................... (1,413) ------- 4,786Less short-term portion..................................... (1,180) Less short-term portion..................................... (1,180) -------Long-term portion........................................... $ 3,606 ======= NOTE 12. 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, 1999, 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, 1999, the Company'soutstanding commitments with respect to the foreign exchange contracts, whichwere commitments to sell Japanese yen, had a total value of approximately$1,900,000. During the years ended December 31, 1997, 1998, and 1999, the Companyincurred a foreign transaction exchange loss of $186,000, a loss of $24,000, anda gain of $652,000 respectively. 56 58 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: April 14, 2000 57 59 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 Officer, and April 14, 2000--------------------------------------------------- Chairman of the Board (Principal Morris S. Young Executive Officer) /s/ GUY D. ATWOOD Vice President, Chief Financial Officer April 14, 2000--------------------------------------------------- (Principal Financial and Accounting Guy D. Atwood Officer) /s/ THEODORE S. YOUNG Senior Vice President, Marketing, April 14, 2000--------------------------------------------------- Director Theodore S. Young /s/ Director April 14, 2000--------------------------------------------------- Donald L. Tatzin /s/ Director April 14, 2000--------------------------------------------------- Jesse Chen /s/ Director April 14, 2000--------------------------------------------------- B.J. Moore 58 60 AMERICAN XTAL TECHNOLOGY, INC. EXHIBITS TO FORM 10-K ANNUAL REPORT FOR THE YEAR ENDED DECEMBER 31, 1999 EXHIBIT NUMBER DESCRIPTION------- ----------- 2.1(1) Agreement and Plan of Merger between American Xtal Technology, a California corporation, and American Xtal Technology Delaware Corporation, a Delaware corporation. 2.2(4) Agreement and Plan of Reorganization by and among American Xtal Technology, Inc., Monterey Acquisition Corp., Lyte Optronics, Inc. and certain stockholders of Lyte Optronics, Inc. dated May 27, 1999. 2.3(4) Certificate of Merger dated May 27, 1999, filed with the Secretary of State of the State of Delaware on May 28, 1999. 2.4(4) Articles of Merger dated May 27, 1999, filed with the Secretary of State of Nevada on May 28, 1999. 3.1(3) Restated Certificate of Incorporation of American Xtal Technology, Inc. 3.2(4) Certificate of Designation, Preferences and Rights of Series A Preferred Stock, as filed with the Secretary of State of the state of Delaware on May 27, 1999 (which is incorporated herein by reference to Exhibit 2.1 to the registrant's form 8-K dated May 28, 1999). 3.3(1) By Laws of American Xtal Technology, Inc. 4.0(4) Rights Agreement 4.1 Registration rights agreement by and among American Xtal Technology, Inc., Lyte Optronics, Inc. and certain stockholders of Lyte Optronics Inc. dated May 27, 1999.10.1(1) Form of Indemnification Agreement for directors and officers.10.2(1) 1993 Stock Option Plan and forms of agreements thereunder.10.3(1) 1997 Stock Option Plan and forms of agreements thereunder.10.4(1) 1997 Employee Stock Purchase Plan and forms of agreements thereunder.10.5(1) 1998 Employee Stock Purchase Plan and forms of agreements thereunder.10.6(1) Loan Agreement between U.S. Bank National Association and us dated March 4, 1998. 10.7(2) Purchase and Sale Agreement by and between Limar Realty Corp. #23 and us dated April 1998.10.8(3) Loan Agreement between U.S. Bank National Association and us dated September 18, 1998.10.9(3) Letter of Credit and Reimbursement Agreement between U.S. Bank National Association and us dated December 1, 1998.10.10(3) Bond Purchase Contract between Dain Rauscher Incorporated and us dated December 1, 1998.10.11(3) Remarketing Agreement between Dain Rauscher Incorporated and us dated December 1, 1998.21.1 List of Subsidiaries.23.1 Consent of Independent Accountants -- PricewaterhouseCoopers LLP.23.2 Consent of Independent Accountants -- Arthur Andersen LLP.24.1 Power of Attorney (see signature page).27.1 Financial Data Schedule. ---------------(1) As filed with the SEC in our Registration Statement on Form S-1 on March 17, 1998. (2) As filed with the SEC in our Registration Statement on Amendment No. 2 to Form S-1 on May 11, 1998. (3) As filed with the SEC in our Annual Report on Form 10-K for the year ended December 31, 1998 on March 31, 1999. (4) As filed with the SEC in our Form 8-K on June 14, 1999. 59 1 EXHIBIT 4.1 REGISTRATION RIGHTS AGREEMENT This Registration Rights Agreement ("AGREEMENT") is made as of May 27, 1999by and among American Xtal Technology, Inc., a Delaware corporation ("AXT"),Lyte Optronics, Inc., a Nevada corporation ("LYTE OPTRONICS") and Keith Halseyand Robert Shih as representatives of the shareholders of Lyte Optronics(collectively, "SHAREHOLDERS' REPRESENTATIVE"). 1. DEFINITIONS. As used in this Agreement: (a) "AFFILIATE" means each person or party who may be deemed to be an"affiliate" for purposes of paragraphs (c) and (d) of Rule 145 of the SEC,although nothing contained herein shall be construed as an admission by suchperson or party that such person or party is in fact an affiliate of AXT forsuch purposes. (b) "CLOSING DATE" shall mean the Closing Date as defined in theMerger Agreement. (c) "EXCHANGE ACT" means the Securities Exchange Act of 1934, asamended. (d) "FORM S-3" means such form under the Securities Act as in effecton the date hereof or any registration form under the Securities Actsubsequently adopted by the SEC which similarly permits inclusion orincorporation of substantial information by reference to other documents filedby AXT with the SEC. (e) "HOLDER" means: (i) a shareholder of Lyte Optronics to whomshares of Registrable Securities are issued pursuant to the Merger Agreement,for so long as such holder continues to hold such shares, or (ii) a transfereeof Registrable Securities by a Holder, to whom registration rights under thisAgreement are assigned pursuant to Section 6 of this Agreement and who becomes aHolder (within the meaning of this Agreement) of Registrable Securities. (f) "MERGER AGREEMENT" means that certain Agreement and Plan ofReorganization dated as of May 27, 1999 by and among AXT, Lyte OptronicsAcquisition Corporation, and Lyte Optronics. (g) "NASD" means the National Association of Securities Dealers. (h) "REGISTRABLE SECURITIES" means (i) for each Holder, the shares ofAXT Common Stock issued to such Holder pursuant to the Merger Agreement,together with all other shares of AXT Common Stock issued in respect thereof (byway of stock split, dividend, recapitalization, share exchange or otherwise),and (ii) for all Holders, the sum of the Registrable Securities held by them.Registrable Securities shall not include any shares of AXT Common Stocktransferred by a Holder pursuant to SECTION 8 hereof to any person who does notagree to be bound by the terms of this Agreement. (i) "SEC" means the Securities and Exchange Commission. 2 (j) "SECURITIES ACT" means the Securities Act of 1933, as amended. (k) "AXT COMMON STOCK" means common stock, per value $0.01 per shareof AXT. The term "register", "registered" and "registration" refer to aregistration effected by preparing and filing a registration statement or similar document in compliance with the Securities Act, and the declaration orordering of effectiveness of such registration statement or document.Capitalized terms used and not otherwise defined in this Agreement have therespective meanings assigned in the Merger Agreement. 2. REGISTRATION. (a) Requests for Registration. A majority in interest of the Holdersshall be entitled to make up to two (2) requests that AXT register theRegistrable Securities pursuant to the Securities Act, subject in each case tothe following limitations: (i) no request for registration of any RegistrableSecurities shall be made unless and until not less than six (6) months haveelapsed after the Closing Date; (ii) no request for registration of anyRegistrable Securities shall be made if a request for registration of the sameRegistrable Securities has theretofore been made pursuant to this Agreement andAXT has caused the securities covered by such request to be registered; and(iii) AXT shall not be obligated to effect such registration if the Holders,together with the holders of any other securities of AXT entitled to inclusionin such registration, propose to sell Registrable Securities at an aggregateprice to the public (before deduction of any underwriters' discounts orcommissions) of less than $1,000,000. All requests for registration shall be inwriting, signed by the requesting Holders, and delivered to AXT at the addressspecified in the Merger Agreement for notices. If a request for registration ismade, AXT shall give notice of such request to all other Holders at theirrespective address as reflected in the books and records of AXT, and each suchother Holder shall have the right to request that such other Holder'sRegistrable Securities be included in the registration, and (subject to thelimitations set forth elsewhere in this Agreement) such other Holder'sRegistrable Securities shall be included in such registration to the extent thatnotice of such other Holder's request is received by AXT within ten (10) daysafter notice of the original registration request is given by AXT to such otherHolders. Upon receipt of a registration request in accordance with this SECTION2(a), AXT shall use reasonable efforts to cause the applicable RegistrableSecurities to be registered under the Securities Act so as to permit the resalethereof, and in connection therewith AXT shall use reasonable efforts to prepareand file with the SEC and shall use reasonable efforts to cause to becomeeffective promptly thereafter a registration statement on Form S-3 (or anysuccessor form to Form S-3) (a "DEMAND REGISTRATION STATEMENT"). Subject to theprovisions of SECTION 2(d), AXT shall use commercially reasonable efforts tokeep such Demand Registration Statement continuously effective for up to onehundred eighty (180) days or until such earlier date as of which all of theRegistrable Securities included in the registration statement shall have beendisposed of in the manner described in the registration statement.Notwithstanding the foregoing, if for any reason the effectiveness of suchDemand Registration Statement is postponed or suspended then the foregoingperiod shall be extended, if required to complete the disposition of suchRegistrable Securities, by up to the aggregate number of days of 2 3such postponement or suspension. For purpose of the preceding sentence, theregistration shall not be deemed to have been effective (i) unless theregistration statement with respect thereto has become effective, or (ii) ifafter such registration has become effective such registration or the relatedoffer, sale, or distribution of Registrable Securities thereunder is prohibitedby any stop order, injunction or any other order or requirement of theCommission or other governmental agency for any reason not attributable to theHolders, or (iii) if the conditions to closing specified in the underwritingagreement, if any, entered into in connection with such registration are notsatisfied or waived, in each case other than as a result of action or inactionof the Holders. AXT shall have complied with its obligations under thisAgreement, and Holders' right to demand registration pursuant to this SECTION 2(a) shall be deemed to have been satisfied upon the earlier of (x) the date asof which all of the Registrable Securities included in the Demand RegistrationStatement shall have been disposed of pursuant to the Demand Registration Statement, or (y) the date as of which such Demand Registration shall have beeneffective for an aggregate period of one hundred eighty (180) days, providedthat no stop order or similar order is thereafter entered. Notwithstandinganything to the contrary herein, AXT shall not be required to effect more thantwo (2) registrations of Registrable Securities pursuant to this SECTION 2(a). (b) Piggyback Registration. If at any time AXT proposes to prepareand file a registration statement (other than a Demand Registration Statement)under the Securities Act with the SEC covering equity securities of AXT, it willgive written notice of its intention to do so (the "PIGGYBACK NOTICE"), at leastthirty (30) days prior to the filing of any such registration statement, to theHolders; provided, however, that AXT shall not be required to give such 30 dayadvance notice of its intention to file a registration statement if the Board ofDirectors determines in good faith that it is not in the Company's best interestto provide advance notice of a proposed registration statement, and provided,further, that in such circumstance AXT shall give written notice not later thanthe date of filing the registration statement and the date of such writtennotice shall be deemed the date of the Piggyback Notice. Upon the writtenrequest of a Holder (a "REQUESTING HOLDER"), made within ten (10) days after thedate of the Piggyback Notice, that AXT include any of the Requesting Holder'sRegistrable Securities in such proposed registration statement, AXT shall usereasonable efforts to cause such registration statement (a "PIGGYBACKREGISTRATION STATEMENT") to be declared effective under the Securities Act bythe SEC so as to permit the public sale of the Requesting Holder's RegistrableSecurities pursuant thereto. Notwithstanding the provisions of this SECTION2(b), AXT shall have the right, at any time after it shall have given aPiggyback Notice pursuant to this SECTION 2(b) (irrespective of whether anywritten request for inclusion of Registrable Securities shall have already beenmade), to elect not to file any Piggyback Registration Statement or to withdrawthe same after the filing but prior to the effective date thereof. If theregistration pursuant to this SECTION 2(b) shall be underwritten in whole or inpart, the right of any Holder to have its Registrable Shares included in suchregistration shall be conditioned upon such Holder's participation in suchunderwriting and the inclusion of such Holder's Registrable Securities in theunderwriting upon the same terms and conditions as the other holders of AXTCommon Stock otherwise being sold through the underwriters. As a conditionprecedent to the inclusion of such Registrable Securities in such underwriting,each Holder acknowledges and understands that it may be required to (i) provideinformation and make representations and warranties to the underwritersconcerning such Holder's ownership and intended means of distribution of suchHolder's Registrable Securities 3 4and such other matters as may be required by law, (ii) indemnify theunderwriters to the extent as any other similarly situated holders includingshares in such underwriting, and (iii) enter into holdback and other agreementsat the request of the underwriters. If the managing underwriter for suchunderwriting advises AXT that marketing factors require limitation of the numberof shares to be underwritten, the underwriters and AXT may limit the number ofRegistrable Shares to be included in the registration and underwriting, or mayexclude Registrable Securities entirely from such registration and underwriting,in accordance with the following priorities: (i) First there shall be included in the registration andunderwriting any securities sought to be newly issued by AXT; (ii) Second, if after according priority to the securitiesdescribed in clause (i) above, additional shares are to be included in theregistration and underwriting in accordance with the advice of the underwriter,then the additional shares to be registered and sold shall be allocated pro rataamong the selling Holders of Registrable Securities and all other sellingshareholders that AXT has agreed may include shares in such registration. If application of the priorities set forth above should result in some but not all of the Registrable Securities sought to be included by Holders inthe registration and underwriting being so included, AXT shall advise allHolders of any such limitation, and the number of shares of RegistrableSecurities that may be included in the registration and underwriting shall beallocated among all Holders exercising their registration rights and all otherselling shareholders in proportion, as nearly as practicable, to the respectiveamounts of outstanding shares of common stock of AXT held by each such sellingshareholder to the total number of outstanding shares of AXT common stock. Ifany Holder disapproves of the terms of any such underwriting, it may elect towithdraw therefrom by written notice to AXT and the underwriter. Any RegistrableSecurities excluded or withdrawn from such underwriting shall be withdrawn fromsuch registration. (c) Information. Each Holder shall provide all information andmaterials to AXT, and take all action, as may be required in order to permit AXTto comply with all applicable requirements of law and of the SEC and to obtainany desired acceleration of the effective date of any Demand RegistrationStatement or Piggyback Registration Statement. The provision of such informationand materials by Holders is a condition precedent to the obligations of AXTpursuant to this Agreement. (d) Certain Limitations. (i) For each Holder who is an "insider" of AXT or who may bedeemed to be an Affiliate of AXT, AXT shall keep effective each DemandRegistration Statement filed pursuant to SECTION 2(a) and each PiggybackRegistration Statement which includes Registrable Securities of a RequestingHolder pursuant to SECTION 2(b) during such periods as directors, officers andAffiliates of AXT are permitted to purchase and sell AXT Common Stock pursuantto the insider trading policies of AXT (subject to the right of AXT to suspenduse of a prospectus pursuant to SECTION 3(b)) and, notwithstanding theprovisions of 4 5SECTION 3(a)(i) and any other provision of this Agreement to the contrary, shallnot be required to keep any such registration statement effective at any othertime. By making a registration request or selling any Registrable Securitiespursuant to any such registration statement, each such Holder who is an insideror Affiliate of AXT agrees that the right of such Holder to resell RegistrableSecurities pursuant to any such registration statement hereunder shall besuspended, unless otherwise agreed by AXT, whenever AXT "insiders" (as definedin the AXT insider trading policy furnished to such Holders and any amendmentsthereto hereafter furnished to such Holders) are restricted from trading capitalstock of AXT (a "RESTRICTED PERIOD"). Unless otherwise specified by AXT bywritten notice to such Holders who are insiders or Affiliates of AXT, the term"RESTRICTED PERIOD" shall include the period commencing at the opening oftrading on the first day of the third month of each fiscal quarter of AXT andexpiring at the close of trading on the second full trading day followingrelease of AXT financial results for such fiscal quarter (or, in the case of thefourth quarter of each year, for the fiscal year). If a Restricted Period shallcommence or shall expire or terminate on any other date, AXT shall provideadvance written notice of such commencement and prompt written notice of suchexpiration or termination. (ii) Notwithstanding any other provision of this Agreement, AXTshall be entitled to postpone the declaration of effectiveness of any DemandRegistration Statement filed pursuant to SECTION 2(a) and any PiggybackRegistration Statement filed pursuant to SECTION 2(b) for a reasonable period oftime, but not in excess of ninety (90) calendar days after the date the SEC hasinformed AXT that the registration statement will not be reviewed or that theSEC has no further comments with regard to the registration statement, if thechief executive officer of AXT, acting in good faith, determines that thereexists material nonpublic information about AXT which the Board of Directors ofAXT does not wish to disclose in a registration statement which information would otherwise be required by the Securities Act to be disclosed in any DemandRegistration Statement filed pursuant to SECTION 2(a) or any PiggybackRegistration Statement which includes Registrable Securities of a Holderpursuant to SECTION 2(b). (iii) With respect to any Demand Registration Statement filedpursuant to SECTION 2(a) and any Piggyback Registration Statement which includessecurities of a Requesting Holding pursuant to SECTION 2(b) or anypost-effective amendment, when the same has become effective; AXT shall notifyeach Holder (i) of any request by the SEC or any other federal or stategovernmental authority during the period of effectiveness of the registrationstatement for amendments or supplements to the registration statement or relatedprospectus or for additional information relating to the registration statement,(ii) of the issuance by the SEC or any other federal or state governmentalauthority of any stop order suspending the effectiveness of the registrationstatement or the initiation of any proceedings for that purpose, (iii) of thereceipt by AXT of any notification with respect to the suspension of thequalification or exemption from qualification of any of the RegistrableSecurities for sale in any jurisdiction or the initiation or threatening of anyproceeding for such purpose, or (iv) of the happening of any event which makesany statement made in the registration statement or related prospectus or anydocument incorporated or deemed to be incorporated therein by reference untruein any material respect or which requires the making of any changes in theregistration statement or prospectus so that, in the case of the registrationstatement, it will not contain an untrue statement of a material fact or omit tostate a material fact required to be stated therein or necessary to make thestatements therein not misleading, and that in the case of the prospectus, itwill not contain an untrue statement of a 5 6material fact or omit to state a material fact necessary in order to make thestatements therein, in the light of the circumstances under which they weremade, not misleading. In such event, AXT may suspend use of the prospectus onwritten notice to each Holder, in which case each Holder shall not dispose ofRegistrable Securities covered by the registration statement or prospectus untilcopies of a supplemented or amended prospectus are distributed to the Holders oruntil the Holders are advised in writing by AXT that the use of the applicableprospectus may be resumed. AXT shall use its commercially reasonable efforts toensure that the use of the prospectus may be resumed as soon as practicable. AXTshall use its commercially reasonable efforts to obtain the withdrawal of anyorder suspending the effectiveness of the registration statement, or the liftingof any suspension of the qualification (or exemption from qualification) of anyof the securities for sale in any jurisdiction, at the earliest practicablemoment. AXT shall, upon the occurrence of any event contemplated by clause (iv),prepare a supplement or post-effective amendment to the registration statementor a supplement to the related prospectus or any document incorporated thereinby reference or file any other required document so that, as thereafterdelivered to the purchasers of the Registrable Securities being sold thereunder,such prospectus will not contain an untrue statement of a material fact or omitto state a material fact necessary to make the statements therein, in light ofthe circumstances under which they were made, not misleading. 3. SELLING PROCEDURES. Any sale of Registrable Securities pursuant to theregistration statement filed and declared effective in accordance with SECTION2(a) hereof shall be subject to the following conditions and procedures: (a) Stockholder Notice. The selling Holder shall provide writtennotice ("STOCKHOLDER NOTICE") to AXT no less than five (5) business days priorto such Holder's intended sale. Within three (3) business days of receipt of theStockholder Notice, AXT will inform such Holder in writing if the registrationstatement and final prospectus then on file with the SEC is current andotherwise complies with the Securities Act such that sales may be madethereunder. After receipt of notice from AXT that the registration statement iscurrent and complies with the Securities Act, such Holder shall then have ten (10) business days to sell the Registrable Securities proposed to be sold,unless the notice from AXT specifies that no sale may be made until the date ofintended sale as specified in the Stockholder Notice, in which case such Holdermust wait until the date of the intended sale to make such sale and such Holdershall have ten (10) business days thereafter to made such sale. After such ten(10) day period, the Holder shall once again comply with the procedures setforth in this SECTION 3(a) prior to any further sales. (b) Updating the Prospectus. If AXT informs the selling Holder thatthe registration statement or final prospectus then on file with the SEC is notcurrent or otherwise does not comply with the Securities Act, AXT shall usecommercially reasonable efforts to promptly provide to the selling Holder acurrent prospectus that complies with the Securities Act on or before the dateof the intended sale of the Registrable Securities as disclosed in theStockholder Notice; provided, however, that AXT shall have the right to delaythe preparation of 6 7a current prospectus that complies with the Securities Act for up to sixty (60)days without explanation to the Holder, in which case the time of suchsuspension shall be added to the minimum of 180 days of effectiveness of theregistration statement set forth in SECTIONS 2(a) and 4(a). (c) Blackout Periods. In addition to the restrictions set forth inSECTION 2(d) above, Holders who become employees of AXT agree to be bound byAXT's Insider Trading Policy as such may be in effect from time to time for solong as such Holders remain employees of AXT and are subject to such policy. 4. OBLIGATIONS OF AXT. (a) Subject in each case to the limitations of SECTION 2 (includingSECTION 2(d)) above, AXT shall (i) use all reasonable efforts to cause suchregistration statement to become effective promptly after filing and to keepeach such registration statement effective until the Termination Date (ashereinafter defined); (ii) prepare and file with the SEC such amendments andsupplements to such registration statements and the prospectuses used inconnection therewith as may be necessary, and to comply with the provisions ofthe Securities Act with respect to the sale or other disposition of allsecurities proposed to be registered in each such registration statement untilthe Termination Date (as hereinafter defined); (iii) furnish to each Holder suchnumber of copies of any prospectus (including any preliminary prospectus and anyamended or supplemented prospectus) in conformity with the requirements of theSecurities Act, and such other documents, as each Holder may reasonably requestin order to effect the offering and sale of the shares of the RegistrableSecurities to be offered and sold, but only while AXT shall be required underthe provisions hereof to cause such registration statement to remain current;and (iv) use reasonable efforts to register or qualify the shares of theRegistrable Securities covered by such registration statement under thesecurities or blue sky laws of such jurisdictions as each Holder shallreasonably request (provided that AXT shall not be required in connectiontherewith or as a condition thereto to qualify to do business or to file ageneral consent to service of process in any such jurisdiction where it has notbeen qualified). For purposes of this SECTION 4(a), "TERMINATION DATE" withrespect to a given registration statement filed pursuant to SECTION 2(a) orSECTION 2(b) means the earlier of (i) the first anniversary of the Closing Date,(ii) such time as all of the Registrable Securities then held by such Holder canbe sold by such Holder in a three-month period in accordance with Rule 144 underthe Securities Act, (iii) the date on which all of the Registrable Securitieshave been resold pursuant to Rule 144 or an effective registration statement,and (iv) the date on which the registration statement has been effective for anaggregate of one hundred eighty (180) days. (b) In connection with any offering of shares of RegistrableSecurities registered pursuant to this Agreement, AXT shall (i) furnish each Holder, at AXT's expense, with unlegended certificates representing ownership ofthe shares of Registrable Securities being sold in such denominations as eachHolder shall request and (ii) instruct the transfer agent and registrar of theRegistrable Securities to release any stop transfer orders with respect to theshares of Registrable Securities being sold. 7 8 5. EXPENSES. AXT shall pay all of the out-of-pocket costs expensesincurred in connection with a registration of Registrable Securities pursuantSECTION 2(a) or SECTION 2(b) to this Agreement , including all SEC, NASD andblue sky registration and filing fees, printing expenses, transfer agents' andregistrars' fees, and the reasonable fees and disbursements of AXT's outsidecounsel and independent accountants, but not including underwriting discountsand commissions on the Registrable Securities and fees and costs of separatecounsel for the Holders. Underwriting fees and commissions on the RegistrableSecurities and any fees and costs of separate counsel retained by the Holdersshall be borne pro rata among the participating Holders on the basis of thenumber of shares registered. 6. INDEMNIFICATION. In the event of any offering registered pursuant tothis Agreement: (a) Indemnification by AXT. AXT will indemnify each Holder and itsdirectors, officers, legal counsel and independent accountants, and each personcontrolling a Holder, against all claims, losses, damages and liabilities (oractions in respect thereof), including any of the foregoing incurred insettlement of any litigation, commenced or threatened, arising out of or basedon any untrue statement (or alleged untrue statement) of a material factcontained in any registration statement, prospectus, or any amendment orsupplement thereto, incident to any offering registered pursuant to thisAgreement, or based on any omission (or alleged omission) to state therein amaterial fact required to be stated therein or necessary to make the statementstherein, in light of the circumstances in which they are made, not misleading,or any violation by AXT of any rule or regulation promulgated under theSecurities Act, or state securities laws applicable to AXT in connection withany such registration, and subject to SECTION 6(c) of this Agreement, willreimburse each such Holder, and each person controlling such Holder, for anylegal and any other out-of-pocket expenses reasonably incurred in connectionwith investigating, preparing or defending any such claim, loss, damage,liability or action, provided that AXT will not be liable to the extent that anysuch claim, loss, damage, or liability arises out of or is based in any untruestatement or omission or alleged untrue statement or omission, made in relianceupon and in conformity with written information furnished to AXT by such Holderor controlling person for use therein. (b) Indemnification by Holders. Each Holder will, if RegistrableSecurities held by such Holder are included in the securities as to which suchregistration, qualification or compliance is being effected, indemnify AXT, eachof its directors and officers and its legal counsel and independent accountants,each underwriter, if any, of AXT's securities covered by such a registrationstatement, each person who controls AXT or such underwriter within the meaningof Section 15 of the Securities Act, and each other such Holder, and suchHolder's legal counsel and independent accountants, against all claims, losses,damages and liabilities (or actions in respect thereof), including any of theforegoing incurred in settlement of any litigation, commenced or threatened,arising out of or based on any untrue statement (or alleged untrue statement) ofa material fact contained in any such registration statement, prospectus,offering circular or other document, or any omission (or alleged omission) tostate therein a material fact required to be stated therein or necessary to makethe statements therein not misleading, and will reimburse AXT, such Holders,such directors, officers, legal counsel, independent accountants, 8 9underwriters or control persons for any legal or any other expenses reasonablyincurred in connection with investigating or defending any such claim loss,damage, liability or action, in each case to the extent, but only to the extent,that such untrue statement (or alleged untrue statement) or omission (or allegedomission) is made in such registration statement, prospectus, offering circularor other document in reliance upon and in conformity with written informationfurnished to AXT by such Holder for use therein; provided, however, that theobligations of such Holders hereunder shall be several and not joint and shallbe limited to an amount equal to the respective net proceeds before expenses andcommissions to each such Holder of Registrable Securities sold as contemplatedherein. (c) Defending Claims. Each party entitled to indemnification underthis SECTION 6 (the "INDEMNIFIED PARTY") shall give notice to the party requiredto provide indemnification (the "INDEMNIFYING PARTY") promptly after suchIndemnified Party receives written notice of any claim as to which indemnity maybe sought, and shall permit the Indemnifying Party to assume the defense of anysuch claim or any litigation resulting therefrom, provided that counsel for theIndemnifying Party, who shall conduct the defense of such claim or litigation,shall be approved by the Indemnified Party (whose approval shall not beunreasonably withheld), and the Indemnified Party may participate in suchdefense at such party's expense, and provided further that the failure of anyIndemnified Party to give notice as provided herein shall not relieve theIndemnifying Party of its obligations under this Agreement, except to theextent, but only to the extent, that the Indemnifying Party's ability to defendagainst such claim or litigation is impaired as a result of such failure to givenotice. Notwithstanding the foregoing sentence, the Indemnified Party may retainits own counsel to conduct the defense of any such claim or litigation, andshall be entitled to be reimbursed by the Indemnifying Party for expensesincurred by the Indemnified Party in defense of such claim or litigation, in theevent that the Indemnifying Party does not assume the defense of such claim orlitigation within sixty days after the Indemnifying Party receives noticethereof from the Indemnified Party. Further, an Indemnifying Party shall beliable for amounts paid in settlement of any such claim or litigation only ifthe Indemnifying Party consents in writing to such settlement (which consentshall not be reasonably withheld). No Indemnifying Party, in the defense of anysuch claim or litigation, shall, except with the consent of each IndemnifiedParty, consent to entry of any judgment or enter any settlement which does notinclude as an unconditional term thereof the giving by the claimant or plaintiffto such Indemnified Party a release from all liability in respect to such claimor litigation. (d) Contribution. If the indemnification provided for in this Section3 from the Indemnifying Party is unavailable to an Indemnified Party hereunderin respect of any claim, loss, damage or liability referred to herein, then theIndemnifying Party, to the extent such indemnification is unavailable, in lieuof indemnifying such Indemnified Party, shall contribute to the amount paid orpayable by such Indemnified Party as a result of such claims, losses, damages orliabilities in such proportion as is appropriate to reflect the relative benefitto or fault of the Indemnifying Party and Indemnified Parties in connection withthe actions that resulted in such claims, losses, damages and liabilities. Therelative benefit of such Indemnifying Party and Indemnified Parties shall bedetermined by reference to, among other things, the gross proceeds received byeach such party from the sale of Registrable Securities in the mannercontemplated 9 10hereby. The relative fault of such Indemnifying Party and Indemnified Partiesshall be determined by reference to, among other things, whether any action inquestion, including any untrue or alleged untrue statement of a material fact oromission or alleged omission to state a material fact, has been made by, orrelates to information supplied by, such Indemnifying Party or Indemnified Parties, and the parties' relative intent, knowledge, access to information andopportunity to correct or prevent such action. The amount paid or payable by aparty as a result of the claims, losses, damages or liabilities referred toabove shall be deemed to include any legal fees or expenses reasonably incurredby such party in connection with any investigation or proceeding. The partieshereto agree that it would not be just and equitable if contribution pursuant tothis paragraph were determined by pro rata allocation or by any other method ofallocation that does not take account of the equitable considerations referredto above in this paragraph. No party guilty of fraudulent misrepresentation(within the meaning of Section 11(f) of the Securities Act) shall be entitled tocontribution from any party. (e) Survival. The obligations of AXT and each Holder under thisSECTION 6 shall survive the completion of any offering of Registrable Securitiesregistered pursuant to this Agreement and otherwise. 7. ASSIGNMENT OF REGISTRATION RIGHTS. The rights to cause AXT to registerRegistrable Securities pursuant to this Agreement may be assigned by a Holder toa transferee of Registrable Securities only if: (a) AXT is furnished withwritten notice of the name and address of such transferee and the RegistrableSecurities with respect to which such registration rights are being assigned anda copy of a duly executed written instrument in form reasonably satisfactory toAXT pursuant to which such transferee assumes all of the obligations andliabilities of its transferor hereunder and agrees itself to be bound hereby;and (b) immediately following such transfer, the disposition of such RegistrableSecurities by the transferee is restricted under the Securities Act. AXT shallnot be liable for failure to include such assignee's securities in any offeringhereunder unless AXT receives such written notice and agreement sufficiently inadvance of the effectiveness of the registration statement so as to permit suchinclusion without significant prejudice to the rights of AXT or of the otherHolders of Registrable Securities. 8. AMENDMENT OF REGISTRATION RIGHTS. This Agreement, and the registrationrights granted hereunder, may be amended or modified only by an instrument inwriting executed by or on behalf of AXT and Holders holding a majority of theRegistrable Securities then outstanding. 9. TERMINATION. The registration rights set forth in this Agreement shallterminate with respect to a Holder (and the shares held by such Holder shallcease to constitute Registrable Securities) upon the earlier of (i) the secondanniversary of the Closing Date, (ii) such time as all of the RegistrableSecurities then held by such Holder can be sold by such Holder in a three-monthperiod in accordance with Rule 144 under the Securities Act, and (iii) the dateon which all of the Registrable Securities have been resold pursuant to Rule 144or an effective registration statement. 10. MARKET STAND-OFF. The Holders hereby agree that, except as to anyRegistrable Securities included in the registration pursuant hereto, they shallnot, to the extent requested by 10 11AXT and an underwriter of AXT Common Stock, sell or otherwise transfer ordispose of any Registrable Securities for one hundred eighty (180) daysfollowing the effective date of a registration statement of AXT filed under theSecurities Act, provided that all officers and directors and holders of 5% ormore of the outstanding shares of Common Stock of AXT enter into similaragreements. In order to enforce the foregoing, AXT may impose stop-transferinstructions with respect to the Registrable Securities of the Holders (and theshares or securities of every other person subject to the foregoingrestrictions) until the end of such period. 11. OBLIGATIONS OF HOLDERS. By exercising any rights hereunder, eachHolder shall be deemed to assume all obligations of a Holder hereunder as thoughsuch Holder were a signatory hereto. AXT may require Holders to execute an instrument whereby such Holders expressly assume all obligations under thisAgreement of Holders as a condition precedent to any obligations of AXThereunder. 12. REPORTS UNDER THE 1934 ACT. For two years following the Closing Date,with a view to making available to the Holders the benefits of SEC Rule 144promulgated under the Securities Act and any other rule or regulation of the SECthat may at any time permit a Holder to sell securities of AXT to the publicwithout registration, AXT agrees to: (a) make and keep public information available, as those terms areunderstood and defined in SEC Rule 144; (b) file with the SEC in a timely manner all reports and otherdocuments required of AXT under the Securities Act and the Exchange Act; (c) furnish to any Holder, so long as the Holder owns any RegistrableSecurities, forthwith upon request (i) a written statement by AXT as to itscompliance with the reporting requirements of SEC Rule 144 , the Securities Actand the Exchange Act, (ii) a copy of the most recent annual or quarterly reportof AXT and such other reports and documents so filed by AXT, and (iii) suchother information as may be reasonably requested in availing any Holder of anyrule or regulation of the SEC which permits the selling of any such securitieswithout registration. 11 12 IN WITNESS WHEREOF, this Agreement has been executed by the parties ortheir representatives thereunto duly authorized as of the date first writtenabove. AMERICAN XTAL TECHNOLOGY, INC. By: /s/ Morris S. Young -------------------------- Name: Morris S. Young Title: Chief Executive Officer and President LYTE OPTRONICS, INC. /s/ Keith Halsey ------------------------------ Name: Keith Halsey Title: Chief Executive Officer SHAREHOLDERS' REPRESENTATIVE By: /s/ Keith Halsey -------------------------- Keith Halsey /s/ Robert Shih -------------------------- Robert Shih [Signature Page to Registration Rights Agreement] 12 1 EXHIBIT 21.1EXHIBIT 21.1 -- LIST OF SUBSIDIARIESAmerican Xtal Technology Japan Co. LTDBeijing Tongmei Xtal Technology Co., LTDAlpha Photonics (Barbados), Inc.Advanced Semiconductors Corp. Ltd.Lyte Optronics, Ltd.Bestal International Corporation 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTSWe hereby consent to the incorporation by reference in the RegistrationStatement on Form S-8 (No. 333-67297) of American Xtal Technology, Inc. of ourreport dated March 20, 2000 relating to the financial statements, which appearsin this Form 10-K.PricewaterhouseCoopers LLPSan Jose, CaliforniaApril 13, 2000 1 EXHIBIT 23.2CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTSAs independent public accountants, we hereby consent to the incorporation of ourreports included in this Form 10-K, into the Company's previously filedRegistration Statement File No. 333-67297.ARTHUR ANDERSEN LLPLos Angeles, CaliforniaApril 13, 2000
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