AXT
Annual Report 2000

Plain-text annual report

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, 2000 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 AXT, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 94-3031310 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 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: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $.001 PAR VALUE Indicate by checkmark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes [X] No [ ] Indicate by checkmark if disclosure of delinquent filers pursuant to Item405 of Regulation S-K is not contained herein, and will not be contained, to thebest of registrant's knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K. The aggregate market value of the voting stock held by non-affiliates ofthe registrant, based upon the closing sale price of the common stock onDecember 31, 2000 as reported on the Nasdaq National Market, was approximately$662,397,732. Shares of common stock held by each officer, director and by eachperson who owns 5% or more of the outstanding common stock have been excluded inthat such persons may be deemed to be affiliates. This determination ofaffiliate status is not a conclusive determination for other purposes. As of January 31, 2001, 22,025,628 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 2001 annualmeeting of stockholders to be filed with the Commission pursuant to Regulation14A not later than 120 days after the end of the fiscal year covered by thisform are incorporated by reference into Part III of this Form 10-K report. ---------------------------------------------------------------------------------------------------------------------------------------------------------------- 2 PART I This report includes forward-looking statements which reflect our currentviews with respect to future events and our potential financial performance.These forward-looking statements are subject to certain risks and uncertainties,including those discussed in "Business", "Management's Discussion and Analysisof Financial Condition and Results of Operations", and elsewhere in this report,that could cause actual results to differ materially from historical results orthose anticipated. In this report, the words "anticipates," "believes,""expects," "intends," "future" and similar expressions identify forward-lookingstatements. Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date of this report. ITEM 1. BUSINESS -- OVERVIEW We design, develop, manufacture and distribute high-performance compoundsemiconductor substrates, as well as opto-electronic semiconductor devices, suchas high-brightness light emitting diodes, or HBLEDs, and vertical cavity surfaceemitting lasers, or VCSELs. Our substrate products are used primarily in fiberoptic communications, wireless communications and lighting display applications.We believe our proprietary vertical gradient freeze, or VGF, technique formanufacturing compound semiconductor substrates provides significant benefitsover traditional methods and has enabled us to become a leading manufacturer ofcompound semiconductor substrates. We pioneered the commercial use of VGFtechnology to manufacture gallium arsenide, or GaAs, substrates and have usedVGF technology to manufacture substrates from other materials, such as indiumphosphide, or InP, and germanium, or Ge. Customers for our substrates includeAlpha Industries, Agilent Technologies, EMCORE, Nortel Networks, RF MicroDevices, SDL and Sumitomo Chemical. Our acquisition of Lyte Optronics providedus with expertise in epitaxial processes for manufacturing opto-electronicsemiconductor devices. We have used these capabilities to make blue, green andcyan HBLEDs and VCSELs. Our opto-electronic semiconductor devices are used in awide range of applications, such as solid-state lighting and fiber opticcommunications. We have recently undertaken an initiative to significantlyexpand our substrate and device manufacturing capacity and to reduce the overallcost structure of our manufacturing operations. INDUSTRY BACKGROUND Historically, most semiconductor devices were created on a single crystalbase material, or substrate, of silicon. Today, however, a growing number ofelectronic and opto-electronic devices are being developed with requirementsthat exceed the capabilities of silicon. Many of these devices address thecontinually increasing demand to send, receive and display information onhigh-speed wireless and wireline networks. This demand has created a growingneed for power-efficient high-performance systems that can operate at highfrequencies and can be produced cost-effectively in high volumes. These systemsenable the growth and development of a wide range of end-user applications. Forexample, International Data Corporation, or IDC, expects the number of mobilewireless devices for Internet access and other data transmission to grow from10.0 million units in 1999 to more than 562.0 million units by 2004. Other examples of applications for these systems include: - fiber optic networks and optical systems within these networks; - new voice and high-speed wireless data systems; - infrared emitters and optical detectors in computer systems; - solid-state lighting, including exterior and interior automobile lighting; and - satellite communications systems. As a result of the limitations of silicon-based technologies, semiconductordevice manufacturers are increasingly using compound semiconductor substrates toimprove the performance of semiconductor devices and to enable these newapplications. This shift is occurring even though these compound semiconductorsubstrates are more expensive. Compound semiconductor substrates are composed ofmultiple elements that 1 3 include a metal, such as gallium, aluminum or indium, and a non-metal, such asarsenic, phosphorus or nitrogen. The resulting compounds include galliumarsenide, indium phosphide and gallium nitride. Advantages of devicesmanufactured on compound substrates over devices manufactured using siliconsubstrates include: - operation at higher speeds; - lower power consumption; - less noise and distortion; and - opto-electronic properties that enable devices to emit and detect light. The first step in producing a compound semiconductor substrate is to grow acrystal of the materials. Historically, two processes have been used to growcrystals: the Liquid Encapsulated Czochralski, or LEC, technique and theHorizontal-Bridgeman, or HB, technique. We believe two trends are reducing theappeal of these techniques: more semiconductor devices are being formed using anepitaxial process and semiconductor device manufacturers are switching theirproduction lines to six-inch diameter substrates. The LEC and HB techniques eachhave difficulties producing six-inch, high-quality, low-cost compoundsemiconductor substrates for epitaxial processing. We introduced our VGFtechnique in 1986 to respond to the limitations inherent in the LEC and HBtechniques. Compound semiconductor substrates enable the development of a wide range ofelectronic products including power amplifiers and radio frequency integratedcircuits used in wireless handsets. Compound substrates can also be used tocreate opto-electronic products including HBLEDs and VCSELs used in solid statelighting and fiber optic communications. HBLEDs are solid-state compound semiconductor devices that emit light. Theglobal demand for HBLEDs is experiencing rapid growth because HBLEDs have a longuseful life, consume approximately 10% of the power consumed by incandescent orhalogen lighting and improve display visibility. Applications where HBLEDs areincreasingly used include wireless handset displays, automotive displays, fullcolor video displays, traffic lights and various consumer applications.According to Strategies Unlimited, an independent industry analyst, the marketfor HBLEDs is expected to grow from $1.2 billion in 2000 to approximately $3.3billion by 2005.  VCSELs are semiconductor lasers that emit light in a cylindrical beam andoffer significant advantages over traditional laser diodes, including greatercontrol over beam size and wavelength, reduced manufacturing complexity andpackaging costs, lower power consumption and higher frequency performance.Electronics and computing systems manufacturers are using VCSELs in a broadrange of end-market applications, including fiber optic switching and routing,such as Gigabit Ethernet for communications networks and Fibre Channel forstorage area networks. According to ElectroniCast, an independent industryanalyst, the market for VCSELs is expected to grow from $262.0 million in 1999to approximately $3.4 billion by 2004. THE AXT ADVANTAGE We are a leading developer and supplier of high-performance compoundsemiconductor substrates and opto-electronic semiconductor devices, includingHBLEDs and VCSELs. There are four key causes of our success: Our VGF technology is a competitive advantage. We pioneered the commercialuse of VGF technology to manufacture GaAs substrates and we believe that throughthe use of VGF we have become the leading worldwide supplier of GaAs substrates.Our VGF process produces substrates with high mechanical strength and physicaland chemical uniformity, as well as a low defect rate. The following changes inour customers' technologies are increasing demand for substrates with thesefeatures: - Greater use of epitaxy rather than ion implantation. Many of the newest generation of high-performance semiconductor devices for fiber optic and wireless communications applications, including heterojunction bipolar transistors, or HBTs, and pseudomorphic high electron mobility transistors, or 2 4 PHEMTs, are popular because they offer lower power consumption and better device linearity than their predecessors. These devices are created using epitaxial processed substrates. Our VGF substrates are more suitable for these applications than are our competitors' products. - Switch to six-inch diameter wafers. Many of our semiconductor device manufacturing customers are switching their GaAs production lines to six-inch diameter substrates in order to reduce unit costs and increase capacity. Our VGF technique is better suited to developing six-inch substrates than are competing methods. - Introduction of InP substrates. Even GaAs cannot meet the requirements for increasing system performance and network bandwidth of some applications, including SONET OC-768 applications that operate at speeds up to 40 gigabits per second. Manufacturers of these devices are turning to InP substrates that can support these features. We have successfully used our VGF technique to develop InP and we were among the first to offer four-inch InP substrates. In addition, VGF technology gives us further benefits. - Customer technology independence. Our semiconductor device manufacturing customers often compete among themselves. For example, several of our customers compete for technological leadership in the wireless handset market. These customers or end-users all require devices made on GaAs substrates. We are, therefore, largely immune from the effects of such competition and benefit from an overall need for faster, more power efficient electronic and opto-electronic devices. - Faster and less expensive capacity expansion. We build our own crystal growing equipment rather than ordering it from third-party vendors. This capability, coupled with the fact that our equipment is less expensive and simpler to manufacture than LEC equipment, enables us to increase our capacity faster and at lower cost than our competitors. This ability is particularly beneficial in the current rapid growth environment for six-inch GaAs and all InP substrates. Retaining the equipment manufacturing process within AXT also helps protect our proprietary technology. Some customers specify VGF substrates. Our wafers are qualified with mostof the key suppliers of GaAs and InP semiconductor devices. The qualificationprocess, which is lengthy and must be repeated for each customer, can be abarrier to entry for a new material or supplier. Furthermore, certain of ourcustomers now specify that they will only accept VGF-grown substrates for theirmanufacturing processes. As the businesses of these customers grow, we arewell-positioned to grow with them as a key supplier. Our low-cost manufacturing is an advantage. We use our technology andeconomics of scale to be a low-cost manufacturer. Our expansion in Chinaprovides us with a combination of lower costs for facilities, labor andmaterials than we encounter in the United States and positions us to gain accessto low-cost raw materials supply sources. Furthermore, as we increase ourproduction capacity, we are able to spread fixed costs over a larger revenuebase, thereby leveraging our cost structure and achieving economies of scale. We entered the opto-electronic semiconductor device market quickly throughour acquisition of Lyte Optronics. Our acquisition of Lyte Optronics provided uswith expertise in epitaxial processes for manufacturing high-volumes ofopto-electronic semiconductor devices. High-quality epitaxy is a key requirementfor most of today's advanced opto-electronic semiconductor devices, such asHBLEDs and VCSELs. Since acquiring Lyte Optronics, we have developedopto-electronic products that are among the more difficult to create usingepitaxy, including green HBLEDs and VCSELs. We have filed five patentapplications for our approach to fabricating HBLEDs. We believe that we can bean important additional domestic source of these devices. 3 5 THE AXT STRATEGY Our goals are to strengthen our position as the leading developer andsupplier of high-performance compound semiconductor substrates and to develop aleading position in the market for opto-electronic semiconductor devices. Keyelements of our strategy include: Expand GaAs substrate manufacturing capacity and decrease manufacturingcost structure. We are increasing our production capacity in order to increaseour share of the market for GaAs substrates. We believe that we can extend ourleadership position by increasing our manufacturing capacity more rapidly thancompetitors and in a manner that enables us to further lower unit productioncosts. Much of this capacity increase will be for production of our six-inchdiameter GaAs substrates. We further believe that expanding our manufacturingoperations in China will allow us to increase capacity more quickly and at lowercost. Furthermore, this expansion will allow us to form strategic alliances withsuppliers of key raw materials. Strengthen our leadership position in the InP market. We believe that therewill be rapid growth in demand for the next generation of high speed fiber opticdevices, such as devices used in SONET OC-768 applications. These products aremanufactured on InP substrates and we are positioning ourselves to be theleading supplier of InP substrates by significantly expanding our productioncapacity. Our sales of InP substrates during the year ended December 31, 2000grew 373.8% compared to our sales of InP substrates during 1999. Advance VGF technology leadership. We believe that our ability to producehigh-quality substrates using VGF technology continues to provide us with acompetitive advantage in the high growth compound semiconductor substratemarkets. We intend to continue our investment in research and development inorder to expand our leadership position in the commercial use of VGF technology.For example, we intend to leverage our existing knowledge in growing six-inchGaAs substrates to grow longer crystals, which will further reduce our costs. Weare also launching an effort to develop six-inch diameter InP substrates inresponse to customer requests. Enhance our opto-electronic semiconductor devices. We intend to furtherpenetrate the high growth HBLED and VCSEL markets through continued investmentin research and development and expansion of production capacity. We areexpanding our manufacturing capacity by adding metal-organic chemical vapordeposition, or MOCVD, reactors and are modifying our epitaxial process toimprove device performance and yield. We have invested in the research andinfrastructure required to grow our own sapphire substrates, which are used inproducing blue, green and cyan LEDs. During the next year we expect to increaseour VCSEL sales and develop our chip fabrication capabilities, which will enableus to develop one- and two-dimensional VCSEL arrays. Leverage existing customer relationships. We currently sell our GaAssubstrates to more than 300 customers and believe that we are a qualifiedprovider to most of the significant users worldwide of GaAs substrates. Weintend to capitalize on our relationships with our customers in order to bothexpand sales of GaAs substrates and sell other compound substrates, such as InP.We also intend to establish alliances and joint development arrangements withcustomers in emerging high growth markets to develop new products, increasemanufacturing efficiencies and more effectively serve our customers' needs. 4 6 TECHNOLOGY Our core technologies include our proprietary VGF technique used to producehigh quality crystals that are processed into compound substrates, and ourepitaxy technologies that enable us to manufacture blue, green and cyan HBLEDsand VCSELs. [VGF DIAGRAM] Our VGF technique is designed to control the crystal-growth process withminimal temperature variation and is the technique we use to produce our GaAs,InP and Ge substrates. Unlike traditional techniques, our VGF technique placesthe hot compound melt above the cool crystal, thereby reducing the turbulence ofthe melt which results when the melt and crystal are inverted. The temperaturegradient between the melt and the crystal in the VGF technique is significantlylower than in traditional techniques. These aspects of the VGF technique enableus to grow crystals that have a relatively low defect density and highuniformity. The crystal and the resulting substrate, are mechanically strong,resulting in lower breakage rates during a customer's manufacturing process.Since the temperature gradient is controlled electronically rather than byphysical movement, the sensitive crystal is not disturbed. In addition, the meltand growing crystal are contained in a closed chamber, which isolates thecrystal from the outside environment to reduce potential contamination. Thissubstrate isolation allows for more precise control of the gallium-to-arsenicratio, resulting in better consistency and uniformity of the crystals. Our VGF technique offers several benefits when compared to traditionalcrystal growing technologies. The Liquid Encapsulated Czochralski, or LEC,technique is the traditional method for producing semi-insulating GaAssubstrates for electronic applications. During the LEC process, the crystal isgrown 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. Unlike the VGF technique, the LEC technique is designed so thatthe hotter GaAs melt is located beneath the cooler crystal, resulting in greaterturbulence in the melt, and at a temperature gradient that is significantlyhigher than the VGF technique. The turbulence and high temperature causeLEC-grown crystals to have a higher dislocation density than VGF-grown crystals,resulting in a higher rate of breakage during the device manufacturing process.As an open process, the LEC technique also results in greater propensity forcontamination and difficulty controlling the ratio of gallium to 5 7 arsenic. It requires large, complex electro-mechanical systems that areexpensive and require highly skilled personnel to operate. Our VGF technique also offers advantages over the Horizontal-Bridgeman, orHB, technique, for producing semi-conducting GaAs substrates for opto-electronicapplications. The HB technique holds the GaAs melt in a semi-cylindricalcontainer, causing crystals grown using the HB method to have a semi-circular,or D-shaped, cross-section. Accordingly, more crystal material is discarded whenthe D-shaped substrate is subsequently trimmed to a round shape. In addition,crystals grown using the HB technique have a higher defect density thanVGF-grown crystals. The HB technique cannot be used cost-effectively to producesubstrates greater than three inches in diameter. The HB technique houses theGaAs melt in a quartz container during the growth process, which can contaminatethe GaAs melt with silicon impurities, making it unsuitable for producingsemi-insulating GaAs substrates. The following table provides a comparison of these three techniques: VGF --------------- HB LEC ELECTRONIC AND --------------- -------------- SUBSTRATE APPLICATIONS OPTO-ELECTRONIC OPTO-ELECTRONIC ELECTRONIC ---------------------- --------------- --------------- -------------- Largest wafer size available........ 6" 3" 6"Stress/defect levels................ Very Low Low HighCrystal purity...................... Good Poor GoodApplicability to multiple materials......................... GaAs, InP, Ge GaAs GaAs, InP, GaPEquipment and labor cost............ Very Low Low HighAmount of waste material............ Very Low High LowEquipment flexibility............... Versatile Limited LimitedEquipment downtime.................. Minimal Moderate HighNumber of competitors............... Few Many Many VCSEL devices include single lasers as well as one- and two-dimensionalarrays of lasers. Array products are more highly valued than single lasersbecause they provide greater bandwidth, but are harder to form because theyrequire epitaxial structures that possess very high uniformity in chemicalcomposition and low variation in thickness. These features are hard to achievebecause the epitaxial process used to make a VCSEL device places approximately200 layers of epitaxial structure on a substrate, as compared to the less than10 layers of material deposited on a substrate to make an HBLED. Our epitaxialprocess, which includes proprietary in situ monitoring techniques, allows us tomanufacture highly reliable VCSEL wafers that demonstrate comparatively lowthreshold currents and high output power and are sufficiently uniform to produceone- and two-dimensional VCSEL devices. We employ both ion implantation andoxidation processes to produce VCSEL devices from our wafers. We create our opto-electronic semiconductor devices using MOCVD, which isan epitaxial technique to synthesize compound semiconductor thin films ontosubstrates. MOCVD reactors are available from multiple sources and wafersfabricated using MOCVD generally possess a better combination of uniformity andoptical and electronic properties and are easier to produce cost-effectively inhigh volumes than wafers manufactured by other methods, such as molecular beamepitaxy, vapor phase epitaxy or liquid phase epitaxy. As a result, MOCVDreactors have become the choice of the opto-electronic industry for fabricatingdevices such as LEDs, VCSELs and laser diodes. We modify our MOCVD reactors toimprove their performance and use a proprietary growth recipe that controlstemperature, material impurity, defect density, material thickness and layercomposition while allowing for multiple wafer batch replication. 6 8 PRODUCTS We design, develop, manufacture and distribute high-performancesemiconductor substrates, as well as opto-electronic devices, such as HBLEDs andVCSELs. The table below sets forth our products and selected applications: ------------------------------------------------------------------------------------------------PRODUCT APPLICATIONS------------------------------------------------------------------------------------------------ SUBSTRATES ELECTRONIC OPTO-ELECTRONIC GaAs - Cellular phones - LEDs - Direct broadcast television - Lasers - High-performance transistors - Optical couplers - Satellite communications - Displays InP - Fiber optic communications - Fiber optic communications - Satellite communications - Lasers - High-performance transistors - Automotive collision avoidance radars Ge - Satellite solar cells------------------------------------------------------------------------------------------------ VISIBLE EMITTERS Blue, green and cyan - Full color displays HBLEDs - Lighting for the interior and exterior of automobiles - Traffic signals - Back lighting for cellular phones and instrument panels - White light for general illumination VCSELs - Fiber optic and wireless communications------------------------------------------------------------------------------------------------ Substrates. We currently sell compound substrates manufactured from GaAsand InP, as well as single-element substrates manufactured from Ge. We supplyGaAs substrates in two-, three-, four-, five- and six-inch diameters. Wemanufacture InP substrates in two-, three- and four-inch diameters and Gesubstrates in four-inch diameters. We are developing and intend to initiateproduction of sapphire substrates. Visible Emitters. We sell blue, green and cyan HBLED products in wafer andchip form. We began selling blue HBLED products in the first quarter of 2000 andhave recently begun shipping green and cyan HBLEDs. We introduced our firstVSCEL product in August 2000. CUSTOMERS We sell our compound semiconductor substrates worldwide to leadingsemiconductor device manufacturers. Our top substrate customers include: Agilent TechnologiesAlpha IndustriesAlpha PhotonicsEMCOREEpistarEptaxial ProductsEpitronicsKopinMotorolaNortel NetworksOsramPicogigaPrecision Opto WaferQuantum Epitaxial DesignsRF Micro DevicesSDLSpectrolabSumitomo ChemicalTRW Space & DefenseVisual Photonics Epitaxy We sell our HBLED products primarily to customers that incorporate theminto lighting products. Our HBLED customers include Harvatek and King Brite. MANUFACTURING We believe that our success is partially due to our manufacturingefficiency and high product yields and we continually emphasize quality andprocess control throughout our manufacturing operations. We perform 7 9 our substrate manufacturing operations at our facilities in Fremont, Californiaand Beijing, China. As part of our plan to reduce manufacturing costs, we areshifting many of our labor-intensive processes to our facilities in China, wherecosts, including labor costs, are generally lower. We intend to transfer themajority of our substrate manufacturing operations to China by the end of 2001.We believe that our capital investment and subsequent operating costs are lowerfor our manufacturing facilities in China relative to the U.S. Many of ourmanufacturing operations are fully automated and computer monitored orcontrolled, enhancing reliability and yield. We use proprietary equipment in oursubstrate manufacturing operations to protect our intellectual property andcontrol the timing and pace of capacity additions. By assembling our ownequipment, we can quickly increase capacity without incurring delays caused byordering additional equipment or converting older equipment to new technologies.Our epitaxial wafer production is located in El Monte, California. Our Fremontand Beijing substrate facilities are ISO 9002 certified, and we are workingtoward ISO certification for our other manufacturing facilities. We depend on a single or limited number of suppliers for certain criticalmaterials used in the production of our substrates. We generally purchase thesematerials through standard purchase orders and not pursuant to long-term supplycontracts. Although we seek to maintain sufficient inventory levels of certainmaterials to guard against interruptions in supply and to meet our near termneeds, and have to date been able to obtain sufficient supplies of materials ina timely manner, there may be shortages of certain key materials, such asgallium. Accordingly, to help ensure continued supply of materials, we haveformed strategic alliances with suppliers of key raw materials required tomanufacture our products. We believe that these alliances will be advantageousin procuring materials to support our continued growth. We use MOCVD equipment to manufacture our opto-electronic devices. We areinstalling several new MOCVD reactors and expect that these additional machineswill meet our needs for the foreseeable future. The substrate materials and rawwafers used in our visible emitter products are purchased from our substratedivision and other sources. SALES AND MARKETING Each of our divisions is responsible for its own sales and marketingactivities, and each maintains its own sales and marketing personnel. Inaddition, each of our divisions advertises in trade publications, distributespromotional materials, publishes technical articles, conducts marketing programsand participates in industry trade shows and conferences in order to raisemarket awareness of our products. Substrates. We sell our substrate products through our direct sales forcein the U.S. and through independent sales representatives in France, Japan,South Korea, Taiwan and the United Kingdom. Our direct sales force consists ofsales engineers who are knowledgeable in the manufacture and use of compound andsingle-element substrates. Our sales engineers work with customers during allstages of the substrate manufacturing process, from developing the precisecomposition of the substrate through manufacturing and processing the substrateto the customer's exact specifications. We believe that maintaining a closerelationship with customers and providing them with ongoing technical supportimproves customer satisfaction and will provide us with a competitive advantagein selling other substrates to our customers. The substrate division haslaunched a program with selected customers in which we will guarantee that highvolumes of six-inch GaAs and other substrates will be delivered on specificdates and the customer will make a prepayment for part of the value of itsorder. We intend to allow several major customers to participate in thisprogram. Visible Emitters. We sell our HBLED products primarily through independentsales representatives to lamp package manufacturers in Taiwan and China. Weintend to expand sales of these products in the U.S. and Europe primarily usingour direct sales force. We sell our VCSEL devices through our direct sales forceand through independent sales representatives. RESEARCH AND DEVELOPMENT To maintain and improve our competitive position, we focus our research anddevelopment efforts on designing new proprietary processes and products,improving the performance of existing products and reducing manufacturing costs.We have assembled a multi-disciplinary team of highly skilled scientists, 8 10 engineers and technicians to meet our research and development objectives. As aresult of our ongoing research and development activities, we believe that weoffer superior quality products. For example, some customers now qualifysubstrates manufactured using our VGF technique as the only acceptable materialin their design specifications. Our current substrate research and development activities focus oncontinued development and enhancement of six-inch GaAs crystals, includingimproved yield, greater substrate strength and increased crystal length. Wecontinue to develop other compound substrates, such as InP and a low boronversion of our standard GaAs substrates and are initiating research intodevelopment of six-inch InP products. We are developing and intend to initiateproduction of sapphire substrates. We are focusing on all three major stages of LED development: epitaxy,wafer fabrication and die fabrication. Our goal is to improve brightness andyield, create specific colors and enhance uniformity of product, both within andacross production runs. Specific colors are created by controlling the indiumcontent of the epitaxial layers, which we achieve, in part, from modificationsthat we make to our MOCVD reactors. The wafer and die fabrication experience wegained in our Lyte Optronics laser diode operation has helped us develop similartechniques for LEDs. We began research in 1999 to develop VCSEL devices with uniform epitaxystructures on three-inch wafers and announced VCSEL wafer products in August2000. We continue to improve their performance characteristics and intend todevelop one- and two-dimensional array VCSEL chips. We have historically funded a significant portion of our research anddevelopment efforts through contracts with the U.S. government and customerfunded research projects, although we do not have any projects underwaycurrently. Under our contracts, we retain rights to the VGF and waferfabrication technology that we have developed. The U.S. government retains therights to utilize the technologies we develop for government purposes only.During the period from 1997 to 1999 these contracts amounted to $5.7 million.Currently, our research and development is internally funded. COMPETITION The semiconductor industry is characterized by rapid technological changeand price erosion, as well as intense foreign and domestic competition. Webelieve we currently have a leading position in the existing markets forcompound semiconductor substrates primarily as a result of our expertise in VGFtechnology. However, we believe we face actual and potential competition from anumber of established domestic and international companies. We believe that the primary competitive factors in the markets in which ourproducts compete are: - quality; - price; - performance; - meeting customer specifications; - customer support and satisfaction; and - customer investment in 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 use of intellectual property laws and general economic conditions. 9 11 Our primary competition in the market for compound semiconductor substratesincludes Freiberger, Hitachi Cable, Japan Energy, Litton Airtron and SumitomoElectric. In addition, we also face competition from compound semiconductordevice manufacturers that produce substrates for their own internal use, andfrom companies such as IBM that are actively developing alternative compoundsemiconductor materials. Our primary competition in the market for LED products include Cree,LumiLED, Nichia Chemicals, Toyoda Gosei and United Epitaxy. In general, LEDmanufacturers in Taiwan and China have a competitive pricing advantage due tolow overhead and small research and development investments. Cree, NichiaChemicals, Sony and Toyoda Gosei have significant patent portfolios that othercompetitors, including us, must either design around or license. We compete with Agilent, EMCORE and Honeywell in the market for VCSELdevices. PROTECTION OF OUR INTELLECTUAL PROPERTY Our success and the competitive position of our VGF technique depend on ourability to maintain trade secrets and other intellectual property protections.We rely on a combination of patents, copyrights, trademark and trade secretlaws, non-disclosure agreements and other intellectual property protectionmethods to protect our proprietary technology. We believe that, due to the rapidpace of technological innovation in the markets for our products, our ability toestablish and maintain a position of technology leadership depends as much onthe skills of our development personnel as upon the legal protections affordedour existing technologies. To protect our trade secrets, we take certainmeasures to ensure their secrecy, such as executing non-disclosure agreementswith our employees, customers and suppliers. However, reliance on trade secretsis only an effective business practice insofar as trade secrets remainundisclosed and a proprietary product or process is not reverse engineered orindependently developed. To date, we have been issued four U.S. patents which relate to our VGFproducts and processes. We have five U.S. patent applications pending whichrelate to our LED or laser diode technology, and have patent applicationspending in Europe, Canada, China, Japan and Korea which are based on one of ourU.S. patents that relates to our VGF processes. We have no issued foreignpatents. 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 arsenic. We cannot guarantee that our control systems will besuccessful in preventing a release of these materials or other adverseenvironmental conditions. Any release or other failure to comply with present orfuture environmental laws and regulations could result in the imposition ofsignificant fines against us, the suspension of production or a cessation ofoperations. We are cooperating with the California Occupational Safety and HealthAdministration, or Cal-OSHA, in an investigation regarding impermissible levelsof potentially hazardous materials in certain areas of our manufacturingfacility in Fremont, California. In May 2000, Cal-OSHA levied a fine against usin the amount of $313,655 for alleged health and safety violations. We areappealing the citations, and have put in place engineering, administrative andpersonnel protective equipment programs to address this issue. To our knowledge,no accidents or injuries resulted from this matter. EMPLOYEES As of December 31, 2000, we had 1,359 full-time employees, of whom 1,117were principally engaged in manufacturing, 176 in sales and administration and66 in research and development. Of these employees, 826 are located in the U.S.,531 in China and 2 in Japan. Our success is in part dependent on our ability toattract and retain highly skilled workers. Our employees are not represented bya union and we have never experienced a work stoppage. We consider our relationswith our employees to be good. 10 12 EXECUTIVE OFFICERS AND DIRECTORS As of December 31, 2000, our executive officers and directors were asfollows: NAME AGE POSITION ---- --- -------- Morris S. Young, Ph.D. .............. 56 Chairman of the Board of Directors, President and Chief Executive OfficerDonald L. Tatzin..................... 49 Senior Vice President, Chief Financial Officer and DirectorDavis Zhang.......................... 44 President, Substrate DivisionXiao Gordon Liu, Ph.D. .............. 37 Senior Vice President, Marketing and Sales, and Engineering and DevelopmentHeng Liu, Ph.D. ..................... 40 President, LED DivisionBingwen Liang, Ph.D. ................ 39 President, VCSEL DivisionJesse Chen........................... 42 DirectorB.J. Moore........................... 64 DirectorDavid C. Chang, Ph.D................. 59 Director Morris S. Young, Ph.D. co-founded AXT in 1986 and has served as chairman ofour board of directors since February 1998 and president and chief executiveofficer, as well as a director, since 1989. From 1985 to 1989, Dr. Young was aphysicist at Lawrence Livermore National Laboratory. Dr. Young holds a bachelorof science degree in metallurgical engineering from Chengkung University,Taiwan, a master of science degree in metallurgy from Syracuse University and aPh.D. in metallurgy from Polytechnic University. Donald L. Tatzin has served as a director since February 1998 and as chieffinancial officer since August 2000. From April 2000 to August 2000, Mr. Tatzinserved as our interim chief financial officer. From 1993 to 1998, Mr. Tatzinserved as executive vice president of Showboat, a gaming company. In addition,Mr. Tatzin served as a director for Sydney Harbour Casino, an Australian gamingcompany, from April 1995 to October 1996 and as its chief executive officer fromApril 1996 to October 1996. From 1976 to 1993, Mr. Tatzin was a director andconsultant with Arthur D. Little. Mr. Tatzin holds a bachelor of science degreein economics and a bachelor of science and masters degrees in city planning fromthe Massachusetts Institute of Technology and a master of science degree ineconomics from Australian National University. Davis Zhang co-founded AXT in 1986 and served as senior vice president,production from January 1994 until August 1999, and as president of thesubstrate division since August 1999. From 1987 to 1993, Mr. Zhang served as oursenior production manager. Mr. Zhang holds a bachelor of science degree inmechanical engineering from Northern Communication University, Beijing, China. Xiao Gordon Liu, Ph.D. joined us in June 1995 as senior engineer and waspromoted to vice president, engineering and development in November 1998 and tosenior vice president, marketing and sales, and engineering and development inAugust 2000. Prior to joining us, Dr. Liu was a postdoctoral fellow andassociate specialist at University of California at Berkeley and a researchassociate at the University of Lund, Sweden. Dr. Liu holds a Ph.D. in physicsfrom the University of Lund, Sweden and has published more than 30 scientificpapers. Heng Liu, Ph.D. joined us in September 1999 as director of LED epitaxy andwas promoted to president of the newly formed LED division in March 2000. FromSeptember 1994 to September 1999, Dr. Liu worked at the opto-electronicsdivision of Hewlett-Packard Company as a research and development engineer. Dr.Liu holds an undergraduate degree from National Chiao-Tung University in Taiwan,a masters degree in physics from University of Oregon and a Ph.D. in engineeringfrom North Carolina State University. Bingwen Liang, Ph.D. joined us in January 2000 as director of advancedtechnologies and was subsequently promoted to president of the VCSEL division.From November 1999 to January 2000, Dr. Liang was research and developmentmanager of the III-V materials group in the fiber-optic communication divisionof Agilent Technologies. From July 1993 to November 1999, Dr. Liang was aresearch and development manager for Hewlett-Packard Company. Dr. Liang has aPh.D. in applied physics from the University of California at San Diego and haspublished more than 45 scientific papers. 11 13 Jesse Chen has served as a director since February 1998. Since May 1997,Mr. Chen has served as a managing director of Maton Venture, an investmentcompany. Prior to that, Mr. Chen co-founded BusLogic, a computer peripheralscompany and served as its chief executive officer from 1990 to 1996. Mr. Chenserves on the board of directors of several private companies. Mr. Chen has abachelor of science degree in aeronautical engineering from Chenkung University,Taiwan and a master of science degree in electrical engineering from LoyolaMarymount University. B.J. Moore has served as a director 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 boards ofdirectors for Adaptec, a computer peripherals company and Dionex Corporation, anion chromatography systems company, as well as several private companies. From1986 to 1991, Mr. Moore served as president and chief executive officer ofOutlook Technology, an electronics test equipment company. Mr. Moore holds abachelor of science degree and a master of science degree in electricalengineering from the University of Tennessee. David C. Chang, Ph.D. has served as a director since December 14, 2000,filling the Board position vacated by Theodore Young, who resigned from theBoard in August 2000. Dr. Chang is an internationally recognized scholar in thefield of electromagnetics, he has served as president of Polytechnic Universityin New York since 1994. Previously, Dr. Chang was dean of the College ofEngineering and Applied Sciences at Arizona State University for two years.Formerly a professor of electrical and computer engineering at the University ofColorado, Dr. Chang served as director of the NSF/Industry Corporate ResearchCenter for Microwave and Millimeter-Wave Computer Aided Design from 1981 to1989. Dr. Chang holds a master of science degree and a Ph.D. in applied physicsfrom Harvard University and a bachelor of science degree in electricalengineering from National Cheung-Kung University in Taiwan. BOARD COMPOSITION Our board of directors currently consists of five members. Our certificateof incorporation and bylaws provide that the terms of office of the members ofthe board of directors are divided into three classes: class I, whose term willexpire at the annual meeting of stockholders to be held in 2002, class II, whoseterm will expire at the annual meeting of stockholders to be held in 2003, andclass III, whose term will expire at the annual meeting of stockholders to beheld in 2001. The class I directors are Morris S. Young and David C. Chang, theclass II directors are Jesse Chen and Donald L. Tatzin and the class IIIdirector is B.J. Moore. At each annual meeting of stockholders after the initial classification,the successors to directors whose term will then expire will be elected to servefrom the time of election and qualification until the third annual meetingfollowing their election. As a result, only one class of directors will beelected at each annual meeting of stockholders, with the other classescontinuing for the remainder of their terms. Any additional directorshipsresulting from an increase in the number of directors will be distributed amongthe three classes so that, as nearly as possible, each class will consist ofone-third of the total number of directors. This classification of the board ofdirectors may delay or prevent changes in our control or management. Inaddition, our bylaws provide that the authorized number of directors may only bechanged by a resolution of the board of directors. BOARD COMMITTEES The audit committee of our board of directors recommends or will recommendthe appointment of our independent auditors, reviews our internal accountingprocedures and financial statements and consults with and reviews the servicesprovided by our independent auditors, including the results and scope of theiraudit. The audit committee currently consists of Messrs. Chen, Moore and Chang. The compensation committee of our board of directors reviews and recommendsto the board the compensation and benefits of all of our executive officers,administers our stock option plans and establishes and reviews general policiesrelating to compensation and benefits of our employees. The compensationcommittee currently consists of Messrs. Chen, Moore and Chang. 12 14 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Since January 1999, there has not been, nor is there currently proposed,any transaction or series of similar transactions to which we were or are to bea party in which the amount involved exceeds $60,000, and in which any director,executive officer or holder of more than 5% of any class of our votingsecurities or members of that person's immediate family had or will have adirect or indirect material interest other than the transactions describedbelow. Equipment & Materials, a California corporation engaged in internationaltrading and quartzware fabrication, supplies us with various raw materials fromChina and has manufactured quartzware for us. Christina X. Li, the soleshareholder and president of Equipment & Materials, is the wife of Davis Zhang,the president of our substrate division. Purchases from Equipment & Materialswere approximately $8.9 million for the year ended December 31, 2000, $3.6million for 1999 and $3.7 million for 1998. A balance of $318,000 due toEquipment & Materials was included in accounts payable at December 31, 2000. In August 2000, we entered into a business transfer and acquisitionagreement with Demeter Technologies, Inc., a Delaware corporation founded byTheodore S. Young, the former president of our fiber optic division and a formermember of our board of directors, and Robert Shih, the former chief technologyofficer of our visible emitter division. Under this agreement, we have agreed totransfer certain non-core rights to Demeter relating to our research anddevelopment activities in the field of fiber optics. We have entered intonon-compete agreements with Messrs. Shih and Young that prohibit them fromcertain activities, including the manufacture of certain VCSEL devices. We haveleased to Demeter a portion of our owned facility in El Monte, California,subleased a portion of our rented facility in El Monte, California, leasedcertain equipment, including an MOCVD machine, and sold certain inventoryrelating to fiber optics. In exchange, Demeter has granted to us a warrant topurchase up to 4.5 million shares of its Series A convertible preferred stock ata price of $0.5714 per share which we exercised in November 2000. ITEM 2. PROPERTIES Our principal properties are as follows: SQUARE LOCATION FEET PROPERTY DESCRIPTION -------- ------ -------------------- Fremont, CA................................... 58,000 Production and AdministrationFremont, CA................................... 80,000 ProductionFremont, CA................................... 20,292 AdministrationFremont, CA................................... 9,280 WarehouseMonterey Park, CA............................. 22,000 Production and AdministrationTorrance, CA.................................. 6,674 AdministrationTorrance, CA.................................. 15,027 ProductionEl Monte, CA.................................. 26,652 ProductionEl Monte, CA.................................. 6,281 ProductionBeijing, China................................ 31,000 Production and AdministrationBeijing, China................................ 31,000 ProductionBeijing, China................................ 32,000 ProductionXiamen, China................................. 14,000 Production All of the properties listed above are owned except for 20,292 square feetin Fremont, the lease for which expires May 2005, 9,280 square feet in Fremont,the lease for which expires in June 2005, 6,281 square feet in El Monte, thelease for which expires in December 2006, the two Torrance properties, theleases for which expire in May 2003, and the property in Xiamen, China, thelease for which expires in 2001. We consider each facility to be in goodoperating condition and adequate for its present use, and believe that eachfacility has sufficient plant capacity to meet its current and anticipatedoperating requirements. 13 15 ITEM 3. LEGAL PROCEEDINGS None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None 14 16 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 2000 First Quarter ended March 31, 2000..................... $45.750 $14.500 Second Quarter ended June 30, 2000..................... $46.000 $21.250 Third Quarter ended September 30, 2000................. $44.375 $31.125 Fourth Quarter ended December 31, 2000................. $41.688 $24.500FISCAL 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, 2000, there were 131 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. 15 17 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data should be read inconjunction with, and are referenced to, our consolidated financial statementsand related notes and "Management's Discussion and Analysis of FinancialCondition and Results of Operations." YEARS ENDED DECEMBER 31, ---------------------------------------------------- 2000 1999 1998 1997 1996 -------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) INCOME STATEMENT DATA:Revenue..................................................... $121,503 $75,372 $49,074 $25,335 $16,227Cost of revenue, including restructuring cost of $1,844 in 2000...................................................... 73,684 50,026 29,003 15,227 10,065 -------- ------- ------- ------- -------Gross profit................................................ 47,819 25,346 20,071 10,108 6,162Operating expenses: Selling, general, and administrative...................... 18,041 10,474 6,019 2,959 2,033 Research and development.................................. 8,769 2,566 2,504 1,289 592 Restructuring costs....................................... 6,409 -- -- -- -- Acquisition costs......................................... -- 2,810 -- -- -- -------- ------- ------- ------- ------- Total operating expenses............................ 33,219 15,850 8,523 4,248 2,625 -------- ------- ------- ------- -------Income from operations...................................... 14,600 9,496 11,548 5,860 3,537Interest expense............................................ 3,616 2,201 875 570 170Other (income) and expense.................................. (28,432) (1,423) (715) 34 72 -------- ------- ------- ------- -------Income from continuing operations before provision for income taxes.............................................. 39,416 8,718 11,388 5,256 3,295Provision for income taxes.................................. 14,978 4,380 4,668 1,216 1,249 -------- ------- ------- ------- -------Income from continuing operations........................... 24,438 4,338 6,720 4,040 2,046Discontinued operations: Income (loss) from discontinued operations, net of tax benefits................................................ (1,487) (3,658) (2,436) (3,220) 305 Loss on disposal, net of tax benefits..................... (1,341) -- -- -- --Extraordinary item, net of tax benefits..................... -- (508) -- -- -- -------- ------- ------- ------- -------Net income.................................................. $ 21,610 $ 172 $ 4,284 $ 820 $ 2,351 ======== ======= ======= ======= =======Basic income (loss) per share: Income from continuing operations......................... $ 1.24 $ 0.23 $ 0.42 $ 1.09 $ 0.57 Income (loss) from discontinued operations................ (0.14) (0.19) (0.15) (0.87) 0.08 Extraordinary item........................................ -- (0.03) -- -- -- Net income................................................ 1.10 0.01 0.27 0.22 0.65Diluted income (loss) per share: Income from continuing operations......................... $ 1.16 $ 0.22 $ 0.41 $ 0.30 $ 0.16 Income (loss) from discontinued operations................ (0.13) (0.18) (0.15) (0.24) 0.02 Extraordinary item........................................ -- (0.03) -- -- -- Net income................................................ 1.03 0.01 0.26 0.06 0.19Shares used in per share calculations: Basic..................................................... 19,677 18,655 16,076 3,697 3,595 Diluted................................................... 21,059 19,771 16,325 13,598 12,524 DECEMBER 31, ------------------------------------------------------ 2000 1999 1998 1997 1996 -------- -------- -------- ------- ------- (IN THOUSANDS) BALANCE SHEET DATA:Cash and cash equivalents................................... $ 68,585 $ 6,062 $ 16,438 $ 3,199 $ 1,171Working capital............................................. 140,387 40,462 41,644 12,612 6,866Total assets................................................ 250,220 115,762 102,983 37,796 23,178Long-term capital lease, net of current portion............. 7,278 6,853 3,854 -- --Long-term debt, net of current portion...................... 15,123 15,254 18,416 7,728 5,833Stockholders' equity........................................ 185,347 62,459 61,164 17,387 10,237 Income statement data from our substrate division and discontinued consumerproducts division is included in all periods presented. Income statement datafrom our visible emitter division is included from the time of the acquisitionof the visible emitter business on September 29, 1998. All periods have beenrestated to reflect the accounting for discontinued operations. As a result, thediscontinued consumer products division has been eliminated from continuingoperations in the income statements. 16 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS The following discussion and analysis of our financial condition andresults of operations should be read in conjunction with "Selected ConsolidatedFinancial Data" and our consolidated financial statements and related notesincluded elsewhere in this Form 10-K. In addition to historical information, thediscussion in this Form 10-K contains forward-looking statements that involverisks and uncertainties. Our actual results could differ materially from thoseanticipated by these forward-looking statements due to factors, including butnot limited to those set forth under "Risk Factors" and elsewhere in this Form10-K. OVERVIEW We were founded in 1986 to commercialize and enhance our proprietary VGFtechnique for producing high-performance compound semiconductor substrates. Wecurrently operate two divisions: our substrate division and our visible emitterdivision. We made our first substrate sales in 1990 and our substrate divisioncurrently sells GaAs and InP substrates to manufacturers of semiconductordevices for use in applications such as fiber optic and wirelesstelecommunications, LEDs and lasers. We also sell germanium substrates for usein satellite solar cells. We acquired Lyte Optronics, Inc., on May 28, 1999, andcurrently operate part of Lyte's historical business as our visible emitterdivision. The visible emitter division manufactures HBLEDs, VCSELs and laserdiodes for the illumination markets, including full-color displays, automobilelighting and traffic signals, as well as fiber optic communications. Wepreviously operated Lyte's other historical business as the consumer productsdivision which was discontinued in December 2000. This division had focused onthe design and manufacture of laser-pointing and alignment products for theconsumer, commercial and industrial markets. We have been profitable on an annual basis since 1990. Our total revenuefrom continuing operations was $121.5 million for 2000, $75.4 million for 1999and $49.1 million for 1998. Our income from continuing operations was $24.4million for 2000, $4.3 million for 1999 and $6.7 million for 1998. In the third quarter of 2000, we raised approximately $96.0 million fromthe sale of common stock in a private offering and a registered public offering. Several non-recurring events occurred that had a substantial impact on ourperformance and financial results for the quarter and year-ended December 31,2000. First, we realized a $27.3 million non-cash gain as a result of FinisarCorporation's acquisition of Demeter Technologies, a company in which we heldwarrants to purchase preferred stock. This gain is included in other income.Second, on December 14, 2000, the Board of Directors approved our plan todiscontinue our unprofitable consumer products division. As a result ofdiscontinuing the consumer products division, we incurred a pre-tax loss ondisposal of $2.2 million. The results of operations of the consumer productsdivision have been segregated from continuing operations and are reportedseparately as discontinued operations in the income statements. Third, we areexiting our unprofitable 650nm laser diode product line at the visible emitterdivision. As a result of exiting this product line, we incurred a restructuringcharge of $8.2 million, of which $1.8 million has been classified as cost ofgoods sold and $6.4 million has been classified as operating expense. Our five largest customers accounted for 26.1% of our total revenue fromcontinuing operations in 2000, 24.8% in 1999 and 34.9% in 1998. No customeraccounted for more than 10.0% of our total revenue in 2000, 1999 or 1998. We expect to expand substantially our production capacity for compoundsubstrates as well as blue, green and cyan HBLEDs. Most of the expansion forsubstrates will occur at our facilities in China and the remainder of oursubstrate expansion and all of our visible emitter expansion will occur at ourCalifornia facilities. We estimate that our capital expenditures for thisexpansion during the next 12 months will be approximately $41.0 million. In connection with our acquisition of Lyte Optronics and its subsidiaries,we issued approximately 2,023,000 shares of common stock and 883,000 shares ofpreferred stock, with a 5.0% annual dividend rate and $4 per share liquidationpreference over common stock, as adjusted for claims made against shares held inescrow, in exchange for all of the issued and outstanding shares of capitalstock of Lyte Optronics. The 17 19 acquisition was accounted for as a pooling of interests. In connection with theacquisition, we reported a charge of $2.8 million in the second quarter of 1999to reflect transaction costs and other one-time charges. We recognize revenue upon shipment of products to our customers providedthat we have received a signed purchase order, the price is fixed, title hastransferred, collection of resulting receivables is probable, product returnsare reasonably estimable, there are no customer acceptance requirements andthere are no remaining significant obligations. We provide for future returnsbased on historical experience at the time revenue is recognized. Except forsales in Japan and some sales in Taiwan, which in both cases are denominated inJapanese yen, we denominate and collect our international sales in U.S. dollars. Each of our divisions is responsible for its own sales and marketingactivities, and each maintains its own sales and marketing personnel. We sellour substrate products through our direct sales force in the U.S. and throughindependent sales representatives in France, Japan, South Korea, Taiwan and theUnited Kingdom. We sell our HBLED and VCSEL products through our direct salesforce and through independent sales representatives. RESULTS OF OPERATIONS The following table sets forth certain operating data as a percentage oftotal revenues for the periods indicated. YEARS ENDED DECEMBER 31, -------------------------- 2000 1999 1998 ------ ------ ------ Revenue..................................................... 100.0% 100.0% 100.0%Cost of revenue............................................. 60.6% 66.4% 59.1% ----- ----- -----Gross profit................................................ 39.4% 33.6% 40.9%Operating expenses: Selling, general, and administrative...................... 14.8% 13.9% 12.3% Research and development.................................. 7.2% 3.4% 5.1% Restructuring costs....................................... 5.3% 0.0% 0.0% Acquisition costs......................................... 0.0% 3.7% 0.0% ----- ----- ----- Total operating expenses.......................... 27.3% 21.0% 17.4% ----- ----- -----Income from operations...................................... 12.1% 12.6% 23.5%Interest expense............................................ 3.0% 2.9% 1.8%Other (income) and expense.................................. -23.4% -1.9% -1.5% ----- ----- -----Income from continuing operations before provision for income taxes.............................................. 32.5% 11.6% 23.2%Provision for income taxes.................................. 12.3% 5.8% 9.5% ----- ----- -----Income from continuing operations........................... 20.2% 5.8% 13.7%Discontinued operations: Loss from discontinued operations, net of tax benefits.... -1.2% -4.9% -5.0% Loss on disposal, net of tax benefits..................... -1.1% 0.0% 0.0%Extraordinary item, net of tax benefits..................... 0.0% -0.7% 0.0% ----- ----- -----Net income.................................................. 17.9% 0.2% 8.7% ===== ===== ===== YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999 Revenue from continuing operations. Revenue increased $46.1 million, or61.2%, to $121.5 million in 2000 compared to $75.4 million in 1999. Revenue fromour substrate division which represents 93.3% of total revenue for the yearended 2000, increased $56.6 million, or 99.8%, to $113.4 million compared to$56.7 million in 1999. Total GaAs substrate revenue increased $52.0 million, or113.3%, to $97.9 million in 2000 compared to $45.9 million in 1999. Sales of 5"and 6" GaAs subtrates increased $19.2 million, or 3,308.8%, to $19.8 million in2000 compared to $581,000 in 1999. InP substrate revenue increased $11.1million, or 373.8%, to $14.0 million in 2000 compared to $3.0 million in 1999.The increase in GaAs and 18 20 InP substrate sales was a result of increased sales volume to existing and newcustomers due in part to strong growth in the fiber optic and wireless handsetmarkets. Revenue from our visible emitter division which represents 6.7% oftotal revenue for 2000, decreased $10.5 million, or 56.4%, to $8.1 million in2000, compared to $18.6 million in 1999. The decrease was a result of lowerlaser diode sales volume and a decrease in prices. International revenue decreased to 48.2% of total revenue in 2000 comparedto 51.6% of total revenue in 1999. Gross margin. Gross margin increased to 39.4% of revenue in 2000 comparedto 33.6% in 1999. The gross margin at the substrate division increased to 45.9%of revenue in 2000 compared to 41.0% in 1999. The increase was primarily due tohigher sales volume and the realization of lower labor and manufacturing costsas a result of expanding our wafer production capacity in China. The grossmargin at the visible emitter division decreased to negative 51.6% of revenuefor 2000 compared to 11.1% for 1999. The decrease was primarily due to increasedcosts associated with the start-up of blue HBLED and VCSEL product production,lower laser diode sales prices and volume and a restructuring charge towrite-off obsolete laser diode inventory as part of our plan to exit theunprofitable 650nm laser diode product line. Selling, general and administrative expenses. Selling, general andadministrative expenses increased $7.6 million, or 72.2%, to $18.0 million in2000 compared to $10.5 million in 1999. The increase in selling, general andadministrative expenses was primarily due to increases in personnel and relatedexpenses required to support current and future increases in sales volume. As apercentage of total revenue, selling, general and administrative expenses were14.8% in 2000 compared to 13.9% in 1999. Research and development expenses. Research and development expensesincreased $6.2 million, or 241.7%, to $8.8 million in 2000 compared to $2.6million in 1999. The increase was primarily the result of increases in personneland related expenses and materials to support HBLED and VCSEL research anddevelopment at the visible emitter division. As a percentage of total revenue,research and development expenses were 7.2% in 2000 compared to 3.4% in 1999. Restructuring costs. On December 14, 2000, the Company's Board of Directorsapproved management's plan to exit its unprofitable 650nm laser diode productline within its visible emitter division. As a result, during the fourth quarterof 2000, the Company recorded a pre-tax restructuring charge of $8.2 million.The restructuring charge includes $1.8 million to write-off laser diodeinventory, which has been classified as a component of cost of goods sold. Therestructuring charge also includes $3.4 million to write-off net assets includedin property, plant and equipment. These assets consist of laser diode processingequipment that could not be utilized for HBLED or VCSEL processing. These assetshave been taken out of service and will be sold or discarded. The restructuringcharge also includes $848,000 to write-down a portion of goodwill attributableto the laser diode product line. The restructuring charge also includes $2.1million for incremental costs and contractual obligations for such items asleasehold termination payments and other facility exit costs incurred as adirect result of this plan. Interest expense. Interest expense increased $1.4 million, or 64.3%, to$3.6 million in 2000 compared to $2.2 million in 1999. The increase wasprimarily due to using short-term debt to finance the short-term liquidity needsresulting from our increased sales volume as well as the addition of certaincapital leases to finance equipment purchases. Other income and expense. Other income and expense increased $27.0 millionto $28.4 million in 2000 compared to $1.4 million in 1999. The increase wasprimarily the result of a $27.3 million non-cash gain on Demeter Technologywarrants that were exchanged for Finisar Corporation common stock as a result ofFinisar Corporation's acquisition of Demeter Technology. Provision for income taxes. The effective tax rate was 38.0% in 2000. In1999, the effective tax rate was 38% adjusted for the non-deductible acquisitioncosts of approximately $2.8 million. 19 21 YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998 Revenue from continuing operations. Revenue increased 53.6%, or $26.2million to $75.4 million in 1999 from $49.1 million in 1998. The increase inrevenue resulted primarily from a $15.7 million increase in sales of GaAs andInP substrates to existing and new customers offset by a $2.2 million decreasein Ge and contract revenues at the substrate division and 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. Revenue from the substrate division was 75.3% of total revenue and revenuefrom the visible emitter division was 24.7% of total revenue in 1999 compared torevenue from the substrate division of 88.0% of total revenue and revenue fromthe visible emitter division of 12.0% of total revenue in 1998. International revenue increased to 51.6% of total revenue, or $38.9 millionin 1999, compared to 38.5% or $18.9 million in 1998. The increase ininternational revenue resulted primarily from a $7.3 million increase insubstrate sales to new and existing customers and a $11.7 million increase dueto the inclusion of the visible emitter division for a full year in 1999compared to only the fourth quarter in 1998. Gross margin. Gross margin decreased to 33.6% in 1999 compared to 40.9% in1998. The gross margin for substrates decreased slightly to 41.0% from 41.5%,primarily due to a decline in sales prices. The gross margin on products sold bythe visible emitter division was 11.1% in 1999 compared to 36.2% in 1998. 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 32.0% in 1999. Selling, general and administrative expenses. Selling, general andadministrative expenses increased 74.0%, or $4.4 million, to $10.5 million in1999 from $6.0 million in 1998. The inclusion of the visible emitter divisionfor the full year in 1999 compared to only the fourth quarter of 1998 resultedin an increase of $3.3 million. Substrate division expenses increased $1.2million primarily due to increases in personnel and related expenses required tosupport additional sales volume. Selling, general and administrative expenses asa percentage of total revenue increased to 13.9% in 1999 from 12.3% in 1998. Research and development expenses. Research and development expensesincreased 2.5%, or $62,000, to $2.6 million in 1999 from $2.5 million in 1998.This increase resulted primarily from the inclusion of the visible emitterdivision for a full year in 1999 compared to only the fourth quarter in 1998.Research and development expenses as a percentage of total revenue decreased to3.4% of total revenue for 1999 compared to 5.1% of revenue for 1998. Thisdecrease was primarily due to an increase in total revenue. Acquisition cost. As a result of the acquisition of Lyte Optronics in May1999, we incurred a number of one-time expenses which totaled approximately $2.8million. These expenses included fees paid to our investment bankers,accountants, attorneys and other outside consultants and related transactionexpenses. Interest expense. Interest expense increased 151.5%, or $1.3 million to$2.2 million in 1999 compared to $875,000 in 1998. This increase was primarilythe result of the inclusion of the visible emitter division for a full year in1999 compared to only the fourth quarter in 1998, which resulted in increasedborrowing on a line of credit. Other income and expense. Other income and expense increased 99.0%, or$708,000 to $1.4 million in 1999 from $715,000 in 1998. The increase wasprimarily the result of foreign exchange gains. Provision for income taxes. The income tax rate, excluding the effect ofnon-deductible acquisition costs of approximately $2.8 million in 1999,decreased to 38.0% of income before provision for income taxes in 1999 from41.1% in 1998. Extraordinary item, net of tax benefit. In connection with the acquisitionof Lyte Optronics in May 1999, we incurred fees associated with a loan that weprepaid as part of the transaction. 20 22 SELECTED QUARTERLY RESULTS OF OPERATIONS The following table sets forth unaudited quarterly results in dollars andpercentages for the eight quarters ended December 31, 2000. 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 --------------------------------------------------------------------------------------- DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31, 2000 2000 2000 2000 1999 1999 1999 1999 -------- --------- -------- -------- -------- --------- -------- -------- (IN THOUSANDS) Revenue................................. $ 38,167 $33,132 $27,939 $22,265 $20,926 $18,919 $19,197 $16,330Cost of revenue......................... 25,072 18,435 16,883 13,294 12,994 11,775 12,026 13,231 -------- ------- ------- ------- ------- ------- ------- -------Gross profit............................ 13,095 14,697 11,056 8,971 7,932 7,144 7,171 3,099Operating expenses: Selling, general and administrative... 5,414 5,134 4,286 3,207 3,317 2,150 2,327 2,680 Research and development.............. 1,793 3,267 1,800 1,909 723 528 759 556 Restructuring costs................... 6,409 -- -- -- -- -- -- -- Acquisition costs..................... -- -- -- -- -- -- 2,810 -- -------- ------- ------- ------- ------- ------- ------- ------- Total operating expenses........ 13,616 8,401 6,086 5,116 4,040 2,678 5,896 3,236 -------- ------- ------- ------- ------- ------- ------- -------Income (loss) from operations........... (521) 6,296 4,970 3,855 3,892 4,466 1,275 (137)Interest expense........................ 936 762 1,149 769 604 701 518 378Other (income) and expense.............. (27,964) 16 (298) (186) (300) (85) (182) (856) -------- ------- ------- ------- ------- ------- ------- -------Income from continuing operations before provision for income taxes............ 26,507 5,518 4,119 3,272 3,588 3,850 939 341Provision for income taxes.............. 10,062 2,097 1,575 1,244 1,363 1,463 1,425 129 -------- ------- ------- ------- ------- ------- ------- -------Income (loss) from continuing operations............................ 16,445 3,421 2,544 2,028 2,225 2,387 (486) 212Discontinued operations: Loss from discontinued operations, net of tax benefits..................... (721) (519) (191) (56) (662) (750) (1,049) (1,197) Loss on disposal, net of tax benefits............................ (1,341) -- -- -- -- -- -- --Extraordinary item, net of tax benefits.............................. -- -- -- -- -- -- (508) -- -------- ------- ------- ------- ------- ------- ------- -------Net income (loss)....................... $ 14,383 $ 2,902 $ 2,353 $ 1,972 $ 1,563 $ 1,637 $(2,043) $ (985) ======== ======= ======= ======= ======= ======= ======= ======= QUARTERS ENDED --------------------------------------------------------------------------------------- DEC. 31, SEPT. 30, JUNE 30, MAR. 31, DEC. 31, SEPT. 30, JUNE 30, MAR. 31, 2000 2000 2000 2000 1999 1999 1999 1999 -------- --------- -------- -------- -------- --------- -------- -------- Revenue................................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Cost of revenue......................... 65.7% 55.6% 60.4% 59.7% 62.1% 62.2% 62.6% 81.0% ----- ----- ----- ----- ----- ----- ----- -----Gross profit............................ 34.3% 44.4% 39.6% 40.3% 37.9% 37.8% 37.4% 19.0%Operating expenses: Selling, general and administrative... 14.2% 15.5% 15.3% 14.4% 15.9% 11.4% 12.1% 16.4% Research and development.............. 4.7% 9.9% 6.4% 8.6% 3.5% 2.8% 4.0% 3.4% Restructuring costs................... 16.8% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Acquisition costs..................... 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 14.6% 0.0% ----- ----- ----- ----- ----- ----- ----- ----- Total operating expenses........ 35.7% 25.4% 21.8% 23.0% 19.3% 14.2% 30.7% 19.8% ----- ----- ----- ----- ----- ----- ----- -----Income (loss) from operations........... -1.4% 19.0% 17.8% 17.3% 18.6% 23.6% 6.6% -0.8%Interest expense........................ 2.4% 2.3% 4.1% 3.5% 2.9% 3.7% 2.7% 2.3%Other (income) and expense.............. -73.3% 0.0% -1.1% -0.8% -1.4% -0.4% -0.9% -5.2% ----- ----- ----- ----- ----- ----- ----- -----Income from continuing operations before provision for income taxes............ 69.5% 16.7% 14.7% 14.7% 17.1% 20.3% 4.9% 2.1%Provision for income taxes.............. 26.4% 6.3% 5.6% 5.6% 6.5% 7.7% 7.4% 0.8% ----- ----- ----- ----- ----- ----- ----- -----Income (loss) from continuing operations............................ 43.1% 10.3% 9.1% 9.1% 10.6% 12.6% -2.5% 1.3%Discontinued operations: Loss from discontinued operations, net of tax benefits..................... -1.9% -1.6% -0.7% -0.3% -3.2% -4.0% -5.5% -7.3% Loss on disposal, net of tax benefits............................ -3.5% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Extraordinary item, net of tax benefits.............................. 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% -2.6% 0.0% ----- ----- ----- ----- ----- ----- ----- -----Net income (loss)....................... 37.7% 8.8% 8.4% 8.9% 7.5% 8.7% -10.6% -6.0% ===== ===== ===== ===== ===== ===== ===== ===== 21 23 LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents increased $62.5 million to $68.6 million atDecember 31, 2000 compared to $6.1 million at December 31, 1999. The increaseprimarily resulted from $84.9 million provided by financing activities, offsetby $26.1 million used in investing activities. Net cash provided by operating activities of $3.7 million for the yearended December 31, 2000 was comprised primarily of net income adjusted fornon-cash items of $13.7 million, and by $4.2 million used in working capital andother activities. Net cash used in working capital and other activities resultedprimarily from increases in accounts receivable and inventory, offset byincreases in accrued liabilities, deferred income taxes and prepaid expenses. Net cash used in investing activities of $26.1 million primarily reflectspurchases of property and equipment to increase crystal growth and waferprocessing capacity at the substrate division and to increase HBLED and VCSELepitaxy growth and wafer processing capacity at the visible emitter division. Wealso invested $1.6 million in a joint venture in China to provide certainmaterials. We are currently constructing an additional 32,000 square foot building inBeijing, China to expand substrate wafer processing capacity and a 27,000 squarefoot building in El Monte, California to expand HBLED and VCSEL production. Weare also constructing improvements to our existing production facilities inFremont, California to increase crystal growth and wafer processing capacity. Weexpect to invest approximately $41.0 million in additional facilities andequipment over the next 12 months. Net cash provided by financing activities of $84.9 million consisted ofproceeds of $96.0 million from the sale of common stock and $6.0 million fromnew real estate loans, offset by payments of $9.9 million to reduce ourshort-term borrowings, $3.3 million to retire old real estate loans andprincipal and interest payments on long-term debt and $3.9 million for capitallease payments. We currently have a $20.0 million line of credit with a commercial bankbearing interest at 1.75% above LIBOR that was 6.4% at December 31, 2000. Thisline of credit is secured by all of our assets, other than equipment, andexpires on May 31, 2002. At December 31, 2000, there was no balance outstandingunder the line of credit. We generally finance equipment purchases through secured equipment loansand capital leases over five-year terms at interest rates ranging from 6.0% to9.0% per annum. Some of our manufacturing facilities have been financed bylong-term borrowings, which were refinanced by taxable variable rate revenuebonds in 1998. These bonds mature in 2023 and bear interest at 2.0% below theprime rate. The bonds are traded in the public market. Repayment of principaland interest under the bonds is supported by a letter of credit from our bankand is paid on a quarterly basis. We have the option to redeem the bonds inwhole or in part during their term. At December 31, 2000, $10.6 million wasoutstanding under these bonds. We anticipate that the combination of existing working capital and theborrowings available under our current credit agreements will be sufficient tofund working capital and capital expenditure requirements for the next 12months. However, our future capital requirements will be dependent on manyfactors including the rate of revenue growth, our profitability, the timing andextent of spending to support research and development programs, the expansionof our manufacturing facilities, the expansion of our selling and marketing andadministrative activities and market acceptance of our products. We may need toobtain additional equity and debt financing in the future, which may not beavailable on acceptable terms or at all. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards No. 133, or SFAS 133, "Accounting for DerivativeInstruments and Hedging Activities." SFAS 133 established accounting andreporting standards for derivative instruments including certain derivativeinstruments embedded in other contracts and for hedging activities. In June2000, SFAS 133 was amended by SFAS 138. We will implement SFAS 133 beginning in2001. We do not expect that adopting the provisions of SFAS 133 will have amaterial effect on our financial position or results of operations. 22 24 We have adopted the provisions of Staff Accounting Bulletin No. 101, or SAB101, "Revenue Recognition," which did not and does not have a material effect onthe financial position or results of operations of the Company. 23 25 RISKS RELATED TO OUR BUSINESS UNPREDICTABLE FLUCTUATIONS IN OUR OPERATING RESULTS COULD DISAPPOINT ANALYSTS OROUR INVESTORS, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE. We may not be able to sustain our historical growth rate, and we mayexperience significant fluctuations in our revenue and earnings in the future.Our quarterly and annual revenue and operating results have varied significantlyin the past and may vary significantly in the future due to a number of factors,including: - fluctuations in demand for our products; - expansion of our manufacturing capacity; - expansion of our operations in China; - limited availability and increased cost of raw materials; - integration of Lyte Optronics and its business, operations and facilities with our operations; - the volume and timing of orders from our customers; - fluctuation of our manufacturing yields; - decreases in the prices of our competitors' products; - costs incurred in connection with any future acquisitions of businesses or technologies; - increases in our expenses, including expenses for research and development; and - our ability to develop, manufacture and deliver high quality products in a timely and cost-effective manner. Due to these factors, we believe that period-to-period comparisons of ouroperating results may not be a meaningful indicator of our future performance.It is possible that in some future quarter, our operating results may be belowthe expectations of securities analysts or investors. If this occurs, the priceof our common stock would likely decline. IF WE FAIL TO EXPAND OUR MANUFACTURING CAPACITY, WE MAY NOT BE ABLE TO MEETDEMAND FOR OUR PRODUCTS, LOWER OUR COSTS OR INCREASE REVENUE. In order to increase production, we must build new facilities, expand ourexisting facilities and purchase additional manufacturing equipment. If we donot expand our manufacturing capacity, we will be unable to increase production,adversely impacting our ability to reduce unit costs, margins and improve ouroperating results. We are currently constructing additional capacity and facilities inCalifornia and China. Our expansion activities subject us to a number of risks,including: - unforeseen environmental or engineering problems; - unavailability or late delivery of production equipment; - delays in completing new facilities; - delays in bringing production equipment on-line; - work stoppages or delays; - unanticipated cost increases; and - restrictions imposed by requirements of local, state or federal regulatory agencies. If any of these risks occurs, construction may be costlier than anticipatedand completion could be delayed, which could hurt our ability to expand capacityand increase our sales. In addition, if we experience delays in expanding ourmanufacturing capacity, we might not be able to timely meet customerrequirements, 24 26 and we could lose future sales. We are also making substantial investments inequipment and facilities as part of our capacity expansion. To offset theadditional fixed operating expenses, we must increase our revenue by increasingproduction and improving yields. If demand for our products does not grow or ifour yields do not improve as anticipated, we may be unable to offset these costsagainst increased revenue, which would adversely impact our operating results. WE HAVE LIMITED EXPERIENCE WITH SOME OF OUR NEW PRODUCTS, AND WE MAY NOT BE ABLETO ACHIEVE ANTICIPATED SALES OF THESE PRODUCTS. To date, we have limited experience producing and selling our HBLED andVCSEL products, and we may be unable to successfully market and sell theseproducts. To market and sell our HBLED and VCSEL products, we will have todevelop additional distribution channels. In addition, we must apply ourproprietary VGF technique to new substrate products and successfully introduceand market new opto-electronic semiconductor devices, including LED and VCSELproducts. IF WE DO NOT SUCCESSFULLY DEVELOP NEW PRODUCTS TO RESPOND TO RAPIDLY CHANGINGCUSTOMER REQUIREMENTS, OUR ABILITY TO GENERATE SALES AND OBTAIN NEW CUSTOMERSMAY SUFFER. Our success depends on our ability to offer new products that incorporateleading technology and respond to technological advances. In addition, our newproducts must meet customer needs and compete effectively on quality, price andperformance. The life cycles of our products are difficult to predict becausethe markets for our products are characterized by rapid technological change,changing customer needs and evolving industry standards. If our competitorsintroduce products employing new technologies, our existing products couldbecome obsolete and unmarketable. If we fail to offer new products, we may notgenerate sufficient revenue to offset our development costs and other expensesor meet our customers' requirements. Other companies, including IBM, areactively developing substrate materials that could be used to manufacturedevices that could provide the same high-performance, low-power capabilities asGaAs-based devices at competitive prices. If these substrate materials aresuccessfully developed and semiconductor device manufacturers adopt them, demandfor our GaAs substrates could decline and our revenue could suffer. The development of new products can be a highly complex process, and we mayexperience delays in developing and introducing new products. Any significantdelays could cause us to fail to timely introduce and gain market acceptance ofnew products. Further, the costs involved in researching, developing andengineering new products could be greater than anticipated. OUR OPERATING RESULTS DEPEND IN LARGE PART ON FURTHER CUSTOMER ACCEPTANCE OF OUREXISTING SUBSTRATE PRODUCTS AND ON OUR ABILITY TO DEVELOP NEW PRODUCTS BASED ONOUR CORE VGF TECHNOLOGY. A majority of GaAs substrates are manufactured from crystals grown usingthe traditional Liquid Encapsulated Czochralski, or LEC, orHorizontal-Bridgeman, or HB, techniques. In order to expand sales of ourproducts, we must continue to promote our VGF technique as a preferred processfor producing substrates, and we must offer products with superior prices andperformance on a timely basis and in sufficient volumes. If we fail to gainincreased market acceptance of our VGF technique, we may not achieve anticipatedrevenue growth. INTENSE COMPETITION IN THE MARKETS FOR OUR PRODUCTS COULD PREVENT US FROMINCREASING REVENUE AND SUSTAINING PROFITABILITY. The markets for our products are intensely competitive. We face competitionfor our substrate products from other manufacturers of substrates, such asFreiberger, Hitachi Cable, Japan Energy, Litton Airtron and Sumitomo Electricand from semiconductor device manufacturers that produce substrates for theirown use, and from companies, such as IBM, that are actively developingalternative materials to GaAs. We believe that at least one of our competitorshas recently begun shipping GaAs substrates manufactured using a techniquesimilar to our VGF technique. Other competitors may develop and begin usingsimilar technology. If we are unable to compete effectively, our revenue may notincrease and we may not continue to be profitable. We 25 27 face many competitors that have a number of significant advantages over us,particularly in our compound semiconductor device products, including: - greater experience in the business; - more manufacturing experience; - broader name recognition; and - significantly greater financial, technical and marketing resources. Our competitors could develop new or enhanced products that are moreeffective than the products that we have developed or may develop. For example,some competitors in the HBLED market offer devices that are brighter than ourHBLEDs. Some of our competitors may also develop technologies that enable theproduction of commercial products with characteristics similar to or better thanours, but at a lower cost. We expect the intensity of competition to increase in the future.Competitive pressures could reduce our market share, require us to reduce theprices of our products, affect our ability to recover costs or result in reducedgross margins. IF WE HAVE LOW PRODUCT YIELDS, THE SHIPMENT OF OUR PRODUCTS MAY BE DELAYED ANDOUR OPERATING RESULTS MAY BE ADVERSELY IMPACTED. Our products are manufactured using complex technologies, and the number ofusable substrates and devices we can produce can fluctuate as a result of manyfactors, including: - impurities in the materials used; - contamination of the manufacturing environment; - substrate breakage; - equipment failure, power outages or variations in the manufacturing process; and - performance of personnel involved in the manufacturing process. Because many of our manufacturing costs are fixed, our revenue coulddecline if our yields decrease. We have experienced product shipment delays anddifficulties in achieving acceptable yields on both new and older products, anddelays and poor yields have adversely affected our operating results. We mayexperience similar problems in the future and we cannot predict when they mayoccur or their severity. In addition, many of our manufacturing processes arenew and are still being refined, which can result in lower yields, particularlyas we focus on producing higher diameter substrates and new opto-electronicsemiconductor devices. For example, we recently began manufacturing six-inchGaAs wafers and have also made substantial investments in equipment andfacilities to manufacture blue, green and cyan HBLEDs. If we are unable toproduce adequate quantities of our high-brightness LEDs and VCSELs, we may notbe able to meet customer demand and our revenue may decrease. DEMAND FOR OUR PRODUCTS MAY DECREASE IF OUR CUSTOMERS EXPERIENCE DIFFICULTYMANUFACTURING, MARKETING OR SELLING THEIR PRODUCTS. Our products are used as components in our customers' products.Accordingly, demand for our products is subject to factors affecting the abilityof our customers to successfully introduce and market their products, including: - the competition our customers face in their particular industries; - the technical, manufacturing, sales and marketing and management capabilities of our customers; - the financial and other resources of our customers; and - the inability of our customers to sell their products if they infringe third party intellectual property rights. 26 28 If demand for the products offered by our customers decreases, ourcustomers may reduce purchases of our products. WE PURCHASE CRITICAL RAW MATERIALS FROM SINGLE OR LIMITED SOURCES, AND COULDLOSE SALES IF THESE SOURCES FAIL TO FILL OUR NEEDS. We depend on a limited number of suppliers for certain raw materials,components and equipment used in manufacturing our products, including keymaterials such as gallium, arsenic and quartz. We generally purchase thesematerials through standard purchase orders and not pursuant to long-term supplycontracts and none of our suppliers guarantees supply of raw materials to us. Ifwe lose any of our key suppliers, our manufacturing efforts could besignificantly hampered and we could be prevented from timely producing anddelivering products to our customers. We have experienced delays obtainingcritical raw materials, including gallium, due to shortages of these materials.We may experience delays due to shortages of materials and may be unable toobtain an adequate supply of materials. These shortages and delays could resultin higher materials costs and cause us to delay or reduce production of ourproducts. If we have to delay or reduce production, we could fail to meetcustomer delivery schedules, and our revenue and operating results could suffer. IF WE FAIL TO COMPLY WITH ENVIRONMENTAL REGULATIONS, WE MAY BE SUBJECT TOSIGNIFICANT FINES OR CESSATION OF OUR OPERATIONS. We are subject to federal, state and local environmental laws andregulations. These laws, rules and regulations govern the use, storage,discharge and disposal of hazardous chemicals during manufacturing, research anddevelopment and sales demonstrations. If we fail to comply with applicableregulations, we could be subject to substantial liability for clean-up efforts,personal injury and fines or suspension or cessation of our operations. We arecooperating with the California Occupational Safety and Health Administration,or Cal-OSHA, in an investigation primarily regarding impermissible levels ofpotentially hazardous materials in certain areas of our manufacturing facilityin Fremont, California. In May 2000, Cal-OSHA levied a fine against us in theamount of $313,655 for alleged health and safety violations. We are appealingthe citations, and have put in place engineering, administrative and personnelprotective equipment programs to address these issues, but we may have to paythis fine. Our ability to expand or continue to operate our present locationscould be restricted or we could be required to acquire costly remediationequipment or incur other significant expenses. In addition, existing or futurechanges in laws or regulations may require us to incur significant expendituresor liabilities, or may restrict our operations. THE LOSS OF ONE OR MORE OF OUR KEY SUBSTRATE CUSTOMERS WOULD SIGNIFICANTLY HURTOUR OPERATING RESULTS. A small number of substrate customers have historically accounted for asubstantial portion of our total revenue. Our five largest customers accountedfor 26.1% of our total revenue from continuing operations in 2000, 24.8% in 1999and 34.9% in 1998. No customer accounted for more than 10.0% of our totalrevenue in 2000, 1999 and 1998. Our substrate revenue accounted for 93.3% of ourtotal revenue from continuing operations in 2000, 75.3% in 1999 and 88.0% in1998. We expect that a significant portion of our future revenue will continueto be derived from a limited number of substrate customers. Our customers arenot obligated to purchase a specified quantity of our products or to provide uswith binding forecasts of product purchases. In addition, our customers mayreduce, delay or cancel orders at any time without any significant penalty. Ifwe lose a major customer or if a customer cancels, reduces or delays orders, ourrevenue would decline. In addition, customers that have accounted forsignificant revenue in the past may not continue to generate revenue for us inany future period. DEFECTS IN OUR PRODUCTS COULD DIMINISH DEMAND FOR OUR PRODUCTS. Our products are complex and may contain defects. In the past we haveexperienced quality control problems with some of our LED and consumer products,which caused customers to return products to us. If we continue to experiencequality control problems, or experience these problems in our other products,customers may cancel or reduce orders or purchase products from our competitors.Defects in our products 27 29 could cause us to incur higher manufacturing costs and suffer product returnsand additional service expenses, all of which could adversely impact ouroperating results. We are also developing new products and product enhancements, includingsubstrates and compound semiconductor device products. If our new productscontain defects when released, our customers may be dissatisfied and we maysuffer negative publicity or customer claims against us, lose sales orexperience delays in market acceptance of our new products. CYCLICALITY IN THE SEMICONDUCTOR INDUSTRY COULD CAUSE OUR OPERATING RESULTS TOFLUCTUATE SIGNIFICANTLY. Our business depends in significant part upon manufacturers ofsemiconductor devices, as well as the current and anticipated market demand forsuch devices and the products using such devices. The semiconductor industry ishighly cyclical. The industry has in the past, and will likely in the future,experience periods of oversupply that result in significantly reduced demand forsemiconductor devices and components, including our products. When these periodsoccur, our operating results and financial condition are adversely affected. OUR SUBSTRATE AND OPTO-ELECTRONIC SEMICONDUCTOR DEVICE PRODUCTS HAVE A LONGSALES CYCLE THAT MAKES IT DIFFICULT TO PLAN OUR EXPENSES AND FORECAST OURRESULTS. Customers typically place orders with us for our substrate andopto-electronic semiconductor device products three months to a year or moreafter our initial contact with them. The sale of our products may be subject todelays due to our customers' lengthy internal budgeting, approval and evaluationprocesses. During this time, we may incur substantial expenses and expend sales,marketing and management efforts while the customers evaluate our products.These expenditures may not result in sales of our products. If we do not achieveanticipated sales in a period as expected, we may experience an unplannedshortfall in our revenue. As a result, we may not be able to cover expenses,causing our operating results to vary. In addition, if a customer decides not toincorporate our products into its initial design, we may not have anotheropportunity to sell products to this customer for many months or even years. Weanticipate that sales of any future substrate and opto-electronic semiconductordevice products under development will also have lengthy sales cycles and will,therefore, be subject to risks substantially similar to those inherent in thelengthy sales cycle of our current substrate and opto-electronic semiconductordevice products. IF WE FAIL TO MANAGE OUR POTENTIAL GROWTH, OUR OPERATIONS MAY BE DISRUPTED. We have experienced a period of rapid growth and expansion that hasstrained our management and other resources, and we expect this rapid growth tocontinue. Our acquisition of Lyte Optronics, together with expansion of ourmanufacturing capacity, has placed and continues to place a significant strainon our operations and management resources. If we fail to manage our growtheffectively, our operations may be disrupted. To manage our growth effectively,we must implement additional and improved management information systems,further develop our operating, administrative, financial and accounting systemsand controls, add experienced senior level managers, and maintain closecoordination among our executive, engineering, accounting, marketing, sales andoperations organizations. We will spend substantial sums to support our growth and may incuradditional unexpected costs. Our systems, procedures or controls may not beadequate to support our operations, and we may be unable to expand quicklyenough to exploit potential market opportunities. Our future operating resultswill also depend on expanding sales and marketing, research and development andadministrative support. If we cannot attract qualified people or manage growtheffectively, our business and operating results could be adversely affected. 28 30 ANY FUTURE ACQUISITIONS MAY DISRUPT OUR BUSINESS, DILUTE STOCKHOLDER VALUE ORDISTRACT MANAGEMENT ATTENTION. As part of our strategy, we may consider acquisitions of, or significantinvestments in, businesses that offer products, services and technologiescomplementary to ours, such as our acquisition of Lyte Optronics in May 1999.Acquisitions entail numerous risks, including: - we may have difficulty assimilating the operations, products and personnel of the acquired businesses; - our ongoing business may be disrupted; - we may incur unanticipated costs; - our management may be unable to manage the financial and strategic position of acquired or developed products, services and technologies; - we may be unable to maintain uniform standards, controls and procedures and policies; and - our relationships with employees and customers may be impaired as a result of any integration. For example, we incurred substantial costs in connection with ouracquisition of Lyte Optronics, including the assumption of approximately $10.0million of debt, much of which has been repaid or renegotiated, resulting in adecline of cash available. We incurred one-time charges and merger-relatedexpenses of $2.8 million and an extraordinary item of $508,000 relating to theearly extinguishment of debt in the quarter ended June 30, 1999 as a result ofthe acquisition. To the extent that we issue shares of our stock or other rights to purchasestock in connection with any future acquisitions, dilution to our existingstockholders will result and our earnings per share may suffer. Any futureacquisitions may not generate additional revenue or provide any benefit to ourbusiness. IF ANY OF OUR FACILITIES IS DAMAGED, WE MAY NOT BE ABLE TO MANUFACTURE OURPRODUCTS. The ongoing operation of our manufacturing and production facilities inCalifornia and China is critical to our ability to meet demand for our products.If we are not able to use all or a significant portion of our facilities forprolonged periods for any reason, we will not be able to manufacture productsfor our customers. For example, a natural disaster, fire or explosion caused byour use of combustible chemicals and high temperatures during our manufacturingprocesses would render some or all of our facilities inoperable for anindefinite period of time. Actions outside of our control, such as earthquakes,could also damage our facilities, rendering them inoperable. All of our crystalgrowth is currently performed at our Fremont, California facilities, which arelocated very near to an active seismic fault line. If we are unable to operateour facilities and manufacture our products, we will lose customers and revenueand our business will be harmed. IF WE LOSE KEY PERSONNEL OR ARE UNABLE TO HIRE ADDITIONAL QUALIFIED PERSONNEL ASNECESSARY, WE MAY NOT BE ABLE TO SUCCESSFULLY MANAGE OUR BUSINESS OR ACHIEVE OUROBJECTIVES. Our success depends upon the continued service of Morris S. Young, Ph.D.,our president, chairman of the board and chief executive officer, as well asother key management and technical personnel. We do not have long-termemployment contracts with, or key person life insurance on, any of our keypersonnel. In addition, we have only recently hired our chief financial officer,and need to retain senior marketing personnel, particularly for our newopto-electronic semiconductor device products. 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 businessand meet key objectives, including the timely introduction of new products. 29 31 IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WE MAY LOSE VALUABLEASSETS OR INCUR COSTLY LITIGATION. We rely on a combination of patents, copyrights, trademark and trade secretlaws, non-disclosure agreements and other intellectual property protectionmethods to protect our proprietary technology. However, we believe that, due tothe rapid pace of technological innovation in the markets for our products, ourability to establish and maintain a position of technology leadership alsodepends on the skills of our development personnel. Despite our efforts to protect our intellectual property, a third partycould develop products or processes similar to ours. Our means of protecting ourproprietary rights may not be adequate and our competitors may independentlydevelop similar technology, duplicate our products or design around our patents.We believe that at least one of our competitors has begun to ship GaAssubstrates produced using a process similar to our VGF technique. Ourcompetitors may also develop and patent improvements to the VGF, LED and VCSELtechnologies upon which we rely, and thus may limit any exclusivity we enjoy byvirtue of our patents. It is possible that pending or future United States or foreign patentapplications made by us will not be approved, that our issued patents will notprotect our intellectual property, or that third parties will challenge theownership rights or the validity of our patents. In addition, the laws of someforeign countries may not protect our proprietary rights to as great an extentas do the laws of the United States and it may be more difficult to monitor theuse of our intellectual property. Our competitors may be able to legitimatelyascertain non-patented proprietary technology embedded in our systems. If thisoccurs, we may not be able to prevent the development of technologysubstantially similar to ours. We may have to resort to costly litigation to enforce our intellectualproperty rights, to protect our trade secrets or know-how or to determine theirscope, validity or enforceability. Enforcing or defending our proprietarytechnology is expensive, could cause us to divert resources and may not provesuccessful. Our protective measures may prove inadequate to protect ourproprietary rights, and if we fail to enforce or protect our rights, we couldlose valuable assets. WE MIGHT FACE INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS THAT MAY BE COSTLY TORESOLVE AND COULD DIVERT MANAGEMENT ATTENTION. Other companies may hold or obtain patents on inventions or may otherwiseclaim proprietary rights to technology necessary to our business. The markets inwhich we compete are comprised of competitors who in some cases hold substantialpatent portfolios covering aspects of products that could be similar to ours. Wecould become subject to claims that we are infringing patent, trademark,copyright or other proprietary rights of others. Litigation to determine thevalidity of alleged claims could be time-consuming and result in significantexpense to us and divert the efforts of our technical and management personnel,whether or not the litigation is ultimately determined in our favor. If alawsuit is decided against us, we could be subject to significant liabilities,requiring us to seek costly licenses or preventing us from manufacturing andselling our products. We may not be able to obtain required licensing agreementson terms acceptable to us or at all. WE DERIVE A SIGNIFICANT PORTION OF OUR REVENUE FROM INTERNATIONAL SALES, AND OURABILITY TO SUSTAIN AND INCREASE OUR INTERNATIONAL SALES INVOLVES SIGNIFICANTRISKS. Our revenue growth depends in part on the expansion of our internationalsales and operations. International sales represented 48.2% of our total revenuefrom continuing operations for 2000, 51.6% for 1999 and 38.5% for 1998. Weexpect that sales to customers outside the U.S. will continue to represent asignificant portion of our revenue. Our dependence on international sales involves a number of risks,including: - changes in tariffs, import restrictions and other trade barriers; - unexpected changes in regulatory requirements; - longer periods to collect accounts receivable; 30 32 - changes in export license requirements; - political and economic instability; - unexpected changes in diplomatic and trade relationships; and - foreign exchange rate fluctuations. Our sales are denominated in U.S. dollars, except for sales to our Japaneseand some Taiwanese customers, which are denominated in Japanese yen. Thus,increases in the value of the U.S. dollar could increase the price of ourproducts in non-U.S. markets and make our products more expensive thancompetitors' products in these markets. Also, denominating some sales inJapanese yen subjects us to fluctuations in the exchange rates between the U.S.dollar and the Japanese yen. The functional currencies of our Japanese andChinese subsidiaries are the local currencies. We incur transaction gains orlosses resulting from consolidation of expenses incurred in local currencies forthese subsidiaries, as well as in translation of the assets and liabilities ofthese assets at each balance sheet date. If we do not effectively manage therisks associated with international sales, our revenue and financial conditioncould be adversely affected. IF OUR EXPANSION IN CHINA IS MORE COSTLY THAN WE EXPECT, OUR OPERATING RESULTSWILL SUFFER. As part of our planned expansion of our manufacturing capacity, we arebuilding new facilities and expanding existing facilities in China. If we areunable to build and expand our Chinese facilities in a timely manner, we may notbe able to increase production of our products and increase revenue as planned.If our expansion in China proves more costly than we anticipate or we incurgreater ongoing costs than we expect, our operating results would be adverselyaffected. If we do not realize expected cost savings once our expansion iscomplete in China, our margins may be negatively impacted and our operatingresults may suffer. CHANGES IN CHINA'S POLITICAL, SOCIAL AND ECONOMIC ENVIRONMENT MAY AFFECT OURFINANCIAL PERFORMANCE. Our financial performance may be affected by changes in China's political,social and economic environment. The role of the Chinese central and localgovernments in the Chinese economy is significant. Chinese policies towardeconomic liberalization, and laws and policies affecting technology companies,foreign investment, currency exchange rates and other matters could change,resulting in greater restrictions on our ability to do business and operate ourmanufacturing facilities in China. Any imposition of surcharges or any increasein Chinese tax rates could hurt our operating results. The Chinese governmentcould revoke, terminate or suspend our license for national security and similarreasons without compensation to us. If the government of China were to take anyof these actions, we would be prevented from conducting all or part of ourbusiness. Any failure on our part to comply with governmental regulations couldresult in the loss of our ability to manufacture our products in China. China has from time to time experienced instances of civil unrest andhostilities. Confrontations have occurred between the military and civilians.Events of this nature could influence the Chinese economy, result innationalization of foreign-owned operations such as ours, and could negativelyaffect our ability to operate our facilities in China. OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE. Our stock price has fluctuated significantly since we began trading on theNasdaq National Market. For the 12 months ended December 31, 2000, the high andlow closing sales prices of our common stock were $46.00 and $14.50. A number offactors could cause the price of our common stock to continue to fluctuatesubstantially, including: - actual or anticipated fluctuations in our quarterly or annual operating results; - changes in expectations about our future financial performance or changes in financial estimates of securities analysts; - announcements of technological innovations by us or our competitors; 31 33 - new product introduction by us or our competitors; - large customer orders or order cancellations; and - the operating and stock price performance of 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. WE MAY NEED ADDITIONAL CAPITAL TO FUND EXPANSION OF OUR MANUFACTURING CAPACITYAND OUR FUTURE OPERATIONS, WHICH MAY NOT BE AVAILABLE. We may need additional capital to fund expansion of our manufacturing andproduction capacity and our future operations or acquisitions. If we raiseadditional capital through the sale of equity or debt securities, the issuanceof such securities could result in dilution to existing stockholders. Thesesecurities could have rights, preferences and privileges that are senior tothose of holders of our common stock. For example, in December 1998 we issueddebt securities for the purchase and improvement of our facilities in Fremont,California. If we require additional capital in the future, it might not be availableon acceptable terms, or at all. If we are unable to obtain additional capitalwhen needed, we may be required to reduce the scope of our planned expansion ofour manufacturing capacity or of our product development and marketing efforts,which could adversely affect our business and operating results. PROVISIONS IN OUR CHARTER, BYLAWS OR DELAWARE LAW MAY DELAY OR PREVENT A CHANGEIN CONTROL OF OUR COMPANY. Provisions in our amended and restated certificate of incorporation andbylaws may have the effect of delaying or preventing a merger, acquisition orchange of control of us, or changes in our management. These provisions include: - the division of our board of directors into three separate classes, each with three year terms; - the right of our board to elect a director to fill a space created by a board vacancy or the expansion of the board; - the ability of our board to alter our bylaws; - the ability of our board to authorize the issuance of up to 2,000,000 shares of blank check preferred stock; and - the requirement that only our board or the holders of at least 10% of our outstanding shares may call a special meeting of our stockholders. 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 these large stockholders 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. ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Since our Japanese and some Taiwanese invoices are denominated in Japaneseyen, doing business in Japan subjects us to fluctuations in exchange ratesbetween the U.S. dollar and the Japanese yen. We incurred a foreign transactionexchange loss of $552,000 in 2000, a gain of $652,000 in 1999, and a loss of$24,000 in 1998. We purchase foreign exchange contracts to hedge against certaintrade accounts receivable in Japanese 32 34 yen. The outstanding commitments with respect to such foreign exchange contractshad a total contract value of approximately $500,000 as of December 31, 2000.Many of the contracts were entered into six months prior to the due date and thedates coincide with the receivable terms on customer invoices. By matching thereceivable collection date and contract due date, we attempt to economicallyminimize the impact of foreign exchange fluctuations. The fair market value of long-term fixed and variable interest rate debt issubject to interest rate risk. The effect of an immediate 10% change in interestrates would not have a material impact on our future operating results or cashflows. Marketable securities are valued at fair market value at December 31, 2000.There is no assurance that we will realize this value when we sell thesesecurities in the future. ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Consolidated Financial Statements and Supplementary Data required bythis item are set forth at the pages indicated at Item 14 (a). ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ANDFINANCIAL DISCLOSURES None. 33 35 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 endof the fiscal year covered by this report, and certain information therein isincorporated in this report by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is incorporated herein by referenceto information set forth in our definitive 2001 proxy statement under thesection entitled "Election of Directors" and in Part I of this report under thesection entitled "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 herein byreference to information set forth in the definitive 2001 Proxy Statement underthe heading "Executive Compensation and Other matters." ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated herein by referenceto information set forth in our definitive 2001 proxy statement under thesection entitled "Executive Compensation and Other matters." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated herein by referenceto information set forth in our definitive 2001 proxy statement under thesection entitled "Security Ownership of Certain Beneficial Owners andManagement." 34 36 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 -- PricewaterhouseCoopers LLP....................................................... 36Report of Independent Public Accountants -- Arthur Andersen LLP....................................................... 37Consolidated Balance Sheets................................. 38Consolidated Income Statements.............................. 39Consolidated Statement of Stockholders' Equity.............. 40Consolidated Statements of Cash Flows....................... 41Notes to Consolidated Financial Statements.................. 42 - 57 (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 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, or incorporated by reference into, this report on Form 10-K. (b) Reports on Form 8-K. None 35 37 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of AXT, 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 stockholders' equity and of cash flows present fairly, in allmaterial respects, the financial position of AXT, Inc. and its subsidiaries atDecember 31, 2000 and 1999, and the results of their operations and their cashflows for each of the three years in the period ended December 31, 2000 inconformity with accounting principles generally accepted in the United States ofAmerica. These financial statements are the responsibility of the Company'smanagement; our responsibility is to express an opinion on these financialstatements based on our audits. The consolidated financial statements giveretroactive effect to the merger of Lyte Optronics, Inc. on May 28, 1999 in atransaction accounted for as a pooling of interests, as described in Note 5 tothe consolidated financial statements. We did not audit the balance sheet, theresults of operations and cash flows of Lyte Optronics, Inc. for the year endedDecember 31, 1998, which statements reflect total assets of $25,435,000 as ofDecember 31, 1998 and total revenues of $18,137,000 for the year ended December31, 1998. Those statements were audited by other auditors whose report thereonhas been furnished to us, and our opinion expressed herein, insofar as itrelates to the amounts included for Lyte Optronics, Inc., is based solely on thereport of the other auditors. We conducted our audits of these statements inaccordance with auditing standards generally accepted in the United States ofAmerica, which require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits and the report of other auditors provide a reasonable basis for theopinion expressed above. PricewaterhouseCoopers LLP San Jose, CaliforniaFebruary 9, 2001 36 38 REPORT OF INDEPENDENT PUBLIC 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 year ended December 31, 1998 (not presented herein). These financialstatements are the responsibility of the Company's management. Ourresponsibility is to express an opinion on these financial statements based onour 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 year ended December 31, 1998 in conformity withaccounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Los Angeles, CaliforniaMay 27, 1999 37 39 AXT, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) ASSETS DECEMBER 31, -------------------- 2000 1999 -------- -------- Current assets: Cash and cash equivalents................................. $ 68,585 $ 6,062 Marketable securities..................................... 30,852 -- Accounts receivable....................................... 27,773 17,561 Inventories............................................... 51,846 35,470 Prepaid expenses and other current assets................. 3,603 8,945 Deferred income taxes..................................... -- 3,210 -------- -------- Total current assets.............................. 182,659 71,248Property, plant and equipment............................... 63,401 40,865Other assets................................................ 3,312 1,405Goodwill.................................................... 848 2,244 -------- -------- Total assets...................................... $250,220 $115,762 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITYCurrent liabilities: Short-term bank borrowing................................. $ 1,353 $ 11,298 Accounts payable.......................................... 10,009 8,294 Accrued liabilities....................................... 16,651 7,464 Deferred income taxes..................................... 3,847 -- Current portion of long-term debt......................... 4,355 1,568 Current portion of capital lease obligation............... 6,057 2,162 -------- -------- Total current liabilities......................... 42,272 30,786Long-term debt, net of current portion...................... 15,123 15,254Long-term capital lease, net of current portion............. 7,278 6,853Other long-term liabilities................................. 200 410 -------- -------- Total liabilities................................. 64,873 53,303 -------- -------- Commitments and Contingencies (Note 15) Stockholders' equity: Preferred stock, $.001 par value; 2,000 shares authorized; 883 and 981 shares issued and outstanding.............. 3,532 3,990 Common stock, $.001 par value; 40,000 shares authorized; 21,952 and 18,659 shares issued and outstanding........ 145,748 46,340 Deferred compensation..................................... (107) (217) Retained earnings......................................... 33,980 12,370 Other comprehensive income................................ 2,194 (24) -------- -------- Total stockholders' equity........................ 185,347 62,459 -------- -------- Total liabilities and stockholders' equity........ $250,220 $115,762 ======== ======== The accompanying notes are an integral part of these consolidated financial statements. 38 40 AXT, INC. CONSOLIDATED INCOME STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE DATA) YEARS ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- ------- ------- Revenue..................................................... $121,503 $75,372 $49,074Cost of revenue, including restructuring costs of $1,844 in 2000...................................................... 73,684 50,026 29,003 -------- ------- -------Gross profit................................................ 47,819 25,346 20,071Operating expenses: Selling, general and administrative....................... 18,041 10,474 6,019 Research and development.................................. 8,769 2,566 2,504 Restructuring costs....................................... 6,409 -- -- Acquisition costs......................................... -- 2,810 -- -------- ------- ------- Total operating expenses.......................... 33,219 15,850 8,523 -------- ------- -------Income from operations...................................... 14,600 9,496 11,548Interest expense............................................ 3,616 2,201 875Other (income) and expense.................................. (28,432) (1,423) (715) -------- ------- -------Income from continuing operations before provision for income taxes.............................................. 39,416 8,718 11,388Provision for income taxes.................................. 14,978 4,380 4,668 -------- ------- -------Income from continuing operations........................... 24,438 4,338 6,720Discontinued operations: Loss from discontinued operations, net of tax benefits of $912, $2,241 and $1,692................................ (1,487) (3,658) (2,436) Loss on disposal, net of tax benefits of $822............. (1,341) -- --Extraordinary item, net of tax benefits of $311............. -- (508) -- -------- ------- ------- -------- ------- -------Net income.................................................. $ 21,610 $ 172 $ 4,284 ======== ======= =======Basic income (loss) per share: Income from continuing operations......................... $ 1.24 $ 0.23 $ 0.42 Loss from discontinued operations......................... (0.14) (0.19) (0.15) Extraordinary item........................................ -- (0.03) -- Net income................................................ 1.10 0.01 0.27Diluted income (loss) per share: Income from continuing operations......................... $ 1.16 $ 0.22 $ 0.41 Loss from discontinued operations......................... (0.13) (0.18) (0.15) Extraordinary item........................................ -- (0.03) -- Net income................................................ 1.03 0.01 0.26Shares used in per share calculations: Basic..................................................... 19,677 18,655 16,076 Diluted................................................... 21,059 19,771 16,325 The accompanying notes are an integral part of these consolidated financial statements. 39 41 AXT, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (IN THOUSANDS) PREFERRED STOCK COMMON STOCK OTHER ----------------- ----------------- DEFERRED RETAINED COMPREHENSIVE SHARES AMOUNT SHARES AMOUNT COMPENSATION EARNINGS INCOME TOTAL ------- ------- ------ -------- ------------ -------- ------------- -------- BALANCE AT DECEMBER 31, 1997........................ 10,129 $ 8,553 3,800 $ 1,337 $(220) $ 7,914 $ (197) $ 17,387Common stock options exercised................... 71 138 138Issuance of common stock...... 123 724 724Issuance of common stock and Series A preferred stock in connection with the acquisition of Alpha Photonics, Inc.............. 981 4,000 1,267 7,500 11,500Issuance of common stock as settlement of trade payables.................... 4 25 25Reacquisition and retirement of common stock............. (61)Issuance of common stock in connection with financing... 185 994 994Conversion of Series C convertible preferred stock to common stock............. (10,129) (8,553) 10,129 8,553 --Issuance of common stock upon initial public offering..... 2,875 25,792 25,792Deferred compensation......... 203 (203) --Amortization of deferred compensation................ 96 96Comprehensive income Net income.................. 4,284 4,284 Currency translation adjustment................ 224 224 ------- ------- ------ -------- ----- ------- ------ --------BALANCE AT DECEMBER 31, 1998........................ 981 $ 4,000 18,393 $ 45,266 $(327) $12,198 $ 27 $ 61,164Common stock options exercised................... 201 648 648Repurchase of shares of common stock in connection with the early extinguishment of debt........................ (21) (211) (211)Acquisition costs paid by shareholders................ (10) (139) (149)Issuance of Employee Stock Purchase Plan stock......... 86 776 776Amortization of deferred compensation................ 110 110Comprehensive income Net income.................. 172 172 Currency translation adjustment................ (51) (51) ------- ------- ------ -------- ----- ------- ------ --------BALANCE AT DECEMBER 31, 1999........................ 981 $ 3,990 18,659 $ 46,340 $(217) $12,370 $ (24) $ 62,459Common stock options exercised................... 711 6,038 6,038Issuance of Employee Stock Purchase Plan stock......... 63 648 648Reacquisition and retirement of common stock and Series A preferred stock in connection with merger of Lyte Optronics.............. (98) (458) (225) 458 --Issuance of common stock in private placement........... 234 8,507 8,507Issuance of common stock in follow on public offering... 2,510 80,812 80,812Income tax benefit from stock option exercises............ 2,945 2,945Amortization of deferred compensation................ 110 110Comprehensive income.......... -- Net income.................. 21,610 21,610 Unrealized gain on marketable securities..... 2,185 2,185 Currency translation adjustment................ 33 33 ------- ------- ------ -------- ----- ------- ------ --------BALANCE AT DECEMBER 31, 2000........................ 883 $ 3,532 21,952 $145,748 $(107) $33,980 $2,194 $185,347 ======= ======= ====== ======== ===== ======= ====== ======== COMPREHENSIVE INCOME ------------- BALANCE AT DECEMBER 31, 1997........................ $ 727Common stock options exercised...................Issuance of common stock......Issuance of common stock and Series A preferred stock in connection with the acquisition of Alpha Photonics, Inc..............Issuance of common stock as settlement of trade payables....................Reacquisition and retirement of common stock.............Issuance of common stock in connection with financing...Conversion of Series C convertible preferred stock to common stock.............Issuance of common stock upon initial public offering.....Deferred compensation.........Amortization of deferred compensation................Comprehensive income Net income.................. 4,284 Currency translation adjustment................ 224 -------BALANCE AT DECEMBER 31, 1998........................ $ 4,508Common stock options exercised...................Repurchase of shares of common stock in connection with the early extinguishment of debt........................Acquisition costs paid by shareholders................Issuance of Employee Stock Purchase Plan stock.........Amortization of deferred compensation................Comprehensive income Net income.................. 172 Currency translation adjustment................ (51) -------BALANCE AT DECEMBER 31, 1999........................ $ 121Common stock options exercised...................Issuance of Employee Stock Purchase Plan stock.........Reacquisition and retirement of common stock and Series A preferred stock in connection with merger of Lyte Optronics..............Issuance of common stock in private placement...........Issuance of common stock in follow on public offering...Income tax benefit from stock option exercises............Amortization of deferred compensation................Comprehensive income.......... Net income.................. 21,610 Unrealized gain on marketable securities..... 2,185 Currency translation adjustment................ 33 -------BALANCE AT DECEMBER 31, 2000........................ $23,828 ======= The accompanying notes are an integral part of these consolidated financial statements. 40 42 AXT, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) YEARS ENDED DECEMBER 31, -------------------------------- 2000 1999 1998 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income................................................ $ 21,610 $ 172 $ 4,284 Adjustments to reconcile net income to cash provided by (used in) operations: Depreciation........................................... 6,854 5,444 2,959 Deferred income taxes.................................. 5,718 (758) (1,126) Amortization of goodwill............................... 548 599 149 Stock compensation..................................... 110 110 96 Stock option tax benefits.............................. 2,945 Non cash restructuring costs........................... 6,249 -- -- Non cash gain on marketable securities................. (27,328) -- -- Gain on sale of property, plant and equipment.......... (183) -- -- Changes in assets and liabilities: Accounts receivable.................................. (10,212) (4,433) (4,192) Inventories.......................................... (18,220) (10,170) (11,074) Prepaid expenses..................................... 5,282 (5,674) (1,610) Other assets......................................... (369) 522 (243) Accounts payable..................................... 1,715 444 1,540 Accrued liabilities.................................. 9,187 2,222 533 Other long-term liabilities.......................... (210) (194) 110 -------- -------- -------- Net cash provided by (used in) operating activities...................................... 3,696 (11,716) (8,574) -------- -------- --------CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment................ (26,278) (2,758) (14,899) Investment in China joint venture......................... (1,599) -- -- Proceeds from sale of property plant and equipment........ 1,805 -- -- -------- -------- -------- Net cash used in investing activities............. (26,072) (2,758) (14,899) -------- -------- --------CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from (payments of): Issuance of common stock............................... 96,005 1,064 27,648 Capital lease payments................................. (3,850) (1,958) (263) Short-term bank borrowings............................. (9,945) 9,370 (2,320) Long-term debt borrowings.............................. 6,000 -- 17,002 Long-term debt payments................................ (3,344) (4,327) (5,574) -------- -------- -------- Net cash provided by financing activities......... 84,866 4,149 36,493 -------- -------- --------Effect of exchange rate changes............................. 33 (51) 219 -------- -------- --------Net increase in cash and cash equivalents................... 62,523 (10,376) 13,239Cash and cash equivalents at the beginning of the period.... 6,062 16,438 3,199 -------- -------- --------Cash and cash equivalents at the end of the period.......... $ 68,585 $ 6,062 $ 16,438 ======== ======== ========NON CASH ACTIVITY: Purchases of property, plant and equipment through capital leases................................................. $ 8,170 $ 5,927 $ 1,737 Exchange of Finisar shares for Demeter shares............. $ 27,328 $ -- $ --SUPPLEMENTAL DISCLOSURES: Interest paid............................................. $ 3,597 $ 2,288 $ 1,481 Income taxes paid......................................... $ 4,645 $ 6,268 $ 4,338 The accompanying notes are an integral part of these consolidated financial statements. 41 43 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. THE COMPANY AND SUMMARY OF ACCOUNTING POLICIES The Company AXT, Inc. designs, develops, manufactures, and distributes high-performancecompound semiconductor substrates, as well as opto-electronic semiconductordevices, such as high-brightness light-emitting diodes, or HBLEDs, and verticalcavity surface emitting lasers, or VCSELs. AXT expanded its markets in 1999 through the acquisition of Lyte Optronics,Inc., (see Note 5). Lyte Optronics operates as the visible emitter division,which focuses on manufacturing HBLEDs and VCSELs and the consumer productsdivision, which focuses on designing and marketing laser-pointing,laser-alignment and LED products. The consumer products division has beendiscontinued (see Note 3). The Company officially changed its name from American Xtal Technology, Inc.to AXT, Inc. on July 7, 2000. 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 majority-owned subsidiaries. All significant intercompany accounts andtransactions have been eliminated. Investments in business entities in which AXTdoes not have control, but has the ability to exercise significant influenceover operating and financial policies (generally 20 - 50% ownership), areaccounted for by the equity method. 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 U.S. dollar for theCompany or in the local currencies for the subsidiaries are included in otherincome for the periods presented. The assets and liabilities of the subsidiaries are translated at the ratesof exchange on the balance sheet date. Revenue and expense items are translatedat the average rate of exchange for the period. Gains and losses from foreigncurrency translation are included in other comprehensive income in stockholders'equity. Revenue Recognition The Company recognizes revenue upon the shipment of its products to thecustomer provided that the Company has received a signed purchase order, theprice is fixed, title has transferred, collection of resulting receivables isprobable, product returns are reasonably estimable, there are no customeracceptance requirements and there are no remaining significant obligations. TheCompany provides for future returns based on historical experience at the timerevenue is recognized.  Fair Value of Financial Instruments The reported amounts of certain of the Company's financial instrumentsincluding cash and cash equivalents, accounts receivable, accounts payable andaccrued liabilities approximate fair value due to their 42 44 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) short maturities. The reported amounts of short-term bank borrowing, loanspayable and capital lease obligations approximate fair value due to the marketinterest rates which these debts bear. Concentration of Credit Risk Financial instruments which potentially subject the Company toconcentration of credit risk consist primarily of trade accounts receivable. TheCompany invests primarily in money market accounts and commercial paperinstruments. Cash equivalents are maintained with high quality institutions andtheir composition and maturities are regularly monitored by management. The Company performs ongoing credit evaluations of its customers' financialcondition, and limits the amount of credit extended when deemed necessary, butgenerally does not require collateral. No customer represented greater than 10% of product revenues for the yearsended December 31, 2000, 1999, and 1998. No customer accounted for 10% or more of the trade accounts receivablebalance as of December 31, 2000 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. Marketable Securities The Company classifies all of its marketable securities asavailable-for-sale securities as prescribed in Financial Accounting Standard No.115, "Accounting for Certain Investments in Debt and Equity Securities."Marketable securities consist of equity securities that are stated at marketvalue, with unrealized gains and losses reflected, net of tax, as othercomprehensive income in shareholders' equity. Realized gains and losses onmarketable securities are included in earnings and are derived using thespecific identification method for determining cost of securities. Allsecurities are considered to be available-for-sale and are classified as currentassets. Inventories Inventories are stated at the lower of cost or market. Cost is determinedusing the weighted average cost method. Finished goods and work-in-processinventories include material, labor and manufacturing overhead costs. Property, Plant and Equipment Property, plant and equipment are stated at cost less accumulateddepreciation computed using the straight-line method over the estimated economiclives of the assets, which vary from three to ten years. Leasehold improvementsare amortized over the shorter of the estimated useful life or the term of thelease. Goodwill Goodwill, the excess of cost over the fair value of net assets acquired, isbeing amortized over 5 years. 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," the Company reviews long-lived assets 43 45 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) based upon a gross cash flow basis and will reserve for impairment wheneverevents or changes in circumstances indicate the carrying amount of the assetsmay not be fully recoverable. 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." Research and Development Research and development costs are expensed as incurred. 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. Valuation allowances are established when necessary toreduce deferred tax assets when management estimates, based on availableobjective evidence, that it is more likely than not that the benefit will not berealized for the deferred tax assets. Comprehensive Income Comprehensive income is defined as the change in equity of a company duringa period from transactions and other events and circumstances excludingtransactions resulting from investment by owners and distribution to owners. Thedifference between net income and comprehensive income for the Company relatesto foreign currency translation adjustments and unrealized gains and losses onmarketable securities. Comprehensive income for the years ended December 31,2000, 1999 and 1998 is disclosed in the "Consolidated Statement of Stockholders'Equity." Basic and Diluted Net Income (Loss) Per Share Basic income (loss) per share is computed by dividing the income (loss)available to holders of common stock for the period by the weighted averagenumber of shares of common stock outstanding during the period. The calculationof diluted income (loss) per share excludes potential common stock if the effectof such stock is antidilutive. Potential common stock consists of common sharesissuable upon the exercise of stock options. Reclassifications  Certain reclassifications have been made to the prior years consolidatedfinancial statements to conform to current period presentation. Recent Accounting Pronouncements In June 1998, the FASB issued Statement of Financial Accounting StandardNo. 133, or SFAS 133, "Accounting for Derivative Instruments and HedgingActivities." SFAS 133 established accounting and reporting standards forderivative instruments including certain derivative instruments embedded inother contracts and for hedging activities. In June 2000, SFAS 133 was amendedby SFAS 138. The Company will implement SFAS 133 beginning in 2001. Adopting theprovisions of SFAS 133 is not expected to have a material effect on theCompany's financial position or results of operations. 44 46 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) We have adopted the provisions of Staff Accounting Bulletin No. 101, or SAB101, "Revenue Recognition," which did not and does not have a material effect onthe financial position or results of operations of the Company. NOTE 2. GAIN ON DEMETER WARRANTS The Company received approximately 1.1 million shares of FinisarCorporation common stock as a result of Finisar Corporations acquisition ofDemeter Technologies. AXT held a warrant in Demeter that it received in exchangefor certain leases and transferred technology. A gain of $27.3 million wasrecorded in other income as a result of the transaction. The investment in theFinisar Corporation shares is classified as a marketable security (see Note 6).The Company may receive up to an additional 118,000 shares that are currentlyheld in escrow. These shares will be released from escrow on November 31, 2001subject to claims of indemnification. NOTE 3. DISCONTINUED OPERATIONS On December 14, 2000, the Company's Board of Directors approvedmanagement's plan to exit the Company's unprofitable consumer products business.The Company expects to complete the plan by June 30, 2001. Certain assets of theconsumer products division will be sold, transferred to other divisions ordiscarded. At December 31, 2000, the Company had a remaining balance of $1.1million in accrued liabilities for anticipated expenses of asset disposal andoperating losses through the estimated date of disposal. Certain information with respect to discontinued operations is summarizedbelow (in thousands): JANUARY 1, 2000 THROUGH DECEMBER 14, YEAR ENDED YEAR ENDED 2000 1999 1998 ------------ ---------- ---------- Revenue................................................. $ 4,832 $ 6,149 $12,240Cost of revenue......................................... 4,311 7,343 9,946 ------- ------- -------Gross profit............................................ 521 (1,194) 2,294Operating expenses: Selling, general and administrative................... 2,899 3,543 5,519 Research and development.............................. 160 520 180 ------- ------- ------- Total operating expenses........................... 3,059 4,063 5,699Loss from operations.................................... (2,538) (5,257) (3,405)Interest expense........................................ 0 526 606Other (income) expense.................................. (139) 116 117 ------- ------- -------Loss before provision for income taxes.................. (2,399) (5,899) (4,128)Income tax benefit...................................... (912) (2,241) (1,692) ------- ------- -------Loss from discontinued operations....................... $(1,487) $(3,658) $(2,436) ======= ======= ======= The charge in 2000 for loss on disposal of the consumer products businessincludes the following (in thousands): Carrying value of net assets in excess of anticipated proceeds.................................................. $1,060Expenses of asset disposal and anticipated operating loss for the period December 15, 2000 through the estimated date of disposal.......................................... 1,103 ------Loss on disposal before taxes............................... 2,163Income tax benefit.......................................... (822) ------Loss on disposal............................................ $1,341 ====== 45 47 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 4. RESTRUCTURING COSTS On December 14, 2000, the Company's Board of Directors approvedmanagement's plan to exit its unprofitable 650nm laser diode product line withinits visible emitter division. As a result, during the fourth quarter of 2000,the Company recorded a pre-tax restructuring charge of $8.2 million. Therestructuring charge includes $1.8 million to write-off laser diode inventory,which has been classified as a component of cost of goods sold. Therestructuring charge also includes $3.4 million to write-off net assets includedin property, plant and equipment. These assets consist of laser diode processingequipment that could not be utilized for HBLED or VCSEL processing. These assetshave been taken out of service and will be sold or discarded. The restructuringcharge also includes $848,000 to write-down a portion of goodwill attributableto the laser diode product line. The restructuring charge also includes $2.1million for incremental costs and contractual obligations for such items asleasehold termination payments and other facility exit costs incurred as adirect result of this plan. Certain information with respect to restructuring costs is summarized below(in thousands): UTILIZED ---------------- BALANCE RESERVE CASH NON-CASH DECEMBER 31, 2000 ------- ---- -------- ----------------- Inventory write-off.............................. $1,844 $-- $1,844 $ --Property, plant and equipment write-off.......... 3,436 -- 3,436 --Goodwill write-off............................... 848 -- 848 --Incremental restructuring costs.................. 2,124 12 121 1,991 ------ --- ------ ------ $8,252 $12 $6,249 $1,991 ====== === ====== ====== The fair value of assets determined to be impaired in accordance with theguidance for assets to be held and used in SFAS No. 121, "Accounting for theImpairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,"were the result of management estimates. The above noted exit costs weredetermined in accordance with EITF No. 94-3, "Liability Recognition for CertainEmployee Termination Benefits and Other Costs to Exit an Activity." Therestructuring actions, as outlined by the plan, are intended to be executed tocompletion by July 31, 2001. NOTE 5. ACQUISITION Merger of the Company with Lyte Optronics, Inc. On May 28, 1999, the Company completed a merger with Lyte Optronics, Inc.,or Lyte, a Nevada corporation and all of its subsidiaries, including AlphaPhotonics, Inc., Lyte Optronics Ltd. (a United Kingdom company) and AdvancedSemiconductor (a Xiamen, China company). Lyte and its subsidiaries manufactureand distribute semiconductor laser diode chips, high-brightness LEDs and laserpointers. Under the terms of the merger agreement, the Company issued approximately2,023,000 shares of its 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 883,000 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 approximately 115,000 shares of the Company's commonstock. 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 Lyte. 46 48 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company incurred costs of approximately $2.8 million associated withthe merger, which were charged to operations during the quarter ended June 30,1999, the period in which the merger was consummated. Acquisition of Alpha Photonics, Inc. by Lyte Optronics, Inc. On September 29, 1998, Lyte acquired Alpha Photonics, Inc., or Alpha. Thetransaction was accounted for as a purchase. Lyte issued its common andpreferred stock with a value of $11.5 million in exchange for all theoutstanding shares of capital stock of Alpha. Lyte recorded goodwill of $3.0million, representing the excess of the value of the shares issued by Lyte overthe net book value of Alpha. The results of operations of Alpha are included inthe operations of the Company beginning on September 29, 1998. NOTE 6. MARKETABLE SECURITIES Marketable securities consist of Finisar Corporation common stock. Anunrealized gain of $2.2 million net of tax was recorded in 2000. Thesesecurities are valued at fair market value at December 31, 2000. There is noassurance that the Company will realize this value when the securities are soldin the future. 47 49 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 7. BALANCE SHEET DETAIL  The components of selected balance sheet accounts are summarized below (inthousands): DECEMBER 31, -------------------- 2000 1999 -------- -------- Inventories: Raw materials........................................ $ 20,623 $ 13,503 Work-in-process...................................... 26,795 16,151 Finished goods....................................... 4,428 5,816 -------- -------- $ 51,846 $ 35,470 ======== ========Prepaid expenses: Income tax receivable................................ $ 1,389 $ 4,013 Other................................................ 2,214 4,932 -------- -------- $ 3,603 $ 8,945 ======== ========Property, plant and equipment: Land................................................. $ 2,447 $ 2,447 Building............................................. 19,747 18,507 Machinery and equipment.............................. 40,002 31,058 Leasehold improvements............................... 4,079 2,704 Construction in progress............................. 14,694 1,008 -------- -------- 80,969 55,724 Less: accumulated depreciation and amortization...... (17,568) (14,859) -------- -------- $ 63,401 $ 40,865 ======== ========Accrued liabilities: Accrued compensation and other....................... $ 3,186 $ 2,090 Customer prepayments................................. 5,402 -- Accrued restructuring costs.......................... 1,991 -- Accrued discontinued operation costs................. 1,103 -- Other................................................ 4,969 5,374 -------- -------- $ 16,651 $ 7,464 ======== ======== NOTE 8. DEBT Short-Term Bank Borrowing The Company has a $20.0 million bank line of credit that expires on May 31,2002. The line of credit is secured by the Company's operating assets, excludingequipment. Borrowings bear interest at 1.75% above LIBOR that was 6.4% atDecember 31, 2000 or 0.5% above the bank's variable prime rate that was 9.5% atDecember 31, 2000. The line of credit is subject to certain financial covenantsregarding current financial ratios and cash flow requirements that have all beenmet as of December 31, 2000. The amounts outstanding under the line of creditwere $0 at December 31, 2000 and $11.3 million at December 31, 1999. At December 31, 2000, the Company had two notes outstanding with banks inChina in the amount of $1.4 million. These notes mature in 2001 and bearinterest at 4.9% and 5.5% and are secured by a $400,000 certificate of depositand a building and land usage rights. 48 50 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Long-Term Debt The components of long-term debt are summarized below (in thousands): DECEMBER 31, ------------------ 2000 1999 ------- ------- Various notes payable to banks, secured by certain equipment, bearing interest at fixed rates between 7.69% and 9.01%, maturing between February 2001 and May 2003.... $ 2,035 $ 2,948Debenture loan to Bay Area Employment Development Company, guaranteed by the U.S. Small Business Administration, bearing interest at a fixed rate of 7.27%, maturing October 2016.............................................. 888 917Taxable revenue bonds, secured by a letter of credit from a bank, bearing interest at the H15 30 day bond yield for commercial paper that was 6.65% on December 31, 2000, maturing December 2023.................................... 10,555 11,135Mortgage notes payable to a bank, secured by property, bearing interest at 150 basis points above the prime rate that was 9.5% on December 31, 2000, maturing May 2003..... 6,000 1,822 ------- ------- 19,478 16,822Less current portion........................................ (4,355) (1,568) ------- ------- $15,123 $15,254 ======= ======= Maturities of long-term debt at December 31, 2000 were as follows: 2001....................................................... $ 4,3552002....................................................... 2,3572003....................................................... 3,5902004....................................................... 4942005....................................................... 457Thereafter................................................. 8,225 ------- $19,478 ======= Following the merger with Lyte Optronics in 1999, the Company prepaid LyteOptronics debt. The prepayment resulted in an extraordinary loss in the amountof $508,000, net of tax benefits. 49 51 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 9. INCOME TAXES The components of the provision for income taxes are summarized below (inthousands): YEARS ENDED DECEMBER 31, ---------------------------- 2000 1999 1998 ------- ------ ------- Current: Federal.............................................. $ 7,738 $4,201 $ 5,297 State................................................ 948 690 611 Foreign.............................................. 155 247 51 ------- ------ ------- Total current................................ 8,841 5,138 5,959 ------- ------ -------Deferred: Federal.............................................. 5,489 (663) (1,097) State................................................ 648 (95) (194) ------- ------ ------- Total deferred............................... 6,137 (758) (1,291) ------- ------ ------- Total provision from continuing operations before discontinued operations............. $14,978 $4,380 $ 4,668 ======= ====== ======= A reconciliation of the effective income tax rates and the U.S. statutoryfederal income tax rate is summarized below: YEARS ENDED DECEMBER 31, ------------------------ 2000 1999 1998 ---- ---- ---- Statutory federal income tax rate.......................... 35.0% 34.0% 34.0%State income taxes, net of federal tax benefits............ 3.3% 4.8% 2.6%Foreign sales corporation benefit.......................... (1.4)% (3.0)% (3.2)%Foreign income taxed at higher rate........................ 0.0% 0.0% 0.8%Acquisition costs.......................................... 0.0% 11.0% 0.0%Other...................................................... 1.1% 3.4% 6.9% ---- ---- ----Effective tax rate......................................... 38.0% 50.2% 41.1% ==== ==== ==== Deferred tax assets and liabilities are summarized below (in thousands): YEARS ENDED DECEMBER 31, ------------------- 2000 1999 -------- ------- Deferred tax assets: Accruals and reserves not yet deductible.................. $ 8,529 $ 3,659 State taxes............................................... 288 98 Net operating loss........................................ 867 925 Credits................................................... 165 128 -------- ------- $ 9,849 $ 4,810Deferred tax liabilities: Unrealized appreciation on Finisar marketable securities............................................. (1,339) -- Gain on receipt of Finisar marketable securities.......... (9,945) -- Depreciation.............................................. (2,412) (1,600) -------- ------- $(13,696) $(1,600) Net deferred tax assets (liabilities)............. $ (3,847) $ 3,210 ======== ======= 50 52 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 10. NET INCOME PER SHARE A reconciliation of the numerators and denominators of the basic anddiluted net income per share calculations is as follows (in thousands, exceptper share data): YEARS ENDED DECEMBER 31, ----------------------------- 2000 1999 1998 ------- ------- ------- Numerator: Net income................................................ $21,610 $ 172 $ 4,284 ======= ======= =======Denominator: Denominator for basic net income per share -- weighted average common shares.................................. 19,677 18,655 16,076 Effect of dilutive securities: Common stock options................................... 1,382 1,116 249 ------- ------- -------Denominator for dilutive net income per share............... $21,059 $19,771 $16,325 ======= ======= =======Basic income per share...................................... $ 1.10 $ 0.01 $ 0.27Diluted income per share.................................... $ 1.03 $ 0.01 $ 0.26Options excluded from diluted net income per share as the impact is antidilutive.................................... 118 415 7 ======= ======= ======= NOTE 11. STOCKHOLDERS' EQUITY In May 1998, the Company completed its initial public offering, or IPO, andissued 2,875,000 shares of its common stock at $10.00 per share, including theshares from an over-allotment option. The Company received cash of approximately$25.8 million net of underwriting discounts, commissions and IPO expenses. Uponthe closing of the IPO, all outstanding shares of the Company's then convertiblepreferred stock were automatically converted into shares of common stock. On May 28, 1999, the Company completed its acquisition of Lyte Optronics,Inc. Under the terms of the acquisition, the Company issued approximately2,023,000 shares of common stock and 883,000 shares of non-voting andnon-convertible preferred stock with a 5.0% cumulative annual dividend ratepayable when declared by the board of directors of the Company and $4 per shareliquidation preference over common stock, in exchange for all of the issued andoutstanding shares of capital stock of Lyte. On July 25, 2000 the Company completed a private securities offering,raising approximately $8.5 million in exchange for 234,115 shares of commonstock. On September 19, 2000, the Company sold pursuant to an underwritten publicoffering, 2,510,000 shares of its common stock at a price of $34.25 per share,including the shares from an over-allotment option. The Company received cash ofapproximately $80.8 million net of underwriting discounts, commissions andexpenses. Following the public offering, proceeds were used to repay its line ofcredit and for general corporate purposes. NOTE 12. 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, 1998. Optionsgranted under the 1993 Plan are generally for periods not to exceed ten yearsand are granted at the fair market value of the stock at the date of grant asdetermined by the board of directors. Options granted under 51 53 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) the 1993 Plan generally vest 25.0% upon grant and 25.0% each year thereafter,with full vesting 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,5,901,501 shares of common stock have been reserved for issuance as of December31, 2000. 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. Information about stock option activities is summarized below: OPTIONS OUTSTANDING ---------------------------------------- WEIGHTED AVERAGE OPTIONS EXERCISE EXERCISE AVAILABLE NUMBER OF PRICE PER PRICE PER FOR GRANT SHARES SHARE SHARE ---------- --------- -------------- --------- Balance at December 31, 1997.............. 467,819 1,346,152 $ 4.77 Additional shares authorized............ 1,500,000 -- -- Granted................................. (320,599) 320,599 $ 5.00 - 11.87 7.46 Exercised............................... -- (71,407) 1.20 - 5.00 1.94 Cancelled............................... 64,268 (64,268) 5.00 - 7.50 5.39 ---------- ---------Balance at December 31, 1998.............. 1,711,488 1,531,076 5.44 Additional shares authorized............ 1,000,000 -- -- Granted................................. (1,504,350) 1,504,350 9.12 - 24.96 18.21 Exercised............................... -- (200,679) 1.20 - 8.25 4.64 Cancelled............................... 154,645 (154,645) 1.90 - 22.69 13.82 ---------- ---------Balance at December 31, 1999.............. 1,361,783 2,680,102 12.18 Additional shares authorized............ 2,101,501 -- -- Granted................................. (1,182,550) 1,182,550 15.06 - 47.00 30.21 Exercised............................... -- (711,259) 0.20 - 22.69 8.49 Cancelled............................... 681,218 (681,218) $ 1.90 - 47.00 17.29 ---------- ---------Balance at December 31, 2000.............. 2,961,952 2,470,175 $20.46 ========== ========= 52 54 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)  Information about stock options outstanding at December 31, 2000 issummarized below: OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------- ---------------------- WEIGHTED AVERAGE WEIGHTED REMAINING AVERAGE RANGE OF NUMBER CONTRACTUAL NUMBER EXERCISE EXERCISE PRICES OUTSTANDING LIFE OUTSTANDING PRICE --------------- ----------- ----------- ----------- -------- $ 5.00 - 5.00 353,944 6.63 259,162 $5.00 5.50 - 9.12 393,771 7.40 129,619 6.92 10.04 - 15.69 259,417 8.87 15,292 14.11 15.87 - 21.19 277,293 8.60 82,186 19.92 21.25 - 24.00 329,300 8.93 2,182 22.69 24.50 - 29.56 105,500 9.28 -- -- 29.56 - 31.63 277,100 9.61 -- -- 31.88 - 36.50 269,300 9.67 -- -- 36.623 - 44.25 204,050 9.65 125 39.13 $44.38 - 44.38 500 9.13 -- -- --------- ---- ------- ----- 2,470,175 8.55 488,566 $8.39 ========= ==== ======= ===== Stock-Based Compensation Under APB No. 25 In connection with certain stock option grants the Company recordeddeferred compensation costs totaling $203,000 for the year ended December 31,1998 and $322,000 for the year ended December 31, 1997. Compensation cost is thedifference between the exercise price and the deemed fair value at the date ofgrant. Compensation cost is being amortized over the vesting period relating tothese options, of which approximately $110,000 was amortized for the year endedDecember 31, 2000, $110,000 for 1999 and $96,000 for 1998. Certain Pro Forma Disclosures Pro forma information regarding net income and net income per share isrequired by SFAS No. 123, which also requires that information be determined asif the Company had accounted for its employee stock options granted under thefair value method. The fair value for these options was estimated using theBlack-Scholes option pricing model. The Company calculated the fair value of each option grant on the date ofgrant using the Black-Scholes option pricing model as prescribed by SFAS No. 123using the following assumptions: YEARS ENDED DECEMBER 31, ------------------------- 2000 1999 1998 ----- ---- ---- Risk free interest rate................................... 5.8% 5.6% 5.2%Expected life (in years).................................. 5.0 5.0 5.0Dividend yield............................................ 0.0% 0.0% 0.0%Volatility................................................ 124.0% 96.0% 75.0% The weighted average grant-date fair value of options granted during theyear ended December 31, 2000 was $25.73, $13.09 in 1999 and $4.57 in 1998. 53 55 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Had compensation cost for the Company's options been determined based onthe fair value at the grant dates, as prescribed in SFAS 123, the Company's proforma net income and net income per share would have been as summarized below(in thousands except per share data): YEARS ENDED DECEMBER 31, ---------------------------- 2000 1999 1998 ------- ------- ------ Net income: As reported.......................................... $21,610 $ 172 $4,284 Pro forma net income................................. 16,417 (2,747) 3,936Net income per share: As reported: Basic............................................. $ 1.10 $ 0.01 $ 0.27 Diluted........................................... 1.03 0.01 0.26 Pro forma net income: Basic............................................. $ 0.83 $ (0.15) $ 0.24 Diluted........................................... 0.78 (0.15) 0.24 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 February 1998, the Company's board of directors approved the 1998Employee Stock Purchase Plan (the "1998 Purchase Plan"). The Company'sstockholders approved the 1998 Purchase Plan in March 1998. At December 31, 2000a total of 900,000 shares of the Company's common stock were reserved forissuance under the 1998 Purchase Plan. A total of 149,000 shares were purchasedas of December 31, 2000. The 1998 Purchase Plan permits eligible employees toacquire shares of the Company's common stock through payroll deductions. Thecommon stock purchase price is determined as 85.0% of the lower of the marketprice of the common stock at the purchase date or the date of offer to theemployee. 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 after90 days from the date of hire. Participants may contribute up to 10.0% of theirearnings to the Savings Plan with a discretionary matching amount provided bythe Company. The Company's contributions to the Savings Plan were $236,000 forthe year ended December 31, 2000, $146,000 for 1999 and $101,000 for 1998. NOTE 13. SEGMENT AND FOREIGN OPERATIONS INFORMATION The Company has three reportable segments: substrates, visible emitters anddiscontinued consumer products. The segments in which the Company operates aresubject to rapid technological change and significant competition. Also, thenumber of suppliers of certain materials used by the Company and the number ofcustomers are limited. 54 56 AXT, INC.  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Selected financial information by business segment is summarized below (inthousands): YEARS ENDED DECEMBER 31, -------------------------------- 2000 1999 1998 -------- -------- -------- Subtrates Division Net revenues from external customers............. $113,374 $ 56,732 $ 43,177 Gross profit..................................... 52,013 23,286 17,936 Operating income................................. 34,087 12,275 10,416 Identifiable assets.............................. 215,527 88,579 76,505Visible Emitter Division Net revenues from external customers............. $ 8,129 $ 18,640 $ 5,897 Gross profit (loss) *............................ (4,194) 2,060 2,135 Operating income (loss) *........................ (19,487) (2,779) 1,132 Identifiable assets.............................. 33,181 23,423 18,917Discontinued Consumer Products Division Identifiable assets.............................. $ 1,512 $ 3,760 $ 7,561 Total Net revenues from external customers............. $121,503 $ 75,372 $ 49,074 Gross profit..................................... 47,819 25,346 20,071 Operating income................................. 14,600 9,496 11,548 Identifiable assets.............................. 250,220 115,762 102,983 ---------------* Includes restructuring charge of $1.8 million in gross profit and $8.2 million in operating loss in 2000 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 (inthousands): YEARS ENDED DECEMBER 31, ------------------------------ 2000 1999 1998 -------- ------- ------- Net revenues: United States...................................... $ 62,905 $36,497 $30,172 Europe............................................. 12,743 8,175 3,960 Canada............................................. 6,661 2,221 1,356 Japan, Asia Pacific and other...................... 39,194 28,479 13,586 -------- ------- ------- Consolidated....................................... $121,503 $75,372 $49,074 ======== ======= ======= Property, plant and equipment by geographic location is summarized below(in thousands): YEARS ENDED DECEMBER 31, ------------------ 2000 1999 ------- ------- Property, plant and equipment, net: United States.......................................... $58,022 $37,362 China.................................................. 5,379 3,491 Other.................................................. -- 12 ------- ------- $63,401 $40,865 ======= ======= 55 57 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 14. RELATED PARTY TRANSACTIONS Equipment & Materials, a California corporation engaged in internationaltrading and quartzware fabrication, supplies us with various raw materials fromChina and has manufactured quartzware for us. Christina X. Li, the soleshareholder and president of Equipment & Materials, is the wife of Davis Zhang,the president of our substrate division. Purchases from Equipment & Materialswere approximately $8.9 million for the year ended December 31, 2000, $3.6million for 1999 and $3.7 million for 1998. A balance of $318,000 due toEquipment & Materials was included in accounts payable at December 31, 2000. NOTE 15. COMMITMENTS AND CONTINGENCIES 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 has entered into contracts to supply several large customerswith GaAs wafers. The contracts guarantee the delivery of a certain number ofwafers between January 1, 2001 and December 31, 2001 with a current contractvalue of $87.8 million. The contract sales prices are subject to reviewquarterly and can be adjusted in the event that raw material prices change. Inthe event of non-delivery of the determined wafer quantities in any monthlydelivery period, the Company could be subject to non-performance penalties ofbetween 5% and 10% of the value of the delinquent monthly deliveries. Partialprepayments received for these supply contracts totaling $5.4 million areincluded in accrued liabilities at December 31, 2000. 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 leases wasapproximately $224,048 for the year ended December 31, 2000. Included in property and equipment is approximately $13.0 million ofequipment that is leased under non-cancelable leases accounted for as capitalleases. These leases expire at various dates through 2005. Total minimum lease payments under the above leases as of December 31,2000, are summarized below (in thousands): CAPITAL OPERATING LEASES LEASES TOTAL ------- --------- ------- 2001.................................................. $ 3,742 $ 359 $ 4,1012002.................................................. 4,386 375 4,7612003.................................................. 4,289 391 4,6802004.................................................. 2,348 407 2,7552005.................................................. 633 148 781Thereafter............................................ -- -- -- ------- ------ ------- 15,398 $1,680 $17,078 ====== =======Less amounts representing interest at 6.0% to 8.8%.... (2,063)Less amounts representing interest at 6.0% to 8.8%.... (2,063) ------- 13,335Less short-term portion............................... (6,057) -------Long-term portion..................................... $ 7,278 ======= NOTE 16. 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. The Companyhas purchased foreign exchange contracts to hedge 56 58 AXT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) against certain trade accounts receivable denominated in Japanese yen. Thechange in the fair value of the forward contracts is recognized as part of therelated foreign currency transactions as they occur. As of December 31, 2000,the Company's outstanding commitments with respect to the foreign exchangecontracts, which were commitments to sell Japanese yen, had a total contractvalue of approximately $500,000. The Company incurred a foreign transaction exchange loss of $552,000 forthe year ended December 31, 2000, a gain of $652,000 in 1999 and a loss of$24,000 in 1998. 57 59 Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the registrant has caused this report to be signed on itsbehalf by the undersigned, thereto duly authorized. AXT, Inc. By: /s/ MORRIS S. YOUNG ------------------------------------ Morris S. Young, Chief Executive Officer and President Date: February 22, 2001 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signatureappears below hereby constitutes and appoints Morris S. Young and Donald L.Tatzin, and each of them, his true and lawful attorney-in-fact and agent, withfull power 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 dates indicated.  SIGNATURE TITLE DATE --------- ----- ---- /s/ MORRIS S. YOUNG President, Chief Executive February 22, 2001--------------------------------------------------- Officer and Chairman of the Morris S. Young Board /s/ DONALD L. TATZIN Senior Vice President, Chief February 22, 2001--------------------------------------------------- Financial Officer Donald L. Tatzin /s/ JOHN E. DRURY Corporate Controller February 22, 2001--------------------------------------------------- John E. Drury /s/ DAVID C. CHANG Director February 22, 2001--------------------------------------------------- David C. Chang /s/ JESSE CHEN Director February 22, 2001--------------------------------------------------- Jesse Chen /s/ B.J. MOORE Director February 22, 2001--------------------------------------------------- B.J. Moore 58 60 EXHIBITS TO FORM 10-K ANNUAL REPORT FOR THE YEAR ENDED DECEMBER 31, 2000 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 dated May 27, 1999 (which is incorporated herein by reference to Exhibit 2.1 to the registrant's form 8-K dated May 28, 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 (which is incorporated herein by reference to Exhibit 2.1 to the registrant's form 8-K dated 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 (which is incorporated herein by reference to Exhibit 2.1 to the registrant's form 8-K dated May 28, 1999). 2.5(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. 3.1(3) Restated Certificate of Incorporation. 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(4) By Laws. 4.0(4) Rights Agreement.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, 199810.9(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, 1998.10.12 Loan Agreement between U.S. Bank National Association and us dated August 28, 2000.21.1(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). ---------------(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 (4) As filed with the SEC in our Form 8-K on June 14, 1999 59 1 EXHIBIT 10.12 CREDIT AGREEMENT AMONG AXT, INC. AND THE LENDERS NAMED HEREIN AND U.S. BANK NATIONAL ASSOCIATION AS AGENT AUGUST 28, 2000 2 TABLE OF CONTENTS Page ---- Article I Definitions............................................................2 SECTION 1.1 Defined Terms.......................................2 SECTION 1.2 Interpretation.....................................16 SECTION 1.3 Headings...........................................16Article II The Credits...........................................................16 SECTION 2.1 Line Of Credit.....................................16 SECTION 2.2 Term Loans.........................................19 SECTION 2.3 The Letter Of Credit Facility......................21 SECTION 2.4 Notice Of Borrowing................................22 SECTION 2.5 Interest/Fees......................................23 SECTION 2.6 Conversion Of Interest Options.....................25 SECTION 2.7 Other Payment Terms................................26 SECTION 2.8 Prepayment.........................................27 SECTION 2.9 Funding............................................28 SECTION 2.10 Pro Rata Treatment.................................29 SECTION 2.11 Change Of Circumstances............................29 SECTION 2.12 Taxes On Payments..................................31 SECTION 2.13 Funding Loss Indemnification.......................32 SECTION 2.14 Authorized Representatives.........................33 SECTION 2.15 Collateral.........................................33 SECTION 2.16 Guaranties.........................................34Article III Payments With Respect To The Bonds And The Letter Of Credit...........34 SECTION 3.1 Annual Redemption Of Bonds.........................34 SECTION 3.2 Reimbursement Deposit Account......................35 SECTION 3.3 Other Optional Redemptions Of Bonds................35Article IV Representations And Warranties........................................35 -i- 3 SECTION 4.1 Legal Status.......................................36 SECTION 4.2 Authorization And Validity.........................36 SECTION 4.3 No Violation.......................................36 SECTION 4.4 No Additional Approvals............................36 SECTION 4.5 Litigation.........................................36 SECTION 4.6 Correctness Of Financial Statement.................37 SECTION 4.7 Income Tax Returns.................................37 SECTION 4.8 No Subordination...................................37 SECTION 4.9 Permits, Franchises................................37 SECTION 4.10 ERISA..............................................37 SECTION 4.11 Other Obligations..................................38 SECTION 4.12 Government Regulations.............................38 SECTION 4.13 Securities Activities..............................38 SECTION 4.14 Environmental Matters..............................38 SECTION 4.15 Real Property Collateral...........................38 SECTION 4.16 Subsidiaries.......................................39 SECTION 4.17 Truth, Accuracy Of Information.....................39Article V Conditions............................................................39 SECTION 5.1 Conditions Of Initial Extension Of Credit..........39 SECTION 5.2 Conditions Of Each Extension Of Credit.............43Article VI Affirmative Covenants.................................................44 SECTION 6.1 Punctual Payments..................................44 SECTION 6.2 Accounting Records.................................44 SECTION 6.3 Financial Statements...............................44 SECTION 6.4 Compliance.........................................45 SECTION 6.5 Insurance..........................................45 SECTION 6.6 Facilities.........................................45 SECTION 6.7 Taxes And Other Liabilities........................46 SECTION 6.8 Litigation.........................................46 SECTION 6.9 Financial Condition................................46 -ii- 4 SECTION 6.10 Notice To Agent....................................47 SECTION 6.11 Site Visits; Right To Stop Work....................47 SECTION 6.12 Security...........................................47 SECTION 6.13 Related Documents..................................47 SECTION 6.14 Investigations And Inquiries.......................47 SECTION 6.15 Contract Collateral................................48 SECTION 6.16 Borrowing Base Deficiency..........................48 SECTION 6.17 Notice Of Certain Matters..........................48Article VII Negative Covenants....................................................49 SECTION 7.1 Use Of Funds.......................................49 SECTION 7.2 Other Indebtedness.................................50 SECTION 7.3 Merger, Consolidation, Organizational Structure, Transfer Of Assets......................50 SECTION 7.4 Guaranties.........................................50 SECTION 7.5 Loans, Advances, Investments.......................50 SECTION 7.6 Dividends And Distributions........................50 SECTION 7.7 Pledge Of Assets...................................51Article VIII Events Of Default.....................................................51 SECTION 8.1 Events Of Default..................................51 SECTION 8.2 Remedies...........................................53Article IX The Agent.............................................................54 SECTION 9.1 Authorization And Action...........................54 SECTION 9.2 Reliance By Agent..................................55 SECTION 9.3 Defaults...........................................55 SECTION 9.4 Indemnification....................................55 SECTION 9.5 Non-Reliance On Agent..............................56 SECTION 9.5 Non-Reliance On Agent..............................56 SECTION 9.6 Successor Agent....................................56 SECTION 9.7 Execution Of Loan Documents........................57 SECTION 9.8 Agent In Its Individual Capacity...................57 -iii- 5 Article X Miscellaneous.........................................................57 SECTION 10.1 Notices............................................57 SECTION 10.2 Costs, Expenses Attorneys' Fees....................58 SECTION 10.3 Indemnification....................................58 SECTION 10.4 Waivers, Amendments................................59 SECTION 10.5 Successors And Assigns.............................60 SECTION 10.6 Setoff.............................................63 SECTION 10.7 No Waiver; Cumulative Remedies.....................63 SECTION 10.8 Entire Agreement, Amendment........................63 SECTION 10.9 No Third Party Beneficiaries.......................63 SECTION 10.10 Time...............................................64 SECTION 10.11 Severability Of Provisions.........................64 SECTION 10.12 Governing Law......................................64 SECTION 10.13 Submission To Jurisdiction.........................64 SECTION 10.14 Arbitration........................................64 SECTION 10.15 Counterparts.......................................67 SECTION 10.16 Confidentiality....................................67 -iv- 6 LIST OF SCHEDULES AND EXHIBITS Schedule 1 Lenders and Proportionate SharesSchedule 2.1(d) Borrower Letter of Credit AgreementSchedule 2.3(a) Amortization Schedule for the Letter of Credit FacilitySchedule 2.13(b) Prepayment IndemnitySchedule 4Schedule 5 Contract Collateral DescriptionSchedule 7.4 Existing IndebtednessSchedule 7.5 Existing GuarantiesSchedule 7.7 Existing Loans; Advances; InvestmentsSchedule 7.8 Existing Liens; Pledges of AssetsExhibit A Letter of CreditExhibit B Form of Line of Credit NoteExhibit C Form of Term NoteExhibit D Notice of BorrowingExhibit E Notice of Conversion or ContinuationExhibit F Notice of Authorized RepresentativesExhibit G Assignment and Assumption AgreementExhibit H Borrowing Base Certificate -v- 7 CREDIT AGREEMENT THIS CREDIT AGREEMENT is entered into as of August 28, 2000, byand among AXT, INC., a Delaware corporation ("Borrower"), each of the financialinstitutions from time to time listed on Schedule I attached hereto, as amendedfrom time to time (collectively, "Lenders"), and U.S. BANK NATIONAL ASSOCIATION("U.S. Bank"), as agent for the Lenders (in such capacity, "Agent"), and asarranger. RECITALS WHEREAS, Borrower has requested from Lenders the line of credit,term loan and other credit facilities described herein for the purposesdescribed herein; and WHEREAS, Borrower has issued a series of bonds designated theVariable Rate Taxable Demand Revenue Bonds Series 1998, in the aggregateprincipal amount of $11,615,000.00 (the "Bonds"), pursuant to an Indenture datedas of December 1, 1998 (the "Indenture") between Borrower and Harris TrustCompany of California, as trustee (the "Trustee"); and WHEREAS, to support certain payments with respect to the Bonds,Borrower requested U.S. Bank to issue, and U.S. Bank issued for the account ofBorrower and for the benefit of the Trustee, an irrevocable direct-pay letter ofcredit (the "Letter of Credit"), in the original stated amount of$11,986,680.00, a copy of which is attached hereto as Exhibit A, pursuant tothat certain Reimbursement Agreement dated as of December 1, 1998, betweenBorrower and U.S. Bank; and WHEREAS, as of the date of this Agreement, [$11,092,000.00] ofthe principal amount of the Bonds remains outstanding; and WHEREAS, Borrower will be responsible for amounts drawn under theLetter of Credit and for certain fees and amounts due with respect to the Letterof Credit and this Credit Agreement; and WHEREAS, Lenders and Agent have agreed to provide said Letter ofCredit facility to Borrower, as well as a revolving line of credit facility andcertain term loans to Borrower on the terms and subject to the conditionscontained herein. NOW, THEREFORE, in consideration of the mutual covenants andpromises of the parties contained herein, Agent, Lenders and Borrower herebyagree as follows: -1- 8 ARTICLE I --------- DEFINITIONS SECTION 1.1 DEFINED TERMS. As used in this Agreement, all termsdefined above shall have the meanings set forth above, and the following termsshall have the meanings set forth after each: "Accounts" means all currently existing and hereafter arising accounts, contract rights, and all other forms of obligations owing to Borrower arising out of the sale or lease of goods or the rendition of services by Borrower, irrespective of whether earned by performance, and any and all credit insurance, guaranties, or security therefor. "Agent's Office" means (i) initially, Agent's office designated as such in Schedule I attached hereto, and (ii) subsequently, such other office designated as such in writing by Agent to Lenders and Borrower. "Agreement" means this Credit Agreement, as amended, amended and restated, modified or supplemented from time to time. "Applicable Lending Office" means, with respect to each Lender, (i) initially, its office designated as such in Schedule I attached hereto, and (ii) subsequently, such other office or offices designated as such in writing by such Lender to Agent. "Assignee" has the meaning assigned to that term in Section 10.5(c) hereof. "Assignment" has the meaning assigned to that term in Section 10.5(c) hereof. "Assignment Agreement" has the meaning assigned to that term in Section 10.5(c) hereof. "Assignor" has the meaning assigned to that term in Section 10.5(c) hereof. "Authorized Representatives" means those officers and employees designated by Borrower on the most current Notice of Authorized Representatives delivered by Borrower to Agent as being authorized to request any borrowing or to make any interest rate selection on behalf of Borrower hereunder, or to give Agent any other notice hereunder that is required by the terms hereof to be made through one of Borrower's Authorized Representatives. -2- 9 "Bankruptcy Code" means the Bankruptcy Reform Act, Title 11 of the United States Code, as amended or recodified from time to time, including (unless the context otherwise requires) any rules or regulations promulgated thereunder. "Bond Interest Payment Date" has the meaning assigned to that term in the Indenture. "Bonds" means the Bonds described in the Recitals hereof. "Borrower Letter of Credit(s)" has the meaning assigned to that term in Section 2.1(d) hereof. "Borrower Letter of Credit Agreement(s)" has the meaning assigned to that term in Section 2.1(d) hereof. "Borrower's Books" means all of Borrower's books and records including: ledgers; records indicating, summarizing, or evidencing Borrower's properties or assets (including the Personal Property Collateral) or liabilities; all information relating to Borrower's business operations or financial condition; and all computer programs, disk or tape files, printouts, runs, or other computer prepared information. "Borrowing Base" has the meaning assigned to that term in Section 2.1(b) hereof. "Borrowing Base Certificate" has the meaning assigned to that term in Section 2.1(b) hereof. "Business Day" means any day other than a Saturday, Sunday or other day on which commercial banks in New York City or Seattle are authorized or required by law to close and, if the applicable Business Day relates to any LIBOR borrowing, means such a day which is also a day on which banks in the City of London are generally open for interbank or foreign exchange transactions. "Change of Law" means the adoption of any Governmental Rule, any change in any Governmental Rule or the application or requirements thereof (whether such change occurs in accordance with the terms of such Governmental Rule as enacted, as a result of amendment or otherwise), any change in the interpretation or administration of any Governmental Rule by any Governmental Authority, or compliance by any Lender (or any entity controlling such Lender) with any request, guideline or directive (whether or not having the force of law) of any Governmental Authority. -3- 10 "Closing Date" means the date on which all of the conditions set forth in Section 5.1 of this Agreement have been satisfied or waived by Agent. "Collateral" means, collectively, the Personal Property Collateral and the Real Property Collateral. "Contract Collateral" has the meaning assigned to that term in Section 5.1(b)(xiv) hereof. "Credits" means the Line of Credit, the Term Loans and the Letter of Credit Facility. "Date of Issuance" means December 1, 1998. "Deeds of Trust" means, collectively, all of the deeds of trust for the benefit of Agent that secure the obligations of Borrower to Agent and Lenders under this Agreement. "Default" means an Event of Default or an event or condition which, with the giving of notice or the passage of time, or both, would constitute an Event of Default. "EBITDA" means, for the most recent trailing four-quarter period, consolidated net income from operations (after eliminating all extraordinary items of gain or loss) plus interest expense, income taxes, depreciation and amortization, in each case defined in accordance with GAAP and, if applicable, to the extent each has been deducted in the determination of net income. "El Monte Property" means that certain real property located at 9650 Telstar Avenue, in the City of El Monte, County of Los Angeles, California, owned by Borrower and improved with a commercial building used for research and development and manufacturing purposes. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended or recodified from time to time, including (unless the context otherwise requires) any rules or regulations promulgated thereunder. "Event of Default" has the meaning assigned to that term in Section 8.1 hereof. "Expiration Date" means December 1, 2008. "Federal Funds Rate" means, for any day, the weighted average of the per annum rates on overnight Federal funds transactions with member banks of the Federal Reserve System arranged by Federal funds brokers as published by -4- 11 the Federal Reserve Bank of New York for such day (or, if such rate is not so published for any day, the average rate quoted to Agent on such day by three (3) Federal funds brokers of recognized standing selected by Agent). "Fixed Charge Coverage Ratio" means the ratio of (A) EBITDA less the aggregate amount of (i) unfinanced capital expenditures, (ii) cash taxes, and (ii) permitted dividends, distributions and treasury stock purchases, divided by (B) the aggregate amount of the following, each measured for the most recent four historical quarters (excluding the current quarter in possession) (i) cash Interest Expense (including any letter of credit fees payable to U.S. Bank) and (ii) capital lease payments plus the average of current maturities of long-term debt (including all bond redemptions required by this Agreement) measured for the most recent four historical quarters (excluding the current quarter in possession) and (iii) the current maturity of subordinated debt measured for the most recent four historical quarters (excluding the current quarter in possession). "Fixed Rate Term" means a period of one (1), two (2), three (3), or six (6) months, as designated by Borrower, during which all or a portion of the Line of Credit or the Term Loan bears interest determined in relation to LIBOR; provided however, that (a) no Fixed Rate Term may be selected for a principal amount less than One Million Dollars ($1,000,000.00); (b) no Fixed Rate Term shall extend beyond the scheduled maturity date hereof; (c) any Fixed Rate Term which would otherwise expire on a day which is not a Business Day shall be extended to the next succeeding Business Day, unless the result of such extension would be to extend such Fixed Rate Term into another calendar month, in which event the Fixed Rate Term shall end on the immediately preceding Business Day; (d) any Fixed Rate Term that begins on the last Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Fixed Rate Term) shall end on the last Business Day of a calendar month; and (e) with respect to the Term Loans, no Fixed Rate Term shall extend beyond a date on which Borrower is required to make a scheduled payment of principal on the Term Loans unless the aggregate principal amount of Term Loans bearing interest at the Reference Rate plus the aggregate principal amount of Term Loans bearing interest at LIBOR with Fixed Rate Terms expiring on or before such date equals or exceeds the principal amount required to be paid on the Term Loans on such date. "Funded Debt" means the aggregate amount of all obligations for (1) borrowed money, including senior bank debt, subordinated debt and amounts owing under the Bonds; (2) capital leases; (3) issued but undrawn letters of credit, except the direct pay Letter of Credit supporting the Bonds, plus any -5- 12 amounts outstanding under drawn letters of credit; and (4) contingent obligations. "GAAP" means generally accepted accounting principles as in effect in the United States of America from time to time, consistently applied. "General Intangibles" means all of Borrower's present and future general intangibles and other personal property (including the Contract Collateral and all contract rights, rights arising under common law, statutes, or regulations, choses or things in action, goodwill, patents, trade names, trademarks, servicemarks, copyrights, blueprints, drawings, purchase orders, customer lists, monies due or recoverable from pension funds, route lists, rights to payment and other rights under any royalty or licensing agreements, infringement claims, computer programs, information contained on computer disks or tapes, literature, reports, catalogs, deposit accounts, insurance premium rebates, tax refunds, and tax refund claims), other than goods, Accounts and Negotiable Collateral. "Governmental Authority" means any domestic or foreign national, state or local government, any political subdivision thereof, any department, agency, authority or bureau of any of the foregoing, or any other entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government, including the Federal Deposit Insurance Corporation, the Federal Reserve Board, the Comptroller of the Currency, any central bank or any comparable authority. "Governmental Rule" means any law, rule, regulation, ordinance, order, code interpretation, judgment, decree, directive, guideline, policy or similar form of decision of any Governmental Authority. "Guarantee" means any guarantee of Borrower's obligations to Agent and Lenders under the Loan Documents executed by a Guarantor. "Guarantor" means, subject to the release provisions set forth in Section 2.16 hereof, collectively, AXT-Japan, Beijing Tongmei Xtal Technology Co., Ltd., American Xtal Technology (Hong Kong), Lyte Optronics, Inc., Lyte Optronics Ltd. (UK), Advanced Semiconductor (Xiamen), Bestal Substrate Foreign Sales Corp., and each future wholly-owned subsidiary of Borrower. "Indemnitees" has the meaning assigned to that term in Section 10.3 hereof. "Indenture" has the meaning assigned to that term in the Recitals hereof. -6- 13 "Interest Expense" means any and all interest owing by Borrower under any debt obligations, including the Credits, during the measured period. "Inventory" means all present and future inventory in which Borrower has any interest, including goods held for sale or lease or to be furnished under a contract of service and all of Borrower's present and future raw materials, work in process, finished goods, and packing and shipping materials, wherever located. "Investment Property" means all of Borrower's presently existing and hereafter acquired or arising investment property (as that term is defined in Section 9115 of the California Uniform Commercial Code). "Issuance Spread" means two and one-half of one percent (2.50%) per annum. "Letter of Credit" has the meaning assigned to that term in the Recitals hereof. "Letter of Credit Facility" means the credit facility available to Borrower pursuant to Section 2.3 hereof pursuant to which U.S. Bank has issued the direct pay Letter of Credit to the Trustee. "LIBOR" means, for each Fixed Rate Term, the rate per annum (computed on the basis of a 360-day year and the actual number of days elapsed and rounded upward if necessary to the nearest whole 1/16 of 1%) and determined pursuant to the following formula: Base LIBOR LIBOR = ---------------------------------------------------- 100% - LIBOR Reserve Percentage As used herein, (i) "Base LIBOR" shall mean the rate per annum at which United States dollar deposits would be offered to U.S. Bank in the London interbank market at approximately 11:00 a.m. London time on the date which is two Business Days prior to the first day of a Fixed Rate Term for delivery of funds on the first day of such Fixed Rate Term for a period of time substantially equal to the number of days in such Fixed Rate Term and in an amount substantially equal to the principal amount to which such Fixed Rate Term applies, and (ii) "LIBOR Reserve Percentage" shall mean the reserve percentage measured as of the date which is two Business Days prior to the date of pricing, prescribed by the Board of Governors of the Federal Reserve System (or any successor) for "Eurocurrency Liabilities" (as defined in Regulation D of -7- 14 the Federal Reserve Board, as amended), required to be maintained by U.S. Bank, adjusted by U.S. Bank for expected changes in such reserve percentage during the applicable Fixed Rate Term. "Line Maturity Date" means May 31, 2002. "Line of Credit" means a revolving credit facility in the maximum principal amount of $20,000,000.00, as defined more fully in Section 2.1 hereof. "Line of Credit Facility Fee" has the meaning assigned to that term in Section 2.5(c)(i). "Line of Credit Note" means a promissory note executed by Borrower in favor of a Lender to evidence advances under the Line of Credit, substantially in the form of Exhibit B attached hereto. "Line of Credit Pricing Grid" means the following Line of Credit Pricing Grid:----------------------------------------------------------------------------------------------------- - APPLICABLE MARGINS (IN BASIS POINTS) & FEE ------------------------------------------------------------------------------------------------------ RATIO OF FUNDED PRICING LIBOR REFERENCE LINE OF CREDIT DEBT TO EBITDA LEVEL MARGIN RATE MARGIN FACILITY FEE----------------------------------------------------------------------------------------------------- less than 1.00 I 175 50 25.0 equal to/greater than 1.00 less than 1.50 II 200 75 25.0 equal to/greater than 1.50 less than 2.00 III 225 100 37.5 equal to/greater than 2.00 less than 2.50 IV 250 125 50.0----------------------------------------------------------------------------------------------------- Borrower shall be eligible for Level I pricing when its ratio of Funded Debt to EBITDA is less than 1.00:1.00; for Level II pricing when such ratio is equal to or greater than 1.00:1.00, but less than 1.50:1.00; for Level III pricing when such ratio is equal to or greater than 1.50:1.00, but less than 2.00:1.00; for Level IV pricing when such ratio is equal to or greater than 2.00:1.00, but less than 2.50:1.00. This ratio shall be measured quarterly for the preceding four-quarter period. The pricing will be set at Level IV until receipt of the first financial covenant compliance reflecting the Funded Debt to EBITDA ratio. "Loan Costs" means all costs incurred by Agent in connection with the Credits, including, without limitation, all taxes and assessments, recording fees, title insurance premiums and other title charges, document binding costs, -8- 15 appraisal fees, lien and judgment search costs, fees of architects, engineers, surveyors and any special consultants, construction and Collateral inspection and exam fees, brokers fees (except as otherwise specified herein), escrow fees, all travel and out-of-pocket expenses of Agent to conduct audits or inspections and wire transfer fees. "Loan Documents" means this Agreement, the Notes, the Security Documents and each other notice, document, contract or instrument required by or at any time delivered to Agent in connection with this Agreement. "Majority Lenders" means two (2) or more Lenders whose Proportionate Shares at any time equal or exceed sixty-six and two-thirds percent (66-2/3%) of the Total Commitments. "Material Adverse Effect" means a material adverse effect on (i) the business operations or financial condition of Borrower and its Subsidiaries taken as a whole or (ii) the ability of Borrower to repay the amounts loaned to Borrower by Lenders hereunder. "Minimum Interest Coverage Ratio" means EBITDA divided by Interest Expense (net of capitalized interest expense) for the most recent four quarter period. "Monterey Park Property" means that certain real property located at 2019 Saturn Street, in the City of Monterey Park, County of Los Angeles, California owned by Borrower and improved with a commercial building used for research and development and manufacturing purposes. "Negotiable Collateral" means all of Borrower's present and future letters of credit, notes, drafts, instruments, securities (including the shares of stock of Subsidiaries of Borrower), documents, personal property leases (wherein Borrower is the lessor), and chattel paper. "Notes" means, collectively, the Line of Credit Note and all of the Term Notes. "Notice of Authorized Representatives" has the meaning set forth in Section 2.14 hereof. "Notice of Borrowing" has the meaning set forth in Section 2.4 hereof. "Notice of Conversion or Continuation" has the meaning assigned to that term in Section 2.6(b) hereof. -9- 16 "Participant" has the meaning assigned to that term in Section 10.5(b) hereof. "Permitted Indebtedness" means, subject to Borrower's compliance with the financial covenants required under this Agreement, the following: (a) Indebtedness of Borrower in favor of Lenders arising hereunder or any other Loan Document: (b) Capital leases incurred solely to purchase equipment which is secured by a purchase money security interest and is not in excess of the lesser of the purchase price for such equipment or the fair market value of such equipment on the date of acquisition. (c) Indebtedness to trade creditors incurred in the ordinary course of business; (d) Indebtedness set forth on Schedule 7.7 hereto; (e) Indebtedness incurred to refinance any Indebtedness permitted under the foregoing clause (b) or clause (d); (f) Accrued dividends on the capital stock of Borrower; (g) Interest rate and currency hedging agreements; (h) Guaranties of any Subsidiary's suppliers in connection with the purchase of supplies in the ordinary course of business; (i) Guaranties of lease obligations incurred in the ordinary course of business and to the extent otherwise permitted hereunder; "Permitted Investments" means, subject to Borrower's compliance with the financial covenants required under this Agreement, the following: (a) Investments existing on the Closing Date and disclosed in Schedule 7.7 attached hereto; (b) Marketable direct obligations issued or unconditionally guaranteed by the United States of America or any agency or any State thereof maturing within one year from the date of acquisition thereof, (ii) commercial paper maturing no more than one year from the date of creation thereof and currently having a rating of at least A-2 or P-2 from either Standard & Poor's Corporation or Moody's Investors Service, (iii) certificates of -10- 17 deposit maturing no more than one year from the date of investment therein; and (iv) money market accounts; (c) Investments consisting of travel advances and employee relocation loans and other employee loans and advances in the ordinary course of business; (d) Joint ventures or strategic alliances in the ordinary course of Borrower's business consisting of the non-exclusive licensing of technology, the development of technology or the providing of technical support, provided that any such investments by Borrower do not exceed $3,000,000.00 in the aggregate in any fiscal year; and (e) Investments or capital infusions in Borrower's Subsidiaries. "Permitted Liens" means, subject to Borrower's compliance with the financial covenants required under this Agreement, the following: (a) Liens in favor of Agent; (b) liens and security interests existing on the Closing Date and disclosed in Schedule 4.15 attached hereto; (c) liens for taxes, fees, assessment or other governmental charges or levies, either not delinquent or being contested in good faith by appropriate proceedings; (d) liens securing claims or demands of materialmen, mechanics, carriers, warehousemen, landlords and other like persons or entities imposed without action of such parties, provided that the payment thereof is not yet required; (e) liens arising from judgments, decrees or attachments in circumstances not constituting an Event of Default hereunder; (f) liens incurred or deposits made in the ordinary course of Borrower's business in connection with workers' compensation, unemployment insurance, Social Security and other like laws; (g) liens and security interests (a) upon or in any equipment acquired or held by the Borrower to secure the purchase price of such equipment or indebtedness incurred solely for the purpose of financing the acquisition of such equipment, or (b) existing on such equipment at the time of its acquisition, provided that the -11- 18 lien and security interest is confined solely to the property so acquired and improvements thereon, and the proceeds of such equipment; (h) liens consisting of leases and subleases and licenses and sublicenses granted to others in the ordinary course of Borrower's business not interfering in any material respect with the business of Borrower and any interest or title of a lessor or licensor under any lease or license, as applicable; (i) liens in favor of customs and revenue authorities arising as a matter of law to secure payment of customs duties in connection with the importation of goods; and (j) liens that are not prior to Agent's security interest which constitute rights of set-off of a customary nature. "Person" means an individual, a corporation, a partnership, a limited liability company, an association, a trust or any other entity or organization, including a Governmental Authority. "Personal Property Collateral" means each of the following: (k) the Accounts, (l) Borrower's Books, (m) the General Intangibles, (n) the Inventory, (o) the Investment Property, (p) the Negotiable Collateral, (q) any money, or other assets of Borrower that now or hereafter come into the possession, custody, or control of U.S. Bank or the Lenders, and (r) the proceeds and products, whether tangible or intangible, of any of the foregoing, including proceeds of insurance covering any or all of the Personal Property Collateral, and any and all Accounts, Borrower's Books, General Intangibles, Inventory, Investment Property, Negotiable Collateral, Real Property, money, deposit accounts, or other tangible or intangible property resulting from -12- 19 the sale, exchange, collection, or other disposition of any of the foregoing, or any portion thereof or interest therein, and the proceeds thereof. "Plan" means any defined employee pension benefit plan as defined in ERISA. "Proportionate Share" means, for each Lender, the dollar amount determined at any time by multiplying the percentage set forth opposite such Lender's name in Schedule 1 attached hereto by the amount of the Total Commitments at such time, and shall include, where the context so requires, the amount of all outstanding credit from such Lender to Borrower pursuant to this Agreement and the obligation of such Lender to make advances or otherwise extend credit up to such amount on the terms and subject to the conditions set forth herein. "Real Property" means collectively, the Monterey Park Property, the El Monte Property, the Technology Drive Property and the Solar Way Property. "Real Property Collateral" means, collectively, the Monterey Park Property, the El Monte Property, the Technology Drive Property and the Solar Way Property. "Reference Rate" means at any time the rate of interest which U.S. Bank establishes as its reference rate and is not necessarily the lowest rate of interest which it collects from any borrower or class of borrowers. If U.S. Bank ceases to publicly announce or publish its Reference Rate, U.S. Bank will choose a new index by using a comparable index or reference rate as its Reference Rate. "Register" has the meaning assigned to that term in Section 10.5(d) hereof. "Reimbursement Default Rate" has the meaning assigned to that term in Section 2.3(b). "Reimbursement Deposit Account" means the demand deposit account established by Borrower with U.S. Bank as defined in Section 3.2 hereof. "Reimbursement Obligations" mean the obligations of Borrower to Lenders described in Section 2.3(b) hereof. "Related Documents" means the Bonds, the Indenture, the Bond Loan Agreement, the Deeds of Trust, the UCC-1 Financing Statements, the Security Agreements, the Guarantees and any other agreement or instrument related to the issuance of the Bonds and pertaining to Borrower. -13- 20 "Security Agreements" means, collectively, all of the security agreements for the benefit of Agent that secure the obligations of Borrower to Agent and Lenders under this Agreement. "Security Documents" means, collectively, the Deeds of Trust and the Security Agreements. "Solar Way Property" means that certain real property located at 4211 Solar Way in the City of Fremont, County of Alameda, California owned by Borrower and improved with a manufacturing and research and development facility. "Stated Amount" means $11,986,680.00, as such amount may be reduced from time to time as a result of unreinstated Drawings on the Letter of Credit in accordance with the terms thereof. "Subsidiary" means any corporation, association, limited liability company, partnership, joint venture or other business entity of which more than fifty percent (50%) of the voting stock or other equity interest is owned directly or indirectly by Borrower. "Tangible Net Worth" means, at any time, total stockholders' equity at such time less the amount of any treasury stock less the value of any in tangible assets at such time. "Taxes" has the meaning assigned to that term in Section 2.12(a) hereof. "Technology Drive Property" means that certain real property located at 4281 Technology Drive in the City of Fremont, County of Alameda, California owned by Borrower and improved with a manufacturing facility. "Term Loan A" means a credit facility available to Borrower in the maximum principal amount of $1,190,000.00, as defined more fully in Section 2.2 hereof. "Term Loan A Maturity Date" means May 31, 2003. "Term Loan B" means a credit facility available to Borrower in the maximum principal amount of $1,610,000.00, as defined more fully in Section 2.2 hereof. "Term Loan B Maturity Date" means May 31, 2003. -14- 21 "Term Loan C" means a credit facility available to Borrower in the maximum principal amount of $3,200,000.00, as more fully defined in Section 2.2 hereof. "Term Loan C Maturity Date" means May 31, 2003. "Term Loan Pricing Grid" means the following Term Loan Pricing Grid:--------------------------------------------------------------------------------------------- - APPLICABLE MARGINS (IN BASIS POINTS) ---------------------------------------------------------------------------------------------- RATIO OF FUNDED PRICING LIBOR MARGIN REFERENCE DEBT TO EBITDA LEVEL RATE MARGIN--------------------------------------------------------------------------------------------- less than 1.00 I 200 75equal to/greater than 1.00 less than 1.50 II 225 100equal to/greater than 1.50 less than 2.00 III 250 125equal to/greater than 2.00 less than 2.50 IV 275 150--------------------------------------------------------------------------------------------- Borrower shall be eligible for Level I pricing when its ratio of Funded Debt to EBITDA is less than 1.00:1.00; for Level II pricing when such ratio is equal to or greater than 1.00:1.00, but less than 1.50:1.00; for Level III pricing when such ratio is equal to or greater than 1.50:1.00, but less than 2.00:1.00; for Level IV pricing when such ratio is equal to or greater than 2.00:1.00, but less than 2.50:1.00. This ratio shall be measured quarterly for the preceding four-quarter period. The pricing will be set at Level IV until receipt of the first financial covenant compliance reflecting the Funded Debt to EBITDA ratio. "Term Loans" means, collectively, Term Loan A, Term Loan B and Term Loan C. "Term Notes" means, collectively, each of the promissory notes executed by Borrower in favor of a Lender to evidence advances under each of the Term Loans, substantially in the form of Exhibit C attached hereto. "Termination Date" has the meaning assigned to that term in Section 3.2 hereof. "Total Commitments" means, for all Lenders and at any time, the then aggregate amount of (i) the outstanding principal balance of each of the Credits, and (ii) the maximum undisbursed principal amount of each of the Credits. -15- 22 "Treasury Rate" means the Issuance Spread plus the yield to maturity of the most recently issued one, two or three year U.S. Treasury Security, as elected by Borrower, as quoted in the Wall Street Journal on the date of election of a Treasury Rate. If such date is not a Business Day, then the quote shall be obtained on the Business Day immediately preceding such date. If the Wall Street Journal (i) quotes more than one such one, two or three year U.S. Treasury Security, the highest of such quotes shall apply, or (ii) ceases to publish such quotes, the one, two or three year U.S. Treasury Security, as elected by Borrower, shall be determined from such substitute financial reporting service or source as U.S. Bank in its reasonable discretion shall determine. "Trustee" has the meaning assigned to that term in the Recitals hereof. SECTION 1.2 INTERPRETATION. The meaning of each defined term isequally applicable to both the singular and plural forms of the terms defined.As used in this Agreement and each of the other Loan Documents, the term"including" is not limiting, and means "including without limitation." SECTION 1.3 HEADINGS. Headings in this Agreement and each of theother Loan Documents are for convenience of reference only and are not part ofthe substance hereof or thereof. ARTICLE II ---------- THE CREDITS SECTION 2.1 LINE OF CREDIT. (a) Line of Credit. On the terms and subject to the conditionsset forth in this Agreement, each Lender hereby severally agrees, on a pro ratabasis in accordance with Schedule 1 attached hereto, to make advances toBorrower under the Line of Credit from time to time up to and including the LineMaturity Date, not to exceed at any time the aggregate principal amount ofTwenty Million Dollars ($20,000,000.00), the proceeds of which shall be used forgeneral corporate purposes, including working capital financing, and for theissuance of standby and commercial letters of credit, subject to a sublimit of$250,000.00 for such letters of credit as described in subparagraph (d), below.Borrower's obligation to repay advances under the Line of Credit shall beevidenced by the Line of Credit Note, all terms of which are incorporated hereinby this reference. (b) Limitation on Borrowings. Outstanding borrowings under theLine of Credit, to a maximum of the principal amount set forth above, shall notat any -16- 23time exceed an aggregate of (i) eighty percent (80%) of eligible receivablesgenerated by U.S. based obligors, (ii) eighty percent (80%) of eligiblereceivables generated by obligors with principal offices outside of the UnitedStates provided that such foreign eligible receivables are insured in a manneracceptable to Lender, and (iii) the lesser of $7,500,000 or fifty percent (50%)of eligible inventory (the "Borrowing Base"), as evidenced by a borrowing basecertificate in the form attached hereto as Exhibit H (the "Borrowing BaseCertificate"). All of the foregoing shall be determined by Agent upon receiptand review of the collateral reports required hereunder and such other documentsand collateral information as Agent may from time to time require. As used herein, "eligible receivables" shall consist solely oftrade accounts which have been created in the ordinary course of Borrower's orany Guarantor's business, upon which Borrower's or any Guarantor's right toreceive payment is absolute and not contingent upon the fulfillment of anycondition whatsoever, and in which Agent has a perfected security interest offirst priority, and shall not include: (i) any Account which is past due more than ninety (90) days after the invoice date; (ii) that portion of any Account for which there exists any right of setoff, defense or discount (except regular discounts allowed in the ordinary course of business to promote prompt payment) or for which any defense or counterclaim has been asserted; (iii) any Account which represents an obligation of any state or municipal government or of the United States government or any political subdivision thereof (except accounts which represent obligations of the United States government and for which Assignment of Claims Act forms reasonably satisfactory to Agent have been duly executed and acknowledged); (iv) any Account which arises from the sale or lease to or performance of services for, or represents an obligation of, an employee, affiliate, partner, member, parent or subsidiary of Borrower; (v) that portion of any Account which represents interim or progress billings or retention rights on the part of the account debtor; (vi) any Account which represents an obligation of any account debtor when twenty percent (25%) or more of Borrower's accounts from such account debtor are not eligible pursuant to (i) above; -17- 24 (vii) that portion of any Account from an account debtor which represents the amount by which Borrower's total accounts from said account debtor exceeds twenty-five percent (25%) of Borrower's total accounts; (viii) any Account deemed ineligible by Agent when Agent, in its sole discretion, deems the creditworthiness or financial condition of the account debtor to be unsatisfactory; or (ix) uninsured foreign receivables. As used herein, "eligible inventory" shall mean, at any time, allof Borrower's Inventory constituting raw materials (valued at the lower of costor market), except: (i) Inventory which is not owned by Borrower free and clear of all security interests, liens, encumbrances and claims of third parties; and (ii) Inventory which Agent, in its sole discretion, deems to be obsolete, unsalable, damaged, defective or unfit for further processing. (c) Borrowing and Repayment. Borrower may from time to timeduring the term of the Line of Credit borrow, partially or wholly repay itsoutstanding borrowings, and reborrow, subject to all the limitations, terms andconditions contained herein; provided however, that the total outstandingborrowings under the Line of Credit shall not at any time exceed the maximumprincipal amount set forth above in this Section 2.1. (d) Borrower Letter of Credit Subfeature. As a subfeature underthe Line of Credit, Agent agrees from time to time during the term thereof toissue standby or commercial letters of credit for the account of Borrower (each,a "Borrower Letter of Credit" and collectively, "Borrower Letters of Credit");provided however, that the form and substance of each Borrower Letter of Creditshall be subject to reasonable approval by Agent and the aggregate amount ofBorrower Letters of Credit issued at any one time shall not exceed $250,000.00.Except with the prior approval of Agent, which may be granted or withheld in itssole discretion, no Borrower Letter of Credit shall have an expiration datesubsequent to the Line Maturity Date. The undrawn amount of all Borrower Lettersof Credit issued and outstanding under this letter of credit subfeature shall bereserved under the Line of Credit and shall not be available for borrowingsthereunder. Each Borrower Letter of Credit shall be subject to the additionalterms and conditions of the Borrower Letter of Credit Agreement and relateddocuments, if any, required by Agent in connection with the issuance thereof(each, a "Borrower Letter of Credit Agreement" and collectively, the "BorrowerLetter  -18- 25of Credit Agreements"), each of which shall be substantially in the formattached hereto as Schedule 2.1. Each draft paid by Agent under a BorrowerLetter of Credit shall be deemed an advance under the Line of Credit and shallbe repaid by Borrower on or before the Line Maturity Date in accordance with theterms and conditions of this Agreement. Borrower agrees that Agent, in its solediscretion, may debit any demand deposit account maintained by Borrower withAgent, other than a demand deposit account maintained by Borrower on behalf of ajoint venture of which Borrower is a member, for the amount of any such draft. SECTION 2.2 TERM LOANS. (a) Term Loan A. On the terms and subject to the conditions setforth in this Agreement, each Lender hereby severally agrees, on a pro ratabasis in accordance with Schedule 1 attached hereto, to grant Term Loan A toBorrower on the Closing Date in the principal amount of One Million One HundredNinety Thousand Dollars ($1,190,000.00), the proceeds of which shall be used torepay existing indebtedness encumbering the Monterey Park Property in theapproximate amount of $684,260.00 and to finance improvements and additions tothe El Monte Property. Borrower's obligation to repay Term Loan A shall beevidenced by the Term Note for Term Loan A, all terms of which are incorporatedherein by this reference. (b) Repayment of Term Loan A. Interest on Term Loan A shall bepaid monthly or as otherwise set forth in this Agreement. Commencing September30, 2000, and on the last day of each calendar quarter thereafter, Borrowershall make quarterly installments of principal in the amount required in orderto amortize fully the principal amount of Term Loan A, together with interestthereon at the rates of interest applicable under the Term Loan A Notes, overtwenty (20) years and continuing until the Term Loan A Maturity Date, asfollows: ---------------------------------------------------------------------- YEAR QUARTERLY PAYMENT AMOUNT ---------------------------------------------------------------------- 2000 $14,875 2001 $14,875 2002 $14,875 2003 $14,875 BALANCE DUE $1,011,500 ======================================================================There will be one payment due on March 31, 2003 in the amount of $14,875 withthe entire balance of principal and interest then unpaid due and payable on theTerm Loan A Maturity Date. Such quarterly payment shall be credited toprincipal, and interest shall be paid separately as set forth herein. -19- 26 (c) Term Loan B. On the terms and subject to the conditions setforth in this Agreement, each Lender hereby severally agrees, on a pro ratabasis in accordance with Schedule 1 attached hereto, to grant Term Loan B toBorrower on the Closing Date in the principal amount of One Million Six HundredTen Thousand Dollars ($1,610,000.00), the proceeds of which shall be used torepay existing indebtedness encumbering the El Monte Property in the approximateamount of $1,106,559.00 and to finance improvements and additions to the ElMonte Property. Borrower's obligation to repay Term Loan B shall be evidenced bythe Term Notes for Term Loan B, all terms of which are incorporated herein bythis reference. (d) Repayment of Term Loan B. Interest on Term Loan B shall bepaid monthly or as otherwise set forth in this Agreement. Commencing onSeptember 30, 2000, and on the last day of each calendar quarter thereafter,Borrower shall make quarterly installments of principal in the amount requiredin order to amortize fully the principal amount of Term Loan B, together withinterest thereon at the rates of interest applicable under the Term Loan BNotes, over twenty (20) years and continuing until the Term Loan B MaturityDate, as follows: ---------------------------------------------------------------------- YEAR QUARTERLY PAYMENT AMOUNT ---------------------------------------------------------------------- 2000 $20,125 2001 $20,125 2002 $20,125 2003 $20,125 BALANCE DUE $1,368,500 =====================================================================There will be one payment due on March 31, 2003 in the amount of $20,125 withthe entire balance of principal and interest then unpaid due and payable on theTerm Loan B Maturity Date. Such quarterly payment shall be credited toprincipal, and interest shall be paid separately as set forth herein. (e) Term Loan C. On the terms and subject to the conditions setforth in this Agreement, each Lender hereby severally agrees, on a pro ratabasis in accordance with Schedule 1 attached hereto, to grant Term Loan C toBorrower on the Closing Date in the principal amount of Three Million TwoHundred Thousand Dollars ($3,200,000.00), the proceeds of which shall be used tofinance the construction of improvements and additions to the El Monte Property.Borrower's obligation to repay Term Loan C shall be evidenced by the Term Notesfor Term Loan C, all terms of which are incorporated herein by this reference. -20- 27 (f) Repayment of Term Loan C. Borrower shall make installments ofinterest only through December 31, 2000 monthly or as otherwise set forth inthis Agreement. Commencing on March 31, 2001, and on the last day of eachcalendar quarter thereafter, Borrower shall make quarterly installments ofprincipal in the amount required in order to amortize fully the principal amountof Term Loan C, together with interest thereon at the rates of interestapplicable under the Term Loan C Notes, over five (5) years and continuing untilthe Term Loan C Maturity Date, as follows: ---------------------------------------------------------------------- YEAR QUARTERLY PAYMENT AMOUNT ---------------------------------------------------------------------- 2001 $160,000 2002 $160,000 2003 $160,000 ---------------------------------------------------------------------- BALANCE DUE $1,760,000 ======================================================================There will be one payment due on March 31, 2003 in the amount of $160,000 withthe entire balance of principal and interest then unpaid due and payable on theTerm Loan C Maturity Date. Such quarterly payment shall be credited toprincipal, and interest shall be paid separately as set forth herein. (g) Prepayment. Borrower may prepay principal on each of the TermLoans solely in accordance with the provisions of Sections 2.8 and 2.13 of thisAgreement. SECTION 2.3 THE LETTER OF CREDIT FACILITY. (a) Terms and Amount of Letter of Credit. U.S. Bank has issuedits irrevocable direct-pay Letter of Credit for the account of Borrower in favorof the Trustee in an initial amount equal to the initial Stated Amount, whichamount shall be amortized as follows: $10,340,000.00 of the initial StatedAmount shall be amortized based on a twenty-five (25) year amortization scheduleand $1,275,000.00 of the initial Stated Amount shall be amortized based on afive (5) year amortization schedule. The amount of principal and interest whichBorrower must pay monthly in order to amortize fully the initial Stated Amountaccording to the above amortization schedule is set forth on Schedule 2.3(a)attached hereto. Notwithstanding any contrary provision of this Agreement, thisAgreement shall not expire or be otherwise terminated until such time as allpayment obligations due or to become due to Agent or any Lender with respect tothe Letter of Credit have been paid. -21- 28 (b) Reimbursement Obligations. Borrower agrees to pay to Agent(i) on the day that any drawing is made by the Trustee under the Letter ofCredit, all amounts to be advanced by Agent pursuant to the Letter of Credit onbehalf of Borrower in respect of such drawing, and (ii) interest on any and allamounts that Borrower fails to pay when due under this Agreement from the datesuch amounts become payable until payment in full (collectively, the"Reimbursement Obligations"). For each day that any Reimbursement Obligationremains unpaid, interest shall accrue on such amounts at an aggregate rate perannum equal to five percent (5%) above the Reference Rate (the "ReimbursementDefault Rate"), based on the actual number of days elapsed in a year of 360days. SECTION 2.4 NOTICE OF BORROWING. Borrower, through one of itsAuthorized Representatives, shall request advances under each of the Term Loansand each advance under the Line of Credit by giving Agent irrevocable writtennotice or telephonic notice (confirmed promptly in writing), in the form ofExhibit D attached hereto (each, a "Notice of Borrowing"), which specifies,among other things: (i) the principal amount to be disbursed, if under the Term Loans, or the principal amount of the requested advance, if under the Line of Credit; (ii) the proposed date of borrowing, which shall be a Business Day; (iii) the interest rate option applicable to such borrowing (which, for a LIBOR interest selection, shall be subject to the minimum dollar requirements set forth in Section 2.5(a) hereof); and (iv) if the amounts disbursed or advanced will bear interest determined in relation to LIBOR, the length of the Fixed Rate Term applicable thereto.Each such Notice of Borrowing must be received by Agent not later than 10:00a.m. Pacific Standard time at least one (1) Business Day prior to the date ofborrowing if interest will be determined in relation to the Reference Rate, and(ii) at least three (3) Business Days prior to the date of borrowing if interestwill be determined in relation to LIBOR; provided however, that Agent, at itssole discretion, may permit borrowing requests to be made by telephone(confirmed promptly in writing) and on the same day only if interest will bedetermined in relation to the Reference Rate. Agent shall promptly notify eachLender of the contents of each Notice of Borrowing and of the amount of thedisbursement or advance to be made by such Lender. Each advance for whichinterest will be determined in relation to the Reference Rate shall be in theminimum amount of $100,000.00. -22- 29 SECTION 2.5 INTEREST/FEES. (a) Interest on the Line of Credit. The outstanding principalbalance of the Line of Credit shall bear interest in accordance with thefollowing interest rate options, as designated periodically by Borrower: (i) at the applicable margin over the Reference Rate set forth in the Line of Credit Pricing Grid; or (ii) at the applicable margin over LIBOR set forth in the Line of Credit Pricing Grid; provided, however, that each LIBOR interest selection must be for a minimum amount of $1,000,000 and in integral multiples of $100,000. (b) Interest on the Term Loans. The outstanding principalbalances of each of the Term Loans shall bear interest in accordance with thefollowing interest rate options, as designated periodically by Borrower: (i) at the applicable margin over the Reference Rate set forth in the Term Loan Pricing Grid; (ii) at the applicable margin over LIBOR set forth in the Term Loan Pricing Grid; provided, however, that each LIBOR interest selection must be for a minimum amount of $1,000,000 and in integral multiples of $100,000; or (iii) at a fixed rate per annum equal to the Treasury Rate (for a term of one, two or three years, at Borrower's option).The margins above the Reference Rate or LIBOR, as applicable (the "Interest RateMargins"), at which the outstanding principal balances of the Line of Credit andeach of the Term Loans bear interest from time to time shall be adjusted inaccordance with the Line of Credit Pricing Grid and the Term Loan Pricing Grid,respectively. Until such time as Agent receives Borrower's financial statements(as required under this Agreement) evidencing Borrower's compliance with any ofthe Funded Debt to EBITDA ratios set forth in the applicable Pricing Grid, theLevel IV Interest Rate Margin above the Reference Rate or LIBOR shall apply.Thereafter, Agent shall adjust the Interest Rate Margins in accordance with theapplicable Pricing Grid on the first day of the month following each month inwhich Agent receives updated financial statements from Borrower pursuant to thisAgreement. Such Interest Rate Margins shall be determined (i) using the mostrecent quarterly financial statement of Borrower available to Agent on theapplicable adjustment date to determine the amount of Funded Debt and (ii) usingthe most recent financial statements of Borrower available -23- 30to Agent on the applicable adjustment date for a four (4) consecutive quarterperiod to determine EBITDA. (c) Fees for the Line of Credit. (i) Line of Credit Facility Fee. Commencing on the Closing Date and continuing through the Line Maturity Date, Borrower shall pay to Agent, for the ratable benefit of Lenders, a per annum facility fee (the "Line of Credit Facility Fee") calculated based on the average undisbursed portion of the Line of Credit at the applicable Line of Credit Facility Fee described in the Line of Credit Pricing Grid. Such Line of Credit Facility Fee shall be payable quarterly in arrears commencing September 30, 2000, and on the last day of each calendar quarter thereafter, and on the Line Maturity Date. The rate set forth above shall be adjusted in accordance with the Line of Credit Pricing Grid as of the first day of the month following receipt of Borrower's financial statements as required under this Agreement. (ii) Borrower Letter of Credit Fees. In the event any Borrower Letters of Credit are issued for the account of Borrower, Borrower shall pay to the Agent , for the ratable benefit of the Lenders, (1) with respect to each Borrower Letter of Credit which is a commercial letter of credit, a fee at issuance equal to one quarter of one percent (.25%) of the Borrower Letter of Credit amount plus a flat fee of $125.00 for each commercial letter of credit without negotiation and a fee upon negotiation equal to one quarter of one percent (.25%) of the drawn amount plus a flat fee of $100.00 for each commercial letter of credit with negotiation, and (2) with respect to each Borrower Letter of Credit which is a standby letter of credit, a per annum fee equal to the Interest Rate Margin above LIBOR set forth in the Line of Credit Pricing Grid then applicable and multiplied by the face amount of such standby letter of credit. (d) Term Loan Commitment Fees. Borrower shall pay to Agent anon-refundable commitment fee for each of the Term Loans as set forth below,which fee shall be due and payable in full on the date on which the applicableTerm Loan is made: -- Term Loan A: $11,900.00 -- Term Loan B: $16,100.00 -- Term Loan C: $32,000.00 -24- 31 (e) Letter of Credit Facility Fee. Borrower shall pay to Agent aLetter of Credit Facility fee (for itself) in an amount equal to one andone-quarter of one percent (1.25%) per annum of the Stated Amount of the Letterof Credit, payable annually on each anniversary of the Date of Issuance, untilthe earlier of the termination or expiration of the Letter of Credit Facility,which fee shall be non-refundable even if the Letter of Credit is terminated orcanceled before its stated expiration date. (f) Computation and Payment. All interest and fees shall becomputed on the basis of a 360-day year, actual days elapsed. Interestdetermined in relation to the Reference Rate or the Treasury Rate shall bepayable on the first (1st) day of each month. Interest determined in relation toLIBOR shall be payable on the last day of the Fixed Rate Term to which suchinterest rate applies; provided that if such Fixed Rate Term is for six (6)months, on the first (1st) day of the fourth (4th) month of such Fixed Rate Termand on the last day of such Fixed Rate Term. SECTION 2.6 CONVERSION OF INTEREST OPTIONS. (a) Election. Subject to the minimum dollar requirements setforth in Section 2.5(a) hereof, (i) at any time any portion of the Line ofCredit or any of the Term Loans bear interest determined in relation to theReference Rate, Borrower may convert all or any portion thereof so that it bearsinterest determined in relation to LIBOR for a Fixed Rate Term designated byBorrower, and (ii) at any time any portion of the Line of Credit or the TermLoan bears interest determined in relation to LIBOR, Borrower may convert all ora portion thereof at the end of the Fixed Rate Term applicable thereto so thatit bears interest determined in relation to the Reference Rate or in relation toLIBOR for a new Fixed Rate Term designated by Borrower. In addition, Borrowermay elect to convert any Term Loan to a fixed rate equal to the Treasury Rate asset forth in Section 2.5(b). If Borrower has not made the required interest rateconversion or continuation election prior to the last day of any Fixed RateTerm, Borrower shall be deemed to have made a Reference Rate interest selectionfor the amounts that were subject thereto. (b) Notice to Agent. Borrower, through one of its AuthorizedRepresentatives, shall request each interest rate conversion or continuation bygiving Agent irrevocable written notice or telephonic notice (confirmed promptlyin writing), in the form of Exhibit E attached hereto (a "Notice of Conversionor Continuation"), which specifies, among other things: (i) the Credit to which such Notice applies; (ii) the principal amount which is the subject of such conversion or continuation; -25- 32 (iii) the proposed date of such conversion or continuation, which shall be a Business Day; (iv) and if such Notice pertains to a LIBOR interest selection, the length of the applicable Fixed Rate Term.Any such Notice of Conversion or Continuation must be received by Agent notlater than 10:00 a.m. at least one (1) Business Day prior to the effective dateof any Reference Rate interest selection, and (ii) at least three (3) BusinessDays prior to the effective date of any LIBOR interest selection; providedhowever, that Agent, at its sole discretion, may permit interest rate conversionor continuation requests to be made by telephone (confirmed promptly in writing)and on the same day for a Reference Rate interest selection. Agent shallpromptly notify each Lender of the contents of each such Notice of Conversion orContinuation, or if timely notice is not received from Borrower prior to thelast day of any Fixed Rate Term of the automatic conversion of the amountssubject thereto to the Reference Rate interest option. SECTION 2.7 OTHER PAYMENT TERMS. (a) Automatic Debit. Agent shall, and Borrower hereby authorizesAgent to, debit any deposit account of Borrower with Agent (including theReimbursement Deposit Account described in Section 3.2 hereof) for all paymentsof principal, interest and fees as they become due on any of the Credits. Atleast one Business Day prior to any such debit of a deposit account of Borrower,Agent shall provide a written statement of all amounts to be debited. Should,for any reason whatsoever, the funds in any such deposit account be insufficientto pay all principal, interest and/or fees when due, Borrower shall, immediatelyupon demand, remit to Agent the full amount of any such deficiency. (b) Place and Manner. Borrower shall make all payments due toeach Lender under the Loan Documents by payment to Agent at Agent's Office, forthe account of such Lender, in lawful money of the United States and in same dayor immediately available funds not later than 12:00 noon Pacific Standard timeon the date due. Agent shall promptly disburse to each Lender at such Lender'sApplicable Lending Office each such payment received by Agent for such Lender. (c) Date. Whenever any payment due hereunder shall fall due on aday other than a Business Day, such payment shall be made on the next succeedingBusiness Day, and such extension of time shall be included in the computation ofinterest or fees, as the case may be. (d) Default Interest Rate. Notwithstanding any contrary provisionof this Agreement or any Note, upon the occurrence and during the continuance ofany Event of Default, interest shall accrue on the outstanding principal balanceof the Line -26- 33of Credit and each of the Term Loans at an increased rate per annum (computed onthe basis of a year of 360 days for the actual number of days elapsed) equal totwo percent (2%) above the rate of interest from time to time applicable to suchCredit, and on the outstanding principal balance of the Letter of CreditFacility at an increased rate per annum (computed on the basis of a year of 360days for the actual number of days elapsed) equal to five percent (5%) above theReference Rate in effect from time to time. Borrower agrees that an Event ofDefault will cause the Agent to incur additional expense in servicing theCredits, that the Agent is entitled to damages for the detriment caused thereby,that such damages are extremely difficult and impractical to ascertain, and thatapplication of the above default interest rates to the amounts owing by Borrowerunder the Loan Documents is a reasonable estimate of such damages to Agent. (e) Application of Payments. All payments under the LoanDocuments (including prepayments) shall be applied first to unpaid fees, costsand expenses then due and payable under this Agreement and the other LoanDocuments, second to accrued interest then due and payable under the LoanDocuments, and finally to reduce the outstanding principal amount of suchCredits. Subject to the provisions of Section 3.2, if no Event of Default hasoccurred and is continuing, Agent shall, subject to the preceding sentence,apply all payments to be applied to Borrower's obligations as directed byBorrower. If an Event of Default has occurred and is continuing or if Borrowerfails to direct application, Agent shall apply such payments as determined by itin its discretion. (f) Failure to Pay Agent. Unless Agent shall have received noticefrom Borrower at least one (1) Business Day prior to the date on which anypayment is due to the Lenders hereunder that Borrower will not make such paymentin full, Agent may assume that Borrower has made such payment in full to Agenton such date and Agent may, in reliance upon such assumption, cause to bedistributed to each Lender on such due date an amount equal to the amount thendue such Lender. If and to the extent Borrower shall not have made such paymentin full to Agent, such Lender shall repay to Agent forthwith on demand suchamount distributed to such Lender together with interest thereon, for each dayfrom the date such amount is distributed to such Lender until the date suchLender repays such amount to Agent, at the Federal Funds Rate. A certificate ofAgent submitted to any Lender with respect to any amounts owing by such Lenderunder this Section 2.7(f) shall be presumptive evidence of such amounts. SECTION 2.8 PREPAYMENT. (a) Optional Prepayments. Borrower may, through one of itsAuthorized Representatives and upon at least (i) one (1) Business Day's priorwritten notice to Agent if interest is determined in relation to the ReferenceRate, or (ii) three (3) Business Days' prior written notice to Agent if interestis determined in relation to -27- 34LIBOR, prepay the outstanding amount of the Line of Credit or any Term Loan inwhole or in part, without premium or penalty, except as required by Section 2.13hereof. Partial prepayments of any portion of the Line of Credit or any TermLoan shall be in the minimum amount of $1,000,000 and in integral multiples of$100,000. (b) Application of Term Loan Prepayments. All optionalprepayments on any of the Term Loans pursuant to Section 2.8(a) shall be appliedpro rata to reduce principal then outstanding. SECTION 2.9 FUNDING. (a) Lender Funding and Disbursement. Each Lender shall, before11:00 a.m. (San Francisco time) on the date of each borrowing under the Line ofCredit or under any of the Term Loans, make available to Agent at Agent'sOffice, in same day or immediately available funds, such Lender's ProportionateShare thereof. After Agent's receipt of such funds and upon fulfillment of theapplicable conditions set forth in Article V hereof, Agent will promptlydisburse such funds in same day or immediately available funds to Borrower.Unless otherwise directed by Borrower in writing, Agent shall disburse theproceeds of each borrowing to Borrower by deposit to any demand deposit accountmaintained by Borrower with Agent. (b) Lender's Failure to Fund. Unless Agent shall have receivednotice from a Lender on or prior to the date of any borrowing under the Line ofCredit or any of the Term Loans that such Lender will not make available toAgent such Lender's Proportionate Share thereof, Agent may assume that suchLender has made such portion available to Agent on the date of such borrowing inaccordance with Section 2.9(a) hereof, and Agent may, in reliance upon suchassumption, make available to Borrower (or otherwise disburse) on such date acorresponding amount. If any Lender does not make the amount of itsProportionate Share of any borrowing available to Agent on the date of suchborrowing, such Lender shall pay to Agent, on demand, interest which shallaccrue on such amount until made available to Agent at rates equal to (i) thedaily Federal Funds Rate during the period from the date of such borrowingthrough the third Business Day thereafter, and (ii) thereafter, the ReferenceRate in effect from time to time. A certificate of Agent submitted to any Lenderwith respect to any amounts owing under this Section 2.9(b) shall be presumptiveevidence of such amounts. If any Lender's Proportionate Share of any borrowingis not in fact made available to Agent by such Lender within three (3) BusinessDays after the date of such borrowing, Borrower shall pay to Agent, on demand,an amount equal to such Proportionate Share together with interest thereon, foreach day from the date such amount was made available to Borrower until the datesuch amount is repaid to Agent, at the rate of interest then applicable thereto. (c) Lenders' Obligations Several. The obligation of each Lenderhereunder is several. The failure of any Lender to make available itsProportionate -28- 35Share of any borrowing shall not relieve any other Lender of its obligationhereunder to do so on the date requested, but no Lender shall be responsible forthe failure of any other Lender to make available the Proportionate Share to befunded by such other Lender. SECTION 2.10 PRO RATA TREATMENT. (a) Borrowings. Except as otherwise provided herein, (i) eachextension of credit under any Credit shall be made or shared among the Lenderspro rata according to their respective Proportionate Shares in such Credit, and(ii) each payment of principal of and interest or fees on a Credit shall be madeor shared among the Lenders pro rata according to the respective unpaidprincipal amounts of such Credit held by such Lenders. (b) Sharing of Payments, Etc. If any Lender shall obtain anypayment (whether voluntary, involuntary or otherwise) on account of a Credit inexcess of its ratable share of payments on account of such Credit obtained byall Lenders entitled to such payments, such Lender shall forthwith purchase fromthe other Lenders sufficient participations in such Credit as shall be necessaryto cause the purchasing Lender's interest in the Credit to be equivalent to theexcess payment received; provided however, that if all or any portion of suchexcess payment is thereafter recovered from such purchasing Lender, suchpurchase shall be rescinded and each other Lender shall repay to the purchasingLender the purchase price to the extent of such recovery together with an amountequal to such other Lender's ratable share (according to the proportion of (i)the amount of such other Lender's required repayment to (ii) the total amount sorecovered from the purchasing Lender) of any interest or other amount paid orpayable by the purchasing Lender in respect of the total amount so recovered.Borrower agrees that any Lender so purchasing a participation from anotherLender pursuant to this Section 2.10(b) may, to the fullest extent permitted bylaw, exercise all its rights of payment (but not including any right of setoff)with respect to such participation as fully as if such Lender were the directcreditor of Borrower in the amount of such participation. SECTION 2.11 CHANGE OF CIRCUMSTANCES. (a) Inability to Determine Rate. If Agent at any time shalldetermine that adequate and reasonable means do not exist for ascertainingLIBOR, or the Majority Lenders shall determine at any time that LIBOR does notaccurately reflect the cost to Lenders of making or maintaining LIBOR interestrates hereunder, then Agent shall give telephonic notice (promptly confirmed inwriting) to Borrower and each Lender of such determination. If such notice isgiven, and until such notice has been withdrawn in writing by Agent, then noLIBOR interest option may be selected by Borrower and any portion of any Creditwhich bears interest determined in relation to LIBOR, subsequent to the end ofthe Fixed Rate Term applicable thereto, shall bear -29- 36interest determined in relation to the Reference Rate pursuant to the terms andconditions of this Agreement. (b) Illegality: Termination of Commitment. Notwithstanding anyother provisions herein, if any Change of Law shall make it unlawful for anyLender (i) to make a LIBOR interest rate available, or (ii) to maintain LIBORinterest rates hereunder, then, in the former event, any obligation of Lendershereunder to make available such unlawful LIBOR interest rate shall forthwith becanceled, and in the latter event, any such unlawful LIBOR interest rate thenoutstanding shall at the option of Agent be converted so that interest isdetermined in relation to the Reference Rate pursuant to the terms of thisAgreement; provided however, if any such Change in Law, shall permit a LIBORinterest rate until the expiration of the Fixed Rate Term relating thereto, thensuch permitted LIBOR interest rate shall continue as such until the end of suchFixed Rate Term. With respect to any outstanding principal amount as to whichsuch LIBOR interest rate is converted to a lower rate in accordance with theforegoing terms and provisions, Borrower agrees to pay to Agent, for the benefitof each Lender, as appropriate, the amount of any increase in cost or expense tothe Lenders. (c) Charges: Illegality. Upon the occurrence of any eventdescribed in Section 2.11(b) hereof, Borrower shall pay to Agent, for thebenefit of each Lender, as appropriate, such amount or amounts as may benecessary to compensate such Lender for any fines, fees, changes, penalties orother amounts payable by such Lender as a result thereof and which areattributable to LIBOR interest rates made available to Borrower hereunder. Indetermining which amounts payable by any Lender and/or losses incurred by anyLender are attributable to LIBOR interest rates made available to Borrowerhereunder, any reasonable allocation made by any Lender among its operationsshall be conclusive and binding upon Borrower provided Lender provides Borrowerwith a statement setting forth in reasonable detail such amount and thereasonable calculation thereof. (d) Charges: Change of Law. If, after the date of this Agreement,any Change of Law: (i) shall subject any Lender to any tax, duty or other charge with respect to any LIBOR interest rate, or shall change the basis of taxation of payments by Borrower to any Lender of principal, interest, fees or any other amount payable hereunder (except for changes in the rate of taxation on the overall net income of any Lender imposed by the jurisdiction of such Lender's incorporation or by any jurisdiction in which its Applicable Lending Office is located); or (ii) shall impose, modify or hold applicable any reserve, special deposit, compulsory loan or similar requirement against assets -30- 37 held by, deposits or other liabilities in or for the account of, advances or loans by, or any other acquisition of funds by any Lender; or (iii) shall impose on any Lender any other condition with respect to its performance hereunder;and the effect of any of the foregoing is to increase the cost to such Lender ofmaking, renewing or maintaining any LIBOR interest rate hereunder or to reduceany amount receivable by such Lender in connection therewith, then Borrowershall, pay to Agent, on behalf of each Lender, as appropriate, such amount oramounts as may be necessary to reimburse such Lender for such increased costs orto compensate such Lender for such reduced amounts. A certificate as to theamount of such increased costs or reduced amounts, delivered by such Lender toBorrower (which delivery shall be through Agent) shall, in the absence ofmanifest error, be conclusive and binding on Borrower for all purposes providedLender provides Borrower with a statement setting forth in reasonable detailsuch amount and the reasonable calculation thereof. (e) Capital Requirements. If any Lender shall have determinedthat any Change of Law regarding capital adequacy which occurs after the ClosingDate hereof has or shall have the effect of reducing the rate of return on thecapital of such Lender (or any entity controlling such Lender) as a consequenceof such Lender's obligations hereunder to a level below that which such Lenderor such entity would have achieved but for such Change of Law (taking intoconsideration such Lender's or such entity's policies with respect to capitaladequacy), by an amount deemed by such Lender to be material, then from time totime, within fifteen (15) days after presenting a statement setting forth inreasonable detail such amount and the reasonable calculation thereof. Borrowershall pay to Agent, for the benefit of such Lender such amounts set forththerein which shall compensate such Lender for such reduction. SECTION 2.12 TAXES ON PAYMENTS. (a) Payments Free of Taxes. All payments made by Borrower underthe Loan Documents shall be made free and clear of, and without deduction orwithholding for or on account of, any present or future income, stamp or othertaxes, levies, imposts, duties, charges, fees, deductions or withholdings, nowor hereafter imposed, levied, collected, withheld or assessed by anyGovernmental Authority (except net income taxes imposed on Agent or any Lender)(with all such non-excluded taxes, levies, imposts, duties, charges, fees,deductions and withholdings relating to the payments made hereunder beinghereinafter referred to herein as "Taxes"). If any Taxes are required to bewithheld from any amounts payable to Agent or any Lender under the LoanDocuments, the amounts so payable to Agent or such Lender shall be increased tothe extent necessary to yield to Agent or such Lender (after payment of allTaxes) interest or any such other amounts payable hereunder at the rates or inthe amounts specified in the Loan Documents. Whenever any such -31- 38Taxes are payable by Borrower, as promptly as possible thereafter, Borrowershall send to Agent, for its own account or for the account of such Lender, asthe case may be, a certified copy of an original official receipt received byBorrower showing payment thereof. If Borrower fails to pay any Taxes when due tothe appropriate taxing authority or fails to remit to Agent the requiredreceipts or other required documentary evidence, Borrower shall indemnify Agentand the Lenders for any incremental taxes, interest or penalties that may becomepayable by Agent or any Lender as a result of any such failure. The agreementsin this Section 2.12(a) shall survive the termination of this Agreement for aperiod not to exceed the lesser of the applicable statute of limitations ortwenty-four months. (b) Withholding Exemption Certificates. Each Lender agrees thatit will deliver to Borrower and Agent, upon the reasonable request of Borroweror Agent, either (i) a statement that it is incorporated under the laws of theUnited States of America or a state thereof, or (ii) if it is not soincorporated, two duly completed copies of United States Internal RevenueService Form 1001 or 4224 or successor applicable form, as the case may be,certifying in each case that such Lender is entitled to receive payments underthis Agreement without deduction or withholding of any United States federalincome taxes. SECTION 2.13 FUNDING LOSS INDEMNIFICATION. (a) LIBOR. If Borrower shall (a) repay or prepay any portion of aCredit which bears interest determined in relation to LIBOR on any day otherthan the last day of the Fixed Rate Term therefor (whether an optionalprepayment, a mandatory prepayment, a payment upon acceleration or otherwise),(b) fail to borrow any such portion of a Credit for which a Notice of Borrowinghas been delivered to Agent (whether as a result of the failure to satisfy anyapplicable conditions or otherwise), or (c) fail to convert or continue at theLIBOR interest option any portion of a Credit in accordance with a Notice ofConversion or Continuation delivered to Agent (whether as a result of thefailure to satisfy any applicable conditions or otherwise), Borrower shall,concurrent with Borrower's repayment pursuant to the foregoing, reimburse Agenton behalf of each Lender, as appropriate, and hold such Lender harmless for allcosts and losses incurred by such Lender as a result of such repayment,prepayment or failure. Borrower understands that such costs and losses mayinclude, without limitation, losses incurred by a Lender as a result of fundingand other contracts entered into by such Lender to fund any LIBOR portion of anyCredit. Each Lender demanding payment under this Section 2.13 shall, inaccordance with the foregoing, deliver to Agent for delivery to Borrower acertificate setting forth the amount of costs and losses for which demand ismade. Borrower shall have the right to review and confirm any amount alleged tobe owing and any calculation relating thereto. The agreements in this Section2.13 shall survive the termination of this Agreement. -32- 39 (b) Treasury Rate. If Borrower shall repay or prepay any portionof a Credit which bears interest at the Treasury Rate on any day other than thelast day of its term (whether an optional prepayment, a mandatory prepayment, apayment upon acceleration or otherwise), Borrower shall pay to such Lender the"prepayment indemnity" more particularly described on Schedule 2.13(b). SECTION 2.14 AUTHORIZED REPRESENTATIVES. On the Closing Date, andfrom time to time subsequent thereto at Borrower's option, Borrower shalldeliver to Agent a written notice in the form of Exhibit F attached hereto(each, a "Notice of Authorized Representatives"), which designates by name eachof Borrower's Authorized Representatives and includes each of their respectivespecimen signatures. Agent shall be entitled to rely conclusively on theauthority of each officer or employee designated as an Authorized Representativein the most current Notice of Authorized Representatives delivered by Borrowerto Agent, to request borrowings and select interest rate options hereunder, andto give to Agent such other notices are as specified herein as being madethrough one of Borrower's Authorized Representatives, until such time asBorrower has delivered to Agent, and Agent has actual receipt of, a new writtenNotice of Authorized Representatives. Agent shall have no duty or obligation toBorrower to verify the authenticity of any signature appearing on any Notice ofBorrowing, Notice of Conversion or Continuation or any other written notice froman Authorized Representative or to verify the authenticity of any personpurporting to be an Authorized Representative giving any telephonic noticepermitted hereby. SECTION 2.15 COLLATERAL. (a) Personal Property Collateral and Contract Collateral. Assecurity for all indebtedness of Borrower to Lenders pursuant to this Agreement,as of the Closing Date Borrower grants to Agent, for the benefit of Lenders, asecurity interest of first priority in the Personal Property Collateral. (b) Real Property Collateral. As additional security for allindebtedness of Borrower to Lenders pursuant to this Agreement, as of theClosing Date Borrower grants to Agent, for the benefit of Lenders (but only tothe extent that a Lender has a Proportional Share in any of the Term Loans), (i)a lien of first priority in the Monterey Park Property and all improvementsthereon with respect to Term Loan A, (ii) a lien of first priority in the ElMonte Property and all improvements thereon with respect to Term Loan B, (iii) alien of second priority in the Monterey Park Property and all improvementsthereon with respect to Term Loan C, and (iv) a lien of second priority in theEl Monte Property and all improvements thereon with respect to Term Loan C,subject solely to such exceptions to title as Agent shall deem acceptable. -33- 40 (c) Cross-Collateralization and Cross-Default. Borroweracknowledges that the Lenders have made the Credits to Borrower upon thesecurity of Borrower's collective interests in the Collateral and in relianceupon the Collateral taken together being of greater value as collateral securitythan the sum of the Collateral taken separately. Borrower agrees that theSecurity Agreements are and will be cross-collateralized and cross-defaultedwith each other so that (i) an Event of Default under any Security Agreementshall constitute an Event of Default under each of the other SecurityAgreements; (ii) an Event of Default under any Note or this Agreement shallconstitute an Event of Default under each Security Agreement; and (iii) eachDeed of Trust shall secure the obligations evidenced by all of the Notes as if asingle blanket lien were placed on all of the Collateral as security for suchobligations provided that to the extent that a Lender does not have aProportional Share in a particular Credit hereunder, such Lender's securityinterest in the Collateral for such Credit shall be subordinate and second inpriority to the pro rata security interests of the Lenders having ProportionalShares in such Credit(s). (d) Documentation; Fees. All of the foregoing shall be evidencedby and subject to the terms of the documents described in Section 5.1 hereof.Borrower shall fully cooperate with Agent and perform all additional actsreasonably requested by Agent or any Lender to effect the purposes of thisSection 2.15. Borrower shall reimburse Agent, immediately upon demand, for allreasonable costs and expenses incurred by Agent in connection with any of theforegoing security, including filing and recording fees and costs ofinspections, expert opinions, appraisals, and audits. SECTION 2.16 GUARANTIES. One hundred percent (100%) of theprincipal amount of the Credits plus one hundred percent (100%) of all accruedinterest, late charges, attorney's fees and other charges arising under theCredits, shall be unconditionally guaranteed by each of the Guarantors.Notwithstanding the foregoing, Lender agrees that American Xtal Technology (HongKong) and Lyte Optronics Ltd. (UK) shall be released at such time as Borrowerhas provided Agent with satisfactory evidence that such Guarantors have ceasedall operations and have no assets. ARTICLE III ----------- PAYMENTS WITH RESPECT TO THE BONDS AND THE LETTER OF CREDIT SECTION 3.1 ANNUAL REDEMPTION OF BONDS. Borrower covenants to take all necessary action to prepay theloan and cause optional redemptions of the Bonds pursuant to Article IV of theIndenture and this Section 3.1 at a price equal to the principal amount of theBonds to be redeemed, together with accrued interest to the redemption date, onthe Bond Interest Payment -34- 41Date for December of each year, commencing with the Bond Interest Payment Datefor the month of December 2000. The principal amount of Bonds to be redeemed oneach such December Bond Interest Payment Date is set forth on Schedule 2.3(a)attached hereto. SECTION 3.2 REIMBURSEMENT DEPOSIT ACCOUNT. Borrower agrees tomaintain an interest-bearing deposit account in Borrower's name with U.S. Bank(the "Reimbursement Deposit Account"), which shall be pledged to Agent assecurity for Borrower's performance of its obligations under this Agreement.Borrower agrees to deposit into the Reimbursement Deposit Account on a monthlybasis, three (3) Business Days before the Bond Interest Payment Date for suchmonth, until the earlier to occur of (x) the earliest date on which both nofurther demands may be made for a drawing under the Letter of Credit and allamounts due to Agent or any Lender under this Agreement in respect of the Letterof Credit have been paid in full, or (y) the Expiration Date (such earlier date,the "Termination Date"), an amount equal to the sum of (i) the next monthlyinterest payment that Borrower is obligated to make under the Indenture and (ii)the smallest monthly amount that, if deposited by Borrower into theReimbursement Deposit Account each month during the year commencing on the dateof the last annual principal redemption of the Bonds, would be sufficient tomeet when due the next annual principal redemption of the Bonds as requiredunder Section 3.1 hereof. SECTION 3.3 OTHER OPTIONAL REDEMPTIONS OF BONDS. Notwithstandingany contrary provision of this Agreement, any optional redemption of the Bondsunder the Indenture other than the optional redemptions required by Section 3.1,above, shall require the advance written consent of Agent (which consent shallnot be unreasonably withheld), and Agent's receipt of satisfactory evidence ofBorrower's ability to reimburse Agent and Lenders for any drawing under theLetter of Credit for such redemption. ARTICLE IV ---------- REPRESENTATIONS AND WARRANTIES Except as set forth in Schedules 4.5-4.16 hereto (the "DisclosureSchedule"), the parts of which are numbered according to the relevant Sectionsof this Agreement, Borrower makes the following representations and warrantiesto Agent and Lenders, which representations and warranties shall survive theexecution of this Agreement and shall continue in full force and effect untilthe full and final payment, and satisfaction and discharge, of all obligationsof Borrower to Lenders and Agent under this Agreement. -35- 42 SECTION 4.1 LEGAL STATUS. Borrower is a corporation, dulyorganized and existing and in good standing under the laws of the State ofDelaware, each of Borrower and each Guarantor is qualified or licensed to dobusiness in California and is in good standing as a foreign corporation inCalifornia, and is qualified or licensed to do business (and is in good standingas a foreign corporation, if applicable) in all other jurisdictions in whichsuch qualification or licensing is required or in which the failure to soqualify or to be so licensed could have a Material Adverse Effect. SECTION 4.2 AUTHORIZATION AND VALIDITY. The execution, deliveryand performance by each of Borrower and each Guarantor of the Loan Documents towhich it is a party have been duly authorized, and upon their execution anddelivery in accordance with the provisions hereof such Loan Documents willconstitute legal, valid and binding agreements and obligations of Borrower andsuch Guarantor, enforceable in accordance with their respective terms, except assuch enforceability may be limited by bankruptcy, insolvency, reorganization,moratorium or other laws or equitable principles relating to or limitingcreditors' rights generally or the availability of equitable remedies. SECTION 4.3 NO VIOLATION. The execution, delivery and performanceby Borrower of each of the Loan Documents to which it is a party do not (a) toBorrower's knowledge, violate any provision of any applicable law or regulation,(b) contravene any provision of the Certificate of Incorporation or By-Laws ofBorrower, (c) result in a breach of, or constitute a default under, anycontract, obligation, indenture or other instrument, or, any judgment,injunction, order or decree, to which Borrower is a party or by which Borroweror any of its respective property may be bound, or (d) result in or require thecreation or imposition of any lien, security interest or other charge orencumbrance upon or with respect to any property of Borrower except in favor ofAgent or Lenders. SECTION 4.4 NO ADDITIONAL APPROVALS. No further approval,authorization, consent, order, notice to or filing or registration with anygovernmental authority or any public board or body is legally required withrespect to the execution, delivery or performance by Borrower of the LoanDocuments to which it is a party where the failure to obtain such approval couldreasonably have a Material Adverse Effect. SECTION 4.5 LITIGATION. There are no pending, or to the best ofBorrower's knowledge threatened, actions, claims, investigations, suits orproceedings by or before any governmental authority, arbitrator, court oradministrative agency which could reasonably be expected to have a MaterialAdverse Effect. -36- 43 SECTION 4.6 CORRECTNESS OF FINANCIAL STATEMENT. The auditedconsolidated financial statements of Borrower dated as of December 31, 1999, andthe unaudited interim consolidated financial statements of Borrower dated as ofMarch 31, 2000, heretofore delivered by Borrower to Agent, (a) are complete andcorrect and present fairly the financial condition of Borrower as of the datethereof; (b) disclose all liabilities of Borrower that are required to bereflected or reserved against under GAAP, whether liquidated or unliquidated,fixed or contingent; and (c) have been prepared in accordance with GAAP. Sincethe date of such financial statements there has been no material adverse changein the financial condition of Borrower, nor has Borrower mortgaged, pledged orgranted a security interest in or otherwise encumbered any of its assets orproperties except as permitted by this Agreement or as disclosed by Borrower toAgent in the Disclosure Schedule. SECTION 4.7 INCOME TAX RETURNS. Except to the extent covered bylegally permitted and validly filed extensions, Borrower has filed all UnitedStates federal income tax returns, state tax returns and all other material taxreturns which it is required to file, and have paid all taxes due pursuant tosuch returns or pursuant to any assessment received by them, except for thosebeing actively contested in good faith. The charges, accruals and reserves onthe books of Borrower in respect of taxes or other governmental charges are, inthe opinion of Borrower or its independent certified public accountants,adequate. Borrower has no knowledge of any pending assessments or adjustments ofthe income tax paid or payable by Borrower with respect to any year. SECTION 4.8 NO SUBORDINATION. There is no agreement, indenture,contract or instrument to which Borrower or any Guarantor is a party or by whichBorrower or any Guarantor may be bound that requires the subordination in rightof payment of any of Borrower's or such Guarantor's or such other Person'sobligations subject to this Agreement to any other obligation of Borrower orsuch Guarantor or such other Person. SECTION 4.9 PERMITS, FRANCHISES. Borrower possesses, and willhereafter possess, all permits, franchises and licenses required and rights toall trademarks, trade names, patents and fictitious names, if any, necessary toenable it to conduct the business in which it is now engaged in compliance withapplicable law. SECTION 4.10 ERISA. Borrower and each Guarantor is in compliancein all material respects with all applicable provisions of ERISA; neitherBorrower nor any Guarantor has violated any provision of any Plan maintained orcontributed to by Borrower or such Guarantor or such other Person; no ReportableEvent as defined in ERISA has occurred and is continuing with respect to anyPlan initiated by Borrower or any Guarantor; each of Borrower and each Guarantorhas met its minimum funding requirements under ERISA with respect to each Plan;and each -37- 44Plan will be able to fulfill its benefit obligations as they come due inaccordance with the Plan documents and under GAAP. SECTION 4.11 OTHER OBLIGATIONS. To the best of Borrower'sknowledge, neither Borrower nor any Guarantor is in default on any obligationfor borrowed money, any purchase money obligation or any other material lease,commitment, contract, instrument or obligation. SECTION 4.12 GOVERNMENT REGULATIONS. Neither Borrower nor anyGuarantor is subject to regulation under the Investment Company Act of 1940, theFederal Power Act, the Interstate Commerce Act, the Public Utility HoldingCompany Act of 1935 or any federal or state statute or regulation limiting itsability to incur indebtedness for money borrowed. SECTION 4.13 SECURITIES ACTIVITIES. Neither Borrower nor anyGuarantor is engaged principally, or as one of its important activities, in thebusiness of extending credit for the purpose of purchasing or carrying anymargin stock (as defined within Regulations G, T and U of the Board of Governorsof the Federal Reserve System), and not more than twenty-five percent (25%) ofthe value of Borrower's or any Guarantor's assets consists of such margin stock. SECTION 4.14 ENVIRONMENTAL MATTERS. Except as set forth on theDisclosure Schedule hereto, each of Borrower and each Guarantor is in compliancein all material respects with all applicable Federal and state environmental,hazardous waste, health and safety statutes, and any rules or regulationsadopted pursuant thereto, which govern or affect any of Borrower's or anyGuarantor's operations and/or properties, including the ComprehensiveEnvironmental Response, Compensation and Liability Act of 1980, the SuperfundAmendments and Reauthorization Act of 1986, the Federal Resource Conservationand Recovery Act of 1976, the Federal Toxic Substances Control Act and theCalifornia Health and Safety Code, as any of the same may be amended, modifiedor supplemented from time to time. None of the operations of Borrower or anyGuarantor is the subject of any federal or state investigation evaluatingwhether any remedial action involving a material expenditure is needed torespond to a release of any toxic or hazardous waste or substance into theenvironment. To Borrower's knowledge, neither Borrower nor any Guarantor has anymaterial contingent liability in connection with any release of any toxic orhazardous waste or substance into the environment. SECTION 4.15 REAL PROPERTY COLLATERAL. Except as set forth inSchedule 4.15 hereto, with respect to the Real Property Collateral: (a) All taxes, governmental assessments, insurance premiums, andwater, sewer and municipal charges, and rents (if any) which previously became(or -38- 45without payment before the date hereof would have become) delinquent inrespect thereof have been paid as of the date hereof; (b) There are no mechanics' or similar liens or claims which havebeen filed for work, labor or material (and no rights are outstanding that underlaw could give rise to any such lien) which affect all or any interest in anysuch real property and which are or may be prior to or equal to the lien thereonin favor of Agent; (c) To Borrower's knowledge, none of the improvements which wereincluded for purpose of determining the appraised value of any such realproperty lie outside of the boundaries and/or building restriction linesthereof, and no improvements on adjoining properties materially encroach uponany such real property; and (d) There is no pending, or to the best of Borrower's knowledgethreatened, proceeding for the total or partial condemnation of all or anyportion of any such real property, and all such real property is in good repairand free and clear of any damage that would materially and adversely affect thevalue thereof as security and/or the intended use thereof. SECTION 4.16 SUBSIDIARIES. Borrower does not own any stock orequity interest in any corporation or other entity, other than those listed onthe Disclosure Schedule hereto. SECTION 4.17 TRUTH, ACCURACY OF INFORMATION. All financial andother information furnished to Agent or any Lender in connection with thisAgreement is true and correct as of the date hereof and does not contain anyuntrue statement of a material fact or omit to state a material fact necessaryin order to make the information furnished, in light of the circumstances underwhich furnished, not misleading. ARTICLE V --------- CONDITIONS SECTION 5.1 CONDITIONS OF INITIAL EXTENSION OF CREDIT. Theobligation of Lenders to extend any credit contemplated by this Agreement issubject to the fulfillment to Agent's satisfaction of all of the followingconditions: (a) Approval of Agent's Counsel. All legal matters incidental tothe extension of credit hereunder shall be satisfactory to counsel for Agent. -39- 46 (b) Documentation. Agent shall have received, in form andsubstance satisfactory to Agent, each of the following duly executed: (i) This Agreement and the Notes. (ii) Guaranty from each Guarantor as required by Section 2.16 hereof. (iii) All Security Agreements, UCC-1 Financing Statements and other documentation from Borrower and each other person or entity required by Agent for the creation, perfection and preservation of the personal property security interests described in Section 2.15(a) hereof. (iv) All Deeds of Trust and other documentation from Borrower and each other person or entity required by Agent for the creation, perfection and preservation of the real property security interests described in Section 2.15(b) hereof (including, as deemed necessary by Agent, a modification to the Deeds of Trust encumbering the Solar Way Property and the Technology Drive Property), together with such policies of title insurance covering said parcels of real property, issued by companies, in amounts and in form and substance as Agent shall deem acceptable. (v) Corporate Borrowing Resolution from Borrower. (vi) Resolution from each corporate or limited liability company Guarantor authorizing the execution and delivery of its respective Guaranty and its pledge of collateral required hereunder. (vii) Certified copies of the filed Articles of Incorporation for Borrower and each corporate Guarantor and the certificate of formation for each limited liability company Guarantor. (viii) Certificate of Incumbency from Borrower and each corporate or limited liability company Guarantor. (ix) Notice of Authorized Representatives. (x) Evidence satisfactory to Agent certifying that all improvements at each of the Real Properties comply with all applicable zoning and building laws, and all approvals, consents, licenses, and permits necessary to conduct Borrower's business have been obtained. (xi) An opinion of Gray Cary Ware & Freidenrich LLP, counsel to Borrower, in form satisfactory to Agent, confirming that the -40- 47 Loan Documents are valid, binding and enforceable in accordance with their terms, that they do not violate any usury or other applicable laws and that the Borrower, the Guarantors and each of the Real Properties are in compliance with all applicable laws. (xii) Copies of all of Borrower's franchise agreements and service agreements. (xiii) Evidence of a tax service contract with a third party vendor which shall provide tax information on the Properties. (xiv) Copies of all material contracts, agreements and leases set forth on Schedule 5 hereto (the "Contract Collateral") to which Borrower or any Guarantor is a party and assignments thereof to Agent as additional collateral for the Credits and any consents to such assignment or landlord waivers as Agent may require. (xv) Copies of the most current tax bills for each of the Real Properties evidencing no delinquency in payment and that such Real Property has been segregated from all other property on the applicable municipal tax rolls. (xvi) A written certification executed by Borrower and each Guarantor certifying as to the truth and accuracy of all material facts pertinent to the Credits and to the legal opinion described in (xi) above. (xvii) Such other documents as Agent may require under any other Section of this Agreement. (c) Financial Statements. Agent shall have received, in form andsubstance satisfactory to Agent and Lenders, audited financial statements forBorrower for and as of the fiscal year ending December 31, 1999, which financialstatements shall reflect no material adverse change in the financial conditionof Borrower from the financial information previously delivered to Agent. (d) Fees and Expenses. Borrower shall have paid all fees andinvoiced costs and expenses then due pursuant to the terms of this Agreement andall Loan Costs incurred by Agent as of the Closing Date. (e) Insurance. Borrower shall have delivered to Agent evidence ofinsurance coverage on all Borrower's and Guarantor's property, in form,substance, amounts, covering risks and issued by companies satisfactory toAgent, and where required by Agent, with loss payable endorsements in favor ofAgent, including policies of fire and extended coverage insurance covering theReal Property Collateral, with replacement cost and mortgagee loss payableendorsements, commercial general -41- 48liability insurance for Borrower and each Guarantor with respect to each ofBorrower's and such Guarantor's properties providing for limits of not less than$5,000,000 for both injury to or death of a person and for property damage peroccurrence, and such policies of insurance against specific hazards affectingany such real property as may be required by governmental regulation or Agent. (f) Appraisals; Collateral Audit; and Credit Checks. Agent shallhave obtained, at Borrower's cost (A) an appraisal of all Real PropertyCollateral, all improvements thereon, and all Personal Property Collateralissued by an appraiser acceptable to Agent and in form, substance and reflectingvalues satisfactory to Agent, in its discretion, (B) a collateral audit of allPersonal Property Collateral performed by a person satisfactory to Agent and inform, substance and reflecting values satisfactory to Agent, and (C)satisfactory credit checks on Borrower and each Guarantor. (g) Title Insurance. As to the El Monte Property and the MontereyPark Property, Agent shall have received an ALTA Policy of Title Insurance, withsuch endorsements as Agent may require, including CLTA endorsements 100, 100.29,103.1A, 103.7, 104.7, 111.5, 116, 116.4, 116.7 and 123.2, issued by a companyand in form and substance satisfactory to Agent, in such amount as Agent shallrequire, insuring Agent's lien on the El Monte Property and the Monterey ParkProperty to be of first priority, subject only to such exceptions as Agent shallapprove in its discretion, with all costs thereof to be paid by Borrower. As tothe Solar Way Property and the Technology Drive Property, Agent shall havereceived a CLTA 110.5 modification endorsement to each of the existing TitlePolicies for such properties. (h) Environmental Reports. Agent shall have obtained, atBorrower's cost, a Phase I (and to the extent deemed necessary by Agent, a PhaseII) Environmental Site Assessment for each parcel of Real Property Collateral,and such other documentation as Agent may reasonably determine is necessary inorder to adequately review and make a determination as to the condition of eachsuch parcel of Real Property Collateral. (i) Material Adverse Change. There shall have been no materialadverse change, as determined by Agent, in the business, operations, properties,or financial condition of Borrower since the dates of the financial statementsdelivered to Agent pursuant to Section 5.1(c). (j) Engineering Survey. Agent shall have made a physicalinspection of each parcel of Real Property Collateral and if required by Agent,an independently prepared structural and mechanical engineering reportsatisfactory to Agent. (k) UCC Filings. There shall exist no UCC filings againstBorrower or any Guarantor which have not been approved by Agent, and each ofBorrower and each Guarantor, as applicable, shall have delivered to Agent suchfirst priority UCC-1 -42- 49Financing Statements covering all Personal Property Collateral and ContractCollateral as Agent may require. (l) Subordination Agreement. Agent shall have received, in formand substance satisfactory to Agent, a subordination agreement from the SmallBusiness Administration subordinating its lien in the Solar Way Property toAgent's first priority lien in the Solar Way Property or a re-affirmationthereof consenting to the cross-collateralization as set forth in the LoanDocuments. SECTION 5.2 CONDITIONS OF EACH EXTENSION OF CREDIT. Theobligation of Lenders to make each extension of credit requested by Borrowerhereunder (including the initial extension of credit) shall be subject to thefulfillment to Agent's satisfaction of all of the following conditions: (a) Compliance. The representations and warranties containedherein and in each of the other Loan Documents shall be true on and as of thedate of the signing of this Agreement and on the date of each extension ofcredit by Lenders pursuant hereto, with the same effect as though suchrepresentations and warranties had been made on and as of each such date, and oneach such date, no Default or Event of Default shall have occurred and becontinuing or shall exist, and Agent shall have received a certificateconfirming the matters set forth in this Section 5.2(a) signed by a seniorfinancial officer of Borrower. (b) Borrowing Base. With respect to the Line of Credit, Agent hasdetermined that there is availability under the Borrowing Base to make theextension of credit. (c) Minimum Extension of Credit. The extension of credit is inthe amount of at least $100,000; however, Agent in its sole discretion may makean extension of credit in an amount less than $100,000. (d) Documentation. Agent shall have received all additionaldocuments which may be required in connection with such extension of credit.Borrower shall pay the costs of any additional documentation, legal fees ortitle insurance required by Agent to evidence such extension of credit andpreserve the priority of the lien of the Security Documents. -43- 50 ARTICLE VI ---------- AFFIRMATIVE COVENANTS Borrower covenants that so long as Lenders remain committed toextend credit to Borrower pursuant hereto, or any liabilities (whether direct orcontingent, liquidated or unliquidated) of Borrower to Lenders under any of theLoan Documents remain outstanding, and until payment in full of all obligationsof Borrower subject hereto, Borrower shall, unless Agent otherwise consents inwriting: SECTION 6.1 PUNCTUAL PAYMENTS. Punctually pay all principal,interest, fees or other liabilities due under any of the Loan Documents at thetimes and place and in the manner specified therein. SECTION 6.2 ACCOUNTING RECORDS. Maintain adequate books andrecords in accordance with generally accepted accounting principles consistentlyapplied, and permit any representative of Agent, upon reasonable notice andduring regular business hours, to inspect, audit and examine such books andrecords, to make copies of the same, and to inspect the properties of Borrower.Borrower shall not be responsible for the costs of more than one (1) inspectionand audit of Borrower's books and records in any six (6) month period if anEvent of Default is not continuing during the inspection and audit. SECTION 6.3 FINANCIAL STATEMENTS. Provide to Agent all of thefollowing, in form and detail satisfactory to Agent: (a) not later than ninety (90) days after and as of the end ofeach fiscal year, an audited financial statement of Borrower and each entitywhose financial results are consolidated with those of Borrower for reportingpurposes, prepared by a nationally recognized certified public accountant, toinclude a balance sheet, income statement, statement of cash flows,reconciliation of net worth and notes to financial statements; (b) not later than thirty (30) days prior to the end of eachfiscal year, an annual budget for Borrower, prepared by Borrower, which shallinclude three-year projections of Borrower's operations and planned capitalexpenditures and financial projections for Borrower and each entity whosefinancial results are consolidated with those of Borrower for reporting purposesfor the next fiscal year; (c) not later than forty-five (45) days after and as of the endof each fiscal quarter, a financial statement of Borrower and each entity whosefinancial results are consolidated with those of Borrower for reportingpurposes, prepared by Borrower, to include a balance sheet and income statement; -44- 51 (d) not later than thirty (30) days after and as of the end ofeach calendar month, (i) a calculation of the Borrowing Base certified ascorrect by a senior financial officer of Borrower; and (ii) an accountsreceivable aging and an accounts payable aging; (e) not later than ninety (90) days after and as of the end ofeach fiscal year, a financial statement of each Guarantor hereunder, prepared bysuch Guarantor to include a balance sheet and, for any non-individual Guarantor,an income statement, and within thirty (30) days after filing, copies of eachsuch Guarantor's filed United States federal income tax returns, if any, forsuch year; (f) contemporaneously with each annual and quarterly financialstatement of Borrower required hereby, a certificate of the chief financialofficer or other executive officer of Borrower that said financial statementsare accurate, that Borrower is in compliance with the financial covenants setforth in Section 6.9 below and that there is no Borrowing Base Deficiency asdefined in Section 6.16 below, and that there exists no Event of Default nor anycondition, act or event which, with the giving of notice or the passage of timeor both, would constitute an Event of Default; (g) from time to time such other information as Agent mayreasonably request. SECTION 6.4 COMPLIANCE. Preserve and maintain all licenses,permits, governmental approvals, rights, privileges and franchises necessary forthe conduct of its business; and comply with the provisions of all documentspursuant to which Borrower is organized and/or which govern Borrower's continuedexistence and with the requirements of all laws, rules, regulations and ordersof any governmental authority applicable to Borrower and/or its business. SECTION 6.5 INSURANCE. Maintain and keep in force insurance ofthe types and in amounts customarily carried in lines of business similar tothat of Borrower, including but not limited to fire, extended coverage, publicliability, flood, property damage and workers' compensation, with all suchinsurance carried with companies and in amounts reasonably satisfactory toAgent, and deliver to Agent from time to time at Agent's request schedulessetting forth all insurance then in effect. SECTION 6.6 FACILITIES. Keep all properties useful or necessaryto Borrower's business in good repair and condition, ordinary wear and tearexcepted, and from time to time make necessary repairs, renewals andreplacements thereto so that such properties shall be fully and efficientlypreserved and maintained, ordinary wear and tear excepted. -45- 52 SECTION 6.7 TAXES AND OTHER LIABILITIES. Pay and discharge whendue any and all indebtedness, obligations, assessments and taxes, both real orpersonal, including without limitation federal and state income taxes and stateand local property taxes and assessments, except such (a) as Borrower may ingood faith contest or as to which a bona fide dispute may arise, and (b) forwhich Borrower has made appropriate reserves in accordance with GAAP. SECTION 6.8 LITIGATION. Promptly give notice in writing to Agentof any litigation pending or threatened against Borrower with a claim in excessof $500,000.00. SECTION 6.9 FINANCIAL CONDITION. Maintain Borrower's financialcondition as follows, based on the consolidated financial statements of Borrowerand each entity whose financial results are consolidated with those of Borrowerfor reporting purposes, using generally accepted accounting principlesconsistently applied and used consistently with prior practices (except to theextent modified by the definitions herein): (a) Maintain at all times a ratio of current assets to currentliabilities greater than or equal to 1.75 to 1.00. (b) Without Agent's prior written consent, Borrower shall notincur expenses for capital expenditures in excess of (i) $50,000,000 for theBorrower's fiscal year 2000, and (ii) $40,000,000 for the Borrower's fiscal year2001, and (iii) thereafter, such limit to be mutually approved by Borrower andMajority Lenders. (c) Maintain at all times a Minimum Interest Coverage Ratio of3.00 to 1:00, measured quarterly, based upon the four-quarter period then ended. (d) Maintain, as of the end of each fiscal quarter commencingwith the quarter ended September 30, 2000, a Tangible Net Worth not less than$63,000,000.00 plus seventy-five percent (75%) of net income for each fiscalquarter after June 30, 2000 without deduction for losses, plus 100% of netequity proceeds. (e) Maintain at all times a Fixed Charge Coverage Ratio of notless than (i) 1.15 to 1.00 for the period from January 1, 2000 to December 31,2000, measured as of December 31, 2000, and (ii) 1.25 to 1.00 measured for themost recent four historical quarters (excluding the current quarter inpossession), for the fiscal quarter ending on March 31, 2001 and for each fiscalquarter thereafter. (f) Maintain a ratio of Funded Debt to EBITDA not to exceed thefollowing amounts for the four (4) consecutive fiscal quarter period ending onthe last day of each fiscal quarter during the following periods: -46- 53 -------------------------------------------------------------------- the period from June 30, 2000, through and including December 31, 2000 2.50 to 1.00 -------------------------------------------------------------------- the period from January 1, 2001, through and including December 31, 2001, and each fiscal 2.00 to 1.00 quarter thereafter -------------------------------------------------------------------- SECTION 6.10 NOTICE TO AGENT. Promptly (but in no event more thanfive (5) Business Days after Borrower becomes aware of the occurrence of eachsuch event or matter) give written notice to Agent in reasonable detail of: (a)the occurrence of any Event of Default, or any condition, event or act which,with the giving of notice or the passage of time or both, would constitute anEvent of Default; (b) any change in the name or the organizational structure ofBorrower; (c) the occurrence and nature of any Reportable Event or ProhibitedTransaction, each as defined in ERISA, or any funding deficiency with respect toany Plan; or (d) any termination or cancellation of any insurance policy whichBorrower is required to maintain, or any uninsured or partially uninsured lossthrough liability or property damage, or through fire, theft or any other causeaffecting Borrower's property in excess of an aggregate of $500,000. SECTION 6.11 SITE VISITS; RIGHT TO STOP WORK. Agent and itsagents and representatives shall have the right to enter and visit the RealProperty and the facilities thereon during regular business hours. In eachinstance, Agent shall give Borrower reasonable notice before entering any of theReal Property facilities thereon. Agent shall use its best efforts to reasonablyavoid interfering with Borrower's use of any Real Property facilities thereon orwith Borrower's business operations when exercising any of the rights granted inthis Section 6.11. Notwithstanding this Section 6.11 or any other provisions ofthe Loan Documents, Borrower shall not be responsible for the cost of more thanone (1) such visit to the Real Properties and facilities thereon in any six (6)month period if an Event of Default is not continuing at the time of theproposed visit. SECTION 6.12 SECURITY. At all times maintain in favor of Agentperfected security interests of such priority as is designated herein in allassets in which, under the provisions of this Agreement, Agent has or is toobtain a security interest; take such actions (including the execution offinancing statements and fixture filings) as Agent reasonably requests toprotect Agent's security interests; and provide to Agent such assurances asAgent may require as to Borrower's compliance herewith. SECTION 6.13 RELATED DOCUMENTS. Comply with the terms andcovenants of the Related Documents to which it is a party, and Borrower -47- 54will not amend, modify or terminate, or agree to amend, modify or terminate, anyRelated Document. SECTION 6.14 INVESTIGATIONS AND INQUIRIES. Agent and its agentsand representatives shall have the right once per six (6) month period (or morefrequently if an Event of Default is outstanding) to conduct such investigationsand inquiries as to the credit and operations of Borrower, each of theGuarantors and the Collateral as shall be necessary in connection with theCredits and monitoring of the Credits, and Borrower shall cooperate with Agentand provide Agent with such information reasonably requested by Agent in theexercise of such right and pay for the cost of such inquiry. SECTION 6.15 CONTRACT COLLATERAL. Agent shall have the right toreview any Contract Collateral. SECTION 6.16 BORROWING BASE DEFICIENCY. If at any time and forany reason, Borrower delivers to Agent a quarterly compliance certificate thatshows that the outstanding unpaid principal balance of the Line of Creditexceeds the aggregate amount of the Borrowing Base ("Borrowing BaseDeficiency"), or if at any time and for any reason Agent gives notice toBorrower of a Borrowing Base Deficiency, then Borrower shall immediately prepaythe principal balance of the Line of Credit in an amount equal to the differencebetween the aggregate outstanding principal balance of the Line of Credit andthe amount of the Borrowing Base. SECTION 6.17 NOTICE OF CERTAIN MATTERS. Borrower shall givenotice to Agent, within ten (10) days of Borrower's learning thereof, of any ofthe following: (a) any disputes, litigation, investigation, proceeding orsuspension that may exist at any time between Borrower or any Guarantor and anyGovernmental Agency; (b) any threat or commencement of proceedings in condemnation oreminent domain relating to any of the Real Property Collateral; (c) the commencement of, or any material development in, anylitigation or proceeding relating to any Collateral between the Borrower and (i)any Governmental Authority, (ii) any Person having rights under or in connectionwith any covenants, conditions, restrictions, easements or rights-of-wayaffecting such Collateral, or (iii) any tenant under its lease of suchCollateral, in each case under this subsection (c) the adverse determination ofwhich would reasonably be expected to materially and adversely affect suchCollateral; -48- 55 (d) upon, but in no event later than ten (10) days after,Borrower's becoming aware of (i) any and all enforcement, cleanup, removal orother governmental or regulatory actions, instituted or threatened in writingagainst (A) Borrower that involve potential liability in excess of $5,000,000for any single action or $15,000,000 in the aggregate of all such actions, or(B) any of the Real Properties, pursuant to any applicable environmental laws,(ii) all other environmental claims against (A) Borrower that involve potentialliability in excess of $5,000,000 for any single environmental claim or$15,000,000 in the aggregate for all such environmental claims, or (B) any RealProperty, and (iii) any environmental or similar condition on any real propertyadjoining or in the vicinity of any Real Property that causes such Real Propertyor any part thereof to be subject to any restrictions on the ownership,occupancy, transferability or use of such Real Property under any applicableenvironmental laws; and (e) any trade name hereafter used by Borrower and any change inBorrower's principal place of business. Each notice under this Section 6.17 shall be accompanied by awritten statement by Borrower setting forth details of the occurrence referredto therein, and stating what action, if any, Borrower or any affected Guarantorproposes to take with respect thereto and at what time. Each notice under thisSection 6.17 shall describe with particularity any and all clauses or provisionsof this Agreement or other Loan Documents that have been breached or violated. ARTICLE VII ----------- NEGATIVE COVENANTS Borrower further covenants that so long as Lenders remaincommitted to extend credit to Borrower pursuant to the terms hereof or anyliabilities (whether direct or contingent, liquidated or unliquidated) ofBorrower to Lenders or Agent under any of the Loan Documents remain outstanding,and until payment in full of all obligations of Borrower subject hereto,Borrower will not, and will not permit any Subsidiary to, without the priorwritten consent of Majority Lenders: SECTION 7.1 USE OF FUNDS. Use any of the proceeds of any Creditextended hereunder except for the following purposes: (a) The purposes stated in Article II hereof; (b) Payment of outstanding debt owed to U.S. Bank as of theClosing Date, including U.S. Bank's existing line of credit in the amount of$15,000,000.00 and U.S. Bank's existing bridge loan to Borrower; and -49- 56 (c) Payment of the Loan Costs. SECTION 7.2 OTHER INDEBTEDNESS. Create, incur, assume or permitto exist any indebtedness or liabilities resulting from borrowings, loans oradvances, whether secured or unsecured, matured or unmatured, liquidated orunliquidated, joint or several, which in the aggregate exceed $500,000, except(a) the liabilities of Borrower to Lenders, or (b) Permitted Indebtedness. SECTION 7.3 MERGER, CONSOLIDATION, ORGANIZATIONAL STRUCTURE,TRANSFER OF ASSETS. Merge into or consolidate with any other entity; makesubstantial change in the nature of Borrower's business as conducted as of thedate hereof; acquire all or substantially all of the assets of any other entity;sell, lease, transfer or otherwise dispose of all or a substantial or materialportion of Borrower's assets except in the ordinary course of its business; norchange the day to day control and management of Borrower (which shall includethe resignation or termination of Morris S. Young from his current position butshall not include the changing of officers or employees in the ordinary courseof Borrower's business), Borrower's name, identity or organizational structure;provided, however, that the consent of Majority Lenders will not be required forany of the foregoing that does not result in an expenditure or gain to Borrowerof $1,000,000 or less; provided further, however, that Majority Lenders shallnot unreasonably withhold their consent in the case of a corporate restructureof Borrower in which Borrower is the surviving entity and ownership and controlof Borrower remain substantially unchanged. SECTION 7.4 GUARANTIES. Guarantee or become liable in any way assurety, endorser (other than as endorser of negotiable instruments for depositor collection in the ordinary course of business), accommodation endorser orotherwise for, nor pledge or hypothecate any assets of Borrower as security for,any liabilities or obligations of any other person or entity, except any of theforegoing in favor of Lenders and except as any such liability constitutesPermitted Indebtedness. SECTION 7.5 LOANS, ADVANCES, INVESTMENTS. Except for PermittedInvestments, make any loans or advances to or investments in any person orentity in excess of $1,000,000 in the aggregate in any fiscal year. SECTION 7.6 DIVIDENDS AND DISTRIBUTIONS. Pay any dividend ordistribution in any fiscal year, either in cash, stock or any other property, onBorrower's stock now or hereafter outstanding in an aggregate amount thatexceeds ten (10%) of Borrower's after-tax net income for such fiscal year, norredeem, retire, repurchase or otherwise acquire any shares of any class ofBorrower's stock now or hereafter outstanding in an aggregate amount thatexceeds $1,000,000 in any fiscal year. -50- 57 SECTION 7.7 PLEDGE OF ASSETS. Mortgage, pledge, grant or permitto exist a security interest in, or lien upon, all or any portion of Borrower'sassets now owned or hereafter acquired, except any of the foregoing (a) in favorof Agent, or (b) Permitted Liens. ARTICLE VIII ------------ EVENTS OF DEFAULT SECTION 8.1 EVENTS OF DEFAULT. The occurrence of any of thefollowing shall constitute an "Event of Default" under this Agreement: (a) Loan Document Payments. Borrower fails to pay when due anyprincipal, interest, fees or other amounts payable under any of the LoanDocuments. (b) Other Required Payments. Borrower fails to pay when due anyrequired payment under the Indenture. (c) Misrepresentation. Any financial statement or certificatefurnished to Agent in connection with, or any representation or warranty made byBorrower, or any Guarantor shall prove to be incorrect, false or misleading inany material respect when furnished or made or when deemed made. (d) Other Covenants. Borrower or any Guarantor fails to perform,observe or comply with any obligation, agreement or other provision on its partto be performed under this Agreement or any other Loan Document (other thanthose referred to in subsections (a), (b) and (c) above), and with respect toany such failure which by its nature can be cured, such failure shall continuefor a period of thirty (30) days from its occurrence. (e) Other Defaults. Any event of default by Borrower or anyGuarantor in the payment or performance of any obligation under the terms of anycontract or instrument (other than any of the Loan Documents) pursuant to whichBorrower or any such Guarantor has incurred any debt or other liability inexcess of $500,000 to any person or entity (including any Lender or Agent),which default is not cured within any cure period applicable thereto. The Eventof Default under this Section 8.1(e) caused by the occurrence of an event ofdefault under another agreement described in this Section 8.1(e) shall beautomatically cured for purposes of this Agreement upon the cure or waiver ofthe event of default under the other agreement. (f) Judgment Liens or Levies. The filing of a notice of judgmentlien against Borrower or any Guarantor; or the recording of any abstract ofjudgment -51- 58against Borrower or any Guarantor in any county in which Borrower or suchGuarantor has an interest in real property; or the service of a notice of levyand/or of a writ of attachment or execution or other like process, against theassets of Borrower or any Guarantor; or the entry of a judgment against Borroweror any Guarantor, and any of the foregoing shall relate to a claim or judgmentof $500,000 or more and shall continue unstayed for a period of forty-five (45)days from its occurrence. (g) Insolvency. Borrower or any Guarantor shall suffer or consentto or apply for the appointment of a receiver, trustee, custodian or liquidatorof itself or any of its property, or shall generally fail to pay its debts asthey become due, or shall make a general assignment for the benefit ofcreditors; or Borrower or any Guarantor shall file a voluntary petition inbankruptcy, or seeking reorganization, in order to effect a plan or otherarrangement with creditors or any other relief under the Bankruptcy Code, orunder any state or Federal law granting relief to debtors, whether now orhereafter in effect; or any involuntary petition or proceeding pursuant to theBankruptcy Code or any other applicable state or Federal law relating tobankruptcy, reorganization or other relief for debtors is filed or commencedagainst Borrower or any Guarantor, and such case or proceeding shall continueundismissed for a period of forty-five (45) days from commencement of suchproceeding or case; or Borrower or any Guarantor shall file an answer admittingthe jurisdiction of the court and the material allegations of any involuntarypetition; or Borrower or any Guarantor shall be adjudicated a bankrupt, or anorder for relief shall be entered by any court of competent jurisdiction underthe Bankruptcy Code or any other applicable state or Federal law relating tobankruptcy, reorganization or other relief for debtors. (h) ERISA Event. A Reportable Event (as defined in ERISA), or anyviolation of any provision of any Plan maintained or contributed to by Borroweror any Subsidiary, involving an amount in excess of $500,000 occurs and is notcured within forty-five (45) days. (i) Invalidity. Any material provision of this Agreement, anyother Loan Document or any Related Document shall at any time for any reasoncease to be in full force and effect or valid and binding on Borrower or anyGuarantor, or shall be declared to be null and void, or the validity orenforceability thereof shall be contested by Borrower or any Guarantor, orBorrower or any Guarantor shall deny that it has any further liability orobligation under this Agreement, any other Loan Document or any RelatedDocument, and such event shall have or be likely to have, in the reasonablejudgment of Agent and Majority Lenders, a Material Adverse Effect. (j) Material Adverse Change. A material adverse change, asreasonably determined by Agent and Majority Lenders in the good faith exerciseof their discretion, shall occur in the financial condition of Borrower taken asa whole. -52- 59 (k) Death or Incapacity. The death or incapacity of Morris S.Young, provided that Agent and Majority Banks reasonably determine, in the goodfaith exercise of their discretion, that such death or incapacity shall have orbe likely to have, in their reasonable judgment, a Material Adverse Effect. (l) Dissolution or Liquidation. The dissolution or liquidation ofBorrower or any corporate or limited liability company Guarantor; or Borrower orany such entity Guarantor or their respective directors, stockholders or membersshall take action seeking to effect the dissolution or liquidation of Borroweror such entity Guarantor. (m) Change in Ownership. Any change in ownership during the termof this Agreement which would lead to a change in the management of Borrower;provided, however, that no Event of Default shall be deemed to have occurredunder this Section 8.1(m) as a result of a change in the Borrower's managementor employees in the ordinary course of business. (n) Real Property Transfers. The sale, transfer, hypothecation,assignment or other encumbrance, other than Permitted Liens, whether voluntary,involuntary or by operation of law, without Agent's prior written consent, ofall or any part of or interest in any of the Real Property Collateral. (o) Cross-Default. A defined event of default under any of theSecurity Documents, subject to the applicable cure period, if any, provided insuch Security Document. The Event of Default under this Section 8.1(o) shall beautomatically cured for purposes of this Agreement upon the cure or waiver ofthe event of default under the Security Documents. SECTION 8.2 REMEDIES. During the continuation of any Event ofDefault (other than an Event of Default referred to in Section 8.1(g) hereof),Agent may, with the consent of the Majority Lenders, or shall, upon writteninstructions from the Majority Lenders, by written notice to Borrower, (a)terminate the obligations of the Lenders to extend any further credit under anyof the Loan Documents, and/or (b) declare all indebtedness of Borrower under theLoan Documents to be immediately due and payable without presentment, demand,protest or any other notice of any kind, all of which are hereby expresslywaived by Borrower. Upon the occurrence or existence of any Event of Defaultdescribed in Section 8.1(g) hereof, immediately and without notice, (i) theobligations, if any, of Lenders to extend any further credit under any of theLoan Documents shall automatically cease and terminate, and (ii) allindebtedness of Borrower under the Loan Documents shall automatically becomeimmediately due and payable, without presentment, demand, protest or any othernotice of any kind, all of which are hereby expressly waived by Borrower. Inaddition to the foregoing remedies, during the continuance of any Event ofDefault, Agent may (i) exercise all of its rights and remedies under any RelatedDocument (to which Agent -53- 60is a party or is a third party beneficiary) or applicable law; (ii) require theTrustee to declare a default under the Indenture and accelerate the maturity ofthe Bonds; (iii) require Borrower to deliver and pledge to Agent, as securityfor Borrower's obligations to Agent and Lenders under this Agreement, cashcollateral in the amount of any outstanding but undrawn amounts under the Letteror Credit; (iv) exercise any other right, power or remedy granted to it or theLenders under any Loan Document or permitted to it or the Lenders by law, eitherby suit in equity or by action at law, or both; or (v) exercise all or anycombination of the remedies provided for in this Section 8.2. Immediately aftertaking any action under this Section 8.2, Agent shall notify each Lender of suchaction. ARTICLE IX ---------- THE AGENT SECTION 9.1 AUTHORIZATION AND ACTION. Each Lender herebyirrevocably appoints U.S. Bank as Agent, and authorizes Agent to act as itsagent under the Loan Documents and to take such actions on such Lender's behalfand to exercise such powers and perform such duties under the Loan Documents asare expressly delegated to Agent by the terms thereof, together with such otherpowers as are reasonably incidental thereto. Agent shall have no duties orresponsibilities except those expressly set forth in the Loan Documents, and noimplied covenants, functions, responsibilities, duties, obligations orliabilities shall be read into any Loan Document or otherwise exist againstAgent. Notwithstanding anything to the contrary contained herein, Agent shallnot be required to take any action which is contrary to any Loan Document orapplicable law. Neither Agent nor any Lender shall be responsible to any otherLender for any recitals, statements, representations or warranties made byBorrower contained in any Loan Document, for the value, validity, effectiveness,genuineness, enforceability or sufficiency of any Loan Document or theCollateral or for any failure by Borrower to perform its respective obligationshereunder or thereunder. Agent may employ agents and attorneys-in-fact and shallnot be responsible to any Lender for the negligence or misconduct of any suchagents or attorneys-in-fact selected by it with reasonable care. Neither Agentnor any of its directors, officers, employees or agents shall be responsible toany Lender for any action taken or omitted to be taken by it or them under anyLoan Document or in connection therewith, except for its or their own grossnegligence or willful misconduct. Except as otherwise provided under thisAgreement, Agent shall take such action with respect to the Loan Documents asshall be directed by the Majority Lenders. Notwithstanding the foregoing, Agentshall have the right, after consultation with Borrower, which consultation shallnot be unreasonably withheld or delayed, to change the terms, structure, pricingand/or any amount of any of the Credits, including the right to reallocate therelative principal -54- 61loan amounts among any of the Term Loans and the Line of Credit, and/or toestablish additional Term Loan tranches in the event a syndication of theCredits has not been successfully completed; provided however, that agent shallnot have the right to change the aggregate amount of the Credits unless Agentdetermines in its sole discretion that such change is necessary to ensure asuccessful syndicate of the Credits. SECTION 9.2 RELIANCE BY AGENT. Agent shall be entitled to relyupon any certificate, notice or other document (including any cable, telegram,telecopy, or telex) or conversation believed by it in good faith to be genuineand correct and to have been signed, sent or made by or on behalf of the properperson or persons, and upon advice and statements of legal counsel (includingcounsel to Borrower), independent accountants and other experts selected byAgent with reasonable care. As to any matters not expressly provided for by thisAgreement, Agent shall not be required to take any action or exercise anydiscretion, but shall be required to act or to refrain from acting uponinstructions of the Majority Lenders and shall in all cases be fully protectedby the Lenders in acting, or in refraining from acting, hereunder or under anyother Loan Document in accordance with the instructions of the Majority Lenders,and such instructions of the Majority Lenders and any action taken or failure toact pursuant thereto shall be binding on all of the Lenders. SECTION 9.3 DEFAULTS. Agent shall not be deemed to have knowledgeor notice of the occurrence of a Default unless Agent has received a notice froma Lender or Borrower referring to this Agreement, describing such Default andexpressly stating that such notice is a "notice of default". If Agent receivessuch notice of the occurrence of a Default, Agent shall promptly give noticethereof to the Lenders. Agent thereupon shall take such action with respect tosuch Default as shall be reasonably directed by the Majority Lenders; providedhowever, that unless and until Agent shall have received such directions, Agentmay (but shall not be obligated to) take such action, or refrain from takingsuch action, with respect to such Default as it shall deem advisable in the bestinterests of the Lenders. SECTION 9.4 INDEMNIFICATION. Without limiting the obligations ofBorrower hereunder, each Lender agrees to indemnify Agent, ratably in accordancewith its Proportionate Shares, for any and all liabilities, obligations, losses,damages, penalties, actions, judgments, suits, costs, expenses or disbursementsof any kind or nature whatsoever which may at any time (including at any timefollowing payment of such obligations) be imposed on, incurred by or assertedagainst Agent in any way relating to or arising out of this Agreement or anydocuments contemplated by or referred to herein or therein or the transactionscontemplated hereby or thereby or the enforcement of any of the terms hereof orthereof or of any such other documents or any action taken or omitted by Agentunder or in connection herewith or -55- 62therewith; provided however, that no Lender shall be liable for any of theforegoing to the extent they arise from Agent's gross negligence or willfulmisconduct. Without limiting the foregoing, each Lender agrees to reimburseAgent promptly on demand for its ratable share of any amounts payable but notpaid by Borrower under Section 10.2 hereof. Agent shall be fully justified inrefusing to take or to continue to take any action hereunder unless it shallfirst be indemnified to its satisfaction by the Lenders against any and allliability and expense which may be incurred by Agent by reason of taking orcontinuing to take any such action. The agreements in this Section 9.4 shallsurvive the payment of Borrower's obligations hereunder. SECTION 9.5 NON-RELIANCE ON AGENT. Each Lender represents that ithas, independently and without reliance on Agent or any other Lender, and basedon such documents and information as such Lender has deemed appropriate, madeits own appraisal of and investigation into the financial condition and affairsof Borrower and decision to enter into this Agreement. Each Lender agrees thatsuch Lender will, independently and without reliance upon Agent or any otherLender, and based on such documents and information as it shall deem appropriateat the time, continue to make its own appraisals and decisions in taking or nottaking action under this Agreement. Each Lender acknowledges that Agent has notmade any representation or warranty to it with respect to the financialcondition or affairs of Borrower, any Loan Document or any Collateral, and thatno act by Agent hereafter, including any review of any of such matters, shall bedeemed to constitute any such representation or warranty by Agent to any Lender.Neither Agent nor any Lender shall be required to keep informed as to theperformance or observance by Borrower of the obligations under this Agreement orany other document referred to or provided for herein or to make inquiry of, orto inspect the properties or books of Borrower. Except for notices, reports andother documents and information expressly required to be furnished to theLenders by Agent hereunder, neither Agent nor any Lender shall have any duty orresponsibility to provide any Lender with any credit or other informationconcerning Borrower, which may come into the possession of Agent or such Lender,or any of its or their affiliates. SECTION 9.6 SUCCESSOR AGENT. Subject to the appointment andacceptance of a successor Agent as provided below, Agent may resign at any timeby giving thirty (30) days' written notice thereof to the Lenders, and Agent maybe removed at any time with or without cause by the Majority Lenders. Upon anysuch resignation or removal, the Majority Lenders shall have the right toappoint a successor Agent. If no successor Agent shall have been appointed bythe Majority Lenders and shall have accepted such appointment within thirty (30)days after the retiring Agent's giving of notice of resignation or the MajorityLenders' removal of the retiring Agent, then the retiring Agent may, on behalfof the Lenders, appoint a successor Agent, which shall be a bank having acombined capital, surplus and retained earnings of not less than U.S.$500,000,000. Upon the acceptance of any -56- 63appointment as Agent hereunder by a successor Agent, such successor Agent shallthereupon succeed to and become vested with all the rights, powers, privilegesand duties of the retiring Agent, and the retiring Agent shall be dischargedfrom its duties and obligations hereunder. After any retiring Agent'sresignation or removal hereunder as Agent, the provisions of this Article IXshall continue in effect for its benefit in respect of any actions taken oromitted to be taken by it while it was acting as Agent. SECTION 9.7 EXECUTION OF LOAN DOCUMENTS. Agent is herebyauthorized by the Lenders to execute, deliver and perform each of the LoanDocuments to which Agent is or is intended to be a party and each Lender agreesto be bound by all of the agreements of Agent contained in the Loan Documents. SECTION 9.8 AGENT IN ITS INDIVIDUAL CAPACITY. Agent and itsaffiliates may make loans to, accept deposits from, own securities of andgenerally engage in any kind of business with Borrower, as though Agent were notAgent hereunder, without any duty to give notice thereof or account therefor toany Lender. U.S. Bank as a Lender shall have the same rights and powers underthis Agreement and the other Loan Documents as any other Lender and may exercisethe same as though it were not Agent, and the terms "Lender" or "Lenders" shallinclude U.S. Bank in each such capacity. ARTICLE X --------- MISCELLANEOUS SECTION 10.1 NOTICES. Except as specified otherwise herein, allnotices, requests and demands which any party is required or may desire to giveto any other party under this Agreement must be in writing, addressed to Agentand each Lender at its address or telecopy number set forth as the "Address forNotices" for Agent or such Lender in Schedule I hereto, and addressed toBorrower at the following address or telecopy number:Borrower: AXT, Inc. 4281 Technology Drive Fremont, CA 94538 Attn: Donald Tatzin Chief Financial Officer/Secretary Telecopier: (510) 438-4793 -57- 64 With a copy to: Gray Cary Ware & Freidenrich LLP 400 Hamilton Avenue Palo Alto, CA 9301 Attn: Sally Rau, Esq. Telecopier: (650) 327-3699or to such other address or telecopy number as any party may designate bywritten notice to all other parties. Each such notice, request and demand shallbe deemed given or made as follows: (a) if sent by hand delivery, upon delivery;(b) if sent by mail, upon the earlier of the date of receipt or three (3) daysafter deposit in the U.S. mail, first class and postage prepaid; and (c) if sentby telecopy, upon receipt. SECTION 10.2 COSTS, EXPENSES ATTORNEYS' FEES. Except as otherwise set forth herein, Borrower shall payimmediately upon demand: (a) all reasonable costs, fees and expenses, includingreasonable attorneys' fees and expenses, incurred by Agent in connection withthe preparation, review, execution and delivery of, and the exercise of itsduties under, this Agreement and the other Loan Documents, and the preparationof amendments and waivers hereunder and thereunder; (b) all reasonable costs,fees and expenses, including reasonable attorneys' fees and expenses, incurredby Agent and/or Lenders in connection with the enforcement, preservation orprotection (or attempted enforcement, preservation or protection) of any rightsor remedies of Agent and/or Lenders under this Agreement or any other LoanDocument (including in connection with any "workout" or restructuring relatingto this Agreement, any Credit, or any bankruptcy or insolvency case involvingBorrower; and (c) all reasonable costs, fees and expenses incurred by Agent forappraisals, audits, environmental inspections and reviews, searches and filingsin connection with any of the foregoing. As used herein, the term "reasonableattorneys' fees and expenses" shall include, without limitation, allocable costsand expenses of Agent's (or any Lender's, if applicable) in-house legal counseland staff, and "reasonable costs, fees and expenses" shall include, withoutlimitation, allocable costs, fees and expenses of Agent's (or any Lender's, ifapplicable) internal appraisal, audit, environmental and other similar services. SECTION 10.3 INDEMNIFICATION. To the fullest extent permitted bylaw, Borrower hereby agrees to protect, indemnify, defend and hold harmless eachof the Lenders, Agent, their respective affiliates and each of their respectivepast and present officers, directors, shareholders, employees, agents, attorneysand affiliates, together with their respective heirs, beneficiaries, executors,administrators, trustees, predecessors, successors and assigns (collectively,"Indemnitees") from and against any liabilities, losses, damages or expenses ofany kind or nature and from any suits, claims or demands (including in respectof or for reasonable attorneys' fees and other expenses, including the allocatedcosts and -58- 65expenses of internal counsel) arising on account of or in connection with anymatter or thing or action or failure to act by Indemnitees, or any of them,arising out of or relating to this Agreement or any other Loan Document,including any use by Borrower of any proceeds of any Credit, except to theextent such liability arises from the Indemnitee's own willful misconduct orgross negligence. Upon receiving knowledge of any suit, claim or demand assertedby a third party that Agent or any Lender believes is covered by this indemnity,Agent or such Lender shall give Borrower notice of the matter and an opportunityto defend it, at Borrower's sole cost and expense, with legal counsel reasonablysatisfactory to Agent or such Lender, as the case may be. Agent or such Lendermay also require Borrower to defend the matter. Any failure or delay of Agent orany Lender to notify Borrower of any such suit, claim or demand shall notrelieve Borrower of its obligations under this Section 10.3 but shall reducesuch obligations to the extent of any increase in those obligations causedsolely by an unreasonable failure or delay in providing such notice. If Bankdoes not require Borrower to defend such action, or if Borrower fails or refusesto defend such action, Bank shall have the right to employ counsel to defendsuch action and to participate in the defense thereof, and the fees and expensesof such counsel shall be at the expense of Borrower. In addition, Bank shallhave the right to employ separate counsel and to participate in the defense ofany such action if Bank has been advised by counsel of recognized standing inmatters of banking or securities laws that a single lawyer cannot ethicallyrepresent both Bank or any other Indemnitee and Borrower. The obligations ofBorrower under this Section 10.3 shall survive the payment in full andperformance of all Borrower's obligations to Lenders and Agent. SECTION 10.4 WAIVERS, AMENDMENTS. Any term, covenant, agreementor condition of this Agreement or any other Loan Document may be amended orwaived if such amendment or waiver is in writing and is signed and the MajorityLenders (or by Agent with written consent of the Majority Lenders), Borrower andany other party thereto; provided however, that any amendment, waiver or consentwhich affects the rights or duties of Agent must be in writing and be signedalso by Agent; and provided further, that any amendment, waiver or consent whicheffects any of the following changes must be in writing and signed by allLenders (or by Agent with the written consent of all Lenders): (a) increases the maximum principal amount available under anyCredit or the Borrowing Base; (b) extends the maturity date of any Credit; (c) reduces the principal of, or interest (including default rateinterest) on, any Credit or any fees or other amounts payable for the account ofthe Lenders hereunder; -59- 66 (d) postpones or conditions any date fixed for any payment of theprincipal of, or interest on, any Credit or any fees or other amounts payablefor the account of the Lenders hereunder; (e) waives or amends this Section 10.4; (f) amends the definition of Majority Lenders or any provision ofthis Agreement requiring approval of the Majority Lenders or some otherspecified number or proportion of Lenders; (g) changes the voting percentages of the Lenders; (h) results in a release of any material part of the Collateral;or (i) increases or decreases the Proportionate Share of any Lenderin the Total Commitments (other than through an assignment under Section 10.5hereof).Unless otherwise specified in such waiver or consent, a waiver or consent givenhereunder shall be effective only in the specific instance and for the specificpurpose for which given. SECTION 10.5 SUCCESSORS AND ASSIGNS. (a) Binding Effect. The Loan Documents shall be binding upon andinure to the benefit of Borrower, the Lenders, Agent, all future holders of theNotes and their respective successors and permitted assigns, except thatBorrower may not assign or transfer any of its rights or obligations under anyLoan Document without the prior written consent of Agent and each Lender unlessin accordance with Section 7.3. All references in this Agreement to any personor entity shall be deemed to include all successors and assigns of such personor entity. (b) Participations. Any Lender may, in the ordinary course of itsbusiness and in accordance with applicable law, at any time sell to one or morebanks or other financial institutions ("Participants") participating interestsin any Credit owing to such Lender, any Note held by such Lender, or any otherinterest of such Lender under this Agreement and the other Loan Documents. Inthe event of any such sale by a Lender of a participating interest to aParticipant, (i) such Lender's obligations under this Agreement to the otherparties to this Agreement shall remain unchanged, (ii) such Lender shall remainsolely responsible for the performance thereof, (iii) such Lender shall remainthe holder of any such Note for all purposes under this Agreement, and (iv)Borrower and Agent shall continue to deal solely and directly with such Lenderin connection with such Lender's rights and obligations under this Agreement.Participants shall have no rights under this Agreement or any other LoanDocument except as provided below. No Lender shall sell any participatinginterest under which the Participant shall have any rights to vote on any -60- 67amendment or waiver of this Agreement or any other Loan Document; providedhowever, that a Lender may sell a participating interest under which theParticipant shall have the right to vote on any amendment or waiver of thisAgreement or any Loan Document requiring the unanimous consent of all Lenderspursuant to Section 10.4 hereof; provided further, however, that any agreementpursuant to which any Lender sells a participating interest to a Participant mayrequire the selling Lender to obtain the consent of such Participant in orderfor such Lender to agree in writing to any amendment of a type specified inSection 10.4 hereof not requiring the unanimous consent of all Lenders. Noagreement pursuant to which any Lender sells a participating interest to aParticipant other than a Lender may permit the participant to transfer, pledge,assign, sell participations in or otherwise encumber its participating interest.Borrower agrees that if amounts outstanding under this Agreement and the otherLoan Documents are due and unpaid, or shall have been declared or shall havebecome due and payable upon the occurrence of an Event of Default, eachParticipant shall, to the fullest extent permitted by law, be deemed to have therights of payment (but not including any right of setoff) in respect of itsparticipating interest in amounts owing under this Agreement and any otherDocuments to the same extent as if the amount of its participating interest wereowing directly to it as a Lender under this Agreement or any other Documents;provided however, that such rights of payment shall be subject to the obligationof such Participant to share with the Lenders, and the Lenders agree to sharewith such Participant, as provided in Section 2.10(b) hereof. Borrower alsoagrees that any Lender which has transferred all or part of its interests in theCredits to one or more Participants shall, notwithstanding any such transfer, beentitled to the full benefits accorded such Lender under Sections 2.11 and 2.13hereof, as if such Lender had not made such transfer. (c) Assignments. Any Lender may, in the ordinary course of itsbusiness and in accordance with applicable law, at any time, sell and assign toany Lender, any affiliate of a Lender or any other bank or financial institution(individually, an "Assignee") all or any portion of its rights and obligationsunder this Agreement and the other Loan Documents (such a sale and assignment tobe referred to herein as an "Assignment") pursuant to an Assignment andAssumption Agreement in the form of Exhibit G attached hereto (an "AssignmentAgreement"), executed by each Assignee and such assignor Lender (an "Assignor")and delivered to Agent for its acceptance and recording in the Register;provided however, that: (i) each Assignment shall be in a minimum amount of $5,000,000; and (ii) without the written consents of Borrower and Agent, which consents shall not be unreasonably withheld, no Lender may make any Assignment to any Assignee which is not, immediately prior to such Assignment, a Lender hereunder or an affiliate thereof. -61- 68Upon the execution, delivery, acceptance and recording of each AssignmentAgreement, from and after the effective date set forth therein, (A) eachAssignee thereunder shall be a Lender hereunder with a Proportionate Share asset forth in Section 1 of such Assignment Agreement and shall have the rights,duties and obligations of such a Lender under this Agreement and the other LoanDocuments, and (B) the Assignor thereunder shall be a Lender with aProportionate Share as set forth in Section 1 of such Assignment Agreement, or,if the Proportionate Share of the Assignor has been reduced to 0%, the Assignorshall cease to be a Lender; provided however, that each Assignor shallnevertheless be entitled to the indemnification rights contained in Section 10.3hereof for any events, acts or omissions occurring before the effective date ofits Assignment. Each Assignment Agreement shall be deemed to amend Schedule 1hereto to the extent necessary to reflect the addition of each Assignee and theresulting adjustment of Proportionate Shares arising from the purchase by eachAssignee of all or a portion of the rights and obligations of an Assignor underthis Agreement and the other Loan Documents. (d) Register. Agent shall maintain at Agent's Office a copy ofeach Assignment Agreement delivered to and accepted by Agent and a register (the"Register") for the recordation of the names and addresses of the Lenders andthe Proportionate Shares of each Lender from time to time. The entries in theRegister shall be conclusive and binding for all purposes, absent manifesterror, and Borrower, Agent and the Lenders may treat each entity whose name isrecorded in the Register as a Lender hereunder for all purposes of thisAgreement. The Register shall be available for inspection by Borrower or anyLender at any reasonable time and from time to time upon reasonable priornotice. (e) Registration. Upon its receipt of an Assignment Agreementexecuted by an Assignor and an Assignee (and, in the case of an Assignee that isnot then a Lender or an affiliate of a Lender, by Borrower and Agent) togetherwith payment by such Assignee to Agent of a registration and processing fee of$3,500.00, Agent shall (i) promptly accept such Assignment Agreement, and (ii)on the effective date of such Assignment record the information containedtherein in the Register and give notice of such acceptance and recordation tothe Lenders and Borrower. Agent may, from time to time at its election, prepareand deliver to the Lenders and Borrower a revised Schedule 1 reflecting thenames, addresses and respective Proportionate Shares of all Lenders then partieshereto. (f) Confidentiality. Without limitation, Agent and the Lendersmay disclose the Loan Documents, and any financial or other information relatingto Borrower, to each other or to any potential Participant or Assignee;provided, however, that such potential Participant or Assignee shall have agreedin writing to be bound by Section 10.16 hereof prior to such disclosure. -62- 69 SECTION 10.6 SETOFF. In addition to any rights and remedies ofthe Lenders provided by law, each Lender shall have the right, but only with theprior consent of Agent, which consent may be granted or withheld by Agent in itssole and absolute discretion, but without prior notice to Borrower, any suchnotice being expressly waived by Borrower to the extent permitted by applicablelaw, upon the occurrence and during the continuance of a Default or Event ofDefault, to set-off and apply against any indebtedness, whether matured orunmatured, of Borrower to such Lender, any amount owing from such Lender toBorrower, at or at any time after, the happening of any of the above mentionedevents, and as security for such indebtedness, Borrower hereby grants to eachLender a continuing security interest in any and all deposits, accounts ormoneys of Borrower then or thereafter maintained with such Lender, subject ineach case to Section 2.10(b) hereof. The aforesaid right of set-off may beexercised by such Lender against Borrower or against any trustee in bankruptcy,debtor in possession, assignee for the benefit of creditors, receiver orexecution, judgment or attachment creditor of Borrower or against anyone elseclaiming through or against Borrower or such trustee in bankruptcy, debtor inpossession, assignee for the benefit of creditors, receiver, or execution,judgment or attachment creditor, notwithstanding the fact that such right ofset-off shall not have been exercised by such Lender prior to the occurrence ofa Default or Event of Default. Each Lender agrees promptly to notify Borrowerafter any such set-off and application made by such Lender, provided that thefailure to give such notice shall not affect the validity of such set-off andapplication. SECTION 10.7 NO WAIVER; CUMULATIVE REMEDIES. No failure on thepart of Agent or any Lender to exercise, and no delay in exercising, any right,power, privilege or remedy under any Loan Document shall operate as a waiverthereof; nor shall any single or partial exercise of any such right, power,privilege or remedy preclude any other or further exercise thereof or theexercise of any other right, power, privilege or remedy. The rights and remediesunder the Loan Documents are cumulative and not exclusive of any rights, powers,privileges or remedies that may otherwise be available to the Agent or anyLender. SECTION 10.8 ENTIRE AGREEMENT, AMENDMENT. This Agreement and theother Loan Documents constitute the entire agreement among Borrower, Agent andLenders with respect to the Credits and supersede all prior negotiations,communications, discussions and correspondence concerning the subject matterhereof. This Agreement may be amended or modified only in a writing signed byeach party hereto. SECTION 10.9 NO THIRD PARTY BENEFICIARIES. This Agreement is madeand entered into for the sole protection and benefit of the parties hereto andtheir respective permitted successors and assigns, and no other person or entity(other than an Indemnitee) shall be a third party beneficiary of, or have any -63- 70direct or indirect cause of action or claim in connection with, this Agreementor any other of the Loan Documents to which it is not a party. SECTION 10.10 TIME. Time is of the essence of each and everyprovision of this Agreement and each other of the Loan Documents. SECTION 10.11 SEVERABILITY OF PROVISIONS. If any provision ofthis Agreement shall be prohibited by or invalid under applicable law, suchprovision shall be ineffective only to the extent of such prohibition orinvalidity without invalidating the remainder of such provision or any remainingprovisions of this Agreement. SECTION 10.12 GOVERNING LAW. This Agreement shall be governed byand construed in accordance with the laws of the State of California (withoutregard to the conflicts of law rules of such jurisdiction). SECTION 10.13 SUBMISSION TO JURISDICTION. EACH OF BORROWER, AGENTAND LENDERS HEREBY: (A) SUBMITS TO THE EXCLUSIVE JURISDICTION OF THE COURTS OFTHE STATE OF CALIFORNIA AND THE FEDERAL COURTS OF THE UNITED STATES SITTING INTHE STATE OF CALIFORNIA FOR THE PURPOSE OF ANY ACTION OR PROCEEDING ARISING OUTOF OR RELATING TO ANY OF THE LOAN DOCUMENTS; (B) AGREES THAT ALL CLAIMS INRESPECT OF ANY SUCH ACTION OR PROCEEDING MAY BE HEARD AND DETERMINED IN SUCHCOURTS; (C) IRREVOCABLY WAIVES (TO THE FULL EXTENT PERMITTED BY APPLICABLE LAW)ANY OBJECTION WHICH IT NOW OR HEREAFTER MAY HAVE TO THE LAYING OF VENUE OF ANYSUCH ACTION OR PROCEEDING BROUGHT IN ANY OF THE FOREGOING COURTS, AND ANYOBJECTION ON THE GROUND THAT ANY SUCH ACTION OR PROCEEDING IN ANY SUCH COURT HASBEEN BROUGHT IN AN INCONVENIENT FORUM; AND (D) AGREES THAT A FINAL JUDGMENT INANY SUCH ACTION OR PROCEEDING SHALL BE CONCLUSIVE AND MAY BE ENFORCED IN OTHERJURISDICTIONS BY SUIT ON THE JUDGMENT OR IN ANY OTHER MANNER PERMITTED BY LAW. SECTION 10.14 ARBITRATION. (a) Arbitration. Upon the demand of any party, any Dispute shallbe resolved by binding arbitration (except as set forth in (e) below) inaccordance with the terms of this Agreement. A "Dispute" shall mean any action,dispute, claim or controversy of any kind, whether in contract or tort,statutory or common law, legal or equitable, now existing or hereafter arisingunder or in connection with, or in any way pertaining to, this Agreement or anyof the Related Documents, or any past, present or future extensions of creditand other activities, transactions or obligations of any kind -64- 71related directly or indirectly to this Agreement or any of the RelatedDocuments, including without limitation, any of the foregoing arising inconnection with the exercise of any self-help, ancillary or other remediespursuant to this Agreement or any of the Related Documents. Any party may bysummary proceedings bring an action in court to compel arbitration of a Dispute.Any party who fails or refuses to submit to arbitration following a lawfuldemand by any other party shall bear all costs and expenses incurred by suchother party in compelling arbitration of any Dispute. (b) Governing Rules. Arbitration proceedings shall beadministered by the American Arbitration Association ("AAA") or such otheradministrator as the parties shall mutually agree upon in accordance with theAAA Commercial Arbitration Rules. All Disputes submitted to arbitration shall beresolved in accordance with the Federal Arbitration Act (Title 9 of the UnitedStates Code), notwithstanding any conflicting choice of law provision in thisAgreement or any of the Related Documents; provided, however, thatnotwithstanding the foregoing or anything to the contrary herein, it isspecifically contemplated and agreed by Borrower, Agent and Lenders (and anyParticipants and Assignees) that the provisions of Section 1283.05 of theCalifornia Code of Civil Procedure, as presently in force, be incorporated intoand made a part of, and be applicable to, the arbitration agreement set forth inthis Section 10.14. The arbitration shall be conducted at a location inCalifornia selected by the AAA or other administrator. If there is anyinconsistency between the terms hereof and any such rules, the terms andprocedures set forth herein shall control. All statutes of limitation applicableto any Dispute shall apply to any arbitration proceeding. All discoveryactivities shall be expressly limited to matters directly relevant to theDispute being arbitrated. Judgment upon any award rendered in an arbitration maybe entered in any court having jurisdiction; provided however, that nothingcontained herein shall be deemed to be a waiver by any party that is a bank ofthe protections afforded to it under 12 U.S.C. Section 91 or any similarapplicable state law. (c) No Waiver; Provisional Remedies, Self-Help and Foreclosure.No provision hereof shall limit the right of any party to exercise self-helpremedies such as setoff, foreclosure against or sale of any real or personalproperty collateral or security, or to obtain provisional or ancillary remedies,including without limitation injunctive relief, sequestration, attachment,garnishment or the appointment of a receiver, from a court of competentjurisdiction before, after or during the pendency of any arbitration or otherproceeding. The exercise of any such remedy shall not waive the right of anyparty to compel arbitration or reference hereunder. (d) Arbitrator Qualifications and Powers; Awards. Arbitratorsmust be active members of the California State Bar or retired judges of thestate or federal judiciary of California, with expertise in the substantive lawsapplicable to the subject matter of the Dispute. Arbitrators are empowered toresolve Disputes by summary rulings in response to motions filed prior to thefinal arbitration hearing. Arbitrators -65- 72(i) shall resolve all Disputes in accordance with the substantive law of thestate of California, (ii) may grant any remedy or relief that a court of thestate of California could order or grant within the scope hereof and suchancillary relief as is necessary to make effective any award, and (iii) shallhave the power to award recovery of all costs and fees, to impose sanctions andto take such other actions as they deem necessary to the same extent a judgecould pursuant to the Federal Rules of Civil Procedure, the California Rules ofCivil Procedure or other applicable law. Any Dispute in which the amount incontroversy is $5,000,000 or less shall be decided by a single arbitrator whoshall not render an award of greater than $5,000,000 (including damages, costs,fees and expenses). By submission to a single arbitrator, each party expresslywaives any right or claim to recover more than $5,000,000. Any Dispute in whichthe amount in controversy exceeds $5,000,000 shall be decided by majority voteof a panel of three arbitrators; provided however, that all three arbitratorsmust actively participate in all hearings and deliberations. (e) Judicial Review. Notwithstanding anything herein to thecontrary, in any arbitration in which the amount in controversy exceeds$25,000,000 the arbitrators shall be required to make specific, written findingsof fact and conclusions of law. In such arbitrations (A) the arbitrators shallnot have the power to make any award which is not supported by substantialevidence or which is based on legal error, (B) an award shall not be bindingupon the parties unless the findings of fact are supported by substantialevidence and the conclusions of law are not erroneous under the substantive lawof the state of California, and (C) the parties shall have in addition to thegrounds referred to in the Federal Arbitration Act for vacating, modifying orcorrecting an award the right to judicial review of (1) whether the findings offact rendered by the arbitrators are supported by substantial evidence, and (2)whether the conclusions of law are erroneous under the substantive law of thestate of California. Judgment confirming an award in such a proceeding may beentered only if a court determines the award is supported by substantialevidence and not based on legal error under the substantive law of the state ofCalifornia. (f) Real Property Collateral; Judicial Reference. Notwithstandinganything herein to the contrary, no Dispute shall be submitted to arbitration ifthe Dispute concerns indebtedness secured directly or indirectly, in whole or inpart, by any real property unless (i) the holder of the mortgage, lien orsecurity interest specifically elects in writing to proceed with thearbitration, or (ii) all parties to the arbitration waive any rights or benefitsthat might accrue to them by virtue of the single action rule statute ofCalifornia, thereby agreeing that all indebtedness and obligations of theparties, and all mortgages, liens and security interests securing suchindebtedness and obligations, shall remain fully valid and enforceable. If anysuch Dispute is not submitted to arbitration, the Dispute shall be referred to areferee in accordance with California Code of Civil Procedure Section 638 etseq., and this general reference agreement is intended to be specificallyenforceable in accordance -66- 73with said Section 638. A referee with the qualifications required herein forarbitrators shall be selected pursuant to the AAA's selection procedures.Judgment upon the decision rendered by a referee shall be entered in the courtin which such proceeding was commenced in accordance with California Code ofCivil Procedure Sections 644 and 645. (g) Miscellaneous. To the maximum extent practicable, the AAA,the arbitrators and the parties shall take all action required to conclude anyarbitration proceeding within 180 days of the filing of the Dispute with theAAA. No arbitrator or other party to an arbitration proceeding may disclose theexistence, content or results thereof, except for disclosures of information bya party required in the ordinary course of its business, by applicable law orregulation, or to the extent necessary to exercise any judicial review rightsset forth herein. If more than one agreement for arbitration by or between theparties potentially applies to a Dispute, the arbitration provision mostdirectly related to this Agreement or the subject matter of the Dispute shallcontrol. This arbitration provision shall survive termination, amendment orexpiration of this Agreement any of the Related Documents or any relationshipbetween the parties. SECTION 10.15 COUNTERPARTS. This Agreement may be executed in anynumber of identical counterparts, any set of which signed by all the partieshereto shall be deemed to constitute a complete, executed original for allpurposes. SECTION 10.16 CONFIDENTIALITY. No Lender shall disclose to anyPerson any information with respect to Borrower which is furnished pursuant tothis Agreement and the other Loan Documents, except that Agent and Lenders maydisclose any such information (a) to their own directors, officers, employees,auditors, counsel and other professional advisors and to their respectiveaffiliates if Agent and Lenders reasonably determine that any such party shouldhave access to the information; (b) if such information is generally availableto the public; (c) if required in any report, statement or testimony submittedto any governmental authority having jurisdiction over any Lender; (d) ifrequired in response to any summons or subpoena or in connection with anylitigation, to the extent permitted or deemed advisable by counsel (provided,however, that written notice of such disclosure be given to Borrower at leastfive (5) Business Days prior to such event to allow Borrower to seek aprotective order); (e) to comply with any requirement or law applicable toLenders; (f) to the extent necessary in connection with the exercise of anyright or remedy under any Loan Document; (g) to any Participant or Assignee orprospective Participant or Assignee, provided that such Participant or Assigneeor such prospective Participant or Assignee agrees in writing to be bound bythis Section 10.16 prior to disclosure; or (h) otherwise with the prior writtenconsent of Borrower; provided, however, that any -67- 74disclosure made in violation of this Agreement shall not affect the obligationof Borrower under this Agreement or the other Loan Documents. IN WITNESS WHEREOF, the parties hereto have caused this Agreementto be executed as of the day and year first written above."BORROWER" "AGENT"AXT, INC., a Delaware corporation U.S. BANK NATIONAL ASSOCIATIONBy: /s/ [Signature Illegible] By: /s/ [Signature Illegible] ------------------------------- -----------------------------------Title: CFO, Secretary Title: Vice President -68- 75 SCHEDULE 1 LENDERS AND PROPORTIONATE SHARES PROPORTIONATE SHARES: LENDERS: --------------------------------------- Line of Term Term Term Credit Loan A Loan B Loan C---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- 1. U.S. BANK NATIONAL ASSOCIATION 100% 100% 100% 100%Applicable Lending Office:U.S. Bank National Association2890 N. Main StreetWalnut Creek, California 94596Address for Notices:U.S. BankNational Association2890 N. Main StreetWalnut Creek, California 94596Attn:Telephone: ( )Telecopier: ( )Wiring Instructions:U.S. BankNational AssociationWalnut Creek, CaliforniaABA No.:Beneficiary:Account:Customer Name: AXT, Inc.Obligation No.:Mid-Valley RCBO Note No.:-------------------------------------------------------------------------------------------- Schedule 1 -- Page 1 76 SCHEDULE 2.1(d) BORROWER LETTER OF CREDIT AGREEMENT To be attached Schedule 2.1(d) -- Page 1 77 SCHEDULE 2.3(a) AMORTIZATION SCHEDULE FOR THE LETTER OF CREDIT FACILITY ------------------------------------------------------ YEAR MONTHLY ANNUAL PAYMENT REDEMPTION AMOUNT ------------------------------------------------------ 2000 $55,833.33 $670,000.00 2001 $55,416.67 $665,000.00 2002 $55,833.33 $670,000.00 2003 $55,833.33 $670,000.00 2004 $37,916.67 $455,000.00 2005 $34,583.33 $415,000.00 2006 $34,166.67 $410,000.00 2007 $34,583.33 $415,000.00 2008 $40,416.67 $485,000.00 ------------------------------------------------------ Schedule 2.3(a) -- Page 1 78 SCHEDULE 2.13(b) PREPAYMENT INDEMNITYAs used herein, the following terms have the meanings assigned to them:"AVERAGE MATURITY PERIOD" means, as of any prepayment date, the weighted averagetime period computed by multiplying the dollar amount of each installment orpayment of principal prepaid by the number of days from such prepayment dateuntil the earlier of the scheduled maturity of that installment or payment orthe next Interest Change Date (if any), adding together the resulting productsand dividing the resulting sum by the total dollar amount of principal beingprepaid."INTEREST CHANGE DATE" means the date of any regularly scheduled adjustment inthe interest rate on the Note, if any."INTEREST DIFFERENTIAL" means as of any prepayment date, (i) the Note Rate minus(ii) the Treasury Rate."NOTE RATE" means the per annum rate of interest payable on the Credit bearinginterest at the Treasury Rate as in effect on the date of prepayment.Any voluntary prepayment of a Credit which bears interest at the Treasury Rateshall be either in the full amount of the outstanding Credit bearing interest atthe Treasury Rate or, if a partial prepayment, in the amount of [$100,000] or anintegral multiple thereof, and partial prepayments shall be applied toinstallments or payments due of the Credit bearing interest at the Treasury Ratein inverse order of their maturities. If, at the time of any prepayment (whethervoluntary, mandatory or upon acceleration of the principal of the Credit bearinginterest at the Treasury Rate), the Interest Differential shall exceed zero,such prepayment shall be accompanied, to the extent permitted by applicable law,by payment of a prepayment indemnity. The amount of the prepayment indemnityshall equal the present value (determined by the Bank using the Treasury Rate asof the date of prepayment minus the Issuance Spread as the discount factor) onthe prepayment date of a stream of equal monthly payments in number equal to thenumber of whole months (using a thirty-day month) in the Average MaturityPeriod. The amount of each such monthly payment shall equal the quotientobtained by dividing (a) the product of the amount prepaid, times the InterestDifferential, times a fraction, the numerator of which is the number of days inthe Average Maturity period and the denominator of which is 360, by (b) thenumber of whole months (using a thirty-day month) in the Average MaturityPeriod. Schedule 2.13(b) -- Page 1 79 SCHEDULE 4 Borrower Disclosure Schedule to Credit Agreement By and Among AXT, Inc., U.S. Bank National Association, and the Lenders from time to time who are parties to the Credit AgreementThis Borrower Disclosure Schedule (the "Schedule") contains exceptions to theRepresentations and Warranties of AXT, Inc., a Delaware corporation (the"Borrower") set forth in Article 4 of that certain Credit Agreement dated as ofAugust 28, 2000 (the "Credit Agreement"), by and among the Borrower, U.S. BankNational Association (the "Agent") and the lenders from time to time which areparties thereto (the "Lenders") and are an integral part of the CreditAgreement. Any capitalized term that is used in this Schedule and is not definedherein shall have the meaning ascribed to such term in the Credit Agreement. Thesection numbers of each exception noted in this Schedule correspond to thesection numbers appearing in the Credit Agreement. All information disclosedherein as an exception to any section shall be deemed disclosed under andincorporated into any other section of the Credit Agreement to which it iscross-referenced. Notwithstanding any materiality qualification in anyRepresentation and Warranty in the Credit Agreement, for administrative ease,certain items have been included herein which are not considered by the Borrowerto be material to the business, assets, results of operations, prospects oraffairs of the Borrower, taken as a whole. The inclusion of any item hereinshall not be deemed to be an admission by the Borrower that such item ismaterial to the business, assets, results of operations, prospects or affairs ofthe Borrower, taken as a whole, nor shall it be deemed an admission of anyobligation or liability to any third party.SECTION 4.1 - LEGAL STATUSLyte Optronics, Inc., a Guarantor, is a Nevada corporation, is qualified to dobusiness in California and is in good standing in the state of California. Thefollowing wholly-owned subsidiaries which are Guarantors under the CreditAgreement are not qualified to do business in California or in any otherjurisdiction in the United States: Advanced Semiconductor (Xiamen); AmericanXtal Technology (Hong Kong); AXT - Japan; Beijing Tongmei Xtal Technology Co.,Ltd.; Bestal Substrate Foreign Sales Corp; and Lyte Optronics Ltd. (UK).American Xtal Technology (Hong Kong) and Lyte Schedule 4 -- Page 1 80Optronics Ltd. (UK) are in the process of winding down their respective businessoperations.SECTION 4.5 - LITIGATIONThe Borrower is cooperating with Cal-OSHA in an investigation regardingimpermissible levels of potentially hazardous materials in certain areas of theBorrower's manufacturing facility in Fremont, California. In May, 2000, Cal-OSHAlevied a fine against the Borrower in the amount of $313,655 for alleged healthand safety violations. Although the Borrower is appealing the citations, andhave put in place engineering, administrative and personnel protective equipmentprograms to address the issues, the Borrower may have to pay the fine andfurther penalties, including criminal penalties, could be levied against theBorrower or its management.The Borrower entered into a settlement of a patent infringement lawsuit inapproximately June, 2000. As a result of this settlement, the Borrower will makea payment in the approximate amount of $1,340,000 in early 2001.SECTION 4.6 - CORRECTNESS OF FINANCIAL STATEMENTThe Borrower filed an amended Form 10-Q for each of the quarters ended June 30,1999 and September 30, 1999, however, the amendment reflected financial datathat was reported in the Borrowers Form 10-K filed with respect to the yearended December 31, 1999.As of June 30, 2000, the Borrower carried an intercompany receivable in theapproximate amount of $25,109,450 owed by Lyte Optronics, Inc.As of June 30, 2000, the Borrower carried an intercompany receivable in theapproximate amount of $269,076 owed by Beijing Tongmei Xtal Technology Co., Ltd.SECTION 4.14 - ENVIRONMENTAL MATTERSThe disclosures set forth in Section 4.5 above are incorporated into thisSection by this reference. Schedule 4 -- Page 2 81SECTION 4.15 - REAL PROPERTY COLLATERALThere are several tax liens appearing on the title reports relating to theMonterey Park Property and the El Monte Property (the "Properties"), however,the Borrower believes that these taxes have been paid that that the liens appearagainst the Properties in error. In addition, these title reports reflect a deedof trust under which Pacific Mezzanine Fund, L.P., a California limitedpartnership ("PMF") is the beneficiary. The obligations owed to PMF have beensatisfied and the Borrower believes that these liens appear against theProperties in error.SECTION 4.16 - SUBSIDIARIESThe following entities are wholly-owned subsidiaries of the Borrower:Advanced Semiconductor (Xiamen)American Xtal Technology (Hong Kong)AXT - JapanBeijing Tongmei Xtal Technology Co., Ltd.Bestal Substrate Foreign Sales Corp.Lyte Optronics, Inc.Lyte Optronics Ltd. (UK)The Borrower holds an equity interest in the following entities:Ge MiningGa Mining - Beijing JIYA SemiconductorIn August 2000, the Borrower entered into a business transfer and acquisitionagreement with Demeter Technology, a Delaware corporation founded by Theodore S.Young, the president of the Borrower's fiber optic division and a former memberof the Borrower's board of directors, and Robert Shih, the chief technologyofficer of the Borrower's visible emitter division. Under this agreement, theBorrower agreed to transfer certain non-core rights to Demeter relating to itsresearch and development activities relating to products and services in thefield of fiber optics. The Borrower leased to Demeter a portion of its ownedfacility in El Monte, California, subleased a portion of its rented facility inEl Monte, California, leased certain equipment, including an MOCVD machine andsold certain inventory relating to fiber optics. In exchange, Demeter hasgranted to Borrower a warrant to purchase up to 4.5 million shares of its SeriesA convertible preferred stock at a price of $0.5714 per share.The Borrower has also provided certain wafer inventory to Intelligent Epitaxy("Intelligent"), located in Texas. In exchange, Intelligent has granted Borrower Schedule 4 - Page 3 82warrants to purchase shares of its capital stock with a value up toapproximately $100,000. Schedule 4 -- Page 4 83 SCHEDULE 5 CONTRACT COLLATERAL DESCRIPTION- Standard Industrial/Commercial Multi-Tenant Lease, dated as of July, 2000, by and between American Xtal Technology, Inc., now known as AXT, Inc., and Demeter Technologies, Inc.- Standard Office Lease - Net, dated as of December 23, 1996, by and between Alpha Photonics, Inc. and ABC Management Company (Alpha Photonics is a division of Lyte Optronics, Inc.)- Standard Industrial/Commercial Multi-Tenant Lease - Gross, dated as of January 31, 1998, by and between Lyte Optronics, Inc. and John and Pam Smart Family Trust; Addendum to Standard Industrial/Commercial Multi-Tenant Lease - Gross, dated as of March, 1998, by and between Lyte Optronics, Inc. and John and Pam Smart Family Trust- Standard Industrial/Commercial Multi-Tenant Lease - Net, dated as of April 20, 2000, by and between American Xtal Technology, Inc., now known as AXT, Inc., and Chois Company and Addendum thereto of even date- Standard Industrial/Commercial Multi-Tenant Lease - Net, dated as of April 11, 2000, by and between American Xtal Technology, Inc., now known as AXT, Inc., and Kim Pacific Trading Corp., Inc.- Purchase Requisition by Alpha Photonics (a division of Lyte Optronics, Inc.) and Standard Form of Agreement Between Owner and Contractor dated March 21, 2000- Purchase Requisition by Alpha Photonics (a division of Lyte Optronics, Inc.), dated May 18, 2000, regarding services to be provided by Allied Pacific Builders- Purchase Requisition by Alpha Photonics (a division of Lyte Optronics, Inc.), dated March 28, 2000, regarding services to be provided by J.B. Ford Plumbing, Inc.- Purchase Requisition by Alpha Photonics (a division of Lyte Optronics, Inc.), dated May 18, 2000, regarding services to be provided by J.B. Ford Plumbing, Inc.- Purchase Requisition by Alpha Photonics (a division of Lyte Optronics, Inc.), dated April 28, 2000, regarding services to be provided by Harding Lawson Associates Schedule 5 -- Page 1 84- Purchase Requisition by Alpha Photonics (a division of Lyte Optronics, Inc.), dated December 14, 1999, regarding services to be provided by Facilities Support Services- Purchase Requisition by Alpha Photonics (a division of Lyte Optronics, Inc.), dated March 28, 2000, regarding services to be provided by K&S Air Conditioning, Inc.- Purchase Requisition by Alpha Photonics (a division of Lyte Optronics, Inc.), dated May 18, 2000, regarding services to be provided by K&S Air Conditioning, Inc. Schedule 5 -- Page 2 85 SCHEDULE 7.4 EXISTING INDEBTEDNESS [See Schedule 7.7] Schedule 7.4 -- Page 1 86 SCHEDULE 7.5 EXISTING GUARANTIES Schedule 7.5 -- Page 1 87 SCHEDULE 7.7 EXISTING LOANS; ADVANCES; INVESTMENTSEXISTING INDEBTEDNESSThe Borrower's existing indebtedness is as follows:- That indebtedness set forth in the Borrower's consolidated financial statements dated June 30, 2000, a copy of which has been delivered to Lender.- As of June 30, 2000, the Borrower carried an intercompany receivable in the approximate amount of $25,109,450 owed by Lyte Optronics, Inc.- As of June 30, 2000, the Borrower carried an intercompany receivable in the approximate amount of $269,076 owed by Beijing Tongmei Xtal Technology Co., Ltd.- Indebtedness secured by the existing liens set forth belowEXISTING INVESTMENTSThe following entities are wholly-owned subsidiaries of the Borrower:Advanced Semiconductor (Xiamen)American Xtal Technology (Hong Kong)AXT - JapanBeijing Tongmei Xtal Technology Co., Ltd.Bestal Substrate Foreign Sales Corp.Lyte Optronics, Inc.Lyte Optronics Ltd. (UK)The Borrower holds an equity interest in the following entities:Ge MiningGa Mining - Beijing JIYA SemiconductorIn August 2000, the Borrower entered into a business transfer and acquisitionagreement with Demeter Technology, a Delaware corporation founded by Theodore S.Young, the president of the Borrower's fiber optic division and a former memberof the Borrower's board of directors, and Robert Shih, the chief technologyofficer of the Borrower's visible emitter division. Under this agreement, theBorrower agreed to  Schedule 7.7 -- Page 1 88transfer certain non-core rights to Demeter relating to its research anddevelopment activities relating to products and services in the field of fiberoptics. The Borrower leased to Demeter a portion of its owned facility in ElMonte, California, subleased a portion of its rented facility in El Monte,California, leased certain equipment, including an MOCVD machine and soldcertain inventory relating to fiber optics. In exchange, Demeter has granted toBorrower a warrant to purchase up to 4.5 million shares of its Series Aconvertible preferred stock at a price of $0.5714 per share.The Borrower has also provided certain wafer inventory to Intelligent Epitaxy("Intelligent"), located in Texas. In exchange, Intelligent has granted Borrowerwarrants to purchase shares of its capital stock with a value up toapproximately $100,000.EXISTING LIENS- Bay Area Bank - Financing Statement No. 9602560572 filed on January 24, 1996 evidencing a security interest in all equipment and other property now or hereafter covered by that certain Equipment Financing Agreement (#95092922) between Bay Area Bank and Borrower, including all accessions and additions thereto, modifications thereof and replacements and substitutions therefor and replacements and substitutions therefor, in whole or in part, including items of the following type: Wafer Manufacturing Equipment.- Saratoga National Bank - Financing Statement No. 9602560578 filed on January 24, 1996 evidencing a security interest in all equipment and other property now or hereafter covered by that certain Equipment Financing Agreement (#95092923) between Saratoga National Bank and Borrower, including all accessions and additions thereto, modifications thereof and replacements and substitutions therefor and replacements and substitutions therefor, in whole or in part, including items of the following type: Wafer Manufacturing Equipment.- ValliWide Bank - Financing Statement No. 9607860728 filed on March 14, 1996 evidencing a security interest in all equipment and other property now or hereafter covered by that certain Equipment Financing Agreement (#95092924) between ValliWide Bank and Borrower, including all accessions and additions thereto, modifications thereof and replacements and substitutions therefor, in whole or in part, including items of the following type: Wafer Manufacturing Equipment- Comerica Bank, Successor by Merger to University Bank - Financing Statement No. 9607860778 filed on March 14, 1996 evidencing a security interest in all equipment and other property now or hereafter covered by that certain Equipment Financing Agreement (#95092921) between University Bank and Borrower, including all accessions and additions thereto, modifications thereof and Schedule 7.7 -- Page 2 89 replacements and substitutions therefor, in whole or in part, including items of the following type: Wafer Manufacturing Equipment- U.S. Small Business Administration, assignee of Bay Area Employment Development Company - Financing Statement No. 9612360295 filed on May 1, 1996 evidencing a security interest in specific machinery and equipment purchased with the proceeds of the loan and all accessions, additions, replacements and substitutions, all records of any kind relating to any of the foregoing and all proceeds of such machinery and equipment including insurance, general intangible and accounts proceeds.- Exchange Bank - Financing Statement No. 9714060100 filed on May 15, 1997 evidencing a security interest in all equipment and other property now or hereafter covered by that certain Equipment Financing Agreement (#95092921) between Exchange Bank and Borrower, including all accessions and additions thereto, modifications thereof and replacements and substitutions therefor, in whole or in part, including items of the following type: production test, office and computer equipment- ValliWide Bank - Financing Statement No. 9716161297 filed on June 6, 1997 evidencing a security interest in all equipment and other property now or hereafter covered by that certain Equipment Financing Agreement (#95092922) between ValliWide Bank and Borrower, including all accessions and additions thereto, modifications thereof and replacements and substitutions therefor, in whole or in part, including items of the following type: production test, office and computer equipment.- General Electric Capital Corporation - Financing Statement No. 9800260574 filed on December 30, 1997 evidencing a security interest in specific equipment set forth on Collateral Schedule No. 01 to that certain Master Security Agreement dated as of December 11, 1997 between Borrower and General Electric Capital Corporation- General Electric Capital Corporation - Financing Statement No. 9817660252 filed on June 24, 1998 evidencing a security interest in specific equipment set forth on Collateral Schedule No. 02 to that certain Master Security Agreement dated as of December 11, 1997 between Borrower and General Electric Capital Corporation- NationsBanc Leasing Corporation - Financing Statement No. 9901360408 filed on January 8, 1999 evidencing a security interest in specific equipment Schedule 7.7 -- Page 3 90- NationsBanc Leasing Corporation - Financing Statement No. 9919660999 filed on July 9, 1999 evidencing a security interest in specific equipment- Banc One Leasing Corporation, assignee of Third Street Services, Inc. - Financing Statement No. 9934860649 filed on December 2, 1999 evidencing a security interest in specific equipment- LaSalle National Leasing Corporation, assignee of Third Street Services, Inc. - Financing Statement No. 0002860375 filed on January 27, 2000 evidencing a security interest in specific equipment- Banc One Leasing Corporation, assignee of Third Street Services, Inc. - Financing Statement No. 0004660124 filed on February 10, 2000 evidencing a security interest in specific equipment- Banc One Leasing Corporation, assignee of Third Street Services, Inc. - Financing Statement No. 0004660325 filed on February 10, 2000 evidencing a security interest in specific equipment- Banc One Leasing Corporation, assignee of Third Street Services, Inc. - Financing Statement No. 0005361100 filed on February 17, 2000 evidencing a security interest in specific equipment- Safeco Credit Company, Inc., assignee of Third Street Services, Inc. - Financing Statement No. 0008160175 filed on March 15, 2000 evidencing a security interest in specific equipmentThe following Financing Statements have been filed by U.S. Bank NationalAssociation:- Financing Statement No. 9529260048 filed on October 16, 1995 (assigned from Commercial Bank of Fremont)- Financing Statement No. 9715760787 filed on June 3, 1997 - Financing Statement No. 9715760218 filed on June 4, 1997- Financing Statement No. 9833760671 filed on December 3, 1998- Financing Statement No. 0018860892 filed on June 29, 2000 Schedule 7.7 -- Page 4 91 SCHEDULE 7.8 EXISTING LIENS; PLEDGES OF ASSETS [See Schedule 7.7] Schedule 7.8 -- Page 1 92 EXHIBIT A LETTER OF CREDIT To be attached Exhibit A -- Page 1 93 EXHIBIT B FORM OF LINE OF CREDIT NOTE$20,000,000.00 _______________, 2000 FOR VALUE RECEIVED, the undersigned, AXT, INC., a Delawarecorporation ("Borrower"), hereby promises to pay to the order of U.S. BANKNATIONAL ASSOCIATION ("Lender") on the Line Maturity Date the principal sum ofTwenty Million Dollars ($20,000,000.00), or such lesser amount as shall equalthe aggregate outstanding principal balance of all advances hereunder made byLender to Borrower pursuant to the Credit Agreement referred to below. This promissory note is one of the Line of Credit Notes referredto in, and is subject to the terms of, that certain Credit Agreement amongBorrower, Lender and the other financial institutions from time to time partiesthereto (collectively, the "Lenders"), and U.S. Bank National Association, asagent for the Lenders (in such capacity, "Agent"), dated as of ________, 2000(as amended, modified or supplemented from time to time, the "CreditAgreement"). Capitalized terms used herein and not defined shall have therespective meanings assigned to them in the Credit Agreement. Borrower further promises to pay interest on the outstandingprincipal balance hereof at the interest rates, and payable on the dates, setforth in the Credit Agreement. All payments of principal and interest hereundershall be made to Agent at Agent's Office, for the account of Lender, in lawfulmoney of the United States and in same day or immediately available funds. Lender is authorized but not required to record the date andamount of each advance made hereunder, each conversion to a different interestrate and the length of each Fixed Rate Term, the date and amount of each paymentof principal and interest hereunder, and the resulting unpaid principal balancehereof, in Lender's internal records, and any such recordation shall be primafacie evidence of the accuracy of the information so recorded so long asBorrower is provided with a record thereof for review; provided however, thatLender's failure to so record shall not limit or otherwise affect theobligations of Borrower hereunder and under the Credit Agreement to repay theprincipal hereof and interest hereon. The Credit Agreement provides, among other things, foracceleration (which in certain cases shall be automatic) of the maturity hereofupon the occurrence of certain stated events, in each case without presentment,demand, protest or further notice of any kind, all of which are hereby expresslywaived by Borrower. Exhibit B -- Page 1 94 This promissory note is secured by certain collateral morespecifically described in the Credit Agreement and the other Loan Documents.Borrower may prepay this promissory note in whole or in part in accordance withthe terms of the Credit Agreement. This promissory note shall be governed by and construed inaccordance with the laws of the State of California. AXT, INC., a Delaware corporation By: -------------------------------- -------------------------------- [Printed Name and Title] Exhibit B -- Page 2 95 EXHIBIT C FORM OF TERM NOTE$______________ ________________, 2000 FOR VALUE RECEIVED, the undersigned, AXT, INC., a Delawarecorporation ("Borrower"), hereby promises to pay to the order of U.S. BANKNATIONAL ASSOCIATION ("Lender"), the principal sum of _______________ Dollars($_________), or such lesser amount as may be advanced hereunder, on the datesand in the amounts set forth in that certain Credit Agreement among Borrower,Lender and the other financial institutions from time to time parties thereto(collectively, the "Lenders"), and U.S. Bank National Association, as agent forthe Lenders (in such capacity, "Agent"), dated as of _______, 2000 (as amended,modified or supplemented from time to time, the "Credit Agreement"), with afinal installment consisting of all remaining unpaid principal due and payablein full on May 31, 2003. This promissory note is one of the Term Notes referred to in, andis subject to the terms of, the Credit Agreement. Capitalized terms used hereinand not defined shall have the respective meanings assigned to them in theCredit Agreement. Borrower further promises to pay interest on the outstandingprincipal balance hereof at the interest rates, and payable on the dates, setforth in the Credit Agreement. All payments of principal and interest hereundershall be made to Agent at Agent's Office, for the account of Lender, in lawfulmoney of the United States and in same day or immediately available funds. Lender is authorized but not required to record the date andamount of each advance made hereunder, each conversion to a different interestrate and the length of each Fixed Rate Term, the date and amount of each paymentof principal and interest hereunder, and the resulting unpaid principal balancehereof, in Lender's internal records, and any such recordation shall be primafacie evidence of the accuracy of the information so recorded so long asBorrower is provided that with a record thereof for review; provided however,that Lender's failure to so record shall not limit or otherwise affect theobligations of Borrower hereunder and under the Credit Agreement to repay theprincipal hereof and interest hereon. The Credit Agreement provides, among other things, foracceleration (which in certain cases shall be automatic) of the maturity hereofupon the occurrence of certain stated events, in each case without presentment,demand, protest or further notice of any kind, all of which are hereby expresslywaived by Borrower. Exhibit C -- Page 1 96 This promissory note is secured by certain collateral morespecifically described in the Credit Agreement and the other Loan Documents.Borrower may prepay this promissory note in whole or in part in accordance withthe terms of the Credit Agreement. This promissory note shall be governed by and construed inaccordance with the laws of the State of California. AXT, INC., a Delaware corporation By: -------------------------------- -------------------------------- [Printed Name and Title] Exhibit C -- Page 2 97 EXHIBIT D NOTICE OF BORROWINGU.S. Bank National Association2890 N. Main StreetWalnut Creek, CA 94596Attention: ______________________ Reference is made to that certain Credit Agreement dated as of_________________, 2000 (as amended, modified or supplemented from time to time,the "Credit Agreement") among AXT, Inc., a Delaware corporation ("Borrower"),the financial institutions from time to time parties thereto (collectively, the"Lenders"), and U.S. Bank National Association, as agent for the Lenders (insuch capacity, "Agent"). Capitalized terms used herein shall have the respectivemeanings assigned to them in the Credit Agreement. 1. Pursuant to Section 2.4 of the Credit Agreement, Borrowerhereby requests an advance under the [Line of Credit] [Term Loan A] [Term LoanB] [Term Loan C] upon the following terms: (a) The principal amount of the requested advance is$___________. (b) The date of the requested advance is to be _____________. (c) The aggregate amount of said advance for which a Reference Rate interest selection is made is $_____________. (d) The aggregate amount of said advance for which a LIBOR Rate interest selection is made, and each requested Fixed Rate Term, are: Amount Fixed Rate Term $____________ _____ months $____________ _____ months (e) The aggregate amount of said advance for which a Treasury Rate interest selection is made is $_____________. 2. Borrower hereby certifies to Agent and the Lenders that, on the date of this Notice of Borrowing and after giving effect to the requestedadvance (including the use of the proceeds thereof): Exhibit D -- Page 1 98 (a) the representations and warranties set forth in theCredit Agreement are true and correct as if made on such date; (b) no Default has occurred and is continuing; and (c) each of the Loan Documents remains in full force and effect. The party signing below on behalf of Borrower is an AuthorizedRepresentative of Borrower and has caused this Notice of Borrowing to be dulyexecuted on behalf of Borrower as of __________________.AXT, INC., a Delaware corporationBy: ________________________________ ________________________________ [Printed Name and Title] Exhibit D -- Page 2 99 EXHIBIT E NOTICE OF CONVERSION OR CONTINUATIONU.S. Bank National Bank Association2890 N. Main StreetWalnut Creek, CA 94596Attention: ______________________ Reference is made to that certain Credit Agreement dated as of________________, 2000 (as amended, modified or supplemented from time to time,the "Credit Agreement") among AXT, Inc., a Delaware corporation ("Borrower"),the financial institutions from time to time parties thereto (collectively, the"Lenders"), and U.S. Bank National Association, as agent for the Lenders (insuch capacity, "Agent"). Capitalized terms used herein shall have the respectivemeanings assigned to them in the Credit Agreement. 1. Pursuant to Section 2.6 of the Credit Agreement, Borrowerhereby requests [the continuation of all or part of its outstanding LIBORborrowings with Fixed Rate Terms ending on ___________] [the conversion of allor part of its outstanding Reference Rate borrowings], as follows: (a) The Credit to which this Notice applies is the [Line ofCredit] [Term Loan A] [Term Loan B] [Term Loan C]. (b) The effective date of continuation and/or conversion isto be _______________. (c) The aggregate amount of [said outstanding LIBORborrowings to be continued as] [said outstanding Reference Rate borrowings to beconverted to] LIBOR borrowings, and each requested Fixed Rate Term, are: Amount Fixed Rate Term $_____________ _____ months $_____________ _____ months (d) The aggregate amount of said outstanding LIBORborrowings to be continued as Reference Rate borrowings is $_______________. Exhibit E -- Page 1 100 3. Borrower hereby certifies to Agent and the Lenders that, onthe date of this Notice of Conversion or Continuation, no Default has occurredand is continuing. The party signing below on behalf of Borrower is an AuthorizedRepresentative of Borrower and has caused this Notice of Conversion orContinuation to be duly executed on behalf of Borrower as of __________________.AXT, INC., a Delaware corporationBy: ________________________________ ________________________________ [Printed Name and Title] Exhibit E -- Page 2 101 EXHIBIT F NOTICE OF AUTHORIZED REPRESENTATIVESU.S. Bank National Association2890 N. Main StreetWalnut Creek, California 94596Attention: _________________ Reference is made to that certain Credit Agreement dated as of_______________________, 2000 (as amended, modified or supplemented from time totime, the "Credit Agreement") among AXT, Inc., a Delaware corporation("Borrower"), the financial institutions from time to time parties thereto(collectively, the "Lenders"), and U.S. Bank National Association, as agent forthe Lenders (in such capacity, "Agent"). Borrower hereby represents to Agent andLenders that the following named officers and employees are the AuthorizedRepresentatives of Borrower, as defined in the Credit Agreement, and that thesignatures opposite their names are their true signatures: Name Signature------------------------------ --------------------------------------------------------------- --------------------------------------------------------------- --------------------------------- Borrower further represents to Agent and Lenders that Agent isauthorized to rely on this Notice of Authorized Representatives until such time,if any, as Borrower has delivered to Agent, and Agent has received, a dulyexecuted Notice of Authorized Representatives in substitution hereof. ThisNotice of Authorized Representatives cancels and supersedes any Notice ofAuthorized Representatives at any time prior to the date hereof delivered byBorrower to Agent. Exhibit F -- Page 1 102 IN WITNESS WHEREOF, Borrower hereby confirms that it has causedthis Notice of Authorized Representatives to be duly executed as of______________, 2000.AXT, INC., a Delaware corporationBy: ________________________________ ________________________________ [Printed Name and Title] Exhibit F -- Page 2 103 EXHIBIT G ASSIGNMENT AND ASSUMPTION AGREEMENT THIS ASSIGNMENT AND ASSUMPTION AGREEMENT (this "Agreement") isentered into as of _____________, between _________________________________________ ("Assignor") and ________________________ ("Assignee"). WHEREAS, Assignor is a Lender under that certain Credit Agreementdated as of __________, 2000 (as amended, modified, supplemented or restatedfrom time to time, the "Credit Agreement") among AXT, Inc., a Californiacorporation ("Borrower"), the Lenders from time to time parties thereto, andU.S. Bank National Association, as Agent. Capitalized terms used but not definedin this Agreement shall have the meanings set forth in the Credit Agreement. TheCredit Agreement and all other agreements, documents and instruments referred totherein or delivered pursuant thereto are collectively called the "LoanDocuments". WHEREAS, it is the intention of Assignor and Assignee that (a)Assignor assign to Assignee a portion of Assignor's rights and obligations underthe Credit Agreement, (b) Assignee assume all such obligations of Assignor, and(c) Assignor be released from such assigned obligations. NOW, THEREFORE, in consideration of the mutual agreements hereincontained, the parties hereto agree as follows: 1. Assignment. Effective on the Assignment Effective Date (asdefined in Section 3 hereof), Assignor, without recourse and withoutrepresentation or warranty (except as expressly provided in Section 6 hereof),hereby assigns to Assignee the Assigned Rights and Obligations (as definedbelow). 2. The "Assigned Rights and Obligations" means: (a) [a$__________ portion] [_________%] of Assignor's $__________ Proportionate Shareof [the Line of Credit] [Term Loan A] [Term Loan B] [Term Loan C] TotalCommitment on the Assignment Effective Date; (b) the portion of [the Line ofCredit] [Term Loan A] [Term Loan B] [Term Loan C] outstanding on the AssignmentEffective Date that is attributable to the above portion of Assignor'sProportionate Share of [the Line of Credit] [Term Loan A] [Term Loan B] [TermLoan C] Total Commitment; and (c) all of Assignor's other rights and obligationsunder the Credit Agreement that are attributable to the above portion ofAssignor's Proportionate Share. Exhibit G -- Page 1 104 3. Assumption. Effective on the Assignment Effective Date,Assignee hereby accepts the foregoing assignment of, and hereby assumes fromAssignor all of, the Assigned Rights and Obligations. 4. Effectiveness. This Agreement shall become effective on suchdate as shall be selected by Assignor (the "Assignment Effective Date"), whichdate shall be on or as soon as practicable after the execution and delivery ofcounterparts of this Agreement by Assignor, Assignee, Agent and Borrower.Assignor shall promptly notify Assignee, Agent and Borrower in writing of theAssignment Effective Date. 5. Payments on Assignment Effective Date. In consideration of theassignment by Assignor to, and the assumption by Assignee of, the AssignedRights and Obligations, on the Assignment Effective Date: (a) Assignee shall payto Assignor the principal amount of [the Line of Credit] [Term Loan A] [TermLoan B] [Term Loan C] made by Assignor pursuant to the Credit Agreement that areattributable to the Assigned Rights and Obligations and outstanding on theAssignment Effective Date; [and] (b) each of Assignor and Assignee shall pay tothe other such amounts (if any) as are specified in any written agreement orexchange of letters between them[; and (c) Assignee shall pay to Agent anassignment processing and recordation fee of $________]. 6. Allocation and Payment of Interest and Fees. (a) Agent shall pay to Assignee all interest, commitment feesand other amounts not constituting principal that are paid by or on behalf ofBorrower pursuant to the Loan Documents and are attributable to the AssignedRights and Obligations ("Borrower Amounts") which accrue on and after theAssignment Effective Date. If Assignor receives or collects any such BorrowerAmounts, Assignor shall promptly pay them to Assignee. (b) Agent shall pay to Assignor all Borrower Amounts thataccrue before the Assignment Effective Date. If Assignee receives or collectsany such Borrower Amounts, Assignee shall promptly pay them to Assignor. 7. Representations and Warranties. (a) Each of Assignor and Assignee represents and warrants tothe other party as follows: (i) Such party has full power and authority, and has takenall action necessary, to execute and deliver this Agreement and to fulfill itsobligations under, and to consummate the transactions contemplated by, thisAgreement. Exhibit G -- Page 2 105 (ii) The making and performance of this Agreement and alldocuments required to be executed and delivered by such party pursuant hereto donot and will not violate any law or regulation applicable to such party. (iii) This Agreement has been duly executed and deliveredby, and constitutes a legal, valid and binding obligation of, such party,enforceable in accordance with its terms. (iv) All approvals, authorizations or other actions by, orfilings with, any governmental authority necessary for the validity orenforceability of such party's obligations under this Agreement have been madeor obtained. (b) Assignor represents and warrants to Assignee that Assignorowns the Assigned Rights and Obligations, free and clear of all liens or otherencumbrances. (c) Assignee represents and warrants to Assignor as follows: (i) Assignee has made and shall continue to make its ownindependent investigation of the financial condition, affairs andcreditworthiness of Borrower and any other person or entity obligated under theLoan Documents (collectively, the "Credit Parties"), and the value of anycollateral now or hereafter securing any of the obligations, indebtedness,liabilities or undertakings under the Loan Documents (the "Collateral"), inconnection with Assignee's assumption of the Assigned Rights and Obligations. (ii) Assignee has received a copy of the Loan Documentsand such other documents, financial statements and information as Assignee deemsappropriate to make its own credit analysis and decision to enter into thisAgreement. 8. No Assignor Responsibility. Assignor makes no representationor warranty and assumes no responsibility to Assignee for: (a) the execution by any party other than Assignor,effectiveness, genuineness, validity, enforceability, collectibility orsufficiency of the Loan Documents, or for any representations, warranties,recitals or statements made in the Loan Documents or in any financial or otherwritten or oral statement, instrument, report, certificate or any other documentmade or furnished or made available by Assignor to Assignee or by or on behalfof any Credit Party to Assignor or Assignee in connection with the LoanDocuments and the transactions contemplated thereby; (b) the performance or observance of any of the terms,conditions, provisions, covenants or agreements contained in any of the Loan Exhibit G -- Page 3 106Documents or the existence or possible existence of any default or event ofdefault under the Loan Documents; or (c) the accuracy or completeness of any information providedto Assignee, whether by Assignor or by or on behalf of any Credit Party. Assignor shall have no initial or continuing duty orresponsibility to make any investigation of the financial condition, affairs orcreditworthiness of any of the Credit Parties, or the value of any Collateral,in connection with the assignment of the Assigned Rights and Obligationshereunder, or to provide Assignee with any credit or other information withrespect thereto, whether coming into Assignor's possession before the datehereof or at any time or times thereafter. 9. Assignee Bound By Credit Agreement. Effective on theAssignment Effective Date, Assignee: (a) shall be deemed to be a party to theCredit Agreement; (b) agrees to be bound by the Credit Agreement as it wouldhave been if it had been an original Lender party thereto; and (c) agrees toperform in accordance with their respective terms all obligations which arerequired under the Loan Documents to be performed by it as a Lender. Assigneeappoints and authorizes Agent to take such actions as agent on Assignee's behalfand to exercise such powers under the Loan Documents as are delegated to Agentby the terms thereof, together with such powers as are reasonably incidentalthereto. 10. Assignor Released From Credit Agreement. Effective on theAssignment Effective Date, Assignor shall be released from the Assigned Rightsand Obligations; provided, however, that Assignor shall retain all of its rightsto indemnification under Sections 2.14 and 10.3 of the Credit Agreement and theother Loan Documents for any events, acts or omissions occurring before theAssignment Effective Date. 11. Foreign Withholding.(*) (a) Assignee represents and warrants to Agent, Borrower andAssignor that, under applicable law and treaties, Assignee is entitled toreceive all payments under the Credit Agreement, the Loan Documents and thisAgreement payable to it as provided herein, without deduction or withholding ofany taxes imposed by the United States or any political subdivision thereof. (b) On or before the Assignment Effective Date, Assigneeshall deliver to each of Borrower and Agent two executed copies of valid andproperly completed: (i) United States Internal Revenue Service Form 1001 or 4224certifying--------* Include Section 11 only if Assignee is a foreign institution. Exhibit G -- Page 4 107that Assignee is entitled to receive payments under the Credit Agreement and theLoan Documents payable to it, without deduction or withholding of any UnitedStates federal income taxes; and (ii) Internal Revenue Service Form W-8 or W-9establishing an exemption from United States backup withholding tax. If any suchform is found to be incomplete or incorrect, or must be replaced (on the same ora successor form) in order to maintain its effectiveness, Assignee shall executeand deliver to each of Borrower and Agent two executed copies of a valid,complete and correct replacement form. 12. General. (a) This Agreement constitutes the entire understanding ofthe parties with respect to the subject matter hereof and supersedes all priorand current understandings and agreements, whether written or oral (other thanwith respect to any fees payable as provided in Section 4 hereof). (b) No term or provision of this Agreement may be amended,waived or terminated orally, but only by an instrument signed by the partieshereto. (c) This Agreement may be executed in one or morecounterparts. Each set of executed counterparts shall be an original. Executedcounterparts may be delivered by facsimile transmission. (d) Assignor may at any time and from time to time grant toothers pursuant to the Loan Documents assignments of or participations in all orpart of Assignor's Proportionate Share of [the Line of Credit] [Term Loan A][Term Loan B] [Term Loan C] Total Commitments, but not with respect to theAssigned Rights and Obligations. (e) This Agreement shall be binding upon and inure to thebenefit of the parties hereto and their respective legal representatives,successors and assigns. Neither Assignor nor Assignee may assign or transfer anyof its rights or obligations under this Agreement without the prior writtenconsent of the other. The preceding sentence shall not limit the right ofAssignee to grant to others assignments of or participations in all or part ofthe Assigned Rights and Obligations to the extent permitted by the terms of theLoan Documents. (f) All payments to Assignor or Assignee hereunder shall,unless otherwise specified by the party entitled thereto, be made in UnitedStates Dollars, in immediately available funds, and to the address or accountspecified on the signature pages of this Agreement. The address of Assignee fornotice purposes under the Credit Agreement shall be as specified on thesignature pages of this Agreement. Exhibit G -- Page 5 108 (g) If any provision of this Agreement is held invalid,illegal or unenforceable, the remaining provisions hereof will not be affectedor impaired in any way. (h) Each party shall bear its own expenses in connection withthe preparation and execution of this Agreement. (i) This Agreement shall be governed by and construed inaccordance with the laws of the State of California. IN WITNESS WHEREOF, the parties hereto have executed thisAgreement as of the date first above written. ASSIGNOR: ___________________________________ By: ______________________________ Name: ____________________________ Title: ___________________________ Assignor's Notice Instructions: ___________________________________ ___________________________________ ___________________________________ Attn: ____________________________ Ref: _____________________________ Telephone: (______) ______________ Facsimile: (______) ______________ Assignor's Payment Instructions: ___________________________________ ___________________________________ ___________________________________ ABA No.: _________________________ Account No.: _____________________ Attn: ____________________________ Ref: _____________________________ Exhibit G -- Page 6 109 ASSIGNEE: ___________________________________ By: ______________________________ Name: ____________________________ Title: ___________________________ Assignee's Notice Instructions: ___________________________________ ___________________________________ ___________________________________ Attn: ____________________________ Ref: _____________________________ Telephone: (______) ______________ Facsimile: (______) ______________ Assignee's Payment Instructions: ___________________________________ ___________________________________ ___________________________________ ABA No.: _________________________ Account No.: _____________________ Attn: ____________________________ Ref: _____________________________ Exhibit G -- Page 7 110ACKNOWLEDGED AND AGREED:BORROWER:AXT, INC., a Delaware corporationBy: ______________________________Name: ____________________________Title: ___________________________AGENT:U.S. BANK NATIONAL ASSOCIATION,as AgentBy: ______________________________Name: ____________________________Title: ___________________________ Exhibit G -- Page 8 111 EXHIBIT H FORM OF BORROWING BASE CERTIFICATE Exhibit H -- Page 1 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTSWe hereby consent to the incorporation by reference in the RegistrationStatement on Form S-3 (No. 333-47560) of AXT, Inc. of our report dated February9, 2001 relating to the consolidated financial statements, which appears in thisForm 10-K.PricewaterhouseCoopers LLPSan Jose, CaliforniaFebruary 26, 2001 1 EXHIBIT 23.2 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTSAs independent public accountants, we hereby consent to the incorporation of ourreport included in this Form 10-K, into the Company's previously filedRegistration Statement File No. 333-47560ARTHUR ANDERSEN LLPLos Angeles, CaliforniaFebruary 26, 2001

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