Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condit ion and Results of Operations
In addition to historical information, the following discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ substantially from those referred to herein due to a number of factors, including but not limited to risks described in the section entitled Item 1A. “Risk Factors” and elsewhere in this Annual Report on Form 10-K. This discussion should be read in conjunction with Item 6. “Selected Consolidated Financial Data” and our consolidated financial statements and related notes included elsewhere in this Form 10-K.
Critical Accounting Policies and Estimates
We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Accordingly, we make estimates, assumptions and judgments that affect the amounts reported on our consolidated financial statements. These estimates, assumptions and judgments about future events and their effects on our results cannot be determined with certainty, and are made based upon our historical experience and on other assumptions that are believed to be reasonable under the circumstances. These estimates may change as new events occur or additional information is obtained, and we may periodically be faced with uncertainties, the outcomes of which are not within our control and may not be known for a prolonged period of time.
We have identified the policies below as critical to our business operations and understanding of our financial condition and results of operations. Critical accounting policies are material to the presentation of our consolidated financial statements and require us to make difficult, subjective or complex judgments that could have a material effect on our financial condition and results of operations. They may require us to make assumptions about matters that are highly uncertain at the time of the estimate. Different estimates that we could have used, or changes in the estimate that are reasonably likely to occur, may have a material impact on our financial condition or results of operations. We also refer you to Note 1 to our consolidated financial statements included elsewhere in this Form 10-K.
Revenue Recognition and Sales Returns
We manufacture and sell high-performance compound semiconductor substrates including indium phosphide, gallium arsenide and germanium wafers, and our consolidated subsidiaries sell certain raw materials, including high purity gallium (6N and 7N Ga), pyrolytic boron nitride (pBN) crucibles and boron oxide (B2O3). After we ship our products, there are no remaining obligations or customer acceptance requirements that would preclude revenue recognition. Our products are typically sold pursuant to purchase orders placed by our customers, and our terms and conditions of sale do not require customer acceptance. We account for a contract with a customer when there is a legally enforceable contract, which could be the customer’s purchase order, the rights of the parties are identified, the contract has commercial terms, and collectibility of the contract consideration is probable. The majority of our contracts have a single performance obligation to transfer products and are short term in nature, usually less than six months. Our revenue is measured based on the consideration specified in the contract with each customer in exchange for transferring products that are generally based upon a negotiated, formula, list or fixed price. Revenue is recognized when control of the promised goods is transferred to our customer, which is either upon shipment from our dock, receipt at the customer’s dock, or removal from consignment inventory at the customer’s location, in an amount that reflects the consideration we expect to be entitled to receive in exchange for those goods.
We have elected to account for shipping and handling as activities to fulfill the promise to transfer the goods. As such, shipping and handling fees billed to customers in a sales transaction are recorded in revenue. Shipping and handling costs incurred are recorded in cost of revenue. Sales taxes and value added taxes in foreign jurisdictions that are collected from customers and remitted to governmental authorities are accounted for on a net basis and, therefore, are excluded from revenue.
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We do not provide training, installation or commissioning services. We accrue for future returns based on historical data, prior experience, current economic trends and changes in customer demand at the time revenue is recognized. We do not recognize any asset associated with the incremental cost of obtaining revenue generating customer contracts. As such, sales commissions and other related expenses are expensed as incurred, given that the expected period of benefit is less than one year.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are recorded at the invoiced amount and are not interest bearing. We review at least quarterly, or when there are changes in credit risks, the likelihood of collection on our accounts receivable balances and provide an allowance for doubtful accounts receivable for any expected credit losses primarily based upon the age of these accounts. We evaluate receivables from U.S. customers with an emphasis on balances in excess of 90 days and for receivables from customers located outside the U.S. with an emphasis on balances in excess of 120 days and establish a reserve allowance on the receivable balances if needed. The reason for the difference in the evaluation of receivables between foreign and U.S. customers is that U.S. customers have historically made payments in a shorter period of time than foreign customers. Foreign business practices generally require us to allow customer payment terms that are longer than those accepted in the United States. We assess the probability of collection based on a number of factors, including the length of time a receivable balance has been outstanding, our past history with the customer and their credit-worthiness.
We exercise judgment when determining the adequacy of our reserves as we evaluate historical bad debt trends, general economic conditions in the United States and internationally, and changes in customer financial conditions. Uncollectible receivables are recorded as bad debt expense when a credit loss is expected through the establishment of an allowance, which would then be written off when all efforts to collect have been exhausted and recoveries are recognized when they are received. As of December 31, 2021 and 2020, our accounts receivable, net balance was $34.8 million and $24.6 million, respectively, which was net of an allowance for doubtful accounts of $130,000 and $217,000 as of December 31, 2021 and 2020, respectively. During 2021, we decreased the allowance for doubtful accounts by $87,000 due to the write-off of accounts receivable for a customer. During 2020, we increased the allowance for doubtful accounts by $183,000 due to the poor financial condition of a few customers . If actual uncollectible accounts differ substantially from our estimates, revisions to the estimated allowance for doubtful accounts would be required, which could have a material impact on our financial results for the future periods.
Warranty Reserve
We maintain a warranty reserve based upon our claims experience during the prior twelve months and any pending claims and returns of which we are aware. Warranty costs are accrued at the time revenue is recognized. As of December 31, 2021 and 2020, accrued product warranties totaled $743,000 and $609,000, respectively. The increase in accrued product warranties is primarily attributable to two customers who claimed certain wafers did not meet their specifications. If actual warranty costs or pending new claims differ substantially from our estimates, revisions to the estimated warranty liability would be required, which could have a material impact on our financial condition and results of operations for future periods.
Inventory Valuation
Inventories are stated at the lower of cost (approximated by standard cost) or net realizable value. Cost is determined using the weighted average cost method. Our inventory consists of raw materials as well as finished goods and work-in-process that include material, labor and manufacturing overhead costs. We routinely evaluate the levels of our inventory in light of current market conditions in order to identify excess and obsolete inventory, and we provide a reserve for certain inventories based upon the age and quality of the product and the projections for sale of the completed products. As of December 31, 2021 and 2020, we had an inventory reserve of $19.6 million and $17.7 million, respectively, for excess and obsolete inventory and $66,000 and $162,000, respectively, for lower of cost or net realizable value reserves. If actual demand for our products were to be substantially lower than estimated, additional inventory adjustments for excess or obsolete inventory might be required, which could have a material impact on our business, financial condition and results of operations.
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Impairment of Investments
We classify marketable investments in debt securities as available-for-sale debt securities in accordance with Accounting Standards Codification (“ASC”) Topic 320, Investments—Debt Securities . All available-for-sale debt securities with a quoted market value below cost (or adjusted cost) are reviewed in order to determine whether the decline is other-than-temporary. Factors considered in determining whether a loss is temporary include the magnitude of the decline in market value, the length of time the market value has been below cost (or adjusted cost), credit quality, and our ability and intent to hold the debt securities for a period of time sufficient to allow for any anticipated recovery in market value. We also review our debt investment portfolio at least quarterly, or when there are changes in credit risks or other potential valuation concerns to identify and evaluate whether an allowance for expected credit losses or impairment would be necessary.
We also invest in equity instruments of privately-held raw material companies in China for business and strategic purposes. Investments in our unconsolidated joint venture raw material companies are classified as other assets and accounted for under either the equity or cost method, depending on whether we have the ability to exercise significant influence over their operations or financial decisions. We monitor our investments for impairment and record reductions in carrying value when events or changes in circumstances indicate that the carrying value may not be recoverable. Determination of impairment is highly subjective and is based on a number of factors, including an assessment of the strength of the subsidiary’s management, the length of time and extent to which the fair value has been less than our cost basis, the financial condition and near-term prospects of the subsidiary, fundamental changes to the business prospects of the subsidiary, share prices of subsequent offerings, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in our carrying value.
For the years ended December 31, 2021 and 2020, we had no impairment charges. For the year ended December 31, 2019, we recorded an impairment charge of $1.1 million for a germanium materials company in China in which we have a 25% ownership interest. After receiving such company’s preliminary first quarter 2019 financial results in early April 2019 and its projections for significant losses going forward, we determined that this asset was fully impaired and wrote the asset balance down to zero.
Fair Value of Investments
ASC Topic 820, Fair Value Measurement establishes three levels of inputs that may be used to measure fair value.
Level 1 instruments represent quoted prices in active markets. Therefore, determining fair value for Level 1 instruments does not require significant management judgment, and the estimation is not difficult.
Level 2 instruments include observable inputs other than Level 1 prices, such as quoted prices for similar instruments in markets with insufficient volume or infrequent transactions (less active markets), issuer bank statements, credit ratings, non-binding market consensus prices that can be corroborated with observable market data, model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated with observable market data for substantially the full term of the assets or liabilities, or quoted prices for similar assets or liabilities. These Level 2 instruments require more management judgment and subjectivity compared to Level 1 instruments, including:
● Determining which instruments are most comparable to the instrument being priced requires management to identify a sample of similar securities based on the coupon rates, maturity, issuer, credit rating, and instrument type, and subjectively select an individual security or multiple securities that are deemed most similar to the security being priced.
● Determining which model-derived valuations to use in determining fair value requires management judgment. When observable market prices for similar securities or similar securities are not available, we price our marketable debt instruments using non-binding market consensus prices that are corroborated with observable
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market data or pricing models, such as discounted cash flow models, with all significant inputs derived from or corroborated with observable market data.
Level 3 instruments include unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities. The determination of fair value for Level 3 instruments requires the most management judgment and subjectivity.
We place short-term foreign currency hedges that are intended to offset the potential cash exposure related to fluctuations in the exchange rate between the United States dollar and Japanese yen. We measure the fair value of these foreign currency hedges at each month end and quarter end using current exchange rates and in accordance with generally accepted accounting principles. At quarter end any foreign currency hedges not settled are netted in “Accrued liabilities” on the consolidated balance sheet and classified as Level 3 assets and liabilities. As of December 31, 2021 and 2020, the net change in fair value from the placement of the hedge to settlement at each month end during the quarter had a de minimis impact to the consolidated results.
Impairment of Long-Lived Assets
We evaluate the recoverability of property, equipment and intangible assets in accordance with ASC Topic 360, Property, Plant and Equipment . When events and circumstances indicate that long-lived assets may be impaired, we compare the carrying value of the long-lived assets to the projection of future undiscounted cash flows attributable to such assets. In the event that the carrying value exceeds the future undiscounted cash flows, we record an impairment charge against income equal to the excess of the carrying value over the asset’s fair value. Fair values are determined based on quoted market values, discounted cash flows or internal and external appraisals, as applicable. Assets held for sale are carried at the lower of carrying value or estimated net realizable value. We had no “Assets held for sale” or any impairment of long-lived assets on the consolidated balance sheets as of December 31, 2021 and 2020.
Stock-Based Compensation
We account for stock-based compensation in accordance with ASC Topic 718, Stock-based Compensation . Share-based awards granted include stock options and restricted stock awards. We utilize the Black-Scholes option pricing model to estimate the grant date fair value of stock options, which requires the input of highly subjective assumptions, including estimating stock price volatility and expected term. Historical volatility of our stock price was used while the expected term for our options was estimated based on historical option exercise behavior and post-vesting forfeitures of options, and the contractual term, the vesting period and the expected term of the outstanding options. Further, we apply an expected forfeiture rate in determining the amount of share-based compensation. We use historical forfeitures to estimate the rate of future forfeitures. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our stock compensation. The cost of restricted stock awards is determined using the fair value of our common stock on the date of grant.
We recognize the compensation costs net of an estimated forfeiture rate over the requisite service period of the options award, which is generally the vesting term of four years. Compensation expense for restricted stock awards is recognized over the vesting period, which is generally one, three or four years. Stock-based compensation expense is recorded in cost of revenue, research and development, and selling, general and administrative expenses. (see Note 1—Summary of Significant Accounting Policies—Stock-Based Compensation).
Income Taxes
We account for income taxes in accordance with ASC topic 740, Income Taxes (“ASC 740”), which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. ASC 740 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized. Our deferred tax assets have been reduced to zero by valuation allowance.
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We provide for income taxes based upon the geographic composition of worldwide earnings and tax regulations governing each region, particularly China. The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws, particularly in foreign countries such as China.
See Note 12—”Income Taxes” in the consolidated financial statements for additional information.
Change in Accounting Estimate – Useful Life of Equipment and Facilities
From time to time we review our estimates of the useful lives of our property, plant and equipment. As a result of the review, we determined a portion of our manufacturing equipment was lasting longer than the estimate previously established for the respective useful lives. Where appropriate, we extended the useful life of the manufacturing equipment in our accounting records. In addition, the useful life of our buildings located in China was extended to better align with industry standards. The changes in our estimate of the useful life, effective January 1, 2020, were made in order to remain consistent with U.S. GAAP regarding management estimates. The effect of the change in the useful lives decreased our manufacturing costs for the year ended December 31, 2020 by approximately $1.4 million and increased our basic and diluted net income per share by approximately $0.03, respectively, as a result of lower depreciation expense.
Results of Operations
Overview
We were founded in 1986 to commercialize and enhance our proprietary VGF technology for producing high-performance compound semiconductor substrates or wafers. We have one operating segment and two product lines: specialty material substrates and raw materials used to make such substrates or other related products. We recorded our first substrate sales in 1990 and our substrate products currently include indium phosphide (InP), gallium arsenide (GaAs) and germanium (Ge) substrates used to produce semiconductor devices for use in applications such as fiber optic and wireless telecommunications, light emitting diodes (LEDs), lasers and for solar cells for space and terrestrial photovoltaic applications. Our two raw material companies sell, among other items, purified gallium and pBN crucibles.
Operating Results
We manufacture all of our products in the People’s Republic of China (PRC or China), which generally has favorable costs for facilities and labor compared with comparable facilities in the United States, Europe or Japan. Our supply chain includes partial ownership of raw material companies in China (joint ventures). We believe this supply chain arrangement provides us with pricing advantages, reliable supply and enhanced sourcing lead-times for key raw materials which are central to our final manufactured products.
Our annual revenue increased in 2021 from $95.4 million in 2020 to $137.4 million in 2021 an increase of 44.1%. Our annual revenue increased in 2020 from $83.3 million in 2019 to $95.4 million in 2020 an increase of 14.5%. Our annual revenue decreased in 2019 by 18.7% to $83.3 million. For the years ended in 2018, 2017 and 2016 our revenue grew each year. Our revenue increased in 2018 by 3.8% to $102.4 million, in 2017 by 21.2% to $98.7 million and in 2016 by 5.0% to $81.3 million. In 2021, our gross margin increased from 31.7% of total revenue in 2020 to 34.5% of total revenue in 2021. In 2020, our gross margin increased from 29.8% of total revenue in 2019 to 31.7% of total revenue in 2020. Our gross margin declined in 2019 to 29.8% of total revenue from 36.2% of total revenue in 2018.
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Revenue
Years Ended Dec. 31
2020 to 2021
2019 to 2020
Increase
Increase
2021
2020
2019
(Decrease)
% Change
(Decrease)
% Change
Product Type:
Substrates
$
103,026
$
75,587
$
67,849
$
27,439
36.3
%
$
7,738
11.4
%
Raw materials and other
34,367
19,774
15,407
14,593
73.8
%
4,367
28.3
%
Total revenue
$
137,393
$
95,361
$
83,256
$
42,032
44.1
%
$
12,105
14.5
%
Revenue increased $42.0 million, or 44.1%, in 2021 from $95.4 million in 2020. The $27.4 million increase in wafer substrate sales was led by strong demand for InP wafer substrates for 5G applications and data center upgrades (silicon photonics). GaAs revenue also grew as the result of increased demand for LED products, industrial lasers and other applications requiring low defect densities in the wafer substrate. Revenue from Ge wafer substrates increased modestly, primarily as a result of higher demand from our customers in China. The $14.6 million raw materials revenue increase as compared to the same period in 2020 was primarily the result of increased revenue from sales of purified gallium and favorable pricing. In addition, increased demand for pBN crucibles and pBN-based OLED manufacturing tools resulted in increased revenue for BoYu, one of our consolidated raw material companies .
Revenue increased $12.1 million, or 14.5%, in 2020 from $83.3 million in 2019. The $7.7 million increase in wafer substrate sales was the result of stronger GaAs demand in LED sensors used in the automobile industry and the industrial sensor market. In addition, GaAs sales into wireless applications increased. Revenue from InP sales also increased. The InP revenue increase was driven by 5G infrastructure and data center upgrades (silicon photonics). Revenue from Ge wafer substrates increased, primarily as a result of higher demand from our customers in China. The $4.4 million raw materials revenue increase as compared to the same period in 2019 was primarily the result of increased shipments of purified gallium due to stronger market demand and higher demand for pBN crucibles and OLED manufacturing tools using pBN sold by our consolidated subsidiaries.
Revenue by Geographic Region
Year Ended Dec. 31,
2020 to 2021
2019 to 2020
Increase
Increase
2021
2020
2019
(Decrease)
% Change
(Decrease)
% Change
($ in thousands)
China
$
67,394
$
35,150
$
26,796
$
32,244
91.7
%
$
8,354
31.2
%
% of total revenue
49
%
37
%
32
%
Taiwan
16,841
16,485
16,204
356
2.2
%
281
1.7
%
% of total revenue
12
%
17
%
19
%
Japan
10,112
7,624
6,258
2,488
32.6
%
1,366
21.8
%
% of total revenue
7
%
8
%
8
%
Asia Pacific (excluding China, Taiwan and Japan)
7,540
5,458
7,592
2,082
38.1
%
(2,134)
(28.1)
%
% of total revenue
6
%
6
%
9
%
Europe (primarily Germany)
23,069
19,673
18,178
3,396
17.3
%
1,495
8.2
%
% of total revenue
17
%
21
%
22
%
North America (primarily the United States)
12,437
10,971
8,228
1,466
13.4
%
2,743
33.3
%
% of total revenue
9
%
11
%
10
%
Total revenue
$
137,393
$
95,361
$
83,256
$
42,032
44.1
%
$
12,105
14.5
%
Sales to customers located outside of North America represented approximately 90% of our revenue during 2021, 2020 and 2019, respectively.
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Revenue from customers in China increased in 2021 by 91.7%, primarily due to higher demand for refined gallium and pBN crucibles sold by our consolidated subsidiaries. In addition, revenue from InP, GaAs and Ge wafer substrates increased. Revenue from customers in Taiwan increased in 2021 by 2.2%, primarily due to an increase in demand for wireless applications using GaAs wafer substrates, partially offset by a decline in InP revenue in Taiwan that was transferred to North America. Revenue from customers in Japan increased in 2021 by 32.6% as a result of increased demand for InP wafer substrates, partially offset by lower demand for pBN crucibles sold by one of our consolidated subsidiaries and GaAs used in wireless applications. Revenue from customers in Asia Pacific increased by 38.1% as a result of increased demand for GaAs used in wireless applications and InP wafer substrates, partially offset by lower demand for pBN crucibles sold by one of our consolidated subsidiaries. Revenue from customers in Europe increased in 2021 by 17.3%, primarily due to GaAs used in LED applications, InP wafer substrates and pBN crucibles sold by one of our consolidated subsidiaries, partially offset by lower demand for Ge wafer substrates. Revenue from customers in North America increased by 13.4% primarily due to increased demand for our InP and Ge wafer substrates, and pBN crucibles sold by one of our consolidated subsidiaries.
Revenue from customers in China increased in 2020 by 31.2%, primarily due to higher demand for refined gallium and pBN crucibles sold by our consolidated subsidiaries. In addition, revenue from GaAs wafer substrates increased. Revenue from customers in Taiwan increased in 2020 by 1.7%, primarily due to an increase in demand for wireless applications using GaAs wafer substrates, partially offset by a decline in InP revenue in Taiwan that was transferred to North America. Revenue from customers in Japan increased in 2020 by 21.8% as a result of increased demand for InP wafer substrates and GaAs used in wireless applications, partially offset by lower demand for pBN crucibles sold by our consolidated subsidiary. Revenue from customers in Asia Pacific decreased by 28.1% as a result of lower demand for pBN crucibles sold by our consolidated subsidiaries. Revenue from customers in Europe increased in 2020 by 8.2%, primarily due to pBN crucibles sold by our consolidated subsidiary and Ge wafer substrates. Revenue from customers in North America increased by 33.3% primarily due to increased demand for our InP wafer substrates partially offset by lower demand for wireless applications using our GaAs wafer substrates.
Gross Margin
2020 to 2021
2019 to 2020
Year Ended Dec. 31,
Increase
Increase
2021
2020
2019
(Decrease)
% Change
(Decrease)
% Change
($ in thousands)
Gross profit
$
47,414
$
30,275
$
24,825
$
17,139
56.6
%
$
5,450
22.0
%
Gross Profit %
34.5
%
31.7
%
29.8
%
Gross profit increased $17.1 million in 2021 as compared to 2020. Gross margin in 2021 was 34.5% as compared to 31.7% in 2020. The increase in gross profit is attributed to higher revenue resulting in fixed costs being spread over more units and a favorable change in product mix.
Gross profit increased $5.5 million in 2020 as compared to 2019. Gross margin in 2020 was 31.7% as compared to 29.8% in 2019. The increase in gross profit is attributed to higher revenue resulting in fixed costs being spread over more units and a favorable change in product mix.
Selling, General and Administrative Expenses
2020 to 2021
2019 to 2020
Years Ended Dec. 31
Increase
Increase
2021
2020
2019
(Decrease)
% Change
(Decrease)
% Change
($ in thousands)
Selling, general and administrative expenses
$
24,189
$
19,200
$
19,305
$
4,989
26.0
%
$
(105)
(0.5)
%
% of total revenue
17.6
%
20.1
%
23.2
%
Selling, general and administrative expenses increased $5.0 million, or 26.0%, to $24.2 million for 2021 compared to $19.2 million for 2020. The higher selling, general and administrative expenses were primarily from higher
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personnel-related expenses, stock compensation expenses, license and fees, and an increase in outside commission expenses due to higher volume of sales in 2021, partially offset by lower bad debt expense.
Selling, general and administrative expenses decreased $0.1 million, or 0.5%, to $19.2 million for 2020 compared to $19.3 million for 2019. The lower selling, general and administrative expenses were primarily from lower travel-related expenses driven by the COVID-19 pandemic, reimbursement of certain expenses from the local government in China for relocating our manufacturing line to its province, lower license, tax and registration related expenses and lower professional service-related expenses partially offset by higher personnel-related expenses and increase in our bad debt expenses due to the poor financial condition of a few customers as a result of the COVID-19 pandemic.
Research and Development Expenses
2020 to 2021
2019 to 2020
Years Ended Dec. 31
Increase
Increase
2021
2020
2019
(Decrease)
% Change
(Decrease)
% Change
($ in thousands)
Research and development
$
10,328
$
7,135
$
5,834
$
3,193
44.8
%
$
1,301
22.3
%
% of total revenue
7.5
%
7.5
%
7.0
%
Research and development expenses increased $3.2 million, or 44.8%, to $10.3 million in 2021 from $7.1 million in 2020. The increase in research and development expenses in 2021 was primarily due to higher development expenses for 8-inch GaAs and 6-inch InP wafer substrates and development of new features for certain of our GaAs and InP wafer substrates, new product testing and personnel-related expenses.
Research and development expenses increased $1.3 million, or 22.3%, to $7.1 million in 2020 from $5.8 million in 2019. The increase in research and development expenses in 2020 was primarily due to higher development expenses of new features for certain of our GaAs and InP wafer substrates, product testing and personnel-related expenses.
Interest Income (Expense), Net
2020 to 2021
2019 to 2020
Years Ended Dec. 31
Increase
Increase
2021
2020
2019
(Decrease)
% Change
(Decrease)
% Change
($ in thousands)
Interest income (expense), net
$
(213)
$
(179)
$
217
$
(34)
(19.0)
%
$
(396)
(182.5)
%
% of total revenue
(0.2)
%
(0.2)
%
0.3
%
Interest income (expense), net decreased in 2021 as compared to the same period in 2020, primarily due to lower investment balances in 2021 and increased borrowings in 2021. Interest income (expense), net decreased in 2020 as compared to the same period in 2019, primarily due to lower investment balances in 2020 and increased borrowings in 2020.
Equity in Income (Loss) of Unconsolidated Joint Venture Companies
2020 to 2021
2019 to 2020
Years Ended Dec. 31
Increase
Increase
2021
2020
2019
(Decrease)
% Change
(Decrease)
% Change
($ in thousands)
Equity in income (loss) of unconsolidated joint ventures
$
4,409
$
111
$
(1,876)
$
4,298
3,872.1
%
$
1,987
105.9
%
% of total revenue
3.2
%
0.1
%
(2.3)
%
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Equity in income (loss) of unconsolidated joint ventures is the aggregate net income (loss) from our minority-owned supply chain joint venture companies that are not consolidated. Equity in income (loss) of unconsolidated joint ventures increased $4.3 million to an income of $4.4 million in 2021 from an income of $0.1 million in 2020 as our unconsolidated joint ventures reported better performance in 2021 as compared to 2020.
Equity in income (loss) of unconsolidated joint ventures is the aggregate net income (loss) from our minority-owned supply chain joint venture companies that are not consolidated. Equity in income (loss) of unconsolidated joint ventures increased $2.0 million to an income of $0.1 million in 2020 from a loss of $1.9 million in 2019 as our unconsolidated joint ventures reported better performance in 2020 as compared to 2019. The loss in 2019 includes an impairment charge of $1.1 million from the germanium mining company in our raw material supply chain.
Other Income, Net
2020 to 2021
2019 to 2020
Years Ended Dec. 31
Increase
Increase
2021
2020
2019
(Decrease)
% Change
(Decrease)
% Change
($ in thousands)
Other income, net
$
509
$
3,200
$
947
$
(2,691)
(84.1)
%
$
2,253
237.9
%
% of total revenue
0.4
%
3.4
%
1.1
%
Other income, net decreased $2.7 million to an income of $0.5 million for 2021 as compared to an income of $3.2 million in 2020, primarily due to lower compensation received from the China government by three of our consolidated subsidiaries for relocating their facilities to Kazuo in 2021 as compared to 2020.
Other income, net increased $2.3 million to an income of $3.2 million for 2020 as compared to an income of $0.9 million in 2019, primarily due to compensation received from the China government by three of our consolidated subsidiaries for relocating their facilities to Kazuo.
Provision for Income Taxes
2020 to 2021
2019 to 2020
Years Ended Dec. 31
Increase
Increase
2021
2020
2019
(Decrease)
% Change
(Decrease)
% Change
($ in thousands)
Provision for income taxes
$
1,093
$
2,031
$
562
$
(938)
(46.2)
%
$
1,469
261.4
%
% of total revenue
0.8
%
2.1
%
0.7
%
Provision for income taxes for 2021 and 2020 were $1.1 million and $2.0 million, respectively, which were mostly related to our consolidated wafer substrate subsidiaries in China and our two partially owned consolidated raw material companies. No income taxes or benefits have been provided for AXT as the income in the U.S. had been fully offset by utilization of federal and state net operating loss carryforwards. Additionally, there is uncertainty of generating future profit in the U.S., which has resulted in our deferred tax assets being fully reserved. We have accrued approximately $223,000 in federal income tax for AXT-Tongmei for the year ended December 31, 2021, which has no net operating loss carryover. Our estimated tax rate can vary greatly from year to year because of the change or benefit in the mix of taxable income between our U.S. and China-based operations.
Due to our uncertainty regarding our future profitability, we recorded a valuation allowance against our net deferred tax assets of $15.4 million and $19.8 million for the years 2021 and 2020, respectively.
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Net Income Attributable to Noncontrolling Interests and Redeemable Noncontrolling Interests
2020 to 2021
2019 to 2020
Years Ended Dec. 31
Increase
Increase
2021
2020
2019
(Decrease)
% Change
(Decrease)
% Change
($ in thousands)
Net income attributable to noncontrolling interests and redeemable noncontrolling interests
$
1,934
$
1,803
$
1,012
$
131
7.3
%
$
791
78.2
%
% of total revenue
1.4
%
1.9
%
1.2
%
The increase in noncontrolling interests and redeemable noncontrolling interests’ share of income for 2021 as compared to 2020 was primarily due to the structural changes of the legal entities in China (see Note 1 to our Consolidated Financial Statements) and to a lesser degree, losses generated by our consolidated subsidiary, ChaoYang XinMei High Purity Semiconductor Materials Co., Ltd. (ChaoYang XinMei”).
The increase in noncontrolling interests and noncontrolling interests’ share of income for 2020 as compared to 2019 was due to higher profitability from one of our consolidated subsidiaries in China.
Liquidity and Capital Resources
Year Ended December 31,
2021
2020
2019
($ in thousands)
Net cash provided by (used in):
Operating activities
$
(3,305)
$
5,865
$
12,658
Investing activities
(38,810)
(16,422)
(8,328)
Financing activities
5,725
52,662
6,186
Effect of exchange rate changes
551
3,605
(150)
Net change in cash and cash equivalents
(35,839)
45,710
10,366
Cash and cash equivalents—beginning year
72,602
26,892
16,526
Cash and cash equivalents—end of year
36,763
72,602
26,892
Short and long-term investments—end of year
14,995
5,966
9,427
Total cash, cash equivalents and short-term and long-term investments
$
51,758
$
78,568
$
36,319
We consider cash and cash equivalents, short-term investments and long-term investments as liquid and available for use within two years in our current operations. Short-term investments and long-term investments are comprised of money market accounts, certificates of deposit, corporate bonds and notes, and government securities. As of December 31, 2021, we and our consolidated joint ventures held approximately $26.0 million in cash and investments in foreign bank accounts.
Total cash and cash equivalents, short-term and long-term investments decreased by $26.8 million in 2021. As of December 31, 2021, our principal source of liquidity was $51.8 million, which consisted of cash and cash equivalents of $36.8 million and short-term and long-term investments of $15.0 million. In 2021, cash and cash equivalents decreased by $35.8 million and short-term and long-term investments increased by $9.0 million. The decrease in cash and cash equivalents of $35.8 million in 2021 was primarily due to net cash used in investing activities of $38.8 million and operating activities of $3.3 million and partially offset by net cash provided by financing activities of $5.8 million and the effect of exchange rate changes of $0.6 million.
Total cash and cash equivalents, short-term and long-term investments increased by $42.2 million in 2020. As of December 31, 2020, our principal source of liquidity was $78.6 million, which consisted of cash and cash equivalents of $72.6 million and short-term and long-term investments of $6.0 million. In 2020, cash and cash equivalents increased by $45.7 million and short-term and long-term investments decreased by $3.5 million. The increase in cash and cash
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equivalents of $45.7 million in 2020 was primarily due to net cash provided by financing activities of $52.7 million, operating activities of $5.9 million and the effect of exchange rate changes of $3.6 million and partially offset by net cash used in investing activities of $16.4 million.
Net cash used in operating activities of $3.3 million for 2021 was primarily comprised of net change in operating assets and liabilities of $30.2 million and gain on equity method investments of $4.4 million, offset in part by our net income of $16.5 million, adjustment of non-cash items of depreciation and amortization of $7.1 million, stock-based compensation of $4.5 million, deferred tax assets of $2.3 million, return of equity method investments (dividends) of $0.8 million and amortization of marketable securities premium of $0.1 million. The $30.2 million net change in operating assets and liabilities primarily resulted from a $12.4 million increase in inventories, a $9.7 million increase in accounts receivable, a $6.3 million increase in other assets, a $3.4 million decrease in accrued liabilities, a $1.2 million decrease in other long-term liabilities, including royalties, and a $0.8 million increase in prepaid expenses and other current assets, offset in part by a $3.6 million increase in accounts payable.
Net cash provided by operating activities of $5.9 million for 2020 was primarily comprised of our net income of $5.0 million, an adjustment of non-cash items of depreciation and amortization of $4.3 million, stock-based compensation of $2.6 million, provision for doubtful accounts of $0.2 million, loss on disposal of equipment of $0.1 million, offset in part by our net change in operating assets and liabilities of $6.3 million and gain on equity method investments of $0.1 million. The $6.3 million net change in operating assets and liabilities primarily resulted from a $6.7 million increase in prepaid expenses and other current assets, a $5.3 million increase in accounts receivable a $0.9 million increase in inventories and a $0.1 million increase in other assets offset in part by a $2.3 million decrease in accounts payable, a $1.9 million decrease in other long-term liabilities, including royalties and a $2.6 million decrease in accrued liabilities.
Net cash provided by operating activities of $12.7 million for 2019 was primarily comprised of an adjustment of non-cash items of depreciation and amortization of $5.5 million, stock-based compensation of $2.3 million, impairment charge on equity investee of $1.1 million, loss on equity method investments of $1.0 million, return on equity method investments of $0.4 million, loss on disposal of equipment of $0.1 million, net change in operating assets and liabilities of $4.0 million offset in part by our net loss of $1.6 million and gain from deconsolidation of a subsidiary of $0.2 million. The $4.0 million net change in operating assets and liabilities primarily resulted from a $8.9 million decrease in inventories, a $2.9 million decrease in prepaid expenses and other current assets, a $0.4 million decrease in accounts receivable, a $0.1 million increase in other long-term liabilities, including royalties, offset in part by a $4.0 million decrease in accrued liabilities, a $3.1 million decrease in accounts payable and a $1.2 million increase in other assets.
Net cash used in investing activities of $38.8 million for 2021 was primarily due to property, plant and equipment of $29.6 million in preparation for our new manufacturing sites, additional equipment for our Beijing site and equipment and facility costs incurred by our consolidated subsidiaries and the purchases of marketable investment securities of $9.6 million, which were partially offset by proceeds from maturities and sales of available-for-sale debt securities of $0.5 million.
Net cash used in investing activities of $16.4 million for 2020 was primarily due to property, plant and equipment of $19.9 million in preparation for our new manufacturing sites, additional equipment for our Beijing site and equipment and facility costs incurred by our consolidated subsidiaries and the purchases of marketable investment securities of $6.0 million, which were partially offset by proceeds from maturities and sales of available-for-sale debt securities of $9.4 million.
Net cash used in investing activities of $8.3 million for 2019 was primarily due to property, plant and equipment of $21.8 million in preparation for our new manufacturing sites, additional equipment for our Beijing site and equipment and facility costs incurred by our consolidated subsidiaries and the purchases of marketable investment securities of $8.7 million, which were partially offset by proceeds from maturities and sales of available-for-sale debt securities of $22.2 million.
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Net cash provided by financing activities was $5.7 million for 2021 which mainly consisted of the proceeds of $20.5 million from short-term loan in China, $1.8 million from short-term loan from noncontrolling interest, $1.7 million from the exercise of common stock options, $1.3 million from formation of new subsidiary with noncontrolling interests and $0.5 million from sale of Tongmei shares to noncontrolling interests, which were partially offset by payments on short-term loans of $19.1 million and $1.1 million of issuance costs in connection with issuance of Tongmei common stock to redeemable noncontrolling interests.
Net cash provided by financing activities was $52.7 million for 2020 which mainly consisted of the proceeds of $47.6 million from issuance of common stock to noncontrolling interests net of issuance cost, $10.4 million from short-term loan in China, $2.5 million from the exercise of common stock options, $0.4 million from sale of Tongmei shares to noncontrolling interests partially offset by payments on short-term loans of $6.0 million and dividends paid by joint ventures to their minority shareholders of $2.2 million.
Net cash provided by financing activities was $6.2 million for 2019 which mainly consisted of the proceeds of $5.8 million from short-term loan in China, $0.3 million from the exercise of common stock options, $0.4 from sale of previously consolidated subsidiary shares partially offset by the considerations paid in cash to repurchase subsidiary shares from noncontrolling interests of $0.3 million.
On October 27, 2014, our Board of Directors approved a stock repurchase program pursuant to which we may repurchase up to $5.0 million of our outstanding common stock. These repurchases can be made from time to time in the open market and are funded from our existing cash balances and cash generated from operations. During 2015, we repurchased approximately 908,000 shares at an average price of $2.52 per share for a total purchase price of approximately $2.3 million under the stock repurchase program. No shares were repurchased during 2021, 2020 and 2019 under this program. As of December 31, 2021, approximately $2.7 million remained available for future repurchases under this program. Currently, we do not plan to repurchase additional shares.
Dividends accrue on our outstanding Series A preferred stock, and are payable as and when declared by our board of directors. We have never paid or declared any dividends on the Series A preferred stock. By the terms of the Series A preferred stock, so long as any shares of Series A preferred stock are outstanding, neither the Company nor any subsidiary of the Company shall redeem, repurchase or otherwise acquire any shares of common stock, unless all accrued dividends on the Series A preferred stock have been paid. During 2013 and 2015, we repurchased shares of our outstanding common stock. As of December 31, 2015, the Series A preferred stock had cumulative dividends of $2.9 million and we included this amount in “Accrued liabilities” in our consolidated balance sheets . At the time we pay this accrued liability, our cash and cash equivalents would be reduced. We account for the cumulative year to date dividends on the Series A preferred stock when calculating our earnings per share. See Item 5, Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities in Part II.
Occasionally, one of our PRC subsidiaries or PRC raw material joint ventures declares and pays a dividend. These dividends generally occur when the PRC joint venture declares a dividend for all of its shareholders. Dividends paid to the Company are subject to a 10% PRC withholding tax. The Company is required to obtain approval from the State Administration of Foreign Exchange (“SAFE”) to transfer funds in or out of the PRC. SAFE requires a valid agreement to approve the transfers, which are processed through a bank. Other than PRC foreign exchange restrictions, the Company is not subject to any PRC restrictions and limitations on its ability to distribute earnings from its businesses. If SAFE approval is denied the dividend payable to the Company would be owed but would not be paid.
For the years ended December 31, 2021, 2020 and 2019, the aggregate dividends paid to us, directly or to an intermediate entity within our corporate structure, by our PRC subsidiaries and PRC raw material joint ventures were approximately $774,000, $0 and $362,000, respectively. In June 2021 and May 2019, we received a dividend of $774,000 and $362,000, respectively, from one of our equity investments, Xiaoyi XingAn Gallium Co., Ltd. For the years ended December 31, 2021 and 2020, the aggregate dividends paid to minority shareholders by our PRC subsidiaries and PRC raw material joint ventures were approximately $0 and $89,000, respectively. All of these distributions were paid to the PRC companies and the minority shareholders.
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We have no current intentions to distribute to our investors earnings under our corporate structure. We settle amounts owed under our transfer pricing arrangements in the ordinary course of business.
As one of the first steps in the process of listing Tongmei on the STAR Market and going public, we sold approximately 7.28% of Tongmei to private equity investors for approximately $49 million in the aggregate. Pursuant to the Capital Investment Agreements with the Investors, each Investor has the right to require AXT to redeem any or all Tongmei shares held by such Investor at the original purchase price paid by such Investor, without interest, in the event of a material adverse change or if Tongmei does not achieve its IPO on or before December 31, 2022. This right is suspended when Tongmei submits its formal application to the Shanghai Stock Exchange and is accepted for review. Tongmei submitted the application in December 2021 and it was formally accepted for review on January 10, 2022. If the Shanghai Stock Exchange approves the formal application, then they will forward it to the CSRC for further review. The process of going public on the STAR Market includes several periods of review and is therefore a lengthy process. Tongmei does not expect to complete the IPO until the second half of 2022. If, on December 31, 2022, the IPO application remains under review, then the date when such Investor is entitled to exercise such redemption right shall be deferred to a date when such submission is rejected by the CSRC or stock exchange, or the date when Tongmei withdraws its IPO application. If the application is approved and Tongmei completes an IPO the redemption right is canceled. The listing of Tongmei on the STAR Market will not change the status of AXT as a U.S. public company.
We believe that we have adequate cash and investments to meet our operating needs and capital expenditures over the next twelve months. If our sales decrease, however, our ability to generate cash from operations will be adversely affected which could adversely affect our future liquidity, require us to use cash at a more rapid rate than expected, and require us to seek additional capital.
On October 24, 2016, we filed with the SEC a registration statement on Form S-3, pursuant to which we may offer up to $60 million of common stock, preferred stock, depositary shares, warrants, debt securities and/or units in one or more offerings and in any combination. On November 4, 2016, the SEC declared the registration statement effective. On November 4, 2019, the registration statement expired.
On July 27, 2021, we filed with the SEC a registration statement on Form S-3, pursuant to which we may offer up to $60 million of common stock, preferred stock, depositary shares, warrants, debt securities and/or units in one or more offerings and in any combination. The SEC has not yet declared the registration statement effective.
Cash from operations could be affected by various risks and uncertainties, including, but not limited to those set forth below under Item 1A. “Risk Factors” above.
Bank Loans and Line of Credit
On August 9, 2019, Tongmei entered into a credit facility (the “Credit Facility”) with the Bank of China with a $5.8 million line of credit at an annual interest rate of approximately 0.4% over the average interest rate quoted by the National Interbank Funding Center. Accrued interest is calculated monthly and paid quarterly. The annual interest rate was approximately 4.7% as of December 31, 2019. The Credit Facility is collateralized by Baoding Tongmei Xtal Technology Co., Ltd.’s land use rights and all of its buildings located at its facility in Dingxing. The primary intended use of the Credit Facility is for general purposes, which may include working capital and other corporate expenses.
On August 9, 2019, we borrowed $2.8 million against the Credit Facility. The repayment of the full amount was due on August 9, 2020. On September 12, 2019 we borrowed an additional $2.8 million against the Credit Facility. The repayment of the full amount was due on September 12, 2020. In August 2020, Tongmei repaid the full amount of the credit facility, including all outstanding accrued interest, of approximately $5.9 million (the “August 2019 borrowing”) and simultaneously applied to renew the credit facility. The process of repaying a loan and then renewing the loan is customary in China.
In September 2020, the August 2019 borrowing was renewed and funded against the credit facility with an interest rate of 3.85%. The interest owed during the term of the loan was deducted prior to funding. The repayment of the loan was due on March 22, 2021, however the credit facility contains an option to renew for an additional six
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months, which was exercised in March 2021 for approximately $3.1 million. In September 2021, Tongmei repaid $3.1 million of the credit facility, including all outstanding accrued interest, and simultaneously applied to renew the credit facility. In September 2021, the credit facility was renewed for approximately $2.7 million with an annual interest rate of 3.85%. As of December 31, 2021 and 2020, $2.8 million and $8.9 million, respectively, was included in “Bank loan” in our consolidated balance sheets.
In October 2020, the September 2019 borrowing was renewed and funded against the credit facility and an additional $2.7 million was approved and funded against the credit facility with the annual interest rate of 4.7%. Accrued interest is calculated monthly and paid quarterly. The combined loan totaled $5.6 million. In April 2021, Tongmei repaid the full amount of the credit facility, including all outstanding accrued interest, of approximately $5.6 million and simultaneously applied to renew the credit facility. In June 2021, the combined loans were renewed for approximately $5.8 million and funded against the credit facility with an annual interest rate of 4.7%. In November 2021, Tongmei repaid the full amount of the credit facility, including all outstanding accrued interest. As of December 31, 2021, $0 was included in “Bank loan” in our consolidated balance sheets.
In February 2020, our consolidated subsidiary, BoYu, entered into a credit facility with the ICBC with a $1.4 million line of credit at an annual interest rate of approximately 0.15% over the loan prime rate. Accrued interest is calculated monthly and paid quarterly. The annual interest rate was approximately 4.3% as of December 31, 2020. The credit facility is collateralized by BoYu’s land use rights and its building located at its facility in Tianjin, China and BoYu’s accounts receivable. The primary intended use of the credit facility is for general purposes, which may include working capital and other corporate expenses.
In March 2020, BoYu borrowed $0.4 million against the credit facility. In December 2020, BoYu repaid the outstanding loan amount of $0.4 million and renewed the credit facility with a $1.5 million line of credit at an annual interest rate of approximately 0.07% over the loan prime rate. Accrued interest is calculated monthly and paid monthly. In December 2021, BoYu repaid the outstanding loan amount of approximately $1.6 million and renewed the credit facility with a $1.6 million line of credit. Accrued interest is calculated monthly and paid monthly. The annual interest rate was approximately 3.92% as of December 31, 2021. As of December 31, 2021 and 2020, $1.6 million and $1.5 million, respectively, was included in “Bank loan” in our consolidated balance sheets.
In September 2021, Tongmei entered into a credit facility with the Bank of Communications with a $3.1 million line of credit at an annual interest rate of 4.0% as of September 30, 2021. Accrued interest is calculated monthly and paid quarterly. The credit facility is collateralized by ChaoYang Tongmei’s land use rights and all of its buildings located at its facility in Kazuo, China. The primary intended use of the credit facility is for general purposes, which may include working capital and other corporate expenses. In November 2021, the Bank of Communications increased the line of credit, under the same terms as the September 2021 line of credit, by $1.6 million for a total line of credit of $4.7 million. As of December 31, 2021, $4.7 million was included in “Bank loan” in our consolidated balance sheets.
In December 2021, Tongmei entered into a credit facility with China Merchants Bank for $1.6 million with an annual interest rate of 3.55%. Accrued interest is calculated monthly and paid quarterly. The repayment of the loan and any accrued interest is due on December 6, 2022. The loan is guaranteed by Beijing Capital Financing Guarantee Co., Ltd. In exchange for the guarantee, Tongmei paid Beijing Capital Financing Guarantee Co., Ltd. a fee of 1.5% of the
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loan amount or approximately $24,000. As of December 31, 2021, $1.6 million was included in “Bank loan” in our consolidated balance sheets.
In December 2021, Tongmei entered into a credit facility with China Merchants Bank for $1.6 million with an annual interest rate of 4.22%. Accrued interest is calculated monthly and paid quarterly. The repayment of the loan and any accrued interest is due on December 7, 2022. The credit facility is not collateralized. As of December 31, 2021, $1.6 million was included in “Bank loan” in our consolidated balance sheets.
Off-Balance Sheet Arrangements
We did not have any off-balance sheet financing arrangements and have never established any special purpose entities as defined under SEC Regulation S-K Item 303(a)(4)(ii). We have not entered into any options on non-financial assets.
Contractual Obligations
We lease certain office space, warehouse facilities and equipment under long-term operating leases expiring at various dates through July 2029. The majority of our lease obligations relate to our lease agreement for a nitrogen system to be used during the manufacturing process for our facility in Dingxing, China. The equipment lease became effective in August 2019 and will expire in July 2029. There are no variable lease payments, residual value guarantees or any restrictions or covenants imposed by the equipment lease. The remainder relate to our lease agreement for our facility in Fremont, California with approximately 19,467 square feet, which expires in 2023. There are no variable lease payments, residual value guarantees or any restrictions or covenants imposed by the facility lease. All other operating leases have a term of 12 months or less. Total rent expenses under these operating leases charged to selling, general and administrative were approximately $431,000, $322,000 and $306,000 for the years ended December 31, 2021, 2020 and 2019, respectively, primarily related to our Fremont facility. Total rent expenses under these operating leases charged to cost of revenue were approximately $296,000, $266,000 and $112,000 for the years ended December 31, 2021, 2020 and 2019, respectively, primarily related to the nitrogen system at our facility in Dingxing.
In 2020, we and a competitor entered into a cross license and covenant agreement (the “Cross License Agreement”), which has a term that begins on January 1, 2020 and expires on December 31, 2029. The Cross License Agreement is a fixed-cost cross license and not a variable-cost cross license that is based on revenue or units. Under the Cross License Agreement, we are obligated to make annual payments over a 10-year period. For the years ended December 31, 2021 and 2020, the royalty expense under the Cross License Agreement was not considered material to our consolidated financial statements.
Land Purchase and Investment Agreement
We have established a wafer processing production line in Dingxing, China. In addition to a land rights and building purchase agreement that we entered into with a private real estate development company to acquire our new manufacturing facility, we also entered into a cooperation agreement with the Dingxing local government. In addition to pledging its full support and cooperation, the Dingxing local government will issue certain tax credits to us as we achieve certain milestones. We, in turn, agreed to hire local workers over time, pay taxes when due and eventually demonstrate a total investment of approximately $90 million in value, assets and capital. The investment will include cash paid for the land and buildings, cash on deposit in our name at local banks, the gross value of new and used equipment (including future equipment that might be used for indium phosphide and germanium substrates production), the deemed value for our customer list or the end user of our substrates (for example, the end users of the 3-D sensing VCSELs), a deemed value for employment of local citizens, a deemed value for our proprietary process technology, other intellectual property, other intangibles and additional items of value. There is no timeline or deadline by which this must be accomplished, rather it is a good faith covenant entered into between AXT and the Dingxing local government. Further, there is no specific penalty contemplated if either party breaches the agreement, however the agreement does state that each party has a right to seek from the other party compensation for losses. Under certain conditions, the Dingxing local government may purchase the land and building at the appraised value. We believe that such cooperation agreements are normal, customary and usual in China and that the future valuation is flexible. We have a similar agreement with the city of Kazuo, China,
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although on a smaller scale. The total investment targeted by AXT in Kazuo is approximately $15 million in value, assets and capital.
Purchase Obligations with Penalties for Cancellation
In the normal course of business, we issue purchase orders to various suppliers. In certain cases, we may incur a penalty if we cancel the purchase order. As of December 31, 2021, we do not have any outstanding purchase orders that will incur a penalty if canceled by the Company.
Recent Accounting Pronouncements
Recent accounting pronouncements are detailed in Note 1 to our Consolidated Financial Statements included in this Annual Report on Form 10-K.