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Commitments and Contingencies | 9 Months Ended
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Sep. 30, 2018
Commitments and Contingencies |
Commitments and Contingencies | Note 12. Commitments and Contingencies Indemnification Agreements We have entered into indemnification agreements with our directors and officers that require us to indemnify our directors and officers against liabilities that may arise by reason of their status or service as directors or officers, other than liabilities arising from willful misconduct of a culpable nature; to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified; and to obtain directors’ and officers’ insurance if available on reasonable terms, which we currently have in place. Product Warranty We provide warranties for our products for a specific period of time, generally twelve months, against material defects. We provide for the estimated future costs of warranty obligations in cost of sales when the related revenue is recognized. The accrued warranty costs represent the best estimate at the time of sale of the total costs that we expect to incur to repair or replace product parts that fail while still under warranty. The amount of accrued estimated warranty costs are primarily based on historical experience as to product failures as well as current information on repair costs. On a quarterly basis, we review the accrued balances and update the historical warranty cost trends. The following table reflects the change in our warranty accrual which is included in “Accrued liabilities” on the condensed consolidated balance sheets, during the three and nine months ended September 30, 2018 and 2017 (in thousands):
|  | Three Months Ended |  | Nine Months Ended |
|  | September 30, |  | September 30, |
|  | 2018 |  | 2017 |  | 2018 |  | 2017 |
Beginning accrued product warranty |  | $ | 178 |  | $ | 130 |  | $ | 133 |  | $ | 251 |
Accruals for warranties issued |  |  | 125 |  |  | 7 |  |  | 258 |  |  | 77 |
Adjustments related to pre-existing warranties including expirations and changes in estimates |  |  | (10) |  |  | 18 |  |  | (33) |  |  | (114) |
Cost of warranty repair |  |  | (65) |  |  | (17) |  |  | (130) |  |  | (76) |
Ending accrued product warranty |  | $ | 228 |  | $ | 138 |  | $ | 228 |  | $ | 138 |
Contractual Obligations We lease certain office space, warehouse facilities and equipment under long-term operating leases expiring at various dates through April 2023. The majority of our lease obligations relate to our lease agreement for the facility in Fremont, California with approximately 19,467 square feet. The term of the original lease for this facility would have expired in 2017. According to the lease agreement, we had an option to extend the term of the lease for an additional three years. In May 2017, we exercised this option and the lease was extended for an additional three year term. All terms of this lease otherwise remain the same and the term of this lease will expire in 2020. Under the terms of the lease agreement, in 2020, we will have the option to extend the term of the lease for an additional three years. We entered into a royalty agreement with a competitor effective December 3, 2010 with a term of eight years, terminating December 31, 2018. We and our related companies are granted a worldwide, nonexclusive, royalty bearing, irrevocable license to certain patents for the term of the agreement. We shall pay up to $7.0 million of royalty payments over eight years that began in 2011 based on future royalty bearing sales. This royalty agreement contains a clause that allows us to claim a credit, starting in 2013, in the event that the royalty bearing sales for the year are lower than a pre-determined amount set forth in this agreement. The following table summarizes our contractual obligations as of September 30, 2018 (in thousands):
|  | Payments due by period |
|  |  |  |  |  |  |  | 1-3 |  | 4-5 |  | More than |
Contractual Obligations |  | Total |  | Less than 1 year |  | years |  | years |  | 5 years |
Operating leases |  | $ | 452 |  | $ | 193 |  | $ | 233 |  | $ | 26 |  | $ | — |
Royalty agreement |  |  | 144 |  |  | 144 |  |  | — |  |  | — |  |  | — |
Total |  | $ | 596 |  | $ | 337 |  | $ | 233 |  | $ | 26 |  | $ | — |
Land Purchase and Investment Agreement We are in the process of relocating our gallium arsenide production line to 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 credits or rebates 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 3-D sensing VCSELs (vertical cavity surface emitting lasers)), 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, although on a smaller scale. The total investment targeted by AXT in Kazuo is approximately $15 million in value, assets and capital. In addition, BoYu has a similar agreement with the city of Kazuo. The total investment targeted by BoYu in Kazuo is approximately $8 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 September 30, 2018, we do not have any outstanding purchase orders that will incur a penalty if cancelled by the Company. Bank Loans In September 2018, Tongmei entered into a credit facility with Industrial and Commercial Bank of China (“ICBC”) in China with a $2.9 million line of credit at an annual interest rate of approximately 0.04% over the current Loan Prime Rate published by ICBC. Accrued interest is calculated and paid monthly. The annual interest rate was approximately 4.4% as of September 30, 2018. This credit line is secured by Tongmei’s land-use right and all of its buildings located at its facility in Beijing. The primary intended use of the credit facility is for general purposes, which may include working capital, capital expenditures and other corporate expenses. On September 30, 2018, we borrowed $291,000 against this credit line. The repayment of the full amount is due in September 2019. As of September 30, 2018, $291,000 was included in “Bank loan” in our condensed consolidated balance sheets. Legal Proceedings From time to time we may be involved in judicial or administrative proceedings concerning matters arising in the ordinary course of business. We do not expect that any of these matters, individually or in the aggregate, will have a material adverse effect on our business, financial condition, cash flows or results of operations.

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