Investments in Privately-Held Raw Material Companies

6 Months Ended

Jun. 30, 2020

Investments in Privately-Held Raw Material Companies

Investments in Privately-Held Raw Material Companies

Note 7. Investments in Privately-Held Raw Material Companies

We have made strategic investments in private companies located in China in order to gain access at a competitive cost to raw materials that are critical to our substrate business. These companies form part of our overall supply chain.

As of June 30, 2020, the investments are summarized below (in thousands):

	Investment Balance as of
	June 30,		December 31,		Accounting	Ownership
Company	2020		2019		Method	Percentage
Nanjing JinMei Gallium Co., Ltd.	$	592	$	592	Consolidated	**100	%
Beijing JiYa Semiconductor Material Co., Ltd.		N/A		N/A	Consolidated	*46	%
Beijing BoYu Semiconductor Vessel Craftwork Technology Co., Ltd.		1,346		1,346	Consolidated	63	%
	$	1,938	$	1,938
Donghai County Dongfang High Purity Electronic Materials Co., Ltd.	$	1,383	$	1,326	Equity	46	%
Beijing JiYa Semiconductor Material Co., Ltd.		1,318		1,621	Equity	*39	%
Xilingol Tongli Germanium Co., Ltd.		—		—	Equity	25	%
Xiaoyi XingAn Gallium Co., Ltd.		2,351		2,367	Equity	25	%
Emeishan Jia Mei High Purity Metals Co., Ltd.		561		647	Equity	25	%
	$	5,613	$	5,961

* Ownership percentage decreased from 46% to 39% as of March 11, 2019 in connection with our sale of shares of this entity.

** In May 2019, we purchased the remaining 3% ownership interest from retiring members of the JinMei management team for approximately $413,000. As a result, our ownership of JinMei increased from 97% to 100%.

Effective as of March 11, 2019, we reduced our ownership in JiYa from 46% to 39% by selling a portion of our JiYa shares to our investor partner, which is also JiYa’s landlord. Based on an independent third party valuation analysis, we sold these shares for $366,000. Previously, we were the largest shareholder and, as such, we had the right to appoint the general manager of JiYa and the ability to exercise control in substance over JiYa’s long-term strategic direction. Further, our Chief Executive Officer was the chairman of JiYa’s board of directors and our Chief Financial Officer was a member of JiYa’s board of financial supervisors. As a result of this transaction, our investor partner, Shanxi Aluminum Industrial Co., Ltd., became the largest shareholder and assumed the right to appoint the general manager and thereby exercised greater control over JiYa’s long-term strategic direction. Further, although our Chief Executive Officer remains on the board, as of March 11, 2019 he was no longer the chairman of JiYa’s board of directors and our Chief Financial Officer was no longer a member of JiYa’s board of financial supervisors.

Previously, we accounted for JiYa’s financial performance under the consolidation method of accounting. As a result of the changes we began to account for JiYa’s financial performance under the equity method of accounting. Therefore, we deconsolidated JiYa from our consolidated financial statements as of March 11, 2019 in accordance with ASC 810. As of March 12, 2019, we accounted for our investment in JiYa under the equity method of accounting as we continue to have board representation and substantial ownership. Pro-forma financials have not been presented because we believe the effects were not material to our condensed consolidated financial position and results of operation for all periods presented. JiYa continues to be a related party to us after deconsolidation, whom we may purchase raw materials from for production in the ordinary course of business from time to time.

We recorded a gain on the deconsolidation of JiYa of $175,000 as a component of “Equity in loss of unconsolidated joint ventures” for the three months ended March 31, 2019 in the condensed consolidated statement of operations and comprehensive income (loss). On the date of deconsolidation, the fair value of the Company’s investment in JiYa exceeded the Company’s share of the net assets of JiYa, which generated the gain. As of March 12, 2019, we recorded our investment in JiYa at a fair value of $2,040,000, which was based on an independent third party valuation analysis. The valuation is based on the asset-based approach. The market-based approach is not deemed appropriate due

to lack of availability of market data for comparable companies on the open market and the discounted cash flow approach is not deemed reliable because of the difficulty in predicting the future profitability of JiYa due to the volatility of the gallium market, the concentration of customers and the significant accumulated losses of JiYa. The asset-based approach examines the value of a company’s assets net of its liabilities to derive a value for the equity holders. The gain on deconsolidation includes the following:

	Amount
	(in thousands)
Fair value of the consideration received	$	366
Fair value of the retained investment in Beijing JiYa Semiconductor Material Co., Ltd.		2,040
Carrying value of noncontrolling interest, net of accumulated other comprehensive income attributable to subsidiary		617
Derecognition of Beijing JiYa Semiconductor Material Co., Ltd.'s net asset		(2,848)
Gain recognized on deconsolidation of Beijing JiYa Semiconductor Material Co., Ltd.	$	175
	Amount
	(in thousands)
Fair value of the retained investment in Beijing JiYa Semiconductor Material Co., Ltd.	$	2,040
Carrying value of retained noncontrolling investment		(1,559)
Gain on retained noncontrolling investment due to remeasurement	$	481

Our ownership of JinMei is 100%. Before June 15, 2018, our ownership of JinMei was 83%. On June 15, 2018, we purchased a 12% ownership interest from one of the minority owners of JinMei for $1.4 million. The $1.4 million was scheduled to be paid in two installments. On June 15, 2018, we paid the first installment of $163,000. In May 2019, we paid the second installment of $1.2 million as the relocation of JinMei’s headquarters and manufacturing operations was nearly complete, which had been previously included in “Accrued liabilities” in our condensed consolidated balance sheets. As a result, our ownership of JinMei increased from 83% to 95%. In September 2018, we purchased a 2% ownership interest from one of the three remaining minority owners of JinMei for $252,000. As a result, our ownership of JinMei increased from 95% to 97%. In May 2019, we purchased the remaining 3% ownership interest from retiring members of the JinMei management team for approximately $413,000. We paid approximately $73,000 and $262,000 in April 2020 and May 2019, respectively, and plan to pay the remainder of approximately $78,000 at a date to be determined by both parties. As a result, our ownership of JinMei increased from 97% to 100%. Prior to June 1, 2019, we reported JinMei as a consolidated joint venture as we had a controlling financial interest and have majority control of the board. As of June 1, 2019, we now refer to it as a wholly-owned subsidiary and reduced the carrying value of the corresponding noncontrolling interests to zero. Our Chief Executive Officer is chairman of the JinMei board and we have appointed two other representatives to serve on the JinMei board.

Our ownership of BoYu is 63%. On November 2, 2017, BoYu raised additional capital in the amount of $2 million in cash from a third-party investor through the issuance of shares equivalent to 10% ownership of BoYu. As a result, our ownership of BoYu was diluted from 70% to 63%. We continue to consolidate BoYu as we have a controlling financial interest and have majority control of the board and, accordingly, no gain was recognized as a result of this equity transaction. Our Chief Executive Officer is chairman of the BoYu board and we have appointed two other representatives to serve on the board.

Although we have representation on the board of directors of each of the privately held raw material companies, the daily operations of each of these companies are managed by local management and not by us. Decisions concerning their respective short-term strategy and operations, ordinary course of business capital expenditures and sales of finished product, are made by local management with regular guidance and input from us.

During the three months ended June 30, 2020 and 2019, the consolidated joint ventures, before eliminating inter-company transactions, generated income of $1.6 million and $0.8 million, respectively, of which gains of $0.6 million and $0.3 million, respectively, were allocated to noncontrolling interests, resulting in an increase of $1.0 million and $0.5 million, respectively, to our net income. During the six months ended June 30, 2020 and 2019, the consolidated joint ventures, before eliminating inter-company transactions, generated income of $2.7 million and $1.5 million, respectively, of which gains of $1.0 million and $0.4 million, respectively, were allocated to noncontrolling interests, resulting in an increase of $1.7 million and $1.1 million respectively, to our net income. Our unaudited condensed consolidated statements of operations for the six months ended June 30, 2019 include JiYa’s results for the period through March 11, 2019.

For AXT’s minority investment entities that are not consolidated, the investment balances are included in “Other assets” in our condensed consolidated balance sheets and totaled $5.6 million and $6.0 million as of June 30, 2020 and December 31, 2019, respectively. Our respective ownership interests in each of these companies are 46%, 39%, 25%, 25% and 25%. These minority investment entities are not considered variable interest entities because:

● all minority investment entities have sustainable businesses of their own;

● our voting power is proportionate to our ownership interests;

● we only recognize our respective share of the losses and/or residual returns generated by the companies if they occur; and

● we do not have controlling financial interest in, do not maintain operational or management control of, do not control the board of directors of, and are not required to provide additional investment or financial support to any of these companies.

One of the minority investment entities in which we have a 25% ownership interest is a germanium materials company in China. This company provides results to us only on a quarterly basis. We received its preliminary first quarter 2019 financial results in early April 2019 as well as its projections for significant losses going forward. Such projected losses would fully deplete our asset investment balance for this company in 2019. This company is experiencing significant disruptions due to upgrades and repairs required to comply with stronger environmental regulations in China. As a result, we determined that this asset was fully impaired and wrote the asset balance down to zero. This resulted in a $1.1 million impairment charge in our first quarter 2019 financial results.

AXT’s minority investment entities are not consolidated and are accounted for under the equity method. Excluding one fully impaired entity, the equity entities had the following summarized income information (in thousands) for the three and six months ended June 30, 2020 and 2019:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2020		2019		2020		2019
Net revenue	$	3,605	$	4,559	$	7,558	$	11,000
Gross profit	$	958	$	1,165	$	2,026	$	1,114
Operating income (loss)	$	265	$	618	$	462	$	(1,421)
Net income (loss)	$	(160)	$	430	$	(158)	$	(2,016)

Our portion of the income and losses from these minority investment entities that are not consolidated and are accounted for under the equity method was a loss of $168,000 and an income of $8,000, respectively, for the three months ended June 30, 2020 and 2019. Our portion of the income and losses, including impairment charges, from these minority investment entities that are not consolidated and are accounted for under the equity method was a loss of $0.3 million and $1.6 million, respectively, for the six months ended June 30, 2020 and 2019.