Table ofContents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

----

 

**FORM 10-Q**

 

**(Mark One)**

 

| **x** | **Quarterly report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|-------|--------------------------------------------------------------------------------------------------------|

 

**for the quarterly period ended March 31, 2010**

 

**Or**

 

| **o** | **Transition report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**for thetransition periodfrom                 to**

 

**Commission File Number 000-24085**

 

----

 

**AXT,INC.**

(Exact name of registrant as specified in itscharter)

 

| **DELAWARE**                                                    | ** ** | **94-3031310**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  Incorporation or organization) |       | (I.R.S. Employer  Identification No.) |

 

**4281Technology Drive, Fremont, California 94538**

(Addressof principal executive offices)****(Zipcode)

 

**(510) 683-5900**

(Registrant’s telephone number, includingarea code)

 

----

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its Web site,if any, every Interactive Data File required to be submitted and postedpursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that theregistrant was required to submit and post such files).  Yes o No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 

| Large  accelerated filer o                     |   | Accelerated  filer o         |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated  filer x                       |   | Smaller  reporting company o |
| (Do not check if  a smaller reporting company) |   |                              |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  YES o NO x

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 

| **Class**                      | ** ** | **Outstanding at April 30, 2010** |
|--------------------------------|------------|-------------------------------------------------------|
| Common Stock, $0.001 par value |       | 30,997,701                                            |

 

 

 

----

Table of Contents

 

AXT, INC.

FORM 10-Q

TABLE OF CONTENTS

 
| ** **                                                                                                | **Page** |
|-----------------------------------------------------------------------------------------------------------|----------|
| PART I.  FINANCIAL INFORMATION                                                                       | 3        |
| Item 1.  Financial Statements (unaudited)                                                                 | 3        |
| Condensed  Consolidated Balance Sheets as of March 31, 2010 and December 31,  2009              | 3        |
| Condensed  Consolidated Statements of Operations for the three months ended  March 31, 2010 and 2009 | 4        |
| Condensed  Consolidated Statements of Cash Flows for the three months ended  March 31, 2010 and 2009 | 5        |
| Notes To Condensed Consolidated Financial Statements                                                      | 6        |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations      | 17       |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                       | 26       |
| Item 4. Controls and Procedures                                                                           | 27       |
| PART II. OTHER INFORMATION                                                                           | 28       |
| Item  1. Legal Proceedings                                                                                | 28       |
| Item  1A. Risk Factors                                                                                    | 28       |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                      | 28       |
| Item 3. Defaults Upon Senior Securities                                                                   | 28       |
| Item 4. [Reserved]                                                                                        | 28       |
| Item  5. Other Information                                                                                | 28       |
| Item 6. Exhibits                                                                                          | 28       |
| Signatures                                                                                                | 30       |

 

2

----

Table of Contents

 

**PART I.FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

AXT, INC.CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except per share data)

 
| ** **                                                                                                                                                                                                                                                                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                    | ** ** | **2010**           | ** ** | **2009 (1)**          | ** ** |
| Assets:                                                                                                                                                                                                                                                                       |       |               |       |                  |       |
| Current assets:                                                                                                                                                                                                                                                               |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                     |       | $                  | 20,607     |                  | $          | 16,934 |   |
| Short-term investments                                                                                                                                                                                                                                                        |       | 15,120             |       | 18,469                |       |
| Accounts receivable, net of allowances of $1,013  and $1,019 as of March 31, 2010 and December 31, 2009, respectively                                                                                                                                               |       | 15,166             |       | 15,362                |       |
| Inventories, net                                                                                                                                                                                                                                                              |       | 28,141             |       | 27,718                |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                     |       | 3,067              |       | 2,411                 |       |
| Total current assets                                                                                                                                                                                                                                                          |       | 82,101             |       | 80,894                |       |
| Long-term investments                                                                                                                                                                                                                                                         |       | 3,614              |       | —                |       |
| Property, plant and equipment, net                                                                                                                                                                                                                                            |       | 20,293             |       | 20,853                |       |
| Other assets                                                                                                                                                                                                                                                                  |       | 6,160              |       | 6,199                 |       |
| Total assets                                                                                                                                                                                                                                                                  |       | $                  | 112,168    |                  | $          | 107,946 |   |
|                                                                                                                                                                                                                                                                          |       |               |       |                  |       |
| Liabilities and stockholders’ equity:                                                                                                                                                                                                                                    |       |               |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                                                          |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                                                                                                              |       | $                  | 6,895      |                  | $          | 5,571 |   |
| Accrued liabilities                                                                                                                                                                                                                                                           |       | 4,975              |       | 4,566                 |       |
| Current portion of long-term debt                                                                                                                                                                                                                                             |       | 77                 |       | 76                    |       |
| Total current liabilities                                                                                                                                                                                                                                                     |       | 11,947             |       | 10,213                |       |
| Long-term debt, net of current portion                                                                                                                                                                                                                                        |       | 401                |       | 420                   |       |
| Other long-term liabilities                                                                                                                                                                                                                                                   |       | 29                 |       | 62                    |       |
| Total liabilities                                                                                                                                                                                                                                                             |       | 12,377             |       | 10,695                |       |
| Commitments and contingencies (Note 10)                                                                                                                                                                                                                                  |       |               |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                                                                                                    |       |               |       |                  |       |
| Preferred  stock, $0.001 par value; 2,000 shares authorized; 883 shares issued and  outstanding as of March 31, 2010 and December 31, 2009  (Liquidation preference of $5.4 million as of March 31,  2010 and December 31, 2009) |       | 3,532              |       | 3,532                 |       |
| Common stock, $0.001 par value per share; 70,000  shares authorized; 30,971 and 30,880 shares issued and outstanding as of  March 31, 2010 and December 31, 2009, respectively                                                                                 |       | 30                 |       | 30                    |       |
| Additional paid-in capital                                                                                                                                                                                                                                                    |       | 188,117            |       | 187,871               |       |
| Accumulated deficit                                                                                                                                                                                                                                                           |       | (98,550            | )          | (101,130              | )          |
| Accumulated other comprehensive income                                                                                                                                                                                                                                        |       | 4,076              |       | 4,300                 |       |
| Total AXT, Inc. stockholders’ equity                                                                                                                                                                                                                                |       | 97,205             |       | 94,603                |       |
|                                                                                                                                                                                                                                                                          |       |               |       |                  |       |
| Noncontrolling interests                                                                                                                                                                                                                                                      |       | 2,586              |       | 2,648                 |       |
| Total stockholders’ equity                                                                                                                                                                                                                                               |       | 99,791             |       | 97,251                |       |
|                                                                                                                                                                                                                                                                          |       |               |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                               |       | $                  | 112,168    |                  | $          | 107,946 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

----

(1)   The condensed consolidatedbalance sheet at December 31, 2009 has been derived from the auditedconsolidated financial statements at that date.

 

3

----

Table of Contents

 

AXT, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share data)

 
| ** **                                                          | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                          | ** ** | **March 31,**               | ** ** |
| ** **                                                          | ** ** | **2010**                         | ** ** | **2009** | ** ** |
|                                                                |       |                             |       |   |   |
| Revenue                                                             |       | $                                | 18,641     |   | $ | 7,654 |   |
| Cost  of revenue                                                    |       | 11,909                           |       | 7,891 |   |
| Gross  profit (loss)                                                |       | 6,732                            |       | (237 | ) |
|                                                                |       |                             |       |   |   |
| Operating  expenses:                                                |       |                             |       |   |   |
| Selling,  general and administrative                                |       | 3,419                            |       | 4,006 |   |
| Research  and development                                           |       | 451                              |       | 460 |   |
| Restructuring  charge                                               |       | —                           |       | 507 |   |
| Total  operating expenses                                           |       | 3,870                            |       | 4,973 |   |
| Income  (loss) from operations                                      |       | 2,862                            |       | (5,210 | ) |
| Interest  income, net                                               |       | 15                               |       | 44 |   |
| Other  income (loss), net                                           |       | 79                               |       | (422 | ) |
|                                                                |       |                             |       |   |   |
| Income  (loss) before provision for income taxes                    |       | 2,956                            |       | (5,588 | ) |
| Provision  for income taxes                                         |       | (246                             | )          | (4 | ) |
| Net  income (loss)                                                  |       | 2,710                            |       | (5,592 | ) |
| Less:  Net income (loss) attributable to noncontrolling interest    |       | (130                             | )          | 76 |   |
| Net  income (loss) attributable to AXT, Inc.                   |       | $                                | 2,580      |   | $ | (5,516 | ) |
|                                                                |       |                             |       |   |   |
| Net  income (loss) attributable to AXT, Inc. per common share: |       |                             |       |   |   |
| Basic                                                               |       | $                                | 0.08       |   | $ | (0.18 | ) |
| Diluted                                                             |       | $                                | 0.08       |   | $ | (0.18 | ) |
|                                                                |       |                             |       |   |   |
| Weighted  average number of common shares outstanding:              |       |                             |       |   |   |
| Basic                                                               |       | 30,743                           |       | 30,434 |   |
| Diluted                                                             |       | 31,792                           |       | 30,434 |   |

 

See accompanyingnotes to condensed consolidated financial statements.

 

4

----

Table of Contents

 

AXT, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

 
| ** **                                                                            | ** ** | **Three Months Ended  March 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
| Cash flows from operating activities:                                                 |       |                                             |       |   |   |
| Net income (loss)                                                                     |       | $                                                | 2,710      |   | $ | (5,592 | ) |
|                                                                                  |       |                                             |       |   |   |
| Adjustments to reconcile net income (loss) to net  cash used in operating activities: |       |                                             |       |   |   |
| Depreciation                                                                          |       | 752                                              |       | 800 |   |
| Accretion of marketable securities premium                                            |       | —                                           |       | (4 | ) |
| Loss on disposal of property, plant and equipment                                     |       | 1                                                |       | 1 |   |
| Stock-based compensation                                                              |       | 114                                              |       | 458 |   |
| Restructuring charge                                                                  |       | —                                           |       | 507 |   |
| Realized loss (gain) on available for sale  investments                               |       | (120                                             | )          | — |   |
| Changes in assets and liabilities:                                                    |       |                                             |       |   |   |
| Accounts receivable, net                                                              |       | 196                                              |       | 3,108 |   |
| Inventories                                                                           |       | (505                                             | )          | 1,583 |   |
| Prepaid expenses and other current assets                                             |       | (655                                             | )          | 833 |   |
| Other assets                                                                          |       | 38                                               |       | 58 |   |
| Accounts payable                                                                      |       | 1,366                                            |       | (2,454 | ) |
| Accrued liabilities                                                                   |       | 325                                              |       | (544 | ) |
| Other long-term liabilities                                                           |       | 9                                                |       | (657 | ) |
| Net cash provided by (used in) operating  activities                                  |       | 4,231                                            |       | (1,903 | ) |
|                                                                                  |       |                                             |       |   |   |
| Cash flows from investing activities:                                                 |       |                                             |       |   |   |
| Purchases of property, plant and equipment                                            |       | (320                                             | )          | (135 | ) |
| Proceeds from sale of property, plant and  equipment                                  |       | 4                                                |       | — |   |
| Purchases of available for sale investments                                           |       | (6,284                                           | )          | (13 | ) |
| Proceeds from sale of available for sale  investments                                 |       | 6,120                                            |       | — |   |
| Decrease in restricted deposits                                                       |       | —                                           |       | 13 |   |
| Net cash used in investing activities                                                 |       | (480                                             | )          | (135 | ) |
|                                                                                  |       |                                             |       |   |   |
| Cash flows from financing activities:                                                 |       |                                             |       |   |   |
| Proceeds from common stock options exercised                                          |       | 132                                              |       | — |   |
| Dividends paid                                                                        |       | (192                                             | )          | — |   |
| Long-term debt payments                                                               |       | (18                                              | )          | (30 | ) |
| Net cash used in financing activities                                                 |       | (78                                              | )          | (30 | ) |
| Effect of exchange rate changes on cash and cash  equivalents                         |       | —                                           |       | 9 |   |
| Net increase (decrease) in cash and cash  equivalents                                 |       | 3,673                                            |       | (2,059 | ) |
| Cash and cash equivalents at the beginning of the  period                             |       | 16,934                                           |       | 13,566 |   |
| Cash and cash equivalents at the end of the period                                    |       | $                                                | 20,607     |   | $ | 11,507 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

5

----

Table ofContents

 

AXT, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

**Note 1.Basis of Presentation**

 

Theaccompanying condensed consolidated financialstatements of AXT, Inc. (“AXT,” the “Company,” “we,” “us,” and “our” referto AXT, Inc. and all of its consolidated subsidiaries) are unaudited, and have been prepared in accordance with accounting principlesgenerally accepted in the United States of America for interim financialinformation and with the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, the year-end condensed consolidated balance sheetdata was derived from our audited consolidated financial statements, but doesnot include all disclosures required by accounting principles generally accepted in the United States of America. In theopinion of our management, the unaudited condensed consolidated financialstatements reflect all adjustments, consisting only of normal recurringadjustments, considered necessary to present fairly the financial position,results of operations and cash flows of AXT and our consolidated subsidiariesfor all periods presented.

 

Ourmanagement has made a number of estimates and assumptions relating to thereporting of assets and liabilities and the disclosure of contingent assets andliabilities to prepare these condensed consolidated financial statements inconformity with accounting principlesgenerally accepted in the United States of America. Actual results coulddiffer materially from those estimates.

 

The results of operationsare not necessarily indicative of the results to be expected in the future orfor the full fiscal year. It is recommended that these condensed consolidatedfinancial statements be read in conjunction with our consolidated financialstatements and the notes thereto included in our 2009 Annual Report on Form 10-Kfiled with the Securities and Exchange Commission (the “SEC”) on March 22,2010.

 

Certainreclassifications have been made to the prior period consolidated financialstatements to conform to current period presentation.  These reclassifications had no impact onpreviously reported total assets, stockholders’ equity or net income (loss).

 

**Note****2****.Accounting for Stock-Based Compensation**

 

We account for stock-based compensation in accordance with theprovisions of FASB Accounting Standards Codification (“ASC”) topic 718, *Compensation-Stock Compensation*(“ASC 718”), whichestablished accounting for stock-based awards exchanged for employee services.Accordingly, stock-based compensation cost is measured at each grant date,based on the fair value of the award, and is recognized as expense over theemployee’s requisite service period of the award. All of the Company’s stock compensationis accounted for as an equity instrument. The provisions of ASC 718 applyto all awards granted or modified after the date of adoption which was January 1,2006. The unrecognized expense of awards not yet vested at the date of adoptionwill be recognized in net income (loss) in the periods after the date ofadoption using the same Black-Scholes valuation method and assumptionsdetermined under the original provisions of ASC 718.

 

We utilized the Black-Scholes valuation model for estimating the fairvalue of the stock compensation granted both before and after the adoption ofASC 718. The following table summarizes compensation costs related to ourstock-based compensation awards (in thousands, except per share data):

 
| ** **                                                                                                            | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
| Stock-based compensation in the form of  employee stock options, included in: |       |                                             |       |   |   |
|                                                                                                                  |       |                                             |       |   |   |
| Cost  of revenue                                                                                                      |       | $                                                | 10         |   | $ | 13 |   |
| Selling,  general and administrative                                                                                  |       | 97                                               |       | 418 |   |
| Research  and development                                                                                             |       | 7                                                |       | 27 |   |
|                                                                                                                  |       |                                             |       |   |   |
| Total  stock-based compensation                                                                                       |       | 114                                              |       | 458 |   |
| Tax  effect on stock-based compensation                                                                               |       | —                                           |       | — |   |
|                                                                                                                  |       |                                             |       |   |   |
| Net  effect on net income                                                                                             |       | $                                                | 114        |   | $ | 458 |   |
| Effect  on net income (loss) attributable to AXT, Inc. per common share:                                         |       |                                             |       |   |   |
| Basic                                                                                                                 |       | $                                                | 0.00       |   | $ | 0.02 |   |
| Diluted                                                                                                               |       | $                                                | 0.00       |   | $ | 0.02 |   |

 

6

----

Table of Contents

 

As of March 31, 2010 the total compensation costs related tounvested stock-based awards granted to employees under our stock option planbut not yet recognized was approximately $941,000, net of estimated forfeituresof $220,000. These costs will be amortized on a straight-line basis over aweighted-average period of approximately 3.19 years and will be adjusted forsubsequent changes in estimated forfeitures. We elected not to capitalizeany stock-based compensation to inventory as of March 31, 2010 due to theimmateriality of the amount.

 

The amortization of stock compensation under ASC 718 for the period after our January 1,2006 adoption is based on the single-option approach.

 

Weestimate the fair value of stock options using a Black-Scholes valuation model,consistent with the provisions of ASC 718. There were no stock option grants made in the threemonths ended March 31, 2010 and 2009.

 

The following tablesummarizes the stock option transactions during the three months ended March 31,2010 (in thousands, except per share data):

 
| ** **                                                     | ** ** | **Shares** | ** ** | **Weighted-  average  Exercise  Price** | ** ** | **Weighted-  average  Remaining  Contractual  Life  (in years****)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|---------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                     | ** ** | ** ** | ** ** | ** **                              | ** ** | ** **                                                                | ** ** | ** **                      | ** ** |
| Options outstanding as of January 1, 2010                 |       | 2,880      |       | $                                       | 2.46       |                                                                      |       |                            |       |   |
|                                                           |       |       |       |                                    |       |                                                                      |       |                            |       |
| Granted                                                        |       | —     |       | —                                  |       |                                                                      |       |                            |       |
|                                                           |       |       |       |                                    |       |                                                                      |       |                            |       |
| Exercised                                                      |       | (90        | )          | 1.48                                    |       |                                                                      |       |                            |       |
|                                                           |       |       |       |                                    |       |                                                                      |       |                            |       |
| Canceled and expired                                           |       | (8         | )          | 10.18                                   |       |                                                                      |       |                            |       |
|                                                           |       |       |       |                                    |       |                                                                      |       |                            |       |
| Options outstanding as of March 31, 2010                  |       | 2,782      |       | $                                       | 2.47       |                                                                      | 5.47       |                            | $          | 3,542 |   |
|                                                           |       |       |       |                                    |       |                                                                      |       |                            |       |
| Options vested and expected to vest as of  March 31, 2010 |       | 2,675      |       | $                                       | 2.49       |                                                                      | 5.31       |                            | $          | 3,405 |   |
|                                                           |       |       |       |                                    |       |                                                                      |       |                            |       |
| Options exercisable as of March 31, 2010                  |       | 1,829      |       | $                                       | 2.67       |                                                                      | 3.50       |                            | $          | 2,333 |   |

 

Asof December 31, 2009, options to purchase 1,900,000 shares at a weightedaverage exercise price of $2.64 per share were vested and exercisable.

 

Theaggregate intrinsic value in the table above represents the total pretaxintrinsic value, based on our closing price of $3.19 on March 31, 2010,which would have been received by the option holder had all option holdersexercised their options on that date. The total number of in-the-money optionsexercisable as of March 31, 2010 was 1,148,000.

 

Theoptions outstanding and exercisable as of March 31, 2010 were in thefollowing exercise price ranges:

** **
| **Options Outstanding as of March 31, 2010** | ** ** | **Options Exercisable  as of March 31, 2010** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| **Range of Exercise Price**                                 | ** ** | **Shares**                                                             | ** ** | **Weighted-  average  Exercise Price** | ** ** | **Weighted-  average  Remaining  Contractual Life** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
| $1.17 - $1.18                                                              |       | 340,000                                                                |       | $ | 1.17 |   | 2.34 |   | 340,000 |   | $ | 1.17 |   |
| $1.22 - $1.34                                                              |       | 260,842                                                                |       | $ | 1.31 |   | 4.76 |   | 260,842 |   | $ | 1.31 |   |
| $1.38 - $1.38                                                              |       | 305,400                                                                |       | $ | 1.38 |   | 3.44 |   | 305,400 |   | $ | 1.38 |   |
| $1.40 - $1.40                                                              |       | 1,094                                                                  |       | $ | 1.40 |   | 4.95 |   | 1,094 |   | $ | 1.40 |   |
| $1.59 - $1.59                                                              |       | 566,901                                                                |       | $ | 1.59 |   | 7.56 |   | 162,346 |   | $ | 1.59 |   |
| $1.88 - $1.98                                                              |       | 17,000                                                                 |       | $ | 1.93 |   | 4.89 |   | 17,000 |   | $ | 1.93 |   |
| $2.04 - $2.04                                                              |       | 488,700                                                                |       | $ | 2.04 |   | 9.57 |   | 0 |   | $ | 0 |   |
| $2.19 - $2.19                                                              |       | 312,600                                                                |       | $ | 2.19 |   | 2.65 |   | 312,600 |   | $ | 2.19 |   |
| $3.11 - $6.31                                                              |       | 440,219                                                                |       | $ | 4.90 |   | 4.88 |   | 380,797 |   | $ | 4.76 |   |
| $9.69 - $41.50                                                             |       | 49,000                                                                 |       | $ | 19.28 |   | 1.71 |   | 49,000 |   | $ | 19.28 |   |
|                                                                       |       | 2,781,756                                                              |       | $ | 2.47 |   | 5.47 |   | 1,829,079 |   | $ | 2.68 |   |

 

7

----

Table of Contents

 

There were 90,159 options exercised in thethree months ended March 31, 2010. The total intrinsic value of optionsexercised for the three months ended March 31, 2010 was $164,568. Cashreceived from options exercised for the three months ended March 31, 2010was $132,000. Therewere no options exercised in the three months ended March 31, 2009.

 

***Restricted stock awards***

 

A summary ofactivity related to restricted stock awards for the three months ended March 31,2010 is presented below:

 
| ** **                                                                 | ** ** | **Shares** | ** ** | **Weighted-Average  Grant Date Fair Value** | ** ** |
|----------------------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------|------------|
| Non-vested restricted stock shares outstanding as  of January 1, 2010 |       | 170,660    |       | $                                                          | 1.21       |   |
| Restricted stock shares granted                                            |       | —     |       | $                                                          | —     |   |
| Restricted stock shares vested                                             |       | —     |       | $                                                          | —     |   |
| Non-vested restricted stock shares outstanding as  of March 31, 2010  |       | 170,660    |       | $                                                          | 1.21       |   |

 

As of March 31, 2010, we had $136,000 of unrecognized compensationexpense, net of forfeitures, related to restricted stock awards, which will berecognized over the weighted average period of 1.78 years. During the threemonths ended March 31, 2010, no shares of restricted stock vested.

 

8

----

Table of Contents

 

**Note 3. Investments and Fair Value Measurements**

 

Ourcash, cash equivalents and investments, and strategic investments inprivately-held companies are classified as follows (in thousands):

 
| ** **                                   | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|----------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | ** **                   | ** ** | **Gross**                       | ** ** | **Gross** | ** ** | ** ** | ** ** | ** ** | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Amortized**                | ** ** | **Unrealized**                  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                   | ** ** | **Cost**                     | ** ** | **Gain**                        | ** ** | **(Loss)** | ** ** | **Value** | ** ** | **Cost** | ** ** | **Gain** | ** ** | **(Loss)** | ** ** | **Value** | ** ** |
| **Classified as:**                           |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash                                         |       | $                            | 20,520     |                            | $          | — |   | $ | — |   | $ | 20,520 |   | $ | 16,790 |   | $ | — |   | $ | — |   | $ | 16,790 |   |
| Cash equivalents:                            |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Money market fund                            |       | 87                           |       | —                          |       | — |   | 87 |   | 144 |   | — |   | — |   | 144 |   |
|                                         |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total cash equivalents                       |       | 87                           |       | —                          |       | — |   | 87 |   | 144 |   | — |   | — |   | 144 |   |
|                                         |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total cash and cash equivalents              |       | 20,607                       |       | —                          |       | — |   | 20,607 |   | 16,934 |   | — |   | — |   | 16,934 |   |
|                                         |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments:                                 |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Certificates of Deposit                      |       | 3,600                        |       |                            |       | (9 | ) | 3,591 |   |   |   |   |   |   |   |   |   |
| US Treasury and agency securities            |       | 1,037                        |       |                            |       | (7 | ) | 1,030 |   |   |   |   |   |   |   |   |   |
| Corporate bonds                              |       | 13,945                       |       | 186                             |       | (18 | ) | 14,113 |   | 18,298 |   | 171 |   | — |   | 18,469 |   |
| Total investments                            |       | 18,582                       |       | 186                             |       | (34 | ) | 18,734 |   | 18,298 |   | 171 |   | — |   | 18,469 |   |
| Total cash, cash equivalents and investments |       | $                            | 39,189     |                            | 186        |   | $ | (34 | ) | $ | 39,341 |   | $ | 35,232 |   | $ | 171 |   | $ | — |   | $ | 35,403 |   |
| **Contractual maturities on  investments:**  |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Due within 1 year                            |       | $                            | 14,941     |                            |       |   |   |   | $ | 15,120 |   | $ | 18,298 |   |   |   |   |   | $ | 18,469 |   |
| Due after 1 through 5 years                  |       | 3,641                        |       |                            |       |   |   | 3,614 |   | — |   |   |   |   |   | — |   |
|                                         |       | $                            | 18,582     |                            |       |   |   |   | $ | 18,734 |   | $ | 18,298 |   |   |   |   |   | $ | 18,469 |   |
|                                              |            |                              |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Wemanage our investments as a single portfolio of highly marketable securitiesthat is intended to be available to meet our current cash requirements. We haveno investments in auction rate securities. For the three months ended March 31,2010 we had $120,000 gross realized gains on sales of our available-for-salesecurities. For the three months ended March 31, 2009 we had no realizedgains or losses on sales of our available-for-sale securities.

 

Thegross unrealized losses related to our portfolio of available-for-salesecurities were primarily due to a decrease in the fair value of debtsecurities. We have determined that the gross unrealized losses on ouravailable-for-sale securities as of March 31, 2010 are temporary innature. We reviewed our investment portfolio to identify and evaluateinvestments that have indications of possible impairment. Factors considered indetermining whether a loss is temporary include the magnitude of the decline inmarket value, the length of time the market value has been below cost (oradjusted cost), credit quality, and our ability and intent to hold thesecurities for a period of time sufficient to allow for any anticipatedrecovery in market value. The following table provides a breakdown of ouravailable-for-sale securities with unrealized losses as of March 31, 2010(in thousands):

 
| ** **                        | ** ** | **In Loss Position  < 12 months** | ** ** | **Total In  Loss Position** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | ** **                                               | ** ** | **Gross**                             | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                        | ** ** | **Fair**                                                 | ** ** | **Unrealized**                        | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                        | ** ** | **Value**                                                | ** ** | **(Loss)**                            | ** ** | **Value** | ** ** | **(Loss)** | ** ** |
| Investments:                      |       |                                                     |       |                                  |       |   |   |   |   |
| Certificates of Deposit           |       | $                                                        | 3,591      |                                  | $          | (9 | ) | $ | 3,591 |   | $ | (9 | ) |
| US Treasury and agency securities |       | 1,030                                                    |       | (7                                    | )          | 1,030 |   | (7 | ) |
| Corporate bonds                   |       | 1,628                                                    |       | (18                                   | )          | 2,626 |   | (18 | ) |
| Total in loss position            |       | $                                                        | 6,249      |                                  | $          | (34 | ) | $ | 7,248 |   | $ | (34 | ) |

 

9

----

Table of Contents

 

***Investmentsin Privately-held Companies***

 

We have made strategic investments in privatecompanies located in China in order to gain access at a competitive cost to rawmaterials that are critical to our substrate business (see Note 9). Theinvestment balances for the two companies accounted for under the equity methodare included in “other assets” in the condensed consolidated balance sheets andtotaled $4.3 million and $4.2 million as of March 31, 2010 and December 31,2009, respectively. We have investments in three unconsolidated privately-heldcompanies accounted for under the cost method. As of March 31, 2010 and December 31,2009, our investments in the three unconsolidated privately-held companiesaccounted for under the cost method had a carrying value of $0.7 million and $0.7million, respectively, and are included in “other assets” in the condensedconsolidated balance sheets.

 

***FairValue Measurements***

 

On January 1, 2008, we adopted ASC topic 820, *FairValue Measurements and Disclosures* (“ASC 820”)which defines fair value,establishes a framework for using fair value to measure assets and liabilities,and expands disclosures about fair value measurements. ASC 820 applieswhenever other statements require or permit assets or liabilities to bemeasured at fair value. ASC 820 applies to all financial assets and financialliabilities that are being measured and reported on a fair value basis andrequires disclosure that establishes a framework for measuring fair value andexpands disclosure about fair value measurements.

 

The following table summarizes our financial assets and liabilitiesmeasured at fair value on a recurring basis in accordance with ASC 820 asof March 31, 2010 (in thousands):

 
| ** **                        | ** ** | **Balance as of  March 31, 2010** | ** ** | **Quoted Prices in  Active Markets of  Identical Assets  (Level 1)** | ** ** | **Significant Other  Observable  Inputs  (Level 2)** | ** ** |
|-----------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| Assets:                           | ** ** | ** **                                            | ** ** | ** **                                                                                         | ** ** | ** **                                                     | ** ** |
| Cash and short-term investments:  |       |                                                  |       |                                                                                               |       |                                                           |       |
| Money market fund - Cash          |       | $                                                     | 87         |                                                                                               | $          | 87                                                             |       | $ | — |   |
| Certificates of deposit           |       | $                                                     | 3,591      |                                                                                               | —     |                                                           | 3,591      |   |
| US Treasury and agency securities |       | $                                                     | 1,030      |                                                                                               | —     |                                                           | 1,030      |   |
| Corporate bonds                   |       | 14,113                                                |       | —                                                                                             |       | 14,113                                                         |       |
| Total                             |       | $                                                     | 18,821     |                                                                                               | $          | 87                                                             |       | $ | 18,734 |   |
| Liabilities                       |       | $                                                     | —     |                                                                                               | $          | —                                                         |       | $ | — |   |

 

Our financial assets andliabilities are valued using market prices on both active markets(Level 1) and less active markets (Level 2). Level 1 instrumentvaluations are obtained from real-time quotes for transactions in activeexchange markets involving identical assets. Level 2 instrument valuationsare obtained from readily-available pricing sources for comparable instruments.As of March 31, 2010, we did not have any assets or liabilities withoutobservable market values that would require a high level of judgment todetermine fair value (Level 3 assets).

 

***Items Measured at Fair Value on a Nonrecurring Basis***

 

Certain assets that aresubject to nonrecurring fair value measurements are not included in the tableabove. These assets include equity and cost method investments in privatecompanies. We did not record other-than-temporary impairment charges for eitherof these investments during the first three months of 2010 or 2009.

 

**Note 4.Inventories, Net**

 

The components ofinventories are summarized below (in thousands):

 
| ** **        | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|--------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| Inventories, net: |       |               |       |                  |       |
| Raw materials     |       | $                  | 13,039     |                  | $          | 12,051 |   |
| Work in process   |       | 11,675             |       | 11,947                |       |
| Finished goods*   |       | 3,427              |       | 3,720                 |       |
|              |       | $                  | 28,141     |                  | $          | 27,718 |   |

 

----

* Finished goodsinclude $2.6 million and $2.1million of consigned inventory as of March 31,2010 and December 31, 2009, respectively.

 

10

----

Table of Contents

 

**Note 5.Restructuring Charge**

 

In March 2009,we reduced the workforce at our Fremont and Beijing facilities by approximately11 positions that were no longer required to support certain production andadministrative operations. This measure was being taken as part of our 2009operating plan. Accordingly, we recorded a restructuring charge of $507,000 in March 2009related to the reduction in force for severance-related expenses from thereduction in force, all of which were paid during the second quarter of 2009.We expect to save approximately $1.3 million annually in payroll and relatedexpenses. We had no restructuring charge in the first three months of 2010.

 

**Note 6. Net Income (Loss) Per Share**

 

Basic net income (loss) per common share is calculated bydividing net income (loss) available to common stockholders by the weightedaverage number of common shares outstanding during the period. Diluted netincome (loss) per common and common equivalent shares include the dilutiveeffect of common stock equivalents outstanding during the period calculatedusing the treasury stock method. Common stock equivalents consist of the sharesissuable upon the exercise of stock options.

 

A reconciliation of the numerators and denominators ofthe basic and diluted net income (loss) per share calculations is as follows(in thousands, except per share data):

 
| ** **                                                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
| Numerator:                                                                                 |       |                                             |       |   |   |
| Net income  (loss) attributable to AXT, Inc.                                          |       | $                                                | 2,580      |   | $ | (5,516 | ) |
| Less: Preferred  stock dividends                                                           |       | (44                                              | )          | (44 | ) |
|                                                                                       |       |                                             |       |   |   |
| Net  income (loss) available to common stockholders                                        |       | $                                                | 2,536      |   | $ | (5,560 | ) |
| Denominator:                                                                               |       |                                             |       |   |   |
| Denominator  for basic net income (loss) per share - weighted average common shares        |       | 30,743                                           |       | 30,434 |   |
| Effect  of dilutive securities:                                                            |       |                                             |       |   |   |
| Common  stock options                                                                      |       | 1,049                                            |       | — |   |
| Denominator  for dilutive net income (loss) per common share                               |       | 31,792                                           |       | 30,434 |   |
| Effect  on net income (loss) attributable to AXT, Inc. per common share:              |       |                                             |       |   |   |
| Basic                                                                                      |       | $                                                | 0.08       |   | $ | (0.18 | ) |
| Diluted                                                                                    |       | $                                                | 0.08       |   | $ | (0.18 | ) |
| Options  excluded from diluted net income (loss) per share as the impact is  anti-dilutive |       | 366                                              |       | 2,753 |   |

 

The883,000 shares of $0.001 par value Series A preferred stock issued on May 28,1999 are non-voting and non-convertible preferred stock with a 5.0% cumulativeannual dividend rate payable when declared by the board of directors, and a $4per share liquidation preference over common stock, and must be paid before anyliquidating distribution is made to common stockholders.

 

11

----

Table of Contents

 

**Note 7.Stockholders’ Equity and Other Comprehensive Income (Loss)**

 

**ConsolidatedStatements of Changes in Equity**

 
| ** **                                                 | ** ** | **Preferred  Stock** | ** ** | **Common  Stock** | ** ** | **Additional  Paid In Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Other  Comprehensive  Income/(loss)** | ** ** | **AXT, Inc.  stockholders  equity** | ** ** | **Noncontrolling  interests** | ** ** | **Total  stockholders’  equity** | ** ** |
|------------------------------------------------------------|------------|----------------------|------------|-------------------|------------|-------------------------------------------|------------|--------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|-------------------------------|------------|---------------------------------------|------------|
| Balance  as of December 31, 2009                      |       | $                    | 3,532      |              | $          | 30                                        |       | $                        | 187,871    |                                    | $          | (101,130                                 | )          | $                             | 4,300      |                                  | $          | 94,603 |   | $ | 2,648 |   | $ | 97,251 |   |
| Common  stock options exercised                            |       |                 |       |              |       | 132                                       |       |                     |       |                                    |       | 132                                      |       |                          |       | 132                                   |       |
| Stock-based  compensation                                  |       |                 |       |              |       | 114                                       |       |                     |       |                                    |       | 114                                      |       |                          |       | 114                                   |       |
| Comprehensive  loss:                                       |       |                 |       |              |       |                                      |       |                     |       |                                    |       |                                     |       |                          |       |                                  |       |
| Net  (loss) income                                         |       |                 |       |              |       |                                      |       | 2,580                    |       |                                    |       | 2,580                                    |       | 130                           |       | 2,710                                 |       |
| Dividend  declared                                         |       |                 |       |              |       |                                      |       |                     |       |                                    |       |                                     |       | (192                          | )          | (192                                  | )          |
| Change  in unrealized (loss) gain on marketable securities |       |                 |       |              |       |                                      |       |                     |       | (19                                     | ))         | (19                                      | )          |                          |       | (19                                   | )          |
| Currency  translation adjustment                           |       |                 |       |              |       |                                      |       |                     |       | (205                                    | )          | (205                                     | )          |                          |       | (205                                  | )          |
| Balance  as of March 31, 2010                         |       | $                    | 3,532      |              | $          | 30                                        |       | $                        | 188,117    |                                    | $          | (98,550                                  | )          | $                             | 4,076      |                                  | $          | 97,205 |   | $ | 2,586 |   | $ | 99,791 |   |

 

The components ofcomprehensive income (loss) are as follows (in thousands):

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                      | ** ** | **March 31,**               | ** ** |
| ** **                                                                      | ** ** | **2010**                         | ** ** | **2009** | ** ** |
|                                                                            |       |                             |       |   |   |
| Net income (loss)  attributable to AXT, Inc                                     |       | $                                | 2,580      |   | $ | (5,516 | ) |
| Other comprehensive  income, net of tax:                                        |       |                             |       |   |   |
| Change in foreign currency  translation gain (loss), net of tax                 |       | (205                             | )          | 2 |   |
| Change in unrealized gain  (loss) on available-for-sale investments, net of tax |       | (19                              | )          | 187 |   |
| Total other comprehensive  income, net of tax                                   |       | (224                             | )          | 189 |   |
| Comprehensive income  (loss)                                                    |       | 2,356                            |       | (5,327 | ) |
| Comprehensive income  attributable to the noncontrolling interest               |       | —                           |       | 1 |   |
| Comprehensive income  (loss) attributable to AXT, Inc.                     |       | $                                | 2,356      |   | $ | (5,326 | ) |

 

**Note 8.Segment Information and Foreign Operations**

 

***Segment Information***

*** ***

We operate in one segmentfor the design, development, manufacture and distribution of high-performancecompound semiconductor substrates and sale of materials. In accordance with ASCtopic 280,*Segment Reporting,*our chief operatingdecision-maker has been identified as the principal executive officer, whoreviews operating results to make decisions about allocating resources andassessing performance for the Company. Since we operate in one segment, allfinancial segment and product line information can be found in the consolidatedfinancial statements.

 

***Product Information***

 
| ** **                | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------|------------|--------------------------------------------------|------------|
| ** **                | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
| Revenue by  product type: |       |                                             |       |   |   |
| GaAs substrates           |       | $                                                | 13,434     |   | $ | 5,012 |   |
| InP  substrates           |       | 875                                              |       | 490 |   |
| Ge  substrates            |       | 1,640                                            |       | 622 |   |
| Raw  materials and other  |       | 2,692                                            |       | 1,530 |   |
| Consolidated              |       | $                                                | 18,641     |   | $ | 7,654 |   |

 

12

----

Table of Contents

 

***Geographical Information***

 

Thefollowing table represents revenue amounts (in thousands) reported for productsshipped to customers in the corresponding geographic region:

 
| ** **      | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------|------------|--------------------------------------------------|------------|
| ** **      | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
| Net  revenues:  |       |                                             |       |   |   |
| North  America* |       | $                                                | 4,531      |   | $ | 1,736 |   |
| Europe          |       | 3,768                                            |       | 2,213 |   |
| Japan           |       | 2,778                                            |       | 1,152 |   |
| Taiwan          |       | 2,582                                            |       | 689 |   |
| Asia  Pacific   |       | 4,982                                            |       | 1,864 |   |
| Consolidated    |       | $                                                | 18,641     |   | $ | 7,654 |   |

 

----

*Primarilythe United States

 

Long-livedassets consist primarily of property, plant and equipment, and are attributedto the geographic location in which they are located. Long-lived assets bygeographic region were as follows (in thousands):

 
| ** **                               | ** ** | **As of**     | ** ** |
|------------------------------------------|------------|--------------------|------------|
| ** **                               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                               | ** ** | **2010**           | ** ** | **2009** | ** ** |
| Long-lived assets by  geographic region: |       |               |       |   |   |
| North America                            |       | $                  | 666        |   | $ | 661 |   |
| China                                    |       | 19,627             |       | 20,192 |   |
|                                     |       | $                  | 20,293     |   | $ | 20,853 |   |

 

***Significant Customers***

*** ***

Onecustomer represented more than 10% of revenue for the three month period ended March 31,2010 while two customers each represented more than 10% of revenue at 14.2% and11.2% for the three month period ended March 31, 2009.  Our top five customers represented 39.6% and43.9% of revenue for the three month periods ended March 31, 2010 and2009, respectively.

 

We perform periodic creditevaluations of our customers’ financial condition and generally do not requirecollateral. Two customers each accounted for 10% or more of our trade accountsreceivable balance as of March 31, 2010 at 27%, and 13%, respectively.

 

**Note 9. Investments in Privately-held Companies**

 

We have made strategicinvestments in private companies located in China in order to gain access toraw materials at a competitive cost that are critical to our substrate business.

 

Our investments aresummarized below (in thousands):

 
| ** **                                                                 | ** ** | **Investment Balance as of** | ** ** | ** **            | ** ** | ** **     | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------|------------|----------------|------------|
| ** **                                                                 | ** ** | **March 31,**                          | ** ** | **December 31,** | ** ** | **Accounting** | ** ** | **Ownership** | ** ** |
| **Company**                                                                | ** ** | **2010**                                    | ** ** | **2009**              | ** ** | **Method**     | ** ** | **Percentage** | ** ** |
| Beijing JiYa Semiconductor  Material Co., Ltd                    |       | $                                           | 996        |                  | $          | 996            |       | Consolidated |   | 46 | % |
| Nanjing Jin Mei  Gallium Co., Ltd                                |       | 592                                         |       | 592                   |       | Consolidated   |       | 83 | % |
| Beijing BoYu Semiconductor  Vessel Craftwork Technology Co., Ltd |       | 410                                         |       | 410                   |       | Consolidated   |       | 70 | % |
| Xilingol Tongli  Germanium Co. Ltd                               |       | 3,371                                       |       | 3,367                 |       | Equity         |       | 25 | % |
| Emeishan Jia Mei High Purity  Metals Co., Ltd                    |       | 882                                         |       | 866                   |       | Equity         |       | 25 | % |
|                                                                            |            |                                             |            |                       |            |                |            |  |  |  |  |

 

13

----

Table of Contents

 

Our ownership of Beijing JiYa Semiconductor Material Co., Ltd. (JiYa) is 46%. We continue toconsolidate JiYa as we have significant influence in management and have amajority control of the board. Our chief executive officer is chairman of the JiYaboard, while our president of China operations and our vice president of Chinaadministration and our vice president of wafer production are also members ofthe JiYa board.

 

Our ownership of Nanjing JinMei Gallium Co., Ltd. (Jin Mei) is 83%. We continue to consolidateJin Mei as we have significant influence in management and have a majoritycontrol of the board. Ourchief executive officer is chairman of the Jin Mei board, while our presidentof China operations and our vice president of China administration are alsomembers of the Jin Mei board.

 

Our ownership of BeijingBoYu Semiconductor Vessel Craftwork Technology Co., Ltd (BoYu), is70%. We continue to consolidate Bo Yu as we have a significant influence overmanagement and have a majority control of the board. Our chief executive officer is chairmanof the BoYu board and our president of China operations and our vice presidentof China administration are members of the BoYu board.

 

Although we haverepresentation on the boards of directors of each of these companies, the dailyoperations of each of these companies are managed by local management and notby us. Decisions concerning their respective short term strategy andoperations, any capacity expansion and annual capital expenditures, anddecisions concerning sales of finished product, are made by local managementwithout input from us.

 

The investment balances forthe two companies accounted for under the equity method are included in otherassets in the consolidated balance sheets and totaled $4.3 million and$4.2 million as of March 31, 2010 and December 31, 2009,respectively. We own 25% of the ownership interests in each of these companies.These two companies are not considered variable interest entities because:

 

·                  both companieshave sustainable businesses of their own;

 

·                  our votingpower is proportionate to our ownership interests;

 

·                  we onlyrecognize our respective share of the losses and/or residual returns generatedby the companies if they occur; and

 

·                  we do not havecontrolling financial interest in, do not maintain operational or managementcontrol of, do not control the board of directors of, and are not required toprovide additional investment or financial support to either company.

 

During the three monthsended March 31, 2010 the three consolidated joint ventures had income of$0.5 million of which $0.1 million was allocated to minority interests,resulting in income of $0.4 million included in our net income. During thethree months ended March 31, 2009 the three consolidated joint ventureslost $0.3 million of income of which $0.1 million was allocated tominority interests, resulting in a loss of $0.2 million included in ournet loss. Our equity earnings from the two-minority owned joint ventures thatare not consolidated are recorded as other income (loss), net and totaled$21,000 and $7,000 for the three months ended March 31, 2010 and 2009,respectively. Undistributed retained earnings relating to all our investmentsin these companies were $12.8 million and $12.4 million as of March 31,2010 and December 31, 2009, respectively.

 

Our twominority-owned joint ventures that are not consolidated and accounted forunder the equity methodhad the following summarized income information (in thousands) for the threemonths ended March 31, 2010 and 2009, respectively.

 
| ** **        | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------|------------|--------------------------------------------------|------------|
| ** **        | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
|              |       |                                             |       |   |   |
| Net  Sales        |       | $                                                | 3,338      |   | $ | 2,104 |   |
| Gross  profit     |       | 895                                              |       | 687 |   |
| Operating  income |       | 123                                              |       | 73 |   |
| Net  income       |       | 82                                               |       | 29 |   |
|                   |            |                                                  |            |  |  |  |  |

 

We have investments in threeunconsolidated privately-held companies accounted for under the cost method. Asof March 31, 2010 and December 31, 2009, our investments in the threeunconsolidated privately-held companies accounted for under the cost method hada carrying value of $0.7 million and $0.7 million, respectively, and areincluded in “other assets” in the condensed consolidated balance sheets.

 

14

----

Table of Contents

 

**Note 10. Commitments and Contingencies**

 

***Indemnification Agreements***

 

Weenter into standard indemnification arrangements in the ordinary course ofbusiness. Pursuant to these arrangements, we indemnify, hold harmless, andagree to reimburse the indemnified parties for losses suffered or incurred bythe indemnified party, generally their business partners or customers, inconnection with any U.S. patent, or any copyright or other intellectualproperty infringement claim by any third party with respect to our products.The term of these indemnification agreements is generally perpetual anytimeafter the execution of the agreement. The maximum potential amount of futurepayments we could be required to make under these agreements is unlimited. Wehave never incurred costs to defend lawsuits or settle claims related to theseindemnification agreements. As a result, we believe the estimated fair value ofthese agreements is minimal.

 

Wehave entered into indemnification agreements with our directors and officersthat may require us to indemnify our directors and officers against liabilitiesthat may arise by reason of their status or service as directors or officers,other than liabilities arising from willful misconduct of a culpable nature; toadvance their expenses incurred as a result of any proceeding against them asto 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***

*** ***

Wewarrant our products for a specific period of time, generally twelve months,against material defects. We provide for the estimated future costs of warrantyobligations in cost of sales when the related revenue is recognized. Theaccrued warranty costs represent the best estimate at the time of sale of thetotal costs that we expect to incur to repair or replace product parts thatfail while still under warranty. The amount of accrued estimated warranty costsare primarily based on historical experience as to product failures as well ascurrent information on repair costs. On a quarterly basis, we review theaccrued balances and update these based on the historical warranty cost trends.The following table reflects the change in our warranty accrual which isincluded in “accrued liabilities” on the condensed consolidated balance sheets,during the three months ended March 31, 2010 and 2009 (in thousands):

 
| ** **                                    | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                    | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
| ** **                                    | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Beginning  accrued warranty and related costs |       | $                                                | 1,082      |   | $ | 1,640 |   |
| Charged  (credited) to cost of revenue        |       | 60                                               |       | 76 |   |
| Actual  warranty expenditures                 |       | (56                                              | )          | (253 | ) |
| Ending  accrued warranty and related costs    |       | $                                                | 1,086      |   | $ | 1,463 |   |

 

***Purchase Obligations***

 

Through the normal course ofbusiness, we purchase or place orders for the necessary materials of ourproducts from various suppliers and we commit to purchase products where we mayincur a penalty if the agreement was canceled. As of March 31, 2010, we donot have any outstanding material purchase obligations.

 

**Legal Proceedings**

 

Fromtime to time we may be involved in judicial or administrative proceedingsconcerning matters arising in the ordinary course of business. We do not expectthat any of these matters, individually or in the aggregate, will have amaterial adverse effect on our business, financial condition, cash flows orresults of operation.

 

**Note 11.Foreign Exchange Transaction Gains/Losses**

 

Weincurred foreign currency transaction exchange losses of $68,000 and $437,000for the three month periods ended March 31, 2010, and 2009, respectively.These amounts are included in “Other income (expense), net” on the condensedconsolidated statements of operations.

 

15

----

Table of Contents

 

**Note 12. Income Taxes**

 

In July 2006,the Financial Accounting Standards Board (“FASB”) issued ASC topic 740,*Income Taxes*(“ASC 740”). ASC 740 clarifies the accounting for uncertainty inincome taxes recognized in an enterprise’s financial statements in accordancewith ASC 740. This interpretation prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken or expected to be taken in a tax return. ASC 740 alsoprovides guidance on derecognition of tax benefits, classification on thebalance sheet, interest and penalties, accounting in interim periods,disclosure, and transition. We adopted ASC 740 effective January 1, 2007.We recognize interest and penalties related to uncertain tax positions inincome tax expense. As of March 31, 2010, we do not have any grossunrecognized tax benefits, nor any accrued interest and penalties related touncertain tax positions. As a result of the implementation of ASC 740, weidentified $16.4 million in the liability for unrecognized tax benefits.Of this amount, none was accounted for as a reduction to the January 1,2007 balance of retained earnings. The amount decreased the tax losscarryforwards in the U.S. which are fully offset by a valuation allowance. Wefile income tax returns in the U.S. federal, various states and foreignjurisdictions. We have substantially concluded all U.S. federal and stateincome tax matters through December 31, 2008.

 

**Note 13.Recent Accounting Pronouncements**

 

With the exception ofthose stated below, there have been no recent accounting pronouncements orchanges in accounting pronouncements during the three months ended March 31,2010, as compared to the recent accounting pronouncements described in theAnnual Report that are of material significance, or have potential materialsignificance, to the Company.

 

Effective April 1,2009, the Company adopted the Financial Accounting Standards Board’s (“FASB’s”)updated guidance Accounting Standards Update (ASU) topic 855, “*Subsequent Events”*, which establishesgeneral standards of accounting for and disclosure of events that occur afterthe balance sheet date but before financial statements are issued or areavailable to be issued. The updated guidance initially required thedisclosure of the date through which an entity has evaluated subsequent eventsand the basis for that date — that is, whether that date represents the datethe financial statements were issued or were available to be issued. However,in February 2010, the FASB amended the guidance to remove the requirementto disclose the date through which subsequent events were evaluated. Adoptionof the updated guidance did not have a material impact on the Company’sconsolidated results of operations or financial condition.

 

In October 2009,the FASB issued ASU No. 2009-13, “*Multiple-DeliverableRevenue Arrangements a Consensus of the FASB Emerging Issues Task Force*”an update to Accounting Standards Codification (ASC) Topic 605, “*Revenue Recognition*.”  This update requiresthe allocation of consideration among separately identified deliverablescontained within an arrangement, based on their related sellingprices.  This update will be effective for annual reporting periodsbeginning January 1, 2011.  The Company is currently evaluatingthe impact of this update on its financial position, results ofoperations, cash flows, and disclosures.

 

In January 2010,the FASB issued ASU No. 2010-06, “*Improving Disclosuresabout Fair Value Measurements*” an update to ASC Topic 820, “*Fair Value Measurements and Disclosures*.” This updaterequires an entity to: (i) disclose separately the amounts of significanttransfers in and out of Level 1 and Level 2 fair value measurements anddescribe the reasons for the transfers and (ii) present separateinformation for Level 3 activity pertaining to gross purchases, sales,issuances, and settlements.  This update became effective for us in thequarter ended March 31, 2010, except that the disclosure on the roll forwardactivities for Level 3 fair value measurements will become effective for uswith the reporting period beginning January 1, 2011. Other than requiringadditional disclosures, adoption of this new guidance did not have a materialimpact on the Company’s financial statements.

 

16

----

Table of Contents

 

**ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

This quarterly report on Form 10-Q, including thefollowing sections, contains forward-looking statements within the meaning of Section 21Eof the Securities Exchange Act of 1934, as amended, particularly statementsrelating to our expectations regarding results of operations, customer demand,our ability to expand our markets and increase sales, customer qualificationsof our products, gross margins, reliable supply and enhanced sourcinglead-times of raw materials, our reserve balances, our expected savings fromour workforce reduction, the impact of the adoption of certain accountingpronouncements, our investments in capital projects, and our belief that wehave adequate cash and investments to meet our needs over the next 12 months.These forward-looking statements are based upon management’s current views withrespect to future events and financial performance, and are subject to certainrisks and uncertainties that could cause actual results to differ materiallyfrom historical results or those anticipated in such forward-lookingstatements. Such risks and uncertainties include those set forth under thesection entitled “Risk Factors” below, which identify important factors thatcould cause actual results to differ materially from those predicted in anysuch forward-looking statements. We caution investors that actual results maydiffer materially from those projected in the forward-looking statements as aresult of certain risk factors identified in this Form 10-Q and otherfilings we have made with the Securities and Exchange Commission.Forward-looking statements may be identified by the use of terms such as “anticipates,”“believes,” “estimates,” “expects,” “intends,” and similar expressions.Statements concerning our future or expected financial results and condition,business strategy and plans or objectives for future operations areforward-looking statements.

 

Theseforward-looking statements are not guarantees of future performance. Readersare cautioned not to place undue reliance on these forward-looking statements,which speak only as of the date hereof. This discussion should be read inconjunction with Management’s Discussion and Analysis of Financial Conditionand Results of Operations included in our Annual Report on Form 10-K for theyear ended December 31, 2009 and the condensed consolidated financialstatements included elsewhere in this report.

 

**Overview**

 

We are a leadingworldwide developer and producer of high-performance compound and singleelement semiconductor substrates comprising gallium arsenide (GaAs), indiumphosphide (InP) and germanium (Ge). We currently sell the following substrateproducts in the sizes and for the applications indicated:

 
| **Product**            | ** ** | ** **                                  |
|------------------------|------------|---------------------------------------------|
| **Substrates**         | ** ** | **Diameter**                                | ** ** | **Applications** |
| GaAs (semi-insulating) |       | 2”, 3”, 4”, 5”, 6” |   | ·  Power  amplifiers and radio frequency integrated circuits for wireless handsets  (cell phones) |
|                   |       |                                        |   | ·  Direct  broadcast television |
|                   |       |                                        |   | ·   High-performance transistors |
|                   |       |                                        |   | ·   Satellite communications |
|                   |       |                                        |   |   |
| GaAs (semi-conducting) |       | 2”, 3”, 4”                   |   | ·  High  brightness light emitting diodes |
|                   |       |                                        |   | ·  Lasers |
|                   |       |                                        |   | ·   Optical couplers |
|                   |       |                                        |   |   |
| InP                    |       | 2”, 3”, 4”                   |   | ·   Broadband and fiber optic communications |
|                   |       |                                        |   |   |
| Ge                     |       | 2”, 4”                            |   | ·   Satellite and terrestrial solar cells |
|                   |       |                                        |   | ·   Optical applications |

 

We manufacture all of our semiconductor substrates using ourproprietary vertical gradient freeze (VGF) technology. Most of our revenue isfrom sales of GaAs substrates. We manufacture all of our products in the People’sRepublic of China (PRC or China), which generally has favorable costs forfacilities and labor compared to comparable facilities in the United States orEurope. We also have three majority-owned and two minority-owned joint venturesin China which provide us favorablepricing, reliable supply and enhanced sourcing lead-times for key raw materialswhich are central to our final manufactured products. These joint ventures produce products including 99.99% puregallium (4N Ga), high purity gallium, arsenic, germanium, germanium dioxide,paralytic boron nitride (pBN) crucibles and boron oxide. AXT’s ownershipinterest in these entities ranges from 25% to 83%. We consolidate the threeventures in which we own a majority or controlling financial interest andemploy equity accounting for the two joint ventures in which we have a 25%interest. We purchase portions of the materials produced by these ventures forour own use and the joint ventures sell the remainder of their production tothird parties. We use our direct sales force in the United Statesand independent sales representatives in Europe and Asia to market oursubstrates. We believe that, as the demand for compound semiconductorsubstrates is expected to increase, we are positioned to leverage our PRC-basedmanufacturing capabilities and access to favorably priced raw materials toincrease our market share.

 

17

----

Table of Contents

 

While the volatilebusiness and financial markets are prompting us to continue to take aconservative approach to our business, we remain optimistic about our business.Positive industry trends in the first quarter of 2010, coupled with ourcompetitive manufacturing and cost advantages give us confidence in our abilityto continue to drive future business in 2010. Following very challengingindustry conditions in the first half of 2009, we began to see stronger salesand improved gross margins in the second half of 2009. Our qualificationefforts in both gallium arsenide and germanium substrates have been successfuland we are pleased with our increasing diversification in these areas.

 

As of March 31,2010, our principal sources of liquidity were $39.3 million in cash and cashequivalents and short-term investments. This increased by $3.9 million comparedto cash and cash equivalents and short-term investments of $35.4 million at December 31,2009.

 

**Critical Accounting Policies and Estimates**

 

We have preparedour condensed consolidated financial statements in accordance with accountingprinciples generally accepted in the United States of America. As such, we havehad to make estimates, assumptions and judgments that affect the amountsreported on our financial statements. These estimates, assumptions and judgmentsabout future events and their effects on our results cannot be determined withcertainty, and are made based upon our historical experience and on otherassumptions that are believed to be reasonable under the circumstances. Theseestimates may change as new events occur or additional information isobtained, and we may periodically be faced with uncertainties, theoutcomes of which are not within our control and may not be known for aprolonged period of time. The discussion and analysis of our results ofoperations and financial condition are based upon these condensed consolidatedfinancial statements.

 

We have identifiedthe policies below as critical to our business operations and understanding ofour financial condition and results of operations.

 

A criticalaccounting policy is one that is both material to the presentation of ourfinancial statements and requires us to make difficult, subjective or complexjudgments that could have a material effect on our financial condition andresults of operations. They may require us to make assumptions aboutmatters that are highly uncertain at the time of the estimate, and differentestimates that we could have used, or changes in the estimate that arereasonably likely to occur, may have a material impact on our financialcondition or results of operations.  Webelieve that the following are our critical accounting policies:

 

***Revenue Recognition***

 

We manufacture and sell high-performance compoundsemiconductor substrates and sell certain raw materials including gallium,germanium dioxide, and pBN crucibles. After we ship our products, there are noremaining obligations or customer acceptance requirements that would precluderevenue recognition. Our products are typically sold pursuant to a purchaseorder placed by our customers, and our terms and conditions of sale do notrequire customer acceptance. We recognize revenue upon shipment and transfer oftitle of products to our customers, which is either upon shipment from ourdock, receipt at the customer’s dock, or removal from consignment inventory atthe customer’s location, provided that we have received a signed purchaseorder, the price is fixed or determinable, title and risk of ownership havetransferred, collection of resulting receivables is probable, and productreturns are reasonably estimable. We do not provide training, installation orcommissioning services. Additionally, we may provide discounts or otherincentives to customers in order to secure business.

 

We provide for future returns based on historicalexperience, current economic trends and changes in customer demand at the timerevenue is recognized.

 

***Accounts Receivable and Allowance for Doubtful Accounts***

 

We periodically review thelikelihood of collection on our accounts receivable balances and provide anallowance for doubtful accounts receivable primarily based upon the age ofthese accounts. We provide a 100% allowance for receivables from U.S. customersin excess of 90 days and for receivables from customers located outside theU.S. in excess of 120 days. We assess the probability of collection based on anumber of factors, including the length of time a receivable balance has beenoutstanding, our past history with the customer and their creditworthiness.

 

As of March 31, 2010 and December 31,2009, our accounts receivable, net, balance was $15.2 million and $15.4million, respectively, which was net of an allowance for doubtful accounts of$0.2 million and $0.2 million, respectively. If actual uncollectible accountsdiffer substantially from our estimates, revisions to the estimated allowancefor doubtful accounts would be required, which could have a material impact onour financial results for the period.

 

18

----

Table of Contents

 

Theallowance for sales returns is also deducted from gross accounts receivable. As of March 31,2010 and December 31, 2009, our allowance for sales returns was $0.8 million and $0.9million, respectively.

 

***Warranty Reserve***

 

We maintain a warranty reserve based upon our claimsexperience during the prior twelve months. Warranty costs are accrued at thetime revenue is recognized. As of March 31, 2010 and December 31,2009, accrued product warranties totaled $1.1 million and $1.1 million,respectively. If actual warranty costs differ substantially from our estimates,revisions to the estimated warranty liability would be required, which couldhave a material impact on our financial condition and results of operations.

 

***Inventory Valuation***

 

Inventories are stated at the lower of cost ormarket. Cost is determined using the weighted average cost method. Ourinventory consists of raw materials as well as finished goods andwork-in-process that include material, labor and manufacturing overhead costs.Given the nature of our substrate products, and the materials used in themanufacturing process, the wafers and ingots comprising work-in-processmay be held in inventory for up to two years and three years, respectively,as the risk of obsolescence for these materials is low. We routinely evaluatethe levels of our inventory in light of current market conditions in order toidentify excess and obsolete inventory, and we provide a valuation allowancefor certain inventories based upon the age and quality of the product and theprojections for sale of the completed products. As of March 31, 2010 and December 31,2009, we had an inventory reserve of $9.9 million and $10.1 million,respectively, for excess and obsolete inventory. The majority of this inventoryhas not been scrapped, and accordingly, may be sold in future periods. Ifactual demand for our products were to be substantially lower than estimated,additional inventory adjustments for excess or obsolete inventory might berequired, which could have a material impact on our business, financialcondition and results of operations.

 

***Impairment of Investments***

 

We classify our investments in debt and equity securities asavailable-for-sale securities as prescribed by ASC topic 320, *Debt and Equity Securities.*All available-for-salesecurities with a quoted market value below cost (or adjusted cost) arereviewed in order to determine whether the decline is other-than-temporary.Factors considered in determining whether a loss is temporary include themagnitude of the decline in market value, the length of time the market valuehas been below cost (or adjusted cost), credit quality, and our ability andintent to hold the securities for a period of time sufficient to allow for anyanticipated recovery in market value.

 

In addition to our five joint ventures, we have in the past invested inequity instruments of privately-held companies for business and strategicpurposes. These investments are classified as other assets and are accountedfor under the cost method as we do not have the ability to exercise significantinfluence over their operations. We monitor our investments for impairment andrecord reductions in carrying value when events or changes in circumstancesindicate that the carrying value may not be recoverable. Determination ofimpairment is highly subjective and is based on a number of factors, includingan assessment of the strength of investee’s management, the length of time andextent to which the fair value has been less than our cost basis, the financialcondition and near-term prospects of the investee, fundamental changes to thebusiness prospects of the investee, share prices of subsequent offerings, andour intent and ability to hold the investment for a period of time sufficientto allow for any anticipated recovery in our carrying value.

 

***Fair Value of Investments***

 

In the current market environment, the assessment of the fair value ofdebt instruments can be difficult and subjective. The volume of tradingactivity of certain debt instruments has declined, and the rapid changesoccurring in today’s financial markets can lead to changes in the fair value offinancial instruments in relatively short periods of time. ASC 820 establishesthree 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 requiresignificant management judgment, and the estimation is not difficult.Level 2 instruments include observable inputs other than Level 1prices, such as quoted prices for identical instruments in markets withinsufficient volume or infrequent transactions (less active markets), issuercredit ratings, non-binding market consensus prices that can be corroboratedwith observable market data, model-derived valuations in which all significantinputs are observable or can be derived principally from or corroborated withobservable market data for substantially the full term of the assets orliabilities, or quoted prices for similar assets or liabilities. TheseLevel 2 instruments require more management judgment and subjectivitycompared to Level 1 instruments, including:

 

19

----

Table of Contents

 

·                  Determiningwhich instruments are most similar to the instrument being priced requiresmanagement to identify a sample of similar securities based on the couponrates, maturity, issuer, credit rating, and instrument type, and subjectivelyselect an individual security or multiple securities that are deemed mostsimilar to the security being priced.

 

·                  Determiningwhether a market is considered active requires management judgment. Ourassessment of an active market for our marketable debt instruments generallytakes into consideration activity during each week of the one-month periodprior to the valuation date of each individual instrument, including the numberof days each individual instrument trades and the average weekly trading volumein relation to the total outstanding amount of the issued instrument.

 

·                  Determiningwhich model-derived valuations to use in determining fair value requiresmanagement judgment. When observable market prices for identical securities orsimilar securities are not available, we price our marketable debt instrumentsusing non-binding market consensus prices that are corroborated with observablemarket data or pricing models, such as discounted cash flow models, with allsignificant inputs derived from or corroborated with observable market data.

 

Level 3 instruments include unobservable inputsto the valuation methodology that are significant to the measurement of fairvalue of assets or liabilities. The determination of fair value forLevel 3 instruments requires the most management judgment andsubjectivity. As of March 31, 2010, we did not have any assets orliabilities without observable market values that would require a high level ofjudgment to determine fair value (Level 3 assets).

 

***Impairment of Long-LivedAssets***

 

We evaluate the recoverability of property,equipment and intangible assets in accordance with ASC topic 360, *Impairment of Disposal of Long-Lived Assets.* When events andcircumstances indicate that long-lived assets may be impaired, we comparethe carrying value of the long-lived assets to the projection of futureundiscounted cash flows attributable to these assets. In the event that thecarrying value exceeds the future undiscounted cash flows, we record animpairment charge against income equal to the excess of the carrying value overthe assets’ fair value. Fair values are determined based on quoted marketvalues, discounted cash flows or internal and external appraisals, asapplicable. Assets held for sale are carried at the lower of carrying value orestimated net realizable value.

 

***Employee Stock Options***

 

We grant options to substantially all managementemployees and believe that this program helps us to attract, motivate andretain high quality employees, to the ultimate benefit of our stockholders.Effective January 1, 2006, we adopted the fair value recognitionprovisions of ASC 718, using the modified prospective application transitionmethod. Under this transition method, stock-based compensation cost wasrecognized in the condensed consolidated financial statements for allshare-based payments after January 1, 2006. Compensation cost recognizedincludes the estimated expense for the portion of the vesting period after January 1,2006 for share-based payments prior to, but not vested as of January 1,2006, based on the grant date fair value estimated in accordance with theoriginal provisions of ASC 718. We recognize these compensation costs net of anestimated forfeiture rate over the requisite service period of the award, whichis generally the vesting term of four years for stock options. Results for priorperiods have not been restated, as provided for under the modified prospectiveapplication transition method.

 

***Income Taxes***

 

We account for income taxes in accordance with ASC 740 which requiresthat deferred tax assets and liabilities be recognized using enacted tax ratesfor the effect of temporary differences between the book and tax bases ofrecorded assets and liabilities. ASC 740 also requires that deferred tax assetsbe reduced by a valuation allowance if it is more likely than not that a portionof the deferred tax asset will not be realized.

 

We provide for income taxes based upon the geographic composition ofworldwide earnings and tax regulations governing each region, particularlyChina. The calculation of tax liabilities involves significant judgment inestimating the impact of uncertainties in the application of complex tax laws,particularly in foreign countries such as China.

 

Effective January 1, 2007, we adopted ASC 740. See Note 12—“IncomeTaxes” in the notes to condensed financial statements for additionalinformation.

 

20

----

Table ofContents

 

**Results ofOperations**

 

**Revenue**

 
| ** **     | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase**                   | ** ** | ** **     | ** ** |
|----------------|------------|--------------------------------------------------|------------|--------------------------------|------------|----------------|------------|
| ** **     | ** ** | **2010**                                         | ** ** | **2009**                       | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **     | ** ** | ** **                                       | ** ** | **($ in thousands)** | ** ** | ** **     | ** ** | ** ** | ** ** |
| GaAs           |       | $                                                | 13,434     |                           | $          | 5,012          |       | $ | 8,422 |   | 168.0 | % |
| InP            |       | 875                                              |       | 490                            |       | 385            |       | 78.6 | % |
| Ge             |       | 1,640                                            |       | 622                            |       | 1,018          |       | 163.7 | % |
| Raw  materials |       | 2,692                                            |       | 1,530                          |       | 1,162          |       | 75.9 | % |
| Total  revenue |       | $                                                | 18,641     |                           | $          | 7,654          |       | $ | 10,987 |   | 143.5 | % |

 

Revenue increased $11.0million, or 143.5%, to $18.6 million for the three months ended March 31,2010 from $7.7 million for the three months ended March 31, 2009. TotalGaAs substrate revenue increased $8.4 million, or 168.0%, to $13.4 million forthe three months ended March 31, 2010 from $5.0 million for the three monthsended March 31, 2009. The increase in revenue was primarily due to thestronger demand environment compared to the prior year, particularly for ourGaAs product.

 

Sales of 5 inch and 6inch diameter GaAs substrates were $5.3 million for the three months ended March 31,2010 compared to $1.2 million for the three months ended March 31, 2009.

 

Sales of 2 inch, 3 inchand 4 inch diameter GaAs substrates were $8.1 million for the three monthsended March 31, 2010 compared with $3.7 million for the three months endedMarch 31, 2009. The increase in revenue from smaller diameter substrateswas due to the stronger demand environment compared to the worldwide economicslowdown we experienced in the prior year.

 

InP substrate revenueincreased $385,000, or 78.6%, to $875,000 for the three months ended March 31,2010 from $490,000 for the three months ended March 31, 2009 as demandfrom customers in the optical networking industry has increased.

 

Ge substrate revenueincreased $1.0 million, or 163.7%, to $1.6 million for the three months ended March 31,2010 from $0.6 million for the three months ended March 31, 2009. Thisincrease came from our new European customer for germanium substrates that wedid not have in the first quarter of 2009, as well as from an increase inoverall demand for concentrated photovoltaic applications from our other Gecustomers.

 

Raw materials revenueincreased $1.2 million, or 75.9%, to $2.7 million for the three months ended March 31,2010 from $1.5 million for the three months ended March 31, 2009. Theincrease in raw materials revenue was primarily due to the recovery in demandfor 4N gallium.

 

***Revenue by GeographicRegion***

 
| ** **                                 | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                 | ** ** | **2010**                                         | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                 | ** ** | **($ in thousands)**                   | ** ** | ** **   | ** ** | ** **     | ** ** |
| North America *                            |       | $                                                | 4,531      |         | $          | 1,736          |       | $ | 2,795 |   | 161.0 | % |
| *% of  total revenue*                      |       | 24                                               | %          | 23           | %          |           |       |   |   |
| Europe                                     |       | 3,768                                            |       | 2,213        |       | 1,555          |       | 70.3 | % |
| *% of  total revenue*                      |       | 20                                               | %          | 29           | %          |           |       |   |   |
| Japan                                      |       | 2,778                                            |       | 1,152        |       | 1,626          |       | 141.1 | % |
| *% of  total revenue*                      |       | 15                                               | %          | 15           | %          |           |       |   |   |
| Taiwan                                     |       | 2,582                                            |       | 689          |       | 1,893          |       | 274.7 | % |
| *% of  total revenue*                      |       | 14                                               | %          | 9            | %          |           |       |   |   |
| Asia  Pacific (excluding Japan and Taiwan) |       | 4,982                                            |       | 1,864        |       | 3,118          |       | 167.3 | % |
| *% of total revenue*                       |       | 27                                               | %          | 24           | %          |           |       |   |   |
| Total  revenue                             |       | $                                                | 18,641     |         | $          | 7,654          |       | $ | 10,987 |   | 143.5 | % |

 

----

*Primarily the UnitedStates

 

Revenue from customers in North America increased by$2.8 million, or 161.0%, to $4.5 million for the three months ended March 31,2010 from $1.7 million for the three months ended March 31, 2009 as thedemand for substrates and for raw materials increased due to thestronger demand environment compared to the economic slowdown we experienced inthe prior year.

 

21

----

Table of Contents

 

Revenue from customers inEurope increased by $1.6 million, or 70.3%, to $3.8 million for the threemonths ended March 31, 2010 from $2.2 million for the three months ended March 31,2009. This increase came primarily from increased substrate sales to customersin Germany and to customers in France. In Germany, in the first quarter of2010, we have a new customer for germanium substrates that we did not have inthe first quarter of 2009.

 

Revenue from customers inJapan increased by $1.6 million, or 141.1%, to $2.8 million for the threemonths ended March 31, 2010 from $1.2 million for the three months ended March 31,2009. The increase came primarily from increased substrate sales to majorexisting customers, in both small and large diameter wafers, and to a lesserextent increased raw material sales of 4N gallium to existing customers.

 

Revenue from customers inTaiwan increased by $1.9 million, or 274.7%, to $2.6 million for the threemonths ended March 31, 2010 from $0.7 million for the three months ended March 31,2009. The increase came mainly from increased sales to five major customers asthe demand for GaAs substrates in all sizes and for 4” germanium substratesincreased due to the stronger demand environment compared to the economicslowdown we experienced in the prior year.

 

Revenue from customers inAsia Pacific (excluding Japan and Taiwan) increased by $3.1 million, or 167.3%,to $5.0 million for the three months ended March 31, 2010 from $1.9million for the three months ended March 31, 2009. The increase came fromseveral customers in China for both substrates and for raw materials, and fromone major customer in Singapore who is part of the IQE group.

 

***Gross Margin***

 
| ** **           | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|--------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2010**                                         | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Gross  profit (loss) |       | $                                                | 6,732      |         | $          | (237           | )     | $ | 6,969 |   | 2,940.5 | % |
| *Gross Margin %*     |       | 36.1                                             | %          | (3.1         | )%         |           |       |   |   |
|                      |            |                                                  |            |              |            |                |            |  |  |  |  |  |

 

Grossmargin increased to 36.1% of total revenue for the three months ended March 31,2010 from negative 3.1% of total revenue for the three months ended March 31,2009. Sales product mix, and process improvements in production such as longeringots and first pass yield improvements in ingots contributed to higher grossprofit for the three months ended March 31, 2010. During the three monthsended March 31, 2010, our manufacturing facility in Beijing was operatingat a higher utilization capacity compared to the same period in the prior year,which resulted in higher absorption rates. The negative 3.1 percent grossmargin for the three months ended March 31, 2009 was primarily due to thelow absorption rates as a result of reduced sales from the fourth quarter of2008, and hence lower production volume.

 

***Selling,General and Administrative Expenses***

 
| ** **                                    | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                    | ** ** | **2010**                                         | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                    | ** ** | **($ in thousands)**                   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Selling,  general and administrative expenses |       | $                                                | 3,419      |         | $          | 4,006          |       | $ | (587 | ) | (14.7 | )% |
| *% of total revenue*                          |       | 18.3                                             | %          | 52.3         | %          |           |       |   |   |
|                                               |            |                                                  |            |              |            |                |            |  |  |  |  |  |

 

Selling, general andadministrative expenses decreased $0.6 million to $3.4 million for the threemonths ended March 31, 2010 from $4.0 million for the three months ended March 31,2009. The $0.6 million decrease was from $0.5 million reduced legal fees, sincein the prior year we had higher legal fees as a result of matters relating tothe change in management in March 2009, in addition to $0.3 million in severancepay for our former chief executive officer, $0.3 million in related stockcompensation expense for his stock option acceleration, and $0.1 million for achief executive search fee. This was partially offset by a $0.4 millionincrease in the allowance for doubtful accounts and from a $0.2 millionincrease in sales commissions.

 

22

----

Table of Contents

 

***Researchand Development***

 
| ** **                | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|---------------------------|------------|--------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                | ** ** | **2010**                                         | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                | ** ** | **($ in thousands)**                   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Research  and development |       | $                                                | 451        |         | $          | 460            |       | $ | (9 | ) | (2.0 | )% |
| *% of total revenue*      |       | 2.4                                              | %          | 6.0          | %          |           |       |   |   |
|                           |            |                                                  |            |              |            |                |            |  |  |  |  |  |

 

Research and development expenses decreased $9,000, or2.0% to $451,000 for the three months ended March 31, 2010 from $460,000for the three months ended March 31, 2009. The decrease was primarily dueto $49,000 less labor costs mostly as a result of our restructuring in March 2009,partially offset by $40,000 higher new products testing costs.

 

***Restructuring Charge***

 
| ** **            | ** ** | **Three Months Ended   March 31,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-----------------------|------------|--------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **            | ** ** | **2010**                                               | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **            | ** ** | **($ in thousands)**                         | ** ** | ** **   | ** ** | ** **     | ** ** |
| Restructuring  charge |       | $                                                      | —     |         | $          | 507            |       | $ | (507 | ) | NM |   |
| *% of total revenue*  |       | 0.0                                                    | %          | 6.6          | %          |           |       |   |   |
|                       |            |                                                        |            |              |            |                |            |  |  |  |  |  |

 

NM = % not meaningful

 

During the first quarterof 2009, we further reduced the workforce at our Fremont and Beijing facilitiesby approximately 11 positions that were no longer required to support certainproduction and administrative operations. This measure was being taken as partof our 2009 operating plan. Accordingly, we recorded a restructuring charge of$507,000 in March 2009 related to the reduction in force forseverance-related expenses from the reduction in force, all of which were cashexpenditures incurred in the second quarter of 2009. We expect to saveapproximately $1.3 million annually in payroll and related expenses. We had norestructuring charge for the first quarter of 2010.

 

***InterestIncome, net***

 
| ** **            | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-----------------------|------------|--------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **            | ** ** | **2010**                                         | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **            | ** ** | **($ in thousands)**                   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Interest  income, net |       | $                                                | 15         |         | $          | 44             |       | $ | (29 | ) | (65.9 | )% |
| *% of total revenue*  |       | 0.1                                              | %          | 0.6          | %          |           |       |   |   |
|                       |            |                                                  |            |              |            |                |            |  |  |  |  |  |

 

Interest income, netdecreased $29,000 to $15,000 for the three months ended March 31, 2010from $44,000 for the three months ended March 31, 2009. Interest income,net for the three months ended March 31, 2009 was higher since we had$59,000 of interest income on investment notes that matured, partially offsetby $15,000 interest expense on our line of credit and tenant improvement loan.Interest income, net for the three months ended March 31, 2010 was loweras we did not have accrued interest on any notes maturing this quarter.

 

***Other Income (Loss), net***

 
| ** **                | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|---------------------------|------------|--------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                | ** ** | **2010**                                         | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                | ** ** | **($ in thousands)**                   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Other  income (loss), net |       | $                                                | 79         |         | $          | (422           | )     | $ | 501 |   | (118.7 | )% |
| *% of total revenue*      |       | 0.4                                              | %          | (5.5         | )%         |           |       |   |   |
|                           |            |                                                  |            |              |            |                |            |  |  |  |  |  |

 

Other income, net was$79,000 for the three months ended March 31, 2010 primarily due a realizedgain of $120,000 on the sale of short-term investments held by us, and $39,000,net, miscellaneous items, partially offset by unrealized foreign exchangelosses of $80,000 on our Yen denominated accounts receivable and miscellaneousitems. Other loss, net was $422,000 for the three months ended March 31,2009 primarily due to unrealized foreign exchange losses of $409,000 on our Yendenominated accounts receivable, and $13,000, net, miscellaneous items.

 

23

----

Table of Contents

 

***Provision for IncomeTaxes***

 
| ** **                  | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                  | ** ** | **2010**                                         | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                  | ** ** | **($ in thousands)**                   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Provision for  income taxes |       | $                                                | 246        |         | $          | 4              |       | $ | 242 |   | 6050.0 | %  |
| *% of  total revenue*       |       | 1.3                                              | %          | 0.0          | %          |           |       |   |   |
|                             |            |                                                  |            |              |            |                |            |  |  |  |  |  |

 

We provided for incometaxes of $246,000 for our China operations for the three months ended March 31,2010 compared to $4,000 for the three months ended March 31, 2009. Theincrease in tax provision was primarily due to increased sales and increasednet income in the first quarter of 2010 compared to the our overall loss positionfor the same period last year.

*** ***

***Noncontrolling interest***

 
| ** **               | ** ** | **Three Months Ended  March 31,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------|------------|--------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **2010**                                         | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**                   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Noncontrolling  interest |       | $                                                | (130       | )       | $          | 76             |       | $ | (206 | )  | (271.1 | )% |
| *% of total revenue*     |       | (0.7                                             | )%         | 1.0          | %          |           |       |   |   |
|                          |            |                                                  |            |              |            |                |            |  |  |  |  |  |

 

Net income (loss)attributable to noncontrolling interest changed $206,000 or 271.1% to anexpense of $130,000 for the three months ended March 31, 2010 from acontribution of $76,000 for the three months ended March 31, 2009 as aresult of higher profitability from our China joint venture operations as rawmaterials sales have increased due to increased demand compared to the sameperiod last year.

 

**Liquidityand Capital Resources**

 

As of March 31,2010, our principal sources of liquidity were $39.3 million in cash and cashequivalents and short-term investments. We consider cash and cash equivalentsand short-term investments as liquid and available for use. Short-terminvestments are comprised of government bonds and high-grade commercial debtinstruments. Approximately $12.3 million of our short-term investments incorporate bonds (see Note 3 to our condensed consolidated financial statements)are invested in Citigroup guaranteed instruments.

 

Cashand cash equivalents and short-term investments of $39.3 million increased by$3.9 million in the first quarter of 2010 compared to the fourth quarter of2009.

 

Net cash providedby operating activities of $4.2 million for the three months ended March 31,2010 was primarily comprised of our net income of $2.7 million, adjusted fornon-cash items of depreciation of $0.8 million, stock-based compensation of$0.1 million, a net decrease of $0.7 million in assets and liabilitiespartially offset by a gain on sale of investments of $0.1 million. The $0.7million net decrease in assets and liabilities primarily resulted from a $1.4million increase in accounts payable, a $0.3 million increase in accruedliabilities, and a $0.2 million increase in accounts receivable, partiallyoffset by a $0.7 million increase in prepaid expenses, and a $0.5 millionincrease in inventory.

 

Accountsreceivable, net increased by $0.2 million as of March 31, 2010 compared toDecember 31, 2009 due to higher sales volume, which was offset by improvedcollections. Our days sales outstanding (DSO) is 73 days as of March 31,2010 and was 79 days as of December 31, 2009.

 

Inventories, net,increased by $0.5 million as of March 31, 2010 compared to Decemeber 31,2009, as raw materials increased by $1.0 million due to timing of purchases,and we decreased work-in-process and finished goods by $0.5 million due tosales.

 

Net cash used inoperating activities of $1.9 million for the three months ended March 31,2009 was primarily comprised of our net loss of $5.5 million, adjusted for non-cashitems of depreciation of $0.8 million, stock-based compensation of $0.5million, and a non-cash restructuring charge of $0.5 million, partially offsetby a net decrease of $1.8 million in assets and liabilities. The $1.8 millionnet decrease in assets and liabilities primarily resulted from a $3.1 milliondecrease in accounts receivable, a $1.6 million decrease in inventories, and a$0.8 million decrease in prepaids and other assets, partially offset by a $2.5million decrease in accounts payable, a $0.7 million decrease in otherlong-term liabilities, primarily minority interests, and a $0.5 milliondecrease in accrued liabilities.

 

24

----

Table of Contents

 

Accounts receivable, netdecreased by $3.1 million as of March 31, 2009 due to the weaker demandenvironment which resulted in lower sales volume.

 

Inventories, net,decreased by $1.6 million as of March 31, 2009 as we decreased inventoryin work-in-process and finished goods by $2.1 million and shipped these out assales, partially offset by a $0.5 million increase in raw materials as demandfor raw material fell.

 

Net cash used ininvesting activities of $0.5 million for the three months ended March 31,2010 was primarily from the purchase of property, plant and equipment of $0.3million and partially offset by the net purchases of marketable securities of$0.2 million.

 

Net cash used ininvesting activities of $0.1 million for the three months ended March 31,2009 was primarily from the purchase of property, plant and equipment of $0.1million.

 

We expect to invest up toapproximately $8.7 million in capital projects at our China facilities forthe remainder of 2010, having delayed certain expansion activities as a resultof the impact of the 2009 worldwide economic conditions.

 

Net cash used infinancing activities of $78,000 for the three months ended March 31, 2010consisted of $192,000 dividends paid, and payments of $18,000 related to ourtenant improvement loan, partially offset by net proceeds of $132,000 on theissuance of common stock.

 

Net cash used infinancing activities of $30,000 for the three months ended March 31, 2009consisted of payments of $30,000 related to our tenant improvement loan.

 

We believe that we haveadequate cash and investments to meet our needs over the next 12 months.If our sales decrease, however, our ability to generate cash from operationswill 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 toseek additional capital. There can be no assurance that such additional capitalwill be available or, if available it will be at terms acceptable to us. Cashfrom operations could be affected by various risks and uncertainties,including, but not limited to those set forth below under Item 1A “RisksFactors.”

 

Outstandingcontractual obligations as of March 31, 2010 are summarized as follows (inthousands):

 
| ** **                       | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**                                 | ** ** | **Less than 1 year** | ** ** | **1-3  years** | ** ** | **3-5  years** | ** ** | **More than  5 years** | ** ** |
| Tenant improvement loan          |       | $                                         | 478        |   | $ | 77 |   | $ | 161 |   | $ | 174 |   | $ | 66 |   |
| Operating leases                 |       | 1,663                                     |       | 307 |   | 554 |   | 594 |   | 208 |   |
| Total                            |       | $                                         | 2,141      |   | $ | 384 |   | $ | 715 |   | $ | 768 |   | $ | 274 |   |

 

We lease certain officespace, manufacturing facilities and property under long-term operating leasesexpiring at various dates through November 2013. On July 2, 2008, weentered into a new lease agreement with the landlord of the facility at 4281Technology Drive, Fremont, California with approximately 27,760 square feet.The new lease commenced December 1, 2008 for a term of seven years, withan option by us to cancel the new lease after five years, upon forfeiture ofthe security deposit and payment of one-half of the fifth year’s rent. Totalrent expenses under these operating leases were approximately $0.1 millionand $0.1 million for the three months ended March 31, 2010 and 2009,respectively.

 

**RecentAccounting Pronouncements**

 

With the exception ofthose stated below, there have been no recent accounting pronouncements orchanges in accounting pronouncements during the three months ended March 31,2010, as compared to the recent accounting pronouncements described in theAnnual Report that are of material significance, or have potential materialsignificance, to the Company.

 

Effective April 1,2009, the Company adopted the Financial Accounting Standards Board’s (“FASB’s”)updated guidance Accounting Standards Update (ASU) topic 855, “*Subsequent Events”*, which establishesgeneral standards of accounting for and disclosure of events that occur afterthe balance sheet date but before financial statements are issued or areavailable to be issued. The updated guidance initially required the disclosureof the date through which an entity has evaluated subsequent events and thebasis for that date — that is, whether that date represents the date thefinancial statements were issued or were available to be issued. However, 

 

25

----

Table of Contents

 

in February 2010,the FASB amended the guidance to remove the requirement to disclose the datethrough which subsequent events were evaluated. Adoption of the updatedguidance did not have a material impact on the Company’s consolidated resultsof operations or financial condition.

 

In October 2009, theFASB issued ASU No. 2009-13, “*Multiple-DeliverableRevenue Arrangements a Consensus of the FASB Emerging Issues Task Force*”an update to Accounting Standards Codification (ASC) Topic 605, “*Revenue Recognition*.”  This update requiresthe allocation of consideration among separately identified deliverablescontained within an arrangement, based on their related sellingprices.  This update will be effective for annual reportingperiods beginning January 1, 2011.  The Company is currentlyevaluating the impact of this update on its financial position,results of operations, cash flows, and disclosures.

 

In January 2010,the FASB issued ASU No. 2010-06, “*Improving Disclosuresabout Fair Value Measurements*” an update to ASC Topic 820, “*Fair Value Measurements and Disclosures*.” This updaterequires an entity to: (i) disclose separately the amounts of significanttransfers in and out of Level 1 and Level 2 fair value measurements anddescribe the reasons for the transfers and (ii) present separateinformation for Level 3 activity pertaining to gross purchases, sales,issuances, and settlements.  This update became effective for us in thequarter ended March 31, 2010, except that the disclosure on the rollforward activities for Level 3 fair value measurements will become effectivefor us with the reporting period beginning January 1, 2011. Other thanrequiring additional disclosures, adoption of this new guidance did not have amaterial impact on the Company’s financial statements.

 

In various areas,including revenue recognition, stock option accounting, accounting standardsand practices continue to evolve. Additionally, the SEC and the FASB’s EmergingIssues Task Force continue to address revenues, stock option accounting relatedaccounting issues. We believe that we are in compliance with all of the rules andrelated guidance as they currently exist. However, any changes to accountingprinciples generally accepted in the United States of America in these areascould impact the future accounting of our operations.

 

**ITEM 3*.*QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

***Foreign Currency Risk***

 

A significant portion of ourbusiness is conducted in currencies other than the U.S. dollar. The functionalcurrency for our foreign operations is the renminbi, the local currency ofChina, where our operating expenses are predominantly in the local currency.Since most of our operations are conducted in China, most of our costs areincurred in Chinese currency, which subjects us to fluctuations in the exchangerates between the U.S. dollar and the Chinese renminbi. We incur transactiongains or losses resulting from consolidation of expenses incurred in localcurrencies for these subsidiaries, as well as in translation of the assets andliabilities of these assets at each balance sheet date. These risks may beincreased by the fluctuations and revaluations of the Chinese renminbi. Ourfinancial results could be adversely affected by factors such as changes inforeign currency exchange rates or weak economic conditions in foreign markets,including the revaluation by China of the renminbi, and any future adjustmentsthat China may make to its currency such as any move it might make to a managedfloat systems with opportunistic interventions. In the future we may experienceforeign exchange losses on our non-functional currency denominated receivables andpayables to the extent that we have not mitigated our exposure utilizingforeign currency forward exchange contracts. Foreign exchange losses could havea materially adverse effect on our operating results and cash flows.

 

We do not currently useshort-term forward exchange contracts for hedging purposes to reduce theeffects of adverse foreign exchange rate movements. We had previously purchasedforeign exchange contracts to hedge against certain trade accounts receivabledenominated in Japanese yen. The change in the fair value of the forwardcontracts was recognized as part of the related foreign currency transactionsas they occur. As of March 31, 2010, we had no outstanding commitmentswith respect to foreign exchange contracts.

 

During the first quarter of2010, we recorded a net realized foreign exchange gain of $12,000, included aspart of other income in our consolidated statements of operations. We incurredforeign currency transaction exchange gains and losses due to operations ingeneral. It is uncertain whether these currency trends will continue. In thefuture we may experience foreign exchange losses on our non-functional currencydenominated receivables and payables to the extent that we have not mitigatedour exposure utilizing foreign currency forward exchange contracts. Foreignexchange losses could have a materially adverse effect on our operating resultsand cash flows. During the first quarter of 2010, we recorded unrealizedforeign currency loss of $80,000, included in the balance of accumulated othercomprehensive income on our consolidated balance sheet.

 

In July 2005, Chinaagreed to a shift in Chinese currency policy. It established a 2% revaluationof the renminbi and referenced the renminbi to a basket of currencies, with adaily trading band of +/-0.3%. Depending on market conditions and thestate of the Chinese economy, it is possible that China will make moreadjustments in the future. Over the next five to ten years, China may move to a

 

26

----

Table of Contents

 

managed float system, with opportunisticinterventions. This reserve diversification may negatively impact the UnitedStates dollar and U.S. interest rates, which, in turn, could negatively impactour operating results and financial condition. The functional currency of ourChinese subsidiary, including our joint ventures, is the local currency; sincemost of our operations are conducted in China, most of our costs are incurredin Chinese currency, which subjects us to fluctuations in the exchange ratesbetween the U.S. dollar and the Chinese renminbi. We incur transaction gains orlosses resulting from consolidation of expenses incurred in local currenciesfor these subsidiaries, as well as in translation of the assets and liabilitiesof these assets at each balance sheet date. These risks may be increased by thefluctuation and revaluation of the Chinese renminbi. If we do not effectivelymanage the risks associated with this currency risk, our revenue, cash flowsand financial condition could be adversely affected.

 

***Interest RateRisk***

 

Cash and cash equivalentsearning interest and certain variable rate debt instruments are subject tointerest rate fluctuations. The following table sets forth the probable impactof a 10% change in interest rates (in thousands):

 
| **Instrument**                             | ** ** | **Balance as of  March 31,  2010** | ** ** | **Current  Interest  Rate** | ** ** | **Projected Annual  Interest  Income/(Expense)** | ** ** | **Proforma 10%  Interest Rate  Decline  Income/(Expense)** | ** ** | **Proforma 10%  Interest Rate  Increase  Income/(Expense)** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------|------------|-----------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| Cash                                       |       | $                                                 | 20,520     |                        | 0.50       | %                                                     | $          | 103                                                                  |       | $                                                                     | 92         |   | $ | 113 |   |
| Cash equivalents                           |       | 87                                                |       | 2.15                        |       | 2                                                     |       | 2                                                                    |       | 2                                                                     |       |
| Investment in debt and  equity instruments |       | 18,734                                            |       | 2.39                        |       | 448                                                   |       | 403                                                                  |       | 493                                                                   |       |
| Tenant improvement loan                    |       | (478                                              | )          | 4.00                        |       | (19                                                   | )          | (17                                                                  | )          | (21                                                                   | )          |
|                                       |       |                                              |       |                        |       | $                                                     | 534        |                                                                 | $          | 480                                                                   |       | $ | 587 |   |
|                                            |            |                                                   |            |                             |            |                                                       |            |                                                                      |            |                                                                       |            |  |  |  |  |

 

The primary objective of ourinvestment activities is to preserve principal while maximizing income withoutsignificantly increasing risk. Financial instruments that potentially subjectus to concentration of credit risk consist primarily of cash and cashequivalents, short-term investments, and trade accounts receivable. We investprimarily in money market accounts, commercial paper instruments, andinvestment grade securities. We are exposed to credit risks in the event ofdefault by the issuers to the extent of the amount recorded on the consolidatedbalance sheets. These securities are generally classified as available-for-saleand consequently are recorded on the balance sheet at fair value with unrealizedgains or losses reported as a separate component of accumulated othercomprehensive income (loss), net of estimated tax. Our cash, cash equivalentsand short-term investments are in high-quality securities placed with Citicorp.We have no investments in auction rate securities. As of March 31, 2010,we have approximately $12.3 million in principal protected notes with Citicorpwith a fair value of approximately $12.5 million. We expect to decrease ourexposure to Citicorp as these principal protected notes come due and theunderlying assets are placed into diversified securities.

 

***Accounts Receivable Risk***

 

We perform periodic creditevaluations of our customers’ financial condition and generally do not requirecollateral. Two customers each accounted for 10% or more of our trade accountsreceivable balance as of March 31, 2010 at 27%, and 13%, respectively.

 

***Equity Risk***

 

We maintain minorityinvestments in two privately-held companies other than our strategicinvestments in private companies located in China. These minority investmentsin two privately-held companies are reviewed for other than temporary declinesin value on a quarterly basis. These investments are classified as other assetsin the consolidated balance sheets and are accounted for under the cost methodas we do not have the ability to exercise significant influence over theiroperations. We monitor our investments for impairment and record reductions incarrying value when events or changes in circumstances indicate that thecarrying value may not be recoverable. Reasons for other than temporarydeclines in value include whether the related company would have insufficientcash flow to operate for the next twelve months, significant changes in theoperating performance and changes in market conditions. As of March 31,2010, the minority investments totaled $0.7 million.

 

**ITEM 4*.*CONTROLSAND PROCEDURES**

 

***Disclosure Controls andProcedures***

 

Underthe supervision and with the participation of our management, our ChiefExecutive Officer and Chief Financial Officer have evaluated the effectivenessof the design and operation of our disclosure controls and procedures, as suchterms are defined under Rule 13a-15(e) and 15d-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended. Based upon thatevaluation, our 

 

27

----

Table of Contents

 

Chief Executive Officer andour Chief Financial Officer concluded that our disclosure controls andprocedures were effective as of the end of the period covered by this quarterlyreport in ensuring that information required to be disclosed on SEC reports is (i) recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms, and (ii) accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding required disclosures.

 

***Changes in Internal Control OverFinancial Reporting***

 

No change in our internal control over financialreporting was made in the three months ended March 31, 2010 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**PART II.OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

Fromtime to time we may be involved in judicial or administrative proceedingsconcerning matters arising in the ordinary course of business. We do not expectthat any of these matters, individually or in the aggregate, will have amaterial adverse effect on our business, financial condition, cash flows orresults of operation.

 

**Item 1A. Risk Factors**

 

There are nomaterial changes from the risk factors set forth under Part I, Item 1A. “RiskFactors” in our Annual Report on Form 10-K for the fiscal year ended December 31,2009.

 

**Item 2.Unregistered Sales of Equity Securities and Use of Proceeds**

 

None

 

**Item 3. Defaults upon SeniorSecurities**

 

None

 

**Item 4. [Reserved]**

 

 

**Item 5. Other Information**

 

None

 

**Item 6. Exhibits**

 

**a. Exhibits**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                       |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                  |
| 3.1(1)              |       | Restated  Certificate of Incorporation                                                                                |
|                |       |                                                                                                                  |
| 3.2(2)              |       | Certificate of  Designation, Preferences and Rights of Series A Preferred Stock.                                 |
|                |       |                                                                                                                  |
| 3.3(3)              |       | Second Amended  and Restated By Laws                                                                                  |
|                |       |                                                                                                                  |
| 4.2(4)              |       | Rights Agreement  dated April 24, 2001 by and between AXT, Inc. and ComputerShare  Trust Company, Inc. |
|                |       |                                                                                                                  |
| 10.1(5)             |       | Supply Agreement signed January 29,  2010 between AXT, Inc. and AZUR SPACE Solar Power GmbH*                |
|                |       |                                                                                                                  |
| 31.1                |       | Certification by Chief Executive  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.             |

 

28

----

Table of Contents

 
| 31.2   |   | Certification by Chief Financial  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                      |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                           |
| 32.1   |   | Certification by Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                           |
| 32.2   |   | Certification by Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

----

(1) Incorporated byreference to the exhibit as of the same number as filed with the SEC in ourAnnual Report on Form 10-K for the year ended December 31, 1998.

 

(2) Incorporated byreference to Exhibit 3.1 to our Form 8-K as filed with the SEC on June 14,1999.

 

(3)  Incorporated by reference to Exhibit 3.4to our Form 8-K as filed with the SEC on May 30, 2001.

 

(4) Incorporated byreference to the exhibit of the same number as filed with the SEC in our Form 8-Kon May 30, 2001.

 

(5) Incorporatedby reference to Exhibit 10.31 to our Form 8-K as filed with the SECon February 2, 2010.

 

*Confidential treatment has been requested of the SEC for portions of thisexhibit.

 

29

----

Table of Contents

 

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this Report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
|                     | AXT, INC. |
|--------------------------|-----------|
|                     |      |   |
| Dated: May 17, 2010 | By:       | /s/ MORRIS S. YOUNG |
|                     |      | Morris S. Young |
| * *                 | * *  | *Chief  Executive Officer* |
| * *                 | * *  | *(Principal  Executive Officer)* |
|                     |      |   |
|                     |      | /s/ RAYMOND A. LOW |
|                     |      | Raymond A. Low |
| * *                 | * *  | *Chief Financial Officer* |
| * *                 | * *  | *(Principal  Financial Officer and**Principal  Accounting Officer)* |

 

30

----

Table of Contents

 

**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                        |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                                   |
|        |       |                                                                                                                                                                                                              |
| 3.1(1)      |       | Restated  Certificate of Incorporation                                                                                                                                                                            |
|        |       |                                                                                                                                                                                                              |
| 3.2(2)      |       | Certificate of  Designation, Preferences and Rights of Series A Preferred Stock (which  is incorporated herein by reference to Exhibit 2.1 to the registrant’s  form 8-K dated May 28, 1999). |
|        |       |                                                                                                                                                                                                              |
| 3.3(3)      |       | Second Amended  and Restated By Laws                                                                                                                                                                              |
|        |       |                                                                                                                                                                                                              |
| 4.2(4)      |       | Rights Agreement  dated April 24, 2001 by and between AXT, Inc. and ComputerShare  Trust Company, Inc.                                                                                             |
|        |       |                                                                                                                                                                                                              |
| 10.1(5)     |       | Supply Agreement signed January 29,  2010 between AXT, Inc. and AZUR SPACE Solar Power GmbH*                                                                                                            |
|        |       |                                                                                                                                                                                                              |
| 31.1        |       | Certification by Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                        |
|        |       |                                                                                                                                                                                                              |
| 31.2        |       | Certification by Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                        |
|        |       |                                                                                                                                                                                                              |
| 32.1        |       | Certification by Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                    |
|        |       |                                                                                                                                                                                                              |
| 32.2        |       | Certification by Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                    |

 

----

(1) Incorporated byreference to the exhibit of the same number as filed with the SEC in our AnnualReport on Form 10-K for the year ended December 31, 1998.

 

(2) Incorporated byreference to Exhibit 3.1 to our Form 8-K as filed with the SEC on June 14,1999.

 

(3) Incorporated byreference to Exhibit 3.4 to our Form 8-K as filed with the SEC on May 30,2001.

 

(4) Incorporated byreference to the exhibit of the same number as filed with the SEC in our Form 8-Kon May 30, 2001

 

(5) Incorporatedby reference to Exhibit 10.31 to our Form 8-K as filed with the SECon February 2, 2010.

 

*Confidential treatment has been requested of the SEC for portions of thisexhibit.

 

31

----