**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC. 20549**

 

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**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, 2008**                                             |
| **or**                                                                                             |
| **o**                                                                                              | ** ** | **Transition report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |
| ** **                                                                                         | ** ** | ** **                                                                                              |
| **for the  transition period  from          to** |

 

**Commission File Number 000-24085**

 

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**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.) |

 

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

(Address of principal executive offices) (Zipcode)

 

**(510) 683-5900**

(Registrant’s telephone number, includingarea code)

 

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.YES  x  NO  o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). YES o  NO  x

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 

| **Class**                      | ** ** | **Outstanding  at April 30, 2008** |
|--------------------------------|------------|-----------------------------------------|
| Common Stock, $0.001 par value |       | 30,408,403                              |

 

 

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AXT, INC.FORM 10-QTABLE OF CONTENTS

 
| ** **                                                                                                | **Page** |
|-----------------------------------------------------------------------------------------------------------|----------|
| PART I.  FINANCIAL INFORMATION                                                                       | 3        |
| Item 1. Financial Statements  (unaudited)                                                                 | 3        |
| Condensed Consolidated  Balance Sheets as of March 31, 2008 and December 31, 2007               | 3        |
| Condensed Consolidated  Statements of Operations for the three months ended March 31, 2008 and  2007 | 4        |
| Condensed Consolidated  Statements of Cash Flows for the three months ended March 31, 2008 and  2007 | 5        |
| Notes To Condensed  Consolidated Financial Statements                                                     | 6        |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations       | 16       |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                       | 27       |
| Item 4. Controls and Procedures                                                                           | 28       |
| PART II. OTHER INFORMATION                                                                           | 29       |
| Item  1. Legal Proceedings                                                                                | 29       |
| Item  1A. Risk Factors                                                                                    | 29       |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                      | 29       |
| Item 3. Defaults Upon Senior Securities                                                                   | 29       |
| Item 4. Submission of Matters to a Vote of Security  Holders                                              | 29       |
| Item  5. Other Information                                                                                | 29       |
| Item 6.  Exhibits                                                                                         | 30       |
| Signatures                                                                                                | 31       |

 

2

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**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,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                               | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Assets:                                                                                                                                                                                  |       |               |       |                  |       |
| Current assets:                                                                                                                                                                          |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                |       | $                  | 23,225     |                  | $          | 18,380 |   |
| Short-term investments                                                                                                                                                                   |       | 16,217             |       | 20,825                |       |
| Accounts receivable, net of allowances of $187 and $379 as of  March 31, 2008 and December 31, 2007, respectively                                                              |       | 16,693             |       | 12,149                |       |
| Inventories, net                                                                                                                                                                         |       | 29,077             |       | 24,781                |       |
| Prepaid expenses and other current assets                                                                                                                                                |       | 5,405              |       | 3,569                 |       |
| Assets held for sale                                                                                                                                                                     |       | —             |       | 5,140                 |       |
| Total current assets                                                                                                                                                                     |       | 90,617             |       | 84,844                |       |
| Property, plant and equipment, net                                                                                                                                                       |       | 17,120             |       | 15,986                |       |
| Restricted deposits                                                                                                                                                                      |       | 6,550              |       | 6,700                 |       |
| Other assets                                                                                                                                                                             |       | 5,468              |       | 5,242                 |       |
| Total assets                                                                                                                                                                             |       | $                  | 119,755    |                  | $          | 112,772 |   |
|                                                                                                                                                                                     |       |               |       |                  |       |
| Liabilities and stockholders’ equity:                                                                                                                                               |       |               |       |                  |       |
| Current liabilities:                                                                                                                                                                     |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                         |       | $                  | 8,973      |                  | $          | 4,328 |   |
| Accrued liabilities                                                                                                                                                                      |       | 4,279              |       | 4,326                 |       |
| Current portion of long-term debt                                                                                                                                                        |       | 735                |       | 450                   |       |
| Income taxes payable                                                                                                                                                                     |       | 633                |       | 390                   |       |
| Total current liabilities                                                                                                                                                                |       | 14,620             |       | 9,494                 |       |
| Long-term debt, net of current portion                                                                                                                                                   |       | 6,100              |       | 6,250                 |       |
| Other long-term liabilities                                                                                                                                                              |       | 2,983              |       | 3,778                 |       |
| Total liabilities                                                                                                                                                                        |       | 23,703             |       | 19,522                |       |
| Commitments and contingencies (Note 10)                                                                                                                                             |       |               |       |                  |       |
| Stockholders’ equity:                                                                                                                                                               |       |               |       |                  |       |
| Preferred stock, $0.001 par value per share; 2,000 shares authorized;  883 shares issued and outstanding as of March 31, 2008 and  December 31, 2007.                          |       | 3,532              |       | 3,532                 |       |
| Common stock, $0.001 par value per share; 70,000 shares authorized;  30,395 and 30,358 shares issued and outstanding as of March 31, 2008 and  December 31, 2007, respectively |       | 30                 |       | 30                    |       |
| Additional paid-in capital                                                                                                                                                               |       | 186,187            |       | 185,949               |       |
| Accumulated deficit                                                                                                                                                                      |       | (96,584            | )          | (98,543               | )          |
| Accumulated other comprehensive income                                                                                                                                                   |       | 2,887              |       | 2,282                 |       |
| Total stockholders’ equity                                                                                                                                                          |       | 96,052             |       | 93,250                |       |
| Total liabilities and stockholders’ equity                                                                                                                                          |       | $                  | 119,755    |                  | $          | 112,772 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

3

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AXT, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share data)

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|
| ** **                                     | ** ** | **March 31,**               | ** ** |
| ** **                                     | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Revenue                                        |       | $                                | 19,634     |   | $ | 12,526 |   |
| Cost of revenue                                |       | 13,413                           |       | 7,121 |   |
| Gross profit                                   |       | 6,221                            |       | 5,405 |   |
| Operating expenses:                            |       |                             |       |   |   |
| Selling, general and administrative            |       | 3,667                            |       | 3,703 |   |
| Research and development                       |       | 504                              |       | 460 |   |
| Impairment on assets held for sale             |       | 83                               |       | — |   |
| Total operating expenses                       |       | 4,254                            |       | 4,163 |   |
| Income from operations                         |       | 1,967                            |       | 1,242 |   |
| Interest income, net                           |       | 124                              |       | 224 |   |
| Other income (expense), net                    |       | 428                              |       | (11 | ) |
| Income before provision for income taxes       |       | 2,519                            |       | 1,455 |   |
| Provision for incomes taxes                    |       | 560                              |       | 111 |   |
| Net income                                     |       | $                                | 1,959      |   | $ | 1,344 |   |
|                                           |       |                             |       |   |   |
| Net income per share:                          |       |                             |       |   |   |
| Basic                                          |       | $                                | 0.06       |   | $ | 0.04 |   |
| Diluted                                        |       | $                                | 0.06       |   | $ | 0.04 |   |
|                                           |       |                             |       |   |   |
| Shares used in computing net income per share: |       |                             |       |   |   |
| Basic                                          |       | 30,367                           |       | 29,798 |   |
| Diluted                                        |       | 31,585                           |       | 31,324 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

4

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AXT, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

 
| ** **                                                          | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                          | ** ** | **March 31,**               | ** ** |
| ** **                                                          | ** ** | **2008**                         | ** ** | **2007** | ** ** |
|                                                                |       |                             |       |   |   |
| Cash flows from operating activities:                               |       |                             |       |   |   |
| Net income                                                          |       | $                                | 1,959      |   | $ | 1,344 |   |
|                                                                |       |                             |       |   |   |
| Adjustments to reconcile net income to net cash used in operations: |       |                             |       |   |   |
| Depreciation                                                        |       | 478                              |       | 321 |   |
| Accretion of marketable securities premium/discount                 |       | —                           |       | (29 | ) |
| Impairment on assets held for sale                                  |       | 83                               |       | — |   |
| Stock-based compensation                                            |       | 170                              |       | 120 |   |
| Realized loss (gain) on sale of investments                         |       | (459                             | )          | 10 |   |
| Changes in assets and liabilities:                                  |       |                             |       |   |   |
| Accounts receivable, net                                            |       | (4,366                           | )          | 1,112 |   |
| Inventories                                                         |       | (4,028                           | )          | (4,096 | ) |
| Prepaid expenses                                                    |       | (1,701                           | )          | 380 |   |
| Other assets                                                        |       | (185                             | )          | (191 | ) |
| Accounts payable                                                    |       | 4,469                            |       | (658 | ) |
| Accrued liabilities                                                 |       | (100                             | )          | 684 |   |
| Income taxes                                                        |       | 221                              |       | (49 | ) |
| Other long-term liabilities                                         |       | (902                             | )          | (464 | ) |
| Net cash used in operating activities                               |       | (4,361                           | )          | (1,516 | ) |
|                                                                |       |                             |       |   |   |
| Cash flows from investing activities:                               |       |                             |       |   |   |
| Purchases of property, plant and equipment                          |       | (986                             | )          | (1,167 | ) |
| Proceeds from sale of assets held for sale                          |       | 5,057                            |       | — |   |
| Purchases of marketable securities                                  |       | (6,808                           | )          | (5,113 | ) |
| Proceeds from sale of marketable securities                         |       | 11,328                           |       | 3,060 |   |
| Decrease in restricted deposits                                     |       | 150                              |       | 150 |   |
| Net cash provided by (used in) investing activities                 |       | 8,741                            |       | (3,070 | ) |
|                                                                |       |                             |       |   |   |
| Cash flows from financing activities:                               |       |                             |       |   |   |
| Proceeds from issuance of common stock, net                         |       | 68                               |       | 3,708 |   |
| Long-term debt payments                                             |       | (150                             | )          | (229 | ) |
| Long-term debt proceeds                                             |       | 274                              |       | — |   |
| Net cash provided by financing activities                           |       | 192                              |       | 3,479 |   |
| Effect of exchange rate changes on cash and cash equivalents        |       | 273                              |       | 55 |   |
| Net increase (decrease) in cash and cash equivalents                |       | 4,845                            |       | (1,052 | ) |
| Cash and cash equivalents at the beginning of the period            |       | 18,380                           |       | 16,116 |   |
| Cash and cash equivalents at the end of the period                  |       | $                                | 23,225     |   | $ | 15,064 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

5

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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 principles generallyaccepted 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 subsidiaries for allperiods presented.

 

Ourmanagement  has made a number of estimatesand assumptions relating to the reporting of assets and liabilities and thedisclosure of contingent assets and liabilities to prepare these condensedconsolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Actualresults could differ materially from those estimates.

 

Theresults of operations are not necessarily indicative of the results to beexpected in the future or for the full fiscal year. It is recommended thatthese condensed consolidated financial statements be read in conjunction withour consolidated financial statements and the notes thereto included in our2007 Annual Report on Form 10-K filed with the Securities and ExchangeCommission on March 14, 2008.

 

**Note****2****. Accountingfor Stock-Based Compensation**

 

Effective January 1,2006, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(revised 2004), “*Share-Based Payment*,”(“SFAS 123(R)”). SFAS123(R) establishes accounting for stock-based awards exchanged foremployee services. Accordingly, stock-based compensation cost is measured atthe grant date, based on the fair value of the award, and is recognized asexpense over the employee requisite service period. All of our stock compensationis accounted for as an equity instrument. We previously applied AccountingPrinciples Board (“APB”) Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations and provided the required pro formadisclosures of SFAS No. 123, “*Accounting for Stock-BasedCompensation*”.

 

We elected the modified prospectivetransition method for adopting SFAS 123(R). Under this method, the provisionsof SFAS 123(R) apply to all awards granted or modified after the date ofadoption. The unrecognized expense of awards not yet vested at the date ofadoption will be recognized in net income in the periods after the date ofadoption using the same Black-Scholes valuation method and assumptionsdetermined under the original provisions of SFAS No. 123, “ *Accounting for Stock-Based Compensation,”*asdisclosed in our previous quarterly and annual reports.

 

The effect of recording stock compensation for thethree months ended March 31, 2008 and 2007 was as follows (in thousands, except per share data):

 
| ** **                                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Stock-based compensation in the form of employee stock options,  included in: |       |                                             |       |   |   |
|                                                                               |       |                                             |       |   |   |
| Cost of revenue                                                                    |       | $                                                | 16         |   | $ | 13 |   |
| Selling, general and administrative                                                |       | 122                                              |       | 89 |   |
| Research and development                                                           |       | 32                                               |       | 18 |   |
|                                                                               |       |                                             |       |   |   |
| Total stock-based compensation                                                     |       | 170                                              |       | 120 |   |
| Tax effect on stock-based compensation                                             |       | —                                           |       | — |   |
|                                                                               |       |                                             |       |   |   |
| Net effect on net income                                                           |       | $                                                | 170        |   | $ | 120 |   |
|                                                                               |       |                                             |       |   |   |
| Effect on basic net income per share                                               |       | $                                                | —     |   | $ | — |   |
| Effect on diluted net income per share                                             |       | $                                                | —     |   | $ | — |   |

 

6

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As of March 31, 2008, the total compensation costs related tounvested stock-based awards granted to employees under our stock option planbut not yet recognized was approximately $1,391,000 net of estimatedforfeitures of $449,000. This cost will be amortized on a straight-line basisover a weighted-average period of approximately 2.4 years and will be adjustedfor subsequent changes in estimated forfeitures. We elected not to capitalizeany stock-based compensation to inventory as of March 31, 2008 and December 31,2007, due to the immateriality of the amount.

 

The amortization of stock compensation under SFAS 123(R) for theperiod after our January 1, 2006 adoption is based on the single-optionapproach.

 

We estimate the fair value of stock options using aBlack-Scholes valuation model, consistent with the provisions of SFAS 123(R),and Securities and Exchange Commission Staff Accounting Bulletin No. 107.There were no stock option grants made in the three months ended March 31,2007. The fair value of our stock options granted to employees for the three months ended March 31,2008 was estimated using the following weighted-average assumptions:

 
| ** **                  | ** ** | **Three Months  Ended  March 31,** | ** ** |
|-----------------------------|------------|----------------------------------------------|------------|
| ** **                  | ** ** | **2008**                                     | ** ** |
| Expected term (in years)    |       | 4.0                                          |       |
|                        |       |                                         |       |
| Volatility                  |       | 60.79                                        | %          |
|                        |       |                                         |       |
| Expected dividend           |       | 0                                            | %          |
|                        |       |                                         |       |
| Risk-free interest rate     |       | 2.69                                         | %          |
|                        |       |                                         |       |
| Estimated forfeitures       |       | 14.64                                        | %          |
|                        |       |                                         |       |
| Weighted-average fair value |       | $                                            | 5.09       |   |
|                             |            |                                              |            |  |

 

7

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The following tablesummarizes the stock option transactions during the three months ended March 31,2008 (in thousands, except per share data):

 
| ** **                                                    | ** ** | **Shares**              | ** ** | **Weighted-  average  Exercise  Price** | ** ** | **Weighted-  average  Remaining  Contractual  Life** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------------------------------------|------------|-------------------------|------------|-----------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                    | ** ** | **(in years****)** | ** ** |
| Options outstanding as of December 31, 2007              |       | 2,477                   |       | $                                       | 2.95       |                                                 |       |                            |       |   |
|                                                          |       |                    |       |                                    |       |                                                 |       |                            |       |
| Granted                                                       |       | 2                       |       | 5.09                                    |       |                                                 |       |                            |       |
|                                                          |       |                    |       |                                    |       |                                                 |       |                            |       |
| Exercised                                                     |       | (38                     | )          | 1.82                                    |       |                                                 |       |                            |       |
|                                                          |       |                    |       |                                    |       |                                                 |       |                            |       |
| Canceled                                                      |       | (34                     | )          | 7.00                                    |       |                                                 |       |                            |       |
|                                                          |       |                    |       |                                    |       |                                                 |       |                            |       |
| Options outstanding as of March 31, 2008                 |       | 2,407                   |       | 2.91                                    |       | 6.79                                                 |       | $                               | 5,732      |   |
|                                                          |       |                    |       |                                    |       |                                                 |       |                            |       |
| Options vested and expected to vest as of March 31, 2008 |       | 2,164                   |       | $                                       | 2.83       |                                                 | 6.61       |                            | $          | 5,351 |   |
|                                                          |       |                    |       |                                    |       |                                                 |       |                            |       |
| Options exercisable as of March 31, 2008                 |       | 1,650                   |       | $                                       | 2.45       |                                                 | 6.00       |                            | $          | 4,677 |   |

 

Asof December 31, 2007, options to purchase 1,638,139 shares at a weightedaverage exercise price of $2.56 per share were vested and exerciseable.

 

Theaggregate intrinsic value in the table above represents the total pretaxintrinsic value, based on our closing price of $4.77 as of March 31, 2008,which would have been received by the optionholder had all optionholdersexercised their options as of that date. The total number of in-the-moneyoptions exerciseable as of March 31, 2008 was 1,919,444.

 

Theoptions outstanding and exercisable as of March 31, 2008 were in thefollowing exercise price ranges:

 
| **Options Outstanding as of March 31, 2008** | ** ** | **Options Exercisable  as of March 31, 2008** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| **Range of Exercise Price**                                 | ** ** | **Shares**                                                             | ** ** | **Weighted-average  Exercise Price** | ** ** | **Weighted-average  Remaining  Contractual Life** | ** ** | **Shares** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
| $ 1.17 - $  1.38                                            |       | 1,213,281                                                              |       | $ | 1.28 |   | 6.66 |   | 936,458 |   | $ | 1.29 |   |
| $ 1.39 - $  1.44                                            |       | 11,500                                                                 |       | $ | 1.41 |   | 7.14 |   | 8,042 |   | $ | 1.41 |   |
| $ 1.45 - $  2.24                                            |       | 445,863                                                                |       | $ | 2.17 |   | 5.09 |   | 430,571 |   | $ | 2.17 |   |
| $ 2.25 - $  6.31                                            |       | 677,995                                                                |       | $ | 4.95 |   | 8.43 |   | 216,431 |   | $ | 3.54 |   |
| $ 6.32 - $41.50                                                       |       | 58,500                                                                 |       | $ | 19.17 |   | 3.35 |   | 58,500 |   | $ | 19.17 |   |
|                                                                       |       | 2,407,139                                                              |       | $ | 2.91 |   | 6.79 |   | 1,650,002 |   | $ | 2.45 |   |

 

The total intrinsic value of optionsexercised for the three months ended March 31, 2008 and 2007, was $128,000and $70,000, respectively. Cash received from option exercises for the threemonths ended March 31, 2008 and 2007 was $68,000 and $45,000,respectively.

 

A summary ofactivity related to restricted stock awards for the three months ended March 31,2008 is presented below:

 
| ** **                                                                  | ** ** | **Shares** | ** ** | **Weighted-Average  Grant Date Fair Value** | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------|------------|
| Non-vested restricted stock shares outstanding at beginning of the  quarter |       | 23,480     |       | $                                                          | 4.26       |   |
| Restricted stock shares granted                                             |       | —     |       | $                                                          | —     |   |
| Restricted stock shares vested                                              |       | —     |       | $                                                          | —     |   |
| Non-vested restricted stock shares outstanding as of March 31,  2008   |       | 23,480     |       | $                                                          | 4.26       |   |

 

As of March 31, 2008, we had $76,000 ofunrecognized compensation expense, net of forfeitures, related to restrictedstock awards, which will be recognized over the weighted average period of 2.43years. During the three months ended March 31, 2008, no shares ofrestricted stock vested.

 

8

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**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, 2008** | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | ** **                   | ** ** | **Gross**                       | ** ** | **Gross** | ** ** | ** ** | ** ** | ** ** | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Amortized**                | ** ** | **Unrealized**                  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                    | ** ** | **Cost**                     | ** ** | **Gain**                        | ** ** | **(Loss)** | ** ** | **Value** | ** ** | **Cost** | ** ** | **Gain** | ** ** | **(Loss)** | ** ** | **Value** | ** ** |
| **Classified as:**                            |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash                                          |       | $                            | 8,308      |                            | $          | — |   | $ | — |   | $ | 8,308 |   | $ | 10,818 |   | $ | — |   | $ | — |   | $ | 10,818 |   |
| Cash equivalents:                             |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Money market fund                             |       | 14,917                       |       | —                          |       | — |   | 14,917 |   | 7,562 |   | — |   | — |   | 7,562 |   |
|                                          |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total cash equivalents                        |       | 14,917                       |       | —                          |       | — |   | 14,917 |   | 7,562 |   | — |   | — |   | 7,562 |   |
|                                          |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total cash and cash equivalents               |       | 23,225                       |       | —                          |       | — |   | 23,225 |   | 18,380 |   | — |   | — |   | 18,380 |   |
|                                          |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments:                                  |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Treasury and agency securities           |       | —                       |       | —                          |       | — |   | — |   | 1,400 |   | — |   | — |   | 1,400 |   |
| Asset-backed securities                       |       | —                       |       | —                          |       | — |   | — |   | 3,820 |   | — |   | (77 | ) | 3,743 |   |
| Commercial paper                              |       | 3,300                        |       | —                          |       | (115 | ) | 3,185 |   | 3,300 |   | — |   | (115 | ) | 3,185 |   |
| Corporate bonds                               |       | 20,060                       |       | —                          |       | (478 | ) | 19,582 |   | 19,051 |   | 260 |   | (114 | ) | 19,197 |   |
| Total investments                             |       | 23,360                       |       | —                          |       | (593 | ) | 22,767 |   | 27,571 |   | 260 |   | (306 | ) | 27,525 |   |
| Total cash, cash equivalents and  investments |       | $                            | 46,585     |                            | $          | — |   | $ | (593 | ) | $ | 45,992 |   | $ | 45,951 |   | $ | 260 |   | $ | (306 | ) | $ | 45,905 |   |
| **Contractual maturities on investments:**    |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Due within 1 year                             |       | $                            | —     |                            |       |   |   |   | $ | — |   | $ | 2,050 |   |   |   |   |   | $ | 2,050 |   |
| Due after 1 through 5 years                   |       | 23,360                       |       |                            |       |   |   | 22,767 |   | 25,521 |   |   |   |   |   | 25,475 |   |
|                                          |       | $                            | 23,360     |                            |       |   |   |   | $ | 22,767 |   | $ | 27,571 |   |   |   |   |   | $ | 27,525 |   |

 

Theinvestments include $6.6 million and $6.7 million recorded as restricteddeposits on the condensed consolidated balance sheets as of March 31, 2008and December 31, 2007, respectively, as a result of the outstandingprincipal amount on our industrial revenue bonds.

 

Wemanage our investments as a single portfolio of highly marketable securitiesthat is intended to be available to meet our current cash requirements. For thethree months ended March 31, 2008, we had $459,000 in gross realized gainson sales of our available-for-sale securities. For the three months ended March 31,2007 we had $10,000 in gross realized losses on sales of our available-for-salesecurities.

 

Thegross unrealized losses related to our portfolio of available-for-salesecurities were primarily due to a decrease in the fair value of debtsecurities as a result of an increase in interest rates during 2007 and thefirst three months of 2008. We have determined that the gross unrealized losseson our available-for-sale securities as of March 31, 2008 are temporary innature. We reviewed our investment portfolio to identify and evaluate investmentsthat have indications of possible impairment. Factors considered in determiningwhether a loss is temporary include the magnitude of the decline in marketvalue, the length of time the market value has been below cost (or adjustedcost), credit quality, and our ability and intent to hold the securities for aperiod of time sufficient to allow for any anticipated recovery in marketvalue. The 

 

9

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followingtable provides a breakdown of our available-for-sale securities with unrealizedlosses as of March 31, 2008 (in thousands):

 
| ** **                          | ** ** | **In Loss Position** | ** ** | **In Loss Position** | ** ** | **Total In**      | ** ** |
|-------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|------------------------|------------|
| ** **                          | ** ** | **< 12 months**   | ** ** | **> 12 months**   | ** ** | **Loss Position** | ** ** |
| ** **                          | ** ** | **Fair**                       | ** ** | **Gross**                      | ** ** | **Fair**               | ** ** | **Gross** | ** ** | **Fair** | ** ** | **Gross** | ** ** |
| ** **                          | ** ** | **Value**                      | ** ** | **Unrealized**                 | ** ** | **Value**              | ** ** | **Unrealized** | ** ** | **Value** | ** ** | **Unrealized** | ** ** |
| ** **                          | ** ** | ** **                     | ** ** | **(Loss)**                     | ** ** | ** **             | ** ** | **(Loss)** | ** ** | ** ** | ** ** | **(Loss)** | ** ** |
| Investments:                        |       |                           |       |                           |       |                   |       |   |   |   |   |   |   |
| U.S. Treasury and agency securities |       | $                              | 3,185      |                           | $          | (115                   | )          | $ | — |   | $ | — |   | $ | 3,185 |   | $ | (115 | ) |
| Corporate bonds                     |       | 19,582                         |       | (478                           | )          | —                 |       | — |   | 19,582 |   | (478 | ) |
| Total in loss position              |       | $                              | 22,767     |                           | $          | (593                   | )          | $ | — |   | $ | — |   | $ | 22,767 |   | $ | (593 | ) |

 

***Investments in 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). At March 31,2008 and December 31, 2007, our investments in privately-held companieshad a carrying value of $5.1 million and $4.9 million, respectively. Theinvestment balances for the two companies accounted for under the equity methodare included in “other assets” in the condensed consolidated balance sheets. Weown 25% of the ownership interests in each of these companies.

 

***Fair Value Measurements***

 

On January 1, 2008, we adopted SFAS No. 157, “*Fair Value Measurements*” (“SFAS No. 157”) whichdefines fair value, establishes a framework for using fair value to measureassets and liabilities, and expands disclosures about fair valuemeasurements.  SFAS No. 157 applies whenever other statements requireor permit assets or liabilities to be measured at fair value.  SFAS No. 157is effective for fiscal years beginning after November 15, 2007, exceptfor nonfinancial assets and liabilities that are recognized or disclosed atfair value in the financial statements on a nonrecurring basis, for whichapplication has been deferred for one year.

 

The followingtable summarizes the Company’s financial assets and liabilities measured atfair value on a recurring basis in accordance with SFAS No. 157 as ofMarch 31, 2008 (in thousands):

 
| ** **              | ** ** | **Balance as of  March 31, 2008** | ** ** | **Quoted Prices in  Active Markets of  Identical Assets  (Level 1)** | ** ** | **Significant Other  Observable Inputs  (Level 2)** | ** ** |
|-------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| Assets:                 | ** ** | ** **                                            | ** ** | ** **                                                                                         | ** ** | ** **                                                         | ** ** |
| Cash equivalents:       |       |                                                  |       |                                                                                               |       |                                                               |       |
| Money market funds .    |       | $                                                     | 14,917     |                                                                                               | $          | 14,917                                                             |       | $ | — |   |
| Short-term investments: |       |                                                  |       |                                                                                               |       |                                                               |       |
| Commercial paper        |       | 3,185                                                 |       | —                                                                                             |       | 3,185                                                              |       |
| Corporate bonds         |       | 19,582                                                |       | —                                                                                             |       | 19,582                                                             |       |
| Total                   |       | $                                                     | 37,684     |                                                                                               | $          | 14,917                                                             |       | $ | 22,767 |   |
|                    |       |                                                  |       |                                                                                               |       |                                                               |       |
| Liabilities             |       | $                                                     | —     |                                                                                               | $          | —                                                             |       | $ | — |   |

 

Our financialassets and liabilities are valued using market prices on both active markets(Level 1) and less active markets (Level 2). Level 1instrument valuations are obtained from real-time quotes for transactions inactive exchange markets involving identical assets. Level 2 instrumentvaluations are obtained from readily-available pricing sources for comparableinstruments. As of March 31, 2008, the Company did not have any assets orliabilities without observable market values that would require a high level ofjudgment to determine fair value (Level 3 assets).

 

10

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***Items Measured at Fair Value on aNonrecurring Basis***

 

Certain assetsthat are subject to nonrecurring fair value measurement are not included in thetable above. 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 quarter of 2008.

 

**Note4. Inventories, Net**

 

The components of inventories are summarized below (in thousands):

 
| ** **        | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|--------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Inventories, net: |       |               |       |                  |       |
| Raw materials     |       | $                  | 13,325     |                  | $          | 11,154 |   |
| Work in process   |       | 13,515             |       | 12,254                |       |
| Finished goods    |       | 2,237              |       | 1,373                 |       |
|              |       | $                  | 29,077     |                  | $          | 24,781 |   |

 

**Note5. Impairment on Assets Held For Sale**

 

During the three months ended March 31,2008, we completed the sale of our property in Fremont, California. The escrowestablished to pay the purchase price of the property closed on March 28,2008. The final purchase price for the property was $5.3 million. We receivednet proceeds of $5.1 million after deducting commissions and selling expenses. Werecorded an impairment charge upon the sale of the property of $83,000. Therewas no impairment charge for the same three month period ended March 31,2007.

 

**Note 6. Net Income Per Share**

 

Basic net income per common share iscalculated by dividing net income available to common stockholders by theweighted average number of common shares outstanding during the period. Dilutednet income per common and common equivalent shares include the dilutive effectof common stock equivalents outstanding during the period calculated using thetreasury stock method. Common stock equivalents consist of the shares issuableupon the exercise of stock options.

 

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

 

 
| ** **                                                                       | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                       | ** ** | **March 31,**               | ** ** |
| ** **                                                                       | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Numerator:                                                                       |       |                             |       |   |   |
| Net income                                                                       |       | $                                | 1,959      |   | $ | 1,344 |   |
| Less: Preferred stock dividends                                                  |       | (44                              | )          | (44 | ) |
| Net income available to common stockholders                                      |       | $                                | 1,915      |   | $ | 1,300 |   |
| Denominator:                                                                     |       |                             |       |   |   |
| Denominator for basic net loss per share -  weighted average common shares       |       | 30,367                           |       | 29,798 |   |
| Effect of dilutive securities:                                                   |       |                             |       |   |   |
| Common stock options                                                             |       | 1,218                            |       | 1,526 |   |
| Denominator for dilutive net loss per  common share                              |       | 31,585                           |       | 31,324 |   |
| Basic net income per share                                                       |       | $                                | 0.06       |   | $ | 0.04 |   |
| Diluted net income per share                                                     |       | $                                | 0.06       |   | $ | 0.04 |   |
| Options excluded from diluted net loss per  share as the impact is anti-dilutive |       | 511                              |       | 362 |   |

 

11

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**Note7. Comprehensive Income**

 

The components of comprehensive income are as follows (in thousands):

 
| ** **                                                          | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                          | ** ** | **March 31,**               | ** ** |
| ** **                                                          | ** ** | **2008**                         | ** ** | **2007** | ** ** |
|                                                                |       |                             |       |   |   |
| Net income                                                          |       | $                                | 1,959      |   | $ | 1,344 |   |
|                                                                |       |                             |       |   |   |
| Change in foreign currency translation gain                         |       | 1,152                            |       | 230 |   |
| Change in unrealized gain (loss) on  available for sale investments |       | (547                             | )          | 29 |   |
| Comprehensive income                                                |       | $                                | 2,564      |   | $ | 1,603 |   |

 

**Note8. Segment Information and Foreign Operations**

 

***Segment Information***

*** ***

Weoperate in one segment for the design, development, manufacture anddistribution of high-performance compound semiconductor substrates and sale ofmaterials. In accordance with SFAS No. 131, *“Disclosures About Segments of an Enterprise andRelated Information”* (“SFAS No. 131”), our chief operatingdecision-maker has been identified as the Chief Executive Officer, who reviewsoperating results to make decisions about allocating our resources and assessingour performance. All material operating units qualify for aggregation underSFAS No. 131 due to their identical customer base and similarities ineconomic characteristics, nature of products and services, and procurement,manufacturing and distribution processes. Since we operate in one segment, allfinancial segment and product line information required by SFAS No. 131can be found in the condensed consolidated financial statements.

 

***Geographical Information***

*** ***

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

 
| ** **         | ** ** | **Three Months Ended** | ** ** |
|--------------------|------------|----------------------------------|------------|
| ** **         | ** ** | **March 31,**               | ** ** |
| ** **         | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Net revenues:      |       |                             |       |   |   |
| North America*     |       | $                                | 4,999      |   | $ | 3,342 |   |
| Europe             |       | 2,817                            |       | 2,065 |   |
| Japan              |       | 4,140                            |       | 2,386 |   |
| Taiwan             |       | 2,807                            |       | 1,812 |   |
| Asia Pacific       |       | 4,871                            |       | 2,921 |   |
| Consolidated total |       | $                                | 19,634     |   | $ | 12,526 |   |

 

----

*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,** | ** ** |
| ** **         | ** ** | **2008**           | ** ** | **2007** | ** ** |
| Long-lived assets: |       |               |       |   |   |
| North America      |       | $                  | 149        |   | $ | 149 |   |
| China              |       | 16,971             |       | 15,837 |   |
|               |       | $                  | 17,120     |   | $ | 15,986 |   |

 

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*** ***

***Significant Customers***

*** ***

Nocustomer represented more than 10% of revenues for the three month periodsended March 31, 2008 and 2007. Our top five customers represented 33.2%and 34.0% of revenue for the three month periods ended March 31, 2008 and2007, respectively.

 

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

 

Wehave made strategic investments in private companies located in China in orderto gain access at a competitive cost to raw materials that are critical to oursubstrate business. Our investments in these privately-held companies aresummarized below (in thousands):

 
| ** **                                                       | ** ** | **Investment Balance as of** | ** ** | ** **                  | ** ** | ** **             | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------|------------|------------------------|------------|
| **Company**                                                      | ** ** | **March 31,  2008**                    | ** ** | **December 31,  2007** | ** ** | **Accounting  Method** | ** ** | **Ownership  Percentage** | ** ** |
| Beijing Ji Ya 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                               |       | 2,319                                       |       | 2,138                       |       | Equity                 |       | 25 | % |
| Emeishan Jia Mei High Purity Metals Co.,  Ltd                    |       | 780                                         |       | 761                         |       | Equity                 |       | 25 | % |
|                                                                  |            |                                             |            |                             |            |                        |            |  |  |  |  |

 

Theinvestment balances for the two companies accounted for under the equity methodare included in “other assets” in the condensed consolidated balance sheets. Weown 25% of the ownership interests in each of these companies. These twocompanies are not considered variable interest entities because:

 
| · |   | both  companies have sustainable businesses of their own;                                                                                                                                                                                              |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                   |
| · |   | our  voting power is proportionate to our ownership interests;                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                   |
| · |   | we  only recognize our respective share of the losses and/or residual returns  generated by the companies if they occur; and                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                   |
| · |   | we  do not have a controlling financial interest in, do not maintain operational  or management control of, do not control the board of directors of, and are  not required to provide additional investment or financial support to, either  company. |

 

Undistributedretained earnings relating to our investments were $8.9 million and $7.8million as of March 31, 2008 and December 31, 2007, respectively. Netincome recorded from our investments was $1,035,000 and $611,000 for the threemonths ended March 31, 2008 and 2007, respectively.

 

The minority interest for those investments that are consolidated isincluded within “Other long-term liabilities” in the condensed consolidatedbalance sheets and within “Other income (expense), net” on the condensedconsolidated statements of operations.

 

We also have investments in two privately-held companies which areaccounted for under the cost method as we do not have the ability to exercisesignificant influence over their operations. As of March 31, 2008 and December 31,2007, these investments totaled approximately $0.4 million and are included in “otherassets” on the condensed consolidated balance sheets.

 

**Note10. 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.

 

13

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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, 2008 and 2007 (in thousands):

 
| ** **                                    | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                    | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
|                                          |       |                                                 |       |   |   |
| Beginning accrued warranty and related  costs |       | $                                                    | 1,030      |   | $ | 459 |   |
| Charged to cost of revenue                    |       | 29                                                   |       | 452 |   |
| Actual warranty expenditures                  |       | (63                                                  | )          | (128 | ) |
| Ending accrued warranty and related costs     |       | $                                                    | 996        |   | $ | 783 |   |

 

**Note11. Foreign Exchange Transaction Gains/Losses**

 

Weincurred foreign currency transaction exchange gains of $189,000 and foreignexchange losses of $44,000 for the three month periods ended March 31,2008, and 2007, respectively. These amounts are included in other income(expense), net on the condensed consolidated statements of operations.

 

**Note 12.Income Taxes**

 

In July 2006, the Financial AccountingStandards Board (“FASB”) issued Interpretation No. 48 (“FIN48”)  , *“Accountingfor Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109),”*,  FIN48 clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with SFAS 109. Thisinterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. FIN 48 also provides guidance onderecognition of tax benefits, classification on the balance sheet, interestand penalties, accounting in interim periods, disclosure, and transition. Weadopted FIN 48 effective January 1, 2007. We recognize interest andpenalties related to uncertain tax positions in income tax expense. As of March 31,2008, we do not have any gross unrecognized tax benefits, nor any accruedinterest and penalties related to uncertain tax positions. As a result of theimplementation of FIN 48, we identified $16.4 million in unrecognized taxbenefits. This amount decreased the tax loss carryforwards in the U.S. whichare fully offset by a valuation allowance. We file income tax returns in theU.S. federal, various states and foreign jurisdictions. We have substantiallyconcluded all U.S. federal and state income tax matters through December 31,2006.

 

**Note13. Recent Accounting Pronouncements**

 

In March 2008, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)SFAS No. 161, “*Disclosures aboutDerivative Instruments and Hedging Activities*” (“SFAS 161”). SFAS161 requires companies with derivative instruments to disclose information thatshould enable financial statement users to understand how and why a companyuses derivative instruments, how derivative instruments and related hedged itemsaffect a company’s financial position, financial performance and cash flows.SFAS 161 is effective for financial statements issued for fiscal years andinterim periods beginning after November 15, 2008. Based on ourcurrent 

 

14

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operations, we do not expect that the adoption of SFAS 161 willhave a material impact on our consolidated financial position or results ofoperations.

 

In December 2007, the FASB issued SFAS No. 141(revised 2007), “*Business Combinations*”,(“SFAS 141R”). SFAS 141R establishes the principles and requirementsfor how an acquirer in a business combination (1) recognizes and measuresin its financial statements the identifiable assets acquired, the liabilitiesassumed and any non-controlling interest in the acquiree, (2) recognizesand measures the goodwill acquired in the business combination or a gain from abargain purchase and (3) determines what information to disclose to enableusers of the financial statements to evaluate the nature and financial effectsof the business combination. SFAS 141(R) is effective beginning withthe Company’s fiscal 2009. The impact of the adoption of SFAS 141(R) onthe Company’s results of operations and financial position will depend on thenature and extent of business combinations that the Company completes, if any,in or after fiscal 2009.

 

In December 2007, the FASB issued SFAS No. 160,*“Noncontrolling Interests in ConsolidatedFinancial Statements”* (“SFAS 160”). SFAS 160 requires thatminority interest be separately reported in the consolidated entity’s equitysection and that no gain or loss shall be reported when transactions occurbetween the controlling interest and the non-controlling interests.Furthermore, the acquisition of non-controlling interest by the controllinginterest is not treated as a business combination. SFAS 160 is effectivefor fiscal years beginning after December 15, 2008. We have not yetevaluated the impact of SFAS 160 on our consolidated financial position,results of operations or cash flows.

 

In February 2007, the FASB issued SFAS No. 159,“*The Fair Value Option for Financial Assetsand Financial Liabilities—Including an amendment of FASB Statement No. 115*”(“SFAS 159”). SFAS 159 expands the use of fair value accounting tomany financial instruments and certain other items. The fair value option isirrevocable and generally made on an instrument-by-instrument basis, even if acompany has similar instruments that it elects not to measure based on fairvalue. SFAS 159 is effective for fiscal years beginning after November 15,2007. We do not have any instruments eligible for election of the fair valueoption. Therefore, the adoption of SFAS 159 in the first quarter of fiscal 2008did not impact our consolidated financial position, results of operations orcash flows.

 

In September 2006, the FASB issued SFAS No. 157,“*Fair Value Measurements*” (“SFAS 157”).SFAS 157 defines fair value, establishes a framework and gives guidanceregarding the methods used for measuring fair value, and expands disclosuresabout fair value measurements. SFAS 157 is effective for financial statementsissued for fiscal years beginning after November 15, 2007, and interimperiods of those fiscal years. In February 2008, the FASB released a FASBStaff Position (FSP FAS 157-2— *EffectiveDate of FASB Statement No. 157*) which delays the effectivedate of SFAS 157 for all nonfinancial assets and nonfinancial liabilities,except those that are recognized or disclosed at fair value in the financialstatements on a recurring basis (at least annually) to fiscal years beginningafter November 15, 2008. These non-financial items include assets andliabilities such as reporting units measured at fair value in a goodwillimpairment test and non-financial assets acquired and liabilities assumed in abusiness combination. The partial adoption of SFAS 157 as of January 1,2008 for financial assets and liabilities did not have a material impact on ourcondensed consolidated financial position, results of operations or cash flows.See Note 3 of the Notes to Condensed Consolidated Financial Statements.

 

15

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

This quarterly report onForm 10-Q, including the following sections, contains forward-lookingstatements within the meaning of Section 21E of theSecurities Exchange Act of 1934, particularly statements relating to ourexpectations regarding results of operations, customer demand, improvements inour product quality, our ability to expand our markets and increase sales,customer qualifications of our products, gross margins, favorable pricing, reliable supply andenhanced sourcing lead-times of raw materials, and our reserve balances. Theseforward-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 identifyimportant factors that could cause actual results to differ materially fromthose predicted in any such forward-looking statements. We caution investorsthat actual results may differ materially from those projected in theforward-looking statements as a result of certain risk factors identified inthis Form 10-Q and other filings we have made with the Securities andExchange Commission. Forward-looking statements may be identified by theuse of terms such as “anticipates,” “believes,” “estimates,” “expects,” “intends,”and similar expressions. Statements concerning our future or expected financialresults and condition, business strategy and plans or objectives for futureoperations are forward-looking statements.

 

These forward-looking statements are not guarantees of futureperformance. Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date hereof. Thisdiscussion should be read in conjunction with Management’s Discussion andAnalysis of Financial Condition and Results of Operations included in ourAnnual Report on Form 10-K for the year ended December 31, 2007 andthe condensed consolidated financial statements included elsewhere in thisreport.

 

**Overview**

 

We are aleading worldwide developer and producer of high-performance compound andsingle element semiconductor substrates comprising gallium arsenide (GaAs),indium phosphide (InP) and germanium (Ge). We currently sell the followingsubstrate products in the sizes and for the applications indicated:

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

 

We manufacture compound semiconductor substrates using our proprietaryvertical gradient freeze, or VGF, technology. Our in-house VGF technologyenables us to add capacity quickly and cost efficiently. We manufacture all ofour products in China, which generally has lower costs for facilities, laborand materials.

 

Wealso have three majority-owned and two minority-owned joint ventures in Chinawhich provide us favorable pricing,reliable supply and enhanced sourcing lead-times for key raw materials whichare 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.

 

16

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Revenue increased $7.1 million, or 56.7%, to$19.6 million for the three months ended March 31, 2008 from $12.5 millionfor the same period of 2007 primarily due to our improved quality, highercustomer demands for six-inch diameter wafers, and an increase in raw materialsales. On March 28, 2008, we completed the sale of our Fremont, Californiafacility and received net proceeds of approximately $5.1 million afterdeducting commissions and selling expenses. As of March 31, 2008, we hadavailable cash, cash equivalents and short-term investments of $39.4 million,excluding restricted deposits.

 

**Critical Accounting Policies and Estimates**

 

We have prepared our condensed consolidatedfinancial statements in accordance with accounting principles generally acceptedin the United States of America. As such, we have had to make estimates,assumptions and judgments that affect the amounts reported on our financialstatements. These estimates, assumptions and judgments about future events andtheir effects on our results cannot be determined with certainty, and are madebased upon our historical experience and on other assumptions that are believedto be reasonable under the circumstances. These estimates may change asnew events occur or additional information is obtained, and wemay periodically be faced with uncertainties, the outcomes of which arenot within our control and may not be known for a prolonged period oftime. The discussion and analysis of our results of operations and financialcondition are based upon these condensed consolidated financial statements.

 

We have identified the policies below ascritical to our business operations and understanding of our financialcondition and results of operations.

 

A critical accounting policy is one that isboth material to the presentation of our financial statements and requires usto make difficult, subjective or complex judgments that could have a materialeffect on our financial condition and results of operations. Theymay require us to make assumptions about matters that are highly uncertainat the time of the estimate, and different estimates that we could have used,or changes in the estimate that are reasonably likely to occur, may have amaterial impact on our financial condition or results of operations.

 

We believe that the following are our critical accounting policies:

 

***Revenue Recognition***

 

We manufacture and sell high-performancecompound semiconductor substrates and sell certain raw materials includinggallium, germanium dioxide, and pBN crucibles. After we ship our products,there are no remaining obligations or customer acceptance requirements thatwould preclude revenue recognition. Our products are typically sold pursuant toa purchase order placed by our customers, and our terms and conditions of saledo not require customer acceptance. We recognize revenue upon shipment andtransfer of title of products to our customers, which is either upon shipmentfrom our dock, receipt at the customer’s dock, or removal from consignmentinventory at the customer’s location, provided that we have received a signedpurchase order, the price is fixed or determinable, title and risk of ownershiphave transferred, collection of resulting receivables is probable, and productreturns are reasonably estimable. We do not provide training, installation orcommissioning services. Additionally, we do not provide discounts or otherincentives to customers.

 

We provide for future returns based onhistorical experience, current economic trends and changes in customer demandat the time revenue is recognized.

 

***Allowance for Doubtful Accounts***

 

We periodically review the likelihood ofcollection on our accounts receivable balances and provide an allowance fordoubtful accounts receivable primarily based upon the age of these accounts. Weprovide a 100% allowance for receivables from U.S. customers in excess of 90days and for receivables from customers located outside the U.S. in excess of120 days. We assess the probability of collection based on a number of factors,including the length of time a receivable balance has been outstanding, ourpast history with the customer and their creditworthiness.

 

As of March 31, 2008 and December 31,2007, our accounts receivable, net, balance was $16.7 million and $12.1million, respectively, which was net of an allowance for doubtful accounts of$187,000 and $379,000, respectively. If actual uncollectible accounts differsubstantially from our estimates, revisions to the estimated allowance fordoubtful accounts would be required, which could have a material impact on ourfinancial results for the period.

 

17

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***Warranty Reserve***

 

We maintain a warranty reserve based upon ourclaims experience during the prior twelve months. Warranty costs are accrued atthe time revenue is recognized. As of March 31, 2008 and December 31,2007, accrued product warranties totaled $1.0 million. If actual warranty costsdiffer substantially from our estimates, revisions to the estimated warrantyliability would be required, which could have a material impact on ourfinancial condition and results of operations.

 

***Inventory Valuation***

 

Inventories are stated at the lower of costor market. 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. Weroutinely evaluate the levels of our inventory in light of current marketconditions in order to identify excess and obsolete inventory, and we provide avaluation allowance for certain inventories based upon the age and quality ofthe product and the projections for sale of the completed products. As of March 31,2008 and December 31, 2007, we had an inventory reserve of $13.5 millionand $13.6 million for excess and obsolete inventory, respectively. The majorityof this inventory has not been scrapped, and accordingly, may be sold in futureperiods. If actual demand for our products were to be substantially lower thanestimated, additional inventory adjustments for excess or obsolete inventorymight be required, which could have a material impact on our business,financial condition and results of operations.

 

***Impairment of Investments***

 

We classify our investments in debt andequity securities as available-for-sale securities as prescribed by Statementof Financial Accounting Standards (“SFAS”) No. 115, *“Accounting for Certain Investments in Debt andEquity Securities”.*All available-for-sale securities with a quotedmarket value below cost (or adjusted cost) are reviewed in order to determinewhether the decline is other-than-temporary. Factors considered in determiningwhether a loss is temporary include the magnitude of the decline in marketvalue, the length of time the market value has been below cost (or adjustedcost), credit quality, and our ability and intent to hold the securities for aperiod of time sufficient to allow for any anticipated recovery in marketvalue.

 

We invest in equity instruments of privately-heldcompanies for business and strategic purposes. These investments are classifiedas other assets and are accounted for either under the cost method or under theequity method as we do not have the ability to exercise significant influence overtheir operations. We monitor our investments for impairment and would recordreductions in carrying value when events or changes in circumstances indicatethat 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 the investee’s management, the length of timeand extent to which the fair value has been less than our cost basis, thefinancial condition and near-term prospects of the investee, fundamentalchanges to the business prospects of the investee, share prices of subsequentofferings, and our intent and ability to hold the investment for a period oftime sufficient to allow for any anticipated recovery in our carrying value.

 

***Impairment of Long-Lived Assets***

 

We evaluate the recoverability of property,equipment and intangible assets in accordance with SFAS No. 144, *“Accounting for the Impairment or Disposal ofLong-Lived Assets.”* When events and circumstances indicate thatlong-lived assets may be impaired, we compare the carrying value of thelong-lived assets to the projection of future undiscounted cash flowsattributable to these assets. In the event that the carrying value exceeds thefuture undiscounted cash flows, we record an impairment charge against incomeequal to the excess of the carrying value over the assets’ fair value. Fairvalues are determined based on quoted market values, discounted cash flows orinternal and external appraisals, as applicable. Assets held for sale arecarried at the lower of carrying value or estimated net realizable value.

 

***Employee Stock Options***

 

We grant options to substantially allmanagement employees and believe that this program helps us to attract,motivate and retain high quality employees, to the ultimate benefit of ourstockholders. Effective January 1, 2006, we adopted the fair valuerecognition provisions of SFAS No. 123 (revised 2004), “*Share-Based Payment*” (“SFAS

 

18

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123(R)”), using the modified prospective application transition method.Under this transition method, stock-based compensation cost was recognized inthe condensed consolidated financial statements for all share-based paymentsafter January 1, 2006. Compensation cost recognized includes the estimatedexpense for the portion of the vesting period after January 1, 2006 forshare-based payments prior to, but not vested as of January 1, 2006, basedon the grant date fair value estimated in accordance with the originalprovisions of SFAS 123, “*Accounting for Stock-BasedCompensation.”* 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 forprior periods have not been restated, as provided for under the modifiedprospective application transition method.

 

As of the date of the filing of this quarterlyreport, we believe there have been no material changes to our criticalaccounting policy on employee stock options during the three months ended March 31,2008 compared to that disclosed in our Annual Report on Form 10K for thefiscal year ended December 31, 2007 filed with the Securities andExchange Commission (“SEC”) on March 14,2008. See Note 2 to our condensed consolidated financial statements.

 

***Income Taxes***

 

We account for income taxes in accordancewith SFAS No. 109 (“SFAS 109”), *“Accountingfor Income Taxes,”* which requires that deferred tax assets andliabilities be recognized using enacted tax rates for the effect of temporarydifferences between the book and tax bases of recorded assets and liabilities.SFAS 109 also requires that deferred tax assets be reduced by a valuationallowance if it is more likely than not that a portion of the deferred taxasset will not be realized.

 

We provide for income taxes based upon thegeographic composition of worldwide earnings and tax regulations governing eachregion, particularly China. The calculation of tax liabilities involvessignificant judgment in estimating the impact of uncertainties in theapplication of complex tax laws, particularly in foreign countries such asChina.

 

Effective January 1, 2007, we adoptedFASB Interpretation No. 48 (“FIN 48”), “*Accounting for Uncertainty in Income Taxes—an interpretation of FASBStatement No. 109*.” See Note 12 — “Income Taxes” in thecondensed consolidated financial statements for additional information.

 

19

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**Resultsof Operations**

 

**Revenue**

 
| ** **    | ** ** | **March 31,**             | ** ** | **Increase** | ** ** | ** **     | ** ** |
|---------------|------------|--------------------------------|------------|--------------|------------|----------------|------------|
| ** **    | ** ** | **2008**                       | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **    | ** ** | **($ in thousands)** | ** ** | ** **   | ** ** |
| GaAs          |       | $                              | 13,720     |         | $          | 8,792          |       | $ | 4,928 |   | 56.1 | % |
| InP           |       | 478                            |       | 518          |       | (40            | )          | (7.7 | )% |
| Ge            |       | 1,385                          |       | 541          |       | 844            |       | 156.0 | % |
| Raw materials |       | 4,041                          |       | 2,630        |       | 1,411          |       | 53.7 | % |
| Other         |       | 10                             |       | 45           |       | (35            | )          | (77.8 | )% |
| Total revenue |       | $                              | 19,634     |         | $          | 12,526         |       | $ | 7,108 |   | 56.7 | % |

 

Revenue increased $7.1 million, or 56.7%, to $19.6 million for thethree months ended March 31, 2008 from $12.5 million for the three monthsended March 31, 2007. Total GaAs substrate revenue increased $4.9 million,or 56.1%, to $13.7 million for the three months ended March 31, 2008 from$8.8 million for the three months ended March 31, 2007.

 

Sales of 5 inch and 6 inch diameter GaAs substrates were $6.9 millionfor the three months ended March 31, 2008 compared to $4.0 million for thethree months ended March 31, 2007. The increase in larger diametersemi-insulating substrates came from the growth in demand for both cellular andWLAN (Wide Local Area Network) markets. Our growth came particularly from IQEplc that awarded us a large production order during the fourth quarter of 2007for their 2008 requirements.

 

 Sales of 2 inch, 3 inch and 4inch diameter GaAs substrates were $6.9 million for the three months ended March 31,2008 compared with $4.8 million for the three months ended March 31, 2007.The increase in revenue from smaller diameter substrates was due to thecontinued market growth generally of LED laser diodes and commercial epitaxy.

 

InP substrate revenue decreased $40,000, or 7.7%, to $478,000 for thethree months ended March 31, 2008 from $518,000 for the three months endedMarch 31, 2007. The decrease in InP substrate revenue was due to loweroverall demand from customers in the optical networking industry.

 

Ge substrate revenue increased $844,000, or 156.0%, to $1.4 million forthe three months ended March 31, 2008 from $541,000 for the three monthsended March 31, 2007. The increase in Ge substrate revenue was due to anincrease in sales to customers in the People’s Republic of China and anincrease in sales to a major customer in Europe who has now qualified ourproduct, as demand for photovoltaic applications increases.

 

Raw materials revenue increased $1.4 million, or 53.7%, to $4.0 millionfor the three months ended March 31, 2008 from $2.6 million for the threemonths ended March 31, 2007. The increase in raw materials revenue wasprimarily due to a combination of increased sales to customers as demandincreased and higher raw materials prices. We do not expect demand to continueat this pace.

 

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*** ***

***Revenueby Geographic Region***

 
| ** **                                | ** ** | **Three Months Ended** | ** ** | ** **   | ** **   | ** **     | ** **   |
|-------------------------------------------|------------|----------------------------------|------------|--------------|--------------|----------------|--------------|
| ** **                                | ** ** | **March 31,**               | ** ** | **Increase** | ** **   | ** **     | ** **   |
| ** **                                | ** ** | **2008**                         | ** ** | **2007**     | ** **   | **(Decrease)** | *** *** | **% Change** | ** ** |
| ** **                                | ** ** | **($ in thousands)**   | ** ** | ** **   | *** *** | ** **     | ** **   |
| North America *                           |       | $                                | 4,999      |         | $            | 3,342          |         | $ | 1,657 | * * | 49.6 | % |
| *% of total revenue*                      |       | 26                               | %          | 27           | %            |           | * *     |   |   |
| Europe                                    |       | 2,817                            |       | 2,065        |         | 752            | * *     | 36.4 | % |
| *% of total revenue*                      |       | 14                               | %          | 16           | %            |           | * *     |   |   |
| Japan                                     |       | 4,140                            |       | 2,386        |         | 1,754          | * *     | 73.5 | % |
| *% of total revenue*                      |       | 21                               | %          | 19           | %            |           | * *     |   |   |
| Taiwan                                    |       | 2,807                            |       | 1,812        |         | 995            | * *     | 54.9 | % |
| *% of total revenue*                      |       | 14                               | %          | 15           | %            |           | * *     |   |   |
| Asia Pacific (excluding Japan and Taiwan) |       | 4,871                            |       | 2,921        |         | 1,950          | * *     | 66.8 | % |
| *% of total revenue*                      |       | 25                               | %          | 23           | %            |           | * *     |   |   |
| Total revenue                             |       | $                                | 19,634     |         | $            | 12,526         |         | $ | 7,108 | * * | 56.7 | % |

 

----

*Primarily the UnitedStates

 

Revenue fromcustomers in North America increased by $1.7 million, or 49.6%, to $5.0 millionfor the three months ended March 31, 2008 from $3.3 million for the threemonths ended March 31, 2007. We expected our North America revenue toincrease substantially in 2008 based upon a supply agreement we signed in thefourth quarter of 2007 with IQE plc. Under the terms of the agreement, IQE plc shallpurchase from us a minimum of approximately $15.1 million of 4-inch and 6-inchsemi-insulating gallium arsenide (GaAs) substrates.  IQE plc has an optionto purchase an additional $3.5 million of 6-inch substrates from us under theagreement.  All substrates ordered pursuant to the agreement are to beshipped by the end of 2008.

 

Revenue from customers in Europe increased by $0.8 million, or 36.4%,to $2.8 million for the three months ended March 31, 2008 from $2.1million for the three months ended March 31, 2007. This increase cameprimarily from increased substrate sales to customers in Germany and France,and from increased raw materials sales to a customer in the Netherlands.

 

Revenue from customers in Japan increased by $1.8 million, or 73.5%, to$4.1 million for the three months ended March 31, 2008 from $2.4 millionfor the three months ended March 31, 2007. The increase came mainly from substratesales to two major existing customers, particularly in large diameter wafers.

 

Revenue from customers in Taiwan increased by $1.0 million, or 54.9%,to $2.8 million for the three months ended March 31, 2008 from $1.8million for the three months ended March 31, 2007. The increase of $1.0million came mainly from one major existing customer for large diameter wafers.

 

Revenue from customers in Asia Pacific (excluding Japan and Taiwan)increased by $2.0 million, or 66.8%, to $4.9 million for the three months endedMarch 31, 2008 from $2.9 million for the three months ended March 31,2007. Sales to customers in the People’s Republic of China increased by $1.7million, of which raw materials was $0.7 million. The other $1.0 millionincrease was from $0.6 million from increased sales to existing customers forsmall diameter GaAs wafers, and $0.4 million from sales to a new customer for 4”Ge wafers. Sales to customers in Singapore increased by $0.2 million, mainlyfrom a customer that is part of the IQE plc group with whom we signed asupply agreement in the fourth quarter of 2007.

 

21

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***Gross Margin***

 
| ** **       | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **       | ** ** | **March 31,**               | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **       | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Gross profit     |       | $                                | 6,221      |         | $          | 5,405          |       | $ | 816 |   | 15.1 | % |
| *Gross Margin %* |       | 31.7                             | %          | 43.2         | %          |           |       |   |   |
|                  |            |                                  |            |              |            |                |            |  |  |  |  |  |

 

Grossmargin decreased to 31.7% of total revenue for the three months ended March 31,2008 from 43.2% of total revenue for the three months ended March 31,2007. Gross margins in the three months ended March 31, 2008 and 2007 werepositively impacted by sales of approximately $620,000 and $785,000,respectively, of gallium arsenide (GaAs) wafers that were previously fullyreserved.. Product mix contributed to higher gross profit for the three monthsended March 31, 2008 as we sold a greater amount of larger diameter GaAswafers which contributed higher gross profit. In addition, we had manufacturingequipment that became fully depreciated since the third quarter of 2006, andthe absence of depreciation expense for this equipment contributedapproximately 2.6 percentage points to gross margin for the three months ended March 31,2007. Finally, higher substrate gross margins were also achieved through betterslicing techniques, longer length ingot growth, shorter runtimes, and higherproduction volumes. In the subsequent four quarters since March 31, 2007,gross margins were negatively impacted by declining average selling prices andrising raw material costs, as well as an increase in depreciation as a resultof our purchase of equipment acquired for our capacity expansion. For the threemonths ended March 31, 2008, product mix also contributed to lower grossmargins as we sold a lesser amount of InP substrates that have higher grossmargins, and we sold more Ge wafers that have lower gross margins.

 

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

*** ***
| ** **                                    | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                    | ** ** | **March 31,**               | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                                    | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                    | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| ** **                                    | ** ** | ** **                       | ** ** | ** **   | ** ** | ** **     | ** ** | ** ** | ** ** |
| Selling, general and administrative  expenses |       | $                                | 3,667      |         | $          | 3,703          |       | $ | (36 | ) | -1.0 | % |
| *% of total revenue*                          |       | 18.7                             | %          | 29.6         | %          |           |       |   |   |
|                                               |            |                                  |            |              |            |                |            |  |  |  |  |  |

*** ***

Selling, general and administrative expenses decreased $36,000 to $ 3.7million for the three months ended March 31, 2008 from $3.7 million forthe three months ended March 31, 2007. The decrease was primarily due to$378,000 lower legal and professional fees since we accrued $350,000 in legalfees in connection with the  settlementreached in April 2007 of the securities class action lawsuit filed againstus, and $184,000 lower bad debt expenses as we collected from our slow-payingcustomers in Asia, partially offset by $436,000 from increases in generalannual salary and related costs, $60,000 from increased sales commissions basedon increased sales volumes, and $30,000 in additional decontamination expenses.

 

***Researchand Development***

*** ***
| ** **               | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|--------------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **March 31,**               | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **               | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Research and development |       | $                                | 504        |         | $          | 460            |       | $ | 44 |   | 9.6 | % |
| *% of total revenue*     |       | 2.6                              | %          | 3.7          | %          |           |       |   |   |
|                          |            |                                  |            |              |            |                |            |  |  |  |  |  |

*** ***

Research and development expenses increased $ 44,000, or 9.6% to $504,000 for the three months ended March 31, 2008 from $460,000 for thethree months ended March 31, 2007. The increase was due to increases insalary and related costs as a result of the appointment of a new chieftechnology officer effective December 31, 2007, and general annual salaryand related cost increases partially offset by lower new products testing costs.

 

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*** ***

***Impairment on AssetsHeld For Sale***

 
| ** **                         | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|------------------------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **                         | ** ** | **March 31,**               | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                         | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                         | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Impairment on assets held for sale |       | $                                | 83         |         | $          | —         |       | $ | 83 |   | NM |   |
| *% of total revenue*               |       | 0.4                              | %          | 0.0          | %          |           |       |   |   |
|                                    |            |                                  |            |              |            |                |            |  |  |  |  |  |

 

NM = % not meaningful

 

During the three months ended March 31,2008, we completed the sale of our property in Fremont, California. The escrowestablished to pay the purchase price was closed on March 28, 2008  The final purchase price for the property was$5.3 million. We received net proceeds of $5.1 million after deductingcommissions and selling expenses. We recorded an impairment charge upon thesale of the property of $83,000. There was no impairment charge for the samethree month period ended March 31, 2007.

 

***InterestIncome, net***

*** ***
| ** **           | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|----------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **March 31,**               | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **           | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Interest income, net |       | $                                | 124        |         | $          | 224            |       | $ | (100 | ) | -44.6 | % |
| *% of total revenue* |       | 0.6                              | %          | 1.8          | %          |           |       |   |   |
|                      |            |                                  |            |              |            |                |            |  |  |  |  |  |

*** ***

Interest income, net decreased $100,000 to $124,000 for the threemonths ended March 31, 2008 from $224,000 for the three months ended March 31,2007 as a result of higher balances of our investments in the three monthsended March 31, 2007, which came from the net proceeds of our publicoffering of common stock, completed in December 2006 and January 2007.

 

***Other Income andExpense, net***

 
| ** **                 | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|----------------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **March 31,**               | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                 | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                 | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Other income (expense) net |       | $                                | 428        |         | $          | (11            | )          | $ | 439 |   | 3990.9 | % |
| *% of total revenue*       |       | 2.2                              | %          | (0.1         | )%         |           |       |   |   |
|                            |            |                                  |            |              |            |                |            |  |  |  |  |  |

*** ***

Other income was $428,000 for the three months ended March 31,2008 due to a realized gain of $459,000 on the sale of short-term investmentsheld by us, partially offset by minority interests in our joint ventures. Otherexpense was $11,000 for the three months ended March 31, 2007 due to theminority interests in our joint ventures.

 

***Provisionfor Income Taxes***

 
| ** **                 | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|----------------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **March 31,**               | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                 | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                 | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Provision for income taxes |       | $                                | 560        |         | $          | 111            |       | $ | 449 |   | 404.5 | % |
| *% of total revenue*       |       | 2.9                              | %          | 0.9          | %          |           |       |   |   |
|                            |            |                                  |            |              |            |                |            |  |  |  |  |  |

*** ***

We provided for income taxes of $560,000 for our China operations forthe three months ended March 31, 2008 compared to $111,000 for the threemonths ended March 31, 2007. Beginning in 2008, the tax provision wascalculated based on the assumption that we will no longer receive refunds forprofit reinvestments in China .

 

23

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**Liquidity and Capital Resources**

 

As of March 31, 2008, our principal sources of liquidity were$39.4 million in cash and cash equivalents and short-term investments,excluding restricted deposits. We consider cash and cash equivalents andshort-term investments as liquid and available for use. Short-term investmentsare comprised of government bonds and high-grade commercial debt instruments.

 

Cashand cash equivalents and short-term investments of $39.4 million increased by$0.2 million in the first quarter of 2008 compared to the fourth quarter of2007.

 

Net cash used in operating activities of $4.4 million for the threemonths  ended March 31, 2008 wasprimarily comprised of our net income of $2.0 million, adjusted for non-cashitems of depreciation of $0.5 million, stock-based compensation of $0.2million, partially offset by a realized gain on sale of investments of$0.5 million, and offset by a net increase of $6.6 million in assets andliabilities. The $6.6 million net increase in assets and liabilities primarilyresulted from a $4.4 million increase in accounts receivable, $4.0 millionincrease in inventories, $1.7 million increase in prepaid expenses, $0.9 milliondecrease in other long-term liabilities, primarily minority interests, a$0.2 million increase in other assets, a $0.1 million decrease inaccrued liabilities, partially offset by a $4.5 million decrease in accountspayable, and a $0.2 million decrease in income taxes payable.

 

Inventories, net, increased by $4.0 million, as we increased inventoryin raw materials and work-in-process to increase production in anticipation ofincreased forecast sales, and finished goods for consignment orders.

 

Accounts receivable, net increased by $4.4 million, as a result of ourincreased sales volume. Our days sales outstanding is 77 days as of March 31,2008 compared to 64 days as of December 31, 2007.

 

Net cash provided by investing activities of $8.7 million for the threemonths ended March 31, 2008 was primarily from the proceeds from the saleof investments of $10.8 million, proceeds from sale of assets held for sale of$5.1 million and the decrease of restricted cash of $0.2 million, partiallyoffset by the purchase of investments totaling $6.4 million, and the purchaseof property, plant and equipment, of $1.0 million,

 

We expect to invest approximately $4.8 million in capital projects forthe remainder of 2008. We believe that our existing and planned facilities andequipment are sufficient to fulfill current and expected future orders.

 

Netcash provided by financing activities of $0.2 million for the three monthsended March 31, 2008 consisted of $0.1 million from the proceeds from theexercise of employee stock options, and $0.3 million from the proceeds of along term borrowing in one of our joint ventures, partially offset by ascheduled payment of $0.2 million related to long-term borrowings.

 

Our main Fremont, California facility is financed by long-termborrowings, which were refinanced by taxable variable rate revenue bonds in1998. These bonds mature in 2023 and bear interest at a variable rate that was3.25% as of March 31, 2008. The bonds are traded in the public market.Repayment of principal and interest under the bonds is supported by a letter ofcredit from our bank and is paid on a quarterly basis. We have the option toredeem the bonds in whole or in part during their term. As of March 31,2008, $6.6 million was outstanding under these bonds.

 

As of March 31, 2008, the credit facility maintained by us with a bank included aletter of credit supporting repayment of our revenue bonds with an outstandingamount of $6.6 million. We have pledged and placed a like amount of investmentsecurities with an affiliate of the bank as additional collateral for thisfacility. We completed the sale of our Fremont, California facility on March 28,2008, and received net proceeds of approximately $5.1 million after deductingcommissions and selling expenses. We plan to repay the outstanding principaland accrued interest on the revenue bond of approximately $6.6 million in July 2008,thereby releasing our restricted cash in such amount.

 

We believe that we have adequate cash and investments to meet our needsover the next 12 months. If our performance fails to improve, we will continueto use cash and may at some time be forced to seek additional capital. Therecan be no assurance that such additional capital will be available or, ifavailable it will be at terms acceptable to us. Cash from operations could beaffected by various risks and uncertainties, including, but not limited tothose set forth below under Item 1A “Risks Factors.”

 

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Outstandingcontractual obligations as of March 31, 2008 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** | ** ** |
| Long-term debt                   |       | $                                         | 6,835      |   | $ | 735 |   | $ | 900 |   | $ | 900 |   | $ | 4,300 |   |
| Operating leases                 |       | 3,756                                     |       | $ | 719 |   | $ | 1,496 |   | $ | 1,541 |   | — |   |
| Less: Sublease income            |       | (1,004                                    | )          | $ | (189 | ) | $ | (395 | ) | $ | (420 | ) | — |   |
| Purchase obligation              |       | 3,735                                     |       | 3,735 |   | — |   | — |   | — |   |
| Total                            |       | $                                         | 13,322     |   | $ | 5,000 |   | $ | 2,001 |   | $ | 2,021 |   | $ | 4,300 |   |

 

Welease certain office space, manufacturing facilities and property underlong-term operating leases expiring at various dates through March 2013.Total rent payments under these operating leases were approximately $0.2million and $0.2 million for the three month periods ended March 31, 2008and 2007, respectively.

 

OnFebruary 27, 2007, we entered into an agreement with Recapture MetalsLimited of Ontario, Canada (“Recapture”), pursuant to which Recapture willsupply our subsidiary in the PRC with one thousand kilograms per month of99.99999% pure gallium, during the eighteen month period beginning July 1,2007. Under the terms of the agreement, we are required to purchase a minimumof eighteen thousand kilograms of gallium, unless the agreement is terminatedprior to the expiration of the eighteen month period on December 31, 2008.

 

**RecentAccounting Pronouncements**

 

In March 2008,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards(“SFAS”) SFAS No. 161, “*Disclosures aboutDerivative Instruments and Hedging Activities*” (“SFAS 161”). SFAS161 requires companies with derivative instruments to disclose information thatshould enable financial-statement users to understand how and why a companyuses derivative instruments, how derivative instruments and related hedgeditems affect a company’s financial position, financial performance and cashflows. SFAS 161 is effective for financial statements issued for fiscal yearsand interim periods beginning after November 15, 2008. Based on ourcurrent operations, we do not expect that the adoption of SFAS 161 willhave a material impact on our consolidated financial position or results ofoperations.

 

In December 2007, the FASB issued SFAS No. 141 (revised2007), “*Business Combinations*”, (“SFAS 141R”).SFAS 141R establishes the principles and requirements for how an acquirerin a business combination (1) recognizes and measures in its financialstatements the identifiable assets acquired, the liabilities assumed and anynon-controlling interest in the acquiree, (2) recognizes and measures thegoodwill acquired in the business combination or a gain from a bargain purchaseand (3) determines what information to disclose to enable users of thefinancial statements to evaluate the nature and financial effects of thebusiness combination. SFAS 141(R) is effective beginning with theCompany’s fiscal 2009. The impact of the adoption of SFAS 141(R) onthe Company’s results of operations and financial position will depend on thenature and extent of business combinations that the Company completes, if any,in or after fiscal 2009.

 

In December 2007, the FASB issued SFAS No. 160, *“Noncontrolling Interests in Consolidated FinancialStatements”* (“SFAS 160”). SFAS 160 requires that minorityinterest be separately reported in the consolidated entity’s equity section andthat no gain or loss shall be reported when transactions occur between thecontrolling interest and the non-controlling interests. Furthermore, theacquisition of non-controlling interest by the controlling interest is nottreated as a business combination. SFAS 160 is effective for fiscal yearsbeginning after December 15, 2008. We have not yet evaluated the impact ofSFAS 160 on our consolidated financial position, results of operations orcash flows.

 

In February 2007, the FASB issued SFAS No. 159, “*The Fair Value Option for Financial Assets andFinancial Liabilities—Including an amendment of FASB Statement No. 115*”(“SFAS 159”). SFAS 159 expands the use of fair value accounting tomany financial instruments and certain other items. The fair value option isirrevocable and generally made on an instrument-by-instrument basis, even if acompany has similar instruments that it elects not to measure based on fairvalue. SFAS 159 is effective for fiscal years beginning after November 15,2007. We do not have any instruments eligible for election of the fair valueoption. Therefore, the adoption of SFAS 159 in the first quarter of fiscal 2008did not impact our consolidated financial position, results of operations orcash flows.

 

In September 2006, the FASB issued SFAS No. 157, “*Fair Value Measurements*” (“SFAS 157”). SFAS 157 defines fairvalue, establishes a framework and gives guidance regarding the methods usedfor measuring fair value, and expands disclosures about fair valuemeasurements. SFAS 157 is effective for financial statements issued for fiscalyears 

 

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beginningafter November 15, 2007, and interim periods of those fiscal years. In February 2008,the FASB released a FASB Staff Position (FSP FAS 157-2— *Effective Date of FASB Statement No. 157*)which delays the effective date of SFAS 157 for all nonfinancial assets andnonfinancial liabilities, except those that are recognized or disclosed at fairvalue in the financial statements on a recurring basis (at least annually) tofiscal years beginning after November 15, 2008. These non-financial itemsinclude assets and liabilities such as reporting units measured at fair valuein a goodwill impairment test and non-financial assets acquired and liabilitiesassumed in a business combination. The partial adoption of SFAS 157 as of January 1,2008 for financial assets and liabilities did not have a material impact on ourcondensed consolidated financial position, results of operations or cash flows.See Note 3 of the Notes to Condensed Consolidated Financial Statements.

 

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**ITEM 3*.*QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

***Foreign Currency Risk***

 

A significant portion of our business is conducted in currencies otherthan the U.S. dollar. The functional currency for our foreign operations is theRenminbi, the local currency of China, where our operating expenses arepredominantly in the local currency. Since most of our operations are conductedin China, most of our costs are incurred in Chinese currency, which subjects usto fluctuations in the exchange rates between the U.S. dollar and the ChineseRenminbi. We incur transaction gains or losses resulting from consolidation ofexpenses incurred in local currencies for these subsidiaries, as well as intranslation of the assets and liabilities of these assets at each balance sheetdate. These risks may be increased by the fluctuations and revaluations of theChinese Renminbi. Our financial results could be adversely affected by factorssuch as changes in foreign currency exchange rates or weak economic conditionsin foreign markets, including the revaluation by China of the Renminbi, and anyfuture adjustments that China may make to its currency such as any move itmight make to a managed float systems with opportunistic interventions. 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.

 

We do not currently use short-term forward exchange contracts forhedging purposes to reduce the effects of adverse foreign exchange ratemovements. We had previously purchased foreign exchange contracts to hedgeagainst certain trade accounts receivable denominated in Japanese yen. Thechange in the fair value of the forward contracts was recognized as part of therelated foreign currency transactions as they occur. As of March 31, 2008,we had no outstanding commitments with respect to foreign exchange contracts.

 

During the first quarter of 2008, we recorded net realized foreignexchange gains of $189,000, included as part of other expense in ourconsolidated statements of operations. The foreign exchange gains wereprimarily due to fluctuation in the Chinese Renminbi versus the U.S. dollar. Itis uncertain whether these currency trends will continue. In the future we mayexperience foreign exchange losses on our non-functional currency denominatedreceivables and payables to the extent that we have not mitigated our exposureutilizing foreign currency forward exchange contracts. Foreign exchange lossescould have a materially adverse effect on our operating results and cash flows.During the first quarter of 2008, we recorded unrealized foreign currency gainsof $1.2 million, in cumulative other comprehensive income on our condensedconsolidated balance sheets.

 

***Interest Rate Risk***

 

Cash and cash equivalents earning interest and certain variable ratedebt instruments are subject to interest rate fluctuations. The following tablesets forth the probable impact of a 10% change in interest rates (inthousands):

 
| **Instrument**                            | ** ** | **Balance as of  March 31,  2008** | ** ** | **Current  Interest  Rate** | ** ** | **Projected Annual  Interest  Income/(Expense)** | ** ** | **Proforma 10%  Interest Rate  Decline  Income/(Expense)** | ** ** | **Proforma 10%  Interest Rate  Increase  Income/(Expense)** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------|------------|-----------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| Cash                                      |       | $                                                 | 8,308      |                        | 0.50       | %                                                     | $          | 41                                                                   |       | $                                                                     | 46         |   | $ | 37 |   |
| Cash equivalents                          |       | 14,917                                            |       | 3.00                        | %          | 448                                                   |       | 492                                                                  |       | 403                                                                   |       |
| Investment in debt and equity instruments |       | 22,767812                                         |       | 3.19                        | %          | 726                                                   |       | 799                                                                  |       | 654                                                                   |       |
| Long-term debt                            |       | (6,550                                            | )          | 3.25                        | %          | (213                                                  | )          | (192                                                                 | )          | (234                                                                  | )          |
|                                      |       |                                              |       |                        |       | $                                                     | 1,002      |                                                                 | $          | 1,145                                                                 |       | $ | 860 |   |
|                                           |            |                                                   |            |                             |            |                                                       |            |                                                                      |            |                                                                       |            |  |  |  |  |

 

The primary objective of our investment activities is to preserveprincipal while maximizing income without significantly increasing risk.Financial instruments that potentially subject us to concentration of creditrisk consist primarily of cash equivalents, short-term investments, and tradeaccounts receivable. We invest primarily in money market accounts, commercialpaper instruments, and investment grade securities. We are exposed to creditrisks in the event of default by the issuers to the extent of the amountrecorded on the consolidated balance sheets. These securities are generallyclassified as available-for-sale and consequently are recorded on the balancesheet at fair value with unrealized gains or losses reported as a separatecomponent of accumulated other comprehensive income, net of estimated tax. Ourcash, cash equivalents and short-term investments are in high-qualitysecurities placed with major banks and financial institutions and commercialpaper. We have no investments in auction rate securities. 

 

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***Equity Risk***

 

We maintain minority investments in privately-held companies. Theseinvestments are reviewed for other than temporary declines in value on aquarterly basis. These investments are classified as other assets in thecondensed consolidated balance sheets and are accounted for either under thecost method or under the equity method as we do not have the ability toexercise significant influence over their operations. We monitor ourinvestments for impairment and record reductions in carrying value when eventsor changes in circumstances indicate that the carrying value may not berecoverable. Reasons for other than temporary declines in value include whetherthe related company would have insufficient cash flow to operate for the nexttwelve months, significant changes in the operating performance and changes inmarket conditions. As of March 31, 2008, the minority investmentsaccounted for under the cost method totaled $0.4 million, while minorityinvestments accounted for under the equity method totaled $3.1 million.

 

**ITEM 4*.*CONTROLSAND PROCEDURES**

 

(a) Under thesupervision and with the participation of our management, our Chief ExecutiveOfficer and Chief Financial Officer have evaluated the effectiveness of ourdisclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended. Based upon thatevaluation, our Chief Executive Officer and our Chief Financial Officerconcluded that the our disclosure controls and procedures were effective as ofthe end of the period covered by this quarterly report.

 

(b) No change in ourinternal control over financial reporting was made during the quarter ended March 31,2008, that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**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.

 

On October 15, 2004, a purported securities class action lawsuitwas filed in the United States Court for the Northern District of California,City of Harper Woods Employees Retirement System v. AXT, Inc. et al., No. C04 4362 MJJ. The Court consolidated the case with a subsequent related case andappointed a lead plaintiff. On April 5, 2005, the lead plaintiff filed aconsolidated complaint, captioned as Morgan v. AXT, Inc. et al., No. C04 4362 MJJ. The lawsuit complaint names AXT, Inc. and our former chieftechnology officer as defendants, and is brought on behalf of a class of allpurchasers of our securities from February 6, 2001 through April 27,2004. The complaint alleges that we announced financial results during thisperiod that were false and misleading. No specific amount of damages isclaimed. On September 23, 2005, the Court granted our motion to dismissthe complaint, with leave to amend. The lead plaintiff filed an amendedcomplaint, which we had moved to dismiss. On April 24, 2007, we reached asettlement of this litigation. On February 27, 2008, the district courtapproved the settlement, and subsequently entered a judgment of dismissal.

 

A former employee, Steve X. Chen, has demanded arbitration of his claimthat his position with AXT, Inc. was eliminated due to his race andnational origin. We believe there is no merit to this claim and intend tocontest it vigorously. An arbitrator has been selected, but discovery has notyet begun.

 

**Item 1A. Risk Factors**

 

There are no material changes from the risk factorsset forth under Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2007.

 

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

 

None

 

**Item 3. Defaults upon SeniorSecurities**

 

None

 

**Item 4. Submission of Matters to a Vote of Security Holders**

 

None

 

**Item 5. Other Information**

 

None

 

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**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 (which  is incorporated herein by reference to Exhibit 2.1 to the registrant’s  form 8-K dated May 28, 1999). |
|                |       |                                                                                                                                                                                                                   |
| 3.3(2)              |       | Second Amended and  Restated By Laws                                                                                                                                                                                   |
|                |       |                                                                                                                                                                                                                   |
| 3.1(1)              |       | Restated Certificate of  Incorporation                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                   |
| 3.1(1)              |       | Restated Certificate of  Incorporation                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                   |
| 4.2(3)              |       | Rights Agreement dated  April 24, 2001 by and between AXT, Inc. and ComputerShare Trust  Company, Inc.                                                                                                  |
|                |       |                                                                                                                                                                                                                   |
| 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.                                                         |

 

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(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 the exhibit as of the same number as filed with the SEC in our Form 8-Kon June 14, 1999.

 

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

 

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**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 12, 2008 | By:       | /s/ Philip C. S. Yin |
|                     |      | Philip C. S. Yin |
|                     |      | Chief Executive Officer |
|                     |      | (Principal Executive  Officer) |
|                     |      |   |
|                     |      | /s/ Wilson W. Cheung |
|                     |      | Wilson W. Cheung |
|                     |      | Chief Financial Officer |
|                     |      | (Principal Financial and  Accounting Officer) |

 

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**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(2)              |       | Second Amended and  Restated By Laws                                                                                                                                                                                   |
|                |       |                                                                                                                                                                                                                   |
| 3.1(1)              |       | Restated Certificate of  Incorporation                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                   |
| 3.1(1)              |       | Restated Certificate of  Incorporation                                                                                                                                                                                 |
|                |       |                                                                                                                                                                                                                   |
| 4.2(3)              |       | Rights Agreement dated  April 24, 2001 by and between AXT, Inc. and ComputerShare Trust  Company, Inc.                                                                                                  |
|                |       |                                                                                                                                                                                                                   |
| 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.                                                         |

 

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(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 the exhibit as of the same number as filed with the SEC in our Form 8-Kon June 14, 1999.

 

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

 

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