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**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**(MarkOne)**

 

| **x**                                                                                                                                                         | ** ** | **Quarterly report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                    | ** ** | ** **                                                                                              |
| **for the quarterly period ended  June 30, 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 asspecified in its charter)

 

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

 

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

(Address of principal executive offices)****(Zip code)

** **

**(510) 683-5900**

(Registrant’s telephone number,including area code)

 

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Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. YES  x  NO  o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definitions of “large accelerated filer,” “accelerated filer,” and“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):

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

 

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

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

 
| **Class**                       | ** ** | **Outstanding at July 30, 2008** |
|---------------------------------|------------|------------------------------------------------------|
| Common  Stock, $0.001 par value |       | 30,435,403                                           |

 

 

 

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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 June 30, 2008 and  December 31, 2007                      | 3        |
| Condensed Consolidated Statements of Operations for the three and six  months ended June 30, 2008 and 2007 | 4        |
| Condensed Consolidated Statements of Cash Flows for the six months  ended June 30, 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             | 15       |
| 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       |

 

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**PART I.FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

AXT, INC.CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except per sharedata)

 
| ** **                                                                                                                                                                                   | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                   | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Assets:                                                                                                                                                                                      |       |              |       |                  |       |
| Current assets:                                                                                                                                                                              |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                    |       | $                 | 19,292     |                  | $          | 18,380 |   |
| Short-term investments                                                                                                                                                                       |       | 17,698            |       | 20,825                |       |
| Accounts receivable, net of allowances of  $126 and $379 as of June 30, 2008 and December 31, 2007,  respectively                                                                  |       | 13,640            |       | 12,149                |       |
| Inventories, net                                                                                                                                                                             |       | 38,887            |       | 24,781                |       |
| Prepaid expenses and other current assets                                                                                                                                                    |       | 5,970             |       | 3,569                 |       |
| Assets held for sale                                                                                                                                                                         |       | —            |       | 5,140                 |       |
| Total current assets                                                                                                                                                                         |       | 95,487            |       | 84,844                |       |
| Property, plant and equipment, net                                                                                                                                                           |       | 19,100            |       | 15,986                |       |
| Restricted deposits                                                                                                                                                                          |       | 6,400             |       | 6,700                 |       |
| Other assets                                                                                                                                                                                 |       | 5,739             |       | 5,242                 |       |
| Total assets                                                                                                                                                                                 |       | $                 | 126,726    |                  | $          | 112,772 |   |
|                                                                                                                                                                                         |       |              |       |                  |       |
| Liabilities and stockholders’ equity:                                                                                                                                                   |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                         |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                             |       | $                 | 14,228     |                  | $          | 4,328 |   |
| Accrued liabilities                                                                                                                                                                          |       | 4,639             |       | 4,326                 |       |
| Current portion of long-term debt                                                                                                                                                            |       | 450               |       | 450                   |       |
| Income taxes payable                                                                                                                                                                         |       | 947               |       | 390                   |       |
| Total current liabilities                                                                                                                                                                    |       | 20,264            |       | 9,494                 |       |
| Long-term debt, net of current portion                                                                                                                                                       |       | 5,962             |       | 6,250                 |       |
| Other long-term liabilities                                                                                                                                                                  |       | 3,028             |       | 3,778                 |       |
| Total liabilities                                                                                                                                                                            |       | 29,254            |       | 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  June 30, 2008 and December 31, 2007.                               |       | 3,532             |       | 3,532                 |       |
| Common stock, $0.001 par value per share;  70,000 shares authorized; 30,435 and 30,358 shares issued and  outstanding as of June 30, 2008 and December 31, 2007, respectively |       | 30                |       | 30                    |       |
| Additional paid-in capital                                                                                                                                                                   |       | 186,419           |       | 185,949               |       |
| Accumulated deficit                                                                                                                                                                          |       | (95,847           | )          | (98,543               | )          |
| Accumulated other comprehensive income                                                                                                                                                       |       | 3,338             |       | 2,282                 |       |
| Total stockholders’ equity                                                                                                                                                              |       | 97,472            |       | 93,250                |       |
| Total liabilities and stockholders’ equity                                                                                                                                              |       | $                 | 126,726    |                  | $          | 112,772 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

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AXT, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per sharedata)

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                      | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                      | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                            |       |                             |       |                           |       |   |   |   |   |
| Revenue                                         |       | $                                | 19,932     |                           | $          | 13,639 |   | $ | 39,566 |   | $ | 26,165 |   |
| Cost of revenue                                 |       | 13,488                           |       | 8,607                          |       | 26,901 |   | 15,728 |   |
| Gross profit                                    |       | 6,444                            |       | 5,032                          |       | 12,665 |   | 10,437 |   |
|                                            |       |                             |       |                           |       |   |   |   |   |
| Operating expenses:                             |       |                             |       |                           |       |   |   |   |   |
| Selling, general and administrative             |       | 3,578                            |       | 3,743                          |       | 7,245 |   | 7,446 |   |
| Research and development                        |       | 569                              |       | 348                            |       | 1,073 |   | 808 |   |
| Impairment (recovery) on assets held for  sale  |       | —                           |       | (481                           | )          | 83 |   | (481 | ) |
| Total operating expenses                        |       | 4,147                            |       | 3,610                          |       | 8,401 |   | 7,773 |   |
| Income from operations                          |       | 2,297                            |       | 1,422                          |       | 4,264 |   | 2,664 |   |
| Interest income, net                            |       | 241                              |       | 225                            |       | 365 |   | 449 |   |
| Minority interests                              |       | (648                             | )          | (493                           | )          | (1,147 | ) | (753 | ) |
| Other income (expense), net                     |       | (518                             | )          | 221                            |       | 409 |   | 470 |   |
|                                            |       |                             |       |                           |       |   |   |   |   |
| Income before provision for income taxes        |       | 1,372                            |       | 1,375                          |       | 3,891 |   | 2,830 |   |
| Provision for income taxes                      |       | 635                              |       | 162                            |       | 1,195 |   | 273 |   |
| Net income                                      |       | $                                | 737        |                           | $          | 1,213 |   | $ | 2,696 |   | $ | 2,557 |   |
|                                            |       |                             |       |                           |       |   |   |   |   |
| Net income per share:                           |       |                             |       |                           |       |   |   |   |   |
| Basic                                           |       | $                                | 0.02       |                           | $          | 0.04 |   | $ | 0.09 |   | $ | 0.08 |   |
| Diluted                                         |       | $                                | 0.02       |                           | $          | 0.04 |   | $ | 0.08 |   | $ | 0.08 |   |
|                                            |       |                             |       |                           |       |   |   |   |   |
| Shares used in computing net income per  share: |       |                             |       |                           |       |   |   |   |   |
| Basic                                           |       | 30,421                           |       | 29,943                         |       | 30,403 |   | 29,871 |   |
| Diluted                                         |       | 31,562                           |       | 31,142                         |       | 31,573 |   | 31,233 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

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AXT, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

 
| ** **                                                           | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                           | ** ** | **June 30,**              | ** ** |
| ** **                                                           | ** ** | **2008**                       | ** ** | **2007** | ** ** |
|                                                                 |       |                           |       |   |   |
| Cash flows from operating activities:                                |       |                           |       |   |   |
| Net income                                                           |       | $                              | 2,696      |   | $ | 2,557 |   |
|                                                                 |       |                           |       |   |   |
| Adjustments to reconcile net income to net  cash used in operations: |       |                           |       |   |   |
| Depreciation                                                         |       | 967                            |       | 686 |   |
| Accretion of marketable securities  premium/discount                 |       | (2                             | )          | (48 | ) |
| Gain on disposal of property, plant and  equipment                   |       | (2                             | )          | — |   |
| Impairment (recovery) on assets held for  sale                       |       | 83                             |       | (481 | ) |
| Stock-based compensation                                             |       | 321                            |       | 211 |   |
| Realized loss (gain) on sale of investments                          |       | (326                           | )          | 29 |   |
| Changes in assets and liabilities:                                   |       |                           |       |   |   |
| Accounts receivable                                                  |       | (1,361                         | )          | (183 | ) |
| Inventories                                                          |       | (13,598                        | )          | (4,590 | ) |
| Prepaid expenses                                                     |       | (2,143                         | )          | (36 | ) |
| Other assets                                                         |       | (439                           | )          | (512 | ) |
| Accounts payable                                                     |       | 9,459                          |       | (1,656 | ) |
| Accrued liabilities                                                  |       | 242                            |       | 51 |   |
| Income taxes                                                         |       | 510                            |       | 149 |   |
| Other long-term liabilities                                          |       | (908                           | )          | (26 | ) |
| Net cash used in operating activities                                |       | (4,501                         | )          | (3,849 | ) |
|                                                                 |       |                           |       |   |   |
| Cash flows from investing activities:                                |       |                           |       |   |   |
| Purchases of property, plant and equipment                           |       | (3,079                         | )          | (2,298 | ) |
| Proceeds from sale of property, plant and  equipment                 |       | 4                              |       | — |   |
| Proceeds from sale of assets held for sale                           |       | 5,057                          |       | — |   |
| Purchases of marketable securities                                   |       | (11,737                        | )          | (10,254 | ) |
| Proceeds from sale of marketable securities                          |       | 14,495                         |       | 11,911 |   |
| Decrease in restricted deposits                                      |       | 300                            |       | 300 |   |
| Net cash provided by (used in) investing  activities                 |       | 5,040                          |       | (341 | ) |
|                                                                 |       |                           |       |   |   |
| Cash flows from financing activities:                                |       |                           |       |   |   |
| Proceeds from issuance of common stock, net                          |       | 149                            |       | 3,842 |   |
| Long-term debt payments                                              |       | (288                           | )          | (387 | ) |
| Net cash provided by (used in) financing  activities                 |       | (139                           | )          | 3,455 |   |
| Effect of exchange rate changes on cash and  cash equivalents        |       | 512                            |       | 35 |   |
| Net increase (decrease) in cash and cash  equivalents                |       | 912                            |       | (700 | ) |
| Cash and cash equivalents at the beginning  of the period            |       | 18,380                         |       | 16,116 |   |
| Cash and cash equivalents at the end of the  period                  |       | $                              | 19,292     |   | $ | 15,416 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

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AXT, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

**Note1. Basis of Presentation**

 

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

 

Our management has made a number of estimates and assumptions relatingto the reporting of assets and liabilities and the disclosure of contingentassets and liabilities to prepare these condensed consolidated financialstatements in conformity with accounting principles generally accepted in the United States ofAmerica. Actual results could differ materially from those estimates.

 

The results of operations are not necessarily indicative of the resultsto be expected in the future or for the full fiscal year. It is recommendedthat these condensed consolidated financial statements be read in conjunctionwith our consolidated financial statements and the notes thereto included inour 2007 Annual Report on Form 10-K filed with the Securities and ExchangeCommission (the “SEC”) on March 14, 2008 and our Quarterly Report on Form 10-Qfor the quarterly period ended March 31, 2008 filed with the SEC on May 12,2008.

 

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

 

Effective January 1,2006, we adopted the provisions of Statement of Financial Accounting Standards(“SFAS”) No. 123 (revised 2004), “*Share-BasedPayment*,” (“SFAS 123(R)”). SFAS 123(R) establishesaccounting for stock-based awards exchanged for employee services. Accordingly,stock-based compensation cost is measured at the grant date, based on the fairvalue of the award, and is recognized as an expense over the employee requisiteservice period. All of our stock compensation is accounted for as an equityinstrument. We previously applied Accounting Principles Board (“APB”) Opinion No. 25,“Accounting for Stock Issued to Employees,” and related interpretations andprovided the required pro forma disclosures of SFAS No. 123, “*Accounting for Stock-Based Compensation*” (“SFAS 123”.

 

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 123,**as disclosed in our previous quarterlyand annual reports.

 

The effect of recording stock compensationfor the three and six months ended June 30, 2008 and 2007 was as follows(in thousands, except per share data):

 
| ** **                                                                         | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Stock-based compensation in the  form of employee stock options, included in: |       |                                            |       |                                          |       |   |   |   |   |
|                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Cost of revenue                                                                    |       | $                                               | 15         |                                          | $          | 13 |   | $ | 31 |   | $ | 26 |   |
| Selling, general and administrative                                                |       | 93                                              |       | 60                                            |       | 215 |   | 149 |   |
| Research and development                                                           |       | 43                                              |       | 18                                            |       | 75 |   | 36 |   |
|                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Total stock-based compensation                                                     |       | 151                                             |       | 91                                            |       | 321 |   | 211 |   |
| Tax effect on stock-based compensation                                             |       | —                                          |       | —                                        |       | — |   | — |   |
|                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Net effect on net income                                                           |       | $                                               | 151        |                                          | $          | 91 |   | $ | 321 |   | $ | 211 |   |
|                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Effect on basic net income per share                                               |       | $                                               | 0.00       |                                          | $          | 0.00 |   | $ | 0.01 |   | $ | 0.01 |   |
| Effect on diluted net income per share                                             |       | $                                               | 0.00       |                                          | $          | 0.00 |   | $ | 0.01 |   | $ | 0.01 |   |

 

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As of June 30, 2008 the totalcompensation costs related to unvested stock-based awards granted to employeesunder our stock option plan but not yet recognized was approximately$1,096,000, net of estimated forfeitures of $133,000. These costs will beamortized on a straight-line basis over a weighted-average period ofapproximately 2.3 years and will be adjusted for subsequent changes inestimated forfeitures. We elected not to capitalize anystock-based compensation to inventory as of June 30, 2008 due to theimmateriality of the amount.

 

The amortization of stock compensation underSFAS 123(R) for the period after our January 1, 2006 adoption isbased on the single-option approach.

 

We estimate the fair value of stock optionsusing a Black-Scholes valuation model, consistent with the provisions of SFAS123(R), and the SEC Staff Accounting Bulletin No. 107. There were no stockoption grants made in the three and six months ended June 30, 2007 and nooptions were granted in the three months ended June 30, 2008. The fairvalue of our stock options granted to employees for the sixmonths ended June 30, 2008 was estimated using the followingweighted-average assumptions:

 
| ** **                  | ** ** | **Six Months Ended** | ** ** |
|-----------------------------|------------|--------------------------------|------------|
| ** **                  | ** ** | **June 30, 2008**    | ** ** |
| Expected term (in years)    |       | 4.0                            |       |
|                        |       |                           |       |
| Volatility                  |       | 60.79                          | %          |
|                        |       |                           |       |
| Expected dividend           |       | 0                              | %          |
|                        |       |                           |       |
| Risk-free interest rate     |       | 2.69                           | %          |
|                        |       |                           |       |
| Estimated forfeitures       |       | 4.3                            | %          |
|                        |       |                           |       |
| Weighted-average fair value |       | $                              | 5.09       |   |
|                             |            |                                |            |  |

 

The followingtable summarizes the stock option transactions during six months ended June 30,2008 (in thousands, except per share data):

 
| ** **                                                    | ** ** | **Shares** | ** ** | **Weighted-  average  Exercise  Price** | ** ** | **Weighted-  average  Remaining  Contractual  Life  (in years****)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|---------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                    | ** ** | ** ** | ** ** | ** **                              | ** ** | ** **                                                                | ** ** | ** **                      | ** ** |
| Options outstanding as of December 31,  2007             |       | 2,477      |       | $                                       | 2.95       |                                                                      |       |                            |       |   |
|                                                          |       |       |       |                                    |       |                                                                      |       |                            |       |
| Granted                                                       |       | 2          |       | 5.09                                    |       |                                                                      |       |                            |       |
|                                                          |       |       |       |                                    |       |                                                                      |       |                            |       |
| Exercised                                                     |       | (78        | )          | 1.92                                    |       |                                                                      |       |                            |       |
|                                                          |       |       |       |                                    |       |                                                                      |       |                            |       |
| Canceled                                                      |       | (34        | )          | 7                                       |       |                                                                      |       |                            |       |
|                                                          |       |       |       |                                    |       |                                                                      |       |                            |       |
| Options outstanding as of June 30,  2008                 |       | 2,367      |       | $                                       | 2.93       |                                                                      | 6.54       |                            | $          | 4,556 |   |
|                                                          |       |       |       |                                    |       |                                                                      |       |                            |       |
| Options vested and expected to vest as of  June 30, 2008 |       | 2,331      |       | $                                       | 2.90       |                                                                      | 6.51       |                            | $          | 4,539 |   |
|                                                          |       |       |       |                                    |       |                                                                      |       |                            |       |
| Options exercisable as of June 30,  2008                 |       | 1,699      |       | $                                       | 2.44       |                                                                      | 5.82       |                            | $          | 3,901 |   |

 

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 $4.19 as of June 30, 2008,which would have been received by the option holder had all option holdersexercised their options as of that date. The total number of in-the-moneyoptions exerciseable as of June 30, 2008 was 1,572,927.

 

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The options outstanding and exercisable as of June 30,2008 were in the following exercise price ranges:

 
| **Options Outstanding as of June 30, 2008** | ** ** | **Options Exercisable  as of June 30, 2008** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| **Range of Exercise Price**                                | ** ** | **Shares**                                                            | ** ** | **Weighted-average  Exercise Price** | ** ** | **Weighted-average  Remaining  Contractual Life** | ** ** | **Shares** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
| $1.17 - $1.38                                                             |       | 1,203,281                                                             |       | $ | 1.28 |   | 6.40 |   | 989,436 |   | $ | 1.28 |   |
| $1.39 - $1.44                                                             |       | 11,500                                                                |       | $ | 1.41 |   | 6.89 |   | 8,761 |   | $ | 1.41 |   |
| $1.45 - $2.24                                                             |       | 415,863                                                               |       | $ | 2.16 |   | 4.76 |   | 407,728 |   | $ | 2.16 |   |
| $2.25 - $5.09                                                             |       | 410,320                                                               |       | $ | 4.07 |   | 7.44 |   | 234,624 |   | $ | 3.64 |   |
| $5.10 - $41.50                                                            |       | 326,175                                                               |       | $ | 8.62 |   | 8.20 |   | 58,500 |   | $ | 19.17 |   |
|                                                                      |       | 2,367,139                                                             |       | $ | 2.93 |   | 6.54 |   | 1,699,049 |   | $ | 2.44 |   |

 

The total intrinsic value ofoptions exercised for the three and six months ended June 30, 2008, was$117,000 and $245,000, respectively. The total intrinsic value of optionsexercised for the three and six months ended June 30, 2007, was $90,000and $160,000, respectively.  Cashreceived from option exercises for the three and six months ended June 30,2008 was $81,000 and $149,000, respectively. Cash received from option exercises for the three and six months ended June 30,2007 was $183,000 and $228,000, respectively.

 

Asummary of activity related to restricted stock awards for the six months endedJune 30, 2008 is presented below:

 
| ** **                                                                   | ** ** | **Shares** | ** ** | **Weighted-Average  Grant Date Fair Value** | ** ** |
|------------------------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------|------------|
| Non-vested restricted stock shares  outstanding as of December 31, 2007 |       | 23,480     |       | $                                                          | 4.26       |   |
| Restricted stock shares granted                                              |       | —     |       | $                                                          | —     |   |
| Restricted stock shares vested                                               |       | (3,536     | )          | $                                                          | 3.77       |   |
| Non-vested restricted stock shares  outstanding as of June 30, 2008     |       | 19,944     |       | $                                                          | 4.26       |   |

 

As of June 30, 2008, wehad $68,000 of unrecognized compensation expense, net of forfeitures, relatedto restricted stock awards, which will be recognized over the weighted averageperiod of 2.02 years. During the six months ended June 30, 2008, 3,536shares of restricted stock vested.

 

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

 

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

 
| ** **                                    | ** ** | **June 30, 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                                          |       | $                           | 19,292     |                            | $          | — |   | $ | — |   | $ | 19,292 |   | $ | 10,818 |   | $ | — |   | $ | — |   | $ | 10,818 |   |
| Cash equivalents:                             |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Money market fund                             |       | —                      |       | —                          |       | — |   | — |   | 7,562 |   | — |   | — |   | 7,562 |   |
|                                          |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total cash equivalents                        |       | —                      |       | —                          |       | — |   | — |   | 7,562 |   | — |   | — |   | 7,562 |   |
|                                          |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total cash and cash equivalents               |       | 19,292                      |       | —                          |       | — |   | 19,292 |   | 18,380 |   | — |   | — |   | 18,380 |   |
|                                          |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments:                                  |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Treasury, agency securities              |       | —                      |       | —                          |       | — |   | — |   | 1,400 |   | — |   | — |   | 1,400 |   |
| Asset-backed securities                       |       | —                      |       | —                          |       | — |   | — |   | 3,820 |   | — |   | (77 | ) | 3,743 |   |
| Commercial paper                              |       | —                      |       | —                          |       | — |   | — |   | 3,300 |   | — |   | (115 | ) | 3,185 |   |
| Corporate bonds                               |       | 24,841                      |       | —                          |       | (743 | ) | 24,098 |   | 19,051 |   | 260 |   | (114 | ) | 19,197 |   |
| Total investments                             |       | 24,841                      |       | —                          |       | (743 | ) | 24,098 |   | 27,571 |   | 260 |   | (306 | ) | 27,525 |   |
| Total cash, cash equivalents and  investments |       | $                           | 44,133     |                            | —     |   | $ | (743 | ) | $ | 43,390 |   | $ | 45,951 |   | $ | 260 |   | $ | (306 | ) | $ | 45,905 |   |
| **Contractual maturities on investments:**    |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Due within 1 year                             |       | $                           |       |                            |       |   |   |   | $ | — |   | $ | 2,050 |   |   |   |   |   | $ | 2,050 |   |
| Due after 1 through 5 years                   |       | 24,841                      |       |                            |       |   |   | 24,098 |   | 25,521 |   |   |   |   |   | 25,475 |   |
|                                          |       | $                           | 24,841     |                            |       |   |   |   | $ | 24,098 |   | $ | 27,571 |   |   |   |   |   | $ | 27,525 |   |
|                                               |            |                             |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Theinvestments include $6.4 million and $6.7 million recorded as restricteddeposits on the condensed consolidated balance sheets as of June 30, 2008and December 31, 2007, respectively, as a result of the outstandingprincipal amount on our industrial revenue bonds.  Subsequently on July 1, 2008, we paiddown the entire principal amount of $6.4 million plus accrued interest andaccordingly the restricted deposits were released.

 

Wemanage our investments as a single portfolio of highly marketable securitiesthat is intended to be available to meet our current cash requirements. For thethree and six months ended June 30, 2008, we had $133,000 in gross realizedlosses and $326,000 in gross realized gains on sales of our available-for-salesecurities, respectively. For the three and six months ended June 30, 2007we had $19,000 and $29,000 in gross realized losses on sales of ouravailable-for-sale securities, respectively.

 

Thegross unrealized losses related to our portfolio of available-for-salesecurities were primarily due to a decrease in the fair value of debtsecurities. We have determined that the gross unrealized losses on ouravailable-for-sale securities as of June 30, 2008 are temporary in nature.We reviewed our investment portfolio to identify and evaluate investments thathave 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 market value.The following table provides a breakdown of our available-for-sale securitieswith unrealized losses as of June 30, 2008 (in thousands):

 
| ** **             | ** ** | **In Loss Position** | ** ** | **In Loss Position** | ** ** | **Total In**      | ** ** |
|------------------------|------------|--------------------------------|------------|--------------------------------|------------|------------------------|------------|
| ** **             | ** ** | **< 12 months**   | ** ** | **> 12 months**   | ** ** | **Loss Position** | ** ** |
| ** **             | ** ** | ** **                     | ** ** | **Gross**                      | ** ** | ** **             | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **             | ** ** | **Fair**                       | ** ** | **Unrealized**                 | ** ** | **Fair**               | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **             | ** ** | **Value**                      | ** ** | **(Loss)**                     | ** ** | **Value**              | ** ** | **(Loss)** | ** ** | **Value** | ** ** | **(Loss)** | ** ** |
| Investments:           |       |                           |       |                           |       |                   |       |   |   |   |   |   |   |
| Corporate bonds        |       | $                              | 24,098     |                           | $          | (743                   | )          | $ | — |   | $ | — |   | $ | 24,098 |   | $ | 743 | ) |
| Total in loss position |       | $                              | 24,098     |                           | $          | (743                   | )          | $ | — |   | $ | — |   | $ | 24,098 |   | $ | (743 | ) |

 

***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). As of June 30,2008 and December 31, 2007, our investments in privately-held companieshad a carrying value of $5.4 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”)which defines fair value, establishes a framework for using fair value tomeasure assets 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 non-financial 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 our financial assets and liabilities measured at fair value ona recurring basis in accordance with SFAS No. 157 as of June 30,2008 (in thousands):

 
| ** **              | ** ** | **Balance as of  June 30, 2008** | ** ** | **Quoted Prices in  Active Markets of  Identical Assets  (Level 1)** | ** ** | **Significant Other  Observable Inputs  (Level 2)** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| Assets:                 | ** ** | ** **                                           | ** ** | ** **                                                                                         | ** ** | ** **                                                         | ** ** |
| Short-term investments: |       |                                                 |       |                                                                                               |       |                                                               |       |
| Corporate bonds         |       | $                                                    | 24,098     |                                                                                               | $          | —                                                             |       | $ | 24,098 |   |
| Total                   |       | $                                                    | 24,098     |                                                                                               | $          | —                                                             |       | $ | 24,098 |   |
|                    |       |                                                 |       |                                                                                               |       |                                                               |       |
| 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 June 30, 2008, we did not have any assets orliabilities without observable market values that would require a high level ofjudgment to determine fair value (Level 3 assets).

 

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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 six months of 2008.

 

**Note4. Inventories, Net**

 

The components ofinventories are summarized below (in thousands):

 
| ** **        | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|-------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Inventories, net: |       |              |       |                  |       |
| Raw materials     |       | $                 | 18,605     |                  | $          | 11,154 |   |
| Work in process   |       | 15,249            |       | 12,254                |       |
| Finished goods    |       | 5,033             |       | 1,373                 |       |
|              |       | $                 | 38,887     |                  | $          | 24,781 |   |

 

**Note5. Recovery (Impairment) on Assets Held For Sale**

 

During the firstsix months of 2008, we completed the sale of our property in Fremont,California for $5.3 million in gross proceeds and $5.1 million in net proceedsafter deducting commissions and selling expenses. We recorded an impairmentcharge upon the sale of the property of $83,000.

 

During the firstsix months of 2007, we benefited from a recovery of impairment on assets heldfor sale in connection with our adjustment of the fair value of the sameproperty in Fremont, California, which has been decontaminated and was beingprepared for sale.  We recorded a $481,000market value adjustment after we entered into an agreement with an independentthird party purchaser in June 2007. However, the sale ultimately was not consummated.

 

**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 thenumerators and denominators of the basic and diluted net income per share calculationsis as follows (in thousands, except per share data):

 
| ** **                                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                       | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                       | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Numerator:                                                                       |       |                             |       |                           |       |   |   |   |   |
| Net income                                                                       |       | $                                | 737        |                           | $          | 1,213 |   | $ | 2,696 |   | $ | 2,557 |   |
| Less: Preferred stock dividends                                                  |       | (44                              | )          | (44                            | )          | (88 | ) | (88 | ) |
|                                                                             |       |                             |       |                           |       |   |   |   |   |
| Net income available to common stockholders                                      |       | $                                | 693        |                           | $          | 1,169 |   | $ | 2,608 |   | $ | 2,469 |   |
| Denominator:                                                                     |       |                             |       |                           |       |   |   |   |   |
| Denominator for basic net income per share  - weighted average common shares     |       | 30,421                           |       | 29,943                         |       | 30,403 |   | 29,871 |   |
| Effect of dilutive securities:                                                   |       |                             |       |                           |       |   |   |   |   |
| Common stock options                                                             |       | 1,141                            |       | 1,199                          |       | 1,170 |   | 1,362 |   |
| Denominator for dilutive net income per  common share                            |       | 31,562                           |       | 31,142                         |       | 31,573 |   | 31,233 |   |
| Basic net income per share                                                       |       | $                                | 0.02       |                           | $          | 0.04 |   | $ | 0.09 |   | $ | 0.08 |   |
| Diluted net income per share                                                     |       | $                                | 0.02       |                           | $          | 0.04 |   | $ | 0.08 |   | $ | 0.08 |   |
| Options excluded from diluted net loss per  share as the impact is anti-dilutive |       | 130                              |       | 372                            |       | 130 |   | 362 |   |

 

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**Note7. Comprehensive Income**

 

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

 
| ** **                                                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                          | ** ** | **June 30,**                | ** ** | **June 30,**              |
| ** **                                                          | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                |       |                             |       |                           |       |   |   |   |   |
| Net income                                                          |       | $                                | 737        |                           | $          | 1,213 |   | $ | 2,696 |   | $ | 2,557 |   |
| Change in foreign currency translation gain                         |       | 601                              |       | 369                            |       | 1,753 |   | 599 |   |
| Change in unrealized gain (loss) on  available-for-sale investments |       | (150                             | )          | 443                            |       | (697 | ) | 472 |   |
| Comprehensive income                                                |       | $                                | 1,188      |                           | $          | 2,025 |   | $ | 3,752 |   | $ | 3,628 |   |

 

**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 andassessing our performance. We manage the Company on a consolidated basis with areview of revenue by product.  We discussrevenue and capacity for both AXT and our China joint ventures collectively,when determining capacity constraints and need for raw materials in ourbusiness, and consider their capacity when determining our strategic andproduct marketing and advertising strategies. While we consolidate three of the joint ventures, we do not allocateresources to any of them, nor allocate any portion of overhead, interest andother income, interest expense or taxes to them.  Accordingly, we have determined that ourjoint venture operations do not constitute an operating segment in accordancewith SFAS No. 131.  Since we operatein one segment, all financial segment and product line information required bySFAS No. 131 can be found in the condensed consolidated financialstatements.

 

***Product Information***

*** ***
| ** **              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **              | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **              | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Product by type:        |       |                             |       |                           |       |   |   |   |   |
| GaAs substrates         |       | $                                | 13,142     |                           | $          | 9,296 |   | $ | 26,862 |   | $ | 18,088 |   |
| InP substrates          |       | 500                              |       | 660                            |       | 978 |   | 1,178 |   |
| Ge substrates           |       | 1,384                            |       | 402                            |       | 2,769 |   | 943 |   |
| Raw materials and other |       | 4,906                            |       | 3,281                          |       | 8,957 |   | 5,956 |   |
| Consolidated            |       | $                                | 19,932     |                           | $          | 13,639 |   | $ | 39,566 |   | $ | 26,165 |   |

 

***GeographicalInformation***

*** ***

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

 
| ** **     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **     | ** ** | **June 30,**                | ** ** | **June 30**               | ** ** |
| ** **     | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net revenues:  |       |                             |       |                           |       |   |   |   |   |
| North America* |       | $                                | 5,437      |                           | $          | 2,756 |   | $ | 10,436 |   | $ | 6,098 |   |
| Europe         |       | 3,966                            |       | 2,606                          |       | 6,783 |   | 4,671 |   |
| Japan          |       | 4,595                            |       | 3,012                          |       | 8,735 |   | 5,398 |   |
| Taiwan         |       | 2,061                            |       | 2,228                          |       | 4,868 |   | 4,040 |   |
| Asia Pacific   |       | 3,873                            |       | 3,037                          |       | 8,744 |   | 5,958 |   |
| Consolidated   |       | $                                | 19,932     |                           | $          | 13,639 |   | $ | 39,566 |   | $ | 26,165 |   |

 

----

*Primarilythe United States

 

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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**    | ** ** |
|--------------------|------------|-------------------|------------|
| ** **         | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| ** **         | ** ** | **2008**          | ** ** | **2007** | ** ** |
| Long-lived assets: |       |              |       |   |   |
| North America      |       | $                 | 209        |   | $ | 149 |   |
| China              |       | 18,891            |       | 15,837 |   |
|               |       | $                 | 19,100     |   | $ | 15,986 |   |

 

***Significant Customers***

 

Twocustomers represented 11.6% and 11.1% of revenues for the three month periodended June 30, 2008 while no customers represented more than 10% ofrevenues for the three month period ended June 30, 2007. No customersrepresented more than 10% of revenues for the six month periods ended June 30,2008 and 2007.  Our top five customersrepresented 45.5% and 35.2% of revenue for the three month periods ended June 30,2008 and 2007, respectively.  Our topfive customers represented 34.6% and 33.6% of revenue for the six month periodsended June 30, 2008 and 2007, 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**                                                      | ** ** | **June 30,  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                               |       | 2,494                                       |       | 2,138                       |       | Equity                 |       | 25 | % |
| Emeishan Jia Mei High Purity Metals Co.,  Ltd                    |       | 888                                         |       | 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 $10.1 million and $7.8million as of June 30, 2008 and December 31, 2007, respectively. Netincome recorded from our investments was $1.2 million and $955,000 for thethree months ended June 30, 2008 and 2007, respectively. Net incomerecorded from our investments was $2.2 million and $1.6 million for the sixmonths ended June 30, 2008 and 2007, respectively.

 

The minority interest forthe three majority-owned joint ventures that are consolidated is includedwithin “Other long-term liabilities” in the condensed consolidated balancesheets and separately disclosed under “Minority interests” on the condensedconsolidated statements of operations. The equity earnings from the two minority-owned joint ventures that arenot consolidated are recorded as “Other income (expense), net” on the condensedconsolidated statements of operations.

 

We also have investmentsin two privately-held companies which are accounted for under the cost methodas we do not have the ability to exercise significant influence over theiroperations. As of June 30, 2008 and December 31, 2007, theseinvestments totaled approximately $0.4 million and are included in “Otherassets” on the condensed consolidated balance sheets.

 

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** **

**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.

 

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 and six months ended June 30, 2008 and 2007 (inthousands):

 
| ** **                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                    | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                          |       |                                            |       |                                          |       |   |   |   |   |
| Beginning accrued warranty and related  costs |       | $                                               | 996        |                                          | $          | 783 |   | $ | 1,030 |   | $ | 459 |   |
| Charged to cost of revenue                    |       | 379                                             |       | 244                                           |       | 408 |   | 696 |   |
| Actual warranty expenditures                  |       | (66                                             | )          | (78                                           | )          | (129 | ) | (206 | ) |
| Ending accrued warranty and related costs     |       | $                                               | 1,309      |                                          | $          | 949 |   | $ | 1,309 |   | $ | 949 |   |

 

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

 

Weincurred foreign currency transaction exchange losses of $593,000 and $246,000for the three month periods ended June 30, 2008, and 2007, respectively.We incurred foreign currency transaction exchange losses due to operations ingeneral of $404,000 and $290,000 for the six month periods ended June 30,2008, 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”), *“Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109)”*  (“SFAS109”). FIN 48 clarifies the accounting for uncertainty in income taxesrecognized in an enterprise’s financial statements in accordance with SFAS 109.This interpretation prescribes a recognition threshold and measurementattribute for the financial statement recognition and measurement of a taxposition taken or expected to be taken in a tax return. FIN 48 also providesguidance on derecognition of tax benefits, classification on the balance sheet,interest and penalties, accounting in interim periods, disclosure, andtransition. We adopted FIN 48 effective January 1, 2007. We recognizeinterest and penalties related to uncertain tax positions in income taxexpense. As of June 30, 2008, we do not have any gross unrecognized taxbenefits, nor any accrued interest and penalties related to uncertain taxpositions. As a result of the implementation of FIN 48, we identified$16.4 million in unrecognized tax benefits. This amount decreased the taxloss carryforwards in the U.S. which are fully offset by a valuation allowance.We file income tax returns in the U.S. federal, various states and foreignjurisdictions. We have substantially concluded all U.S. federal and stateincome tax matters through December 31, 2007.

 

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**Note13. Recent Accounting Pronouncements**

 

In March 2008, the FASB issued SFAS No. 161, “*Disclosures about Derivative Instruments and Hedging Activities*”(“SFAS 161”). SFAS 161 requires companies with derivative instruments todisclose information that should enable financial-statement users to understandhow and why a company uses derivative instruments, how derivative instrumentsand related hedged items affect a company’s financial position, financialperformance and cash flows. SFAS 161 is effective for financial statementsissued for fiscal years and interim periods beginning after November 15,2008. Based on our current operations, we do not expect that the adoptionof SFAS 161 will have a material impact on our consolidated financialposition or results of operations.

 

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 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 impactthat the adoption of SFAS 160 will have on our consolidated financialposition, 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— *Effective Dateof FASB Statement No. 157*) which delays the effective date ofSFAS 157 for all nonfinancial assets and nonfinancial liabilities, except thosethat are recognized or disclosed at fair value in the financial statements on arecurring basis (at least annually) to fiscal years beginning after November 15,2008. These non-financial items include assets and liabilities such asreporting units measured at fair value in a goodwill impairment test andnon-financial assets acquired and liabilities assumed in a businesscombination. The partial adoption of SFAS 157 as of January 1, 2008 forfinancial 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.

 

**Note14. Subsequent Events**

 

On July 1, 2008, we exercised our rightto redeem the taxable variable rate revenue bond and repaid all outstandingindebtedness and accrued interest under the terms of the revenue bond ofapproximately $6.4 million.  Accordingly,all of our remaining obligations under the revenue bond have terminated and therestricted deposits on the condensed consolidated balance sheets as of June 30,2008 have been released.

 

On July 2, 2008, we entered into a newlease agreement with T. Drive Partners, L.P., a California partnership, for theapproximately 27,760 square foot facility located at 4281 Technology Drive,Fremont California.  The new lease commenceson December 1, 2008 for a term of seven years. We have the option tocancel the lease at any time after December 1, 2013, upon forfeiture ofthe security deposit and payment of one-half of the fifth year’s rent.  The base rent for the new lease shall be$0.72 per square foot per month triple net, with annual rental increases of4.5% per annum, payment of $50,000 security deposit, and tenant improvements of$575,000 to be amortized over seven years at 4% per annum.

 

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

 

This quarterly report on Form 10-Q,including the following sections, contains forward-looking statements withinthe meaning of Section 21E of the Securities Exchange Act of 1934, asamended, particularly statements relating to our expectations regarding resultsof operations, customer demand, improvements in our product quality, ourability to expand our markets and increase sales, customer qualifications ofour products, gross margins, favorable pricing, reliable supply and enhancedsourcing 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 identify important factors thatcould cause actual results to differ materially from those predicted in anysuch forward-looking statements. We caution investors that actual results maydiffer materially from those projected in the forward-looking statements as aresult of certain risk factors identified in this Form 10-Q and otherfilings we have made with the Securities and Exchange Commission.Forward-looking statements may be identified by the use of terms such as “anticipates,”“believes,” “estimates,” “expects,” “intends,” and similar expressions.Statements concerning our future or expected financial results and condition,business strategy and plans or objectives for future operations areforward-looking statements.

 

These forward-lookingstatements are not guarantees of future performance. Readers are cautioned notto place undue reliance on these forward-looking statements, which speak onlyas of the date hereof. This discussion should be read in conjunction withManagement’s Discussion and Analysis of Financial Condition and Results ofOperations included in our Annual Report on Form 10-K for the year ended December31, 2007 and the condensed consolidated financial statements included elsewherein this report.

 

**Overview**

 

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

 
| **Product**            | ** ** | ** **                |
|------------------------|------------|---------------------------|
| **Substrates**         | ** ** | **Diameter**              | ** ** | **Applications** |
| GaAs (semi-insulating) |       | 2” 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 compoundsemiconductor substrates using our proprietary vertical gradient freeze, orVGF, technology. Our in-house VGF technology enables us to add capacity quicklyand cost efficiently. We manufacture all of our products in China, whichgenerally has lower costs for facilities, labor and 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.

 

Revenue increased $13.4million, or 51.2%, to $39.6 million for the six months ended June 30, 2008from $26.2 million for the same period of 2007 primarily due to higher customerdemands for six-inch diameter wafers, and an increase in germanium substratesand raw material sales. On March 28, 2008, we completed the sale of ourFremont, California facility and received net proceeds of 

 

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approximately $5.1million after deducting commissions and selling expenses. As of June 30,2008, we had available cash, cash equivalents and short-term investments of$37.0 million, excluding restricted deposits. Subsequently on July 1, 2008, we exercised our right to redeem thetaxable variable rate revenue bond and repaid all outstanding indebtedness andaccrued interests under the terms of the revenue bond of approximately $6.4million.  Accordingly, all of ourremaining obligations under the revenue bond have terminated and the restricteddeposits on the condensed consolidated balance sheets as of June 30, 2008have been released.

 

**Critical Accounting Policies and Estimates**

 

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

 

We have identified thepolicies below as critical to our business operations and understanding of ourfinancial condition and results of operations.

 

A critical accountingpolicy is one that is both material to the presentation of our financialstatements and requires us to make difficult, subjective or complex judgmentsthat could have a material effect on our financial condition and results ofoperations. They may require us to make assumptions about matters that arehighly uncertain at the time of the estimate, and different estimates that wecould have used, or changes in the estimate that are reasonably likely tooccur, may have a material impact on our financial condition or results ofoperations.

 

We believe that thefollowing are our critical accounting policies:

 

***Revenue Recognition***

 

We manufacture and sell high-performance compoundsemiconductor substrates and sell certain raw materials including gallium,germanium dioxide, and pBN crucibles. After we ship our products, there are noremaining obligations or customer acceptance requirements that would precluderevenue recognition. Our products are typically sold pursuant to a purchaseorder placed by our customers, and our terms and conditions of sale do notrequire customer acceptance. We recognize revenue upon shipment and transfer oftitle of products to our customers, which is either upon shipment from ourdock, receipt at the customer’s dock, or removal from consignment inventory atthe customer’s location, provided that we have received a signed purchaseorder, the price is fixed or determinable, title and risk of ownership havetransferred, collection of resulting receivables is probable, and productreturns are reasonably estimable. We do not provide training, installation orcommissioning services. Additionally, we 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 June 30, 2008 and December 31,2007, our accounts receivable, net, balance was $13.6 million and $12.1million, respectively, which was net of an allowance for doubtful accounts of$126,000 and $379,000, respectively. If actual uncollectible accounts differ substantiallyfrom our estimates, revisions to the estimated allowance for doubtful accountswould be required, which could have a material impact on our financial resultsfor the period.

 

***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 June 30, 2008 and December 31,2007, accrued product warranties totaled $1.3 million and $1.0 million,respectively. If actual warranty costs differ substantially from our estimates,revisions to the estimated warranty liability would be required, which couldhave a material impact on our financial condition and results of operations.

 

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***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 June 30,2008 and December 31, 2007, we had an inventory reserve of $12.8 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 SFAS No. 115,*“Accounting for Certain Investments in Debtand Equity Securities”.*All available-for-sale securities with aquoted market value below cost (or adjusted cost) are reviewed in order todetermine whether the decline is other-than-temporary. Factors considered indetermining whether a loss is temporary include the magnitude of the decline inmarket value, the length of time the market value has been below cost (oradjusted cost), credit quality, and our ability and intent to hold thesecurities for a period of time sufficient to allow for any anticipatedrecovery in market value.

 

We invest in equity instruments ofprivately-held companies for business and strategic purposes. These investmentsare classified as other assets and are accounted for either under the costmethod or under the equity method as we do not have the ability to exercisesignificant influence over their operations. We monitor our investments forimpairment and would record reductions in carrying value when events or changesin circumstances indicate that the carrying value may not be recoverable.Determination of impairment is highly subjective and is based on a number offactors, including an assessment of the strength of the investee’s management,the length of time and extent to which the fair value has been less than ourcost basis, the financial condition and near-term prospects of the investee,fundamental changes to the business prospects of the investee, share prices ofsubsequent offerings, and our intent and ability to hold the investment for aperiod of time sufficient to allow for any anticipated recovery in our carryingvalue.

 

***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 the long-livedassets to the projection of future undiscounted cash flows attributable tothese assets. In the event that the carrying value exceeds the futureundiscounted cash flows, we record an impairment charge against income equal tothe excess of the carrying value over the assets’ fair value. Fair values aredetermined based on quoted market values, discounted cash flows or internal andexternal appraisals, as applicable. Assets held for sale are carried at thelower 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 123(R)”),using the modified prospective application transition method. Under thistransition method, stock-based compensation cost was recognized in thecondensed consolidated financial statements for all share-based payments after January 1,2006. Compensation cost recognized includes the estimated expense for theportion of the vesting period after January 1, 2006 for share-based paymentsprior to, but not vested as of January 1, 2006, based on the grant datefair value estimated in accordance with the original provisions of SFAS 123, “*Accounting for Stock-Based Compensation.”* We recognize thesecompensation costs net of an estimated forfeiture rate over the requisiteservice period of the award, which is generally the vesting term of four yearsfor stock options. Results for prior periods have not been restated, asprovided for under the modified prospective application transition method.

 

***Income Taxes***

 

We account for income taxes in accordancewith SFAS No. 109, *“Accounting forIncome Taxes,”* (“SFAS 109”) which requires that deferred taxassets and liabilities be recognized using enacted tax rates for the effect oftemporary differences between the book and tax bases of recorded assets andliabilities. SFAS 109 also requires that deferred tax assets be reduced bya valuation allowance if it is more likely than not that a portion of thedeferred tax asset will not be realized.

 

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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.

 

**Resultsof Operations**

 

**Revenue**

 
| ** **    | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|---------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **    | ** ** | **June 30,**                | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **    | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **    | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** |
| GaAs          |       | $                                | 13,142     |         | $          | 9,296          |       | $ | 3,846 |   | 41.4 | % |
| InP           |       | 500                              |       | 660          |       | (160           | )          | (24.2 | )% |
| Ge            |       | 1,384                            |       | 402          |       | 982            |       | 244.3 | % |
| Raw materials |       | 4,906                            |       | 3,281        |       | 1,625          |       | 49.5 | % |
| Total revenue |       | $                                | 19,932     |         | $          | 13,639         |       | $ | 6,293 |   | 46.1 | % |

 

Revenue increased $6.3million, or 46.1%, to $19.9 million for the three months ended June 30,2008 from $13.6 million for the three months ended June 30, 2007. TotalGaAs substrate revenue increased $3.8 million, or 41.4%, to $13.1 million forthe three months ended June 30, 2008 from $9.3 million for the threemonths ended June 30, 2007.

 

Sales of 5 inch and 6inch diameter GaAs substrates were $6.1 million for the three months ended June 30,2008 compared to $3.9 million for the three months ended June 30, 2007.The increase in larger diameter semi-insulating substrates came from the growthin demand for both cellular and WLAN (Wide Local Area Network) markets. Ourgrowth came particularly from production orders pursuant to a supply agreementwe signed in the fourth quarter of 2007 with IQE plc.

 

 Sales of 2 inch, 3 inch and 4 inch diameterGaAs substrates were $7.1 million for the three months ended June 30, 2008compared with $5.3 million for the three months ended June 30, 2007. Theincrease in revenue from smaller diameter substrates was due to the continuedmarket growth generally of LED laser diodes and commercial epitaxy.

 

InP substrate revenuedecreased $160,000, or 24.2%, to $500,000 for the three months ended June 30,2008 from $660,000 for the three months ended June 30, 2007. In the threemonths ended June 30, 2007 we had a one-time sale of $251,000 indium scrapmetal. Excluding the impact of the one-time sale, InP substrate revenueincreased by $91,000 for the three months ended June 30, 2008 compared tothe three months ended June 30, 2007 due to a slight increase in demandfrom customers in the optical networking industry.

 

Ge substrate revenueincreased $982,000, or 244.3%, to $1.4 million for the three months ended June 30,2008 from $402,000 for the three months ended June 30, 2007. The increasein Ge substrate revenue was due to an increase in sales to customers in thePeople’s Republic of China and an increase in sales to a major customer inEurope who has now qualified our product, as demand for photovoltaicapplications increases.

 

Raw materials revenueincreased $1.6 million, or 49.5%, to $4.9 million for the three months ended June 30,2008 from $3.3 million for the three months ended June 30, 2007. Theincrease in raw materials revenue was primarily due to a combination ofincreased sales to customers as demand increased and higher raw materialsprices. We do not expect demand to continue at this pace for the remainder of2008.

 

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| ** **    | ** ** | **Six Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|---------------|------------|--------------------------------|------------|--------------|------------|----------------|------------|
| ** **    | ** ** | **June 30,**              | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **    | ** ** | **2008**                       | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **    | ** ** | **($ in thousands)** | ** ** | ** **   | ** ** |
| GaAs          |       | $                              | 26,862     |         | $          | 18,088         |       | $ | 8,774 |   | 48.5 | % |
| InP           |       | 978                            |       | 1,178        |       | (200           | )          | (17.0 | )% |
| Ge            |       | 2,769                          |       | 943          |       | 1,826          |       | 193.6 | % |
| Raw materials |       | 8,947                          |       | 5,911        |       | 3,036          |       | 51.4 | % |
| Other         |       | 10                             |       | 45           |       | (35            | )          | (77.8 | )% |
| Total revenue |       | $                              | 39,566     |         | $          | 26,165         |       | $ | 13,401 |   | 51.2 | % |

 

Revenue increased $13.4million, or 51.2%, to $39.6 million for the six months ended June 30, 2008from $26.2 million for the six months ended June 30, 2007. Total GaAssubstrate revenue increased $8.8 million, or 48.5%, to $26.9 million for thesix months ended June 30, 2008 from $18.1 million for the six months endedJune 30, 2007.

 

Sales of 5 inch and 6inch diameter GaAs substrates were $12.9 million for the six months ended June 30,2008 compared to $8.0 million for the six months ended June 30, 2007. Theincrease in larger diameter semi-insulating substrates came from the growth indemand for both cellular and WLAN (Wide Local Area Network) markets. Our growthcame particularly from production orders pursuant to a supply agreement wesigned in the fourth quarter of 2007 with IQE plc.

 

 Sales of 2 inch, 3 inch and 4 inch diameterGaAs substrates were $13.9 million for the six months ended June 30, 2008compared with $10.1 million for the six months ended June 30, 2007. The increasein revenue from smaller diameter substrates was due to the continued marketgrowth generally of LED laser diodes and commercial epitaxy.

 

InP substrate revenuedecreased $200,000, or 17.0%, to $978,000 for the six months ended June 30,2008 from $1.2 million for the six months ended June 30, 2007. In thethree months ended June 30, 2007 we had a one-time sale of $251,000 indiumscrap metal. Excluding the impact of the one-time sale, InP substrate revenueincreased $51,000 for the six months ended June 30, 2008 compared to thesix months ended June 30, 2007due to a slight increase in demand fromcustomers in the optical networking industry.

 

Ge substrate revenueincreased $1.8 million, or 193.6%, to $2.8 million for the six months ended June 30,2008 from $943,000 for the six months ended June 30, 2007. The increase inGe substrate revenue was due to an increase in sales to customers in the People’sRepublic of China and an increase in sales to a major customer in Europe whohas now qualified our product, as demand for photovoltaic applicationsincreases.

 

Raw materials revenueincreased $3.0 million, or 51.4%, to $8.9 million for the six months ended June 30,2008 from $5.9 million for the six months ended June 30, 2007. Theincrease in raw materials revenue was primarily due to a combination ofincreased sales to customers as demand increased and higher raw materialsprices. We do not expect demand to continue at this pace for the remainder of2008.

 

***Revenueby Geographic Region***

 
| ** **                                | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                | ** ** | **June 30,**                | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                                | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| North America *                           |       | $                                | 5,437      |         | $          | 2,756          |       | $ | 2,681 |   | 97.3 | % |
| *% of total revenue*                      |       | 27                               | %          | 20           | %          |           |       |   |   |
| Europe                                    |       | 3,966                            |       | 2,606        |       | 1,360          |       | 52.2 | % |
| *% of total revenue*                      |       | 20                               | %          | 19           | %          |           |       |   |   |
| Japan                                     |       | 4,595                            |       | 3,012        |       | 1,583          |       | 52.6 | % |
| *% of total revenue*                      |       | 23                               | %          | 22           | %          |           |       |   |   |
| Taiwan                                    |       | 2,061                            |       | 2,228        |       | (167           | )          | (7.5 | )% |
| *% of total revenue*                      |       | 10                               | %          | 17           | %          |           |       |   |   |
| Asia Pacific (excluding Japan and Taiwan) |       | 3,873                            |       | 3,037        |       | 836            |       | 27.5 | % |
| *% of total revenue*                      |       | 20                               | %          | 22           | %          |           |       |   |   |
| Total revenue                             |       | $                                | 19,932     |         | $          | 13,639         |       | $ | 6,293 |   | 46.1 | % |

 

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*Primarily the UnitedStates

 

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Revenue fromcustomers in North America increased by $2.7 million, or 97.3%, to $5.4 millionfor the three months ended June 30, 2008 from $2.8 million for the three monthsended June 30, 2007. We expected our North America revenue to increasesubstantially in 2008 based upon a supply agreement we signed in the fourthquarter of 2007 with IQE plc. Underthe terms of the agreement, IQE plc shall purchase from us a minimum ofapproximately $15.1 million of 4-inch and 6-inch semi-insulating galliumarsenide (GaAs) substrates.  IQE plc has an option to purchase anadditional $3.5 million of 6-inch substrates from us under the agreement. All substrates ordered pursuant to the agreement are to be shipped by theend of 2008.

 

Revenue from customers inEurope increased by $1.4 million, or 52.2%, to $4.0 million for the threemonths ended June 30, 2008 from $2.6 million for the three months ended June 30,2007. This increase came primarily from increased substrate sales to customersin Germany and France, and to a lesser extent from increased sales to acustomer in the United Kingdom that is part of the IQE plc group with whom wesigned a supply agreement in the fourth quarter of 2007.

 

Revenue from customers inJapan increased by $1.6 million, or 52.6%, to $4.6 million for the three monthsended June 30, 2008 from $3.0 million for the three months ended June 30,2007. The increase came from $1.2 million increased substrate sales to twomajor existing customers, particularly in large diameter wafers, and from $0.4million increased raw material sales of 4N gallium.

 

Revenue from customers inTaiwan decreased by $167,000, or 7.5%, to $2.1 million for the three monthsended June 30, 2008 from $2.2 million for the three months ended June 30,2007. The decrease came mainly from one major existing customer for largediameter wafers.

 

Revenue from customers inAsia Pacific (excluding Japan and Taiwan) increased by $0.8 million, or 27.5%,to $3.9 million for the three months ended June 30, 2008 from $3.0 millionfor the three months ended June 30, 2007. Sales to customers in the People’sRepublic of China increased by $1.1 million, of which raw materials was $0.5million, while $0.6 million was from increased sales to existing customers forsmall diameter GaAs wafers. Sales to a major customer in Singapore that is partof the IQE plc group decreased by $0.5 million as they shifted somepurchases to other geographic areas. Sales to customers in Korea increased by$0.2 million as demand increased in smaller diameter wafers.

*** ***
| ** **                                | ** ** | **Six Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|-------------------------------------------|------------|--------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                | ** ** | **June 30,**              | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                                | ** ** | **2008**                       | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                | ** ** | **($ in thousands)** | ** ** | ** **   | ** ** | ** **     | ** ** |
| North America *                           |       | $                              | 10,436     |         | $          | 6,098          |       | $ | 4,338 |   | 71.1 | % |
| *% of total revenue*                      |       | 27                             | %          | 23           | %          |           |       |   |   |
| Europe                                    |       | 6,783                          |       | 4,671        |       | 2,112          |       | 45.2 | % |
| *% of total revenue*                      |       | 17                             | %          | 18           | %          |           |       |   |   |
| Japan                                     |       | 8,735                          |       | 5,398        |       | 3,337          |       | 61.8 | % |
| *% of total revenue*                      |       | 22                             | %          | 21           | %          |           |       |   |   |
| Taiwan                                    |       | 4,868                          |       | 4,040        |       | 828            |       | 20.5 | % |
| *% of total revenue*                      |       | 12                             | %          | 15           | %          |           |       |   |   |
| Asia Pacific (excluding Japan and Taiwan) |       | 8,744                          |       | 5,958        |       | 2,786          |       | 46.8 | % |
| *% of total revenue*                      |       | 22                             | %          | 23           | %          |           |       |   |   |
| Total revenue                             |       | $                              | 39,566     |         | $          | 26,165         |       | $ | 13,401 |   | 51.2 | % |

 

----

*Primarily the UnitedStates

 

Revenue fromcustomers in North America increased by $4.3 million, or 71.1%, to $10.4million for the six months ended June 30, 2008 from $6.1 million for thesix months ended June 30, 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 inEurope increased by $2.1 million, or 45.2%, to $6.8 million for the six monthsended June 30, 2008 from $4.7 million for the six months ended June 30,2007. This increase came primarily from increased substrate sales to customersin Germany and France, and to a lesser extent from increased sales to acustomer in the United Kingdom that is part of the IQE plc group with whom wesigned a supply agreement in the fourth quarter of 2007.

 

Revenue from customers inJapan increased by $3.3 million, or 61.8%, to $8.7 million for the six monthsended June 30, 2008 from $5.4 million for the six months ended June 30,2007. The increase came from $2.8 million increased substrate sales to twomajor existing customers, particularly in large diameter wafers, and from $0.5million increased raw material sales of 4N gallium.

 

20

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Revenue from customers inTaiwan increased by $0.8 million, or 20.5%, to $4.9 million for the six monthsended June 30, 2008 from $4.0 million for the six months ended June 30,2007. The increase came mainly from one major existing customer for largediameter wafers.

 

Revenue from customers inAsia Pacific (excluding Japan and Taiwan) increased by $2.8 million, or 46.8%,to $8.7 million for the six months ended June 30, 2008 from $6.0 millionfor the six months ended June 30, 2007. Sales to customers in the People’sRepublic of China increased by $2.8 million, of which raw materials was $1.1million, while $1.7 million was from increased sales to existing customers forsmall diameter GaAs wafers. Sales to a major customer in Singapore that is partof the IQE plc group decreased by $0.3 million as they shifted somepurchases to other geographic areas. Sales to customers in Korea increased by$0.3 million as demand increased in smaller diameter wafers.

 

***Gross Margin***

 
| ** **       | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **       | ** ** | **June 30,**                | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **       | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Gross profit     |       | $                                | 6,444      |         | $          | 5,032          |       | $ | 1,412 |   | 28.1 | % |
| *Gross Margin %* |       | 32.3                             | %          | 36.9         | %          |           |       |   |   |
|                  |            |                                  |            |              |            |                |            |  |  |  |  |  |

 

Grossmargin decreased to 32.3% of total revenue for the three months ended June 30,2008 from 36.9% of total revenue for the three months ended June 30, 2007.Gross margins in the three months ended June 30, 2008 and 2007 werepositively impacted by sales of approximately $735,000 and $387,000,respectively, of GaAs wafers that were previously fully reserved. In the threemonths ended June 30, 2007 we had manufacturing equipment that had becomefully depreciated since the third quarter of 2006, and the absence ofdepreciation expense for this equipment, partially offset by depreciation onproperty, plant and equipment additions, contributed approximately 3.3percentage points to gross margin in the three months ended June 30, 2007.In addition, we had a one-time sale of $251,000 indium scrap metal thatcontributed approximately 1.8 percentage points to gross margin in the threemonths ended June 30, 2007. In the subsequent four quarters since June 30,2007, gross margins were negatively impacted by declining average sellingprices and rising raw material costs, as well as an increase in depreciation asa result of our purchase of equipment acquired for our capacity expansion.

 
| ** **       | ** ** | **Six Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|------------------|------------|--------------------------------|------------|--------------|------------|----------------|------------|
| ** **       | ** ** | **June 30,**              | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **       | ** ** | **2008**                       | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **($ in thousands)** | ** ** | ** **   | ** ** | ** **     | ** ** |
| Gross profit     |       | $                              | 12,665     |         | $          | 10,437         |       | $ | 2,228 |   | 21.3 | % |
| *Gross Margin %* |       | 32.0                           | %          | 39.9         | %          |           |       |   |   |
|                  |            |                                |            |              |            |                |            |  |  |  |  |  |

 

Grossmargin decreased to 32.0% of total revenue for the six months ended June 30,2008 from 39.9% of total revenue for the six months ended June 30, 2007.Gross margins in the six months ended June 30, 2008 and 2007 werepositively impacted by sales of approximately $1.4 million and $1.2 million,respectively, of GaAs wafers that were previously fully reserved. In the sixmonths ended June 30, 2007 we had manufacturing equipment that had becomefully depreciated since the third quarter of 2006, and the absence ofdepreciation expense for this equipment, partially offset by depreciation onproperty, plant and equipment additions, contributed approximately 3.2percentage points to gross margin in the six months ended June 30, 2007.In addition, we had a one-time sale of $251,000 indium scrap metal thatcontributed approximately 1.0 percentage points to gross margin in the sixmonths ended June 30, 2007. In the subsequent four quarters since June 30,2007, gross margins were negatively impacted by declining average sellingprices and rising raw material costs, as well as an increase in depreciation asa result of our purchase of equipment acquired for our capacity expansion.

 

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

*** ***
| ** **                                    | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                    | ** ** | **June 30,**                | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                                    | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                    | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Selling, general and administrative  expenses |       | $                                | 3,578      |         | $          | 3,743          |       | $ | (165 | ) | -4.4 | % |
| *% of total revenue*                          |       | 18.0                             | %          | 27.4         | %          |           |       |   |   |
|                                               |            |                                  |            |              |            |                |            |  |  |  |  |  |

 

Selling, general andadministrative expenses decreased $165,000 to $3.6 million for the three monthsended June 30, 2008 from $3.7 million for the three months ended June 30,2007. The decrease was primarily due to $629,000 lower bad debt expenses as wecollected from our slow-paying customers in Asia, partially offset by increasesof $297,000 in general annual salary and related labor costs, $51,000 in stockbased compensation expenses, $42,000 in health insurance costs, $32,000 in rentexpenses, and $24,000 in sales commissions based on increased sales volumes.

 

21

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| ** **                                    | ** ** | **Six Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                    | ** ** | **June 30,**              | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                                    | ** ** | **2008**                       | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                    | ** ** | **($ in thousands)** | ** ** | ** **   | ** ** | ** **     | ** ** |
| Selling, general and administrative  expenses |       | $                              | 7,245      |         | $          | 7,446          |       | $ | (201 | ) | -2.7 | % |
| *% of total revenue*                          |       | 18.3                           | %          | 28.5         | %          |           |       |   |   |
|                                               |            |                                |            |              |            |                |            |  |  |  |  |  |

 

Selling, general andadministrative expenses decreased $201,000, or 2.7% to $7.2 million for the sixmonths ended June 30, 2008 from $7.4 million for the six months ended June 30,2007. The decrease was primarily due to $813,000 lower bad debt expenses as wecollected from our slow-paying customers in Asia and $412,000 lower legal fees,partially offset by increases of $733,000 in general annual salary and relatedlabor costs, $86,000 in sales commissions based on increased sales volumes, and$84,000 in stock based compensation.

 

***Researchand Development***

 
| ** **               | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|--------------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **June 30,**                | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **               | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Research and development |       | $                                | 569        |         | $          | 348            |       | $ | 221 |   | 63.5 | % |
| *% of total revenue*     |       | 2.9                              | %          | 2.6          | %          |           |       |   |   |
|                          |            |                                  |            |              |            |                |            |  |  |  |  |  |

 

Research and developmentexpenses increased $221,000, or 63.5% to $569,000 for the three months ended June 30,2008 from $348,000 for the three months ended March 31, 2007. The increasewas due to salary and related costs associated with the appointment of a newchief technology officer effective December 31, 2007, higher consultingfees and general annual salary and related cost increases.

 
| ** **               | ** ** | **Six Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|--------------------------|------------|--------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **June 30,**              | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **               | ** ** | **2008**                       | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)** | ** ** | ** **   | ** ** | ** **     | ** ** |
| Research and development |       | $                              | 1,073      |         | $          | 808            |       | $ | 265 |   | 32.8 | % |
| *% of total revenue*     |       | 2.7                            | %          | 3.1          | %          |           |       |   |   |
|                          |            |                                |            |              |            |                |            |  |  |  |  |  |

 

Research and developmentexpenses increased $265,000, or 32.8% to $1.1 million for the six months ended June 30,2008 from $808,000 for the six months ended March 31, 2007. The increasewas due to salary and related costs associated with the appointment of a newchief technology officer effective December 31, 2007, higher consultingfees and general annual salary and related cost increases.

 

***Impairment (Recovery) onAssets Held For Sale***

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                     | ** ** | **June 30,**                | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                                     | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                     | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Impairment (Recovery) on assets held for  sale |       | $                                | —     |         | $          | (481           | )          | $ | 481 |   | NM |   |
| *% of total revenue*                           |       | 0.0                              | %          | -3.5         | %          |           |       |   |   |
|                                                |            |                                  |            |              |            |                |            |  |  |  |  |  |

 

NM = % not meaningful

 

There was no impairment(recovery) charge for the three months ended June 30, 2008.  During the three months ended June 30,2007, we benefited from a recovery of impairment of assets held for sale inconnection with our adjustment of the fair value of our property located inFremont, California, which had been decontaminated and was being prepared forsale.  We recorded a $481,000 marketvalue adjustment after we entered into an agreement with an independent thirdparty purchaser in June 2007 to purchase the property for estimated netproceeds of $5.1 million, after deducting estimated commission and sellingexpenses.  However, this independentthird party purchaser backed out of the transaction and the sale was notconsummated.

 

22

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| ** **                                     | ** ** | **Six Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|------------------------------------------------|------------|--------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                     | ** ** | **June 30,**              | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                                     | ** ** | **2008**                       | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                     | ** ** | **($ in thousands)** | ** ** | ** **   | ** ** | ** **     | ** ** |
| Impairment (Recovery) on assets held for  sale |       | $                              | 83         |         | $          | (481           | )          | $ | (564 | ) | NM |   |
| *% of total revenue*                           |       | 0.2                            | %          | -1.8         | %          |           |       |   |   |
|                                                |            |                                |            |              |            |                |            |  |  |  |  |  |

 

NM = % not meaningful

 

During the six monthsended June 30, 2008, we completed the sale of our property in Fremont,California. The escrow established to pay the purchase price was closed on March 28,2008.  The final purchase price for theproperty was $5.3 million. We received net proceeds of $5.1 million afterdeducting commissions and selling expenses. We recorded an impairment chargeupon the sale of the property of $83,000.

 

***InterestIncome, net***

 
| ** **           | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|----------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **June 30,**                | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **           | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Interest income, net |       | $                                | 241        |         | $          | 225            |       | $ | 16 |   | 7.1 | % |
| *% of total revenue* |       | 1.2                              | %          | 1.6          | %          |           |       |   |   |
|                      |            |                                  |            |              |            |                |            |  |  |  |  |  |

 

Interest income, netincreased $16,000 to $241,000 for the three months ended June 30, 2008from $225,000 for the three months ended June 30, 2007.  Interest income, net for the three monthsended June 30, 2008 was the result of interest income received on amaturing investment, partially offset by lower interest expense from lowerrates and a lower balance on our taxable revenue bond, while interest income,net for the three months ended June 30, 2007 was primarily generated fromthe net proceeds of our public offering of common stock, completed in December 2006and January 2007.

 
| ** **           | ** ** | **Six Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|----------------------|------------|--------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **June 30,**              | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **           | ** ** | **2008**                       | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)** | ** ** | ** **   | ** ** | ** **     | ** ** |
| Interest income, net |       | $                              | 365        |         | $          | 449            |       | $ | (84 | ) | -18.7 | % |
| *% of total revenue* |       | 0.9                            | %          | 1.7          | %          |           |       |   |   |
|                      |            |                                |            |              |            |                |            |  |  |  |  |  |

 

Interest income, netdecreased $84,000 to $365,000 for the six months ended June 30, 2008 from$449,000 for the six months ended June 30, 2007 as a result of higherbalances of our investments in the six months ended June 30, 2007, whichcame from the net proceeds of our public offering of common stock, completed inDecember 2006 and January 2007.

 

***Minority interests***

 
| ** **           | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|----------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **June 30,**                | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **           | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Minority interests   |       | $                                | (648       | )            | $          | (493           | )          | $ | 155 |   | 31.4 | % |
| *% of total revenue* |       | (3.3                             | )%         | (3.6         | )%         |           |       |   |   |
|                      |            |                                  |            |              |            |                |            |  |  |  |  |  |

 

Minority interestsincreased $155,000 or 31.4% to $648,000 for the three months ended June 30,2008 from $493,000 for the three months ended June 30, 2007 as each of ourthree majority-owned joint ventures increased sales due to capacity expansion,and were more profitable, and consequently the minority interests increased.

 
| ** **           | ** ** | **Six Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|----------------------|------------|--------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **June 30,**              | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **           | ** ** | **2008**                       | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)** | ** ** | ** **   | ** ** | ** **     | ** ** |
| Minority interests   |       | $                              | (1,147     | )            | $          | (753           | )          | $ | 394 |   | 52.3 | % |
| *% of total revenue* |       | (2.9                           | )%         | (2.9         | )%         |           |       |   |   |
|                      |            |                                |            |              |            |                |            |  |  |  |  |  |

 

23

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Minority interestsincreased $394,000 or 52.3% to $1,147,000 for the six months ended June 30,2008 from $753,000 for the six months ended June 30, 2007 as each of ourthree majority-owned joint ventures increased sales due to capacity expansion,and were more profitable, and consequently the minority interests increased.

 

***Other Income andExpense, net***

 
| ** **                    | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|-------------------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **                    | ** ** | **June 30,**                | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                    | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                    | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Other income and expense, net |       | $                                | (518       | )            | $          | 221            |       | $ | (739 | ) | (334.4 | )% |
| *% of total revenue*          |       | (2.6                             | )%         | 1.6          | %          |           |       |   |   |
|                               |            |                                  |            |              |            |                |            |  |  |  |  |  |

 

Other expense, net was$518,000 for the three months ended June 30, 2008 primarily due to foreigncurrency transaction exchange losses of $593,000, partially offset by $75,000,net, of other income, mainly from our investments. Other income, net was$221,000 for the three months ended June 30, 2007 primarily $341,000 fromour equity earnings from the two minority-owned joint ventures that are notconsolidated and $126,000 other income, mainly insurance proceeds from a fireloss in China, partially offset by foreign currency transaction exchange lossesof $246,000.

 
| ** **                    | ** ** | **Six Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|-------------------------------|------------|--------------------------------|------------|--------------|------------|----------------|------------|
| ** **                    | ** ** | **June 30,**              | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                    | ** ** | **2008**                       | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                    | ** ** | **($ in thousands)** | ** ** | ** **   | ** ** | ** **     | ** ** |
| Other income and expense, net |       | $                              | 409        |         | $          | 470            |       | $ | (61 | ) | (13.0 | )% |
| *% of total revenue*          |       | 1.0                            | %          | 1.8          | %          |           |       |   |   |
|                               |            |                                |            |              |            |                |            |  |  |  |  |  |

 

Other income, net was$409,000 for the six months ended June 30, 2008 primarily from $460,000from our equity earnings from the two minority-owned joint ventures that arenot consolidated, $326,000 from our realized gain on sale of investments, and$27,000 other income, partially offset by foreign currency transaction exchangelosses of $404,000. Other income, net was $470,000 for the six months ended June 30,2007 primarily $568,000 from our equity earnings from the two minority-ownedjoint ventures that are not consolidated and $192,000 other income, mainlyinsurance proceeds from a fire loss in China, partially offset by foreigncurrency transaction exchange losses of $290,000.

 

***Provisionfor Income Taxes***

 
| ** **                 | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|----------------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **June 30,**                | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                 | ** ** | **2008**                         | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                 | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Provision for income taxes |       | $                                | 635        |         | $          | 162            |       | $ | 473 |   | 292.0 | % |
| *% of total revenue*       |       | 3.2                              | %          | 1.2          | %          |           |       |   |   |
|                            |            |                                  |            |              |            |                |            |  |  |  |  |  |

 

We provided for incometaxes of $635,000 for our China operations for the three months ended June 30,2008 compared to $162,000 for the three months ended June 30, 2007.Beginning in 2008, the tax provision was calculated based on the assumptionthat we will no longer receive refunds for profit reinvestments in China.

 
| ** **                 | ** ** | **Six Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|----------------------------|------------|--------------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **June 30,**              | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                 | ** ** | **2008**                       | ** ** | **2007**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                 | ** ** | **($ in thousands)** | ** ** | ** **   | ** ** | ** **     | ** ** |
| Provision for income taxes |       | $                              | 1,195      |         | $          | 273            |       | $ | 922 |   | 337.7 | % |
| *% of total revenue*       |       | 3.0                            | %          | 1.0          | %          |           |       |   |   |
|                            |            |                                |            |              |            |                |            |  |  |  |  |  |

 

We provided for incometaxes of $1.2 million for our China operations for the six months ended June 30,2008 compared to $273,000 for the six months ended June 30, 2007.Beginning in 2008, the tax provision was calculated based on the assumptionthat we will no longer receive refunds for profit reinvestments in China.

 

**Liquidityand Capital Resources**

 

As of June 30, 2008,our principal sources of liquidity were $37.0 million in cash and cashequivalents and short-term investments, excluding restricted deposits. Weconsider cash and cash equivalents and short-term investments as liquid andavailable for use. Short-term investments are comprised of government bonds andhigh-grade commercial debt instruments.

 

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Cashand cash equivalents and short-term investments of $37.0 million decreased by$2.5 million in the second quarter of 2008 compared to the first quarter of2008.

 

Net cash used inoperating activities of $4.5 million for the six months ended June 30,2008 was primarily comprised of our net income of $2.7 million, adjusted fornon-cash items of depreciation of $1.0 million, stock-based compensation of$0.3 million, partially offset by a realized gain on sale of investments of$0.3 million, and offset by a net increase of $8.2 million in assets andliabilities. The $8.2 million net increase in assets and liabilities primarilyresulted from a $13.6 million increase in inventories, $2.1 million increase inprepaid expenses, $1.4 million increase in accounts receivable,$0.9 million decrease in other long-term liabilities, primarily minorityinterests, a $0.4 million increase in other assets, partially offset by a$9.5 million increase in accounts payable, a $0.5 million increase inincome taxes payable, and a $0.2 million increase in accrued liabilities.

 

Inventories, net,increased by $13.6 million, as we increased inventory in raw materials to avoidcertain transportation restrictions prior to the commencement of the BeijingOlympics, and work-in-process to increase production in anticipation ofincreased forecast sales, and finished goods for consignment orders.

 

Accounts receivable, netincreased by $1.4 million, as a result of increased sales and a slightreduction in our allowance for doubtful accounts. Our days sales outstanding(DSO) is 62 days as of June 30, 2008 compared to 77 days as of March 31,2008, and compared to 64 days as of December 31, 2007.

 

Net cash provided byinvesting activities of $5.0 million for the six months ended June 30,2008 was primarily from the proceeds from the sale of investments of $14.5million, proceeds from sale of assets held for sale of $5.1 million and thedecrease of restricted cash of $0.3 million, partially offset by the purchaseof investments totaling $11.7 million, and the purchase of property, plant andequipment, of $3.1 million.

 

We expect to investapproximately $2.7 million in capital projects for the remainder of 2008. Webelieve that our existing and planned facilities and equipment are sufficientto fulfill current and expected future orders.

 

Net cash used infinancing activities of $0.1 million for the six months ended June 30,2008 consisted of scheduled payments of $0.3 million related to long-termborrowings, partially offset by $0.1 million from the proceeds from theexercise of employee stock options.

 

Our main Fremont,California facility was financed by long-term borrowings, which were refinancedby taxable variable rate revenue bonds in 1998. These bonds were traded on thepublic market, were set to mature in 2023 and bore a variable interest ratethat was 3.0% as of June 30, 2008. Repayment of principal and interestunder the bonds was supported by a letter of credit from our bank and was beingpaid on a quarterly basis. As of June 30, 2008, the credit facilitymaintained by us with a bank included a letter of credit supporting repaymentof these bonds with an outstanding amount of $6.4 million.

 

We had pledged and placeda like amount of investment securities with an affiliate of the bank asadditional collateral for this facility, and had the option to redeem the bondsin whole or part during their term. We completed the sale of our Fremont,California facility on March 28, 2008, and received net proceeds ofapproximately $5.1 million after deducting commissions and selling expenses.Subsequently on July 1, 2008, we have repaid the outstanding principal andaccrued interest on the revenue bond of approximately $6.4 million, andaccordingly our restricted cash in such amount has been released.

 

We believe that we haveadequate cash and investments to meet our needs over the next 12 months. If ourperformance fails to improve, we will continue to use cash and may at some timebe forced to seek additional capital. There can be no assurance that suchadditional capital will be available or, if available it will be at termsacceptable to us. Cash from operations could be affected by various risks anduncertainties, including, but not limited to those set forth below under Item1A “Risks Factors.”

 

Outstanding contractual obligations as of June 30, 2008, which donot reflect our repayment of the revenue bonds on July 1, 2008, aresummarized as follows (in thousands):

 
| ** **                       | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1 - 3  years** | ** ** | **3 - 5  years** | ** ** | **More than  5 years** | ** ** |
| Debt                             |       | $                                         | 6,412      |   | $ | 450 |   | $ | 912 |   | $ | 900 |   | $ | 4,150 |   |
| Operating leases                 |       | 3,576                                     |       | 723 |   | 1,507 |   | 1,346 |   | — |   |
| Less: Sublease income            |       | (956                                      | )          | (190 | ) | (398 | ) | (368 | ) | — |   |
| Purchase obligation              |       | 2,490                                     |       | 2,490 |   | — |   | — |   | — |   |
| Total                            |       | $                                         | 11,522     |   | $ | 3,473 |   | $ | 2,021 |   | $ | 1,878 |   | $ | 4,150 |   |

 

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We lease certain office space, manufacturing facilities and propertyunder long-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 June 30, 2008and 2007, respectively.  On July 2,2008, we entered into a new lease agreement with T. Drive Partners, L.P., aCalifornia partnership of the facility located at 4281 Technology Drive,Fremont California with approximately 27,760 square feet.  The new lease shall commence on December 1,2008 for a term of seven years, with an option by us to cancel after fiveyears, upon forfeiture of the security deposit and payment of one-half of thefifth year’s rent.  The base rent for thenew lease shall be $0.72 per square foot per month triple net, with annualrental increases of 4.5% per annum, payment of $50,000 security deposit, andtenant improvements of $575,000 to be amortized over seven years at 4% perannum.

 

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 FASB issued SFAS No. 161, “*Disclosures about Derivative Instruments and Hedging Activities*”(“SFAS 161”). SFAS 161 requires companies with derivative instruments todisclose information that should enable financial-statement users to understandhow and why a company uses derivative instruments, how derivative instrumentsand related hedged items affect a company’s financial position, financialperformance and cash flows. SFAS 161 is effective for financial statementsissued for fiscal years and interim periods beginning after November 15,2008. Based on our current operations, we do not expect that theadoption of SFAS 161 will have a material impact on our consolidatedfinancial position or results of operations.

 

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) will be applicable beginningwith our fiscal 2009. The impact of the adoption of SFAS 141(R) onour results of operations and financial position will depend on the nature andextent of business combinations that we complete, if any, in or after fiscal2009.

 

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 that the adoption of of SFAS 160 will have on ourconsolidated 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 is irrevocableand generally made on an instrument-by-instrument basis, even if a company hassimilar instruments that it elects not to measure based on fair value.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 effective dateof SFAS 157 for all nonfinancial assets and nonfinancial liabilities, exceptthose 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.

 

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**ITEM3*.*QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

***Foreign CurrencyRisk***

 

A significant portion of our business isconducted in currencies other than the U.S. dollar. The functional currency forour foreign operations is the Renminbi, the local currency of China, where ouroperating expenses are predominantly in the local currency. Since most of ouroperations are conducted in China, most of our costs are incurred in Chinesecurrency, which subjects us to fluctuations in the exchange rates between theU.S. dollar and the Chinese Renminbi. We incur transaction gains or lossesresulting from consolidation of expenses incurred in local currencies for thesesubsidiaries, as well as in translation of the assets and liabilities of theseassets at each balance sheet date. These risks may be increased by thefluctuations and revaluations of the Chinese Renminbi. Our financial resultscould be adversely affected by factors such as changes in foreign currencyexchange rates or weak economic conditions in foreign markets, including therevaluation by China of the Renminbi, and any future adjustments that China maymake to its currency such as any move it might make to a managed float systemswith opportunistic interventions. We also have certain trade accountsreceivable denominated in Japanese Yen. In the future we may experience foreignexchange losses on our non-functional currency denominated receivables and payablesto the extent that we have not mitigated our exposure utilizing foreigncurrency forward exchange contracts. Foreign exchange losses could have amaterially adverse effect on our operating results and cash flows.

 

We do not currently use short-term forwardexchange contracts for hedging purposes to reduce the effects of adverseforeign exchange rate movements. We had previously purchased foreign exchangecontracts to hedge against certain trade accounts receivable denominated inJapanese yen. The change in the fair value of the forward contracts wasrecognized as part of the related foreign currency transactions as they occur.As of June 30, 2008, we had no outstanding commitments with respect toforeign exchange contracts.

 

In the three months ended June 30, 2008,we recorded net realized foreign exchange losses of $593,000, included as partof other expense in our consolidated statements of operations. The foreignexchange losses were primarily due to fluctuation in the Japanese Yen versusthe U.S. dollar on our Yen-denominated accounts receivables. During the secondquarter of 2008, we recorded unrealized foreign currency gains of $601,000 incumulative other comprehensive income on our condensed consolidated balancesheets.

 

***Interest Rate Risk***

 

Cash and cash equivalents earning interestand certain variable rate debt instruments are subject to interest ratefluctuations. The following table sets forth the probable impact of a 10%change in interest rates (in thousands):

 
| **Instrument**                            | ** ** | **Balance as of  June 30,  2008** | ** ** | **Current  Interest  Rate** | ** ** | **Projected Annual  Interest  Income/(Expense)** | ** ** | **Proforma 10%  Interest Rate  Decline  Income/(Expense)** | ** ** | **Proforma 10%  Interest Rate  Increase  Income/(Expense)** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|-----------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| Cash                                      |       | $                                                | 19,292     |                        | 0.50       | %                                                     | $          | 96                                                                   |       | $                                                                     | 87         |   | $ | 106 |   |
| Investment in debt and equity instruments |       | 24,098                                           |       | 2.38                        | %          | 574                                                   |       | 516                                                                  |       | 631                                                                   |       |
| Long-term debt                            |       | (6,400                                           | )          | 3.00                        | %          | (192                                                  | )          | (173                                                                 | )          | (211                                                                  | )          |
|                                      |       |                                             |       |                        |       | $                                                     | 478        |                                                                 | $          | 430                                                                   |       | $ | 526 |   |
|                                           |            |                                                  |            |                             |            |                                                       |            |                                                                      |            |                                                                       |            |  |  |  |  |

 

The primary objective of our investmentactivities is to preserve principal while maximizing income without significantlyincreasing risk. Financial instruments that potentially subject us toconcentration of credit risk consist primarily of cash equivalents, short-terminvestments, and trade accounts receivable. We invest primarily in money marketaccounts, commercial paper instruments, and investment grade securities. We areexposed to credit risks in the event of default by the issuers to the extent ofthe amount recorded on the consolidated balance sheets. These securities aregenerally classified as available-for-sale and consequently are recorded on thebalance sheet at fair value with unrealized gains or losses reported as aseparate component of accumulated other comprehensive income, net of estimatedtax. Our cash, 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.

 

***Equity Risk***

 

We maintain minority investments inprivately-held companies. These investments are reviewed for other thantemporary declines in value on a quarterly basis. These investments areclassified as other assets in the condensed consolidated balance sheets and areaccounted for either under the cost method or under the equity method as we donot have the ability to exercise significant influence over their operations.We monitor our investments for impairment and record reductions in carryingvalue when events or changes in circumstances indicate that the carrying valuemay not be recoverable. Reasons for other than temporary declines in valueinclude whether the related company would have insufficient cash flow tooperate for the next twelve months, significant changes in the operatingperformance and changes in market conditions. As of June 30, 2008, theminority investments accounted for under the cost method totaled$0.4 million, while minority investments accounted for under the equitymethod totaled $3.4 million.

 

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**ITEM 4*.*CONTROLSAND PROCEDURES**

 

***Disclosure Controls andProcedures***

 

Under thesupervision and with the participation of our management, our Chief ExecutiveOfficer and Chief Financial Officer have evaluated the effectiveness of thedesign and operation of our disclosure controls and procedures, as such termsare defined under Rule 13a-15(e) and 15d-15(e) promulgated underthe Securities Exchange Act of 1934, as amended. Based upon that evaluation,our Chief Executive Officer and our Chief Financial Officer concluded that theour disclosure controls and procedures were effective as of the end of theperiod covered by this quarterly report.

 

***Changes in InternalControl Over Financial Reporting***

 

No change inour internal control over financial reporting was made in the three monthsended June 30, 2008 that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

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**PART II.OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

From time to time we may be involved in judicial or administrativeproceedings concerning matters arising in the ordinary course of business. Wedo not expect that any of these matters, individually or in the aggregate, willhave a material adverse effect on our business, financial condition, cash flowsor results of operation.

 

On October 15, 2004, a purportedsecurities class action lawsuit was filed in the United States Court for theNorthern District of California, City of Harper Woods Employees RetirementSystem v. AXT, Inc. et al., No. C 04 4362 MJJ. The Court consolidatedthe case with a subsequent related case and appointed a lead plaintiff. On April 5,2005, the lead plaintiff filed a consolidated complaint, captioned as Morgan v.AXT, Inc. et al., No. C 04 4362 MJJ. The lawsuit named AXT, Inc.and our former chief technology officer as defendants, and was brought onbehalf of a class of all purchasers of our securities from February 6,2001 through April 27, 2004. The complaint alleged that we announcedfinancial results during this period that were false and misleading. No specificamount of damages was claimed. On September 23, 2005, the Court grantedour motion to dismiss the complaint, with leave to amend. The lead plaintifffiled an amended complaint, which we had moved to dismiss. On April 24,2007, we reached a settlement of this litigation. On February 27, 2008,the district court approved the settlement, and subsequently entered a judgmentof dismissal.

 

The claims of a former employee, Steve X.Chen, that his layoff was due to his race and national origin were resolvedwithout cost to the Company.

 

**Item 1A. Risk Factors**

 

There are no materialchanges from the risk factors set forth under Part I, Item 1A. “RiskFactors” in our Annual Report on Form 10-K for the fiscal year ended December 31,2007.

 

**Item 2. Unregistered Sales of EquitySecurities and Use of Proceeds**

 

None

 

**Item 3. Defaults uponSenior Securities**

 

None

 

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

 

AXT held its annual meeting of stockholders at its headquarters inFremont, California on May 20, 2008. Of the 30,989,501 shares outstanding as of the record date, 26,007,714shares were represented in person or by proxy at the meeting.  Proxies were solicited by the Companypursuant to Regulation 14A under the Securities Exchange Act of 1934, asamended.  At the meeting, AXT’sstockholders voted on the following matters:

 

(1)               Proposal to elect two class I directorsto hold office for a three-year term, and until their successors are electedand qualified.

 
| **Class I directors** | ** ** | **For**    | ** ** | **Abstain** | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------|------------|-------------|------------|------------|------------|
| Morris S. Young                 |       | 24,691,881 |       | 1,265,833   |       |       |       |
| David C. Chang                  |       | 25,459,209 |       | 548,505     |       |       |       |

 

In addition, the term of office as directors of Dr. Philip C.S.Yin, Mr. Jesse Chen and Mr. Leonard LeBlanc continued after themeeting.

 

(2)               Proposal to ratify the appointment ofBurr, Pilger & Mayer LLP as independent registered public accountingfirm for the fiscal year ending December 31, 2008

 
| ** **                        | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|-----------------------------------|------------|------------|------------|-------------|------------|-------------|------------|
| Burr, Pilger & Mayer LLP |       | 25,918,343 |       | 64,463      |       | 24,908      |       |

 

Accordingly, both proposals were approved bythe stockholders.

 

**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.                                                                          |
|                |       |                                                                                                                                                           |
| 3.3(3)              |       | Second  Amended and Restated By Laws                                                                                                                           |
|                |       |                                                                                                                                                           |
| 4.2(4)              |       | Rights  Agreement dated April 24, 2001 by and between AXT, Inc. and  ComputerShare Trust Company, Inc.                                          |
|                |       |                                                                                                                                                           |
| 10.28(5)            |       | Lease  Agreement executed July 2, 2008 by and between AXT, Inc. and T.  Drive Partners, L.P. a California partnership.                               |
|                |       |                                                                                                                                                           |
| 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) Incorporatedby reference 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) Incorporatedby reference to Exhibit 3.1 to our Form 8-K as filed with the SEC on June 14,1999.

 

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

 

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

 

(5) Incorporatedby reference to the exhibit of the same number as filed with the SEC in our Form 8-Kon July 8, 2008.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this Report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                         | AXT, INC. |
|------------------------------|-----------|
|                         |      |   |
| Dated:  August 11, 2008 | By:       | /s/ Philip  C. S. Yin |
|                         |      | Philip C. S.  Yin |
|                         |      | Chairman of  the Board and  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(3)              |       | Second  Amended and Restated By Laws                                                                                                                                                                                   |
|                |       |                                                                                                                                                                                                                   |
| 4.2(4)              |       | Rights  Agreement dated April 24, 2001 by and between AXT, Inc. and  ComputerShare Trust Company, Inc.                                                                                                  |
|                |       |                                                                                                                                                                                                                   |
| 10.28(5)            |       | Lease  Agreement executed July 2, 2008 by and between AXT, Inc. and T.  Drive Partners, L.P. a California partnership.                                                                                       |
|                |       |                                                                                                                                                                                                                   |
| 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) Incorporatedby reference to the exhibit of the same number as filed with the SEC in ourAnnual Report on Form 10-K for the year ended December 31, 1998.

 

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

 

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

 

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

 

(5) Incorporatedby reference to the exhibit as of the same number as filed with the SEC in our Form 8-Kon July 8, 2008.

 

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