Table ofContents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

 

**x****  Quarterly report pursuant to Section 13 or 15(d) of the SecuritiesExchange Act of 1934**

 

**for the quarterly period ended September 30, 2010**

 

**Or**

 

**o****  Transition report pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934**

 

**for the transition periodfrom                 to                **

 

**Commission File Number 000-24085**

 

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**AXT, INC.**

(Exact name of registrant as specified in itscharter)

 

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

 

**4281 Technology 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 by check markwhether the registrant (1) has filed all reports required to be filed bySection 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 whetherthe registrant has submitted electronically and posted on its Web site, if any,every Interactive Data File required to be submitted and posted pursuant toRule 405 of Regulation S-T (§232.405 of this chapter) during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files).  Yes o No o

 

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

 

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

 

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

 

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

 

| **Class**                      | ** ** | **Outstanding at October 28, 2010** |
|--------------------------------|------------|---------------------------------------------------------|
| Common Stock, $0.001 par value |       | 31,543,087                                              |

 

 

 

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Table ofContents

 

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  September 30, 2010 and December 31, 2009                              | 3        |
| Condensed Consolidated Statements of Operations for  the three months and nine months ended September 30, 2010 and 2009 | 4        |
| Condensed Consolidated Statements of Cash Flows for  the nine months ended September 30, 2010 and 2009                  | 5        |
| Notes To Condensed Consolidated Financial Statements                                                                         | 6        |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations                          | 16       |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                                          | 28       |
| Item 4. Controls and Procedures                                                                                              | 30       |
| PART II.  OTHER INFORMATION                                                                                             | 30       |
| Item  1. Legal Proceedings                                                                                                   | 30       |
| Item  1A. Risk Factors                                                                                                       | 30       |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                                         | 30       |
| Item 3. Defaults Upon Senior Securities                                                                                      | 30       |
| Item 4. Reserved                                                                                                             | 30       |
| Item  5. Other Information                                                                                                   | 30       |
| Item 6. Exhibits                                                                                                             | 31       |
| Signatures                                                                                                                   | 32       |

 

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** **

**PART I.FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

 

AXT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

 
| ** **                                                                                                                                                                                                                                                                                                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                               | ** ** | **2010**               | ** ** | **2009 (1)**     | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                               | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| Assets:                                                                                                                                                                                                                                                                                                                                  |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                                                                                                                                                                          |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                                                |       | $                      | 23,393     |                  | $          | 16,934 |   |
| Short-term investments                                                                                                                                                                                                                                                                                                                   |       | 4,467                  |       | 18,469                |       |
| Accounts receivable, net of allowances of $475 and  $1,019 as of September 30, 2010 and December 31, 2009, respectively                                                                                                                                                                                                        |       | 18,977                 |       | 15,362                |       |
| Inventories, net                                                                                                                                                                                                                                                                                                                         |       | 33,153                 |       | 27,718                |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                                                                                |       | 3,451                  |       | 2,411                 |       |
| Total current assets                                                                                                                                                                                                                                                                                                                     |       | 83,441                 |       | 80,894                |       |
| Long-term investments                                                                                                                                                                                                                                                                                                                    |       | 13,139                 |       | —                |       |
| Property, plant and equipment, net                                                                                                                                                                                                                                                                                                       |       | 22,709                 |       | 20,853                |       |
| Other assets                                                                                                                                                                                                                                                                                                                             |       | 6,313                  |       | 6,199                 |       |
| Total assets                                                                                                                                                                                                                                                                                                                             |       | $                      | 125,602    |                  | $          | 107,946 |   |
|                                                                                                                                                                                                                                                                                                                                     |       |                   |       |                  |       |
| Liabilities and stockholders’ equity:                                                                                                                                                                                                                                                                                               |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                                                                                                                     |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                                                                                                                                                                         |       | $                      | 5,979      |                  | $          | 5,571 |   |
| Accrued liabilities                                                                                                                                                                                                                                                                                                                      |       | 6,557                  |       | 4,566                 |       |
| Current portion of long-term debt                                                                                                                                                                                                                                                                                                        |       | —                 |       | 76                    |       |
| Total current liabilities                                                                                                                                                                                                                                                                                                                |       | 12,536                 |       | 10,213                |       |
| Long-term debt, net of current portion                                                                                                                                                                                                                                                                                                   |       | —                 |       | 420                   |       |
| Other long-term liabilities                                                                                                                                                                                                                                                                                                              |       | 30                     |       | 62                    |       |
| Total liabilities                                                                                                                                                                                                                                                                                                                        |       | 12,566                 |       | 10,695                |       |
| Commitments and contingencies (Note 10)                                                                                                                                                                                                                                                                                             |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                                                                                                                                                               |       |                   |       |                  |       |
| Preferred stock, $0.001 par value; 2,000 shares  authorized; 883 shares issued and outstanding  as of September 30, 2010 and December 31, 2009,  respectively (Liquidation preference of $5.5 million and $5.4 million  as of September 30, 2010 and December 31, 2009,  respectively) |       | 3,532                  |       | 3,532                 |       |
| Common stock, $0.001 par value per share; 70,000  shares authorized; 31,543 and 30,880 shares issued and outstanding as of  September 30, 2010 and December 31, 2009, respectively                                                                                                                                        |       | 30                     |       | 30                    |       |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                               |       | 189,110                |       | 187,871               |       |
| Accumulated deficit                                                                                                                                                                                                                                                                                                                      |       | (87,376                | )          | (101,130              | )          |
| Accumulated other comprehensive income                                                                                                                                                                                                                                                                                                   |       | 4,276                  |       | 4,300                 |       |
| Total AXT, Inc. stockholders’ equity                                                                                                                                                                                                                                                                                           |       | 109,572                |       | 94,603                |       |
|                                                                                                                                                                                                                                                                                                                                     |       |                   |       |                  |       |
| Noncontrolling interests                                                                                                                                                                                                                                                                                                                 |       | 3,464                  |       | 2,648                 |       |
| Total stockholders’ equity                                                                                                                                                                                                                                                                                                          |       | 113,036                |       | 97,251                |       |
|                                                                                                                                                                                                                                                                                                                                     |       |                   |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                                                                          |       | $                      | 125,602    |                  | $          | 107,946 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

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(1)          The CondensedConsolidated Balance Sheet at December 31, 2009 has been derived from theaudited consolidated financial statements at that date.

 

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AXT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share data)

 
| ** **                                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                          | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                          | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Revenue                                                             |       | $                                | 26,809     |                            | $          | 16,819 |   | $ | 68,627 |   | $ | 37,528 |   |
| Cost of revenue                                                     |       | 16,278                           |       | 11,281                          |       | 42,829 |   | 29,711 |   |
| Gross profit                                                        |       | 10,531                           |       | 5,538                           |       | 25,798 |   | 7,817 |   |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Operating expenses:                                                 |       |                             |       |                            |       |   |   |   |   |
| Selling, general and administrative                                 |       | 3,347                            |       | 3,323                           |       | 9,805 |   | 10,815 |   |
| Research and development                                            |       | 462                              |       | 360                             |       | 1,428 |   | 1,175 |   |
| Restructuring charge                                                |       | —                           |       | —                          |       | — |   | 507 |   |
| Total operating expenses                                            |       | 3,809                            |       | 3,683                           |       | 11,233 |   | 12,497 |   |
| Income (loss) from operations                                       |       | 6,722                            |       | 1,855                           |       | 14,565 |   | (4,680 | ) |
| Interest income (expense), net                                      |       | 26                               |       | 39                              |       | 16 |   | 117 |   |
| Other income (expense), net                                         |       | 442                              |       | 638                             |       | 2,077 |   | 537 |   |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Income (loss) before provision for income taxes                     |       | 7,190                            |       | 2,532                           |       | 16,658 |   | (4,026 | ) |
| Provision for income taxes                                          |       | 871                              |       | 201                             |       | 1,677 |   | 513 |   |
| Net income (loss)                                                   |       | 6,319                            |       | 2,331                           |       | 14,981 |   | (4,539 | ) |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Less: Net income attributable to noncontrolling  interest           |       | (680                             | )          | (210                            | )          | (1,227 | ) | (136 | ) |
| Net income (loss) attributable to AXT, Inc.                    |       | $                                | 5,639      |                            | $          | 2,121 |   | $ | 13,754 |   | $ | (4,675 | ) |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Net income (loss) attributable to AXT, Inc.  per common share: |       |                             |       |                            |       |   |   |   |   |
| Basic                                                               |       | $                                | 0.18       |                            | $          | 0.07 |   | $ | 0.44 |   | $ | (0.16 | ) |
| Diluted                                                             |       | $                                | 0.17       |                            | $          | 0.07 |   | $ | 0.42 |   | $ | (0.16 | ) |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Weighted average number of common shares  outstanding:              |       |                             |       |                            |       |   |   |   |   |
| Basic                                                               |       | 30,944                           |       | 30,475                          |       | 30,853 |   | 30,449 |   |
| Diluted                                                             |       | 32,509                           |       | 30,911                          |       | 32,170 |   | 30,449 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

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AXT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited,in thousands)

 
| ** **                                                                                | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| Cash flows from operating activities:                                                     |       |                                                |       |   |   |
| Net income (loss)                                                                         |       | $                                                   | 14,981     |   | $ | (4,539 | ) |
|                                                                                      |       |                                                |       |   |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                                |       |   |   |
| Depreciation                                                                              |       | 2,122                                               |       | 2,309 |   |
| Amortization (accretion) of marketable securities  premium                                |       | 174                                                 |       | (9 | ) |
| Loss on disposal of property, plant and equipment                                         |       | 1                                                   |       | — |   |
| Stock-based compensation                                                                  |       | 420                                                 |       | 677 |   |
| Restructuring charge                                                                      |       | —                                              |       | 507 |   |
| Realized loss (gain) on available for sale  securities                                    |       | (346                                                | )          | 9 |   |
| Changes in assets and liabilities:                                                        |       |                                                |       |   |   |
| Accounts receivable, net                                                                  |       | (3,621                                              | )          | (2,495 | ) |
| Inventories                                                                               |       | (5,451                                              | )          | 6,410 |   |
| Prepaid expenses and other current assets                                                 |       | (1,046                                              | )          | 1,056 |   |
| Other assets                                                                              |       | (118                                                | )          | (340 | ) |
| Accounts payable                                                                          |       | 416                                                 |       | 528 |   |
| Accrued liabilities                                                                       |       | 1,997                                               |       | (138 | ) |
| Other long-term liabilities                                                               |       | (25                                                 | )          | (219 | ) |
| Net cash provided by operating activities                                                 |       | 9,504                                               |       | 3,756 |   |
|                                                                                      |       |                                                |       |   |   |
| Cash flows from investing activities:                                                     |       |                                                |       |   |   |
| Purchases of property, plant and equipment                                                |       | (4,040                                              | )          | (1,018 | ) |
| Proceeds from sale of property, plant and  equipment                                      |       | 10                                                  |       | 4 |   |
| Purchases of available for sale securities                                                |       | (18,982                                             | )          | (13 | ) |
| Proceeds from available for sale securities                                               |       | 19,846                                              |       | 440 |   |
| Decrease in restricted deposits                                                           |       | —                                              |       | 13 |   |
| Net cash used in investing activities                                                     |       | (3,166                                              | )          | (574 | ) |
|                                                                                      |       |                                                |       |   |   |
| Cash flows from financing activities:                                                     |       |                                                |       |   |   |
| Proceeds from common stock options exercised                                              |       | 819                                                 |       | 48 |   |
| Dividends paid by joint ventures                                                          |       | (528                                                | )          | (756 | ) |
| Long-term debt payments                                                                   |       | (496                                                | )          | (67 | ) |
| Net cash used in financing activities                                                     |       | (205                                                | )          | (775 | ) |
| Effect of exchange rate changes on cash and cash  equivalents                             |       | 326                                                 |       | 69 |   |
| Net increase in cash and cash equivalents                                                 |       | 6,459                                               |       | 2,476 |   |
| Cash and cash equivalents at the beginning of the  period                                 |       | 16,934                                              |       | 13,566 |   |
| Cash and cash equivalents at the end of the period                                        |       | $                                                   | 23,393     |   | $ | 16,042 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

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AXT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

**Note 1.Basis of Presentation**

 

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

 

Our management has made anumber of estimates and assumptions relating to the reporting of assets andliabilities and the disclosure of contingent assets and liabilities to preparethese condensed consolidated financial statements in conformity with accountingprinciples generally accepted in the United States ofAmerica. Actual results could differ materially from those estimates.

 

The results of operationsare not necessarily indicative of the results to be expected in the future orfor the full fiscal year. It is recommended that these condensed consolidatedfinancial statements be read in conjunction with our consolidated financialstatements and the notes thereto included in our 2009 Annual Report onForm 10-K filed with the Securities and Exchange Commission (the “SEC”) onMarch 22, 2010 and our Quarterly Report on Form 10-Q for thequarterly periods ended March 31, 2010 and June 30, 2010 filed withthe SEC on May 17, 2010 and August 9, 2010, respectively.

 

Thecondensed consolidated financial statements include the accounts of AXT and ourmajority-owned subsidiaries. All significant inter-company accounts andtransactions have been eliminated. Investments in business entities in which wedo not have control, but have the ability to exercise significant influenceover operating and financial policies (generally 20-50% ownership), areaccounted for by the equity method. For majority-owned subsidiaries, we reflectthe noncontrolling interest of the portion we do not own on our CondensedConsolidated Balance Sheets in Equity and our Condensed Consolidated Statementsof Operations.

 

Certain reclassificationshave been made to the prior period consolidated financial statements to conformto current period presentation.  Thesereclassifications had no impact on previously reported total assets, stockholders’equity or net income (loss).

 

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

 

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

 

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

 
| ** **                                                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Stock-based compensation in the form of  employee stock options, included in: |       |                                                 |       |                                                |       |   |   |   |   |
|                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of revenue                                                                    |       | $                                                    | 12         |                                                | $          | 8 |   | $ | 27 |   | $ | 31 |   |
| Selling, general and administrative                                                |       | 159                                                  |       | 84                                                  |       | 359 |   | 595 |   |
| Research and development                                                           |       | 16                                                   |       | 6                                                   |       | 34 |   | 51 |   |
|                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Total stock-based compensation                                                     |       | 187                                                  |       | 98                                                  |       | 420 |   | 677 |   |
| Tax effect on stock-based compensation                                             |       | —                                               |       | —                                              |       | — |   | — |   |
|                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Net effect on net income (loss)                                                    |       | $                                                    | 187        |                                                | $          | 98 |   | $ | 420 |   | $ | 677 |   |
|                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Effect on net income (loss) attributable to  AXT, Inc. per common share:      |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                                              |       | $                                                    | (0.01      | )                                                   | $          | (0.00 | ) | $ | (0.01 | ) | $ | (0.02 | ) |
| Diluted                                                                            |       | $                                                    | (0.01      | )                                                   | $          | (0.00 | ) | $ | (0.01 | ) | $ | (0.02 | ) |

 

As ofSeptember 30, 2010 the total compensation costs related to unvestedstock-based awards granted to employees under our stock option plan but not yetrecognized was approximately $1,718,000, net of estimated forfeitures of$290,000. These costs will be amortized on a straight-line basis over aweighted-average period of approximately 3.10 years and will be adjusted forsubsequent changes in estimated forfeitures. We elected not to capitalizeany stock-based compensation to inventory as of September 30, 2010 due tothe immateriality of the amount.

 

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

 

Weestimate the fair value of stock options using a Black-Scholes valuation model,consistent with the provisions of ASC 718. There were 379,000 and 300,000stock options granted in the three months ended September 30, 2010 and2009, respectively. There were 379,000 and 300,000 stock options granted in thenine months ended September 30, 2010 and 2009, respectively. The fairvalue of our stockoptions granted to employees for the nine months ended September 30, 2010and 2009 were estimated using the following weighted-average assumptions:

 
| ** **                   | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------|------------|-----------------------------------------------------|------------|
| ** **                   | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| Expected term (in  years)    |       | 4.0                                                 |       | 4.0 |   |
|                         |       |                                                |       |   |   |
| Volatility                   |       | 69.84                                               | %          | 68.35 | % |
|                         |       |                                                |       |   |   |
| Expected dividend            |       | 0                                                   | %          | 0 | % |
|                         |       |                                                |       |   |   |
| Risk-free interest rate      |       | 1.00                                                | %          | 2.00 | % |
|                         |       |                                                |       |   |   |
| Estimated forfeitures        |       | 6.15                                                | %          | 10.63 | % |
|                         |       |                                                |       |   |   |
| Weighted-average fair  value |       | $                                                   | 3.06       |   | $ | 0.84 |   |
|                              |            |                                                     |            |  |  |  |  |

 

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The following tablesummarizes the stock option transactions during the nine months endedSeptember 30, 2010 (in thousands, except per share data):

 
| ** **                                                         | ** ** | **Shares** | ** ** | **Weighted-  average  Exercise  Price** | ** ** | **Weighted-   average  Remaining  Contractual  Life  (in years****)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|---------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                         | ** ** | ** ** | ** ** | ** **                              | ** ** | ** **                                                                      | ** ** | ** **                      | ** ** |
| Options outstanding as of January 1, 2010                     |       | 2,880      |       | $                                       | 2.46       |                                                                            |       |                            |       |   |
|                                                               |       |       |       |                                    |       |                                                                            |       |                            |       |
| Granted                                                            |       | 379        |       | 5.83                                    |       |                                                                            |       |                            |       |
|                                                               |       |       |       |                                    |       |                                                                            |       |                            |       |
| Exercised                                                          |       | (541       | )          | 1.51                                    |       |                                                                            |       |                            |       |
|                                                               |       |       |       |                                    |       |                                                                            |       |                            |       |
| Canceled and expired                                               |       | (89        | )          | 8.57                                    |       |                                                                            |       |                            |       |
|                                                               |       |       |       |                                    |       |                                                                            |       |                            |       |
| Options outstanding as of September 30, 2010                  |       | 2,629      |       | $                                       | 2.93       |                                                                            | 6.43       |                            | $          | 10,121 |   |
|                                                               |       |       |       |                                    |       |                                                                            |       |                            |       |
| Options vested and expected to vest as of  September 30, 2010 |       | 2,524      |       | $                                       | 2.91       |                                                                            | 6.31       |                            | $          | 9,804 |   |
|                                                               |       |       |       |                                    |       |                                                                            |       |                            |       |
| Options exercisable as of September 30, 2010                  |       | 1,431      |       | $                                       | 2.69       |                                                                            | 4.16       |                            | $          | 6,075 |   |

 

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

 

Theaggregate intrinsic value in the table above represents the total pretaxintrinsic value, based on our closing price of $6.62 on September 30,2010, which would have been received by the option holder had all optionholders exercised their options on that date. The total number of in-the-moneyoptions exercisable as of September 30, 2010 was 1,387,277.

 

Theoptions outstanding and exercisable as of September 30, 2010 were in thefollowing exercise price ranges:

** **
| **Options Outstanding as of September 30, 2010** | ** ** | **Options Exercisable  as of September 30, 2010** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **Range of Exercise Price**                                     | ** ** | **Shares**                                                                 | ** ** | **Weighted-  average  Exercise Price** | ** ** | **Weighted-  average  Remaining  Contractual Life** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
| $1.18 - $1.33                                                                  |       | 300,342                                                                    |       | $ | 1.27 |   | 4.50 |   | 300,342 |   | $ | 1.27 |   |
| $1.34 - $1.34                                                                  |       | 7,500                                                                      |       | $ | 1.34 |   | 5.05 |   | 7,500 |   | $ | 1.34 |   |
| $1.38 - $1.38                                                                  |       | 295,400                                                                    |       | $ | 1.38 |   | 2.94 |   | 295,400 |   | $ | 1.38 |   |
| $1.40 - $1.40                                                                  |       | 1,094                                                                      |       | $ | 1.40 |   | 4.45 |   | 1,094 |   | $ | 1.40 |   |
| $1.59 - $1.59                                                                  |       | 449,899                                                                    |       | $ | 1.59 |   | 8.55 |   | 153,473 |   | $ | 1.59 |   |
| $1.88 - $1.98                                                                  |       | 17,000                                                                     |       | $ | 1.93 |   | 4.39 |   | 17,000 |   | $ | 1.93 |   |
| $2.04 - $2.04                                                                  |       | 488,700                                                                    |       | $ | 2.04 |   | 9.07 |   | 0 |   | $ | 0.00 |   |
| $2.19 - $2.19                                                                  |       | 306,750                                                                    |       | $ | 2.19 |   | 2.15 |   | 306,750 |   | $ | 2.19 |   |
| $3.11 - $5.09                                                                  |       | 236,220                                                                    |       | $ | 3.87 |   | 4.66 |   | 230,843 |   | $ | 3.84 |   |
| $5.83 - $39.80                                                                 |       | 525,625                                                                    |       | $ | 6.84 |   | 8.59 |   | 118,875 |   | $ | 10.18 |   |
|                                                                           |       | 2,628,530                                                                  |       | $ | 2.94 |   | 6.43 |   | 1,431,277 |   | $ | 2.69 |   |

 

Therewere 424,679 and 541,337 options exercised in the three months and nine monthsended September 30, 2010, respectively. The total intrinsic value ofoptions exercised for the three and nine months ended September 30, 2010was $1,975,810 and $2,242,484, respectively. Cash received from optionsexercised for the three and nine months ended September 30, 2010 was$652,975 and $819,175, respectively. There were 6,250 and 36,833options exercised in the three and nine months ended September 30, 2009,respectively. The total intrinsic value of options exercised for the three andnine months ended September 30, 2009 was $433 and $2,298, respectively.Cash received from options exercised for the three and nine months endedSeptember 30, 2009 was $8,175 and $48,175, respectively.

 

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***Restricted stock awards***

*** ***

A summary of activity related to restricted stockawards for the nine months ended September 30, 2010 is presented below:

 
| ** **                                                                    | ** ** | **Shares** | ** ** | **Weighted-Average  Grant Date Fair Value** | ** ** |
|-------------------------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------|------------|
| Non-vested restricted stock shares outstanding as  of January 1, 2010    |       | 170,660    |       | $                                                          | 1.21       |   |
| Restricted stock shares granted                                               |       | 121,237    |       | $                                                          | 5.29       |   |
| Restricted stock shares vested                                                |       | (48,127    | )          | $                                                          | 1.43       |   |
| Non-vested restricted stock shares outstanding as  of September 30, 2010 |       | 243,770    |       | $                                                          | 3.20       |   |

 

Asof September 30, 2010, we had $697,000 of unrecognized compensationexpense, net of forfeitures, related to restricted stock awards, which will berecognized over the weighted average period of 2.44 years. During the ninemonths ended September 30, 2010 and 2009, 48,127 shares and 7,827 sharesof restricted stock vested respectively.

 

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

 

Ourcash, cash equivalents and investments are classified as follows (inthousands):

 

 
| ** **                                    | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | ** **                       | ** ** | **Gross**                       | ** ** | **Gross** | ** ** | ** ** | ** ** | ** ** | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Amortized**                    | ** ** | **Unrealized**                  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                    | ** ** | **Cost**                         | ** ** | **Gain**                        | ** ** | **(Loss)** | ** ** | **Value** | ** ** | **Cost** | ** ** | **Gain** | ** ** | **(Loss)** | ** ** | **Value** | ** ** |
| **Classified as:**                            |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash                                          |       | $                                | 21,125     |                            | $          | — |   | $ | — |   | $ | 21,125 |   | $ | 16,790 |   | $ | — |   | $ | — |   | $ | 16,790 |   |
| Cash  equivalents:                            |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Money  market fund                            |       | 2,268                            |       | —                          |       | — |   | 2,268 |   | 144 |   | — |   | — |   | 144 |   |
|                                          |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  cash and cash equivalents              |       | 23,393                           |       | —                          |       | — |   | 23,393 |   | 16,934 |   | — |   | — |   | 16,934 |   |
|                                          |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments:                                  |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Certificates  of Deposit                      |       | 3,600                            |       | 10                              |       | — |   | 3,610 |   |   |   |   |   |   |   |   |   |
| US  Treasury and agency securities            |       | 4,935                            |       | 8                               |       | — |   | 4,943 |   |   |   |   |   |   |   |   |   |
| Corporate  bonds                              |       | 9,072                            |       | —                          |       | (19 | ) | 9,053 |   | 18,298 |   | 171 |   | — |   | 18,469 |   |
| Total  investments                            |       | 17,607                           |       | 18                              |       | (19 | ) | 17,606 |   | 18,298 |   | 171 |   | — |   | 18,469 |   |
| Total  cash, cash equivalents and investments |       | $                                | 41,000     |                            | $          | 18 |   | $ | (19 | ) | $ | 40,999 |   | $ | 35,232 |   | $ | 171 |   | $ | — |   | $ | 35,403 |   |
| **Contractual maturities on investments:**    |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Due  within 1 year                            |       | $                                | 4,474      |                            |       |   |   |   | $ | 4,467 |   | $ | 18,298 |   |   |   |   |   | $ | 18,469 |   |
| Due  after 1 through 5 years                  |       | 13,133                           |       |                            |       |   |   | 13,139 |   | — |   |   |   |   |   | — |   |
|                                          |       | $                                | 17,607     |                            |       |   |   |   | $ | 17,606 |   | $ | 18,298 |   |   |   |   |   | $ | 18,469 |   |

 

Wemanage our investments as a single portfolio of highly marketable securitiesthat is intended to be available to meet our current cash requirements. We haveno investments in auction rate securities. For the three and nine months endedSeptember 30, 2010 we had $150,000 and $346,000 of gross realized gains onsales of our available-for-sale securities, respectively. For the three andnine months ended September 30, 2009 we had $9,000 of gross realizedlosses on sales of our available-for-sale securities.

 

Thegross unrealized losses related to our portfolio of available-for-salesecurities were primarily due to a decrease in the fair value of debtsecurities. We have determined that the gross unrealized losses on ouravailable-for-sale securities as of September 30, 2010 are temporary innature. We reviewed our investment portfolio to identify and evaluateinvestments that have indications of possible impairment. Factors considered indetermining whether a loss is temporary include the magnitude of the decline inmarket value, the length of time the market value has been below cost (oradjusted cost), credit quality, and our ability and intent to hold thesecurities for a period of time sufficient to allow for any anticipatedrecovery in market value. The following table provides a breakdown of ouravailable-for-sale securities with unrealized losses as of September 30,2010 (in thousands):

 

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| ** **             | ** ** | **In Loss Position  < 12 months** | ** ** | **Total In  Loss Position** | ** ** |
|------------------------|------------|----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **             | ** ** | ** **                                               | ** ** | **Gross**                             | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **             | ** ** | **Fair**                                                 | ** ** | **Unrealized**                        | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **             | ** ** | **Value**                                                | ** ** | **(Loss)**                            | ** ** | **Value** | ** ** | **(Loss)** | ** ** |
| Investments:           |       |                                                     |       |                                  |       |   |   |   |   |
| Corporate bonds        |       | $                                                        | 9,053      |                                  | $          | (19 | ) | $ | 9,053 |   | $ | (19 | ) |
| Total in loss position |       | $                                                        | 9,053      |                                  | $          | (19 | ) | $ | 9,053 |   | $ | (19 | ) |

 

***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 (see Note 9). The investment balances for the two companiesaccounted for under the equity method are included in “other assets” in thecondensed consolidated balance sheets and totaled $4.3 million and$4.2 million as of September 30, 2010 and December 31, 2009,respectively. We have investments in three unconsolidated privately-heldcompanies accounted for under the cost method. As of September 30, 2010and December 31, 2009, our investments in the three unconsolidatedprivately-held companies accounted for under the cost method had a carryingvalue of $0.7 million and $0.7 million, respectively, and are included in “otherassets” in the condensed consolidated balance sheets.

 

***Fair ValueMeasurements***

 

On January 1, 2008, we adopted ASC topic 820, *Fair Value Measurements and Disclosures* (“ASC820”) which defines fair value, establishes a framework for using fair value tomeasure assets and liabilities, and expands disclosures about fair valuemeasurements. ASC 820 applies whenever other statements require or permitassets or liabilities to be measured at fair value. ASC 820 applies to allfinancial assets and financial liabilities that are being measured and reportedon a fair value basis and requires disclosure that establishes a framework formeasuring fair value and expands disclosure about fair value measurements.Certain financial assets and liabilities that are not required to be recordedat fair value, including accounts receivable, accounts payable, accruedliabilities and term debt, have recorded values that approximate fair valuegiven their short term nature and relative terms of the agreement.

 

The following table summarizes our financial assets and liabilitiesmeasured at fair value on a recurring basis in accordance with ASC 820 asof September 30, 2010 (in thousands):

 
| ** **                        | ** ** | **Balance as of  September 30, 2010** | ** ** | **Quoted Prices in  Active Markets of  Identical Assets  (Level 1)** | ** ** | **Significant Other  Observable  Inputs  (Level 2)** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| Assets:                           | ** ** | ** **                                                | ** ** | ** **                                                                                         | ** ** | ** **                                                     | ** ** |
| Cash equivalents and investments: |       |                                                      |       |                                                                                               |       |                                                           |       |
| Money market fund - cash          |       | $                                                         | 2,268      |                                                                                               | $          | 2,268                                                          |       | $ | — |   |
| Certificates of deposit           |       | 3,610                                                     |       | —                                                                                             |       | 3,610                                                          |       |
| US Treasury and agency securities |       | 4,943                                                     |       | —                                                                                             |       | 4,943                                                          |       |
| Corporate bonds                   |       | 9,053                                                     |       | —                                                                                             |       | 9,053                                                          |       |
| Total                             |       | $                                                         | 19,874     |                                                                                               | $          | 2,268                                                          |       | $ | 17,606 |   |
| Liabilities                       |       | $                                                         | —     |                                                                                               | $          | —                                                         |       | $ | — |   |

 

Ourfinancial assets and liabilities are valued using market prices on both activemarkets (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 September 30, 2010, we did not have any assets orliabilities without observable market values that would require a high level ofjudgment to determine fair value (Level 3 assets).

 

***Items Measured at Fair Value on a NonrecurringBasis***

 

Certainassets that are subject to nonrecurring fair value measurements are notincluded in the table above. These assets include equity and cost methodinvestments in private companies. We did not record other-than-temporaryimpairment charges for either of these investments during the first nine monthsof 2010 or 2009.

 

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**Note 4.Inventories, Net**

 

Thecomponents of inventories are summarized below (in thousands):

 
| ** **        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|------------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| Inventories, net: |       |                   |       |                  |       |
| Raw materials     |       | $                      | 15,296     |                  | $          | 12,051 |   |
| Work in process   |       | 13,777                 |       | 11,947                |       |
| Finished goods    |       | 4,080                  |       | 3,720                 |       |
|              |       | $                      | 33,153     |                  | $          | 27,718 |   |

 

**Note 5.Restructuring Charge**

 

InMarch 2009, we reduced the workforce at our Fremont and Beijing facilitiesby approximately 11 positions that were no longer required to support certainproduction and administrative operations. This measure was being taken as partof our 2009 operating plan. Accordingly, we recorded a restructuring charge of$507,000 in March 2009 for severance-related expenses from the reductionin force, all of which were paid during the second quarter of 2009. We expectto save approximately $1.3 million annually in payroll and related expenses. Wehad no restructuring charge in the first nine months of 2010.

 

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

 

Basicnet income (loss) per common share iscalculated by dividing net income (loss) available to common stockholders bythe weighted average number of common shares outstanding during the period.Diluted net income (loss) per common and common equivalent shares include thedilutive effect of common stock equivalents outstanding during the periodcalculated using the treasury stock method. Common stock equivalents consist ofthe shares issuable upon the exercise of stock options.

 

Areconciliation of the numerators and denominators of the basic and diluted netincome (loss) per share calculations is as follows (in thousands, except per share data):

 
| ** **                                                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                          | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                          | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| Numerator:                                                                          |       |                             |       |                            |       |   |   |   |   |
| Net income (loss) attributable to AXT, Inc.                                    |       | $                                | 5,639      |                            | $          | 2,121 |   | $ | 13,754 |   | $ | (4,675 | ) |
| Less: Preferred stock dividends                                                     |       | (44                              | )          | (44                             | )          | (132 | ) | (132 | ) |
|                                                                                |       |                             |       |                            |       |   |   |   |   |
| Net income (loss) available to common stockholders                                  |       | $                                | 5,595      |                            | $          | 2,077 |   | $ | 13,622 |   | $ | (4,807 | ) |
| Denominator:                                                                        |       |                             |       |                            |       |   |   |   |   |
| Denominator for basic net income (loss) per share  - weighted average common shares |       | 30,944                           |       | 30,475                          |       | 30,853 |   | 30,449 |   |
| Effect of dilutive securities:                                                      |       |                             |       |                            |       |   |   |   |   |
| Common stock options                                                                |       | 1,565                            |       | 436                             |       | 1,317 |   | — |   |
| Denominator for dilutive net income (loss) per  common share                        |       | 32,509                           |       | 30,911                          |       | 32,170 |   | 30,449 |   |
| Effect on net income (loss) attributable to  AXT, Inc. per common share:       |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                               |       | $                                | 0.18       |                            | $          | 0.07 |   | $ | 0.44 |   | $ | (0.16 | ) |
| Diluted                                                                             |       | $                                | 0.17       |                            | $          | 0.07 |   | $ | 0.42 |   | $ | (0.16 | ) |
| Options excluded from diluted per share  calculation as the impact is anti-dilutive |       | 471                              |       | 2,115                           |       | 434 |   | 2,655 |   |

 

The 883,000 shares of $0.001par value Series A preferred stock issued on May 28, 1999 arenon-voting and non-convertible preferred stock with a 5.0% cumulative annualdividend rate payable when declared by the board of directors, and a $4 pershare liquidation preference over common stock, and must be paid before anydistribution is made to common stockholders.

 

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

 

**ConsolidatedStatements of Changes in Equity**

 
| ** **                                                 | ** ** | **Preferred  Stock** | ** ** | **Common  Stock** | ** ** | **Additional  Paid In Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Other  Comprehensive  Income/(loss)** | ** ** | **AXT, Inc.  stockholders  equity** | ** ** | **Noncontrolling  interests** | ** ** | **Total  stockholders’  equity** | ** ** |
|------------------------------------------------------------|------------|----------------------|------------|-------------------|------------|-------------------------------------------|------------|--------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|-------------------------------|------------|---------------------------------------|------------|
| Balance  as of December 31, 2009                      |       | $                    | 3,532      |              | $          | 30                                        |       | $                        | 187,871    |                                    | $          | (101,130                                 | )          | $                             | 4,300      |                                  | $          | 94,603 |   | $ | 2,648 |   | $ | 97,251 |   |
| Common  stock options exercised                            |       |                 |       |              |       | 819                                       |       |                     |       |                                    |       | 819                                      |       |                          |       | 819                                   |       |
| Stock-based  compensation                                  |       |                 |       |              |       | 420                                       |       |                     |       |                                    |       | 420                                      |       |                          |       | 420                                   |       |
| Comprehensive  income:                                     |       |                 |       |              |       |                                      |       |                     |       |                                    |       |                                     |       |                          |       |                                  |       |
| Net  income                                                |       |                 |       |              |       |                                      |       | 13,754                   |       |                                    |       | 13,754                                   |       | 1,227                         |       | 14,981                                |       |
| Dividend  paid                                             |       |                 |       |              |       |                                      |       |                     |       |                                    |       |                                     |       | (528                          | )          | (528                                  | )          |
| Change  in unrealized (loss) gain on marketable securities |       |                 |       |              |       |                                      |       |                     |       | (172                                    | )          | (172                                     | )          |                          |       | (172                                  | )          |
| Currency  translation adjustment                           |       |                 |       |              |       |                                      |       |                     |       | 148                                     |       | 148                                      |       | 117                           |       | 265                                   |       |
| Balance  as of September 30, 2010                     |       | $                    | 3,532      |              | $          | 30                                        |       | $                        | 189,110    |                                    | $          | (87,376                                  | )          | $                             | 4,276      |                                  | $          | 109,572 |   | $ | 3,464 |   | $ | 113,036 |   |

 

Thecomponents of comprehensive income (loss) are as follows (in thousands):

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                      | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                      | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Net income (loss) attributable to AXT, Inc.                                |       | $                                | 5,639      |                            | $          | 2,121 |   | $ | 13,754 |   | $ | (4,675 | ) |
| Other comprehensive income (loss), net of tax:                                  |       |                             |       |                            |       |   |   |   |   |
| Change in foreign currency translation gain  (loss), net of tax                 |       | 628                              |       | 19                              |       | 265 |   | (21 | ) |
| Change in unrealized gain (loss) on available-for-sale  investments, net of tax |       | 121                              |       | 518                             |       | (172 | ) | 1,408 |   |
| Total other comprehensive income (loss), net of  tax                            |       | 749                              |       | 537                             |       | 93 |   | 1,387 |   |
| Comprehensive income (loss)                                                     |       | 6,388                            |       | 2,658                           |       | 13,847 |   | (3,288 | ) |
| Comprehensive income (loss) attributable to the  noncontrolling interest        |       | (117                             | )          | —                          |       | (117 | ) | — |   |
| Comprehensive income (loss) attributable to  AXT, Inc.                     |       | $                                | 6,271      |                            | $          | 2,658 |   | $ | 13,730 |   | $ | (3,288 | ) |

 

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

 

***Segment Information***

 

We operate in one segment for the design, development, manufacture anddistribution of high-performance compound semiconductor substrates and sale ofmaterials. In accordance with ASC topic 280,*Segment Reporting,*ourchief operating decision-maker has been identified as the principal executiveofficer, who reviews operating results to make decisions about allocatingresources and assessing performance for the Company. Since we operate in onesegment, all financial segment and product line information can be found in theconsolidated financial statements.

 

***Product Information***

 
| ** **               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **               | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| Revenue by product type: |       |                             |       |                            |       |   |   |   |   |
| GaAs substrates          |       | $                                | 19,174     |                            | $          | 13,316 |   | $ | 48,843 |   | $ | 28,436 |   |
| InP substrates           |       | 956                              |       | 688                             |       | 2,908 |   | 1,862 |   |
| Ge substrates            |       | 2,267                            |       | 1,787                           |       | 5,509 |   | 3,626 |   |
| Raw materials and other  |       | 4,412                            |       | 1,028                           |       | 11,367 |   | 3,604 |   |
| Total                    |       | $                                | 26,809     |                            | $          | 16,819 |   | $ | 68,627 |   | $ | 37,528 |   |

 

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***Geographical Information***

 

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

 
| ** **                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **September 30,**           | ** ** | **September 30**           | ** ** |
| ** **                    | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| Revenue by geographic region: |       |                             |       |                            |       |   |   |   |   |
| North America*                |       | $                                | 5,224      |                            | $          | 2,975 |   | $ | 14,472 |   | $ | 7,139 |   |
| Europe                        |       | 5,775                            |       | 3,115                           |       | 13,744 |   | 7,592 |   |
| Japan                         |       | 3,040                            |       | 2,304                           |       | 9,322 |   | 5,494 |   |
| Taiwan                        |       | 3,869                            |       | 3,462                           |       | 10,470 |   | 6,897 |   |
| Asia Pacific                  |       | 8,901                            |       | 4,963                           |       | 20,619 |   | 10,406 |   |
| Total                         |       | $                                | 26,809     |                            | $          | 16,819 |   | $ | 68,627 |   | $ | 37,528 |   |

 

----

*Primarilythe United States

 

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

 
| ** **                              | ** ** | **As of**         | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                              | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Long-lived assets by geographic region: |       |                   |       |   |   |
| North America                           |       | $                      | 597        |   | $ | 661 |   |
| China                                   |       | 22,112                 |       | 20,192 |   |
|                                    |       | $                      | 22,709     |   | $ | 20,853 |   |

 

***Significant Customers***

 

Onecustomer represented more than 10% of revenue at 19.0% for the three monthperiod ended September 30, 2010 while two customers each represented morethan 10% of revenue at 16.5% and 10.1% for the three month period ended September 30,2009.  One customer represented more than10% of revenue at 18.1% for the nine month period ended September 30, 2010while two customers each represented more than 10% at 15.8% and 10.8% revenuesfor the nine month period ended September 30, 2009.Our top five customersrepresented 42.6% and 46.9% of revenue for the three month periods endedSeptember 30, 2010 and 2009, respectively. Our top five customersrepresented 40.0% and 42.9% of revenue for the nine month periods endedSeptember 30, 2010 and 2009, respectively.

 

We perform periodic credit evaluations of our customers’ financialcondition and generally do not require collateral. Two customers each accountedfor 10% or more of our trade accounts receivable balance as ofSeptember 30, 2010 at 31%, and 14%, respectively.

 

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

 

We have made strategic investments in private companies located inChina in order to gain access to raw materials at a competitive cost that arecritical to our substrate business.

 

Our investments are summarized below (in thousands):

 
| ** **                                                       | ** ** | **Investment Balance as of** | ** ** | ** **            | ** ** | ** **     | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------|------------|----------------|------------|
| ** **                                                       | ** ** | **September 30,**                      | ** ** | **December 31,** | ** ** | **Accounting** | ** ** | **Ownership** | ** ** |
| **Company**                                                      | ** ** | **2010**                                    | ** ** | **2009**              | ** ** | **Method**     | ** ** | **Percentage** | ** ** |
| Beijing JiYa Semiconductor  Material Co., Ltd          |       | $                                           | 996        |                  | $          | 996            |       | Consolidated |   | 46 | % |
| Nanjing Jin Mei Gallium Co., Ltd                       |       | 592                                         |       | 592                   |       | Consolidated   |       | 83 | % |
| Beijing BoYu Semiconductor Vessel Craftwork  Technology Co., Ltd |       | 410                                         |       | 410                   |       | Consolidated   |       | 70 | % |
|                                                             |       | $                                           | 1,998      |                  | $          | 1,998          |       |   |   |   |   |
|                                                             |       |                                        |       |                  |       |           |       |   |   |
| Xilingol Tongli Germanium Co. Ltd                      |       | $                                           | 3,398      |                  | $          | 3,367          |       | Equity |   | 25 | % |
| Emeishan Jia Mei High Purity  Metals Co., Ltd          |       | 857                                         |       | 866                   |       | Equity         |       | 25 | % |
|                                                             |       | $                                           | 4,255      |                  | $          | 4,233          |       |   |   |   |   |

 

Our ownership of Beijing Ji Ya SemiconductorMaterial Co., Ltd. (JiYa) is 46%. We continue to consolidate JiYa aswe have significant influence in management and have a majority control of theboard. Our chief executive officer is chairman of the JiYa board, while ourpresident of China operations and our vice president of China administrationand our vice president of wafer production are also members of the JiYa board.

 

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Our ownership of Nanjing Jin Mei Gallium Co., Ltd. (Jin Mei)is 83%. We continue to consolidate Jin Mei as we have significant influence inmanagement and have a majority control of the board. Our chief executiveofficer is chairman of the Jin Mei board, while our president of Chinaoperations and our vice president of China administration are also members ofthe Jin Mei board.

 

Our ownership of Beijing BoYu Semiconductor Vessel CraftworkTechnology Co., Ltd (BoYu), is 70%. We continue to consolidate Bo Yuas we have a significant influence over management and have a majority controlof the board. Our chief executive officer is chairman of the BoYu board and ourpresident of China operations and our vice president of China administrationare members of the BoYu board.

 

Although we have representation on the boards of directors of each ofthese companies, the daily operations of each of these companies are managed bylocal management and not by us. Decisions concerning their respective shortterm strategy and operations, any capacity expansion and annual capitalexpenditures, and decisions concerning sales of finished product, are made bylocal management with some input from us.

 

The investment balances for the two companies accounted for under theequity method are included in other assets in the consolidated balance sheetsand totaled $4.3 million and $4.2 million as of September 30, 2010and December 31, 2009, respectively. We own 25% of the ownership interestsin each of these companies. These two companies are not considered variableinterest entities because:

 

·                  both companies have sustainable businesses oftheir own;

 

·                  our voting power is proportionate to ourownership interests;

 

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

 

·                  we do not have controlling financial interestin, do not maintain operational or management control of, do not control theboard of directors of, and are not required to provide additional investment orfinancial support to either company.

 

During the three and nine months ended September 30, 2010 thethree consolidated joint ventures had income of $2.0 million and $3.8 millionof which $0.7 million and $1.2 million, respectively, were allocated tominority interests, resulting in income of $1.3 million and $2.6 million,respectively, included in our net income. During the three and nine monthsended September 30, 2009 the three consolidated joint ventures had incomeof $705,000 and $538,000, respectively of which $210,000 and $136,000 wereallocated to minority interests, resulting in income of $494,000 and $401,000included in our net income, respectively. Our equity earnings from thetwo-minority owned joint ventures that are not consolidated are recorded asother income (loss), net and totaled $182,000 and $409,000 for the nine monthsended September 30, 2010 and 2009, respectively. Undistributed retainedearnings relating to all our investments in these companies were $15.2 million and $ 12.4 million as of September 30, 2010 and December 31,2009, respectively.

 

Our two minority-owned joint ventures that are not consolidated andaccounted for under the equity method had the following summarized incomeinformation (in thousands) for the three and nine months endedSeptember 30, 2010 and 2009.

 
| ** **       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **       | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
|             |       |                                                 |       |                                                |       |   |   |   |   |
| Net Sales        |       | $                                                    |       | 3,009                                               |       | $ | 3,037 |   | $ | 9,851 |   | $ | 9,252 |   |
| Gross profit     |       | 933                                                  |       | 1,392                                               |       | 2,723 |   | 3,243 |   |
| Operating income |       | 238                                                  |       | 800                                                 |       | 638 |   | 1,548 |   |
| Net income       |       | 400                                                  |       | 1,083                                               |       | 726 |   | 1,638 |   |
|                  |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |  |

 

We have investments in three unconsolidated privately-held companiesaccounted for under the cost method. As of September 30, 2010 andDecember 31, 2009, our investments in the three unconsolidatedprivately-held companies accounted for under the cost method had a carryingvalue of $0.7 million and $0.7 million, respectively, and are included in “otherassets” in the condensed consolidated balance sheets.

 

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**Note 10.Commitments and Contingencies**

 

***Indemnification Agreements***

 

Weenter into standard indemnification arrangements in the ordinary course ofbusiness. Pursuant to these arrangements, we indemnify, hold harmless, andagree to reimburse the indemnified parties for losses suffered or incurred bythe indemnified party, generally our 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. The accruedwarranty costs represent the best estimate at the time of sale of the totalcosts that we expect to incur to repair or replace product parts that failwhile still under warranty. The amount of accrued estimated warranty costs areprimarily 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 sheetsduring the three and nine months ended September 30, 2010 and 2009 (inthousands):

 
| ** **                                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                   | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                         |       |                                                 |       |                                                |       |   |   |   |   |
| Beginning accrued warranty and related costs |       | $                                                    | 880        |                                                | $          | 1,495 |   | $ | 1,082 |   | $ | 1,640 |   |
| Charged to cost of revenue                   |       | (17                                                  | )          | 538                                                 |       | (163 | ) | 856 |   |
| Actual warranty expenditures                 |       | —                                               |       | (321                                                | )          | (56 | ) | (784 | ) |
| Ending accrued warranty and related costs    |       | $                                                    | 863        |                                                | $          | 1,712 |   | $ | 863 |   | $ | 1,712 |   |

 

***Purchase Obligations***

 

Through the normal course of business, we purchase or place orders forthe necessary materials of our products from various suppliers and we commit topurchase products where we may incur a penalty if the agreement was canceled.As of September 30, 2010, we did not have any outstanding materialpurchase obligations.

 

**LegalProceedings**

 

From time to time we may beinvolved in judicial or administrative proceedings concerning matters arisingin the ordinary course of business. We do not expect that any of these matters,individually or in the aggregate, will have a material adverse effect on ourbusiness, financial condition, cash flows or results of operation.

 

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

 

Weincurred foreign currency transaction exchange gains of $210,000 and $341,000for the three months ended September 30, 2010, and 2009, respectively. Weincurred foreign currency transaction exchange gains of $372,000 and $88,000 forthe nine months  ended September 30,2010, and 2009, respectively. These amounts are included in “Other income(expense), net” on the condensed consolidated statements of operations.

 

**Note 12. Income Taxes**

 

InJuly 2006, the Financial Accounting Standards Board (“FASB”) issued ASCtopic 740, *Income Taxes*(“ASC 740”). ASC 740clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with ASC 740. Thisinterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. ASC 740 also provides guidance onderecognition of tax benefits, classification on the balance sheet, interestand penalties, accounting in interim periods, disclosure, and transition. We

 

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adoptedASC 740 effective January 1, 2007. We recognize interest and penaltiesrelated to uncertain tax positions in income tax expense. As ofSeptember 30, 2010, we did not have any gross unrecognized tax benefits,nor any accrued interest and penalties related to uncertain tax positions. As aresult of the implementation of ASC 740, we identified $16.4 million inthe liability for unrecognized tax benefits. Of this amount, none was accountedfor as a reduction to the January 1, 2007 balance of retained earnings.The amount decreased the tax loss carryforwards in the U.S. which are fullyoffset by a valuation allowance. We file income tax returns in the U.S. federal,various states and foreign jurisdictions. We have substantially concluded allU.S. federal and state income tax matters through December 31, 2008. Therewere no Federal U.S. tax expense during three and nine months ended September 30,2010 due to the valuation allowance being utilized.

 

**Note 13.Recent Accounting Pronouncements**

 

Withthe exception of those stated below, there have been no recent accountingpronouncements or changes in accounting pronouncements during the three monthsended September 30, 2010, as compared to the recent accountingpronouncements described in the Annual Report that are of materialsignificance, or have potential material significance, to the Company.

 

InMay 2009, the FASB issued guidance contained in FASB ASC 855, “*Subsequent Events*” to establish general standards ofaccounting for and disclosure of events that occur after the balance sheet datebut before financial statements are issued or are available to be issued. Thisguidance was effective for interim or annual financial periods ending afterJune 15, 2009. In February, 2010, the FASB issued Accounting StandardsUpdate 2010-09 — “Subsequent Events” which removed the requirement to disclosethe date through which subsequent events had been considered for disclosure.This update was effective upon issuance. In accordance with this guidance, wehave evaluated and, as necessary, made changes to these unaudited CondensedConsolidated Financial Statements for the events.

 

InOctober 2009, the FASB issued ASU No. 2009-13, “*Multiple-Deliverable Revenue Arrangements a Consensus of the FASBEmerging Issues Task Force*” an update to Accounting StandardsCodification (ASC) Topic 605, “*Revenue Recognition*.”  Thisupdate requires the allocation of consideration among separately identifieddeliverables contained within an arrangement, based on their related sellingprices.  This update will be effective for annual reportingperiods beginning January 1, 2011.  The Company is currentlyevaluating the impact of this update on its financial position,results of operations, cash flows, and disclosures.

 

InJanuary 2010, the FASB issued ASU No. 2010-06, “*Improving Disclosures about Fair Value Measurements*” anupdate to ASC Topic 820, “*Fair Value Measurementsand Disclosures*.” This update requires an entity to:(i) disclose separately the amounts of significant transfers in and out ofLevel 1 and Level 2 fair value measurements and describe the reasons for thetransfers and (ii) present separate information for Level 3 activitypertaining to gross purchases, sales, issuances, and settlements.  Thisupdate became effective for us in the quarter ended March 31, 2010, exceptthat the disclosure on the roll forward activities for Level 3 fair valuemeasurements will become effective for us with the reporting period beginningJanuary 1, 2011. Other than requiring additional disclosures, adoption ofthis new guidance did not have a material impact on the Company’s financialstatements.

 

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

 

Thisquarterly report on Form 10-Q, including the following sections, containsforward-looking statements within the meaning of Section 21E of theSecurities Exchange Act of 1934, as amended, particularly statements relatingto our expectations regarding results of operations, customer demand, ourability to leverage our manufacturing capabilities and access to favorablypriced raw materials to increase our market share, our ability to drive futurebusiness, industry trends, our progress in our penetration of the solar cellmarket, our ability to expand our markets and increase sales, gross margins,our reserve balances, our expected savings from our the workforce reductionimplemented in 2009, the impact of the adoption of certain accountingpronouncements, our investments in capital projects, and our belief that wehave adequate cash and investments to meet our needs over the next 12 months.These forward-looking statements are based upon management’s current views withrespect to future events and financial performance, and are subject to certainrisks and uncertainties that could cause actual results to differ materiallyfrom historical results or those anticipated in such forward-lookingstatements. Such risks and uncertainties include those set forth under thesection entitled “Risk Factors” below and in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2009, which identify importantfactors that could cause actual results to differ materially from those predictedin any such forward-looking statements. We caution investors that actualresults may differ materially from those projected in the forward-lookingstatements as a result of certain risk factors identified in thisForm 10-Q and other filings we have made with the Securities and ExchangeCommission. Forward-looking statements may be identified by the use of termssuch as “anticipates,” “believes,” “estimates,” “expects,” “intends,” andsimilar expressions. Statements concerning our future or expected financialresults and condition, business strategy and plans or objectives for futureoperations are forward-looking statements.

 

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Theseforward-looking statements are not guarantees of future performance. Readersare cautioned not to place undue reliance on these forward-looking statements,which speak only as of the date hereof. This discussion should be read in conjunctionwith Management’s Discussion and Analysis of Financial Condition and Results ofOperations included in our Annual Report on Form 10-K for the year endedDecember 31, 2009 and the condensed consolidated financial statementsincluded elsewhere in this report.

 

**Overview**

 

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

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

 

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

 

Whilethe volatile business and financial markets are prompting us to continue totake a conservative approach to our business, we remain optimistic about ourbusiness. Positive industry trends in the first half of 2010, coupled with ourcompetitive manufacturing and cost advantages give us confidence in our abilityto continue to drive future business in 2010. Following very challengingindustry conditions in the first half of 2009, we began to see stronger sales andimproved gross margins in the second half of 2009. Our qualification efforts inboth gallium arsenide and germanium substrates have been successful and we arepleased with our increasing diversification in these areas.

 

Asof September 30, 2010, our principal sources of liquidity were $41.0million in cash and cash equivalents and short and long-term investments. Thisincreased by $5.6 million compared to cash and cash equivalents and short-terminvestments of $35.4 million at December 31, 2009.

 

**Critical Accounting Policies and Estimates**

 

Wehave prepared our condensed consolidated financial statements in accordancewith accounting principles generally accepted in the United States of America.As such, we have had to make estimates, assumptions and judgments that affectthe amounts reported on our financial statements. These estimates, assumptionsand judgments about future events and their effects on our results cannot bedetermined with certainty, and are made based upon our historical experienceand on other assumptions that are believed to be reasonable under thecircumstances. These estimates may change as new events occur oradditional information is obtained, and we may periodically be faced withuncertainties, the outcomes of which are not within our control andmay not be known for a prolonged period of time. The discussion andanalysis of our results of operations and financial condition are based uponthese condensed consolidated financial statements.

 

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Wehave identified the policies below as critical to our business operations andunderstanding of our financial condition and results of operations.

 

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

 

***Revenue Recognition***

 

Wemanufacture and sell high-performance compound semiconductor substrates andsell certain raw materials including gallium, germanium dioxide, and pBNcrucibles. After we ship our products, there are no remaining obligations orcustomer acceptance requirements that would preclude revenue recognition. Ourproducts are typically sold pursuant to a purchase order placed by ourcustomers, and our terms and conditions of sale do not require customeracceptance. We recognize revenue upon shipment and transfer of title ofproducts to our customers, which is either upon shipment from our dock, receiptat the customer’s dock, or removal from consignment inventory at the customer’slocation, provided that we have received a signed purchase order, the price isfixed or determinable, title and risk of ownership have transferred, collectionof resulting receivables is probable, and product returns are reasonablyestimable. We do not provide training, installation or commissioning services.We may provide discounts or other incentives to customers in order to securebusiness.

 

Weprovide for future returns based on historical experience, current economictrends and changes in customer demand at the time revenue is recognized.

 

***Accounts Receivable and Allowancefor Doubtful Accounts***

 

Weperiodically review the likelihood of collection on our accounts receivablebalances and provide an allowance for doubtful accounts receivable primarilybased upon the age of these accounts. We provide a 100% allowance forreceivables from U.S. customers in excess of 90 days and for receivables fromcustomers located outside the U.S. in excess of 120 days. We assess theprobability of collection based on a number of factors, including the length oftime a receivable balance has been outstanding, our past history with thecustomer and their creditworthiness.

 

Asof September 30, 2010 and December 31, 2009, our accounts receivable,net, balance was $19.0 million and $15.4 million, respectively, which was netof an allowance for doubtful accounts of $0.1 million and $0.2 million,respectively. If actual uncollectible accounts differ substantially from our estimates,revisions to the estimated allowance for doubtful accounts would be required,which could have a material impact on our financial results for the period.

 

The allowance for sales returns is also deductedfrom gross accounts receivable. As of September 30, 2010 andDecember 31, 2009, our allowance for sales returns was $0.4 million and$0.8 million, respectively.

 

***Warranty Reserve***

 

Wemaintain a warranty reserve based upon our claims experience during the priortwelve months. Warranty costs are accrued at the time revenue is recognized. Asof September 30, 2010 and December 31, 2009, accrued productwarranties totaled $0.9 million and $1.1 million, respectively. If actualwarranty costs differ substantially from our estimates, revisions to theestimated warranty liability would be required, which could have a materialimpact on our financial condition and results of operations.

 

***Inventory Valuation***

 

Inventoriesare stated at the lower of cost or market. Cost is determined using theweighted average cost method. Our inventory consists of raw materials as wellas finished goods and work-in-process that include material, labor andmanufacturing overhead costs. Given the nature of our substrate products, andthe materials used in the manufacturing process, the wafers and ingotscomprising work-in-process may be held in inventory for up to two yearsand three years, respectively, as the risk of obsolescence for these materialsis low. We routinely evaluate the levels of our inventory in light of currentmarket conditions in order to identify excess and obsolete inventory, and weprovide a valuation allowance for certain inventories based upon the age andquality of the product and the projections for sale of the completed products.As of September 30, 2010 and December 31, 2009, we had an inventoryreserve of $8.4 million and $10.1 million, respectively, for excess andobsolete inventory. The majority of this inventory has not been scrapped, andaccordingly, may be sold in future periods. If actual demand for our productswere to be substantially lower than estimated, additional inventory adjustmentsfor excess or obsolete inventory might be required, which could have a materialimpact on our business, financial condition and results of operations.

 

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***Impairment of Investments***

 

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

 

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

 

***Fair Value of Investments***

 

In the current market environment, the assessment of the fair value ofdebt instruments can be difficult and subjective. The volume of tradingactivity of certain debt instruments has declined, and the rapid changesoccurring in today’s financial markets can lead to changes in the fair value offinancial instruments in relatively short periods of time. ASC 820 establishesthree levels of inputs that may be used to measure fair value.

 

Level 1 instruments represent quoted prices in active markets.Therefore, determining fair value for Level 1 instruments does not requiresignificant management judgment, and the estimation is not difficult.Level 2 instruments include observable inputs other than Level 1prices, such as quoted prices for identical instruments in markets withinsufficient volume or infrequent transactions (less active markets), issuercredit ratings, non-binding market consensus prices that can be corroboratedwith observable market data, model-derived valuations in which all significantinputs are observable or can be derived principally from or corroborated withobservable market data for substantially the full term of the assets orliabilities, or quoted prices for similar assets or liabilities. TheseLevel 2 instruments require more management judgment and subjectivitycompared to Level 1 instruments, including:

 

·                  Determining which instruments are mostsimilar to the instrument being priced requires management to identify a sampleof similar securities based on the coupon rates, maturity, issuer, creditrating, and instrument type, and subjectively select an individual security ormultiple securities that are deemed most similar to the security being priced.

 

·                  Determining whether a market is consideredactive requires management judgment. Our assessment of an active market for ourmarketable debt instruments generally takes into consideration activity duringeach week of the one-month period prior to the valuation date of eachindividual instrument, including the number of days each individual instrumenttrades and the average weekly trading volume in relation to the totaloutstanding amount of the issued instrument.

 

·                  Determining which model-derived valuations touse in determining fair value requires management judgment. When observablemarket prices for identical securities or similar securities are not available,we price our marketable debt instruments using non-binding market consensusprices that are corroborated with observable market data or pricing models,such as discounted cash flow models, with all significant inputs derived fromor corroborated with observable market data.

 

Level 3 instruments include unobservable inputsto the valuation methodology that are significant to the measurement of fairvalue of assets or liabilities. The determination of fair value forLevel 3 instruments requires the most management judgment andsubjectivity. As of September 30, 2010, we did not have any assets orliabilities without observable market values that would require a high level ofjudgment to determine fair value (Level 3 assets).

 

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

 

Weevaluate the recoverability of property, equipment and intangible assets inaccordance with ASC topic 360, *Impairment of Disposal ofLong-Lived Assets.* When events and circumstances indicate thatlong-lived assets may be impaired, we compare the carrying value of thelong-lived assets to the projection of future undiscounted cash flowsattributable to these assets. In the event that the carrying value exceeds thefuture undiscounted cash flows, we record an impairment charge against incomeequal to the excess of the carrying value over the assets’ fair value. Fairvalues are determined based on quoted market values, discounted cash flows orinternal and external appraisals, as applicable. Assets held for sale arecarried at the lower of carrying value or estimated net realizable value.

 

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***Employee Stock Options***

 

Wegrant options to substantially all management employees and believe that thisprogram helps us to attract, motivate and retain high quality employees, to theultimate benefit of our stockholders. Effective January 1, 2006, weadopted the fair value recognition provisions of ASC 718, using the modifiedprospective application transition method. Under this transition method,stock-based compensation cost was recognized in the condensed consolidatedfinancial statements for all share-based payments after January 1, 2006.Compensation cost recognized includes the estimated expense for the portion ofthe vesting period after January 1, 2006 for share-based payments priorto, but not vested as of January 1, 2006, based on the grant date fairvalue estimated in accordance with the original provisions of ASC 718. Werecognize these compensation costs net of an estimated forfeiture rate over therequisite service period of the award, which is generally the vesting term offour years for stock options. Results for prior periods have not been restated,as provided for under the modified prospective application transition method.

 

***Income Taxes***

 

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

 

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

 

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

 

**Results ofOperations**

 

**Revenue**

 
| ** **              | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase**               | ** ** | ** **     | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|----------------------------|------------|----------------|------------|
| ** **              | ** ** | **2010**                                             | ** ** | **2009**                   | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **              | ** ** | ** **                                           | ** ** | **($  in thousands)** | ** ** | ** **     | ** ** | ** ** | ** ** |
| GaAs                    |       | $                                                    | 19,174     |                       | $          | 13,316         |       | $ | 5,858 |   | 44.0 | % |
| InP                     |       | 956                                                  |       | 688                        |       | 268            |       | 39.0 | % |
| Ge                      |       | 2,267                                                |       | 1,787                      |       | 480            |       | 26.9 | % |
| Raw materials and other |       | 4,412                                                |       | 1,028                      |       | 3,384          |       | 329.2 | % |
| Total revenue           |       | $                                                    | 26,809     |                       | $          | 16,819         |       | $ | 9,990 |   | 59.4 | % |

 

Revenueincreased $10.0 million, or 59.4%, to $26.8 million for the three months endedSeptember 30, 2010 from $16.8 million for the three months endedSeptember 30, 2009. Total GaAs substrate revenue increased $5.9 million,or 44.0%, to $19.2 million for the three months ended September 30, 2010from $13.3 million for the three months ended September 30, 2009. Theincrease in revenue was primarily due to the improved demand environment duringthe quarter positively affecting sales of all diameters of substrates.

 

Salesof 5 inch and 6 inch diameter GaAs substrates, which are mainly used inwireless devices, were $7.6 million for the three months endedSeptember 30, 2010 compared to $5.9 million for the three months endedSeptember 30, 2009. The increased demand for large diameter substrates wasfueled by strong sales of wireless devices.

 

Salesof 2 inch, 3 inch and 4 inch diameter GaAs substrates, which are mainly used inLED applications, were $11.6 million for the three months endedSeptember 30, 2010 compared with $7.5 million for the three months endedSeptember 30, 2009. Similar to the increase in revenue from largerdiameter substrates, the increase in revenue from smaller diameter substrateswas due to strong sales of wireless devices as well as the increasing worldwideadoption and investment in LED technology in many applications.

 

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InPsubstrate revenue increased $0.3 million, or 39.0%, to $1.0 million for thethree months ended September 30, 2010 from $0.7 million for the threemonths ended September 30, 2009 as demand from customers in the opticalnetworking industry increased. We continued to see renewed demand for thesesubstrates as investment in high-speed optical communications increasedworldwide.

 

Gesubstrate revenue increased $0.5 million, or 26.9%, to $2.3 million for thethree months ended September 30, 2010 from $1.8 million for the threemonths ended September 30, 2009. Our Ge substrate revenue increased asdemand from our customers increased for concentrated photovoltaic solarapplications. We continued to make progress in our penetration of the solarcell market, particularly in satellite applications.

 

Rawmaterials revenue increased $3.4 million, or 329.2%, to $4.4 million for thethree months ended September 30, 2010 from $1.0 million for the threemonths ended September 30, 2009. Raw materials revenue was low in theprior year primarily due to the worldwide drop in demand for 4N gallium. Wehave seen an increase in the demand for 4N gallium in 2010 as the marketrecovers from the worldwide downturn of 2009.

 
| ** **              | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **              | ** ** | **2010**                                            | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **              | ** ** | **($  in thousands)**                          | ** ** | ** **   | ** ** |
| GaAs                    |       | $                                                   | 48,843     |         | $          | 28,436         |       | $ | 20,407 |   | 71.8 | % |
| InP                     |       | 2,908                                               |       | 1,862        |       | 1,046          |       | 56.2 | % |
| Ge                      |       | 5,509                                               |       | 3,626        |       | 1,883          |       | 51.9 | % |
| Raw materials and other |       | 11,367                                              |       | 3,604        |       | 7,763          |       | 215.4 | % |
| Total revenue           |       | $                                                   | 68,627     |         | $          | 37,528         |       | $ | 31,099 |   | 82.9 | % |

 

Revenueincreased $31.1 million, or 82.9%, to $68.6 million for the nine months endedSeptember 30, 2010 from $37.5 million for the nine months endedSeptember 30, 2009. Total GaAs substrate revenue increased $20.4 million,or 71.8%, to $48.8 million for the nine months ended September 30, 2010from $28.4 million for the nine months ended September 30, 2009. Theincrease in revenue was primarily due to the improved demand environmentpositively affecting sales of all diameters of substrates.

 

Salesof 5 inch and 6 inch diameter GaAs substrates were $19.8 million for the ninemonths ended September 30, 2010 compared to $11.6 million for the ninemonths ended September 30, 2009. The increased demand for large diametersubstrates was fueled by strong sales of wireless devices.

 

Salesof 2 inch, 3 inch and 4 inch diameter GaAs substrates were $29.1 million forthe nine months ended September 30, 2010 compared with $16.8 million forthe nine months ended September 30, 2009. Similar to the increase inrevenue from larger diameter substrates, the increase in revenue from smallerdiameter substrates was due to strong sales of wireless devices as well as theincreasing worldwide adoption and investment in LED technology in manyapplications.

 

InPsubstrate revenue increased $1.0 million, or 56.2%, to $2.9 million for thenine months ended September 30, 2010 from $1.9 million for the nine monthsended September 30, 2009 as demand from customers in the opticalnetworking industry increased. We continued to see renewed demand for thesesubstrates as investment in high-speed optical communications increasedworldwide.

 

Gesubstrate revenue increased $1.9 million, or 51.9%, to $5.5 million for thenine months ended September 30, 2010 from $3.6 million for the nine monthsended September 30, 2009. Our Ge substrate revenue increased as demandfrom our customers increased for concentrated photovoltaic solar applications.We continued to make progress in our penetration of the solar cell market,particularly in satellite applications.

 

Rawmaterials revenue increased $7.8 million, or 215.4%, to $11.4 million for thenine months ended September 30, 2010 from $3.6 million for the nine monthsended September 30, 2009. Raw materials revenue was low in the prior yearprimarily due to the worldwide drop in demand for 4N gallium. We have seen anincrease in the demand for 4N gallium in 2010 as the market recovers from theworldwide downturn of 2009.

 

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***Revenue by Geographic Region***

 
| ** **                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                | ** ** | **2010**                                             | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| North America *                           |       | $                                                    | 5,224      |         | $          | 2,975          |       | $ | 2,249 |   | 75.6 | % |
| *% of total revenue*                      |       | 19.5                                                 | %          | 17.7         | %          |           |       |   |   |
| Europe                                    |       | 5,775                                                |       | 3,115        |       | 2,660          |       | 85.4 | % |
| *% of total revenue*                      |       | 21.5                                                 | %          | 18.5         | %          |           |       |   |   |
| Japan                                     |       | 3,040                                                |       | 2,304        |       | 736            |       | 31.9 | % |
| *% of total revenue*                      |       | 11.3                                                 | %          | 13.7         | %          |           |       |   |   |
| Taiwan                                    |       | 3,869                                                |       | 3,462        |       | 407            |       | 11.8 | % |
| *% of total revenue*                      |       | 14.4                                                 | %          | 20.6         | %          |           |       |   |   |
| Asia Pacific (excluding Japan and Taiwan) |       | 8,901                                                |       | 4,963        |       | 3,938          |       | 79.3 | % |
| *% of total revenue*                      |       | 33.2                                                 | %          | 29.5         | %          |           |       |   |   |
| Total revenue                             |       | $                                                    | 26,809     |         | $          | 16,819         |       | $ | 9,990 |   | 59.4 | % |

 

----

*Primarily the United States

 

Revenue fromcustomers in North America increased by $2.2 million, or 75.6%, to $5.2 millionfor the three months ended September 30, 2010 from $3.0 million for thethree months ended September 30, 2009 as the demand for substratesincreased by $1.7 million and the demand for raw materials increased by $0.5million due to the stronger demand environment compared to the economicslowdown we experienced in the prior year.

 

Revenuefrom customers in Europe increased by $2.7 million, or 85.4%, to $5.8 millionfor the three months ended September 30, 2010 from $3.1 million for thethree months ended September 30, 2009. This increase came primarily fromincreased substrate sales of $1.2 million to customers in Germany due toincreased demand, as well as $0.5 million increased raw material sales tocustomers in Germany as the demand for 4N gallium increased.

 

Revenuefrom customers in Japan increased by $0.7 million, or 31.9%, to $3.0 millionfor the three months ended September 30, 2010 from $2.3 million for thethree months ended September 30, 2009. Substrate sales increased by $0.7million, particularly in large diameter wafers, and raw material sales of 4Ngallium increased by $0.1 million as demand increased.

 

Revenuefrom customers in Taiwan increased by $0.4 million, or 11.8%, to $3.9 millionfor the three months ended September 30, 2010 from $3.5 million for thethree months ended September 30, 2009. The increase came mainly fromdemand for both semi-insulating and semi-conducting substrates.

 

Revenuefrom customers in Asia Pacific (excluding Japan and Taiwan) increased by $3.9million, or 79.3%, to $8.9 million for the three months endedSeptember 30, 2010 from $5.0 million for the three months endedSeptember 30, 2009. Sales to customers in Singapore increased by $1.3million, as demand for large diameter wafers increased, while sales tocustomers in China increased by $2.5 million, primarily from sales of rawmaterials.

 
| ** **                                | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                | ** ** | **2010**                                            | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| North America *                           |       | $                                                   | 14,472     |         | $          | 7,139          |       | $ | 7,333 |   | 102.7 | % |
| *% of total revenue*                      |       | 21.1                                                | %          | 19.0         | %          |           |       |   |   |
| Europe                                    |       | 13,744                                              |       | 7,592        |       | 6,152          |       | 81.0 | % |
| *% of total revenue*                      |       | 20.0                                                | %          | 20.2         | %          |           |       |   |   |
| Japan                                     |       | 9,322                                               |       | 5,494        |       | 3,828          |       | 69.7 | % |
| *% of total revenue*                      |       | 13.6                                                | %          | 14.6         | %          |           |       |   |   |
| Taiwan                                    |       | 10,470                                              |       | 6,897        |       | 3,573          |       | 51.8 | % |
| *% of total revenue*                      |       | 15.3                                                | %          | 18.4         | %          |           |       |   |   |
| Asia Pacific (excluding Japan and Taiwan) |       | 20,619                                              |       | 10,406       |       | 10,213         |       | 98.1 | % |
| *% of total revenue*                      |       | 30,0                                                | %          | 27.7         | %          |           |       |   |   |
| Total revenue                             |       | $                                                   | 68,627     |         | $          | 37,528         |       | $ | 31,099 |   | 82.9 | % |

 

----

*Primarily the United States

 

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Revenue from customersin North America increased by $7.3 million, or 102.7%, to $14.5 million for thenine months ended September 30, 2010 from $7.1 million for the nine monthsended September 30, 2009 as the demand for substrates increased by $5.8million and the demand for raw materials increased by $1.5 million due to thestronger demand environment compared to the economic slowdown we experienced inthe prior year.

 

Revenuefrom customers in Europe increased by $6.2 million, or 81.0%, to $13.7 millionfor the nine months ended September 30, 2010 from $7.6 million for thenine months ended September 30, 2009. This increase came primarily fromincreased substrate sales of $3.8 million to customers in Germany and $0.9million to customers in France, due to increased demand, as well as $1.1million increased raw material sales to customers in Slovakia as the demand for4N gallium increased.

 

Revenuefrom customers in Japan increased by $3.8 million, or 69.7%, to $9.3 millionfor the nine months ended September 30, 2010 from $5.5 million for thenine months ended September 30, 2009. Substrate sales increased by $2.8million, particularly in large diameter wafers, and raw material sales of 4Ngallium increased by $1.1 million as demand increased.

 

Revenuefrom customers in Taiwan increased by $3.6 million, or 51.8%, to $10.5 millionfor the nine months ended September 30, 2010 from $6.9 million for thenine months ended September 30, 2009. The increase came mainly from demandfor both semi-insulating and semi-conducting substrates.

 

Revenuefrom customers in Asia Pacific (excluding Japan and Taiwan) increased by $10.2million, or 98.1%, to $20.6 million for the nine months endedSeptember 30, 2010 from $10.4 million for the nine months endedSeptember 30, 2009. Sales to customers in Singapore increased by $4.3million, as demand for large diameter wafers increased, while sales tocustomers in China increased by $5.4 million, primarily from substrate sales,and substrate sales to Korea increased by $0.5 million as demand increased.

 

***Gross Margin***

 
| ** **       | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **       | ** ** | **2010**                                             | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Gross profit     |       | $                                                    | 10,531     |         | $          | 5,538          |       | $ | 4,993 |   | 90.2 | % |
| *Gross Margin %* |       | 39.3                                                 | %          | 32.9         | %          |           |       |   |   |
|                  |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

Grossmargin increased to 39.3% of total revenue for the three months endedSeptember 30, 2010 from 32.9% of total revenue for the three months endedSeptember 30, 2009. Sales product mix, process improvements in productionsuch as longer ingots, first pass yield improvements in wafers and improvedslicing methods contributed to higher gross profit for the three months endedSeptember 30, 2010. During the three months ended September 30, 2010,our manufacturing facility in Beijing was operating at a higher utilizationcapacity compared to the same period in the prior year, which resulted inhigher absorption rates. The lower 32.9% gross margin for the three monthsended September 30, 2009 was primarily due to the low absorption rates asa result of reduced sales and hence lower production volume.

 
| ** **       | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **       | ** ** | **2010**                                            | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Gross profit     |       | $                                                   | 25,798     |         | $          | 7,817          |       | $ | 17,981 |   | 230.0 | % |
| *Gross Margin %* |       | 37.6                                                | %          | 20.8         | %          |           |       |   |   |
|                  |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

Grossmargin increased to 37.6% of total revenue for the nine months endedSeptember 30, 2010 from 20.8% of total revenue for the nine months endedSeptember 30, 2009. Sales product mix, process improvements in productionsuch as longer ingots and first pass yield improvements in wafers and improvedslicing methods contributed to higher gross profit for the nine months endedSeptember 30, 2010. During the nine months ended September 30, 2010,our manufacturing facility in Beijing was operating at a higher utilizationcapacity compared to the same period in the prior year, which resulted inhigher absorption rates. The lower 20.8% gross margin for the nine months endedSeptember 30, 2009 was primarily due to the low absorption rates as aresult of reduced sales and hence lower production volume.

 

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***Selling, General andAdministrative Expenses***

 
| ** **                                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------------------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                   | ** ** | **2010**                                             | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                   | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Selling, general and administrative expenses |       | $                                                    | 3,347      |         | $          | 3,323          |       | $ | 24 |   | 0.7 | % |
| *% of total revenue*                         |       | 12.5                                                 | %          | 19.8         | %          |           |       |   |   |
|                                              |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

Selling,general and administrative expenses at $3.3 million for the three months endedSeptember 30, 2010 was comparable to $3.3 million for the three monthsended September 30, 2009. We had an increase of $0.1 million in legal feesfor patents, a $0.1 million increase in sales commissions as a result ofincreased sales volumes, a $0.1 million increase in consumable supplies andoffice supplies to support the increase in business operations, and offset by a$0.4 million decrease in China health benefits as a result of a refund from theChina government as a stimulus incentive.

 
| ** **                                   | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                   | ** ** | **2010**                                            | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                   | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Selling, general and administrative expenses |       | $                                                   | 9,805      |         | $          | 10,815         |       | $ | (1,010 | ) | (9.3 | )% |
| *% of total revenue*                         |       | 14.3                                                | %          | 28.9         | %          |           |       |   |   |
|                                              |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

Selling,general and administrative expenses decreased $1.0 million, or 9.3%, to $9.8million for the nine months ended September 30, 2010 from $10.8 millionfor the nine months ended September 30, 2009. The $1.0 million decreasewas from $0.5 million in reduced legal fees, since in the prior year we hadhigher legal fees as a result of matters relating to the change in managementin March 2009, in addition to $0.3 million in severance pay for our formerchief executive officer, $0.2 million is related stock compensation expense forhis stock option acceleration, $0.3 million in severance pay for our formerchief operating officer, and $0.3 million decrease in China health benefits asa result of refunds from the China government as a stimulus incentive, whichwas partially offset by a $0.3 million increase in bad debt expense, since inthe prior year first quarter we had a large recovery from an account we hadprovided for at the 2008 year end, and a $0.3 million increase in salescommissions due to increased sales.

 

***Research and Development***

 
| ** **               | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **2010**                                             | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Research and development |       | $                                                    | 462        |         | $          | 360            |       | $ | 102 |   | 28.3 | % |
| *% of total revenue*     |       | 1.7                                                  | %          | 2.1          | %          |           |       |   |   |
|                          |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

Researchand development expenses increased $0.1 million, or 28.3%, to $0.5 million forthe three months ended September 30, 2010 from $0.4 million for the threemonths ended September 30, 2009. The increase was primarily due to $0.1million in increased labor costs from engineers hired and new products testingcosts as we develop and improve our products.

 
| ** **               | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **2010**                                            | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Research and development |       | $                                                   | 1,428      |         | $          | 1,175          |       | $ | 253 |   | 21.5 | % |
| *% of total revenue*     |       | 2.1                                                 | %          | 3.1          | %          |           |       |   |   |
|                          |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

Researchand development expenses increased $0.3 million, or 21.5%, to $1.4 million forthe nine months ended September 30, 2010 from $1.2 million for the ninemonths ended September 30, 2009. The increase was primarily due to $0.2million in new products testing costs as we develop and improve our productsand $0.1 million increased labor costs from engineers hired.

 

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***Restructuring Charge***

 
| ** **           | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2010**                                            | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Restructuring charge |       | $                                                   | —     |         | $          | 507            |       | $ | (507 | ) | NM |   |
| *% of total revenue* |       | 0.0                                                 | %          | 0.1          | %          |           |       |   |   |
|                      |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

NM= % not meaningful

 

Duringthe first quarter of 2009, we reduced the workforce at our Fremont and Beijingfacilities by approximately 11 positions that were no longer required tosupport certain production and administrative operations. This measure wastaken as part of our 2009 operating plan. Accordingly, we recorded arestructuring charge of $507,000 in March 2009 for severance-relatedexpenses from the reduction in force, all of which were paid in the secondquarter of 2009. We expect to save approximately $1.3 million annually inpayroll and related expenses as a result of the restructuring. We had norestructuring charge for the first nine months of 2010.

 

***Interest Income (expense), net***

 
| ** **                      | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                      | ** ** | **2010**                                             | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                      | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Interest income (expense) , net |       | $                                                    | 26         |         | $          | 39             |       | $ | (13 | ) | (33.3 | )% |
| *% of total revenue*            |       | 0.1                                                  | %          | 0.2          | %          |           |       |   |   |
|                                 |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

Interestincome (expense), net decreased $13,000 to $26,000 income, net, for the threemonths ended September 30, 2010 from $39,000 interest income, net for thethree months ended September 30, 2009. Interest income, net for the three months ended September 30, 2010was lower due to lower interest rates, in addition to higher interest incomeearned in nine months ended September 30, 2009 due to higher accrued intereston principal protected notes.

 
| ** **                     | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                     | ** ** | **2010**                                            | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Interest income (expense), net |       | $                                                   | 16         |         | $          | 117            |       | $ | (101 | ) | (86.3 | )% |
| *% of total revenue*           |       | 0.0                                                 | %          | 0.3          | %          |           |       |   |   |
|                                |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

Interestincome (expense), net decreased $101,000 to $16,000 expense, net, for the ninemonths ended September 30, 2010 from $117,000 interest income, net for thenine months ended September 30, 2009. Interest income, net for the nine months ended September 30, 2010was lower due to lower interest rates, as well as in the nine months endedSeptember 30, 2009 which had higher interest income due to higher accruedinterest on principal protected notes.

 

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

 
| ** **           | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2010**                                             | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Other income, net    |       | $                                                    | 442        |         | $          | 638            |       | $ | (196 | ) | (30.7 | )% |
| *% of total revenue* |       | 1.6                                                  | %          | 3.8          | %          |           |       |   |   |
|                      |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

Otherincome, net was $0.4 million for the three months ended September 30, 2010primarily due to unrealized foreign exchange gains of $0.2 million andinvestment income of $0.2 million mainly from marketable securities and the twominority-owned joint ventures that are not consolidated. Other income, net was$0.6 million for the three months ended September 30, 2009 primarily dueto unrealized foreign exchange gains of $0.3 million and investment income of$0.3 million from the two minority-owned joint ventures that are notconsolidated.

 
| ** **               | ** ** | **Nine Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|--------------------------|------------|---------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **September 30,**          | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **               | ** ** | **2010**                        | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Other income (loss), net |       | $                               | 2,077      |         | $          | 537            |       | $ | 1,540 |   | 286.8 | % |
| *% of total revenue*     |       | 3.0                             | %          | 1.4          | %          |           |       |   |   |
|                          |            |                                 |            |              |            |                |            |  |  |  |  |  |

 

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Otherincome, net was $2.1 million for the nine months ended September 30, 2010primarily due to a $1.2 million sales tax refund, unrealized foreign exchangegains of $0.3 million and investment income of $0.6 million from the twominority-owned joint ventures that are not consolidated. Other income, net was$0.5 million for the nine months ended September 30, 2009 primarily due toinvestment income of $0.4 million from the two minority-owned joint venturesthat are not consolidated and unrealized foreign exchange gains of $0.1million.

*** ***

***Net Income attributable tononcontrolling interest***

 
| ** **              | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **              | ** ** | **2010**                                             | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **              | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Noncontrolling interest |       | $                                                    | 680        |         | $          | 210            |       | $ | 470 |   | 223.8 | % |
| *% of total revenue*    |       | 2.5                                                  | %          | 1.2          | %          |           |       |   |   |
|                         |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

Noncontrollinginterest increased $0.5 million to $0.7 million for the three months endedSeptember 30, 2010 from $0.2 million for the three months endedSeptember 30, 2009 indicating higher profitability in our China jointventures, and hence higher noncontrolling interest portion, as raw materialssales increased due to a stronger demand environment.

 
| ** **              | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **              | ** ** | **2010**                                            | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **              | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Noncontrolling interest |       | $                                                   | 1,227      |         | $          | 136            |       | $ | 1,091 |   | 802.2 | % |
| *% of total revenue*    |       | 1.8                                                 | %          | 0.0          | %          |           |       |   |   |
|                         |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

Noncontrollinginterest increased $1.1 million to $1.3 million for the nine months endedSeptember 30, 2010 from $0.1 million contribution for the nine monthsended September 30, 2009 indicating higher profitability in our Chinajoint ventures, and hence higher noncontrolling interest portion, as raw materialshave increased due to a stronger demand environment.

 

***Provision for Income Taxes***

 
| ** **                 | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | ** **     | ** ** |
|----------------------------|------------|----------------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **September 30,**           | ** ** | **Increase** | ** ** | ** **     | ** ** |
| ** **                 | ** ** | **2010**                         | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                 | ** ** | **($ in thousands)**   | ** ** | ** **   | ** ** | ** **     | ** ** |
| Provision for income taxes |       | $                                | 871        |         | $          | 201            |       | $ | 670 |   | 333.3 | % |
| *% of total revenue*       |       | 3.2                              | %          | 1.2          | %          |           |       |   |   |
|                            |            |                                  |            |              |            |                |            |  |  |  |  |  |

 

Weprovided for income taxes of $0.9 million for our China operations for thethree months ended September 30, 2010 compared to $0.2 million for thethree months ended September 30, 2009. The increase in tax provision wasprimarily due to increased sales and increased net income in the third quarterof 2010 compared to the same period last year. No income taxes have beenprovided for U.S. operations based upon available net operating losscarryforwards.

 
| ** **                 | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **2010**                                            | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                 | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Provision for income taxes |       | $                                                   | 1,677      |         | $          | 513            |       | $ | 1,164 |   | 226.9 | % |
| *% of total revenue*       |       | 2.4                                                 | %          | 1.4          | %          |           |       |   |   |
|                            |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

Weprovided for income taxes of $1.7 million for our China operations for the ninemonths ended September 30, 2010 compared to $0.5 million for the ninemonths ended September 30, 2009. The increase in tax provision wasprimarily due to increased sales and increased net income for the first ninemonths of 2010 compared to the same period last year. No income taxes have beenprovided for U.S. operations based upon available net operating losscarryforwards.

 

**Liquidity and Capital Resources**

 

Asof September 30, 2010, our principal sources of liquidity were $41.0 millionin cash and cash equivalents and short and long-term investments. We considercash and cash equivalents and short-term investments as liquid and availablefor use. Short-term investments are comprised of government bonds andhigh-grade commercial debt instruments. In December 2008 during the globalfinancial crisis we disclosed that we had a substantial portion of ourinvestments in principal protected notes in Citigroup. As these notes maturedover time we decreased our exposure to Citigroup and placed the underlyingassets into other diversified securities. As of September 30, 2010 we nolonger have any investments in Citigroup guaranteed instruments.

 

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Cashand cash equivalents and investments of $41.0 million increased by $2.1 millionin the third quarter of 2010 compared to the second quarter of 2010.

 

Netcash provided by operating activities of $9.5 million for the nine months endedSeptember 30, 2010 was primarily comprised of our net income of $15.0million, adjusted for non-cash items of depreciation of $2.1 million,amortization (accretion) of marketable securities premium of $0.2 million, stock-basedcompensation of $0.4 million, partially offset by a realized gain on sale ofinvestments of $0.4 million, and offset by a net increase of $7.8 million inassets and liabilities. The $7.8 million net increase in assets and liabilitiesprimarily resulted from a $5.5 million increase in inventories, $3.6 millionincrease in accounts receivable, a $1.0 million increase in prepaid expenses, a$0.1 million increase in other assets, partially offset by a $0.4 millionincrease in accounts payable and a $2.0 million increase in accruedliabilities.

 

Accountsreceivable, net increased by $3.6 million as of September 30, 2010compared to December 31, 2009 due to higher sales volume. Our days salesoutstanding (DSO) was 65 days as of September 30, 2010 and was 79 days asof December 31, 2009.

 

Netcash provided by operating activities of $3.8 million for the nine months endedSeptember 30, 2009 was primarily comprised of our net loss of $4.5million, adjusted for non-cash items of depreciation of $2.3 million, stock-basedcompensation of $0.7 million, and a restructuring charge of $0.5 million,partially offset by a net decrease of $4.8 million in assets and liabilities.The $4.8 million net decrease in assets and liabilities primarily resulted froma $6.4 million decrease in inventory, a $1.1 million decrease in prepaidexpenses and a $0.5 million increase in accounts payable, partially offset by a$2.5 million increase in accounts receivable, a $0.3 million increase in otherassets, a $0.2 million decrease in other long-term liabilities, and a $0.2million decrease in accrued liabilities.

 

Netcash used in investing activities of $3.2 million for the nine months endedSeptember 30, 2010 was primarily from the purchase of property, plant andequipment of $4.0 million and by the purchase of investments totaling $19.0million offset by the sale of investments totaling $19.8 million

 

Netcash used in investing activities of $0.6 million for the nine months endedSeptember 30, 2009 was primarily from the purchase of property, plant andequipment of $1.0 million partially offset by the proceeds on sale ofmarketable securities of $0.4 million.

 

We expect to invest up to approximately $4.0 million in capitalprojects at our China facilities for the remainder of 2010, having delayedcertain expansion activities as a result of the impact of the 2009 worldwideeconomic conditions.

 

Netcash used in financing activities of $0.2 million for the nine months endedSeptember 30, 2010 consisted of dividend payments of $0.5 million by ourjoint ventures, and fully paying down our tenant improvement loan of $0.5,partially offset by net proceeds of $0.8 million on the issuance of commonstock pursuant to stock option exercises.

 

Netcash used in financing activities of $0.8 million for the nine months endedSeptember 30, 2009 consisted of $0.8 million dividends paid, and paymentsof $67,000 related to our tenant improvement loan, partially offset by netproceeds of $48,000 on the issuance of common stock.

 

We believe that we have adequate cash and investments to meet our needsover the next 12 months. If our sales decrease, however, our ability togenerate cash from operations will be adversely affected which could adverselyaffect our future liquidity, require us to use cash at a more rapid rate thanexpected, and require us to seek additional capital. There can be no assurancethat such additional capital will be available or, if available it will be atterms acceptable to us. Cash from operations could be affected by various risksand uncertainties, including, but not limited to those set forth below underItem 1A “Risks Factors.”

 

Outstandingcontractual obligations as of September 30, 2010 are summarized 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** | ** ** |
| Operating leases                 |       | $                                         | 1,509      |   | $ | 287 |   | $ | 563 |   | $ | 607 |   | $ | 52 |   |
| Total                            |       | $                                         | 1,509      |   | $ | 287 |   | $ | 563 |   | $ | 607 |   | $ | 52 |   |

 

We lease certain office space, manufacturing facilities and propertyunder long-term operating leases expiring at various dates throughNovember 2013. On July 2, 2008, we entered into a new lease agreementwith the landlord of the facility at 4281 Technology Drive, Fremont, Californiawith approximately 27,760 square feet. The new lease commenced December 1,2008 for a term of seven years, with an option by us to cancel the new leaseafter five years, upon forfeiture of the security deposit and payment ofone-half of the fifth year’s rent. Total rent expenses under these operatingleases were approximately $0.3 million and $0.3 million for the ninemonths ended September 30, 2010 and 2009, respectively.

 

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**RecentAccounting Pronouncements**

 

Withthe exception of those stated below, there have been no recent accountingpronouncements or changes in accounting pronouncements during the three monthsended September 30, 2010, as compared to the recent accountingpronouncements described in the Annual Report that are of materialsignificance, or have potential material significance, to the Company.

 

InMay 2009, the FASB issued guidance contained in FASB ASC 855, “*Subsequent Events*” to establish general standards ofaccounting for and disclosure of events that occur after the balance sheet datebut before financial statements are issued or are available to be issued. Thisguidance was effective for interim or annual financial periods ending afterSeptember 15, 2009. In February, 2010, the FASB issued AccountingStandards Update 2010-09 — “Subsequent Events” which removed the requirement todisclose the date through which subsequent events had been considered fordisclosure. This update was effective upon issuance. In accordance with thisguidance, we have evaluated and, as necessary, made changes to these unauditedCondensed Consolidated Financial Statements for the events.

 

InOctober 2009, the FASB issued ASU No. 2009-13, “*Multiple-Deliverable Revenue Arrangements a Consensus of the FASBEmerging Issues Task Force*” an update to Accounting StandardsCodification (ASC) Topic 605, “*Revenue Recognition*.”  Thisupdate requires the allocation of consideration among separatelyidentified deliverables contained within an arrangement, based on their relatedselling prices.  This update will be effective for annualreporting periods beginning January 1, 2011.  The Company iscurrently evaluating the impact of this update on its financialposition, results of operations, cash flows, and disclosures.

 

InJanuary 2010, the FASB issued ASU No. 2010-06, “*Improving Disclosures about Fair Value Measurements*” anupdate to ASC Topic 820, “*Fair Value Measurementsand Disclosures*.” This update requires an entity to:(i) disclose separately the amounts of significant transfers in and out ofLevel 1 and Level 2 fair value measurements and describe the reasons for thetransfers and (ii) present separate information for Level 3 activitypertaining to gross purchases, sales, issuances, and settlements.  Thisupdate became effective for us in the quarter ended March 31, 2010, exceptthat the disclosure on the roll forward activities for Level 3 fair valuemeasurements will become effective for us with the reporting period beginning January 1,2011. Other than requiring additional disclosures, adoption of this newguidance did not have a material impact on the Company’s financial statements.

 

In various areas, including revenue recognition, stock optionaccounting, accounting standards and practices continue to evolve.Additionally, the SEC and the FASB’s Emerging Issues Task Force continue toaddress revenues, stock option accounting related accounting issues. We believethat we are in compliance with all of the rules and related guidance asthey currently exist. However, any changes to accounting principles generallyaccepted in the United States of America in these areas could impact the futureaccounting of our operations.

 

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

 

***Foreign Currency Risk***

 

A significant portion of our business is conducted in currencies otherthan the U.S. dollar. The functional currency for our foreign operations is therenminbi, the local currency of China, where our operating expenses arepredominantly in the local currency. Since most of our operations are conductedin China, most of our costs are incurred in Chinese currency, which subjects usto fluctuations in the exchange rates between the U.S. dollar and the Chineserenminbi. We incur transaction gains or losses resulting from consolidation ofexpenses incurred in local currencies for these subsidiaries, as well as intranslation of the assets and liabilities of these assets at each balance sheetdate. Our financial results could be adversely affected by factors such aschanges in foreign currency exchange rates or weak economic conditions inforeign markets, including the revaluation by China of the renminbi, and anyfuture adjustments that China may make to its currency such as any move itmight make to a managed float systems with opportunistic interventions. In thefuture we may experience foreign exchange losses on our non-functional currencydenominated receivables and payables to the extent that we have not mitigatedour exposure utilizing foreign currency forward exchange contracts. Foreignexchange losses could have a material adverse effect on our operating resultsand cash flows. The U.S. is currently pressuring China to devalue the renminbi,which could adversely affect our operation costs and results of operations. Ifwe do not effectively manage against these risks, our cash flows and financialcondition may be adversely affected.

 

We do not currently use short-term forward exchange contracts forhedging purposes to reduce the effects of adverse foreign exchange ratemovements. We had previously purchased foreign exchange contracts to hedgeagainst certain trade accounts receivable denominated in Japanese yen. Thechange in the fair value of the forward contracts was recognized as part of therelated foreign currency transactions as they occur. As of September 30,2010, we had no outstanding commitments with respect to foreign exchange contracts.

 

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During the third quarter of 2010, we recorded a net realized foreignexchange loss of $52,000, included as part of other income in our consolidatedstatements of operations. We incurred foreign currency transaction exchangegains and losses due to operations in general. It is uncertain whether thesecurrency trends will continue. In the future we may experience foreign exchangelosses on our non-functional currency denominated receivables and payables tothe extent that we have not mitigated our exposure utilizing foreign currencyforward exchange contracts. Foreign exchange losses could have a materially adverseeffect on our operating results and cash flows. During the third quarter of2010, we recorded unrealized foreign currency gain of $262,000, included in thebalance of accumulated other comprehensive income on our consolidated balancesheet.

 

In July 2005, China agreed to a shift in Chinese currency policy.It established a 2% revaluation of the renminbi and referenced the renminbi toa basket of currencies, with a daily trading band of +/–0.3%. Depending onmarket conditions and the state of the Chinese economy, it is possible thatChina will make more adjustments in the future. Over the next five to tenyears, China may move to a managed float system, with opportunisticinterventions. This may negatively impact the United States dollar and U.S.interest rates, which, in turn, could negatively impact our operating resultsand financial condition. The functional currency of our Chinese subsidiary,including our joint ventures, is 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 thefluctuation and revaluation of the Chinese renminbi. If we do not effectivelymanage the risks associated with this currency risk, our revenue, cash flowsand financial condition could be adversely affected.

 

***Interest Rate Risk***

 

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

 
| **Instrument**                            | ** ** | **Balance as of  September 30,  2010** | ** ** | **Current  Interest  Rate** | ** ** | **Projected Annual  Interest  Income/(Expense)** | ** ** | **Proforma 10%  Interest Rate  Decline  Income/(Expense)** | ** ** | **Proforma 10%  Interest Rate  Increase  Income/(Expense)** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| Cash                                      |       | $                                                     | 21,125     |                        | 0.50       | %                                                     | $          | 106                                                                  |       | $                                                                     | 95         |   | $ | 117 |   |
| Cash equivalents                          |       | 2,268                                                 |       | 0.50                        |       | 11                                                    |       | 10                                                                   |       | 12                                                                    |       |
| Investment in debt and equity instruments |       | 17,606                                                |       | 3.77                        |       | 664                                                   |       | 598                                                                  |       | 730                                                                   |       |
|                                      |       |                                                  |       |                        |       | $                                                     | 781        |                                                                 | $          | 703                                                                   |       | $ | 859 |   |
|                                           |            |                                                       |            |                             |            |                                                       |            |                                                                      |            |                                                                       |            |  |  |  |  |

 

The primary objective of our investment activities is to preserveprincipal while maximizing income without significantly increasing risk.Financial instruments that potentially subject us to concentration of creditrisk consist primarily of cash and cash equivalents, short-term investments,and trade accounts receivable. We invest primarily in money market accounts,commercial paper instruments, and investment grade securities. We are exposedto credit risks in the event of default by the issuers to the extent of theamount 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 a separatecomponent of accumulated other comprehensive income (loss), net of estimatedtax. Our cash, cash equivalents and short-term investments are in high-qualitysecurities. We have no investments in auction rate securities. In December 2008during the global financial crisis we disclosed that we had a substantialportion of our investments in principal protected notes in Citigroup. As thesenotes matured over time we decreased our exposure to Citigroup and placed theunderlying assets into other diversified securities. As of September 30,2010, there were no remaining investments in Citigroup, and all our investmentswere placed into diversified securities.

 

***Accounts Receivable Risk***

 

We perform periodic credit evaluations of our customers’ financialcondition and generally do not require collateral. Two customers each accountedfor 10% or more of our trade accounts receivable balance as ofSeptember 30, 2010 at 31%, and 14%, respectively.

 

***Equity Risk***

 

We maintain minority investments in three privately-held companiesother than our strategic investments in private companies located in China.These minority investments in two privately-held companies are reviewed forother than temporary declines in value on a quarterly basis. These investmentsare classified as other assets in the consolidated balance sheets and areaccounted for under the cost method as we do not have the ability to exercisesignificant influence over their operations. We monitor our investments forimpairment and record reductions in carrying value when events or changes incircumstances indicate that the carrying value may not be recoverable. Reasonsfor other than temporary declines in value include whether the related companywould have insufficient cash flow to operate for the next twelve months,significant changes in the operating performance and changes in marketconditions. As of September 30, 2010, the minority investments totaled$0.7 million.

 

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**ITEM 4*.*CONTROLS AND PROCEDURES**

 

***Disclosure Controls andProcedures***

 

Under the supervision andwith the participation of our management, our Chief Executive Officer and ChiefFinancial Officer have evaluated the effectiveness of the design and operationof our disclosure controls and procedures, as such terms are defined underRule 13a-15(e) and 15d-15(e) promulgated under the SecuritiesExchange Act of 1934, as amended. Based upon that evaluation, our ChiefExecutive Officer and our Chief Financial Officer concluded that our disclosurecontrols and procedures were effective as of the end of the period covered bythis quarterly report in ensuring that information required to be disclosed onSEC reports is (i) recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms, and(ii) accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosures.

 

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

 

No change in our internalcontrol over financial reporting was made in the three months endedSeptember 30, 2010 that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

**PART II.OTHER INFORMATION**

 

**Item 1.Legal Proceedings**

 

From time to time we may beinvolved in judicial or administrative proceedings concerning matters arising inthe ordinary course of business. We do not expect that any of these matters,individually or in the aggregate, will have a material adverse effect on ourbusiness, financial condition, cash flows or results of operation.

 

**Item 1A.Risk Factors**

 

There are no material changes from the risk factorsset forth under Part I, Item 1A. “Risk Factors” in our Annual Reporton Form 10-K for the fiscal year ended December 31, 2009.

 

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

 

None

 

**Item 3. Defaults upon Senior Securities**

 

None

 

**Item 4. Reserved**

 

**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                                                                                                                           |
|                |       |                                                                                                                                                           |
| 3.3(4)              |       | Certificate  of Amendment of By Laws                                                                                                                           |
|                |       |                                                                                                                                                           |
| 4.2(5)              |       | Rights  Agreement dated April 24, 2001 by and between AXT, Inc. and  ComputerShare Trust Company, Inc.                                          |
|                |       |                                                                                                                                                           |
| 31.1                |       | Certification by Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                     |
|                |       |                                                                                                                                                           |
| 31.2                |       | Certification by Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                     |
|                |       |                                                                                                                                                           |
| 32.1                |       | Certification by Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                                                                           |
| 32.2                |       | Certification by Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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(1) 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 onJune 14, 1999.

 

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

 

(4) Incorporated by reference to Exhibit 3.1to our Form 8-K as filed with the SEC on October 26, 2010.

 

(5) Incorporatedby reference to the exhibit of the same number as filed with the SEC in ourForm 8-K on May 30, 2001.

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisReport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|                          |     | AXT, INC. |
|-------------------------------|----------|----------------|
|                          |     |           |   |
| Dated:  November 9, 2010 |     | By:            | /s/  MORRIS S. YOUNG |
|                          |     |           | Morris S. Young |
| * *                      | * * | * *       | *Chief  Executive Officer* |
| * *                      | * * | * *       | *(Principal  Executive Officer)* |
|                          |     |           |   |
|                          |     |           | /s/  RAYMOND A. LOW |
|                          |     |           | Raymond  A. Low |
| * *                      | * * | * *       | *Chief Financial Officer* |
| * *                      | * * | * *       | *(Principal  Financial Officer and**Principal  Accounting Officer)* |

 

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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                                                                                                                                                                              |
|        |       |                                                                                                                                                                                                              |
| 3.4(4)      |       | Certificate  of Amendment of By Laws                                                                                                                                                                              |
|        |       |                                                                                                                                                                                                              |
| 4.2(5)      |       | Rights  Agreement dated April 24, 2001 by and between AXT, Inc. and  ComputerShare Trust Company, Inc.                                                                                             |
|        |       |                                                                                                                                                                                                              |
| 31.1        |       | Certification by Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                        |
|        |       |                                                                                                                                                                                                              |
| 31.2        |       | Certification by Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                        |
|        |       |                                                                                                                                                                                                              |
| 32.1        |       | Certification by Chief Executive  Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                    |
|        |       |                                                                                                                                                                                                              |
| 32.2        |       | Certification by Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                    |

 

----

(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 onJune 14, 1999.

 

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

 

(4) Incorporated by reference to Exhibit 3.1to our Form 8-K as filed with the SEC on October 26, 2010.

 

(5) Incorporatedby reference to the exhibit of the same number as filed with the SEC in ourForm 8-K on May 30, 2001

 

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