Table ofContents

 

 

 

**UNITEDSTATESSECURITIES 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 June 30, 2010**

 

**Or**

 

**o****Transition report pursuant toSection 13 or 15(d) of the Securities 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  Incorporation or organization) |       | (I.R.S. Employer  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 markwhether the registrant has submitted electronically and posted on its Web site,if any, every Interactive Data File required to be submitted and postedpursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that theregistrant was required to submit and post such files).  Yes o No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” 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 July 23, 2010** |
|--------------------------------|------------|------------------------------------------------------|
| Common Stock, $0.001 par value |       | 31,024,198                                           |

 

 

 

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AXT, INC.FORM 10-QTABLE OF CONTENTS

 
| ** **                                                                                                              | **Page** |
|-------------------------------------------------------------------------------------------------------------------------|----------|
| PART I.  FINANCIAL INFORMATION                                                                                     | 3        |
| Item 1. Financial Statements (unaudited)                                                                                | 3        |
| Condensed  Consolidated Balance Sheets as of June 30, 2010 and December 31,  2009                             | 3        |
| Condensed  Consolidated Statements of Operations for the three months and six months  ended June 30, 2010 and 2009 | 4        |
| Condensed  Consolidated Statements of Cash Flows for the six months ended June 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                    | 17       |
| Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                                     | 29       |
| Item 4. Controls and  Procedures                                                                                        | 30       |
| PART II. OTHER  INFORMATION                                                                                        | 30       |
| Item 1. Legal Proceedings                                                                                               | 30       |
| Item  1A. Risk Factors                                                                                                  | 31       |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                                    | 31       |
| Item 3.  Defaults Upon Senior Securities                                                                                | 31       |
| Item  4. Reserved                                                                                                       | 31       |
| Item 5. Other Information                                                                                               | 31       |
| Item  6. Exhibits                                                                                                       | 31       |
| Signatures                                                                                                              | 33       |

 

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**PART I.FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

 

AXT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

 
| ** **                                                                                                                                                                                                                                                                                                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                    | ** ** | **2010**          | ** ** | **2009 (1)**          | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                    | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| Assets:                                                                                                                                                                                                                                                                                                                       |       |              |       |                  |       |
| Current assets:                                                                                                                                                                                                                                                                                                               |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                                     |       | $                 | 20,394     |                  | $          | 16,934 |   |
| Short-term investments                                                                                                                                                                                                                                                                                                        |       | 11,321            |       | 18,469                |       |
| Accounts receivable, net of allowances of $797 and  $1,019 as of June 30, 2010 and December 31, 2009, respectively                                                                                                                                                                                                  |       | 18,640            |       | 15,362                |       |
| Inventories, net                                                                                                                                                                                                                                                                                                              |       | 27,247            |       | 27,718                |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                                                                     |       | 4,032             |       | 2,411                 |       |
| Total current assets                                                                                                                                                                                                                                                                                                          |       | 81,634            |       | 80,894                |       |
| Long-term investments                                                                                                                                                                                                                                                                                                         |       | 7,210             |       | —                |       |
| Property, plant and equipment, net                                                                                                                                                                                                                                                                                            |       | 20,314            |       | 20,853                |       |
| Other assets                                                                                                                                                                                                                                                                                                                  |       | 6,199             |       | 6,199                 |       |
| Total assets                                                                                                                                                                                                                                                                                                                  |       | $                 | 115,357    |                  | $          | 107,946 |   |
|                                                                                                                                                                                                                                                                                                                          |       |              |       |                  |       |
| Liabilities and stockholders’ equity:                                                                                                                                                                                                                                                                                    |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                                                                                                          |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                                                                                                                                                              |       | $                 | 4,008      |                  | $          | 5,571 |   |
| Accrued liabilities                                                                                                                                                                                                                                                                                                           |       | 5,424             |       | 4,566                 |       |
| Current portion of long-term debt                                                                                                                                                                                                                                                                                             |       | 77                |       | 76                    |       |
| Total current liabilities                                                                                                                                                                                                                                                                                                     |       | 9,509             |       | 10,213                |       |
| Long-term debt, net of current portion                                                                                                                                                                                                                                                                                        |       | 381               |       | 420                   |       |
| Other long-term liabilities                                                                                                                                                                                                                                                                                                   |       | 3                 |       | 62                    |       |
| Total liabilities                                                                                                                                                                                                                                                                                                             |       | 9,893             |       | 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 June 30,  2010 and December 31, 2009, respectively (Liquidation preference of  $5.5 million and $5.4 million as of June 30, 2010  and December 31, 2009, respectively) |       | 3,532             |       | 3,532                 |       |
| Common stock, $0.001 par value per share; 70,000  shares authorized; 31,024 and 30,880 shares issued and outstanding as of  June 30, 2010 and December 31, 2009, respectively                                                                                                                                  |       | 30                |       | 30                    |       |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                    |       | 188,270           |       | 187,871               |       |
| Accumulated deficit                                                                                                                                                                                                                                                                                                           |       | (93,015           | )          | (101,130              | )          |
| Accumulated other comprehensive income                                                                                                                                                                                                                                                                                        |       | 3,644             |       | 4,300                 |       |
| Total AXT, Inc. stockholders’ equity                                                                                                                                                                                                                                                                                |       | 102,461           |       | 94,603                |       |
|                                                                                                                                                                                                                                                                                                                          |       |              |       |                  |       |
| Noncontrolling interests                                                                                                                                                                                                                                                                                                      |       | 3,003             |       | 2,648                 |       |
| Total stockholders’ equity                                                                                                                                                                                                                                                                                               |       | 105,464           |       | 97,251                |       |
|                                                                                                                                                                                                                                                                                                                          |       |              |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                                                               |       | $                 | 115,357    |                  | $          | 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** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                          | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                          | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                |       |                   |       |                 |       |   |   |   |   |
| Revenue                                                             |       | $                      | 23,177     |                 | $          | 13,055 |   | $ | 41,818 |   | $ | 20,709 |   |
| Cost of revenue                                                     |       | 14,642                 |       | 10,539               |       | 26,551 |   | 18,430 |   |
| Gross profit                                                        |       | 8,535                  |       | 2,516                |       | 15,267 |   | 2,279 |   |
|                                                                |       |                   |       |                 |       |   |   |   |   |
| Operating expenses:                                                 |       |                   |       |                 |       |   |   |   |   |
| Selling, general and administrative                                 |       | 3,039                  |       | 3,486                |       | 6,458 |   | 7,492 |   |
| Research and development                                            |       | 515                    |       | 355                  |       | 966 |   | 815 |   |
| Restructuring charge                                                |       | —                 |       | —               |       | — |   | 507 |   |
| Total operating expenses                                            |       | 3,554                  |       | 3,841                |       | 7,424 |   | 8,814 |   |
| Income (loss) from operations                                       |       | 4,981                  |       | (1,325               | )          | 7,843 |   | (6,535 | ) |
| Interest income (expense), net                                      |       | (25                    | )          | 34                   |       | (10 | ) | 78 |   |
| Other income (expense), net                                         |       | 1,556                  |       | 321                  |       | 1,635 |   | (101 | ) |
|                                                                |       |                   |       |                 |       |   |   |   |   |
| Income (loss) before provision for income taxes                     |       | 6,512                  |       | (970                 | )          | 9,468 |   | (6,558 | ) |
| Provision for income taxes                                          |       | (560                   | )          | (308                 | )          | (806 | ) | (312 | ) |
| Net income (loss)                                                   |       | 5,952                  |       | (1,278               | )          | 8,662 |   | (6,870 | ) |
|                                                                |       |                   |       |                 |       |   |   |   |   |
| Less: Net income (loss) attributable to  noncontrolling interest    |       | (417                   | )          | (2                   | )          | (547 | ) | 74 |   |
| Net income (loss) attributable to AXT, Inc.                    |       | $                      | 5,535      |                 | $          | (1,280 | ) | $ | 8,115 |   | $ | (6,796 | ) |
|                                                                |       |                   |       |                 |       |   |   |   |   |
| Net income (loss) attributable to AXT, Inc.  per common share: |       |                   |       |                 |       |   |   |   |   |
| Basic                                                               |       | $                      | 0.18       |                 | $          | (0.04 | ) | $ | 0.26 |   | $ | (0.23 | ) |
| Diluted                                                             |       | $                      | 0.17       |                 | $          | (0.04 | ) | $ | 0.25 |   | $ | (0.23 | ) |
|                                                                |       |                   |       |                 |       |   |   |   |   |
| Weighted average number of common shares  outstanding:              |       |                   |       |                 |       |   |   |   |   |
| Basic                                                               |       | 30,834                 |       | 30,439               |       | 30,789 |   | 30,437 |   |
| Diluted                                                             |       | 32,172                 |       | 30,439               |       | 31,982 |   | 30,437 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

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AXT, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

 
| ** **                                                                                          | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2010**                                      | ** ** | **2009** | ** ** |
| Cash flows from operating activities:                                                               |       |                                          |       |   |   |
| Net income (loss)                                                                                   |       | $                                             | 8,662      |   | $ | (6,870 | ) |
|                                                                                                |       |                                          |       |   |   |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |       |                                          |       |   |   |
| Depreciation                                                                                        |       | 1,411                                         |       | 1,570 |   |
| Amortization (accretion) of marketable securities  premium                                          |       | 47                                            |       | (6 | ) |
| Loss (gain) on disposal of property, plant and  equipment                                           |       | 1                                             |       | 4 |   |
| Stock-based compensation                                                                            |       | 233                                           |       | 579 |   |
| Restructuring charge                                                                                |       | —                                        |       | 507 |   |
| Realized loss (gain) on available for sale  securities                                              |       | (196                                          | )          | 9 |   |
| Changes in assets and liabilities:                                                                  |       |                                          |       |   |   |
| Accounts receivable, net                                                                            |       | (3,306                                        | )          | (1,386 | ) |
| Inventories                                                                                         |       | 350                                           |       | 6,766 |   |
| Prepaid expenses and other current assets                                                           |       | (1,657                                        | )          | 1,394 |   |
| Other assets                                                                                        |       | (22                                           | )          | (101 | ) |
| Accounts payable                                                                                    |       | (1,523                                        | )          | (2,302 | ) |
| Accrued liabilities                                                                                 |       | 869                                           |       | (385 | ) |
| Other long-term liabilities                                                                         |       | (12                                           | )          | (983 | ) |
| Net cash provided by (used in) operating  activities                                                |       | 4,857                                         |       | (1,204 | ) |
|                                                                                                |       |                                          |       |   |   |
| Cash flows from investing activities:                                                               |       |                                          |       |   |   |
| Purchases of property, plant and equipment                                                          |       | (1,187                                        | )          | (390 | ) |
| Proceeds from sale of property, plant and  equipment                                                |       | 4                                             |       | — |   |
| Purchases of available for sale securities                                                          |       | (11,202                                       | )          | (13 | ) |
| Proceeds from available for sale securities                                                         |       | 10,996                                        |       | 440 |   |
| Decrease in restricted deposits                                                                     |       | —                                        |       | 13 |   |
| Net cash provided by (used in) investing  activities                                                |       | (1,389                                        | )          | 50 |   |
|                                                                                                |       |                                          |       |   |   |
| Cash flows from financing activities:                                                               |       |                                          |       |   |   |
| Proceeds from common stock options exercised                                                        |       | 166                                           |       | 40 |   |
| Dividends paid                                                                                      |       | (192                                          | )          | — |   |
| Long-term debt payments                                                                             |       | (38                                           | )          | (49 | ) |
| Net cash used in financing activities                                                               |       | (64                                           | )          | (9 | ) |
| Effect of exchange rate changes on cash and cash  equivalents                                       |       | 52                                            |       | 10 |   |
| Net increase (decrease) in cash and cash  equivalents                                               |       | 3,460                                         |       | (1,153 | ) |
| Cash and cash equivalents at the beginning of the  period                                           |       | 16,934                                        |       | 13,566 |   |
| Cash and cash equivalents at the end of the period                                                  |       | $                                             | 20,394     |   | $ | 12,413 |   |

 

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 period ended March 31, 2010 filed with the SEC on May 17,2010.

 

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 yetvested at the date of adoption will be recognized in net income (loss) in theperiods after the date of adoption using the same Black-Scholes valuationmethod and assumptions determined under the original provisions ofASC 718.

 

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

 
| ** **                                                                         | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                         | ** ** | **2010**                                        | ** ** | **2009**                                      | ** ** | **2010** | ** ** | **2009** | ** ** |
| Stock-based compensation in the form of  employee stock options, included in: |       |                                            |       |                                          |       |   |   |   |   |
|                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Cost of revenue                                                                    |       | $                                               | 5          |                                          | $          | 10 |   | $ | 15 |   | $ | 23 |   |
| Selling, general and administrative                                                |       | 103                                             |       | 93                                            |       | 200 |   | 511 |   |
| Research and development                                                           |       | 11                                              |       | 18                                            |       | 18 |   | 45 |   |
|                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Total stock-based compensation                                                     |       | 119                                             |       | 121                                           |       | 233 |   | 579 |   |
| Tax effect on stock-based compensation                                             |       | —                                          |       | —                                        |       | — |   | — |   |
|                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Net effect on net income (loss)                                                    |       | $                                               | 119        |                                          | $          | 121 |   | $ | 233 |   | $ | 579 |   |
|                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Effect on net income (loss) attributable to  AXT, Inc. per common share:      |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                                                              |       | $                                               | 0.00       |                                          | $          | 0.00 |   | $ | 0.01 |   | $ | 0.02 |   |
| Diluted                                                                            |       | $                                               | 0.00       |                                          | $          | 0.00 |   | $ | 0.01 |   | $ | 0.02 |   |

 

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As of June 30,2010 the total compensation costs related to unvested stock-based awardsgranted to employees under our stock option plan but not yet recognized wasapproximately $830,000, net of estimated forfeitures of $200,000. These costswill be amortized on a straight-line basis over a weighted-average period ofapproximately 2.98 years and will be adjusted for subsequent changes inestimated forfeitures. We elected not to capitalize any stock-basedcompensation to inventory as of June 30, 2010 due to the immateriality ofthe 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 no stock optiongrants made in the three and six months ended June 30, 2010 and 2009.

 

The following tablesummarizes the stock option transactions during the six months endedJune 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                                                       |       | —     |       | —                                  |       |                                                                            |       |                            |       |
|                                                          |       |       |       |                                    |       |                                                                            |       |                            |       |
| Exercised                                                     |       | (117       | )          | 1.43                                    |       |                                                                            |       |                            |       |
|                                                          |       |       |       |                                    |       |                                                                            |       |                            |       |
| Canceled and expired                                          |       | (15        | )          | 19.99                                   |       |                                                                            |       |                            |       |
|                                                          |       |       |       |                                    |       |                                                                            |       |                            |       |
| Options outstanding as of June 30, 2010                  |       | 2,748      |       | $                                       | 2.41       |                                                                            | 5.27       |                            | $          | 6,657 |   |
|                                                          |       |       |       |                                    |       |                                                                            |       |                            |       |
| Options vested and expected to vest as of  June 30, 2010 |       | 2,659      |       | $                                       | 2.43       |                                                                            | 5.14       |                            | $          | 6,425 |   |
|                                                          |       |       |       |                                    |       |                                                                            |       |                            |       |
| Options exercisable as of June 30, 2010                  |       | 1,819      |       | $                                       | 2.60       |                                                                            | 3.35       |                            | $          | 4,298 |   |

 

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 $4.51 on June 30, 2010,which would have been received by the option holder had all option holdersexercised their options on that date. The total number of in-the-money optionsexercisable as of June 30, 2010 was 1,212,000.

 

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

** **
| **Options Outstanding as of June 30, 2010** | ** ** | **Options Exercisable  as of June 30, 2010** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| **Range of Exercise Price**                                | ** ** | **Shares**                                                            | ** ** | **Weighted-  average  Exercise Price** | ** ** | **Weighted-  average  Remaining  Contractual Life** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
| $1.17 - $1.18                                                             |       | 318,200                                                               |       | $ | 1.17 |   | 2.15 |   | 318,200 |   | $ | 1.17 |   |
| $1.25 - $1.34                                                             |       | 257,842                                                               |       | $ | 1.32 |   | 4.56 |   | 257,842 |   | $ | 1.32 |   |
| $1.38 - $1.38                                                             |       | 305,400                                                               |       | $ | 1.38 |   | 3.19 |   | 305,400 |   | $ | 1.38 |   |
| $1.40 - $1.40                                                             |       | 1,094                                                                 |       | $ | 1.40 |   | 4.70 |   | 1,094 |   | $ | 1.40 |   |
| $1.59 - $1.59                                                             |       | 565,621                                                               |       | $ | 1.59 |   | 7.33 |   | 171,185 |   | $ | 1.59 |   |
| $1.88 - $1.98                                                             |       | 17,000                                                                |       | $ | 1.93 |   | 4.64 |   | 17,000 |   | $ | 1.93 |   |
| $2.04 - $2.04                                                             |       | 488,700                                                               |       | $ | 2.04 |   | 9.32 |   | 0 |   | $ | 0 |   |
| $2.19 - $2.19                                                             |       | 312,250                                                               |       | $ | 2.19 |   | 2.40 |   | 312,250 |   | $ | 2.19 |   |
| $3.11 - $6.31                                                             |       | 438,317                                                               |       | $ | 4.90 |   | 4.65 |   | 392,191 |   | $ | 4.78 |   |
| $9.69 - $39.80                                                            |       | 44,000                                                                |       | $ | 16.75 |   | 1.63 |   | 44,000 |   | $ | 16.75 |   |
|                                                                      |       | 2,748,424                                                             |       | $ | 2.41 |   | 5.27 |   | 1,819,162 |   | $ | 2.60 |   |

 

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Therewere 26,497 and 116,658 options exercised in the three months and six monthsended June 30, 2010, respectively. The total intrinsic value of optionsexercised for the three and six months ended June 30, 2010 was $102,106and $266,674, respectively. Cash received from options exercised for the threeand six months ended June 30, 2010 was $34,200 and $166,200, respectively.There were no options exercised in the three and six months ended June 30,2009.

 

***Restricted stock awards***

 

A summary of activity related to restricted stockawards for the six months ended June 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                                            |       | 27,027     |       | $                                                          | 3.33       |   |
| Restricted stock shares vested                                             |       | (43,839    | )          | $                                                          | 1.11       |   |
| Non-vested restricted stock shares outstanding as  of June 30, 2010   |       | 153,848    |       | $                                                          | 1.61       |   |

 

Asof June 30, 2010, we had $194,000 of unrecognized compensation expense,net of forfeitures, related to restricted stock awards, which will berecognized over the weighted average period of 1.35 years. During the sixmonths ended June 30, 2010 and 2009, 43,839 shares and 3,532 shares ofrestricted stock vested respectively.

 

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

 

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

 
| ** **                                   | ** ** | **June 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                                         |       | $                           | 20,339     |                            | $          | — |   | $ | — |   | $ | 20,339 |   | $ | 16,790 |   | $ | — |   | $ | — |   | $ | 16,790 |   |
| Cash equivalents:                            |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Money market fund                            |       | 55                          |       | —                          |       | — |   | 55 |   | 144 |   | — |   | — |   | 144 |   |
|                                         |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total cash and cash equivalents              |       | 20,394                      |       | —                          |       | — |   | 20,394 |   | 16,934 |   | — |   | — |   | 16,934 |   |
|                                         |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments:                                 |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Certificates of Deposit                      |       | 4,560                       |       | 3                               |       | (3 | ) | 4,560 |   |   |   |   |   |   |   |   |   |
| US Treasury and agency securities            |       | 4,969                       |       | 2                               |       | (3 | ) | 4,968 |   |   |   |   |   |   |   |   |   |
| Corporate bonds                              |       | 9,124                       |       | —                          |       | (121 | ) | 9,003 |   | 18,298 |   | 171 |   | — |   | 18,469 |   |
| Total investments                            |       | 18,653                      |       | 5                               |       | (127 | ) | 18,531 |   | 18,298 |   | 171 |   | — |   | 18,469 |   |
| Total cash, cash equivalents and investments |       | $                           | 39,047     |                            | $          | 5 |   | $ | (127 | ) | $ | 38,925 |   | $ | 35,232 |   | $ | 171 |   | $ | — |   | $ | 35,403 |   |
| **Contractual maturities on  investments:**  |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Due within 1 year                            |       | $                           | 11,411     |                            |       |   |   |   | $ | 11,321 |   | $ | 18,298 |   |   |   |   |   | $ | 18,469 |   |
| Due after 1 through 5 years                  |       | 7,242                       |       |                            |       |   |   | 7,210 |   | — |   |   |   |   |   | — |   |
|                                         |       | $                           | 18,653     |                            |       |   |   |   | $ | 18,531 |   | $ | 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 six months endedJune 30, 2010 we had $76,000 and $196,000 gross realized gains on sales ofour available-for-sale securities, respectively. For the three and six monthsended June 30, 2009 we had $9,000 gross realized losses on sales of ouravailable-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 June 30, 2010 are temporary in nature.We reviewed our investment portfolio to identify and evaluate investments thathave indications of possible impairment. Factors considered in determiningwhether a loss is temporary include the magnitude of the decline in marketvalue, the length of time the market value has been below cost (or adjustedcost), credit quality, and our ability and intent to hold the securities for aperiod of time sufficient to allow for any anticipated recovery in marketvalue. The following table provides a breakdown of our available-for-salesecurities with unrealized losses as of June 30, 2010 (in thousands):

 
| ** **                        | ** ** | **In Loss Position  < 12 months** | ** ** | **In Loss Position  > 12 months** | ** ** | **Total In  Loss Position** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | ** **                                               | ** ** | **Gross**                                                | ** ** | ** **                            | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                        | ** ** | **Fair**                                                 | ** ** | **Unrealized**                                           | ** ** | **Fair**                              | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                        | ** ** | **Value**                                                | ** ** | **(Loss)**                                               | ** ** | **Value**                             | ** ** | **(Loss)** | ** ** | **Value** | ** ** | **(Loss)** | ** ** |
| Investments:                      |       |                                                     |       |                                                     |       |                                  |       |   |   |   |   |   |   |
| Certificates of Deposit           |       | $                                                        | 3,117      |                                                     | $          | (3                                    | )          | $ | — |   | $ | — |   | $ | 3,117 |   | $ | (3 | ) |
| US Treasury and agency securities |       | 2,534                                                    |       | (3                                                       | )          | —                                |       | — |   | 2,534 |   | (3 | ) |
| Corporate bonds                   |       | 1,586                                                    |       | (35                                                      | )          | 7,417                                 |       | (83 | ) | 9,003 |   | (118 | ) |
| Total in loss position            |       | $                                                        | 7,237      |                                                     | $          | (41                                   | )          | $ | 7,417 |   | $ | (83 | ) | $ | 14,654 |   | $ | (124 | ) |

 

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***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 June 30, 2010 and December 31, 2009,respectively. We have investments in three unconsolidated privately-heldcompanies accounted for under the cost method. As of June 30, 2010 andDecember 31, 2009, our investments in the three unconsolidatedprivately-held companies accounted for under the cost method had a carrying valueof $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. Certainfinancial assets and liabilities that are not required to be recorded at fairvalue, including accounts receivable, accounts payable, accrued liabilities andterm debt, have recorded values that approximate fair value given their shortterm 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 June 30, 2010 (in thousands):

 
| ** **                        | ** ** | **Balance as of  June 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          |       | $                                                    | 55         |                                                                                               | $          | 55                                                             |       | $ | — |   |
| Certificates of deposit           |       | $                                                    | 4,560      |                                                                                               | —     |                                                           | 4,560      |   |
| US Treasury and agency securities |       | $                                                    | 4,968      |                                                                                               | —     |                                                           | 4,968      |   |
| Corporate bonds                   |       | 9,003                                                |       | —                                                                                             |       | 9,003                                                          |       |
| Total                             |       | $                                                    | 18,586     |                                                                                               | $          | 55                                                             |       | $ | 18,531 |   |
| 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 June 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 six monthsof 2010 or 2009.

 

**Note 4.Inventories, Net**

 

Thecomponents of inventories are summarized below (in thousands):

 
| ** **        | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|-------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| Inventories, net: |       |              |       |                  |       |
| Raw materials     |       | $                 | 11,387     |                  | $          | 12,051 |   |
| Work in process   |       | 12,129            |       | 11,947                |       |
| Finished goods    |       | 3,731             |       | 3,720                 |       |
|              |       | $                 | 27,247     |                  | $          | 27,718 |   |

 

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**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 related to the reduction in force forseverance-related expenses from the reduction in force, all of which were paidduring the second quarter of 2009. We expect to save approximately $1.3 millionannually in payroll and related expenses. We had no restructuring charge in thefirst six 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** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                          | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                          | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
| Numerator:                                                                          |       |                             |       |                           |       |   |   |   |   |
| Net income (loss) attributable to AXT, Inc.                                    |       | $                                | 5,535      |                           | $          | (1,280 | ) | $ | 8,115 |   | $ | (6,796 | ) |
| Less: Preferred stock dividends                                                     |       | (44                              | )          | (44                            | )          | (88 | ) | (88 | ) |
|                                                                                |       |                             |       |                           |       |   |   |   |   |
| Net income (loss) available to common stockholders                                  |       | $                                | 5,491      |                           | $          | (1,324 | ) | $ | 8,027 |   | $ | (6,884 | ) |
| Denominator:                                                                        |       |                             |       |                           |       |   |   |   |   |
| Denominator for basic net income (loss) per share  - weighted average common shares |       | 30,834                           |       | 30,439                         |       | 30,789 |   | 30,437 |   |
| Effect of dilutive securities:                                                      |       |                             |       |                           |       |   |   |   |   |
| Common stock options                                                                |       | 1,338                            |       | —                         |       | 1,193 |   | — |   |
| Denominator for dilutive net income (loss) per  common share                        |       | 32,172                           |       | 30,439                         |       | 31,982 |   | 30,437 |   |
| Effect on net income (loss) attributable to  AXT, Inc. per common share:       |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                               |       | $                                | 0.18       |                           | $          | (0.04 | ) | $ | 0.26 |   | $ | (0.23 | ) |
| Diluted                                                                             |       | $                                | 0.17       |                           | $          | (0.04 | ) | $ | 0.25 |   | $ | (0.23 | ) |
| Options excluded from diluted per share calculation  as the impact is anti-dilutive |       | 351                              |       | 2,615                          |       | 355 |   | 2,615 |   |

 

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                            |       |                 |       |              |       | 166                                       |       |                     |       |                                    |       | 166                                      |       |                          |       | 166                                   |       |
| Stock-based  compensation                                  |       |                 |       |              |       | 233                                       |       |                     |       |                                    |       | 233                                      |       |                          |       | 233                                   |       |
| Comprehensive  income:                                     |       |                 |       |              |       |                                      |       |                     |       |                                    |       |                                     |       |                          |       |                                  |       |
| Net  income                                                |       |                 |       |              |       |                                      |       | 8,115                    |       |                                    |       | 8,115                                    |       | 547                           |       | 8,662                                 |       |
| Dividend  paid                                             |       |                 |       |              |       |                                      |       |                     |       |                                    |       |                                     |       | (192                          | )          | (192                                  | )          |
| Change  in unrealized (loss) gain on marketable securities |       |                 |       |              |       |                                      |       |                     |       | (293                                    | )          | (293                                     | )          |                          |       | (293                                  | )          |
| Currency  translation adjustment                           |       |                 |       |              |       |                                      |       |                     |       | (363                                    | )          | (363                                     | )          |                          |       | (363                                  | )          |
| Balance  as of June 30, 2010                          |       | $                    | 3,532      |              | $          | 30                                        |       | $                        | 188,270    |                                    | $          | (93,015                                  | )          | $                             | 3,644      |                                  | $          | 102,461 |   | $ | 3,003 |   | $ | 105,464 |   |

 

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

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                      | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                      | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                            |       |                             |       |                           |       |   |   |   |   |
| Net income (loss) attributable to AXT, Inc.                                |       | $                                | 5,535      |                           | $          | (1,280 | ) | $ | 8,115 |   | $ | (6,796 | ) |
| Other comprehensive income (loss), net of tax:                                  |       |                             |       |                           |       |   |   |   |   |
| Change in foreign currency translation gain  (loss), net of tax                 |       | (158                             | )          | (42                            | )          | (363 | ) | (40 | ) |
| Change in unrealized gain (loss) on  available-for-sale investments, net of tax |       | (274                             | )          | 703                            |       | (293 | ) | 890 |   |
| Total other comprehensive income (loss), net of  tax                            |       | (432                             | )          | 661                            |       | (656 | ) | 850 |   |
| Comprehensive income (loss)                                                     |       | 5,103                            |       | (619                           | )          | 7,459 |   | (5,946 | ) |
| Comprehensive income (loss) attributable to the  noncontrolling interest        |       | —                           |       | 1                              |       | — |   | 2 |   |
| Comprehensive income (loss) attributable to  AXT, Inc.                     |       | $                                | 5,103      |                           | $          | (618 | ) | $ | 7,459 |   | $ | (5,944 | ) |

 

**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** | ** ** | **Six Months Ended** | ** ** |
|--------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **               | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
| Revenue by product type: |       |                             |       |                           |       |   |   |   |   |
| GaAs substrates          |       | $                                | 16,235     |                           | $          | 10,108 |   | $ | 29,669 |   | $ | 15,120 |   |
| InP substrates           |       | 1,077                            |       | 684                            |       | 1,952 |   | 1,174 |   |
| Ge substrates            |       | 1,602                            |       | 1,217                          |       | 3,242 |   | 1,839 |   |
| Raw materials and other  |       | 4,263                            |       | 1,046                          |       | 6,955 |   | 2,576 |   |
| Total                    |       | $                                | 23,177     |                           | $          | 13,055 |   | $ | 41,818 |   | $ | 20,709 |   |

 

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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** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                    | ** ** | **June 30,**                | ** ** | **June 30**               | ** ** |
| ** **                    | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
| Revenue by geographic region: |       |                             |       |                           |       |   |   |   |   |
| North America*                |       | $                                | 4,717      |                           | $          | 2,428 |   | $ | 9,248 |   | $ | 4,164 |   |
| Europe                        |       | 4,201                            |       | 2,264                          |       | 7,969 |   | 4,477 |   |
| Japan                         |       | 3,504                            |       | 2,038                          |       | 6,282 |   | 3,190 |   |
| Taiwan                        |       | 4,019                            |       | 2,746                          |       | 6,601 |   | 3,435 |   |
| Asia Pacific                  |       | 6,736                            |       | 3,579                          |       | 11,718 |   | 5,443 |   |
| Total                         |       | $                                | 23,177     |                           | $          | 13,055 |   | $ | 41,818 |   | $ | 20,709 |   |

 

----

*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**    | ** ** |
|-----------------------------------------|------------|-------------------|------------|
| ** **                              | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| ** **                              | ** ** | **2010**          | ** ** | **2009** | ** ** |
| Long-lived assets by geographic region: |       |              |       |   |   |
| North America                           |       | $                 | 610        |   | $ | 661 |   |
| China                                   |       | 19,704            |       | 20,192 |   |
|                                    |       | $                 | 20,314     |   | $ | 20,853 |   |

 

***Significant Customers***

 

Onecustomer represented more than 10% of revenue at 18.7% for the three monthperiod ended June 30, 2010 while two customers each represented more than10% of revenue at 16.0% and 11.6% for the three month period endedJune 30, 2009.  One customer representedmore than 10% of revenue at 17.6% for the six month period ended June 30,2010 while two customers represented more than 10% at 15.3% and 11.5% revenuesfor the six month period ended June 30, 2009.Our top five customersrepresented 42.5% and 43.4% of revenue for the three month periods endedJune 30, 2010 and 2009, respectively. Our top five customers represented40.5% and 40.3% of revenue for the six month periods ended June 30, 2010and 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 of June 30,2010 at 30%, and 11%, 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** | ** ** | ** **            | ** ** | ** **     | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------|------------|----------------|------------|
| ** **                                                       | ** ** | **June 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                      |       | $                                           | 3,355      |                  | $          | 3,367          |       | Equity |   | 25 | % |
| Emeishan Jia Mei High Purity  Metals Co., Ltd          |       | 959                                         |       | 866                   |       | Equity         |       | 25 | % |
|                                                             |       | $                                           | 4,314      |                  | $          | 4,233          |       |   |   |   |   |

 

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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.

 

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 June 30, 2010 andDecember 31, 2009, respectively. We own 25% of the ownership interests in eachof these companies. These two companies are not considered variable interestentities 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 six months ended June 30, 2010 the threeconsolidated joint ventures had income of $1.3 million and $1.8 million ofwhich $0.4 million and $0.5 million, respectively, was allocated tominority interests, resulting in income of $0.9 million and $1.3 million,respectively, included in our net income. During the three and six months endedJune 30, 2009 the three consolidated joint ventures had $83,000 of incomeand a loss of $167,000 of which $2,000 and a loss of $74,000 was allocated tominority interests, resulting in income of $81,000 and a loss of$93,000.included in our net loss. Our equity earnings from the two-minorityowned joint ventures that are not consolidated are recorded as other income(loss), net and totaled $82,000 and $139,000 for the six months endedJune 30, 2010 and 2009, respectively. Undistributed retained earningsrelating to all our investments in these companies were $13.8 million and$12.4 million as of June 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 six months ended June 30,2010 and 2009, respectively.

 
| ** **       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **       | ** ** | **2010**                                        | ** ** | **2009**                                      | ** ** | **2010** | ** ** | **2009** | ** ** |
|             |       |                                            |       |                                          |       |   |   |   |   |
| Net Sales        |       | $                                               | 3,504      |                                          | $          | 4,111 |   | $ | 6,842 |   | $ | 6,215 |   |
| Gross profit     |       | 895                                             |       | 1,164                                         |       | 1,790 |   | 1,851 |   |
| Operating income |       | 277                                             |       | 675                                           |       | 400 |   | 748 |   |
| Net income       |       | 244                                             |       | 526                                           |       | 326 |   | 555 |   |
|                  |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

 

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We have investments in three unconsolidated privately-held companiesaccounted for under the cost method. As of June 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.

 

**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. Theaccrued warranty costs represent the best estimate at the time of sale of thetotal costs that we expect to incur to repair or replace product parts thatfail while still under warranty. The amount of accrued estimated warranty costsare primarily based on historical experience as to product failures as well ascurrent information on repair costs. On a quarterly basis, we review theaccrued balances and update these based on the historical warranty cost trends.The following table reflects the change in our warranty accrual which isincluded in “accrued liabilities” on the condensed consolidated balance sheetsduring the three and six months ended June 30, 2010 and 2009 (inthousands):

 
| ** **                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                   | ** ** | **2010**                                        | ** ** | **2009**                                      | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                         |       |                                            |       |                                          |       |   |   |   |   |
| Beginning accrued warranty and related costs |       | $                                               | 1,086      |                                          | $          | 1,463 |   | $ | 1,082 |   | $ | 1,640 |   |
| Charged to cost of revenue                   |       | (206                                            | )          | 242                                           |       | (146 | ) | 318 |   |
| Actual warranty expenditures                 |       | —                                          |       | (210                                          | )          | (56 | ) | (463 | ) |
| Ending accrued warranty and related costs    |       | $                                               | 880        |                                          | $          | 1,495 |   | $ | 880 |   | $ | 1,495 |   |

 

***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 June 30, 2010, we did not have any outstanding material purchaseobligations.

 

**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 $230,000 and $183,000for the three month periods ended June 30, 2010, and 2009, respectively.We incurred foreign currency transaction exchange gains of $162,000 and foreignexchange losses of $253,000 for the six month periods ended June 30, 2010,and 2009, respectively. These amounts are included in “Other income (expense),net” on the condensed consolidated statements of operations.

 

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**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 an enterprise’sfinancial statements in accordance with ASC 740. This interpretation prescribesa recognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. ASC 740 also provides guidance on derecognition of tax benefits,classification on the balance sheet, interest and penalties, accounting ininterim periods, disclosure, and transition. We adopted ASC 740 effectiveJanuary 1, 2007. We recognize interest and penalties related to uncertaintax positions in income tax expense. As of June 30, 2010, we did not haveany gross unrecognized tax benefits, nor any accrued interest and penaltiesrelated to uncertain tax positions. As a result of the implementation of ASC740, we identified $16.4 million in the liability for unrecognized taxbenefits. Of this amount, none was accounted for as a reduction to theJanuary 1, 2007 balance of retained earnings. The amount decreased the taxloss carryforwards in the U.S. which are fully offset by a valuation allowance.We file income tax returns in the U.S. federal, various states and foreignjurisdictions. We have substantially concluded all U.S. federal and stateincome tax matters through December 31, 2008. There were no Federal U.S.tax expense during three and six months ended June 30, 2010 due to thevaluation 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 June 30, 2010, as compared to the recent accounting pronouncementsdescribed in the Annual Report that are of material significance, or havepotential 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 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*” an updateto ASC Topic 820, “*Fair Value Measurementsand Disclosures*.” This update requires an entity to: (i) discloseseparately the amounts of significant transfers in and out of Level 1 and Level2 fair value measurements and describe the reasons for the transfers and (ii) presentseparate information for Level 3 activity pertaining to gross purchases, sales,issuances, and settlements.  This update became effective for us in thequarter ended March 31, 2010, except that the disclosure on the rollforward activities for Level 3 fair value measurements will become effectivefor us with the reporting period beginning January 1, 2011. Other thanrequiring additional disclosures, adoption of this new guidance did not have amaterial impact on the Company’s financial statements.

 

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**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, industry trends, our abilityto expand our markets and increase sales, gross margins, our reserve balances,our expected savings from our workforce reduction, the impact of the adoptionof certain accounting pronouncements, our investments in capital projects, ourbelief that we have adequate cash and investments to meet our needs over the next12 months, and our expectation that our exposure to Citigroup will decrease asour principal protected notes comes due and the underlying assets are placedinto diversified securities. These forward-looking statements are based uponmanagement’s current views with respect to future events and financialperformance, and are subject to certain risks and uncertainties that couldcause actual results to differ materially from historical results or thoseanticipated in such forward-looking statements. Such risks and uncertaintiesinclude those set forth under the section entitled “Risk Factors” below, whichidentify important factors that could cause actual results to differ materiallyfrom those predicted in any such forward-looking statements. We caution investorsthat actual results may differ materially from those projected in theforward-looking statements as a result of certain risk factors identified inthis Form 10-Q and other filings we have made with the Securities andExchange Commission. Forward-looking statements may be identified by the use ofterms such 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.

 

Theseforward-looking statements are not guarantees of future performance. Readersare cautioned not to place undue reliance on these forward-looking statements,which speak only as of the date hereof. This discussion should be read inconjunction with Management’s Discussion and Analysis of Financial Conditionand Results of Operations included in our Annual Report on Form 10-K forthe year ended December 31, 2009 and the condensed consolidated financialstatements included 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 ownership interestin these entities ranges from 25% to 83%. We consolidate the three ventures inwhich we own a majority or controlling financial interest and employ equityaccounting for the two joint ventures in which we have a 25% interest. Wepurchase portions of the materials produced by these ventures for our own useand the joint ventures sell the remainder of their production to third parties. We use ourdirect sales force in the United States and independent sales 

 

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representativesin Europe and Asia to market our substrates. We believe that, as the demand forcompound semiconductor substrates is expected to increase, we are positioned toleverage our PRC-based manufacturing capabilities and access to favorablypriced raw materials to increase 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 salesand improved gross margins in the second half of 2009. Our qualificationefforts in both gallium arsenide and germanium substrates have been successfuland we are pleased with our increasing diversification in these areas.

 

Asof June 30, 2010, our principal sources of liquidity were $38.9 million incash and cash equivalents and short and long-term investments. This increasedby $3.5 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.

 

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 primarily basedupon the age of these accounts. We provide a 100% allowance for receivablesfrom U.S. customers in excess of 90 days and for receivables from customerslocated outside the U.S. in excess of 120 days. We assess the probability ofcollection based on a number of factors, including the length of time areceivable balance has been outstanding, our past history with the customer andtheir creditworthiness.

 

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Asof June 30, 2010 and December 31, 2009, our accounts receivable, net,balance was $18.6 million and $15.4 million, respectively, which was net of anallowance 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 June 30, 2010 and December 31,2009, our allowance for sales returns was $0.7 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 June 30, 2010 and December 31, 2009, accrued product warrantiestotaled $0.9 million and $1.1 million, respectively. If actual warranty costsdiffer substantially from our estimates, revisions to the estimated warrantyliability would be required, which could have a material impact on ourfinancial condition and results of operations.

 

***Inventory Valuation***

 

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 June 30, 2010 and December 31, 2009, we had an inventoryreserve of $9.7 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.

 

***Impairment of Investments***

 

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

 

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

 

***Fair Value of Investments***

 

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

 

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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 June 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.

 

***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 a portionof the deferred tax asset will not be realized.

 

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

 

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

 

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**Results ofOperations**

 

**Revenue**

 
| ** **              | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase**               | ** ** | ** **     | ** ** |
|-------------------------|------------|-------------------------------------------------|------------|----------------------------|------------|----------------|------------|
| ** **              | ** ** | **2010**                                        | ** ** | **2009**                   | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **              | ** ** | ** **                                      | ** ** | **($  in thousands)** | ** ** | ** **     | ** ** | ** ** | ** ** |
| GaAs                    |       | $                                               | 16,235     |                       | $          | 10,108         |       | $ | 6,127 |   | 60.6 | % |
| InP                     |       | 1,077                                           |       | 684                        |       | 393            |       | 57.5 | % |
| Ge                      |       | 1,602                                           |       | 1,217                      |       | 385            |       | 31.6 | % |
| Raw materials and other |       | 4,263                                           |       | 1,046                      |       | 3,217          |       | 307.6 | % |
| Total revenue           |       | $                                               | 23,177     |                       | $          | 13,055         |       | $ | 10,122 |   | 77.5 | % |

 

Revenueincreased $10.1 million, or 77.5%, to $23.2 million for the three months endedJune 30, 2010 from $13.1 million for the three months ended June 30,2009. Total GaAs substrate revenue increased $6.1 million, or 60.6%, to $16.2million for the three months ended June 30, 2010 from $10.1 million forthe three months ended June 30, 2009. The increase in revenue wasprimarily due to the improved demand environment positively affecting sales ofall diameters.

 

Salesof 5 inch and 6 inch diameter GaAs substrates were $6.8 million for the threemonths ended June 30, 2010 compared to $4.4 million for the three monthsended June 30, 2009. The increased demand for large diameter substrateswas fueled by strong sales of wireless devices.

 

Salesof 2 inch, 3 inch and 4 inch diameter GaAs substrates were $9.4 million for thethree months ended June 30, 2010 compared with $5.7 million for the threemonths ended June 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.

 

InPsubstrate revenue increased $0.4 million, or 57.5%, to $1.1 million for thethree months ended June 30, 2010 from $0.7 million for the three monthsended June 30, 2009 as demand from customers in the optical networkingindustry increased. We continue to see renewed demand for these substrates asinvestment in high-speed optical communications is increasing worldwide.

 

Gesubstrate revenue increased $0.4 million, or 31.6%, to $1.6 million for thethree months ended June 30, 2010 from $1.2 million for the three monthsended June 30, 2009. Our Ge substrate revenue increased as demand from ourcustomers increases for concentrated photovoltaic solar applications. Wecontinue to make progress in our penetration of the solar cell market,particularly in satellite applications.

 

Rawmaterials revenue increased $3.2 million, or 307.6%, to $4.3 million for thethree months ended June 30, 2010 from $1.0 million for the three monthsended June 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.

 
| ** **              | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase**               | ** ** | ** **     | ** ** |
|-------------------------|------------|-----------------------------------------------|------------|----------------------------|------------|----------------|------------|
| ** **              | ** ** | **2010**                                      | ** ** | **2009**                   | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **              | ** ** | ** **                                    | ** ** | **($  in thousands)** | ** ** | ** **     | ** ** | ** ** | ** ** |
| GaAs                    |       | $                                             | 29,669     |                       | $          | 15,120         |       | $ | 14,549 |   | 96.2 | % |
| InP                     |       | 1,952                                         |       | 1,174                      |       | 778            |       | 66.3 | % |
| Ge                      |       | 3,242                                         |       | 1,839                      |       | 1,403          |       | 76.3 | % |
| Raw materials and other |       | 6,955                                         |       | 2,576                      |       | 4,379          |       | 170.0 | % |
| Total revenue           |       | $                                             | 41,818     |                       | $          | 20,709         |       | $ | 21,109 |   | 101.9 | % |

 

Revenueincreased $21.1 million, or 101.9%, to $41.8 million for the six months endedJune 30, 2009 from $20.7 million for the six months ended June 30,2009. Total GaAs substrate revenue increased $14.5 million, or 96.2%, to $29.7million for the six months ended June 30, 2010 from $15.1 million for thesix months ended June 30, 2009. The increase in revenue was primarily dueto the improved demand environment positively affecting sales of all diameters.

 

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Salesof 5 inch and 6 inch diameter GaAs substrates were $12.3 million for the sixmonths ended June 30, 2010 compared to $5.6 million for the six monthsended June 30, 2009. The increased demand for large diameter substrateswas fueled by strong sales of wireless devices.

 

Salesof 2 inch, 3 inch and 4 inch diameter GaAs substrates were $17.4 million forthe six months ended June 30, 2010 compared with $9.5 million for the sixmonths ended June 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.

 

InPsubstrate revenue increased $0.8 million, or 66.3%, to $2.0 million for the sixmonths ended June 30, 2010 from $1.2 million for the six months endedJune 30, 2009 as demand from customers in the optical networking industryincreased. We continue to see renewed demand for these substrates as investmentin high-speed optical communications is increasing worldwide.

 

Gesubstrate revenue increased $1.4 million, or 76.3%, to $3.2 million for the sixmonths ended June 30, 2010 from $1.8 million for the six months ended June 30,2009. Our Ge substrate revenue increased as demand from our customers increasefor concentrated photovoltaic solar applications. We continue to make progressin our penetration of the solar cell market, particularly in satelliteapplications.

 

Rawmaterials revenue increased $4.4 million, or 170.0%, to $7.0 million for thesix months ended June 30, 2010 from $2.6 million for the six months endedJune 30, 2009. Raw materials revenue was low in the prior year primarilydue to the worldwide drop in demand for 4N gallium. We have seen an increase inthe demand for 4N gallium in 2010 as the market recovers from the worldwidedownturn of 2009.

 

***Revenue by Geographic Region***

 
| ** **                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                | ** ** | **2010**                                        | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| North America *                           |       | $                                               | 4,717      |         | $          | 2,428          |       | $ | 2,289 |   | 94.3 | % |
| *% of total revenue*                      |       | 20.4                                            | %          | 18.6         | %          |           |       |   |   |
| Europe                                    |       | 4,201                                           |       | 2,264        |       | 1,937          |       | 85.6 | % |
| *% of total revenue*                      |       | 18.1                                            | %          | 17.4         | %          |           |       |   |   |
| Japan                                     |       | 3,504                                           |       | 2,038        |       | 1,466          |       | 71.9 | % |
| *% of total revenue*                      |       | 15.1                                            | %          | 15.6         | %          |           |       |   |   |
| Taiwan                                    |       | 4,019                                           |       | 2,746        |       | 1,273          |       | 46.4 | % |
| *% of total revenue*                      |       | 17.3                                            | %          | 21.0         | %          |           |       |   |   |
| Asia Pacific (excluding Japan and Taiwan) |       | 6,736                                           |       | 3,579        |       | 3,157          |       | 88.2 | % |
| *% of total revenue*                      |       | 29.1                                            | %          | 27.4         | %          |           |       |   |   |
| Total revenue                             |       | $                                               | 23,177     |         | $          | 13,055         |       | $ | 10,122 |   | 77.5 | % |

 

----

*Primarily the United States

 

Revenue fromcustomers in North America increased by $2.3 million, or 94.3%, to $4.7 millionfor the three months ended June 30, 2010 from $2.4 million for the threemonths ended June 30, 2009 as the demand for substrates increased by $1.9million and the demand for raw materials increased by $0.4 million due to thestronger demand environment compared to the economic slowdown we experienced inthe prior year.

 

Revenuefrom customers in Europe increased by $1.9 million, or 85.6%, to $4.2 millionfor the three months ended June 30, 2010 from $2.3 million for the threemonths ended June 30, 2009. This increase came primarily from increasedsubstrate sales of $1.1 million to customers in Germany due to increaseddemand, as well as $0.8 million increased raw material sales to customers inSlovakia as the demand for 4N gallium increased.

 

Revenuefrom customers in Japan increased by $1.5 million, or 71.9%, to $3.5 millionfor the three months ended June 30, 2010 from $2.0 million for the threemonths ended June 30, 2009. Substrate sales increased by $0.8 million,particularly in large diameter wafers, and raw material sales of 4N galliumincreased by $0.7 million as demand increased.

 

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Revenuefrom customers in Taiwan increased by $1.3 million, or 46.4%, to $4.0 millionfor the three months ended June 30, 2010 from $2.7 million for the threemonths ended June 30, 2009. The increase came mainly from demand for bothsemi-insulating and semi-conducting substrates.

 

Revenuefrom customers in Asia Pacific (excluding Japan and Taiwan) increased by $3.2million, or 88.2%, to $6.7 million for the three months ended June 30,2010 from $3.6 million for the three months ended June 30, 2009. Sales tocustomers in Singapore increased by $1.6 million, as demand for large diameterwafers increased, while sales to customers in China increased by $1.4 million,primarily from sales and of raw materials.

 
| ** **                                | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                | ** ** | **2010**                                      | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| North America *                           |       | $                                             | 9,248      |         | $          | 4,164          |       | $ | 5,084 |   | 122.1 | % |
| *% of total revenue*                      |       | 22.1                                          | %          | 20.1         | %          |           |       |   |   |
| Europe                                    |       | 7,969                                         |       | 4,477        |       | 3,492          |       | 78.0 | % |
| *% of total revenue*                      |       | 19.1                                          | %          | 21.6         | %          |           |       |   |   |
| Japan                                     |       | 6,282                                         |       | 3,190        |       | 3,092          |       | 96.9 | % |
| *% of total revenue*                      |       | 15.0                                          | %          | 15.4         | %          |           |       |   |   |
| Taiwan                                    |       | 6,601                                         |       | 3,435        |       | 3,166          |       | 92.2 | % |
| *% of total revenue*                      |       | 15.8                                          | %          | 16.6         | %          |           |       |   |   |
| Asia Pacific (excluding Japan and Taiwan) |       | 11,718                                        |       | 5,443        |       | 6,275          |       | 115.3 | % |
| *% of total revenue*                      |       | 28.0                                          | %          | 26.3         | %          |           |       |   |   |
| Total revenue                             |       | $                                             | 41,818     |         | $          | 20,709         |       | $ | 21,109 |   | 101.9 | % |

 

----

*Primarily the United States

 

Revenue fromcustomers in North America increased by $5.1 million, or 122.1%, to $9.2million for the six months ended June 30, 2009 from $4.2 million for thesix months ended June 30, 2009 as the demand for substrates increased by$4.1 million and the demand for raw materials increased by $1.0 million due tothe stronger demand environment compared to the economic slowdown weexperienced in the prior year.

 

Revenuefrom customers in Europe increased by $3.5 million, or 78.0%, to $8.0 millionfor the six months ended June 30, 2010 from $4.5 million for the sixmonths ended June 30, 2009. This increase came primarily from increasedsubstrate sales of $2.2 million to customers in Germany and $0.6 million tocustomers in France, due to increased demand, as well as $1.1 million increasedraw material sales to customers in Slovakia as the demand for 4N galliumincreased, partially offset by $0.4 million decrease in raw material sales tocustomers in the United Kingdom.

 

Revenuefrom customers in Japan increased by $3.1 million, or 96.9%, to $6.3 millionfor the six months ended June 30, 2010 from $3.2 million for the sixmonths ended June 30, 2009. Substrate sales increased by $2.0 million,particularly in large diameter wafers, and raw material sales of 4N galliumincreased by $1.1 million as demand increased.

 

Revenuefrom customers in Taiwan increased by $3.2 million, or 92.2%, to $6.6 millionfor the three months ended June 30, 2010 from $3.4 million for the sixmonths ended June 30, 2009. The increase came mainly from demand for bothsemi-insulating and semi-conducting substrates.

 

Revenuefrom customers in Asia Pacific (excluding Japan and Taiwan) increased by $6.3million, or 115.3%, to $11.7 million for the six months ended June 30,2010 from $5.4 million for the six months ended June 30, 2009. Sales tocustomers in Singapore increased by $3.1 million, as demand for large diameterwafers increased, while sales to customers in China increased by $2.9 million,primarily from substrate sales, and sales to Korea increased by $0.3 million asdemand increased.

 

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***Gross Margin***

 
| ** **       | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **       | ** ** | **2010**                                        | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Gross profit     |       | $                                               | 8,535      |         | $          | 2,516          |       | $ | 6,019 |   | 239.2 | % |
| *Gross Margin %* |       | 36.8                                            | %          | 19.3         | %          |           |       |   |   |
|                  |            |                                                 |            |              |            |                |            |  |  |  |  |  |

 

Grossmargin increased to 36.8% of total revenue for the three months ended June 30,2010 from 19.3% of total revenue for the three months ended June 30, 2009.Sales product mix, and process improvements in production such as longer ingotsand first pass yield improvements in ingots contributed to higher gross profitfor the three months ended June 30, 2010. During the three months endedJune 30, 2010, our manufacturing facility in Beijing was operating at ahigher utilization capacity compared to the same period in the prior year,which resulted in higher absorption rates. The lower 19.3% gross margin for thethree months ended June 30, 2009 was primarily due to the low absorptionrates as a result of reduced sales and hence lower production volume.

 
| ** **       | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **       | ** ** | **2010**                                      | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Gross profit     |       | $                                             | 15,267     |         | $          | 2,279          |       | $ | 12,988 |   | 569.9 | % |
| *Gross Margin %* |       | 36.5                                          | %          | 11.0         | %          |           |       |   |   |
|                  |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

Grossmargin increased to 36.5% of total revenue for the six months ended June 30,2010 from 11.0% of total revenue for the six months ended June 30, 2009.Sales product mix, and process improvements in production such as longer ingotsand first pass yield improvements in ingots contributed to higher gross profitfor the six months ended June 30, 2010. During the six months endedJune 30, 2010, our manufacturing facility in Beijing was operating at ahigher utilization capacity compared to the same period in the prior year,which resulted in higher absorption rates. The lower 11.0% gross margin for thesix months ended June 30, 2009 was primarily due to the low absorptionrates as a result of reduced sales and hence lower production volume.

 

***Selling, General andAdministrative Expenses***

 
| ** **                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                   | ** ** | **2010**                                        | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                   | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Selling, general and administrative expenses |       | $                                               | 3,039      |         | $          | 3,486          |       | $ | (447 | ) | (12.8 | )% |
| *% of total revenue*                         |       | 13.1                                            | %          | 26.7         | %          |           |       |   |   |
|                                              |            |                                                 |            |              |            |                |            |  |  |  |  |  |

 

Selling,general and administrative expenses decreased $0.4 million, or 12.8%, to $3.0million for the three months ended June 30, 2010 from $3.5 million for thethree months ended June 30, 2009. The $0.4 million decrease was from $0.1million reduced legal fees, since in the same period in the prior year we hadhigher legal fees as a result of matters relating to the change in managementin March 2009, in addition to $0.2 million lower labor costs since in theprior year we had severance pay for our former chief operating officer, $0.3million in lower bad debt expense since in the same period in the prior year wehad higher bad debt expense on slower accounts receivables. This was partiallyoffset by a $0.2 million increase in commissions and sales expenses based onincreased sales.

 
| ** **                                   | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                   | ** ** | **2010**                                      | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                   | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Selling, general and administrative expenses |       | $                                             | 6,458      |         | $          | 7,492          |       | $ | (1,034 | ) | (13.8 | )% |
| *% of total revenue*                         |       | 15.4                                          | %          | 36.2         | %          |           |       |   |   |
|                                              |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

Selling,general and administrative expenses decreased $1.0 million, or 13.8%, to $6.5million for the six months ended June 30, 2010 from $7.5 million for thesix months ended June 30, 2009. The $1.0 million decrease was from $0.7million reduced legal fees, since in the prior year we had higher legal fees asa result of matters relating to the change in management in March 2009, inaddition to $0.3 million in severance pay for our former chief executiveofficer, $0.2 million in related stock compensation expense for his stock optionacceleration, and $0.2 million in severance pay for our former chief operatingofficer. This was partially offset by a $0.2 million increase in bad debtexpense, since in the prior year first quarter we had a large recovery from anaccount we had provided for at the 2008 year end, and from a $0.2 millionincrease in sales commissions based on increased sales.

 

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***Research and Development***

 
| ** **               | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **2010**                                        | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Research and development |       | $                                               | 515        |         | $          | 355            |       | $ | 160 |   | 45.1 | % |
| *% of total revenue*     |       | 2.2                                             | %          | 2.7          | %          |           |       |   |   |
|                          |            |                                                 |            |              |            |                |            |  |  |  |  |  |

 

Researchand development expenses increased $0.2 million, or 45.1%, to $0.5 million forthe three months ended June 30, 2010 from $0.4 million for the threemonths ended June 30, 2009. The increase was primarily due to $0.1 millionincreased labor costs from engineers hired and $0.1 million new productstesting costs as we develop and improve our products.

 
| ** **               | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **2010**                                      | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Research and development |       | $                                             | 966        |         | $          | 815            |       | $ | 151 |   | 18.5 | % |
| *% of total revenue*     |       | 2.3                                           | %          | 3.9          | %          |           |       |   |   |
|                          |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

Researchand development expenses increased $0.2 million, or 18.5%, to $1.0 million forthe six months ended June 30, 2010 from $0.8 million for the six monthsended June 30, 2009. The increase was primarily due to $0.1 millionincreased labor costs from engineers hired and $0.1 million new productstesting costs as we develop and improve our products.

 

***Restructuring Charge***

 
| ** **           | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2010**                                      | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Restructuring charge |       | $                                             | —     |         | $          | 507            |       | $ | (507 | ) | NM |   |
| *% of total revenue* |       | 0.0                                           | %          | 2.4          | %          |           |       |   |   |
|                      |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

NM= % not meaningful

 

Duringthe first quarter of 2009, we further reduced the workforce at our Fremont andBeijing facilities by approximately 11 positions that were no longer requiredto support 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 related to the reduction inforce for severance-related expenses from the reduction in force, all of whichwere paid in the second quarter of 2009. We expect to save approximately $1.3million annually in payroll and related expenses. We had no restructuringcharge for the first six months of 2010.

 

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

 
| ** **                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|---------------------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                      | ** ** | **2010**                                        | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                      | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Interest income (expense) , net |       | $                                               | (25        | )            | $          | 34             |       | $ | (59 | ) | (173.5 | )% |
| *% of total revenue*            |       | 0.1                                             | %          | 0.3          | %          |           |       |   |   |
|                                 |            |                                                 |            |              |            |                |            |  |  |  |  |  |

 

Interestincome (expense), net decreased $59,000 to $25,000 expense, net, for the threemonths ended June 30, 2010 from $34,000 interest income, net for the threemonths ended June 30, 2009. Interest income, net for the three months ended June 30, 2010 waslower compared to the three months ended June 30, 2009 which had higherinterest income due to higher accrued interest on principal protected notes.

 
| ** **                     | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                     | ** ** | **2010**                                      | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Interest income (expense), net |       | $                                             | (10        | )            | $          | 78             |       | $ | (88 | ) | (112.8 | )% |
| *% of total revenue*           |       | 0.0                                           | %          | 0.4          | %          |           |       |   |   |
|                                |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

Interestincome (expense), net decreased $88,000 to $10,000 expense, net, for the sixmonths ended June 30, 2010 from $78,000 interest income, net for the sixmonths ended June 30, 2009.  Interest income, net for the six months endedJune 30, 2010 was lower compared to the six months ended June 30,2009 which had higher interest income due to higher accrued interest onprincipal protected notes.

 

25

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Table of Contents

 

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

 
| ** **           | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2010**                                        | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Other income, net    |       | $                                               | 1,556      |         | $          | 321            |       | $ | 1,235 |   | 384.7 | % |
| *% of total revenue* |       | 6.7                                             | %          | 2.5          | %          |           |       |   |   |
|                      |            |                                                 |            |              |            |                |            |  |  |  |  |  |

 

Otherincome, net was $1.6 million for the three months ended June 30, 2010primarily due to a $1.2 million sales tax refund and unrealized foreignexchange gains of $0.2 million and investment income of $0.2 million mainlyfrom marketable securities and the two minority-owned joint ventures that arenot consolidated. Other income, net was $321,000 for the three months endedJune 30, 2009 primarily due to unrealized foreign exchange gains of $0.2 millionand investment income of $0.1 million from the two minority-owned jointventures that are not consolidated.

 
| * *                 |   | **Six Months Ended** |       |         |   |           |   |
|--------------------------|--------|--------------------------------|------------|--------------|--------|----------------|--------|
| * *                 |   | **June 30,**              |       | **Increase** |   |           |   |
| * *                 |   | **2010**                       | ** ** | **2009**     |   | **(Decrease)** |   | **% Change** |   |
| * *                 |   | **($ in thousands)** |       | ** **   |   | ** **     |   |
| Other income (loss), net |   | $                              | 1,635      |         | $      | (101           | )      | $ | 1,736 |   | 1,718.8 | % |
| *% of total revenue*     |   | 3.9                            | %          | (0.5         | )%     |           |   |   |   |
|                          |        |                                |            |              |        |                |        |  |  |  |  |  |

 

Otherincome, net was $1.6 million for the six months ended June 30, 2010primarily due to a $1.2 million sales tax refund and unrealized foreignexchange gains of $0.2 million and investment income of $0.1 million from thetwo minority-owned joint ventures that are not consolidated. Other loss, netwas $0.1 million for the six months ended June 30, 2009 primarily due tounrealized foreign exchange loss of $0.3 million, offset by investment incomeof $0.2 million from the two minority-owned joint ventures that are notconsolidated.

 

***Noncontrolling interest***

 
| * *                |   | **Three Months Ended  June 30,** |       | **Increase** |       |           |       |
|-------------------------|--------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| * *                |   | **2010**                                        | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** |   |
| * *                |   | **($ in thousands)**                  |       |         |       |           |       |
| Noncontrolling interest |   | $                                               | (417       | )            | $          | (2             | )          | $ | (415 | ) | (20,750.0 | )% |
| *% of total revenue*    |   | 1.8                                             | %          | 0.0          | %          |           |       |   |   |
|                         |        |                                                 |            |              |            |                |            |  |  |  |  |  |

 

Noncontrollinginterest increased $0.4 million to $0.4 million for the three months endedJune 30, 2010 from $2,000 for the three months ended June 30, 2009indicating more profitability, and hence higher noncontrolling interestportion, from our China joint venture operations as raw materials salesincreased due to a stronger demand environment.

 
| * *                |   | **Six Months Ended  June 30,** |       | **Increase** |       |           |       |
|-------------------------|--------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| * *                |   | **2010**                                      | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** |   |
| * *                |   | **($ in thousands)**                |       |         |       |           |       |
| Noncontrolling interest |   | $                                             | (547       | )            | $          | 74             |       | $ | (621 | ) | (839.2 | )% |
| *% of total revenue*    |   | 1.3                                           | %          | 0.4          | %          |           |       |   |   |
|                         |        |                                               |            |              |            |                |            |  |  |  |  |  |

 

Noncontrollinginterest increased $0.6 million to $0.5 million for the six months endedJune 30, 2010 from $74,000 contribution for the six months endedJune 30, 2009 indicating profitability, and hence higher noncontrollinginterest portion, from our China joint venture operations as raw materials haveincreased due to a stronger demand environment.

 

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***Provision for Income Taxes***

 
| * *                   |   | **Three Months Ended** |       |         |       |           |       |
|----------------------------|--------|----------------------------------|------------|--------------|------------|----------------|------------|
| * *                   |   | **June 30,**                |       | **Increase** |       |           |       |
| * *                   |   | **2010**                         | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** |   |
| * *                   |   | **($ in thousands)**   |       |         |       |           |       |
| Provision for income taxes |   | $                                | 560        |         | $          | 308            |       | $ | 252 |   | 81.8 | % |
| *% of total revenue*       |   | 2.4                              | %          | 2.4          | %          |           |       |   |   |
|                            |        |                                  |            |              |            |                |            |  |  |  |  |  |

 

Weprovided for income taxes of $0.6 million for our China operations for thethree months ended June 30, 2010 compared to $0.3 million for the threemonths ended June 30, 2009. The increase in tax provision was primarilydue to increased sales and increased net income in the second quarter of 2010compared to the same period last year. No income taxes have been provided forU.S. operations based upon available net operating loss carryforwards.

 
| ** **                 | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **2010**                                      | ** ** | **2009**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                 | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Provision for income taxes |       | $                                             | 806        |         | $          | 312            |       | $ | 494 |   | 158.3 | % |
| *% of total revenue*       |       | 1.9                                           | %          | 1.5          | %          |           |       |   |   |
|                            |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

Weprovided for income taxes of $0.8 million for our China operations for the sixmonths ended June 30, 2010 compared to $.03 million for the six monthsended June 30, 2009. The increase in tax provision was primarily due toincreased sales and increased net income for the first six months of 2010compared to the same period last year. No income taxes have been provided forU.S. operations based upon available net operating loss carryforwards.

 

**Liquidity and Capital Resources**

 

Asof June 30, 2010, our principal sources of liquidity were $38.9 million incash and cash equivalents and short and long-term investments. We consider cashand cash equivalents and short-term investments as liquid and available foruse. Short-term investments are comprised of government bonds and high-grade commercialdebt instruments. Approximately $7.5 million of our short-term investments incorporate bonds (see Note 3 to our condensed consolidated financial statements)are invested in Citigroup guaranteed instruments.

 

Cashand cash equivalents and investments of $38.9 million decreased by $0.4 millionin the second quarter of 2010 compared to the first quarter of 2010.

 

Netcash provided by operating activities of $4.9 million for the six months endedJune 30, 2010 was primarily comprised of our net income of $8.7 million,adjusted for non-cash items of depreciation of $1.4 million, stock-basedcompensation of $0.2 million, partially offset by a realized gain on sale ofinvestments of $0.2 million, and offset by a net increase of $5.3 millionin assets and liabilities. The $5.3 million net increase in assets andliabilities primarily resulted from a $3.3 million increase in accountsreceivable, a $1.7 million increase in prepaid expenses, a $1.5 milliondecrease in accounts payable, partially offset by a $0.9 million increasein accrued liabilities, and a $0.4 million decrease in inventories.

 

Accountsreceivable, net increased by $3.3 million as of June 30, 2010 compared toDecember 31, 2009 due to higher sales volume. Our days sales outstanding(DSO) was 73 days as of June 30, 2010 and was 79 days as ofDecember 31, 2009.

 

Netcash used in operating activities of $1.2 million for the six months endedJune 30, 2009 was primarily comprised of our net loss of $6.9 million,adjusted for non-cash items of depreciation of $1.6 million, stock-basedcompensation of $0.6 million, and a restructuring charge of $0.5 million,partially offset by a net decrease of $3.0 million in assets and liabilities.The $2.9 million net decrease in assets and liabilities primarily resulted froma $6.8 million decrease in inventory, a $1.4 million decrease in prepaidexpenses, partially offset by a $2.3 million decrease in accounts payable, a$1.4 million increase in accounts receivable, a $1.0 million decrease inother long-term liabilities, a $0.4 million decrease in accrued liabilities,and a $0.1 million increase in other assets.

 

Netcash used in investing activities of $1.4 million for the six months endedJune 30, 2010 was primarily from the purchase of property, plant andequipment of $1.2 million and by the purchase of investments totaling $11.2million offset by the sale of investments totaling $11.0 million

 

Netcash provided by investing activities of $0.1 million for the six months endedJune 30, 2009 was primarily from the proceeds on sale of marketablesecurities of $0.5 million, partially offset by the purchase of property, plantand equipment of $0.4 million.

 

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We expect to invest up to approximately $7.7 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 $0.1 million for the six months endedJune 30, 2010 consisted of dividends and long term debt payments of $0.3million, partially offset by net proceeds of $0.2 million on the issuance ofcommon stock pursuant to stock option exercises.

 

Netcash used in financing activities of $9,000 for the six months endedJune 30, 2009 consisted of long term debt payments of $49,000, partiallyoffset by net proceeds of $40,000 on the issuance of common stock pursuant tostock option exercises.

 

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 June 30, 2010 are summarized as follows (inthousands):

 
| ** **                       | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**                                 | ** ** | **Less than 1  year** | ** ** | **1-3  years** | ** ** | **3-5  years** | ** ** | **More than  5 years** | ** ** |
| Tenant improvement loan          |       | $                                         | 458        |   | $ | 77 |   | $ | 164 |   | $ | 178 |   | $ | 39 |   |
| Operating leases                 |       | 1,586                                     |       | 297 |   | 559 |   | 600 |   | 130 |   |
| Total                            |       | $                                         | 2,044      |   | $ | 374 |   | $ | 723 |   | $ | 778 |   | $ | 169 |   |

 

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 $0.2 million and $0.2 million for the sixmonths ended June 30, 2010 and 2009, respectively.

 

**RecentAccounting Pronouncements**

 

Withthe exception of those stated below, there have been no recent accountingpronouncements or changes in accounting pronouncements during the three monthsended June 30, 2010, as compared to the recent accounting pronouncementsdescribed in the Annual Report that are of material significance, or havepotential 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 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) discloseseparately the amounts of significant transfers in and out of Level 1 and Level2 fair value measurements and describe the reasons for the transfers and (ii) presentseparate information for Level 3 activity pertaining to gross purchases, sales,issuances, and settlements.  This update became effective for us in thequarter ended March 31, 2010, except that the disclosure on the rollforward activities for Level 3 fair value measurements will become effectivefor us with the reporting period beginning January 1, 2011. Other thanrequiring additional disclosures, adoption of this new guidance did not have amaterial impact on the Company’s financial statements.

 

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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. These risks may be increased by the fluctuations and revaluations of theChinese renminbi. Our financial results could be adversely affected by factorssuch as changes in foreign currency exchange rates or weak economic conditionsin foreign markets, including the revaluation by China of the renminbi, and anyfuture adjustments that China may make to its currency such as any move itmight make to a managed float systems with opportunistic interventions. In the futurewe may experience foreign exchange losses on our non-functional currencydenominated receivables and payables to the extent that we have not mitigatedour exposure utilizing foreign currency forward exchange contracts. Foreignexchange losses could have a materially adverse effect on our operating resultsand cash flows.

 

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

 

During the second quarter of 2010, we recorded a net realized foreignexchange gain of $41,000, 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 materiallyadverse effect on our operating results and cash flows. During the secondquarter of 2010, we recorded unrealized foreign currency gain of $189,000,included in the balance of accumulated other comprehensive income on ourconsolidated balance sheet.

 

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%. Dependingon market 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 flows andfinancial 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  June 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                                      |       | $                                      | 20,339     |                        | 0.50       | %                                                | $          | 102                                                        |       | $                                                           | 92         |   | $ | 112 |   |
| Cash equivalents                          |       | 55                                     |       | 0.50                        |       | 0                                                |       | 0                                                          |       | 0                                                           |       |
| Investment in debt and equity instruments |       | 18,531                                 |       | 2.74                        |       | 508                                              |       | 457                                                        |       | 559                                                         |       |
| Tenant improvement loan                   |       | (458                                   | )          | 4.00                        |       | (18                                              | )          | (16                                                        | )          | (20                                                         | )          |
|                                      |       |                                   |       |                        |       | $                                                | 592        |                                                       | $          | 533                                                         |       | $ | 651 |   |
|                                           |            |                                        |            |                             |            |                                                  |            |                                                            |            |                                                             |            |  |  |  |  |

 

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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 aseparate component of accumulated other comprehensive income (loss), net ofestimated tax. Our cash, cash equivalents and short-term investments are inhigh-quality securities placed with Citicorp. We have no investments in auctionrate securities. As of June 30, 2010, we had approximately $7.5 million inone remaining principal protected note with Citigroup with a fair value ofapproximately $7.5 million. We will decrease our exposure to Citigroup as thisprincipal protected note comes due and the underlying assets are placed intodiversified 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 of June 30,2010 at 30%, and 11%, respectively.

 

***Equity Risk***

 

We maintain minority investments in two privately-held companies otherthan our strategic investments in private companies located in China. Theseminority investments in two privately-held companies are reviewed for otherthan temporary declines in value on a quarterly basis. These investments are classifiedas other assets in the consolidated balance sheets and are accounted for underthe cost method as we do not have the ability to exercise significant influenceover their operations. We monitor our investments for impairment and recordreductions in carrying value when events or changes in circumstances indicatethat the carrying value may not be recoverable. Reasons for other thantemporary declines in value include whether the related company would haveinsufficient cash flow to operate for the next twelve months, significantchanges in the operating performance and changes in market conditions. As of June 30,2010, the minority investments totaled $0.7 million.

 

**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 under Rule 13a-15(e) and15d-15(e) promulgated under the Securities Exchange Act of 1934, asamended. Based upon that evaluation, our Chief Executive Officer and our ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective as of the end of the period covered by this quarterly report inensuring that information required to be disclosed on SEC reports is (i) recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms, and (ii) accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding required disclosures.

 

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

 

No change in our internalcontrol over financial reporting was made in the three months endedJune 30, 2010 that has materially affected, or is reasonably likely tomaterially 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 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.

 

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**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

 

**Item 6.Exhibits**

 

**a. Exhibits**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                       |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                  |
| 3.1(1)              |       | Restated  Certificate of Incorporation                                                                                |
|                |       |                                                                                                                  |
| 3.2(2)              |       | Certificate  of Designation, Preferences and Rights of Series A Preferred Stock.                                 |
|                |       |                                                                                                                  |
| 3.3(3)              |       | Second  Amended and Restated By Laws                                                                                  |
|                |       |                                                                                                                  |
| 4.2(4)              |       | Rights  Agreement dated April 24, 2001 by and between AXT, Inc. and  ComputerShare Trust Company, Inc. |

 

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| 31.1   |   | Certification by Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                     |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                           |
| 31.2   |   | Certification by Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                     |
|   |   |                                                                                                                                                           |
| 32.1   |   | Certification by Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                           |
| 32.2   |   | Certification by Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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

 

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

 

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

 

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

 

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

 

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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:  August 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                                                                                                                                                                              |
|        |       |                                                                                                                                                                                                              |
| 4.2(4)      |       | 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 of the same number as filed with the SEC in ourAnnual Report on Form 10-K for the year ended December 31, 1998.

 

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

 

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

 

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

 

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

 

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