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 or15(d) of the Securities Exchange Act of 1934**

** **

**for the quarterly period ended June 30, 2009**

** **

**Or**

** **

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

** **

**for thetransition period from                   to**

 

**Commission File Number 000-24085**

 

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**AXT,INC.**

(Exact name of registrant as specified in itscharter)

 

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

 

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

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

 

**(510) 683-5900**

(Registrant’s telephone number, includingarea code)

 

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

 

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

 

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

 

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

 

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

 

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

 

| **Class**                      | ** ** | **Outstanding at July 30, 2009** |
|--------------------------------|------------|------------------------------------------------------|
| Common Stock, $0.001 par value |       | 30,664,390                                           |

 

 

 

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Table of Contents

 

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, 2009 and December 31, 2008                              |       | 3        |
| Condensed Consolidated  Statements of Operations for the three months and six months ended  June 30, 2009 and 2008 |       | 4        |
| Condensed Consolidated  Statements of Cash Flows for the six months ended June 30, 2009 and 2008                   |       | 5        |
| Notes To  Condensed Consolidated Financial Statements                                                                   |       | 6        |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations                    |       | 18       |
| Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                                     |       | 32       |
| Item 4. Controls and  Procedures                                                                                        |       | 33       |
| PART II.  OTHER INFORMATION                                                                                        |       | 34       |
| Item 1. Legal Proceedings                                                                                               |       | 34       |
| Item 1A. Risk Factors                                                                                                   |       | 34       |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                                    |       | 34       |
| Item 3.  Defaults Upon Senior Securities                                                                                |       | 34       |
| Item 4.  Submission of Matters to a Vote of Security Holders                                                            |       | 34       |
| Item 5. Other Information                                                                                               |       | 34       |
| Item 6. Exhibits                                                                                                        |       | 35       |
| Signatures                                                                                                              |       | 36       |

 

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**PART I.FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

AXT, INC.CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except per share data)

 
| ** **                                                                                                                                                                                   | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                   | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Assets:                                                                                                                                                                                      |       |              |       |                  |       |
| Current assets:                                                                                                                                                                              |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                    |       | $                 | 12,413     |                  | $          | 13,566 |   |
| Short-term investments                                                                                                                                                                       |       | 18,216            |       | 17,756                |       |
| Accounts receivable, net of allowances of $358 and  $663 as of June 30, 2009 and December 31, 2008, respectively                                                                   |       | 12,883            |       | 11,497                |       |
| Inventories, net                                                                                                                                                                             |       | 28,304            |       | 35,082                |       |
| Prepaid expenses and other current assets                                                                                                                                                    |       | 1,734             |       | 3,131                 |       |
| Total current assets                                                                                                                                                                         |       | 73,550            |       | 81,032                |       |
| Property, plant and equipment, net                                                                                                                                                           |       | 20,957            |       | 22,184                |       |
| Restricted deposits                                                                                                                                                                          |       | 3,000             |       | 3,013                 |       |
| Other assets                                                                                                                                                                                 |       | 5,531             |       | 5,433                 |       |
| Total assets                                                                                                                                                                                 |       | $                 | 103,038    |                  | $          | 111,662 |   |
|                                                                                                                                                                                         |       |              |       |                  |       |
| Liabilities and stockholders’ equity:                                                                                                                                                   |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                         |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                             |       | $                 | 4,347      |                  | $          | 6,657 |   |
| Accrued liabilities                                                                                                                                                                          |       | 4,574             |       | 4,453                 |       |
| Line of credit                                                                                                                                                                               |       | 3,000             |       | 3,013                 |       |
| Current portion of long-term debt                                                                                                                                                            |       | 74                |       | 73                    |       |
| Total current liabilities                                                                                                                                                                    |       | 11,995            |       | 14,196                |       |
| Long-term debt, net of current portion                                                                                                                                                       |       | 459               |       | 496                   |       |
| Other long-term liabilities                                                                                                                                                                  |       | 64                |       | 94                    |       |
| Total liabilities                                                                                                                                                                            |       | 12,518            |       | 14,786                |       |
| Commitments and contingencies (Note 11)                                                                                                                                                 |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                   |       |              |       |                  |       |
| Preferred stock, $0.001 par value per share; 2,000  shares authorized; 883 shares issued and outstanding as of June 30, 2009  and December 31, 2008, respectively                  |       | 3,532             |       | 3,532                 |       |
| Common stock, $0.001 par value per share; 70,000  shares authorized; 30,664 and 30,513 shares issued and outstanding as of  June 30, 2009 and December 31, 2008, respectively |       | 30                |       | 30                    |       |
| Additional paid-in capital                                                                                                                                                                   |       | 187,373           |       | 186,754               |       |
| Accumulated deficit                                                                                                                                                                          |       | (106,028          | )          | (99,232               | )          |
| Accumulated other comprehensive income                                                                                                                                                       |       | 3,432             |       | 2,580                 |       |
| Total AXT, Inc. stockholders’ equity                                                                                                                                               |       | 88,339            |       | 93,664                |       |
|                                                                                                                                                                                         |       |              |       |                  |       |
| Noncontrolling interests                                                                                                                                                                     |       | 2,181             |       | 3,212                 |       |
| Total stockholders’ equity                                                                                                                                                              |       | 90,520            |       | 96,876                |       |
|                                                                                                                                                                                         |       |              |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                              |       | $                 | 103,038    |                  | $          | 111,662 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

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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,**    | ** ** |
| ** **                                                          | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                |       |                   |       |                 |       |   |   |   |   |
| Revenue                                                             |       | $                      | 13,055     |                 | $          | 19,932 |   | $ | 20,709 |   | $ | 39,566 |   |
| Cost  of revenue                                                    |       | 10,539                 |       | 13,488               |       | 18,430 |   | 26,901 |   |
| Gross  profit                                                       |       | 2,516                  |       | 6,444                |       | 2,279 |   | 12,665 |   |
|                                                                |       |                   |       |                 |       |   |   |   |   |
| Operating  expenses:                                                |       |                   |       |                 |       |   |   |   |   |
| Selling,  general and administrative                                |       | 3,486                  |       | 3,578                |       | 7,492 |   | 7,245 |   |
| Research  and development                                           |       | 355                    |       | 569                  |       | 815 |   | 1,073 |   |
| Impairment  on assets held for sale                                 |       | —                 |       | —               |       | — |   | 83 |   |
| Restructuring  charge                                               |       | —                 |       | —               |       | 507 |   | — |   |
| Total  operating expenses                                           |       | 3,841                  |       | 4,147                |       | 8,814 |   | 8,401 |   |
| Income  (loss) from operations                                      |       | (1,325                 | )          | 2,297                |       | (6,535 | ) | 4,264 |   |
| Interest  income, net                                               |       | 34                     |       | 241                  |       | 78 |   | 365 |   |
| Other  income (expense), net                                        |       | 321                    |       | (518                 | )          | (101 | ) | 409 |   |
|                                                                |       |                   |       |                 |       |   |   |   |   |
| Income  (loss) before provision for income taxes                    |       | (970                   | )          | 2,020                |       | (6,558 | ) | 5,038 |   |
| Provision  for income taxes                                         |       | 308                    |       | 635                  |       | 312 |   | 1,195 |   |
| Net  income (loss)                                                  |       | (1,278                 | )          | 1,385                |       | (6,870 | ) | 3,843 |   |
|                                                                |       |                   |       |                 |       |   |   |   |   |
| Less:  Net income (loss) attributable to noncontrolling interest    |       | (2                     | )          | (648                 | )          | 74 |   | (1,147 | ) |
| Net  income (loss) attributable to AXT, Inc.                   |       | $                      | (1,280     | )                    | $          | 737 |   | $ | (6,796 | ) | $ | 2,696 |   |
|                                                                |       |                   |       |                 |       |   |   |   |   |
| Net  income (loss) attributable to AXT, Inc. per common share: |       |                   |       |                 |       |   |   |   |   |
| Basic                                                               |       | $                      | (0.04      | )                    | $          | 0.02 |   | $ | (0.23 | ) | $ | 0.09 |   |
| Diluted                                                             |       | $                      | (0.04      | )                    | $          | 0.02 |   | $ | (0.23 | ) | $ | 0.08 |   |
|                                                                |       |                   |       |                 |       |   |   |   |   |
| Weighted  average number of common shares outstanding:              |       |                   |       |                 |       |   |   |   |   |
| Basic                                                               |       | 30,439                 |       | 30,421               |       | 30,437 |   | 30,403 |   |
| Diluted                                                             |       | 30,439                 |       | 31,562               |       | 30,437 |   | 31,573 |   |

 

See accompanying 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,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                            | ** ** | **2009**                                      | ** ** | **2008** | ** ** |
| Cash flows from operating activities:                                                 |       |                                          |       |   |   |
| Net income (loss) attributable to AXT, Inc.                                      |       | $                                             | (6,796     | ) | $ | 2,696 |   |
|                                                                                  |       |                                          |       |   |   |
| Adjustments to reconcile net income (loss) to net  cash used in operating activities: |       |                                          |       |   |   |
| Depreciation                                                                          |       | 1,570                                         |       | 967 |   |
| Accretion of marketable securities premium                                            |       | (6                                            | )          | (2 | ) |
| Loss (gain) on disposal of property, plant and  equipment                             |       | 4                                             |       | (2 | ) |
| Impairment on assets held for sale                                                    |       | —                                        |       | 83 |   |
| Stock-based compensation                                                              |       | 579                                           |       | 321 |   |
| Restructuring charge                                                                  |       | 507                                           |       | — |   |
| Realized loss (gain) on sale of investments                                           |       | 9                                             |       | (326 | ) |
| Changes in assets and liabilities:                                                    |       |                                          |       |   |   |
| Accounts receivable, net                                                              |       | (1,386                                        | )          | (1,361 | ) |
| Inventories                                                                           |       | 6,766                                         |       | (13,598 | ) |
| Prepaid expenses and other current assets                                             |       | 1,394                                         |       | (2,143 | ) |
| Other assets                                                                          |       | (101                                          | )          | (439 | ) |
| Accounts payable                                                                      |       | (2,302                                        | )          | 9,459 |   |
| Accrued liabilities                                                                   |       | (385                                          | )          | 752 |   |
| Other long-term liabilities                                                           |       | (1,057                                        | )          | (908 | ) |
| Net cash used in operating activities                                                 |       | (1,204                                        | )          | (4,501 | ) |
|                                                                                  |       |                                          |       |   |   |
| Cash flows from investing activities:                                                 |       |                                          |       |   |   |
| Purchases of property, plant and equipment                                            |       | (390                                          | )          | (3,079 | ) |
| Proceeds from sale of property, plant and equipment                                   |       | —                                        |       | 4 |   |
| Proceeds from sale of assets held for sale                                            |       | —                                        |       | 5,057 |   |
| Purchases of marketable securities                                                    |       | (13                                           | )          | (11,737 | ) |
| Proceeds from sale of marketable securities                                           |       | 440                                           |       | 14,495 |   |
| Decrease in restricted deposits                                                       |       | 13                                            |       | 300 |   |
| Net cash provided by investing activities                                             |       | 50                                            |       | 5,040 |   |
|                                                                                  |       |                                          |       |   |   |
| Cash flows from financing activities:                                                 |       |                                          |       |   |   |
| Proceeds from issuance of common stock, net                                           |       | 40                                            |       | 149 |   |
| Long-term debt payments                                                               |       | (49                                           | )          | (288 | ) |
| Net cash used in financing activities                                                 |       | (9                                            | )          | (139 | ) |
| Effect of exchange rate changes on cash and cash  equivalents                         |       | 10                                            |       | 512 |   |
| Net increase (decrease) in cash and cash  equivalents                                 |       | (1,153                                        | )          | 912 |   |
| Cash and cash equivalents at the beginning of the  period                             |       | 13,566                                        |       | 18,380 |   |
| Cash and cash equivalents at the end of the period                                    |       | $                                             | 12,413     |   | $ | 19,292 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

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AXT, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

**Note 1.Basis of Presentation**

 

Theaccompanying condensed consolidated financialstatements of AXT, Inc. (“AXT”, the “Company”, “we,” “us,” and “our” referto AXT, Inc. and all of its consolidated subsidiaries) are unaudited, and have been prepared in accordance with accounting 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 subsidiaries for allperiods presented.

 

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

 

Theresults of operations are not necessarily indicative of the results to beexpected in the future or for the full fiscal year. It is recommended thatthese condensed consolidated financial statements be read in conjunction withour consolidated financial statements and the notes thereto included in our2008 Annual Report on Form 10-K filed with the Securities and ExchangeCommission (the “SEC”) on March 31, 2009 and our Quarterly Report on Form 10-Qfor the quarterly period ended March 31, 2009 filed with the SEC on May 11,2009.

 

Certainreclassifications have been made to the prior period consolidated financialstatements to conform to current period presentation.  These reclassifications had no impact on previouslyreported 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 SFAS No. 123 (revised 2004), “*Share-Based Payment*,” (“SFAS 123(R)”), 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 ofSFAS 123(R) apply to all awards granted or modified after the date ofadoption which was January 1, 2006. The unrecognized expense of awards notyet vested at the date of adoption will be recognized in net income (loss) inthe periods after the date of adoption using the same Black-Scholes valuationmethod and assumptions determined under the original provisions of SFAS No. 123,“*Accounting for Stock-Based Compensation.*”

 

We utilized the Black-Scholes valuation model for estimating the fairvalue of the stock compensation granted both before and after the adoption ofSFAS 123(R). The following table summarizes compensation costs related toour stock-based compensation awards (in thousands, except per share data):

 
| ** **                                                                         | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                                        | ** ** | **2008**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| Stock-based compensation in the form of  employee stock options, included in: |       |                                            |       |                                          |       |   |   |   |   |
|                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Cost of revenue                                                                    |       | $                                               | 10         |                                          | $          | 15 |   | $ | 23 |   | $ | 31 |   |
| Selling, general and administrative                                                |       | 93                                              |       | 93                                            |       | 511 |   | 215 |   |
| Research and development                                                           |       | 18                                              |       | 43                                            |       | 45 |   | 75 |   |
|                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Total stock-based compensation                                                     |       | 121                                             |       | 151                                           |       | 579 |   | 321 |   |
| Tax effect on stock-based compensation                                             |       | —                                          |       | —                                        |       | — |   | — |   |
|                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Net effect on net income (loss)                                                    |       | $                                               | 121        |                                          | $          | 151 |   | $ | 579 |   | $ | 321 |   |
|                                                                               |       |                                            |       |                                          |       |   |   |   |   |
| Effect on basic net income (loss) per share                                        |       | $                                               | 0.00       |                                          | $          | 0.00 |   | $ | 0.02 |   | $ | 0.01 |   |
| Effect on diluted net income (loss) per share                                      |       | $                                               | 0.00       |                                          | $          | 0.00 |   | $ | 0.02 |   | $ | 0.01 |   |

 

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As of June 30, 2009 the total compensation costs related tounvested stock-based awards granted to employees under our stock option planbut not yet recognized was approximately $645,000, net of estimated forfeituresof $106,000. These costs will be amortized on a straight-line basis over aweighted-average period of approximately 2.66 years and will be adjusted forsubsequent changes in estimated forfeitures. We elected not to capitalizeany stock-based compensation to inventory as of June 30, 2009 due to theimmateriality of the amount.

 

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

 

We estimate the fair value of stock options using aBlack-Scholes valuation model, consistent with the provisions of SFAS 123(R),and the SEC Staff Accounting Bulletin No. 107. There were no stock optiongrants made in the three and six months ended June 30, 2009 and no optionswere granted in the three months ended June 30, 2008. The fair value of our stock options granted to employees forthe six months ended June 30, 2008 was estimated using the followingweighted-average assumptions:

 
| ** **                   | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------|------------|-----------------------------------------------|------------|
| ** **                   | ** ** | **2009**                                      | ** ** | **2008** | ** ** |
| Expected term (in  years)    |       | n/a                                           |       | 4.0 |   |
|                         |       |                                          |       |   |   |
| Volatility                   |       | n/a                                           |       | 60.79 | % |
|                         |       |                                          |       |   |   |
| Expected dividend            |       | n/a                                           |       | 0 | % |
|                         |       |                                          |       |   |   |
| Risk-free interest rate      |       | n/a                                           |       | 2.69 | % |
|                         |       |                                          |       |   |   |
| Estimated forfeitures        |       | 5.07                                          | %          | 4.3 | % |
|                         |       |                                          |       |   |   |
| Weighted-average fair  value |       | n/a                                           |       | $ | 5.09 |   |
|                              |            |                                               |            |  |  |  |

 

The following tablesummarizes the stock option transactions during the six months ended June 30,2009 (in thousands, except per share data):

 
| ** **                                                    | ** ** | **Shares** | ** ** | **Weighted-  average  Exercise  Price** | ** ** | **Weighted-   average  Remaining  Contractual  Life  (in years****)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|---------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                    | ** ** | ** ** | ** ** | ** **                              | ** ** | ** **                                                                      | ** ** | ** **                      | ** ** |
| Options outstanding as of December 31, 2008              |       | 2,764      |       | $                                       | 2.74       |                                                                            |       |                            |       |   |
|                                                          |       |       |       |                                    |       |                                                                            |       |                            |       |
| Granted                                                       |       | —     |       | —                                  |       |                                                                            |       |                            |       |
|                                                          |       |       |       |                                    |       |                                                                            |       |                            |       |
| Exercised                                                     |       | (31        | )          | 1.31                                    |       |                                                                            |       |                            |       |
|                                                          |       |       |       |                                    |       |                                                                            |       |                            |       |
| Canceled and expired                                          |       | (118       | )          | 4.28                                    |       |                                                                            |       |                            |       |
|                                                          |       |       |       |                                    |       |                                                                            |       |                            |       |
| Options outstanding as of June 30, 2009                  |       | 2,615      |       | $                                       | 2.68       |                                                                            | 4.93       |                            | $          | 116 |   |
|                                                          |       |       |       |                                    |       |                                                                            |       |                            |       |
| Options vested and expected to vest as of  June 30, 2009 |       | 2,587      |       | $                                       | 2.68       |                                                                            | 4.68       |                            | $          | 116 |   |
|                                                          |       |       |       |                                    |       |                                                                            |       |                            |       |
| Options exercisable as of June 30, 2009                  |       | 2,164      |       | $                                       | 2.62       |                                                                            | 4.11       |                            | $          | 115 |   |

 

Asof December 31, 2008, options to purchase 1,914,000 shares at a weightedaverage exercise price of $2.58 per share were vested and exerciseable.

 

Theaggregate intrinsic value in the table above represents the total pretaxintrinsic value, based on our closing price of $1.38 on June 30, 2009,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 optionsexerciseable as of June 30, 2009 was 1,153,000.

 

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** **

Theoptions outstanding and exercisable as of June 30, 2009 were in thefollowing exercise price ranges:

** **
| **Options Outstanding as of June 30, 2009** | ** ** | **Options Exercisable  as of June 30, 2009** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| **Range of Exercise Price**                                | ** ** | **Shares**                                                            | ** ** | **Weighted-  average  Exercise Price** | ** ** | **Weighted-  average  Remaining  Contractual Life** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
| $1.17 - $1.38                                                             |       | 1,162,425                                                             |       | $ | 1.28 |   | 4.19 |   | 1,141,720 |   | $ | 1.28 |   |
| $1.39 - $1.40                                                             |       | 1,094                                                                 |       | $ | 1.40 |   | 5.70 |   | 1,094 |   | $ | 1.40 |   |
| $1.41 - $2.24                                                             |       | 791,838                                                               |       | $ | 1.89 |   | 5.25 |   | 518,282 |   | $ | 2.04 |   |
| $2.25 - $6.31                                                             |       | 605,743                                                               |       | $ | 4.99 |   | 5.29 |   | 453,340 |   | $ | 4.72 |   |
| $6.32 - $41.50                                                            |       | 53,500                                                                |       | $ | 18.98 |   | 2.30 |   | 53,500 |   | $ | 18.98 |   |
|                                                                      |       | 2,614,600                                                             |       | $ | 2.68 |   | 4.73 |   | 2,167,936 |   | $ | 2.62 |   |

 

There were 31,000 options exercised in thethree and six months ended June 30, 2009. The total intrinsic value ofoptions exercised for the three and six months ended June 30, 2009 was$2,000. Cash received from options exercised for the three months ended June 30,2009 was $40,000. The total intrinsic value of options exercised for the threeand six months ended June 30, 2008 was $117,000 and $245,000,respectively. Cash received from option exercises for the three and six monthsended June 30, 2008 was $81,000 and $149,000, respectively.

 

A summary ofactivity related to restricted stock awards for the six months ended June 30,2009 is presented below:

 
| ** **                                                                   | ** ** | **Shares** | ** ** | **Weighted-Average  Grant Date Fair Value** | ** ** |
|------------------------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------|------------|
| Non-vested  restricted stock shares outstanding as of December 31, 2008 |       | 78,544     |       | $                                                          | 2.12       |   |
| Restricted stock shares granted                                              |       | 120,908    |       | $                                                          | 0.88       |   |
| Restricted stock shares vested                                               |       | (3,532     | )          | $                                                          | 3.77       |   |
| Non-vested restricted stock shares outstanding as  of June 30, 2009     |       | 195,920    |       | $                                                          | 1.33       |   |

 

As of June 30, 2009 and 2008, we had$212,000 and $68,000 of unrecognized compensation expense, net of forfeitures,related to restricted stock awards respectively, which will be recognized overthe weighted average period of 2.47 and 2.02 years, respectively. During thesix months ended June 30, 2009 and 2008, 3,532 shares and 3,536 shares ofrestricted stock vested respectively.

 

**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, 2009** | ** ** | **December 31, 2008** | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | ** **                  | ** ** | **Gross**                       | ** ** | **Gross** | ** ** | ** ** | ** ** | ** ** | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                   | ** ** | **Amortized**               | ** ** | **Unrealized**                  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                   | ** ** | **Cost**                    | ** ** | **Gain**                        | ** ** | **(Loss)** | ** ** | **Value** | ** ** | **Cost** | ** ** | **Gain** | ** ** | **(Loss)** | ** ** | **Value** | ** ** |
| **Classified as:**                           |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash                                         |       | $                           | 11,807     |                            | $          | — |   | $ | — |   | $ | 11,807 |   | $ | 13,385 |   | $ | — |   | $ | — |   | $ | 13,385 |   |
| Cash equivalents:                            |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Money market fund                            |       | 606                         |       | —                          |       | — |   | 606 |   | 181 |   | — |   | — |   | 181 |   |
|                                         |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total cash equivalents                       |       | 606                         |       | —                          |       | — |   | 606 |   | 181 |   | — |   | — |   | 181 |   |
|                                         |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total cash and cash equivalents              |       | 12,413                      |       | —                          |       | — |   | 12,413 |   | 13,566 |   | — |   | — |   | 13,566 |   |
|                                         |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments:                                 |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Corporate bonds                              |       | 21,905                      |       | —                          |       | (689 | ) | 21,216 |   | 22,348 |   | — |   | (1,579 | ) | 20,769 |   |
| Total investments                            |       | 21,905                      |       | —                          |       | (689 | ) | 21,216 |   | 22,348 |   | — |   | (1,579 | ) | 20,769 |   |
| Total cash, cash equivalents and investments |       | $                           | 34,318     |                            | —     |   | $ | (689 | ) | $ | 33,629 |   | $ | 35,914 |   | $ | — |   | $ | (1,579 | ) | $ | 34,335 |   |
| **Contractual maturities on  investments:**  |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Due within 1 year                            |       | $                           | 14,405     |                            |       |   |   |   | $ | 14,049 |   | $ | 4,060 |   |   |   |   |   | $ | 3,822 |   |
| Due after 1 through 5 years                  |       | 7,000                       |       |                            |       |   |   | 7,167 |   | 18,288 |   |   |   |   |   | 16,947 |   |
|                                         |       | $                           | 21,905     |                            |       |   |   |   | $ | 21,216 |   | $ | 22,348 |   |   |   |   |   | $ | 20,769 |   |
|                                              |            |                             |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Theinvestments include $3.0 million recorded as restricted deposits on thecondensed consolidated balance sheets as of June 30, 2009 and December 31,2008. The $3.0 million restricted deposit was a drawdown of our line of creditfacility, with an annual interest rate of 1.57% as of June 30, 2009.

 

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 ended June 30,2009 we had $9,000 gross realized losses on sales of our available-for-salesecurities. For the three and six months ended June 30, 2008 we had$133,000 in gross realized losses and $326,000 in gross realized gains on salesof our available-for-sale securities, respectively.

 

Thegross unrealized losses related to our portfolio of available-for-salesecurities were primarily due to a decrease in the fair value of debtsecurities. We have determined that the gross unrealized losses on ouravailable-for-sale securities as of June 30, 2009 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, 2009 (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:           |       |                                                     |       |                                                     |       |                                  |       |   |   |   |   |   |   |
| Corporate bonds        |       | $                                                        | 7,167      |                                                     | $          | (333                                  | )          | $ | 14,049 |   | $ | (356 | ) | $ | 21,216 |   | $ | (689 | ) |
| Total in loss position |       | $                                                        | 7,167      |                                                     | $          | (333                                  | )          | $ | 14,049 |   | $ | (356 | ) | $ | 21,216 |   | $ | (689 | ) |

 

***Investmentsin Privately-held Companies***

 

We have made strategic investments in privatecompanies located in China in order to gain access at a competitive cost to rawmaterials that are critical to our substrate business (see Note 10). Theinvestment balances for the two companies accounted for under the equity methodare included in “other assets” in the condensed consolidated balance sheets andtotaled $3.9 million and $3.7 million as of June 30, 2009 and December 31,2008, respectively. We have investments in two unconsolidated privately-heldcompanies accounted for under the cost method. As of June 30, 2009 and December 31,2008, our investments in the two unconsolidated privately-held companiesaccounted for under the cost method had a carrying value of $0.4 million and$0.4 million, respectively, and are included in “other assets” in the condensedconsolidated balance sheets.

 

***FairValue Measurements***

 

On January 1, 2008, we adopted SFAS 157 which defines fairvalue, establishes a framework for using fair value to measure assets andliabilities, and expands disclosures about fair value measurements.SFAS 157 applies whenever other statements require or permit assets orliabilities to be measured at fair value. SFAS No. 157 applies to all financial assets andfinancial liabilities that are being measured and reported on a fair valuebasis and requires disclosure that establishes a framework for measuring fairvalue and expands disclosure about fair value measurements.

 

The following table summarizes our financial assets and liabilitiesmeasured at fair value on a recurring basis in accordance with SFAS 157 asof June 30, 2009 (in thousands):

 
| ** **              | ** ** | **Balance as of  June 30, 2009** | ** ** | **Quoted Prices in  Active Markets of  Identical Assets  (Level 1)** | ** ** | **Significant Other  Observable  Inputs  (Level 2)** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| Assets:                 |       | ** **                                           | ** ** | ** **                                                                                         | ** ** | ** **                                                     | ** ** |
| Short-term investments: |       |                                                 |       |                                                                                               |       |                                                           |       |
| Money market fund       |       | $                                                    | 606        |                                                                                               | $          | 606                                                            |       | $ | — |   |
| Corporate bonds         |       | 21,216                                               |       | —                                                                                             |       | 21,216                                                         |       |
| Total                   |       | $                                                    | 21,822     |                                                                                               | $          | 606                                                            |       | $ | 21,216 |   |
| Liabilities             |       | $                                                    | —     |                                                                                               | $          | —                                                         |       | $ | — |   |

 

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Our financial assets and liabilities are valuedusing market prices on both active markets (Level 1) and less activemarkets (Level 2). Level 1 instrument valuations are obtained fromreal-time quotes for transactions in active exchange markets involvingidentical assets. Level 2 instrument valuations are obtained fromreadily-available pricing sources for comparable instruments. As of June 30,2009, we did not have any assets or liabilities without observable marketvalues that would require a high level of judgment to determine fair value(Level 3 assets).

 

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

 

Certain assets that aresubject to nonrecurring fair value measurements are not included in the tableabove. These assets include equity and cost method investments in privatecompanies. We did not record other-than-temporary impairment charges for eitherof these investments during the first six months of 2009 or 2008.

 

**Note 4.Inventories, Net**

 

The components ofinventories are summarized below (in thousands):

 
| ** **        | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|-------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Inventories, net: |       |              |       |                  |       |
| Raw materials     |       | $                 | 13,965     |                  | $          | 17,863 |   |
| Work in process   |       | 11,108            |       | 12,961                |       |
| Finished goods    |       | 3,231             |       | 4,258                 |       |
|              |       | $                 | 28,304     |                  | $          | 35,082 |   |

 

**Note 5.Impairment on Assets Held For Sale**

 

During the sixmonths ended June 30, 2008, we completed the sale of our property inFremont, California. The escrow established to pay the purchase price of theproperty closed on March 28, 2008. The final purchase price for theproperty was $5.3 million. We received net proceeds of $5.1 million afterdeducting commissions and selling expenses. We recorded an impairment chargeupon the sale of the property of $83,000. There was no impairment charge forthe same six month period ended June 30, 2009.

 

**Note 6.Restructuring Charge**

 

As of June 30, 2009, our restructuring accrualis as follows: (in thousands):

 
| ** **          | ** ** | **Restructuring  Accrual as of  December 31, 2008** | ** ** | **Additions** | ** ** | **Payments** | ** ** | **Restructuring  Accrual as of  June 30, 2009** | ** ** |
|---------------------|------------|-------------------------------------------------------------------------|------------|---------------|------------|--------------|------------|---------------------------------------------------------------------|------------|
| Workforce reduction |       | $                                                                       | —     |          | $          | 507          |       | $                                                                   | (507       | ) | $ | — |   |
| Total               |       | $                                                                       | —     |          | $          | 507          |       | $                                                                   | (507       | ) | $ | — |   |

 

In March 2009,we reduced the workforce at our Fremont and Beijing facilities by approximately11 positions that are no longer required to support certain production andadministrative operations. This measure was being taken as part of our 2009operating plan. Accordingly, we recorded a restructuring charge of $507,000 in March 2009related to the reduction in force for severance-related expenses from thereduction in force, all of which were paid during the second quarter of 2009.We expect to save approximately $1.3 million annually in payroll and relatedexpenses. We had no restructuring charge for the first six months of 2008.

 

**Note 7. Net Income (Loss) Per Share**

 

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

 

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

 
| ** **                                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                       | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                       | ** ** | **2009**                         | ** ** | **2008**                       | ** ** | **2009** | ** ** | **2008** | ** ** |
| Numerator:                                                                       |       |                             |       |                           |       |   |   |   |   |
| Net income (loss)  attributable to AXT, Inc.                                |       | $                                | (1,280     | )                              | $          | 737 |   | $ | (6,796 | ) | $ | 2,696 |   |
| Less: Preferred stock  dividends                                                 |       | (44                              | )          | (44                            | )          | (88 | ) | (88 | ) |
|                                                                             |       |                             |       |                           |       |   |   |   |   |
| Net income (loss)  available to common stockholders                              |       | $                                | (1,324     | )                              | $          | 693 |   | $ | (6,884 | ) | $ | 2,608 |   |
| Denominator:                                                                     |       |                             |       |                           |       |   |   |   |   |
| Denominator for basic net  income per share - weighted average common shares     |       | 30,439                           |       | 30,421                         |       | 30,437 |   | 30,403 |   |
| Effect of dilutive  securities:                                                  |       |                             |       |                           |       |   |   |   |   |
| Common stock options                                                             |       | —                           |       | 1,141                          |       | — |   | 1,170 |   |
| Denominator for dilutive  net income per common share                            |       | 30,439                           |       | 31,562                         |       | 30,437 |   | 31,573 |   |
| Basic net income (loss)  per share                                               |       | $                                | (0.04      | )                              | $          | 0.02 |   | $ | (0.23 | ) | $ | 0.09 |   |
| Diluted net income (loss)  per share                                             |       | $                                | (0.04      | )                              | $          | 0.02 |   | $ | (0.23 | ) | $ | 0.08 |   |
| Options excluded from  diluted net loss per share as the impact is anti-dilutive |       | 2,615                            |       | 130                            |       | 2,615 |   | 130 |   |

 

**Note 8.Comprehensive Income (Loss)**

 

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

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                      | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                      | ** ** | **2009**                         | ** ** | **2008**                       | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                            |       |                             |       |                           |       |   |   |   |   |
| Net income (loss)  attributable to AXT, Inc.                               |       | $                                | (1,280     | )                              | $          | 737 |   | $ | (6,796 | ) | $ | 2,696 |   |
| Other comprehensive  income, net of tax:                                        |       |                             |       |                           |       |   |   |   |   |
| Change in foreign currency  translation gain (loss), net of tax                 |       | (42                              | )          | 502                            |       | (40 | ) | 1,454 |   |
| Change in unrealized gain  (loss) on available-for-sale investments, net of tax |       | 703                              |       | (150                           | )          | 890 |   | (697 | ) |
| Total other comprehensive  income, net of tax                                   |       | 661                              |       | 352                            |       | 850 |   | 757 |   |
| Comprehensive income                                                            |       | (619                             | )          | 1,089                          |       | (5,946 | ) | 3,453 |   |
| Comprehensive income  attributable to the noncontrolling interest               |       | 1                                |       | 99                             |       | 2 |   | 299 |   |
| Comprehensive income  (loss) attributable to AXT, Inc.                     |       | $                                | (618       | )                              | $          | 1,188 |   | $ | (5,944 | ) | $ | 3,752 |   |

 

**Note 9.Segment Information and Foreign Operations**

 

***Segment Information***

*** ***

We operate in one segmentfor the design, development, manufacture and distribution of high-performancecompound semiconductor substrates and sale of materials. In accordance withSFAS No. 131, *“Disclosures aboutSegments of an Enterprise and Related Information,”* our chiefoperating 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.

 

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***Product Information***

 
| ** **               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **               | ** ** | **2009**                         | ** ** | **2008**                       | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenue by product type: |       |                             |       |                           |       |   |   |   |   |
| GaAs substrates          |       | $                                | 10,108     |                           | $          | 13,142 |   | $ | 15,120 |   | $ | 26,862 |   |
| InP substrates           |       | 684                              |       | 500                            |       | 1,174 |   | 978 |   |
| Ge substrates            |       | 1,217                            |       | 1,384                          |       | 1,839 |   | 2,769 |   |
| Raw materials and other  |       | 1,046                            |       | 4,906                          |       | 2,576 |   | 8,957 |   |
| Consolidated             |       | $                                | 13,055     |                           | $          | 19,932 |   | $ | 20,709 |   | $ | 39,566 |   |

 

***GeographicalInformation***

*** ***

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

 
| ** **                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                     | ** ** | **June 30,**                | ** ** | **June 30**               | ** ** |
| ** **                     | ** ** | **2009**                         | ** ** | **2008**                       | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenue by geographic  region: |       |                             |       |                           |       |   |   |   |   |
| North America*                 |       | $                                | 2,428      |                           | $          | 5,437 |   | $ | 4,164 |   | $ | 10,436 |   |
| Europe                         |       | 2,264                            |       | 3,966                          |       | 4,477 |   | 6,783 |   |
| Japan                          |       | 2,038                            |       | 4,595                          |       | 3,190 |   | 8,735 |   |
| Taiwan                         |       | 2,746                            |       | 2,061                          |       | 3,435 |   | 4,868 |   |
| Asia Pacific                   |       | 3,579                            |       | 3,873                          |       | 5,443 |   | 8,744 |   |
| Consolidated                   |       | $                                | 13,055     |                           | $          | 19,932 |   | $ | 20,709 |   | $ | 39,566 |   |

 

----

*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,** | ** ** |
| ** **                               | ** ** | **2009**          | ** ** | **2008** | ** ** |
| Long-lived assets by  geographic region: |       |              |       |   |   |
| North America                            |       | $                 | 716        |   | $ | 867 |   |
| China                                    |       | 20,241            |       | 21,317 |   |
|                                     |       | $                 | 20,957     |   | $ | 22,184 |   |

 

***Significant Customers***

*** ***

Beginning2008, we have grouped sales to all IQE companies as sales to one customer. TheIQE group typically represents more than 10% of our reported revenue for anygiven period.  Two customers represented16.0% and 11.6% of revenues for the three month period ended June 30, 2009while two customers represented 11.6% and 11.1% of revenues for the three monthperiod ended June 30, 2008. Two customers represented 15.3% and 11.5% ofrevenues for the six month period ended June 30, 2009 while no customersrepresented more than 10% of revenues for the six month period ended June 30,2008. Our top five customers represented 43.4% and 45.5% of revenue for thethree month periods ended June 30, 2009 and 2008, respectively. Our topfive customers represented 40.3% and 34.6% of revenue for the six month periodsended June 30, 2009 and 2008, respectively.

 

**Note 10. Investments in Privately-held Companies**

 

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

 

Our investments aresummarized below (in thousands):

 
| ** **                                                                 | ** ** | **Investment Balance as of** | ** ** | ** **            | ** ** | ** **     | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------|------------|----------------|------------|
| ** **                                                                 | ** ** | **June 30,**                           | ** ** | **December 31,** | ** ** | **Accounting** | ** ** | **Ownership** | ** ** |
| **Company**                                                                | ** ** | **2009**                                    | ** ** | **2008**              | ** ** | **Method**     | ** ** | **Percentage** | ** ** |
| Beijing JiYa Semiconductor  Material Co., Ltd                    |       | $                                           | 996        |                  | $          | 996            |       | Consolidated |   | 46 | % |
| Nanjing Jin Mei  Gallium Co., Ltd                                |       | 592                                         |       | 592                   |       | Consolidated   |       | 83 | % |
| Beijing BoYu Semiconductor  Vessel Craftwork Technology Co., Ltd |       | 410                                         |       | 410                   |       | Consolidated   |       | 70 | % |
| Xilingol Tongli  Germanium Co. Ltd                               |       | 3,094                                       |       | 2,906                 |       | Equity         |       | 25 | % |
| Emeishan Jia Mei High  Purity Metals Co., Ltd                    |       | 793                                         |       | 843                   |       | Equity         |       | 25 | % |
|                                                                            |            |                                             |            |                       |            |                |            |  |  |  |  |

 

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Our ownership of Beijing JiYa Semiconductor Material Co., Ltd. (JiYa) is 46%. We continue toconsolidate JiYa as we have significant influence in management and have amajority control of the board. Our chief financial officer is chairman of theboard, while our chief operating officer, and our president of joint ventureoperations are members of the board. Our former chief executive officer,formerly a member of this board of directors, resigned from this board on March 17,2009.

 

Our ownership of Nanjing JinMei Gallium Co., Ltd. (Jin Mei) is 83%. We continue to consolidateJin Mei as we have significant influence in management and have a majoritycontrol of the board. Our chief operating officer is chairman of the board,while our president of joint venture operations is a member of the board. Ourformer chief executive officer, formerly a member of this board of directors,resigned from this board on March 17, 2009.

 

Our ownership of BeijingBoYu Semiconductor Vessel Craftwork Technology Co., Ltd (BoYu), is70%. We continue to consolidate Bo Yu as we have a significant influence overmanagement and have a majority control of the board. Our chief operatingofficer and our president of joint venture operations are members of the board.Our former chief executive officer has resigned as chairman of the board ofBoYu effective March 17, 2009.

 

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

 

The investment balances forthe two companies accounted for under the equity method are included in otherassets in the consolidated balance sheets and totaled $3.9 million and$3.7 million as of June 30, 2009 and December 31, 2008,respectively. We own 25% of the ownership interests in each of these companies.These two companies are not considered variable interest entities because:

 

·                  both companies havesustainable businesses of their own;

 

·                  our voting power isproportionate to our ownership interests;

 

·                  we only recognize ourrespective share of the losses and/or residual returns generated by thecompanies if they occur; and

 

·                  we do not have controllingfinancial interest in, do not maintain operational or management control of, donot control the board of directors of, and are not required to provideadditional investment or financial support to either company.

 

During the three and sixmonths ended June 30, 2009 the three consolidated joint ventures hadincome of $83,000 and a loss of ($167,000), respectively of which $2,000 and($74,000) were allocated to minority interests, resulting in income of $81,000and a loss of ($93,000) included in our net loss, respectively. During thethree and six months ended June 30, 2008 the three consolidated jointventures generated $1.6 million and $2.9 million of income, respectively ofwhich $0.6 million and $1.1 million were allocated to minority interests,resulting in $1.0 million and $1.8 million included in our net income,respectively. Our equity earnings from the two-minority owned joint venturesthat are not consolidated are recorded as other income (loss), net and totaled$139,000 and $461,000 for the six months ended June 30, 2009 and 2008,respectively. Undistributed retained earnings relating to all our investmentsin these companies were $11.2 million, and $11.1 million,respectively as of June 30, 2009 and December 31, 2008, respectively.

 

Our two minority-owned jointventures that are not consolidated had the following summarized incomeinformation (in thousands) for the three and six months ended June 30,2009 and 2008, respectively.

 
| ** **       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **       | ** ** | **2009**                                        | ** ** | **2008**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
|             |       |                                            |       |                                          |       |   |   |   |   |
| Net Sales        |       | $                                               | 4,111      |                                          | $          | 3,107 |   | $ | 6,215 |   | $ | 6,114 |   |
| Gross profit     |       | 1,164                                           |       | 1,704                                         |       | 1,851 |   | 3,180 |   |
| Operating income |       | 675                                             |       | 1,222                                         |       | 748 |   | 2,227 |   |
| Net income       |       | 526                                             |       | 906                                           |       | 555 |   | 1,842 |   |
|                  |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

 

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We have investments in twounconsolidated privately-held companies accounted for under the cost method. Asof June 30, 2009 and December 31, 2008, our investments in the twounconsolidated privately-held companies accounted for under the cost method hada carrying value of $0.4 million and $0.4 million, respectively, and areincluded in “other assets” in the condensed consolidated balance sheets.

 

**Note 11.Commitments and Contingencies**

 

***Indemnification Agreements***

 

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

 

Wehave entered into indemnification agreements with our directors and officersthat may require us to indemnify our directors and officers against liabilitiesthat may arise by reason of their status or service as directors or officers,other than liabilities arising from willful misconduct of a culpable nature; toadvance their expenses incurred as a result of any proceeding against them asto which they could be indemnified; and to obtain directors’ and officers’insurance if available on reasonable terms, which we currently have in place.

 

***Product Warranty***

*** ***

Wewarrant our products for a specific period of time, generally twelve months,against material defects. We provide for the estimated future costs of warrantyobligations in cost of sales when the related revenue is recognized. Theaccrued warranty costs represent the best estimate at the time of sale of thetotal costs that we expect to incur to repair or replace product parts thatfail while still under warranty. The amount of accrued estimated warranty costsare primarily based on historical experience as to product failures as well ascurrent information on repair costs. On a quarterly basis, we review theaccrued balances and update these based on the historical warranty cost trends.The following table reflects the change in our warranty accrual which isincluded in “accrued liabilities” on the condensed consolidated balance sheets,during the three and six months ended June 30, 2009 and 2008 (inthousands):

 
| ** **                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                    | ** ** | **2009**                                        | ** ** | **2008**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                          |       |                                            |       |                                          |       |   |   |   |   |
| Beginning accrued warranty  and related costs |       | $                                               | 1,463      |                                          | $          | 996 |   | $ | 1,640 |   | $ | 1,030 |   |
| Charged to cost of revenue                    |       | 242                                             |       | 379                                           |       | 318 |   | 408 |   |
| Actual warranty  expenditures                 |       | (210                                            | ))         | (66                                           | )          | (463 | ) | (129 | ) |
| Ending accrued warranty  and related costs    |       | $                                               | 1,495      |                                          | $          | 1,309 |   | $ | 1,495 |   | $ | 1,309 |   |

 

***Purchase Obligations***

 

Through the normal course ofbusiness, we purchase or place orders for the necessary materials of ourproducts from various suppliers and we commit to purchase products where we mayincur a penalty if the agreement was canceled. Our purchase agreement topurchase eighteen thousand kilograms of gallium from Recapture Metals expiredon December 31, 2008. As of June 30, 2009, we do not have anymaterial purchase obligations.

 

**Note 12.Foreign Exchange Transaction Gains/Losses**

 

Weincurred foreign currency transaction exchange gains of $183,000 and foreigncurrency transaction exchange losses of $593,000 for the three month periodsended June 30, 2009, and 2008, respectively. We incurred foreign currencytransaction exchange losses of $253,000 and $404,000 for the six month periodsended June 30, 2009, and 2008, respectively. These amounts are included in“Other income (expense), net” on the condensed consolidated statements ofoperations.

 

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**Note 13. Income Taxes**

 

In July 2006,the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48(“FIN48”), *“Accounting for Uncertainty inIncome Taxes—an interpretation of FASB Statement No. 109)”* (“SFAS 109”). FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with SFAS 109. This interpretationprescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. FIN 48 also provides guidance on derecognition of taxbenefits, classification on the balance sheet, interest and penalties,accounting in interim periods, disclosure, and transition. We adopted FIN 48effective January 1, 2007. We recognize interest and penalties related touncertain tax positions in income tax expense. As of March 31, 2009, we donot have any gross unrecognized tax benefits, nor any accrued interest andpenalties related to uncertain tax positions. As a result of the implementationof FIN 48, we identified $16.4 million in the liability for unrecognizedtax benefits. Of this amount, none was accounted for as a reduction to the January 1,2007 balance of retained earnings. The amount decreased the tax losscarryforwards in the U.S. which are fully offset by a valuation allowance. Wefile income tax returns in the U.S. federal, various states and foreignjurisdictions. We have substantially concluded all U.S. federal and stateincome tax matters through December 31, 2007.

 

**Note 14.Recent Accounting Pronouncements**

 

In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157, “*Fair Value Measurements*” (“SFAS 157”). This statementdefines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements. The statement becameeffective for financial statements issued for years beginning after November 15,2007 and interim periods within that year. On February 12, 2008 the FASBissued FASB Staff Position (FSP) FAS 157-2. This FSP permits a delay in theeffective date of SFAS 157 to years beginning after November 15, 2008, fornonfinancial assets and nonfinancial liabilities, except for items that arerecognized or disclosed at fair value in the financial statements on arecurring basis (at least annually). The delay is intended to allow the Boardand constituents additional time to consider the effect of variousimplementation issues that have arisen, or that may arise, from the applicationof SFAS 157. On February 14, 2008, the FASB issued FSP FAS 157-1 toexclude SFAS 13, Accounting for Leases, and its related interpretive accountingpronouncements from the scope of SFAS 157. We adopted this statement forfinancial assets and financial liabilities and nonfinancial assets andnonfinancial liabilities disclosed or recognized at fair value on a recurringbasis (at least annually) as of January 1, 2008. We adopted the statementfor nonfinancial assets and nonfinancial liabilities on January 1, 2009.The adoption of this statement in each period did not have a material impact onour consolidated financial statements.

 

In December 2007, theFASB issued SFAS No. 141 (revised 2007), “*BusinessCombinations*”, (“SFAS 141R”). SFAS 141R establishes theprinciples and requirements for how an acquirer in a business combination (1) recognizesand measures in its financial statements the identifiable assets acquired, theliabilities assumed and any non-controlling interest in the acquiree, (2) recognizesand measures the goodwill acquired in the business combination or a gain from abargain purchase and (3) determines what information to disclose to enableusers of the financial statements to evaluate the nature and financial effectsof the business combination. SFAS 141(R) will be applicable beginningwith our fiscal 2009. We adopted this statement January 1, 2009. There wasno impact upon adoption of on our consolidated financial statements and itseffects on future periods will depend on the nature and extent of businesscombinations that we complete, if any, in or after fiscal 2009.

 

In December 2007, the FASBissued SFAS No. 160, *“Noncontrolling Interestsin Consolidated Financial Statements”* (“SFAS 160”). SFAS 160requires that minority interest be separately reported in the consolidatedentity’s equity section and that no gain or loss shall be reported whentransactions occur between the controlling interest and the non-controllinginterests. Furthermore, the acquisition of non-controlling interest by thecontrolling interest is not treated as a business combination. SFAS 160 iseffective for fiscal years beginning after December 15, 2008. We adoptedthis statement on January 1, 2009. The presentation and disclosuresrequired of SFAS 160, which must be applied retrospectively for all periodspresented, have resulted in reclassifications to our prior period consolidatedfinancial statements.

 

In March 2008, the FASBissued SFAS No. 161, “*Disclosures aboutDerivative Instruments and Hedging Activities*” (“SFAS 161”).SFAS 161 requires companies with derivative instruments to discloseinformation that should enable financial-statement users to understand how andwhy a company uses derivative instruments, how derivative instruments andrelated hedged items affect a company’s financial position, financialperformance and cash flows. SFAS 161 is effective for financial statementsissued for fiscal years and interim periods beginning after November 15,2008. We have determined that there is no impact from adopting this statementon our consolidated financial statements.

 

In June 2008, the FASBissued FASB Staff Position (“FSP”) Emerging Issues Task Force (EITF) 03-6-1, “*Determining Whether InstrumentsGranted in Share-Based Payment Transactions Are Participating Securities*” (FSPEITF 03-6-1). FSP EITF 03-6-1 provides that unvested share-basedpayment awards that contain nonforfeitable rights to dividends or dividendequivalents (whether paid or unpaid) are participating securities and shall beincluded in the computation of earnings per share pursuant to the two-classmethod. FSP EITF 03-6-1 is effective for financial statements issued forfiscal years beginning after December 15, 2008 and interim periods withinthose years. Upon adoption, a company is required to retrospectively adjust itsearnings per share data (including any amounts related to interim periods,summaries of earnings and selected financial data) to conform with theprovisions in FSP EITF 03-6-1. Early application of FSP EITF 03-6-1is prohibited. We have determined that there is no impact from adopting thisstatement on our consolidated financial statements.

 

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In April 2009, the FASB issued FSP FAS 141(R)-1, “*Accounting for Assets Acquired and Liabilities Assumed in a BusinessCombination That Arise from Contingencies*.” This FSP requires thatassets acquired and liabilities assumed in a business combination that arisefrom contingencies be recognized at fair value if fair value can be reasonablyestimated. If fair value cannot be reasonably estimated, the asset or liabilitywould generally be recognized in accordance with SFAS No. 5, “Accountingfor Contingencies” and FASB Interpretation No. 14, “Reasonable Estimationof the Amount of a Loss”. Further, the FASB removed the subsequent accountingguidance for assets and liabilities arising from contingencies from SFAS No. 141(R).The requirements of this FSP carry forward without significant revision theguidance on contingencies of SFAS No. 141, “Business Combinations”, whichwas superseded by SFAS No. 141(R). The FSP also eliminates the requirementto disclose an estimate of the range of possible outcomes of recognizedcontingencies at the acquisition date. For unrecognized contingencies, the FASBrequires that entities include only the disclosures required by SFAS No. 5.SFAS 141(R), as modified by FSP 141(R)-1, is required to be appliedprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008.  The adoption of SFAS 141(R), as modified by FSP 141(R)-1, asof January 1, 2009 had no impact on our consolidated financial statementsand its effects on future periods will depend on the nature and extent ofbusiness combinations that we complete, if any, in or after fiscal 2009.

 

In April 2009,the FASB issued the three new accounting standards which are required to beadopted no later than periods ending after June 15, 2009. We are currentlyevaluating the impact of the following:

 

i.)  FASB Staff Position FAS 157-4, “*Determining Whether a Market Is Not Active and a Transaction Is NotDistressed*” (“FSP FAS 157-4”) provides guidelines for making fairvalue measurements more consistent with the principles presented in SFAS 157.FSP FAS 157-4 provides additional authoritative guidance in determining whethera market is active or inactive, and whether a transaction is distressed, isapplicable to all assets and liabilities (i.e. financial and nonfinancial) andwill require enhanced disclosures.

 

ii.)  FASB Staff Position FAS 115-2 and FAS124-2, “*Recognition and Presentation ofOther-Than-Temporary Impairments*” provides additional guidance toprovide greater clarity about the credit and noncredit component of another-than-temporary impairment event and to improve presentation anddisclosure of other than temporary impairments in the financial statements.

 

iii.)  FASB Staff Position FAS 107-1 and APB28-1, “*Interim Disclosures about Fair Value of FinancialInstruments*” amends FASB Statement No. 107, “Disclosures aboutFair Value of Financial Instruments”, to require disclosures about fair valueof financial instruments in interim as well as in annual financial statements.This FSP also amends APB Opinion No. 28, Interim Financial Reporting, torequire those disclosures in all interim financial statements.

 

In May 2009,the FASB issued SFAS No. 165, “*Subsequent Events*”(“SFAS 165”), which provides guidance to establish general standards ofaccounting for and disclosures of events that occur after the balance sheetdate but before financial statements are issued or are available to be issued.SFAS 165 also requires entities to disclose the date through whichsubsequent events were evaluated as well as the rationale for why that date wasselected. This disclosure should alert all users of financial statements thatan entity has not evaluated subsequent events after that date in the set offinancial statements being presented. SFAS 165 is effective for interim andannual periods ending after June 15, 2009 and is to be appliedprospectively. Accordingly, we adopted the provisions of SFAS 165 in the secondquarter of 2009 and it did not have a material impact on our consolidatedfinancial statements. Refer to Note 15 for our disclosure on subsequent events.

 

In June 2009,the FASB approved the “*FASB Accounting StandardsCodification*” (the “Codification”) as the single source ofauthoritative nongovernmental U.S. GAAP to be launched on July 1, 2009.The Codification does not change current U.S. GAAP, but is intended to simplifyuser access to all authoritative U.S. GAAP by providing all the authoritativeliterature related to a particular topic in one place. All existing accountingstandard documents will be superseded and all other accounting literature notincluded in the Codification will be considered nonauthoritative. TheCodification is effective for interim and annual periods ending after September 15,2009. The Codification is effective for the Company in the interim periodending September 30, 2009 and the Company does not expect the adoption tohave a material impact on its consolidated financial position, results ofoperations or cash flows.

 

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

 

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**Note 15. Subsequent Event**

 

On July 20, 2009, weannounced the appointment of Dr. Morris S. Young as Chief ExecutiveOfficer, effective July 16, 2009. Dr. Young fills the vacancy createdby the March 2009 departure of Dr. Philip C.S. Yin as the Company’schief executive officer. Dr. Young continues to serve as a member of theBoard of Directors of the Company but will no longer be eligible forcompensation for his services as a director but instead will be paidcompensation as disclosed on the Current Report on Form 8-K filed by theCompany with the Securities and Exchange Commission on July 20, 2009.

 

In accordance with SFAS No. 165, “*SubsequentEvents,*” we have evaluated subsequent events through the date thatthe consolidated financial statements were filed with the Securities andExchange Commission on August 10, 2009. No events have taken place, other thanthe appointment of Dr. Morris S. Young as chief executive officer, thatmeet the definition of a subsequent event that require disclosure in thisfiling.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

This quarterly report on Form 10-Q, including thefollowing sections, contains forward-looking statements within the meaning of Section 21Eof the Securities Exchange Act of 1934, as amended, particularly statementsrelating to our expectations regarding results of operations, customer demand,improvements in our product quality, our ability to expand our markets andincrease sales, customer qualifications of our products, gross margins,favorable pricing, reliable supply and enhanced sourcing lead-times of rawmaterials, and our reserve balances. These forward-looking statements are basedupon management’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 cautioninvestors that 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, 2008 and the condensed consolidated financialstatements included elsewhere in this report.

 

**Overview**

 

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

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

 

We manufacture all of our semiconductor substrates using ourproprietary vertical gradient freeze (VGF) technology. Most of our revenue isfrom sales of GaAs substrates. We manufacture all of our products in the People’sRepublic of China (PRC or China), which generally has favorable costs forfacilities and labor compared to comparable facilities in the United States orEurope. We also have three majority-owned and two minority-owned joint venturesin China which provide us favorablepricing, reliable supply and enhanced sourcing lead-times for key raw materialswhich are central to our final manufactured products. These joint ventures produce products including 99.99% puregallium (4N Ga), high purity gallium, arsenic, germanium, germanium dioxide,paralytic boron nitride (pBN) crucibles and boron oxide. AXT’s ownershipinterest in these entities ranges from 25% to 83%. We consolidate the threeventures in which we own a majority or controlling financial interest andemploy equity accounting for the two joint ventures in which we have a 25%interest. We purchase portions of the materials produced by these ventures forour own use and the joint ventures sell the remainder of their production tothird parties. We use our direct sales force in the United Statesand independent sales representatives in Europe and Asia to market oursubstrates. We believe that, as the demand for compound semiconductorsubstrates is expected to increase, we are positioned to leverage our PRC-basedmanufacturing capabilities and access to favorably priced raw materials toincrease our market share. However, the economic downturn that began in 2008,coupled with inventory overhang in the industry put pressure on our financialperformance in 2008 and has continued to have an impact on our results in 2009.

 

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While the volatilebusiness and financial markets are prompting us to continue to take aconservative approach to our business, we remain optimistic about our business.Positive industry trends, coupled with our competitive manufacturing and costadvantages give us confidence in our ability to continue to drive futurebusiness in 2009. Following very challenging industry conditions early in theyear, we are pleased to report that the improvements we began to see at the endof the first quarter continued through the second quarter, resulting instronger sales and improved gross margins. We believe that inventory levels inthe supply chain have improved from the first quarter, with the exception ofour gallium raw materials, which are not expected to begin to recover untillater in 2009.  Our qualification effortsin both gallium arsenide and germanium substrates have been very successful andwe are pleased with our increasing diversification in these areas.

 

As of June 30, 2009,our principal sources of liquidity were $30.6 million in cash and cashequivalents and short-term investments, excluding restricted deposits. Cash andcash equivalents and short-term investments of $30.6 million increased by $1.1million in the second quarter of 2009 compared to the first quarter of 2009.

 

On July 20, 2009, weannounced the appointment of Dr. Morris S. Young as Chief Executive Officer,effective July 16, 2009.  Dr. Youngfills the vacancy created by the March 2009 departure of Dr. PhilipC.S. Yin as the Company’s chief executive officer. Dr. Young continues toserve as a member of the Board of Directors of the Company.

 

**Critical Accounting Policies and Estimates**

 

We have preparedour condensed consolidated financial statements in accordance with accountingprinciples generally accepted in the United States of America. As such, we havehad to make estimates, assumptions and judgments that affect the amountsreported on our financial statements. These estimates, assumptions andjudgments 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.

 

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

 

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

 

***Revenue Recognition***

 

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

 

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

 

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***Allowance for Doubtful Accounts***

 

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

 

As of June 30, 2009 and December 31, 2008,our accounts receivable, net, balance was $12.9 million and $11.5 million,respectively, which was net of an allowance for doubtful accounts of $358,000and $663,000, respectively. If actual uncollectible accounts differsubstantially from our estimates, revisions to the estimated allowance fordoubtful accounts would be required, which could have a material impact on ourfinancial results for the period.

 

***Warranty Reserve***

 

We maintain a warranty reserve based upon our claimsexperience during the prior twelve months. Warranty costs are accrued at thetime revenue is recognized. As of June 30, 2009 and December 31,2008, accrued product warranties totaled $1.5 million and $1.6 million,respectively. If actual warranty costs differ substantially from our estimates,revisions to the estimated warranty liability would be required, which couldhave a material impact on our financial condition and results of operations.

 

***Inventory Valuation***

 

Inventories are stated at the lower of cost ormarket. Cost is determined using the weighted average cost method. Ourinventory consists of raw materials as well as finished goods andwork-in-process that include material, labor and manufacturing overhead costs.Given the nature of our substrate products, and the materials used in themanufacturing process, the wafers and ingots comprising work-in-processmay be held in inventory for up to two years and three years,respectively, as the risk of obsolescence for these materials is low. Weroutinely evaluate the levels of our inventory in light of current marketconditions in order to identify excess and obsolete inventory, and we provide avaluation allowance for certain inventories based upon the age and quality ofthe product and the projections for sale of the completed products. As of eachof June 30, 2009 and December 31, 2008, we had an inventory reserveof $12.5 million and $12.0 million, respectively for excess and obsoleteinventory. 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 Statement of FinancialAccounting Standards (SFAS) No. 115, *“Accountingfor Certain Investments in Debt and Equity Securities.”* Allavailable-for-sale securities with a quoted market value below cost (oradjusted cost) are reviewed in order to determine whether the decline isother-than-temporary. Factors considered in determining whether a loss istemporary include the magnitude of the decline in market value, the length oftime the market value has been below cost (or adjusted cost), credit quality,and our ability and intent to hold the securities for a period of timesufficient to allow for any anticipated 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. SFAS No. 157establishes three 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 subjectivity comparedto 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, 2009, we did not have any assets orliabilities without observable market values that would require a high level ofjudgment to determine fair value (Level 3 assets).

 

***Impairment of Long-LivedAssets***

 

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

 

***Employee Stock Options***

 

We grant options to substantially all managementemployees and believe that this program helps us to attract, motivate andretain high quality employees, to the ultimate benefit of our stockholders.Effective January 1, 2006, we adopted the fair value recognitionprovisions of SFAS No. 123 (revised 2004), “*Share-BasedPayment*” (“SFAS 123(R)”), using the modified prospectiveapplication transition method. Under this transition method, stock-basedcompensation cost was recognized in the condensed consolidated financialstatements 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 SFAS 123, “*Accounting for Stock-Based Compensation.”* We recognize thesecompensation costs net of an estimated forfeiture rate over the requisiteservice period of the award, which is generally the vesting term of four yearsfor stock options. Results for prior periods have not been restated, asprovided for under the modified prospective application transition method.

 

***Income Taxes***

 

We account for income taxes in accordance with SFAS No. 109 (“SFAS 109”),*“Accounting for Income Taxes,”*which requires that deferred tax assets and liabilities be recognized usingenacted tax rates for the effect of temporary differences between the book andtax bases of recorded assets and liabilities. SFAS 109 also requires thatdeferred tax assets be reduced by a valuation allowance if it is more likelythan not that a portion of the deferred tax asset will not be realized.

 

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

 

Effective January 1, 2007, we adopted FASB Interpretation No. 48(“FIN 48”), “*Accounting for Uncertaintyin Income Taxes—an interpretation of FASB Statement No. 109*.”See Note 13—“Income Taxes” in the condensed financial statements foradditional information.

 

**Results ofOperations**

 

**Revenue**

 
| ** **              | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase**                   | ** ** | ** **     | ** ** |
|-------------------------|------------|-------------------------------------------------|------------|--------------------------------|------------|----------------|------------|
| ** **              | ** ** | **2009**                                        | ** ** | **2008**                       | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
|                    |       |                                            |       | **($ in thousands)** |       |           |       |   |   |
| GaAs                    |       | $                                               | 10,108     |                           | $          | 13,142         |       | $ | (3,034 | ) | (23.1 | )% |
| InP                     |       | 684                                             |       | 500                            |       | 184            |       | 36.8 | % |
| Ge                      |       | 1,217                                           |       | 1,384                          |       | (167           | )          | (12.1 | )% |
| Raw materials and other |       | 1,046                                           |       | 4,906                          |       | (3,860         | )          | (78.7 | )% |
| Total revenue           |       | $                                               | 13,055     |                           | $          | 19,932         |       | $ | (6,877 | ) | (34.5 | )% |

 

Revenue decreased $6.9million, or 34.5%, to $13.1 million for the three months ended June 30,2009 from $19.9 million for the three months ended June 30, 2008. TotalGaAs substrate revenue decreased $3.0 million, or 23.1%, to $10.1 million forthe three months ended June 30, 2009 from $13.1 million for the threemonths ended June 30, 2008. The decline in revenue was primarily due tothe overall weaker demand environment and inventory overhang, affecting salesof all diameters.

 

Sales of 5 inch and 6inch diameter GaAs substrates were $4.4 million for the three months ended June 30,2009 compared to $6.1 million for the three months ended June 30, 2008.Despite our renewed supply agreement with IQE plc for 2009, the demand fromtheir end customers also dropped due to the worldwide economic slowdown causingIQE as well as our other customers to temporarily utilize their excessinventory. However, under our agreement with IQE, they have agreed to purchasefrom us a minimum of approximately $14.3 million of GaAs substrates through March 2010and accordingly we expect demand from IQE group will increase in the latterhalf of 2009.

 

Sales of 2 inch, 3 inchand 4 inch diameter GaAs substrates were $5.7 million for the three monthsended June 30, 2009 compared with $7.1 million for the three months ended June 30,2008. Similar to the larger diameter substrate customers, the decrease inrevenue from smaller diameter substrates was due to the drop in demand from ourLED semi-conducting customers while they continue to utilize their excessinventory.

 

InP substrate revenueincreased $0.2 million, or 36.8%, to $684,000 for the three months ended June 30,2009 from $500,000 for the three months ended June 30, 2008 as demand fromcustomers in the optical networking industry has remained steady.

 

Ge substrate revenuedecreased $0.2 million, or 12.1%, to $1.2 for the three months ended June 30,2009 from $1.4 million for the three months ended June 30, 2008. While ourGe substrate revenue has dropped in the first quarter of 2009, our newlyqualified European customer began to release full production orders during thesecond quarter of 2009 for concentrated photovoltaic solar applications.

 

Raw materials revenuedecreased $3.9 million, or 78.7%, to $1.0 million for the three months ended June 30,2009 from $4.9 million for the three months ended June 30, 2008. Thedecrease in raw materials revenue was primarily due to the worldwide drop indemand for 4N gallium. In particular, our China joint venture Jiya hasexperienced the impact of the slowdown causing their customers to postpone orcancel orders while utilizing excess inventory.

 

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| ** **              | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase**                   | ** ** | ** **     | ** ** |
|-------------------------|------------|-----------------------------------------------|------------|--------------------------------|------------|----------------|------------|
| ** **              | ** ** | **2009**                                      | ** ** | **2008**                       | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
|                    |       |                                          |       | **($ in thousands)** |       |           |       |   |   |
| GaAs                    |       | $                                             | 15,120     |                           | $          | 26,862         |       | $ | (11,742 | ) | (43.7 | )% |
| InP                     |       | 1,174                                         |       | 978                            |       | 196            |       | 20.0 | % |
| Ge                      |       | 1,839                                         |       | 2,769                          |       | (930           | )          | (33.6 | )% |
| Raw materials and other |       | 2,576                                         |       | 8,957                          |       | (6,381         | )          | (71.2 | )% |
| Total revenue           |       | $                                             | 20,709     |                           | $          | 39,566         |       | $ | (18,857 | ) | (47.7 | )% |

 

Revenue decreased $18.9million, or 47.7%, to $20.7 million for the six months ended June 30, 2009from $39.6 million for the six months ended June 30, 2008. Total GaAssubstrate revenue decreased $11.7 million, or 43.7%, to $15.1 million for thesix months ended June 30, 2009 from $26.9 million for the six months endedJune 30, 2008. The decline in revenue was primarily due to the overallweaker demand environment and inventory overhang, affecting sales of alldiameters.

 

Sales of 5 inch and 6inch diameter GaAs substrates were $5.7 million for the six months ended June 30,2009 compared to $12.9 million for the six months ended June 30, 2008.Despite our renewed supply agreement with IQE plc for 2009, the demand fromtheir end customers also dropped due to the worldwide economic slowdown causingIQE as well as our other customers to temporarily utilize their excess inventory.However, under our agreement with IQE, they have agreed to purchase from us aminimum of approximately $14.3 million of GaAs substrates through March 2010and accordingly we expect demand from IQE group will increase in the latterhalf of 2009.

 

Sales of 2 inch, 3 inchand 4 inch diameter GaAs substrates were $9.5 million for the six months ended June 30,2009 compared with $13.9 million for the six months ended June 30, 2008.Similar to the larger diameter substrate customers, the decrease in revenue fromsmaller diameter substrates was due to the drop in demand from our LEDsemi-conducting customers while they continue to utilize their excessinventory.

 

InP substrate revenueincreased $0.2 million, or 20.0%, to $1.2 million for the six months ended June 30,2009 from $1.0 million for the six months ended June 30, 2008 as demandfrom customers in the optical networking industry has remained steady.

 

Ge substrate revenuedecreased $0.9 million, or 33.6%, to $1.8 for the six months ended June 30,2009 from $2.8 million for the six months ended June 30, 2008. While ourGe substrate revenue has dropped in the first quarter of 2009, our newlyqualified European customer began to release full production orders during thesecond quarter of 2009 for concentrated photovoltaic solar applications.

 

Raw materials revenuedecreased $6.4 million, or 71.2%, to $2.6 million for the six months ended June 30,2009 from $9.0 million for the six months ended June 30, 2008. Thedecrease in raw materials revenue was primarily due to the worldwide drop indemand for 4N gallium. In particular, our China joint venture Jiya hasexperienced the impact of the slowdown causing their customers to postpone orcancel orders while utilizing excess inventory.

 

***Revenue by GeographicRegion***

 
| ** **                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                | ** ** | **2009**                                        | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
|                                      |       | **($ in thousands)**                  |       |         |       |           |       |
| North America *                           |       | $                                               | 2,428      |         | $          | 5,437          |       | $ | (3,009 | ) | (55.3 | )% |
| *% of total revenue*                      |       | 19                                              | %          | 27           | %          |           |       |   |   |
| Europe                                    |       | 2,264                                           |       | 3,966        |       | (1,702         | )          | (42.9 | )% |
| *% of total revenue*                      |       | 17                                              | %          | 20           | %          |           |       |   |   |
| Japan                                     |       | 2,038                                           |       | 4,595        |       | (2,557         | )          | (55.6 | )% |
| *% of total revenue*                      |       | 16                                              | %          | 23           | %          |           |       |   |   |
| Taiwan                                    |       | 2,746                                           |       | 2,061        |       | 685            |       | 33.2 | % |
| *% of total revenue*                      |       | 21                                              | %          | 10           | %          |           |       |   |   |
| Asia Pacific (excluding Japan and Taiwan) |       | 3,579                                           |       | 3,873        |       | (294           | )          | (7.6 | )% |
| *% of total revenue*                      |       | 27                                              | %          | 20           | %          |           |       |   |   |
| Total revenue                             |       | $                                               | 13,055     |         | $          | 19,932         |       | $ | (6,877 | ) | (34.5 | )% |

 

----

*Primarily the UnitedStates

 

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Revenue from customers in North America decreased by$3.0 million, or 55.3%, to $2.4 million for the three months ended June 30,2009 from $5.4 million for the three months ended June 30, 2008 as thedemand for substrates fell by $2.4 million while the demand for raw materialsfell by $0.6 million. We expect our North America revenue to increase in thelatter part of 2009 based upon a renewed supply agreement we signed in thefourth quarter of 2008 with IQE plc. Under the terms of the agreement, IQE plc has agreed to purchase from usa minimum of approximately $14.3 million of 4-inch and 6-inch semi-insulatinggallium arsenide (GaAs) substrates. All substrates ordered pursuant to theagreement are to be shipped by the end of March 2010.

 

Revenue from customers inEurope decreased by $1.7 million, or 42.9%, to $2.3 million for the threemonths ended June 30, 2009 from $4.0 million for the three months ended June 30,2008. This decrease came primarily from decreased raw material sales of $0.9million to customers in The Netherlands, and decreased substrate sales tocustomers in Germany of $0.6 million and to customers in France of $0.2 milliondue to decreased demand.

 

Revenue from customers inJapan decreased by $2.6 million, or 55.6%, to $2.0 million for the three monthsended June 30, 2009 from $4.6 million for the three months ended June 30,2008. Raw material sales of 4N gallium decreased by $2.1 million as demand fellwhile substrate sales decreased by $0.5 million, particularly in large diameterwafers.

 

Revenue from customers inTaiwan increased by $0.7 million, or 33.2%, to $2.7 million for the threemonths ended June 30, 2009 from $2.0 million for the three months ended June 30,2008. The increase came mainly from three existing customers for small diameterwafers used in the LED market.

 

Revenue from customers inAsia Pacific (excluding Japan and Taiwan) decreased by $0.3 million, or 7.6%,to $3.6 million for the three months ended June 30, 2009 from $3.9 millionfor the three months ended June 30, 2008. Sales to customers in Chinadecreased by $0.8 million, which was partially offset by increased sales of$0.5 million to customers in Singapore, one of which is part of the IQE group.

 
| ** **                                | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                | ** ** | **2009**                                      | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| North America *                           |       | $                                             | 4,164      |         | $          | 10,436         |       | $ | (6,272 | ) | (60.1 | )% |
| *% of total revenue*                      |       | 20                                            | %          | 26           | %          |           |       |   |   |
| Europe                                    |       | 4,477                                         |       | 6,783        |       | (2,306         | )          | (34.0 | )% |
| *% of total revenue*                      |       | 22                                            | %          | 17           | %          |           |       |   |   |
| Japan                                     |       | 3,190                                         |       | 8,735        |       | (5,545         | )          | (63.5 | )% |
| *% of total revenue*                      |       | 15                                            | %          | 22           | %          |           |       |   |   |
| Taiwan                                    |       | 3,435                                         |       | 4,868        |       | (1,433         | )          | (29.4 | )% |
| *% of total revenue*                      |       | 17                                            | %          | 12           | %          |           |       |   |   |
| Asia Pacific (excluding Japan and Taiwan) |       | 5,443                                         |       | 8,744        |       | (3,301         | )          | (37.8 | )% |
| *% of total revenue*                      |       | 26                                            | %          | 22           | %          |           |       |   |   |
| Total revenue                             |       | $                                             | 20,709     |         | $          | 39,566         |       | $ | (18,857 | ) | (47.7 | )% |

 

----

*Primarily the UnitedStates

 

Revenue from customers in North America decreased by$6.3 million, or 60.1%, to $4.2 million for the six months ended June 30,2009 from $10.4 million for the six months ended June 30, 2008 as thedemand for substrates fell by $4.6 million while the demand for raw materialsfell by $1.7 million. We expect our North America revenue to increase in thelatter part of 2009 based upon a renewed supply agreement we signed in thefourth quarter of 2008 with IQE plc. Under the terms of the agreement, IQE plc has agreed to purchase from usa minimum of approximately $14.3 million of 4-inch and 6-inch semi-insulatinggallium arsenide (GaAs) substrates. All substrates ordered pursuant to theagreement are to be shipped by the end of March 2010.

 

Revenue from customers inEurope decreased by $2.3 million, or 34.0%, to $4.5 million for the six monthsended June 30, 2009 from $6.8 million for the six months ended June 30,2008. This decrease came primarily from decreased raw material sales of $1.0million to customers in The Netherlands, and decreased substrate sales tocustomers in Germany of $1.0 million and to customers in France of $1.0 milliondue to decreased demand, partially offset by increased demand from customers inthe United Kingdom of $0.6 million, one of which is part of the IQE group withwhom we renewed a supply agreement in the fourth quarter of 2008. Substratesales to other customers in Europe decreased by $0.1 million.

 

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Revenue from customers inJapan decreased by $5.5 million, or 63.5%, to $3.2 million for the six monthsended June 30, 2009 from $8.7 million for the six months ended June 30,2008. Raw material sales of 4N gallium decreased by $3.5 million as demand fellwhile substrate sales decreased by $2.0 million, particularly in large diameterwafers.

 

Revenue from customers inTaiwan decreased by $1.4 million, or 29.4%, to $3.4 million for the six monthsended June 30, 2009 from $4.9 million for the six months ended June 30,2008. The decrease came mainly from one major existing customer for largediameter wafers due to a fall in demand.

 

Revenue from customers inAsia Pacific (excluding Japan and Taiwan) decreased by $3.3 million, or 37.8%,to $5.4 million for the six months ended June 30, 2009 from $8.7 millionfor the six months ended June 30, 2008. Decrease in demand caused sales tocustomers in China to decrease by $2.9 million, sales to customers in Singaporeto decrease by $0.2 million, and sales to customers in Korea to decrease by$0.1 million.

 

***GrossMargin***

 
| ** **       | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **       | ** ** | **2009**                                        | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Gross profit     |       | $                                               | 2,516      |         | $          | 6,444          |       | $ | (3,928 | ) | (60.9 | )% |
| *Gross Margin %* |       | 19.3                                            | %          | 32.3         | %          |           |       |   |   |
|                  |            |                                                 |            |              |            |                |            |  |  |  |  |  |

 

Grossmargin decreased to 19.3% of total revenue for the three months ended June 30,2009 from 32.3% of total revenue for the three months ended June 30, 2008.Gross margins in the three months ended June 30, 2009 and 2008 werepositively impacted by sales of approximately $633,000 and $735,000,respectively, of GaAs wafers that were previously fully reserved. The 19.3percent gross margin for the three months ended June 30, 2009 wasprimarily due to the lower absorption rates as a result of reduced sales fromthe fourth quarter of 2008, and hence lower production volume. Since late 2008,our gallium joint venture in China also continued to source finished productsfrom an independent third party supplier, resulting in low gross margin. Ourgallium joint venture continues to discuss with this third party supplier anagreement to purchase and distribute a certain amount of its product on anongoing basis, in amounts representing up to 50% of our joint venture’s totalcustomer commitments.  This third-partyprovider has a substantial share of the available gallium and is interested inpartnering with our joint venture in order to leverage its distributioncapabilities. Although this potential partnership would provide additionalcapacity to our joint venture and increase its competitive position, should anagreement be formalized, our raw materials gross margin would be negativelyimpacted. In addition, gross margins were negatively impacted by decliningaverage selling prices and rising raw material costs, as well as an increase indepreciation as a result of our purchase of equipment acquired for our capacityexpansion.

 

Conversely,product mix contributed to higher gross profit for the three months ended June 30,2008 as we sold a greater amount of larger diameter substrates whichcontributed higher gross profit and during the three months ended June 30,2008, our manufacturing facility in Beijing was operating at almost fullcapacity, which resulted in higher absorption rates.

 
| ** **       | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **       | ** ** | **2009**                                      | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Gross profit     |       | $                                             | 2,279      |         | $          | 12,665         |       | $ | (10,386 | ) | (82.0 | )% |
| *Gross Margin %* |       | 11.0                                          | %          | 32.0         | %          |           |       |   |   |
|                  |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

Grossmargin decreased to 11.0% of total revenue for the six months ended June 30,2009 from 32.0% of total revenue for the six months ended June 30, 2008.Gross margins in the six months ended June 30, 2009 and 2008 werepositively impacted by sales of approximately $1.0 million and $1.4 million,respectively, of GaAs wafers that were previously fully reserved. The 11.0percent gross margin for the six months ended June 30, 2009 was primarilydue to the lower absorption rates as a result of reduced sales from the fourthquarter of 2008, and hence lower production volume. Since late 2008, ourgallium joint venture in China also continued to source finished products froman independent third party supplier, resulting in low gross margin. Our galliumjoint venture continues to discuss with this third party supplier an agreementto purchase and distribute a certain amount of its product on an ongoing basis,in amounts representing up to 50% of our joint venture’s total customercommitments.  This third-party providerhas a substantial share of the available gallium and is interested inpartnering with our joint venture in order to leverage its distributioncapabilities. Although this potential partnership would provide additionalcapacity to our joint venture and increase its competitive position, should anagreement be formalized, our raw materials gross margin would be negativelyimpacted. In addition, gross margins were negatively impacted by decliningaverage selling prices and rising raw material costs, as well as an increase indepreciation as a result of our purchase of equipment acquired for our capacityexpansion.

 

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Conversely,product mix contributed to higher gross profit for the six months ended June 30,2008 as we sold a greater amount of larger diameter substrates whichcontributed higher gross profit and during the six months ended June 30,2008, our manufacturing facility in Beijing was operating at almost fullcapacity, which resulted in higher absorption rates.

 

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

 
| ** **                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                   | ** ** | **2009**                                        | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                   | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Selling, general and administrative expenses |       | $                                               | 3,486      |         | $          | 3,578          |       | $ | (92 | ) | (2.6 | )% |
| *% of total revenue*                         |       | 26.7                                            | %          | 18.0         | %          |           |       |   |   |
|                                              |            |                                                 |            |              |            |                |            |  |  |  |  |  |

 

Selling, general andadministrative expenses decreased $0.1 million, or 2.6%, to $3.5 million forthe three months ended June 30, 2009 from $3.6 million for the threemonths ended June 30, 2008. The decrease was from $0.2 million lowerhealth insurance costs in China due to a national refund received, $0.2 millionfrom the absence of bonus accruals in 2009, $0.1 million less rent expense atour Fremont, CA facility, $0.1 million less travel expenses from cost cuttingand from no travel by our former CEO, partially offset by $0.3 million accruedemployee-related expenses, $0.2 million increase in bad debt allowance as weprovide for a slow paying U. S. customer.

 
| ** **                                   | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                   | ** ** | **2009**                                      | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                   | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Selling, general and administrative expenses |       | $                                             | 7,492      |         | $          | 7,245          |       | $ | 247 |   | 3.4 | % |
| *% of total revenue*                         |       | 36.2                                          | %          | 18.3         | %          |           |       |   |   |
|                                              |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

Selling, general andadministrative expenses increased $0.3 million, or 3.4%, to $7.5 million forthe six months ended June 30, 2009 from $7.2 million for the six monthsended June 30, 2008. The increase was from $0.6 million increased legalfees as a result of matters relating to the change in management in March 2009,$0.3 million severance pay for our former chief executive officer, $0.3 millionin related stock compensation expense for his stock option acceleration, and$0.3 million accrued employee-related expenses, partially offset by $0.4million from the absence of bonus accruals in 2009, $0.3 million less rentexpense at our Fremont, CA facility, $0.2 million less travel expenses fromcost cutting and from no travel by our former CEO, $0.1 million less salescommissions due to reduced sales volume, $0.1 million lower health insurancecosts in China due to a national refund received, and $0.1 million less labor costsin our joint ventures, mainly from the absence of bonus accruals beginning in2009.

 

***Researchand Development***

 
| ** **               | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **2009**                                        | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Research and development |       | $                                               | 355        |         | $          | 569            |       | $ | (214 | ) | (37.6 | )% |
| *% of total revenue*     |       | 2.7                                             | %          | 2.9          | %          |           |       |   |   |
|                          |            |                                                 |            |              |            |                |            |  |  |  |  |  |

 

Research and developmentexpenses decreased $0.2 million, or 37.6% to $0.4 million for the three monthsended June 30, 2009 from $0.6 million for the three months ended June 30,2008. The decrease was primarily due to $0.1 million less labor costs as aresult of our restructuring in March 2009 and the absence of bonusaccruals beginning in 2009, and $0.1 million less outside consulting costs.

 
| ** **               | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **2009**                                      | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Research and development |       | $                                             | 815        |         | $          | 1,073          |       | $ | (258 | ) | (24.0 | )% |
| *% of total revenue*     |       | 3.9                                           | %          | 2.7          | %          |           |       |   |   |
|                          |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

Research and developmentexpenses decreased $0.3 million, or 24.0%, to $0.8 million for the six monthsended June 30, 2009 from $1.1 million for the six months ended June 30,2008. The decrease was primarily due to $0.2 million less labor costs as aresult of our restructuring in March 2009 and the absence of bonusaccruals beginning in 2009, and $0.1 million less outside consulting costs.

 

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

*** ***
| ** **                                    | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                    | ** ** | **2009**                                      | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                    | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Impairment (Recovery) on assets held for sale |       | $                                             | —     |         | $          | 83             |       | $ | (83 | ) | NM |   |
| *% of total revenue*                          |       | 0.0                                           | %          | 0.2          | %          |           |       |   |   |
|                                               |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

NM = % not meaningful

 

During the first quarterof 2008, we completed the sale of our property in Fremont, California. Theescrow established to pay the purchase price of the property closed on March 28,2008. The final purchase price for the property was $5.3 million. We receivednet proceeds of $5.1 million after deducting commissions and selling expenses.We recorded an impairment charge upon the sale of the property of $83,000.There was no impairment charge for the three and six month periods ended June 30,2009.

 

***RestructuringCharge***

 
| ** **           | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2009**                                      | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Restructuring charge |       | $                                             |  507  |         | $          | —         |       | $ | 507 |   | NM |   |
| *% of total revenue* |       | 2.4                                           | %          | 0.0          | %          |           |       |   |   |
|                      |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

NM = % not meaningful

 

During the first quarterof 2009, we further reduced the workforce at our Fremont and Beijing facilitiesby approximately 11 positions that are 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 paidin the second quarter of 2009. We expect to save approximately $1.3 millionannually in payroll and related expenses. We had no restructuring charge forthe first six months of 2008.

 

***InterestIncome, net***

 
| ** **           | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2009**                                        | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Interest income, net |       | $                                               | 34         |         | $          | 241            |       | $ | (207 | ) | (85.9 | )% |
| *% of total revenue* |       | 0.3                                             | %          | 1.2          | %          |           |       |   |   |
|                      |            |                                                 |            |              |            |                |            |  |  |  |  |  |

 

Interest income, netdecreased $0.2 million to $34,000 for the three months ended June 30, 2009from $0.2 million for the three months ended June 30, 2008.  Interest income, net for the three monthsended June 30, 2009 was lower due to the overall lower balances of ourcash and investments and with lower yields after we paid down on our taxablerevenue bond in July 2008, while interest income, net for the three monthsended June 30, 2008 had higher cash balances and with higher yields.

 
| ** **           | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2009**                                      | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Interest income, net |       | $                                             | 78         |         | $          | 365            |       | $ | (287 | ) | (78.6 | )% |
| *% of total revenue* |       | 0.4                                           | %          | 0.9          | %          |           |       |   |   |
|                      |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

Interest income, netdecreased $0.3 million to $78,000 for the six months ended June 30, 2009from $0.4 million for the six months ended June 30, 2008.  Interest income, net for the six months endedJune 30, 2009 was lower due to the overall lower balances of our cash andinvestments and with lower yields after we paid down on our taxable revenuebond in July 2008, while interest income, net for the six months ended June 30,2008 had higher cash balances and with higher yields.

 

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***OtherIncome (Loss), net***

 
| ** **               | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **2009**                                        | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Other income (loss), net |       | $                                               | 321        |         | $          | (518           | )          | $ | 839 |   | 161.9 | % |
| *% of total revenue*     |       | 2.5                                             | %          | (2.6         | )%         |           |       |   |   |
|                          |            |                                                 |            |              |            |                |            |  |  |  |  |  |

 

Other income, net was$321,000 for the three months ended June 30, 2009 primarily due tounrealized foreign exchange gains of $0.2 million and investment income of $0.1million from the two minority-owned joint ventures that are not consolidated.Other loss, net was $518,000 for the three months ended June 30, 2008primarily due to foreign exchange loss of $593,000, offset by investment incomeof $75,000 from the same minority-owned joint ventures that are not consolidated.

 
| ** **               | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **2009**                                      | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Other income (loss), net |       | $                                             | (101       | )            | $          | 409            |       | $ | (510 | ) | (124.7 | )% |
| *% of total revenue*     |       | (0.5                                          | )%         | 1.0          | %          |           |       |   |   |
|                          |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

Other loss, net was $0.1million for the six months ended June 30, 2009 primarily due to unrealizedforeign exchange loss of $0.3 million, offset by investment income of $0.2million from the two minority-owned joint ventures that are not consolidated.Other income, net was $409,000 for the six months ended June 30, 2008primarily due to investment income of $0.5 million from the same minority-ownedjoint ventures that are not consolidated, and realized gain on sale ofinvestments of $0.3 million, offset by foreign exchange losses of $0.4 million.

 

***Noncontrollinginterest***

 
| ** **              | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **              | ** ** | **2009**                                        | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **              | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Noncontrolling interest |       | $                                               | (2         | )            | $          | (648           | )          | $ | 646 |   | 99.7 | % |
| *% of total revenue*    |       | 0.0                                             | %          | (3.3         | )%         |           |       |   |   |
|                         |            |                                                 |            |              |            |                |            |  |  |  |  |  |

 

NM = % not meaningful

 

Noncontrolling interestincreased $0.6 million to $2,000 for the three months ended June 30, 2009from $(0.6) million for the three months ended June 30, 2008 indicatingless profitability from our China joint venture operations as raw materialssales have declined due to weaker demand environment causing our customers tocontinue to utilize their excess inventory.

 
| ** **              | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **              | ** ** | **2009**                                      | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **              | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Noncontrolling interest |       | $                                             | 74         |         | $          | (1,147         | )          | $ | 1,221 |   | 106.5 | % |
| *% of total revenue*    |       | 0.0                                           | %          | (2.9         | )%         |           |       |   |   |
|                         |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

Noncontrolling interestincreased $1.2 million to $74,000 for the six months ended June 30, 2009from $(1.1) million for the six months ended June 30, 2008 indicating lessprofitability from our China joint venture operations as raw materials saleshave declined due to weaker demand environment causing our customers tocontinue to utilize their excess inventory.

 

***Provisionfor Income Taxes***

 
| ** **                 | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------------|------------|-------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **2009**                                        | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                 | ** ** | **($ in thousands)**                  | ** ** | ** **   | ** ** | ** **     | ** ** |
| Provision for income taxes |       | $                                               | 308        |         | $          | 635            |       | $ | (327 | ) | (51.5 | )% |
| *% of total revenue*       |       | 2.4                                             | %          | 3.2          | %          |           |       |   |   |
|                            |            |                                                 |            |              |            |                |            |  |  |  |  |  |

 

We provided for incometaxes of $0.3 million for our China operations for the three months ended June 30,2009 compared to $0.6 million for the three months ended June 30, 2008.The decrease in tax provision was primarily due to our overall loss positionfor the first six months of 2009 compared to the same period last year.Beginning in 2008, the tax provision was calculated based on the assumptionthat we will no longer receive refunds for profit reinvestments in China.

 

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| ** **                 | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------------|------------|-----------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **2009**                                      | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                 | ** ** | **($ in thousands)**                | ** ** | ** **   | ** ** | ** **     | ** ** |
| Provision for income taxes |       | $                                             | 312        |         | $          | 1,195          |       | $ | (883 | ) | (73.9 | )% |
| *% of total revenue*       |       | 1.5                                           | %          | 3.0          | %          |           |       |   |   |
|                            |            |                                               |            |              |            |                |            |  |  |  |  |  |

 

We provided for incometaxes of $0.3 million for our China operations for the six months ended June 30,2009 compared to $1.2 million for the six months ended June 30, 2008. Thedecrease in tax provision was primarily due to our overall loss position forthe first six months of 2009 compared to the same period last year. Beginningin 2008, the tax provision was calculated based on the assumption that we willno longer receive refunds for profit reinvestments in China.

 

**Liquidity and Capital Resources**

 

As of June 30, 2009,our principal sources of liquidity were $30.6 million in cash and cashequivalents and short-term investments, excluding restricted deposits. Weconsider cash and cash equivalents and short-term investments as liquid andavailable for use. Short-term investments are comprised of government bonds andhigh-grade commercial debt instruments. All of our short-term investments incorporate bonds (see note 3) are invested in Citigroup guaranteed instruments.

 

Cashand cash equivalents and short-term investments of $30.6 million increased by$1.2 million in the second quarter of 2009 compared to the first quarter of2009.

 

Net cash used inoperating activities of $1.2 million for the six months ended June 30,2009 was primarily comprised of our net loss of $6.8 million, adjusted fornon-cash items of depreciation of $1.6 million, stock-based compensation of$0.6 million, and a restructuring charge of $0.5 million, partially offset by anet decrease of $2.9 million in assets and liabilities. The $2.9 million netdecrease in assets and liabilities primarily resulted from a $6.8 milliondecrease in inventory, a $1.4 million decrease in prepaid expenses, partiallyoffset by a $2.3 million decrease in accounts payable, a $1.4 millionincrease in accounts receivable, a $1.1 million decrease in other long-termliabilities, a $0.4 million decrease in accrued liabilities, and a $0.1 millionincrease in other assets.

 

Accounts receivable, netincreased by $1.4 million as of June 30, 2009 compared to December 31,2008 due to higher sales volume. Our days sales outstanding (DSO) is 90 days asof June 30, 2009 and was 68 days as of December 31, 2008. Our DSO waslower in 2008 as we had higher raw material sales which have quicker collectioncycles than our substrate sales.

 

Inventories, net,decreased by $6.8 million, as we decreased raw materials by $3.9 million as weheld back on purchasing and consumed what we needed from existing inventory,and we decreased work-in-process and finished goods by $2.9 million as weshipped these out as sales. Inventories, net, increased by $13.6 million as of June 30,2008, as we increased inventory in raw materials and work-in-process toincrease production in anticipation of increased forecast sales, and finishedgoods for consignment orders.

 

Net cash used inoperating activities of $4.5 million for the six months ended June 30,2008 was primarily comprised of our net income of $2.7 million, adjusted fornon-cash items of depreciation of $1.0 million, stock-based compensation of$0.3 million, partially offset by a realized gain on sale of investments of$0.3 million, and offset by a net increase of $8.2 million in assets andliabilities. The $8.2 million net increase in assets and liabilities primarilyresulted from a $13.6 million increase in inventories, a $2.1 million increasein prepaid expenses, a $1.4 million increase in accounts receivable,$0.9 million decrease in other long-term liabilities, and a$0.4 million increase in other assets, partially offset by a $9.5 millionincrease in accounts payable, a $0.7 million increase in accruedliabilities.

 

Net cash provided byinvesting activities of $0.1 million for the six months ended June 30,2009 was primarily from the proceeds on sale of marketable securities of $0.5million, partially offset by the purchase of property, plant and equipment of$0.4 million.

 

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

 

We expect to invest up to approximately $4.8 million in capitalprojects at our China facilities for the remainder of 2009, having delayedcertain expansion activities as a result of the impact of the current worldwideeconomic conditions.

 

Net cash used infinancing activities of $9,000 for the six months ended June 30, 2009consisted of payments of $49,000 related to our tenant improvement loan,partially offset by net proceeds of $40,000 on the issuance of common stock.

 

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Net cash used infinancing activities of $139,000 for the six months ended June 30, 2008consisted scheduled payments of $288,000 related to long-term borrowings,partially offset by $149,000 from the proceeds from the exercise of employeestock options.

 

We believe that we have adequate cash andinvestments to meet our needs over the next 12 months. If our salesdecrease, however, our ability to generate cash from operations will beadversely affected which could adversely affect our future liquidity, requireus to use cash at a more rapid rate than expected, and require us to seekadditional capital. There can be no assurance that such additional capital willbe available or, if available it will be at terms acceptable to us. Cash fromoperations could be affected by various risks and uncertainties, including, butnot limited to those set forth below under Item 1A “Risks Factors.”

 

Outstanding contractualobligations as of June 30, 2009 are summarized as follows (in thousands):

 
| ** **                       | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**                                 | ** ** | **Less than 1 year** | ** ** | **1-3  years** | ** ** | **3-5  years** | ** ** | **More than  5 years** | ** ** |
| Line of credit                   |       | $                                         | 3,000      |   | $ | 3,000 |   | $ | — |   | $ | — |   | $ | — |   |
| Tenant improvement loan          |       | 533                                       |       | 74 |   | 158 |   | 171 |   | 130 |   |
| Operating leases                 |       | 1,889                                     |       | 303 |   | 571 |   | 578 |   | 437 |   |
| Total                            |       | $                                         | 5,422      |   | $ | 3,377 |   | $ | 729 |   | $ | 749 |   | $ | 567 |   |

 

We lease certain office space, manufacturingfacilities and property under long-term operating leases expiring at variousdates through November 2013. On July 2, 2008, we entered into a newlease agreement with the landlord of the facility at 4281 Technology Drive,Fremont, California with approximately 27,760 square feet. The new leasecommenced December 1, 2008 for a term of seven years, with an option by usto cancel the new lease after five years, upon forfeiture of the securitydeposit and payment of one-half of the fifth year’s rent. Total rent expensesunder these operating leases were approximately $0.1 million and$0.2 million for the three months ended June 30, 2009 and 2008,respectively.

 

**RecentAccounting Pronouncements**

 

In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157, “*Fair Value Measurements*” (“SFAS 157”). This statementdefines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements. The statement becameeffective for financial statements issued for years beginning after November 15,2007 and interim periods within that year. On February 12, 2008 the FASBissued FASB Staff Position (FSP) FAS 157-2. This FSP permits a delay in theeffective date of SFAS 157 to years beginning after November 15, 2008, fornonfinancial assets and nonfinancial liabilities, except for items that arerecognized or disclosed at fair value in the financial statements on arecurring basis (at least annually). The delay is intended to allow the Boardand constituents additional time to consider the effect of variousimplementation issues that have arisen, or that may arise, from the applicationof SFAS 157. On February 14, 2008, the FASB issued FSP FAS 157-1 toexclude SFAS 13, Accounting for Leases, and its related interpretive accountingpronouncements from the scope of SFAS 157. We adopted this statement forfinancial assets and financial liabilities and nonfinancial assets andnonfinancial liabilities disclosed or recognized at fair value on a recurringbasis (at least annually) as of January 1, 2008. We adopted the statementfor nonfinancial assets and nonfinancial liabilities on January 1, 2009.The adoption of this statement in each period did not have a material impact onour consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 141(revised 2007), “*Business Combinations*”,(“SFAS 141R”). SFAS 141R establishes the principles and requirementsfor how an acquirer in a business combination (1) recognizes and measuresin its financial statements the identifiable assets acquired, the liabilitiesassumed and any non-controlling interest in the acquiree, (2) recognizesand measures the goodwill acquired in the business combination or a gain from abargain purchase and (3) determines what information to disclose to enableusers of the financial statements to evaluate the nature and financial effectsof the business combination. SFAS 141(R) will be applicable beginningwith our fiscal 2009. We adopted this statement January 1, 2009. There wasno impact upon adoption of on our consolidated financial statements and itseffects on future periods will depend on the nature and extent of businesscombinations that we complete, if any, in or after fiscal 2009.

 

In December 2007, the FASB issuedSFAS No. 160, *“Noncontrolling Interestsin Consolidated Financial Statements”* (“SFAS 160”). SFAS 160requires that minority interest be separately reported in the consolidatedentity’s equity section and that no gain or loss shall be reported whentransactions occur between the controlling interest and the non-controllinginterests. Furthermore, the acquisition of non-controlling interest by thecontrolling interest is not treated as a business combination. SFAS 160 iseffective for fiscal years beginning after December 15, 2008. We adoptedthis statement on January 1, 2009. The presentation and disclosuresrequired of SFAS 160, which must be applied retrospectively for all periodspresented, have resulted in reclassifications to our prior period consolidatedfinancial statements.

 

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In March 2008, the FASB issued SFAS No. 161,“*Disclosures about Derivative Instrumentsand Hedging Activities*” (“SFAS 161”). SFAS 161 requirescompanies with derivative instruments to disclose information that shouldenable financial-statement users to understand how and why a company usesderivative instruments, how derivative instruments and related hedged itemsaffect a company’s financial position, financial performance and cash flows.SFAS 161 is effective for financial statements issued for fiscal years andinterim periods beginning after November 15, 2008. We have determined thatthere is no impact from adopting this statement on our consolidated financialstatements.

 

In June 2008, the FASB issued FASB StaffPosition (“FSP”) Emerging Issues Task Force (EITF) 03-6-1, “*Determining Whether InstrumentsGranted in Share-Based Payment Transactions Are Participating Securities*” (FSPEITF 03-6-1). FSP EITF 03-6-1 provides that unvested share-basedpayment awards that contain nonforfeitable rights to dividends or dividendequivalents (whether paid or unpaid) are participating securities and shall beincluded in the computation of earnings per share pursuant to the two-classmethod. FSP EITF 03-6-1 is effective for financial statements issued forfiscal years beginning after December 15, 2008 and interim periods withinthose years. Upon adoption, a company is required to retrospectively adjust itsearnings per share data (including any amounts related to interim periods,summaries of earnings and selected financial data) to conform with theprovisions in FSP EITF 03-6-1. Early application of FSP EITF 03-6-1is prohibited. We have determined that there is no impact from adopting thisstatement on our consolidated financial statements.

 

In April 2009,the FASB issued FSP FAS 141(R)-1, “*Accounting for AssetsAcquired and Liabilities Assumed in a Business Combination That Arise fromContingencies*.” This FSP requires that assets acquired andliabilities assumed in a business combination that arise from contingencies berecognized at fair value if fair value can be reasonably estimated. If fairvalue cannot be reasonably estimated, the asset or liability would generally berecognized in accordance with SFAS No. 5, “Accounting for Contingencies”and FASB Interpretation No. 14, “Reasonable Estimation of the Amount of aLoss”. Further, the FASB removed the subsequent accounting guidance for assetsand liabilities arising from contingencies from SFAS No. 141(R). Therequirements of this FSP carry forward without significant revision theguidance on contingencies of SFAS No. 141, “Business Combinations”, whichwas superseded by SFAS No. 141(R). The FSP also eliminates the requirementto disclose an estimate of the range of possible outcomes of recognizedcontingencies at the acquisition date. For unrecognized contingencies, the FASBrequires that entities include only the disclosures required by SFAS No. 5.SFAS 141(R), as modified by FSP 141(R)-1, is required to be appliedprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008.  The adoption of SFAS 141(R), as modified by FSP 141(R)-1, asof January 1, 2009 had no impact on our consolidated financial statementsand its effects on future periods will depend on the nature and extent ofbusiness combinations that we complete, if any, in or after fiscal 2009.

 

In April 2009, theFASB issued the three new accounting standards which are required to be adoptedno later than periods ending after June 15, 2009. We are currentlyevaluating the impact of the following:

 

i.)  FASBStaff Position FAS 157-4, “*Determining Whether aMarket Is Not Active and a Transaction Is Not Distressed*” (“FSP FAS157-4”) provides guidelines for making fair value measurements more consistentwith the principles presented in SFAS 157. FSP FAS 157-4 provides additionalauthoritative guidance in determining whether a market is active or inactive,and whether a transaction is distressed, is applicable to all assets andliabilities (i.e. financial and nonfinancial) and will require enhanceddisclosures.

 

ii.)  FASBStaff Position FAS 115-2 and FAS 124-2, “*Recognition andPresentation of Other-Than-Temporary Impairments*” providesadditional guidance to provide greater clarity about the credit and noncreditcomponent of an other-than-temporary impairment event and to improvepresentation and disclosure of other than temporary impairments in thefinancial statements.

 

iii.)  FASBStaff Position FAS 107-1 and APB 28-1, “*Interim Disclosures aboutFair Value of Financial Instruments*” amends FASB Statement No. 107,“Disclosures about Fair Value of Financial Instruments”, to require disclosuresabout fair value of financial instruments in interim as well as in annualfinancial statements. This FSP also amends APB Opinion No. 28, InterimFinancial Reporting, to require those disclosures in all interim financialstatements.

 

In May 2009, theFASB issued SFAS No. 165, “*Subsequent Events*”(“SFAS 165”), which provides guidance to establish general standards ofaccounting for and disclosures of events that occur after the balance sheet datebut before financial statements are issued or are available to be issued. SFAS165 also requires entities to disclose the date through which subsequentevents were evaluated as well as the rationale for why that date was selected.This disclosure should alert all users of financial statements that an entityhas not evaluated subsequent events after that date in the set of financialstatements being presented. SFAS 165 is effective for interim and annualperiods ending after June 15, 2009 and is to be applied prospectively.Accordingly, we adopted the provisions of SFAS 165 in the second quarter of2009 and it did not have a material impact on our consolidated financialstatements. Refer to Note 15 for our disclosure on subsequent events.

 

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In June 2009, theFASB approved the “*FASB Accounting StandardsCodification*” (the “Codification”) as the single source of authoritativenongovernmental U.S. GAAP to be launched on July 1, 2009. The Codificationdoes not change current U.S. GAAP, but is intended to simplify user access toall authoritative U.S. GAAP by providing all the authoritative literaturerelated to a particular topic in one place. All existing accounting standarddocuments will be superseded and all other accounting literature not includedin the Codification will be considered nonauthoritative. The Codification iseffective for interim and annual periods ending after September 15, 2009.The Codification is effective for the Company in the interim period ending September 30,2009 and the Company does not expect the adoption to have a material impact onits consolidated financial position, results of operations or cash flows.

 

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

 

We do not currently use short-term forward exchangecontracts for hedging purposes to reduce the effects of adverse foreignexchange rate movements. We had previously purchased foreign exchange contractsto hedge against certain trade accounts receivable denominated in Japanese yen.The change in the fair value of the forward contracts was recognized as part ofthe related foreign currency transactions as they occur. As of June 30,2009, we had no outstanding commitments with respect to foreign exchangecontracts.

 

During the second quarter of 2009, we recorded a netrealized foreign exchange gain of $183,000, included as part of other income inour consolidated statements of operations. We incurred foreign currencytransaction exchange gains and losses due to operations in general. It isuncertain whether these currency trends will continue. In the future we mayexperience foreign exchange losses on our non-functional currency denominatedreceivables and payables to the extent that we have not mitigated our exposureutilizing foreign currency forward exchange contracts. Foreign exchange lossescould have a materially adverse effect on our operating results and cash flows.During the second quarter of 2009, we recorded unrealized foreign currency gainof $0.4 million, included in the balance of accumulated other comprehensiveincome on our consolidated balance sheet.

 

In July 2005, China agreed to a shift in Chinesecurrency policy. It established a 2% revaluation of the renminbi and referencedthe renminbi to a basket of currencies, with a daily trading band of+/-0.3%. Depending on market conditions and the state of the Chineseeconomy, it is possible that China will make more adjustments in the future.Over the next five to ten years, China may move to a managed float system, withopportunistic interventions. This reserve diversification may negatively impactthe United States dollar and U.S. interest rates, which, in turn, couldnegatively impact our operating results and financial condition. The functionalcurrency of our Chinese subsidiary, including our joint ventures, is the localcurrency; since most of our operations are conducted in China, most of our costsare incurred in Chinese currency, which subjects us to fluctuations in theexchange rates between the U.S. dollar and the Chinese renminbi. We incurtransaction gains or losses resulting from consolidation of expenses incurredin local currencies for these subsidiaries, as well as in translation of theassets and liabilities of these assets at each balance sheet date. These risksmay be increased by the fluctuation and revaluation of the Chinese renminbi. Ifwe do not effectively manage the risks associated with this currency risk, ourrevenue, cash flows and financial condition could be adversely affected.

 

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***Interest Rate Risk***

 

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

 
| **Instrument**                            | ** ** | **Balance as of  June 30,  2009** | ** ** | **Current  Interest  Rate** | ** ** | **Projected Annual  Interest  Income/(Expense)** | ** ** | **Proforma 10%  Interest Rate  Decline  Income/(Expense)** | ** ** | **Proforma 10%  Interest Rate  Increase  Income/(Expense)** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|-----------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| Cash                                      |       | $                                                | 11,807     |                        | 0.50       | %                                                     | $          | 59                                                                   |       | $                                                                     | 53         |   | $ | 65 |   |
| Cash equivalents                          |       | 606                                              |       | 1.50                        |       | 9                                                     |       | 8                                                                    |       | 10                                                                    |       |
| Investment in debt and equity instruments |       | 21,216                                           |       | 5.13                        |       | 1,088                                                 |       | 980                                                                  |       | 1,197                                                                 |       |
| Line of credit                            |       | (3,000                                           | )          | 1.57                        |       | (47                                                   | )          | (42                                                                  | )          | (52                                                                   | )          |
| Tenant improvement loan                   |       | (533                                             | )          | 4.00                        |       | (21                                                   | )          | (19                                                                  | )          | (23                                                                   | )          |
|                                      |       |                                             |       |                        |       | $                                                     | 1,088      |                                                                 | $          | 980                                                                   |       | $ | 1,197 |   |
|                                           |            |                                                  |            |                             |            |                                                       |            |                                                                      |            |                                                                       |            |  |  |  |  |

 

The primary objective of our investment activitiesis to preserve principal while maximizing income without significantlyincreasing risk. Financial instruments that potentially subject us toconcentration of credit risk consist primarily of cash and cash equivalents,short-term investments, and trade accounts receivable. We invest primarily inmoney market accounts, commercial paper instruments, and investment gradesecurities. We are exposed to credit risks in the event of default by theissuers to the extent of the amount recorded on the consolidated balancesheets. These securities are generally classified as available-for-sale andconsequently are recorded on the balance sheet at fair value with unrealizedgains or losses reported as a separate component of accumulated othercomprehensive income (loss), net of estimated tax. Our cash, cash equivalentsand short-term investments are in high-quality securities placed with CiticorpSmith Barney. We have no investments in auction rate securities. As of June 30,2009, we have approximately $21.0 million in principal protected noteswith Citicorp Smith Barney with a fair value of approximately$21.0 million. We expect to decrease our exposure to Citicorp Smith Barneyas these principal protected notes come due and the underlying assets areplaced into diversified securities.

 

We perform periodic credit evaluations of ourcustomers’ financial condition and generally do not require collateral. Twocustomers each accounted for 10% or more of our trade accounts receivablebalance as of June 30, 2009 at 27%, and 17%, respectively.

 

***Equity Risk***

 

We maintain minority investments in twoprivately-held companies other than our strategic investments in privatecompanies located in China. These minority investments in two privately-heldcompanies are reviewed for other than temporary declines in value on aquarterly basis. These investments are classified as other assets in theconsolidated balance sheets and are accounted for under the cost method as wedo not have the ability to exercise significant influence over theiroperations. We monitor our investments for impairment and record reductions incarrying value when events or changes in circumstances indicate that thecarrying value may not be recoverable. Reasons for other than temporarydeclines in value include whether the related company would have insufficientcash flow to operate for the next twelve months, significant changes in theoperating performance and changes in market conditions. As of June 30,2009, the minority investments totaled $0.4 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.

 

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

 

During the quarter ended June 30, 2009, wecompleted the following changes in our internal control over financialreporting, or in other factors, that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting:

 

On July 20,2009, the Company announced the appointment of Dr. Morris S. Young asChief Executive Officer, effective July 16, 2009.  Dr. Young fills the vacancy created bythe March 2009 departure of Dr. Philip C.S. Yin as the Company’schief executive officer. As a result of Dr. Young’s appointment, Wilson W. Cheung, the Company’s ChiefFinancial Officer, is no longer performing the functions of principal executiveofficer, but remains as Chief Financial Officer of the Company.

 

Subsequent to the completion of the quarter, weimplemented further controls relating to employee business expenses, corporategifts and business entertaining, and business development activities inconnection with our ongoing effort to improve our control processes andcorporate governance, and to monitor compliance with applicable rules andregulations. We expect to conduct additional training for our employees inAugust 2009 concerning matters relating to understanding of andcompliance with our code of conduct, our process for reporting matters to ouraudit committee, and compliance with applicable rules and regulations.

 

**PART II.OTHER INFORMATION**

 

**Item 1.Legal Proceedings**

 

From time to time wemay be involved in judicial or administrative proceedings concerningmatters arising in the ordinary course of business. We do not expect that anyof these matters, individually or in the aggregate, will have a materialadverse effect on our business, financial condition, cash flows or results ofoperation.

 

**Item 1A.Risk Factors**

 

There are no material changes from the risk factorsset forth under Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2008.

 

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

 

None

 

**Item 3. Defaults upon Senior Securities**

 

None

 

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

 

AXT held its annual meeting ofstockholders at its headquarters in Fremont, California on May 26, 2009.Of the 31,052,393 shares outstanding as of the record date, 24,120,481 shareswere represented in person or by proxy at the meeting. Proxies were solicitedby the Company pursuant to Regulation 14A under the Securities Exchange Act of1934, as amended.  At the meeting, AXT’sstockholders voted on the following matters:

 

(1)               Proposal toelect one class II director to hold office for a three-year term, and until hissuccessor is elected and qualified.

 
| **Class II director** | ** ** | **For**    | ** ** | **Abstain** | ** ** |
|---------------------------------|------------|------------|------------|-------------|------------|
| Jesse Chen                      |       | 22,577,813 |       | 1,542,668   |       |

 

In addition, the term ofoffice as directors of Dr. Morris S. Young, Dr. David C. Chang and Mr. LeonardLeBlanc continued after the meeting.

 

(2)               Proposal toratify the appointment of Burr, Pilger & Mayer LLP as independentregistered public accounting firm for the fiscal year ending December 31,2009.

 
| ** **                        | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|-----------------------------------|------------|------------|------------|-------------|------------|-------------|------------|
| Burr, Pilger & Mayer LLP |       | 23,909,428 |       | 133,263     |       | 77,790      |       |

 

Accordingly,both proposals were approved by the stockholders.

 

**Item 5.Other Information**

 

None

 

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**Item 6.Exhibits**

 

**a. Exhibits**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                           |
| 3.1(1)              |       | Restated Certificate of  Incorporation                                                                                                                         |
|                |       |                                                                                                                                                           |
| 3.2(2)              |       | Certificate of  Designation, Preferences and Rights of Series A Preferred Stock.                                                                          |
|                |       |                                                                                                                                                           |
| 3.3(3)              |       | Second Amended and  Restated By Laws                                                                                                                           |
|                |       |                                                                                                                                                           |
| 4.2(4)              |       | Rights Agreement dated  April 24, 2001 by and between AXT, Inc. and ComputerShare Trust  Company, Inc.                                          |
|                |       |                                                                                                                                                           |
| 10.33(5)            |       | Separation Agreement and  General Release of Claims between AXT, Inc. and Philip C.S. Yin.                                                                |
|                |       |                                                                                                                                                           |
| 10.34(6)            |       | Offer Letter dated  July 16, 2009 between AXT, Inc. and Dr. Morris S. Young.                                                                    |
|                |       |                                                                                                                                                           |
| 31.1                |       | Certification by Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                     |
|                |       |                                                                                                                                                           |
| 31.2                |       | Certification by Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                     |
|                |       |                                                                                                                                                           |
| 32.1                |       | Certification by Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                                                                           |
| 32.2                |       | Certification by Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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

 

(2) Incorporated byreference to 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 our Form 8-Kas filed with the SEC on May 30, 2001.

 

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

 

(5) Incorporated byreference to the exhibit of the same number as filed with the SEC in our Form 8-Kon April 20, 2009.

 

(6) Incorporated byreference to Exhibit 99.1 to our Form 8-K as filed with the SEC on July 20,2009.

 

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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 10, 2009 | By:       | /s/  MORRIS S. YOUNG |
|                         |      | Morris S. Young |
|                         |      | *Chief  Executive Officer* |
|                         |      | *(Principal  Executive Officer)* |
|                         |      |   |
|                         |      | /s/  WILSON W. CHEUNG |
|                         |      | Wilson  W. Cheung |
|                         |      | *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.                                                                                                  |
|        |       |                                                                                                                                                                                                                   |
| 10.33(5)    |       | Separation Agreement and  General Release of Claims between AXT, Inc. and Philip C.S. Yin.                                                                                                                        |
|        |       |                                                                                                                                                                                                                   |
| 10.34(6)    |       | Offer  Letter dated July 16, 2009 between AXT, Inc. and Dr. Morris S.  Young.                                                                                                                           |
|        |       |                                                                                                                                                                                                                   |
| 31.1        |       | Certification by Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                             |
|        |       |                                                                                                                                                                                                                   |
| 31.2        |       | Certification by Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                             |
|        |       |                                                                                                                                                                                                                   |
| 32.1        |       | Certification by Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                         |
|        |       |                                                                                                                                                                                                                   |
| 32.2        |       | Certification by Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                         |

 

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

 

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

 

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

 

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

 

(5) Incorporated byreference to the exhibit as of the same number as filed with the SEC in our Form 8-Kon April 20, 2009.

 

(6) Incorporated byreference to Exhibit 99.1 to our Form 8-K as filed with the SEC on July 20,2009.

 

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