Table of Contents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**(Mark One)**

 
| **x**                                                       | **Quarterly report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**  |
|-------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                                        |                                                                                                    |
| **for the quarterly period ended September 30,  2009** |
|                                                        |                                                                                                    |
| **Or**                                                      |
|                                                        |                                                                                                    |
| **o**                                                       | **Transition report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934** |

 

**for thetransition periodfrom                 to                 **

 

**Commission File Number 000-24085**

 

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**AXT,INC.**

(Exact name of registrant as specified in itscharter)

 

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

 

**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 filingrequirements for the past 90 days.  YES x NO o

 

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

 

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

 

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

 

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 October 30, 2009** |
|--------------------------------|------------|---------------------------------------------------------|
| Common Stock, $0.001 par value |       | 30,670,640                                              |

 

 

 

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AXT, INC.FORM 10-QTABLE OF CONTENTS

 
| ** **                                                                                                                    | ** ** | **Page** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| PART I.  FINANCIAL INFORMATION                                                                                           |       | 3        |
| Item 1.  Financial Statements (unaudited)                                                                                     |       | 3        |
| Condensed Consolidated Balance  Sheets as of September 30, 2009 and December 31, 2008                               |       | 3        |
| Condensed Consolidated Statements  of Operations for the three months and nine months ended September 30,  2009 and 2008 |       | 4        |
| Condensed Consolidated Statements  of Cash Flows for the nine months ended September 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                           |       | 17       |
| 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. FinancialStatements**

 

AXT, INC.CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except per share data)

 
| ** **                                                                                                                                                                                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                        | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| Assets:                                                                                                                                                                                           |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                                   |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                         |       | $                      | 16,042     |                  | $          | 13,566 |   |
| Short-term investments                                                                                                                                                                            |       | 18,737                 |       | 17,756                |       |
| Accounts receivable, net of allowances of $220 and  $663 as of September 30, 2009 and December 31, 2008, respectively                                                                   |       | 13,983                 |       | 11,497                |       |
| Inventories, net                                                                                                                                                                                  |       | 28,642                 |       | 35,082                |       |
| Prepaid expenses and other current assets                                                                                                                                                         |       | 2,070                  |       | 3,131                 |       |
| Total current assets                                                                                                                                                                              |       | 79,474                 |       | 81,032                |       |
| Property, plant and equipment, net                                                                                                                                                                |       | 20,808                 |       | 22,184                |       |
| Restricted deposits                                                                                                                                                                               |       | 3,000                  |       | 3,013                 |       |
| Other assets                                                                                                                                                                                      |       | 5,768                  |       | 5,433                 |       |
| Total assets                                                                                                                                                                                      |       | $                      | 109,050    |                  | $          | 111,662 |   |
|                                                                                                                                                                                              |       |                   |       |                  |       |
| Liabilities and stockholders’ equity:                                                                                                                                                        |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                              |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                                  |       | $                      | 7,165      |                  | $          | 6,657 |   |
| Accrued liabilities                                                                                                                                                                               |       | 4,810                  |       | 4,453                 |       |
| Line of credit                                                                                                                                                                                    |       | 3,000                  |       | 3,013                 |       |
| Current portion of long-term debt                                                                                                                                                                 |       | 75                     |       | 73                    |       |
| Total current liabilities                                                                                                                                                                         |       | 15,050                 |       | 14,196                |       |
| Long-term debt, net of current portion                                                                                                                                                            |       | 440                    |       | 496                   |       |
| Other long-term liabilities                                                                                                                                                                       |       | 65                     |       | 94                    |       |
| Total liabilities                                                                                                                                                                                 |       | 15,555                 |       | 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 September 30,  2009 and December 31, 2008, respectively                  |       | 3,532                  |       | 3,532                 |       |
| Common stock, $0.001 par value per share; 70,000  shares authorized; 30,670 and 30,513 shares issued and outstanding as of  September 30, 2009 and December 31, 2008, respectively |       | 30                     |       | 30                    |       |
| Additional paid-in capital                                                                                                                                                                        |       | 187,478                |       | 186,754               |       |
| Accumulated deficit                                                                                                                                                                               |       | (103,907               | )          | (99,232               | )          |
| Accumulated other comprehensive income                                                                                                                                                            |       | 3,971                  |       | 2,580                 |       |
| Total AXT, Inc. stockholders’ equity                                                                                                                                                    |       | 91,104                 |       | 93,664                |       |
|                                                                                                                                                                                              |       |                   |       |                  |       |
| Noncontrolling interests                                                                                                                                                                          |       | 2,391                  |       | 3,212                 |       |
| Total stockholders’ equity                                                                                                                                                                   |       | 93,495                 |       | 96,876                |       |
|                                                                                                                                                                                              |       |                   |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                                   |       | $                      | 109,050    |                  | $          | 111,662 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

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AXT, INC.CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS

(Unaudited, in thousands, except per share data)

 
| ** **                                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                          | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                |       |                   |       |                   |       |   |   |   |   |
| Revenue                                                             |       | $                      | 16,819     |                   | $          | 17,863 |   | $ | 37,528 |   | $ | 57,429 |   |
| Cost  of revenue                                                    |       | 11,281                 |       | 13,326                 |       | 29,711 |   | 40,227 |   |
| Gross  profit                                                       |       | 5,538                  |       | 4,537                  |       | 7,817 |   | 17,202 |   |
|                                                                |       |                   |       |                   |       |   |   |   |   |
| Operating  expenses:                                                |       |                   |       |                   |       |   |   |   |   |
| Selling,  general and administrative                                |       | 3,323                  |       | 4,901                  |       | 10,815 |   | 12,146 |   |
| Research  and development                                           |       | 360                    |       | 562                    |       | 1,175 |   | 1,635 |   |
| Impairment  on assets held for sale                                 |       | —                 |       | —                 |       | — |   | 83 |   |
| Restructuring  charge                                               |       | —                 |       | —                 |       | 507 |   | — |   |
| Total  operating expenses                                           |       | 3,683                  |       | 5,463                  |       | 12,497 |   | 13,864 |   |
| Income  (loss) from operations                                      |       | 1,855                  |       | (926                   | )          | (4,680 | ) | 3,338 |   |
| Interest  income, net                                               |       | 39                     |       | 68                     |       | 117 |   | 433 |   |
| Other  income, net                                                  |       | 638                    |       | 298                    |       | 537 |   | 707 |   |
|                                                                |       |                   |       |                   |       |   |   |   |   |
| Income  (loss) before provision for income taxes                    |       | 2,532                  |       | (560                   | )          | (4,026 | ) | 4,478 |   |
| Provision  for income taxes                                         |       | 201                    |       | 177                    |       | 513 |   | 1,372 |   |
| Net  income (loss)                                                  |       | 2,331                  |       | (737                   | )          | (4,539 | ) | 3,106 |   |
|                                                                |       |                   |       |                   |       |   |   |   |   |
| Less:  Net (income) loss attributable to noncontrolling interest    |       | (210                   | )          | (277                   | )          | (136 | ) | (1,424 | ) |
| Net  income (loss) attributable to AXT, Inc.                   |       | $                      | 2,121      |                   | $          | (1,014 | ) | $ | (4,675 | ) | $ | 1,682 |   |
|                                                                |       |                   |       |                   |       |   |   |   |   |
| Net  income (loss) attributable to AXT, Inc. per common share: |       |                   |       |                   |       |   |   |   |   |
| Basic                                                               |       | $                      | 0.07       |                   | $          | (0.03 | ) | $ | (0.16 | ) | $ | 0.05 |   |
| Diluted                                                             |       | $                      | 0.07       |                   | $          | (0.03 | ) | $ | (0.16 | ) | $ | 0.05 |   |
|                                                                |       |                   |       |                   |       |   |   |   |   |
| Weighted  average number of common shares outstanding:              |       |                   |       |                   |       |   |   |   |   |
| Basic                                                               |       | 30,475                 |       | 30,455                 |       | 30,449 |   | 30,410 |   |
| Diluted                                                             |       | 30,911                 |       | 30,455                 |       | 30,449 |   | 31,502 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

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AXT, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS

(Unaudited, in thousands)

 
| ** **                                                                            | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
| Cash flows from operating activities:                                                 |       |                                                |       |   |   |
| Net income (loss)                                                                     |       | $                                                   | (4,539     | ) | $ | 3,106 |   |
|                                                                                  |       |                                                |       |   |   |
| Adjustments to reconcile net income (loss) to net  cash used in operating activities: |       |                                                |       |   |   |
| Depreciation                                                                          |       | 2,309                                               |       | 1,494 |   |
| Accretion of marketable securities premium                                            |       | (9                                                  | )          | (5 | ) |
| Loss (gain) on disposal of property, plant and  equipment                             |       | —                                              |       | (2 | ) |
| Impairment on assets held for sale                                                    |       | —                                              |       | 83 |   |
| Stock-based compensation                                                              |       | 677                                                 |       | 468 |   |
| Restructuring charge                                                                  |       | 507                                                 |       | — |   |
| Realized loss (gain) on sale of investments                                           |       | 9                                                   |       | (326 | ) |
| Changes in assets and liabilities:                                                    |       |                                                |       |   |   |
| Accounts receivable, net                                                              |       | (2,495                                              | )          | (1,060 | ) |
| Inventories                                                                           |       | 6,410                                               |       | (13,904 | ) |
| Prepaid expenses and other current assets                                             |       | 1,056                                               |       | 709 |   |
| Other assets                                                                          |       | (340                                                | )          | 50 |   |
| Accounts payable                                                                      |       | 528                                                 |       | 4,106 |   |
| Accrued liabilities                                                                   |       | (138                                                | )          | (1,037 | ) |
| Other long-term liabilities                                                           |       | (219                                                | )          | — |   |
| Net cash provided by (used in) operating  activities                                  |       | 3,756                                               |       | (6,318 | ) |
|                                                                                  |       |                                                |       |   |   |
| Cash flows from investing activities:                                                 |       |                                                |       |   |   |
| Purchases of property, plant and equipment                                            |       | (1,018                                              | )          | (5,995 | ) |
| Proceeds from sale of property, plant and  equipment                                  |       | 4                                                   |       | 4 |   |
| Proceeds from sale of assets held for sale                                            |       | —                                              |       | 5,057 |   |
| Purchases of marketable securities                                                    |       | (13                                                 | )          | (22,638 | ) |
| Proceeds from sale of marketable securities                                           |       | 440                                                 |       | 24,495 |   |
| Decrease in restricted deposits                                                       |       | 13                                                  |       | 3,700 |   |
| Net cash provided by (used in) investing  activities                                  |       | (574                                                | )          | 4,623 |   |
|                                                                                  |       |                                                |       |   |   |
| Cash flows from financing activities:                                                 |       |                                                |       |   |   |
| Proceeds from issuance of common stock, net                                           |       | 48                                                  |       | 171 |   |
| Proceeds from line of credit                                                          |       | —                                              |       | 3,000 |   |
| Dividends paid                                                                        |       | (756                                                | )          | (2,117 | ) |
| Long-term debt payments                                                               |       | (67                                                 | )          | (6,682 | ) |
| Net cash used in financing activities                                                 |       | (775                                                | )          | (5,628 | ) |
| Effect of exchange rate changes on cash and cash  equivalents                         |       | 69                                                  |       | 520 |   |
| Net increase (decrease) in cash and cash  equivalents                                 |       | 2,476                                               |       | (6,803 | ) |
| Cash and cash equivalents at the beginning of the  period                             |       | 13,566                                              |       | 18,380 |   |
| Cash and cash equivalents at the end of the period                                    |       | $                                                   | 16,042     |   | $ | 11,577 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

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AXT, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS

(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 periods ended March 31, 2009 and June 30, 2009filed with the SEC on May 11, 2009 and August 10, 2009, respectively.

 

Certainreclassifications have been made to the prior period consolidated financialstatements to conform to current period presentation.  These reclassifications had no impact onpreviously reported total assets, stockholders’ equity or net income (loss).

 

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

 

We account for stock-based compensation in accordance with theprovisions of FASB Accounting Standards Codification (“ASC”) ASC topic 718, *Compensation-Stock Compensation*(formerly known as SFAS No. 123(revised 2004), “*Share-Based Payment*,”(“SFAS 123(R)”)), which established accounting for stock-based awardsexchanged for employee services. Accordingly, stock-based compensation cost ismeasured at each grant date, based on the fair value of the award, and isrecognized as expense over the employee’s requisite service period of theaward. All of the Company’s stock compensation is accounted for as an equityinstrument. The provisions of ASC 718 apply to all awards granted ormodified after the date of adoption which was January 1, 2006. Theunrecognized expense of awards not yet vested at the date of adoption will berecognized in net income (loss) in the periods after the date of adoption usingthe same Black-Scholes valuation method and assumptions determined under theoriginal provisions of ASC 718.

 

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

 
| ** **                                                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                                             | ** ** | **2008**                                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| Stock-based compensation in the form of  employee stock options, included in: |       |                                                 |       |                                                |       |   |   |   |   |
|                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of revenue                                                                    |       | $                                                    | 8          |                                                | $          | 13 |   | $ | 31 |   | $ | 44 |   |
| Selling, general and administrative                                                |       | 84                                                   |       | 109                                                 |       | 595 |   | 324 |   |
| Research and development                                                           |       | 6                                                    |       | 25                                                  |       | 51 |   | 100 |   |
|                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Total stock-based compensation                                                     |       | 98                                                   |       | 147                                                 |       | 677 |   | 468 |   |
| Tax effect on stock-based compensation                                             |       | —                                               |       | —                                              |       | — |   | — |   |
|                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Net effect on net income (loss)                                                    |       | $                                                    | 98         |                                                | $          | 147 |   | $ | 677 |   | $ | 468 |   |
|                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Effect on basic net income (loss) per share                                        |       | $                                                    | 0.00       |                                                | $          | 0.00 |   | $ | (0.02 | ) | $ | (0.02 | ) |
| Effect on diluted net income (loss) per share                                      |       | $                                                    | 0.00       |                                                | $          | 0.00 |   | $ | (0.02 | ) | $ | (0.01 | ) |

 

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As of September 30, 2009 the total compensation costs related tounvested stock-based awards granted to employees under our stock option planbut not yet recognized was approximately $648,000, net of estimated forfeituresof $230,000. These costs will be amortized on a straight-line basis over aweighted-average period of approximately 3.17 years and will be adjusted forsubsequent changes in estimated forfeitures. We elected not to capitalizeany stock-based compensation to inventory as of September 30, 2009 due tothe immateriality of the amount.

 

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

 

We estimate the fair value of stock options using aBlack-Scholes valuation model, consistent with the provisions of ASC 718.There were 300,000 stock options granted in the three months ended September,2009 and there were no stock options granted in the three months ended September 30,2008. There were 300,000 and 1,500 strock options granted in the nine monthsended September 30, 2009 and 2008, respectively. The fair value of our stock options granted to employees forthe nine months ended September 30, 2009 and 2008 were estimated using thefollowing weighted-average assumptions:

 
| ** **                   | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------|------------|-----------------------------------------------------|------------|
| ** **                   | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
| Expected term (in  years)    |       | 4.0                                                 |       | 4.0 |   |
|                         |       |                                                |       |   |   |
| Volatility                   |       | 68.35                                               | %          | 60.79 | % |
|                         |       |                                                |       |   |   |
| Expected dividend            |       | 0                                                   | %          | 0 | % |
|                         |       |                                                |       |   |   |
| Risk-free interest rate      |       | 2.00                                                | %          | 2.69 | % |
|                         |       |                                                |       |   |   |
| Estimated forfeitures        |       | 10.63                                               | %          | 4.3 | % |
|                         |       |                                                |       |   |   |
| Weighted-average fair  value |       | 0.84                                                |       | $ | 2.47 |   |
|                              |            |                                                     |            |  |  |  |

 

The following tablesummarizes the stock option transactions during the nine months ended September 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                                                            |       | 300        |       | 1.59                                    |       |                                                                            |       |                            |       |
|                                                               |       |       |       |                                    |       |                                                                            |       |                            |       |
| Exercised                                                          |       | (37        | )          | 1.31                                    |       |                                                                            |       |                            |       |
|                                                               |       |       |       |                                    |       |                                                                            |       |                            |       |
| Canceled and expired                                               |       | (372       | )          | 3.46                                    |       |                                                                            |       |                            |       |
|                                                               |       |       |       |                                    |       |                                                                            |       |                            |       |
| Options outstanding as of September 30, 2009                  |       | 2,655      |       | $                                       | 2.53       |                                                                            | 4.47       |                            | $          | 919 |   |
|                                                               |       |       |       |                                    |       |                                                                            |       |                            |       |
| Options vested and expected to vest as of  September 30, 2009 |       | 2,568      |       | $                                       | 2.54       |                                                                            | 4.30       |                            | $          | 893 |   |
|                                                               |       |       |       |                                    |       |                                                                            |       |                            |       |
| Options exercisable as of September 30, 2009                  |       | 2,099      |       | $                                       | 2.60       |                                                                            | 3.20       |                            | $          | 765 |   |

 

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 $1.92 on September 30,2009, which would have been received by the option holder had all optionholders exercised their options on that date. The total number of in-the-moneyoptions exerciseable as of September 30, 2009 was 2,114,000.

 

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

** **
| **Options Outstanding as of September 30, 2009** | ** ** | **Options Exercisable  as of September 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                                                                  |       | 1,132,550                                                                  |       | $ | 1.28 |   | 3.25 |   | 1,132,394 |   | $ | 1.28 |   |
| $1.39 - $1.40                                                                  |       | 1,094                                                                      |       | $ | 1.40 |   | 5.45 |   | 1,094 |   | $ | 1.40 |   |
| $1.41 - $2.24                                                                  |       | 973,338                                                                    |       | $ | 1.82 |   | 5.93 |   | 505,701 |   | $ | 2.04 |   |
| $2.25 - $6.31                                                                  |       | 494,117                                                                    |       | $ | 4.99 |   | 4.65 |   | 406,230 |   | $ | 4.83 |   |
| $6.32 - $41.50                                                                 |       | 53,500                                                                     |       | $ | 18.98 |   | 2.05 |   | 53,500 |   | $ | 18.98 |   |
|                                                                           |       | 2,654,599                                                                  |       | $ | 2.53 |   | 4.47 |   | 2,098,919 |   | $ | 2.60 |   |

 

There were 6,250 and 36,833 options exercisedin the three and nine months ended September 30, 2009, respectively. Thetotal intrinsic value of options exercised for the three and nine months ended September 30,2009 was $433 and $2,298, respectively. Cash received from options exercisedfor the three and nine months ended September 30, 2009 was $8,175 and $48,175,respectively. The total intrinsic value of options exercised for the three andnine months ended September 30, 2008 was $30,000 and $275,000,respectively. Cash received from option exercises for the three and nine monthsended September 30, 2008 was $22,000 and $171,000, respectively.

 

A summary ofactivity related to restricted stock awards for the nine months ended September 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                                                |       | (7,827     | )          | $                                                          | 4.26       |   |
| Non-vested restricted stock shares outstanding as  of September 30, 2009 |       | 191,625    |       | $                                                          | 1.25       |   |

 

As of September 30, 2009 and 2008, wehad $187,000 and $59,000 of unrecognized compensation expense, net offorfeitures, related to restricted stock awards respectively, which will berecognized over the weighted average period of 2.22 and 1.76 years,respectively. During the nine months ended September 30, 2009 and 2008, 7,827shares and 7,827 shares of restricted 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):

 
| ** **                                   | ** ** | **September 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                                         |       | $                                | 15,999     |                            | $          | — |   | $ | — |   | $ | 15,999 |   | $ | 13,385 |   | $ | — |   | $ | — |   | $ | 13,385 |   |
| Cash equivalents:                            |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Money market fund                            |       | 43                               |       | —                          |       | — |   | 43 |   | 181 |   | — |   | — |   | 181 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total cash equivalents                       |       | 43                               |       | —                          |       | — |   | 43 |   | 181 |   | — |   | — |   | 181 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total cash and cash equivalents              |       | 16,042                           |       | —                          |       | — |   | 16,042 |   | 13,566 |   | — |   | — |   | 13,566 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments:                                 |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Corporate bonds                              |       | 21,908                           |       | 7                               |       | (178 | ) | 21,737 |   | 22,348 |   | — |   | (1,579 | ) | 20,769 |   |
| Total investments                            |       | 21,908                           |       | 7                               |       | (178 | ) | 21,737 |   | 22,348 |   | — |   | (1,579 | ) | 20,769 |   |
| Total cash, cash equivalents and investments |       | $                                | 37,950     |                            | 7          |   | $ | (178 | ) | $ | 37,779 |   | $ | 35,914 |   | $ | — |   | $ | (1,579 | ) | $ | 34,335 |   |
| **Contractual maturities on  investments:**  |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Due within 1 year                            |       | $                                | 21,908     |                            |       |   |   |   | $ | 21,737 |   | $ | 4,060 |   |   |   |   |   | $ | 3,822 |   |
| Due after 1 through 5 years                  |       | —                           |       |                            |       |   |   | — |   | 18,288 |   |   |   |   |   | 16,947 |   |
|                                         |       | $                                | 21,908     |                            |       |   |   |   | $ | 21,737 |   | $ | 22,348 |   |   |   |   |   | $ | 20,769 |   |
|                                              |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Theinvestments include $3.0 million recorded as restricted deposits on thecondensed consolidated balance sheets as of September 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 1.50% as of September 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 nine months ended September 30,2009 we had $9,000 gross realized losses on sales of our available-for-salesecurities. For the three and nine months ended September 30, 2008 we hadno realized gains or losses and $326,000 in gross realized gains on sales ofour 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 September 30, 2009 are temporary innature. We reviewed our investment portfolio to identify and evaluateinvestments that have indications of possible impairment. Factors considered indetermining whether a loss is temporary include the magnitude of the decline inmarket value, the length of time the market value has been below cost (oradjusted cost), credit quality, and our ability and intent to hold thesecurities for a period of time sufficient to allow for any anticipatedrecovery in market value. The following table provides a breakdown of ouravailable-for-sale securities with unrealized losses as of September 30,2009 (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        |       | $                                                        | —     |                                                     | $          | —                                |       | $ | 15,728 |   | $ | (178 | ) | $ | 15,728 |   | $ | (178 | ) |
| Total in loss position |       | $                                                        | —     |                                                     | $          | —                                |       | $ | 15,728 |   | $ | (178 | ) | $ | 15,728 |   | $ | (178 | ) |

 

***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 $4.2 million and $3.7 million as of September 30, 2009and December 31, 2008, respectively. We have investments in twounconsolidated privately-held companies accounted for under the cost method. Asof September 30, 2009 and December 31, 2008, our investments in thetwo unconsolidated privately-held companies accounted for under the cost methodhad a carrying value of $0.4 million and $0.4 million, respectively, and areincluded in “other assets” in the condensed consolidated balance sheets.

 

***FairValue Measurements***

 

On January 1, 2008, we adopted ASC topic 820, *FairValue Measurements and Disclosures* (formerly known as SFAS 157)which defines fair value, establishes a framework for using fair valueto measure assets and liabilities, and expands disclosures about fair valuemeasurements. ASC 820 applies whenever other statements require or permitassets or liabilities to be measured at fair value. ASC 820 applies to 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 ASC 820 asof September 30, 2009 (in thousands):

 
| ** **              | ** ** | **Balance as of  September 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       |       | $                                                         | 43         |                                                                                               | $          | 43                                                             |       | $ | — |   |
| Corporate bonds         |       | 21,737                                                    |       | —                                                                                             |       | 21,737                                                         |       |
| Total                   |       | $                                                         | 21,780     |                                                                                               | $          | 43                                                             |       | $ | 21,737 |   |
| Liabilities             |       | $                                                         | —     |                                                                                               | $          | —                                                         |       | $ | — |   |

 

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Our financial assets andliabilities are valued using market prices on both active markets(Level 1) and less active markets (Level 2). Level 1 instrumentvaluations are obtained from real-time quotes for transactions in activeexchange markets involving identical assets. Level 2 instrument valuationsare obtained from readily-available pricing sources for comparable instruments.As of September 30, 2009, we did not have any assets or liabilities withoutobservable market values that would require a high level of judgment todetermine 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 nine months of 2009 or 2008.

 

**Note 4.Inventories, Net**

 

The components ofinventories are summarized below (in thousands):

 
| ** **        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|------------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| Inventories, net: |       |                   |       |                  |       |
| Raw materials     |       | $                      | 11,887     |                  | $          | 17,863 |   |
| Work in process   |       | 13,022                 |       | 12,961                |       |
| Finished goods    |       | 3,733                  |       | 4,258                 |       |
|              |       | $                      | 28,642     |                  | $          | 35,082 |   |

 

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

 

During the ninemonths ended September 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 nine month period ended September 30, 2009.

 

**Note 6.Restructuring Charge**

 

As of September 30, 2009, our restructuringaccrual is as follows: (in thousands):

 
| ** **          | ** ** | **Restructuring  Accrual as of  December 31, 2008** | ** ** | **Additions** | ** ** | **Payments** | ** ** | **Restructuring  Accrual as of  Sept. 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 nine 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 reconciliation of the numerators and denominators ofthe basic and diluted net income (loss) per share calculations is as follows(in thousands, except per share data):

 
| ** **                                                                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2009**                                             | ** ** | **2008**                                            | ** ** | **2009** | ** ** | **2008** | ** ** |
| Numerator:                                                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Net  income (loss) attributable to AXT, Inc.                                |       | $                                                    | 2,121      |                                                | $          | (1,014 | ) | $ | (4,675 | ) | $ | 1,682 |   |
| Less: Preferred stock  dividends                                                 |       | (44                                                  | )          | (44                                                 | )          | (132 | ) | (132 | ) |
|                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Net income (loss)  available to common stockholders                              |       | $                                                    | 2,077      |                                                | $          | (1,058 | ) | $ | (4,807 | ) | $ | 1,550 |   |
| Denominator:                                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Denominator for basic net  income per share - weighted average common shares     |       | 30,475                                               |       | 30,455                                              |       | 30,449 |   | 30,410 |   |
| Effect of dilutive  securities:                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Common stock options                                                             |       | 436                                                  |       | —                                              |       | — |   | 1,092 |   |
| Denominator for dilutive  net income per common share                            |       | 30,911                                               |       | 30,455                                              |       | 30,449 |   | 31,502 |   |
| Basic net income (loss)  per share                                               |       | $                                                    | 0.07       |                                                | $          | (0.03 | ) | $ | (0.16 | ) | $ | 0.05 |   |
| Diluted net income (loss)  per share                                             |       | $                                                    | 0.07       |                                                | $          | (0.03 | ) | $ | (0.16 | ) | $ | 0.05 |   |
| Options excluded from  diluted net loss per share as the impact is anti-dilutive |       | 2,115                                                |       | 2,353                                               |       | 2,655 |   | 679 |   |

 

The 883,000 shares of $0.001par value Series A preferred stock issued on May 28, 1999 are non-voting andnon-convertible preferred stock with a 5.0% cumulative annual dividend ratepayable when declared by the board of directors, and $4 per share liquidationpreference over common stock, and must be paid before any distribution is madeto common stockholders.

 

**Note 8.Stockholders’ Equity and Other Comprehensive Income (Loss)**

 

**ConsolidatedStatements of Changes in Equity**

 
| ** **                                                 | ** ** | **Preferred  Stock** | ** ** | **Common  Stock** | ** ** | **Additional  Paid In Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Other  Comprehensive  Income/(loss)** | ** ** | **AXT, Inc.  stockholders  equity** | ** ** | **Noncontrolling  interests** | ** ** | **Total  stockholders’  equity** | ** ** |
|------------------------------------------------------------|------------|----------------------|------------|-------------------|------------|-------------------------------------------|------------|--------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|-------------------------------|------------|---------------------------------------|------------|
| Balance  as of December 31, 2008                      |       | $                    | 3,532      |              | $          | 30                                        |       | $                        | 186,754    |                                    | $          | (99,232                                  | )          | $                             | 2,580      |                                  | $          | 93,664 |   | $ | 3,212 |   | $ | 96,876 |   |
| Common  stock options exercised                            |       |                 |       |              |       | 47                                        |       |                     |       |                                    |       | 47                                       |       |                          |       | 47                                    |       |
| Stock-based  compensation                                  |       |                 |       |              |       | 677                                       |       |                     |       |                                    |       | 677                                      |       |                          |       | 677                                   |       |
| Comprehensive  loss:                                       |       |                 |       |              |       |                                      |       |                     |       |                                    |       |                                     |       |                          |       |                                  |       |
| Net (loss)  income                                         |       |                 |       |              |       |                                      |       | (4,675                   | )          |                                    |       | (4,675                                   | )          | 136                           |       | (4,539                                | )          |
| Dividend  declared                                         |       |                 |       |              |       |                                      |       |                     |       |                                    |       |                                     |       | (953                          | )          | (953                                  | )          |
| Change  in unrealized (loss) gain on marketable securities |       |                 |       |              |       |                                      |       |                     |       | 1,408                                   |       | 1,408                                    |       |                          |       | 1,408                                 |       |
| Currency  translation adjustment                           |       |                 |       |              |       |                                      |       |                     |       | (17                                     | )          | (17                                      | )          | (4                            | )          | (21                                   | )          |
| Balance  as of September 30, 2009                     |       | $                    | 3,532      |              | $          | 30                                        |       | $                        | 187,478    |                                    | $          | (103,907                                 | )          | $                             | 3,971      |                                  | $          | 91,104 |   | $ | 2,391 |   | $ | 93,495 |   |

 

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

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                      | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                      | ** ** | **2009**                         | ** ** | **2008**                        | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Net income (loss)                                                               |       | $                                | 2,331      |                            | $          | (737 | ) | $ | (4,539 | ) | $ | (3,106 | ) |
| Other comprehensive  income, net of tax:                                        |       |                             |       |                            |       |   |   |   |   |
| Change in foreign currency  translation gain (loss), net of tax                 |       | 19                               |       | 7                               |       | (21 | ) | 1,461 |   |
| Change in unrealized gain  (loss) on available-for-sale investments, net of tax |       | 518                              |       | (707                            | )          | 1,408 |   | (1,404 | ) |
| Total other comprehensive  income, net of tax                                   |       | 537                              |       | (700                            | )          | 1,387 |   | 57 |   |
| Comprehensive income  (loss)                                                    |       | 2,868                            |       | (1,437                          | )          | (3,152 | ) | (3,049 | ) |
| Comprehensive income  attributable to the noncontrolling interest               |       | (206                             | )          | (256                            | )          | (136 | ) | (1,104 | ) |
| Comprehensive income  (loss) attributable to AXT, Inc.                     |       | $                                | 2,662      |                            | $          | (1,693 | ) | $ | (3,288 | ) | $ | (4,153 | ) |

 

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**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 with ASCtopic 280,*Segment Reporting*(formerly known as SFAS No. 131,*“Disclosures about Segments of an Enterpriseand Related Information,”*)our chief operating decision-maker has been identified as the principalexecutive officer, who reviews operating results to make decisions aboutallocating resources and assessing performance for the company. Since weoperate in one segment, all financial segment and product line information canbe found in the consolidated financial statements.

 

***Product Information***

 
| ** **               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **               | ** ** | **2009**                         | ** ** | **2008**                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenue by product type: |       |                             |       |                            |       |   |   |   |   |
| GaAs substrates          |       | $                                | 13,316     |                            | $          | 13,617 |   | $ | 28,436 |   | $ | 40,479 |   |
| InP substrates           |       | 688                              |       | 484                             |       | 1,862 |   | 1,462 |   |
| Ge substrates            |       | 1,787                            |       | 795                             |       | 3,626 |   | 3,564 |   |
| Raw materials and other  |       | 1,028                            |       | 2,967                           |       | 3,604 |   | 11,924 |   |
| Consolidated             |       | $                                | 16,819     |                            | $          | 17,863 |   | $ | 37,528 |   | $ | 57,429 |   |

 

***GeographicalInformation***

*** ***

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

 
| ** **                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **September 30,**           | ** ** | **September 30**           | ** ** |
| ** **                     | ** ** | **2009**                         | ** ** | **2008**                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenue by geographic  region: |       |                             |       |                            |       |   |   |   |   |
| North America*                 |       | $                                | 2,975      |                            | $          | 5,030 |   | $ | 7,139 |   | $ | 15,466 |   |
| Europe                         |       | 3,115                            |       | 2,913                           |       | 7,592 |   | 9,696 |   |
| Japan                          |       | 2,304                            |       | 3,557                           |       | 5,494 |   | 12,292 |   |
| Taiwan                         |       | 3,462                            |       | 1,978                           |       | 6,897 |   | 6,846 |   |
| Asia Pacific                   |       | 4,963                            |       | 4,385                           |       | 10,406 |   | 13,129 |   |
| Consolidated                   |       | $                                | 16,819     |                            | $          | 17,863 |   | $ | 37,528 |   | $ | 57,429 |   |

 

----

*Primarilythe United States

 

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

 
| ** **                               | ** ** | **As of**         | ** ** |
|------------------------------------------|------------|------------------------|------------|
| ** **                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                               | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Long-lived assets by  geographic region: |       |                   |       |   |   |
| North America                            |       | $                      | 688        |   | $ | 867 |   |
| China                                    |       | 20,120                 |       | 21,317 |   |
|                                     |       | $                      | 20,808     |   | $ | 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 (includingthe IQE group) represented 16.5% and 10.1% of revenues for the three monthperiod ended September 30, 2009 while two customers (including the IQEgroup) represented 28.7% and 10.2% of revenues for the three month period endedSeptember 30, 2008. Two customers (including the IQE group) represented15.8% and 10.8% of revenues for the nine month period ended September 30,2009 while one customer (the IQE group) represented 20.2% of revenues for thenine month period ended September 30, 2008. Our top five customersrepresented 46.9% and 62.0% of revenue for the three month periods ended September 30,2009 and 2008, respectively. Our top five customers represented 42.9% and 47.5%of revenue for the nine month periods ended September 30, 2009 and 2008,respectively.

 

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** **

**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** | ** ** | ** **            | ** ** | ** **     | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------|------------|----------------|------------|
| ** **                                                                 | ** ** | **September 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                               |       | 3,324                                       |       | 2,906                 |       | Equity         |       | 25 | % |
| Emeishan Jia Mei High  Purity Metals Co., Ltd                    |       | 835                                         |       | 843                   |       | Equity         |       | 25 | % |
|                                                                            |            |                                             |            |                       |            |                |            |  |  |  |  |

 

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 president of joint venture operations is amember of the board. Our former chief executive officer and former chieffinancial officer, formerly members of this board of directors, resigned fromthis board on March 17, 2009 and August 28, 2009, respectively.

 

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 president of joint venture operations is a member ofthe board. Our former chief executive officer, formerly a member of this boardof 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 president of jointventure operations is a member of the board. Our former chief executive officerhas resigned as chairman of the board of BoYu 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 $4.2 million and$3.7 million as of September 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 ninemonths ended September 30, 2009 the three consolidated joint ventures hadincome of $705,000 and a income of $538,000, respectively of which $210,000 and$136,000 were allocated to minority interests, resulting in income of $494,000and a income of $401,000 included in our net income, respectively. During thethree and nine months ended September 30, 2008 the three consolidatedjoint ventures generated $0.8 million and $3.7 million of income, respectivelyof which $277,000 and $1.4 million were allocated to minority interests,resulting in $0.5 million and $2.3 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 $409,000and $812,000 for the nine months ended September 30, 2009 and 2008,respectively. Undistributed retained earnings relating to all our investmentsin these companies were $11.9 million, and $11.1 million,respectively as of September 30, 2009 and December 31, 2008,respectively.

 

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

 
| ** **       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **       | ** ** | **2009**                                             | ** ** | **2008**                                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|             |       |                                                 |       |                                                |       |   |   |   |   |
| Net Sales        |       | $                                                    | 3,037      |                                                | $          | 3,465 |   | $ | 9,252 |   | $ | 9,579 |   |
| Gross profit     |       | 1,392                                                |       | 2,093                                               |       | 3,243 |   | 5,273 |   |
| Operating income |       | 800                                                  |       | 1,527                                               |       | 1,548 |   | 3,754 |   |
| Net income       |       | 1,083                                                |       | 1,404                                               |       | 1,638 |   | 3,246 |   |
|                  |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |

 

We have investments in twounconsolidated privately-held companies accounted for under the cost method. Asof September 30, 2009 and December 31, 2008, our investments in thetwo unconsolidated privately-held companies accounted for under the cost methodhad a 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 nine months ended September 30, 2009 and 2008 (inthousands):

 
| ** **                                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                    | ** ** | **2009**                                             | ** ** | **2008**                                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                          |       |                                                 |       |                                                |       |   |   |   |   |
| Beginning accrued warranty  and related costs |       | $                                                    | 1,495      |                                                | $          | 1,309 |   | $ | 1,640 |   | $ | 1,030 |   |
| Charged (credited) to cost  of revenue        |       | 538                                                  |       | (95                                                 | )          | 856 |   | 313 |   |
| Actual warranty  expenditures                 |       | (321                                                 | )          | (118                                                | )          | (784 | ) | (247 | ) |
| Ending accrued warranty  and related costs    |       | $                                                    | 1,712      |                                                | $          | 1,096 |   | $ | 1,712 |   | $ | 1,096 |   |

 

***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 September 30, 2009, we do not have anyoutstanding material purchase obligations.

 

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

 

Weincurred foreign currency transaction exchange gains of $341,000 and foreigncurrency transaction exchange losses of $69,000 for the three month periodsended September 30, 2009, and 2008, respectively. We incurred foreigncurrency transaction exchange gains of $88,000 and foreign currency transactionexchange losses of $473,000 for the nine month periods ended September 30,2009, and 2008, respectively. These amounts are included in “Other income(expense), net” on the condensed consolidated statements of operations.

 

**Note 13. Income Taxes**

 

In July 2006,the Financial Accounting Standards Board (“FASB”) issued (formerly known as ASC topic 740,*Income Taxes*) Interpretation No. 48 (“FIN48”), *“Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109)”* (“SFAS 109”). ASC 740 clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with ASC 740. This interpretation prescribesa recognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. FIN 48 also provides guidance on derecognition of tax benefits,classification on the balance sheet, interest and penalties, accounting ininterim periods, disclosure, and transition. We adopted ASC 740 effective January 1,2007. We recognize interest and penalties related to uncertain tax positions inincome tax expense. As of September 30, 2009, we do not have any grossunrecognized tax benefits, nor any accrued interest and penalties related touncertain tax positions. As a result of the implementation of ASC 740, weidentified $16.4 million in the liability for unrecognized tax 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 Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 157, *FairValue Measurements*(“Statement 157”) (and as required by FASBAccounting Standards Codification (“ASC”) topic 820, *Fair Value Measurements and Disclosures*). Statement 157provides guidance for using fair value to measure assets and liabilities and alsoresponds to investors’ requests for expanded information about the extent towhich companies measure assets and liabilities at fair value, the informationused to measure fair value and the effect of fair value measurements onearnings. Statement 157 applies whenever other standards require (orpermit) assets or liabilities to be measured at fair value. Statement 157does not expand the use of fair value in any new circumstances. The Companyadopted Statement 157 on January 1, 2008 for all financial assets andliabilities recognized or disclosed at fair value in its consolidated financialstatements on a recurring basis (at least annually). Refer to Note 6. In February 2008,the FASB issued FASB Staff Position No. 157-2, *Effective Date of FASB Statement No. 157*(and asrequired by ASC topic 820, *Fair ValueMeasurements and Disclosures*), which delayed the effective date 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 Company adopted Statement 157 on January 1,2009 for nonfinancial assets and liabilities. The Company’s adoption ofStatement 157 did not have a material impact on its nonfinancial assets andliabilities or on its financial position and results of operations.

 

In December 2007, the FASB issued Statement ofFinancial Accounting Standards No. 141(R), *Business Combinations*(“Statement 141(R)”) (and as requiredby ASC topic 805, *Business Combinations*).Statement 141(R) establishes revised principles and requirements for therecognition and measurement of assets and liabilities in a businesscombination. Statement 141(R) requires (i) recognition of 100% of thefair value of acquired assets, including goodwill, and assumed liabilities uponobtaining control, (ii) contingent consideration to be recorded at fairvalue at the acquisition date, (iii) transaction costs to be expensed asincurred, (iv) pre-acquisition contingencies to be accounted for at theacquisition date at fair value and (v) costs of a plan to exit an activityor terminate or relocate employees to be accounted for as post-combinationcosts. The Company adopted Statement 141(R) on January 1, 2009. There was noimpact 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 issued Statement ofFinancial Accounting Standards No. 160, *NoncontrollingInterests in Consolidated Financial Statements—an amendment of ARB No. 51*(“Statement160”) (and as required by ASC topic 810, *Consolidation*). Statement 160 clarifies the classification of noncontrollinginterests in consolidated statements of financial position and the accountingfor and reporting of transactions between the reporting entity and holders ofsuch noncontrolling interests. The Company adopted Statement 160 on January 1,2009. The presentation and disclosures required of SFAS 160, which must beapplied retrospectively for all periods presented, have resulted inreclassifications to our prior period consolidated financial statements.

 

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In March 2008, the FASB issued Statement ofFinancial Accounting Standards No. 161, *Disclosuresabout Derivative Instruments and Hedging Activities—an amendment of FASBStatement No. 133*(“Statement 161”) (and as required by ASCtopic 815, *Derivatives and Hedging*).Statement 161 requires expanded disclosures about (i) how and why anentity uses derivative instruments, (ii) how derivative instruments andrelated hedged items are accounted for under FASB Statement of FinancialAccounting Standards No. 133, *Accountingfor Derivative Instruments and Hedging Activities*(“Statement 133”)and its related interpretations, and (iii) how derivative instruments andrelated hedged items affect an entity’s financial position, financialperformance and cash flows. We have determined that there is no impactfrom adopting this statement on our consolidated financial statements.

 

In May 2008, the FASB issued FASB Staff Position(“FSP”) No. APB 14-1, *Accounting forConvertible Debt Instruments That May Be Settled in Cash upon Conversion(Including Partial Cash Settlement)*(“FSP APB 14-1”) (and asrequired by ASC topic 470, Debt, topic 815, *Derivativesand Hedging*, and topic 825, *FinancialInstruments*). We have determined that there is no impactfrom adopting this statement on our consolidated financial statements.

 

In June 2008, the FASB issued FSP Emerging IssuesTask Force 03-6-1, *Determining WhetherInstruments Granted in Share-Based Payment Transactions Are ParticipatingSecurities*(“FSP EITF 03-6-1”) (and as required by ASC topic 260, *Earnings per Share*). FSP EITF 03-6-1 wasissued to clarify that unvested share-based payment awards with a right toreceive nonforfeitable dividends are participating securities and to provideguidance on how to allocate earnings to participating securities and computebasic earnings per share using the two-class method. The Company adopted FSPEITF 03-6-1 on January 1, 2009 and applied it retrospectively to allperiods presented. We have determined that there is no impact fromadopting this statement on our consolidated financial statements.

 

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 FSP FAS No. 107-1 and APB 28-1, *Interim Disclosures about Fair Value of Financial Instruments*(“FSP107-1”) (and as required by ASC topic 825, *FinancialInstruments*). FSP 107-1 amends Statement of FinancialAccounting Standards No. 107, *Disclosuresabout Fair Value of Financial Instruments,*to require disclosuresabout fair value of financial instruments in interim reportingperiods. Such disclosures were previously required only in annual financialstatements. The Company adopted FSP 107-1 in the first quarter of 2009 and hasincluded the required disclosures in its consolidated financial statements.Refer to Note 3.

 

In May 2009,the FASB issued Statement of Financial Accounting Standards No. 165, *Subsequent Events*(“Statement 165”) (andas required by ASC topic 855, *SubsequentEvents*). Statement 165 establishes general standards ofaccounting for and disclosure of events that occur after the balance sheet datebut before the date the financial statements are issued or available to beissued. Disclosures should include the nature of the event and either anestimate of its financial effect or a statement that an estimate cannot be madeand the date through which an entity has evaluated subsequent events. TheCompany adopted Statement 165 in the second quarter of 2009 and has applied itsguidance prospectively. The implementation of this standard did not have asignificant impact on the Company’s consolidated financial statements and theCompany has included the required disclosures in its consolidated financialstatements. 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”) which establishes theCodification as the single source of authoritative nongovernmental U.S. GAAP(and as required by ASC topic 105, Generally Accepted Accounting Principles).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 combines all authoritative standards into a comprehensive,topically organized database. Since the Codification will completelyreplace existing standards, all future references to authoritative accountingliterature references in the

 

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Company’s financialstatements will be in accordance with the Codification. The Codification iseffective for interim and annual periods ending after September 15, 2009.The Company will apply the Codification beginning in the third quarter of 2009;however, references to both current GAAP and the Codification are included inthis filing. We have determined that there is no impact fromadopting the Codification on our consolidated financial statements.

 

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 areas couldimpact the future accounting of our operations.

 

**Note15. Subsequent Event**

 

On October 29, 2009,we announced three executive promotions. Raymond A. Low, formerly AXT’svice president, corporate controller and acting chief financial officer, wasappointed vice president and chief financial officer. Davis Zhang, formerly AXT’spresident of joint venture operations, was appointed president of AXT ChinaOperations, with responsibility for managing and developing AXT’s joint ventureoperations, as well as assisting chief executive officer, Dr. MorrisYoung, with the management of AXT’s manufacturing facilities in China. RobertG. Ochrym, formerly AXT’s vice president of business development, was appointedvice president of business development, strategic sales and marketing.  His responsibilities include sales for theNorth American East Coast, as well as for Europe, continuing to work closelywith John J. Cerilli, vice president of global sales and marketing, to maximizecustomer support around the world.  Hewill also be responsible for developing sales and marketing strategies, majorsale contract negotiations, major market identification and other strategicsales and marketing functions. These executive promotions were disclosed on theCurrent Report on Form 8-K filed by the Company with the Securities andExchange Commission on October 30, 2009.

 

In accordance with ASC topic 855, *Subsequent Events* (formerlyknown as SFAS No. 165, “*Subsequent Events,*”)we have evaluated subsequent events through the date that the consolidatedfinancial statements were filed with the Securities and Exchange Commission on November 9,2009. No events have taken place, other than the executive promotions, thatmeet the definition of a subsequent event that require disclosure in thisfiling.

 

**ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL 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:

 

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| **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 and employequity accounting for the two joint ventures in which we have a 25% interest.We purchase portions of the materials produced by these ventures for our ownuse and the joint ventures sell the remainder of their production to thirdparties. We use our direct sales force in the United States and independentsales representatives in Europe and Asia to market our substrates. We believethat, as the demand for compound semiconductor substrates is expected toincrease, we are positioned to leverage our PRC-based manufacturingcapabilities and access to favorably priced raw materials to increase ourmarket share. However, the economic downturn that began in 2008, coupled withinventory overhang in the industry put pressure on our financial performance in2008 and has continued to have an impact on our results in 2009.

 

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 second quarter continued through the third quarter, resulting instronger sales and improved gross margins. We believe that inventory levels inthe supply chain have improved from the second quarter, with the exception of ourgallium raw materials, which are not expected to begin to recover until late2009 into the first quarter of 2010.  Ourqualification efforts in both gallium arsenide and germanium substrates havebeen very successful and we are pleased with our increasing diversification inthese areas.

 

As of September 30,2009, our principal sources of liquidity were $34.8 million in cash and cashequivalents and short-term investments, excluding restricted deposits. Cash andcash equivalents and short-term investments of $34.8 million increased by $4.2million in the third quarter of 2009 compared to the second quarter of 2009.

 

On July 20, 2009, weannounced the appointment of Dr. Morris S. Young as chief executiveofficer, 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. On August 28,2009, our chief financial officer and corporate secretary resigned from theCompany and Mr. Raymond A. Low, vice president and corporate controllerwas appointed acting chief financial officer.

 

On October 29, 2009,we announced three executive promotions. Raymond A. Low, formerly AXT’svice president, corporate controller and acting chief financial officer, wasappointed vice president and chief financial officer. Davis Zhang, formerly AXT’spresident of joint venture operations, was appointed president of AXT ChinaOperations, with responsibility for managing and developing AXT’s joint ventureoperations, as well as assisting chief executive officer, Dr. MorrisYoung, with the management of AXT’s manufacturing facilities in China. RobertG. Ochrym, formerly AXT’s vice president of business development, was appointedvice president of business development, strategic sales and marketing.  His responsibilities include sales for theNorth American East Coast, as well as for Europe, continuing to work closelywith John J. Cerilli, vice president of global sales and marketing, to maximizecustomer support around the world.  Hewill also be responsible for developing sales and marketing strategies, majorsale contract negotiations, major market identification and other strategicsales and marketing functions.

 

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**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 and judgmentsabout future events and their effects on our results cannot be determined withcertainty, and are made based upon our historical experience and on otherassumptions that are believed to be reasonable under the circumstances. Theseestimates may change as new events occur or additional information isobtained, and we may periodically be faced with uncertainties, theoutcomes of which are not within our control and may not be known for aprolonged period of time. The discussion and analysis of our results ofoperations and financial condition are based upon these condensed consolidatedfinancial statements.

 

We have 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.

 

***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 September 30, 2009 and December 31,2008, our accounts receivable, net, balance was $14.0 million and $11.5million, respectively, which was net of an allowance for doubtful accounts of$220,000 and $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 September 30, 2009 and December 31,2008, accrued product warranties totaled $1.7 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.

 

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***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 and work-in-processthat include material, labor and manufacturing overhead costs. Given the natureof our substrate products, and the materials used in the manufacturing process,the wafers and ingots comprising work-in-process may be held in inventoryfor up to two years and three years, respectively, as the risk of obsolescencefor these materials is low. We routinely evaluate the levels of our inventoryin light of current market conditions in order to identify excess and obsoleteinventory, and we provide a valuation allowance for certain inventories basedupon the age and quality of the product and the projections for sale of thecompleted products. As of each of September 30, 2009 and December 31,2008, we had an inventory reserve of $11.4 million and $12.0 million,respectively for excess and obsolete inventory. The majority of this inventoryhas not been scrapped, and accordingly, may be sold in future periods. Ifactual demand for our products were to be substantially lower than estimated,additional inventory adjustments for excess or obsolete inventory might berequired, which could have a material impact on our business, financialcondition and results of operations.

 

***Impairment of Investments***

 

We classify our investments in debt and equity securities as available-for-salesecurities as prescribed by ASC topic 320, *Debt and Equity Securities*(formerly known as Statement of Financial Accounting Standards (SFAS) No. 115,*“Accounting for Certain Investments in Debtand Equity Securities.”)* All available-for-sale securities with aquoted market value below cost (or adjusted cost) are reviewed in order todetermine whether the decline is other-than-temporary. Factors considered indetermining whether a loss is temporary include the magnitude of the decline inmarket value, the length of time the market value has been below cost (oradjusted cost), credit quality, and our ability and intent to hold thesecurities for a period of time sufficient to allow for any anticipatedrecovery in market value.

 

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

 

***Fair Value of Investments***

 

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

 

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 1 prices,such as quoted prices for identical instruments in markets with insufficientvolume or infrequent transactions (less active markets), issuer credit ratings,non-binding market consensus prices that can be corroborated with observablemarket data, model-derived valuations in which all significant inputs areobservable or can be derived principally from or corroborated with observablemarket data for substantially the full term of the assets or liabilities, orquoted prices for similar assets or liabilities. These Level 2 instrumentsrequire more management judgment and subjectivity compared to Level 1instruments, 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.

 

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Level 3 instruments include unobservable inputsto the valuation methodology that are significant to the measurement of fairvalue of assets or liabilities. The determination of fair value forLevel 3 instruments requires the most management judgment andsubjectivity. As of September 30, 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 ASC topic 360, *Impairment of Disposal of Long-Lived Assets* (formerly knownas SFAS No. 144, *“Accounting for theImpairment or Disposal of Long-Lived Assets.”)* When events andcircumstances indicate that long-lived assets may be impaired, we comparethe carrying value of the long-lived assets to the projection of futureundiscounted cash flows attributable to these assets. In the event that thecarrying value exceeds the future undiscounted cash flows, we record animpairment charge against income equal to the excess of the carrying value overthe assets’ fair value. Fair values are determined based on quoted marketvalues, discounted cash flows or internal and external appraisals, asapplicable. Assets held for sale are carried at the lower of carrying value orestimated 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 ASC 718, using the modified prospective application transitionmethod. Under this transition method, stock-based compensation cost wasrecognized in the condensed consolidated financial statements for allshare-based payments after January 1, 2006. Compensation cost recognizedincludes the estimated expense for the portion of the vesting period after January 1,2006 for share-based payments prior to, but not vested as of January 1,2006, based on the grant date fair value estimated in accordance with theoriginal provisions of ASC 718.*”* We recognizethese compensation 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 ASC 740 which requiresthat deferred tax assets and liabilities be recognized using enacted tax ratesfor the effect of temporary differences between the book and tax bases ofrecorded assets and liabilities. ASC 740 also requires that deferred tax assetsbe reduced by a valuation allowance if it is more likely than not that aportion of the deferred tax asset will not be realized.

 

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

 

Effective January 1, 2007, we adopted ASC 740. SeeNote 13—“Income Taxes” in the condensed financial statements foradditional information.

 

**Results ofOperations**

 

**Revenue**

 
| ** **              | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase**                   | ** ** | ** **     | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|--------------------------------|------------|----------------|------------|
| ** **              | ** ** | **2009**                                             | ** ** | **2008**                       | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **              | ** ** | ** **                                           | ** ** | **($ in thousands)** | ** ** | ** **     | ** ** | ** ** | ** ** |
| GaAs                    |       | $                                                    | 13,316     |                           | $          | 13,617         |       | $ | (301 | ) | (2.2 | )% |
| InP                     |       | 688                                                  |       | 484                            |       | 204            |       | 42.1 | % |
| Ge                      |       | 1,787                                                |       | 795                            |       | 992            |       | 124.8 | % |
| Raw materials and other |       | 1,028                                                |       | 2,967                          |       | (1,939         | )          | (65.4 | )% |
| Total revenue           |       | $                                                    | 16,819     |                           | $          | 17,863         |       | $ | (1,044 | ) | (5.8 | )% |

 

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Revenue decreased $1.0million, or 5.8%, to $16.8 million for the three months ended September 30,2009 from $17.9 million for the three months ended September 30, 2008.Total GaAs substrate revenue decreased $0.3 million, or 2.2%, to $13.3 millionfor the three months ended September 30, 2009 from $13.6 million for thethree months ended September 30, 2008. The slight decline in revenue wasprimarily due to the overall weaker demand environment compared to the prioryear.

 

Sales of 5 inch and 6inch diameter GaAs substrates were $5.9 million for the three months ended September 30,2009 compared to $6.1 million for the three months ended September 30,2008. The worldwide economic slowdown started in the three months ended September 30,2008 and demand has fallen since then. We have seen some recovery in the demandfor large diameter GaAs substrates and our revenue in the three months ended September 30,2009 increased over our revenue in the three months ended June 30, 2009which had in turn increased over our revenue in the three months ended March 31,2009. We expect revenue to increase only slightly in the next quarter as themarket is still cautious.

 

Sales of 2 inch, 3 inchand 4 inch diameter GaAs substrates were $7.5 million for the three monthsended September 30, 2009 compared with $7.5 million for the three monthsended September 30, 2008. Similar to sales of the larger diametersubstrates we expect revenue of smaller diameter GaAs substrates to increaseonly slightly in the next quarter as the market is still cautious.

 

InP substrate revenueincreased $0.2 million, or 42.1%, to $688,000 for the three months ended September 30,2009 from $484,000 for the three months ended September 30, 2008 as demandfrom customers in the optical networking industry has increased.

 

Ge substrate revenueincreased $1.0 million, or 124.8%, to $1.8 million for the three months ended September 30,2009 from $0.8 million for the three months ended September 30, 2008. Thisincrease was due to our newly qualified European customer for concentratedphotovoltaic solar applications.

 

Raw materials revenuedecreased $1.9 million, or 65.4%, to $1.0 million for the three months ended September 30,2009 from $2.9 million for the three months ended September 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 its customers to postpone orcancel orders.

 
| ** **              | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase**                   | ** ** | ** **     | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|--------------------------------|------------|----------------|------------|
| ** **              | ** ** | **2009**                                            | ** ** | **2008**                       | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **              | ** ** | ** **                                          | ** ** | **($ in thousands)** | ** ** | ** **     | ** ** | ** ** | ** ** |
| GaAs                    |       | $                                                   | 28,436     |                           | $          | 40,479         |       | $ | (12,043 | ) | (29.8 | )% |
| InP                     |       | 1,862                                               |       | 1,462                          |       | 400            |       | 27.4 | % |
| Ge                      |       | 3,626                                               |       | 3,564                          |       | 62             |       | 1.7 | % |
| Raw materials and other |       | 3,604                                               |       | 11,924                         |       | (8,320         | )          | (69.8 | )% |
| Total revenue           |       | $                                                   | 37,528     |                           | $          | 57,429         |       | $ | (19,901 | ) | (34.7 | )% |

 

Revenue decreased $19.9million, or 34.7%, to $37.5 million for the nine months ended September 30,2009 from $57.4 million for the nine months ended September 30, 2008.Total GaAs substrate revenue decreased $12.0 million, or 29.8%, to $28.4million for the nine months ended September 30, 2009 from $40.5 millionfor the nine months ended September 30, 2008. The decline in revenue wasprimarily due to the overall weaker demand environment and inventory overhang,affecting sales of all diameters.

 

Sales of 5 inch and 6inch diameter GaAs substrates were $11.6 million for the nine months ended September 30,2009 compared to $18.9 million for the nine months ended September 30,2008. The worldwide economic slowdown caused the demand from our large diametercustomers’ end customers to drop, causing our customers to temporarily utilizetheir excess inventory.  We expect demandfor our large diameter substrates to slightly increase in the fourth quarter of2009 and in the first quarter of 2010.

 

Sales of 2 inch, 3 inchand 4 inch diameter GaAs substrates were $16.8 million for the nine monthsended September 30, 2009 compared with $21.6 million for the nine monthsended September 30, 2008. Similar to the demand from our customers for ourlarger diameter substrates, the decrease in revenue from customers of smallerdiameter substrates was also due to the drop in demand due to the worldwideeconomic slowdown.

 

InP substrate revenueincreased $0.4 million, or 27.4%, to $1.9 million for the nine months ended September 30,2009 from $1.5 million for the nine months ended September 30, 2008 asdemand from customers in the optical networking industry has remained steady.

 

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Ge substrate revenueremained steady at $3.6 million for the nine months ended September 30,2009 compared to $3.6 million for the nine months ended September 30,2008. We had a decrease in revenue to customers in China and Germany that wasoffset by sales to our newly qualified European customer for concentratedphotovoltaic solar applications.

 

Raw materials revenuedecreased $8.3 million, or 69.5%, to $3.6 million for the nine months ended September 30,2009 from $11.9 million for the nine months ended September 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 its customers to postpone orcancel orders.

 

***Revenue by GeographicRegion***

 
| ** **                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                | ** ** | **2009**                                             | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| North America *                           |       | $                                                    | 2,975      |         | $          | 5,030          |       | $ | (2,055 | ) | (40.9 | )% |
| *% of total revenue*                      |       | 18                                                   | %          | 28           | %          |           |       |   |   |
| Europe                                    |       | 3,115                                                |       | 2,913        |       | 202            |       | 6.9 | % |
| *% of total revenue*                      |       | 19                                                   | %          | 16           | %          |           |       |   |   |
| Japan                                     |       | 2,304                                                |       | 3,557        |       | (1,253         | )          | (35.2 | )% |
| *% of total revenue*                      |       | 14                                                   | %          | 20           | %          |           |       |   |   |
| Taiwan                                    |       | 3,462                                                |       | 1,978        |       | 1,484          |       | 75.0 | % |
| *% of total revenue*                      |       | 21                                                   | %          | 11           | %          |           |       |   |   |
| Asia Pacific (excluding Japan and Taiwan) |       | 4,963                                                |       | 4,385        |       | 578            |       | 13.2 | % |
| *% of total revenue*                      |       | 30                                                   | %          | 25           | %          |           |       |   |   |
| Total revenue                             |       | $                                                    | 16,819     |         | $          | 17,863         |       | $ | (1,044 | ) | (5.8 | )% |

 

----

*Primarily the UnitedStates

 

Revenue from customers in NorthAmerica decreased by $2.1 million, or 40.9%, to $3.0 million for the threemonths ended September 30, 2009 from $5.0 million for the three monthsended September 30, 2008 as the demand for substrates fell due to theworldwide economic slowdown causing our customers to temporarily utilize theirexcess inventory. We expect demand from our North American customers toslightly increase in the fourth quarter of 2009 and in the first quarter of2010.

 

Revenue fromcustomers in Europe increased by $0.2 million, or 6.9%, to $3.1 million for thethree months ended September 30, 2009 from $2.9 million for the threemonths ended September 30, 2008. This increase came primarily from Gesubstrate sales to our newly qualified European customer for concentrated photovoltaicsolar applications that was partially offset by reduced sales to other Europeancustomers as demand for GaAs substrates fell due to the worldwide economicslowdown.

 

Revenue fromcustomers in Japan decreased by $1.3 million, or 35.2%, to $2.3 million for thethree months ended September 30, 2009 from $3.6 million for the threemonths ended September 30, 2008. This decrease was primarily caused by rawmaterial sales of 4N gallium as demand fell.

 

Revenue fromcustomers in Taiwan increased by $1.5 million, or 75.0%, to $3.5 million forthe three months ended September 30, 2009 from $2.0 million for the threemonths ended September 30, 2008. The increase came mainly from twoexisting customers for large diameter wafers as demand increased after the slowdownfrom the previous year.

 

Revenue fromcustomers in Asia Pacific (excluding Japan and Taiwan) increased by $0.6million, or 13.2%, to $5.0 million for the three months ended September 30,2009 from $4.4 million for the three months ended September 30, 2008. Thisincrease was primarily from increased sales to customers in China as demandincreased particularly in Ge substrates.

 
| ** **                                 | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                 | ** ** | **2009**                                            | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                 | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| North America *                            |       | $                                                   | 7,139      |         | $          | 15,466         |       | $ | (8,327 | ) | (53.8 | )% |
| *% of total revenue*                       |       | 19                                                  | %          | 27           | %          |           |       |   |   |
| Europe                                     |       | 7,592                                               |       | 9,696        |       | (2,104         | )          | (21.7 | )% |
| *% of total revenue*                       |       | 20                                                  | %          | 17           | %          |           |       |   |   |
| Japan                                      |       | 5,494                                               |       | 12,292       |       | (6,798         | )          | (55.3 | )% |
| *% of total revenue*                       |       | 15                                                  | %          | 21           | %          |           |       |   |   |
| Taiwan                                     |       | 6,897                                               |       | 6,846        |       | 51             |       | 0.7 | % |
| *% of total revenue*                       |       | 18                                                  | %          | 12           | %          |           |       |   |   |
| Asia Pacific (excluding  Japan and Taiwan) |       | 10,406                                              |       | 13,129       |       | (2,723         | )          | (20.7 | )% |
| *% of total revenue*                       |       | 28                                                  | %          | 23           | %          |           |       |   |   |
| Total revenue                              |       | $                                                   | 37,528     |         | $          | 57,429         |       | $ | (19,901 | ) | (34.7 | )% |

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*Primarily the UnitedStates

 

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Revenue from customers inNorth America decreased by $8.3 million, or 53.8%, to $7.1 million for the ninemonths ended September 30, 2009 from $15.5 million for the nine monthsended September 30, 2008 as the demand for substrates fell by $6.6 millionwhile the demand for raw materials fell by $1.7 million. The worldwide economicslowdown caused the demand from our North American customers’ end customers todrop, causing our North American customers to temporarily utilize their excessinventory.  We expect demand from ourNorth American customers to increase in the fourth quarter of 2009 and in thefirst quarter of 2010.

 

Revenue fromcustomers in Europe decreased by $2.1 million, or 21.7%, to $7.6 million forthe nine months ended September 30, 2009 from $9.7 million for the ninemonths ended September 30, 2008. This decrease came primarily fromdecreased raw material sales of $1.0 million to customers in The Netherlands,and decreased substrate sales to customers in Germany of $1.1 million and tocustomers in France of $0.9 million due to decreased demand, partially offsetby increased demand from customers in the United Kingdom of $0.7 million, oneof which is part of the IQE group with whom we renewed a supply agreement inthe fourth quarter of 2008. Substrate sales to other customers in Europedecreased by $0.2 million.

 

Revenue fromcustomers in Japan decreased by $6.8 million, or 55.3%, to $5.5 million for thenine months ended September 30, 2009 from $12.3 million for the ninemonths ended September 30, 2008. Raw material sales of 4N galliumdecreased by $5.1 million as demand fell while substrate sales decreased by$1.7 million, particularly in large diameter wafers.

 

Revenue from customers inTaiwan increased by $51,000, or 0.7%, to $6.9 million for the nine months endedSeptember 30, 2009 from $6.9 million for the nine months ended September 30,2008. We have seen some recovery by a large customer for demand for largediameter demand and our revenue from this customer in the three months ended September 30,2009 increased over our revenue from this customer in the three months ended June 30,2009 which had in turn increased over our revenue from this customer in thethree months ended March 31, 2009. We expect revenue from customers inTaiwan to increase only slightly in the next quarter as the market is stillcautious.

 

Revenue fromcustomers in Asia Pacific (excluding Japan and Taiwan) decreased by $2.7million, or 20.7%, to $10.4 million for the nine months ended September 30,2009 from $13.1 million for the nine months ended September 30, 2008.Decrease in demand caused sales to customers in China to decrease by $2.3million, sales to customers in Singapore to decrease by $0.3 million, and salesto customers in Korea to decrease by $0.1 million.

 

***Gross Margin***

 
| ** **       | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **       | ** ** | **2009**                                             | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Gross profit     |       | $                                                    | 5,538      |         | $          | 4,537          |       | $ | 1,001 |   | 22.1 | % |
| *Gross Margin %* |       | 32.9                                                 | %          | 25.4         | %          |           |       |   |   |
|                  |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

Gross margin increased to32.9% of total revenue for the three months ended September 30, 2009 from25.4% of total revenue for the three months ended September 30, 2008.Gross margins in the three months ended September 30, 2009 and 2008 werepositively impacted by the net sales of approximately $94,000 and $708,000,respectively, of GaAs wafers that were previously fully reserved. In the pastwe reported the gross sale of fully reserved wafers and its effects on grossmargin without taking into account the charge to cost of goods sold and itseffect on gross margin for wafers that were added to fully reserved wafers. Weare now reporting the net sale of fully reserved wafers and its effects ongross margin. The net sale is derived from the gross sale of fully reservedwafers less the charge to cost of goods sold for wafers that were added tofully reserved wafers. We have done this retroactively for all prior periodsreported. The 32.9 % gross margin for the three months ended September 30,2009 was primarily due to increases in our capacity utilization, favorableproduct mix, improved manufacturing efficiency, and a focus on cost-control. Inaddition, in the prior year, gross margins were negatively impacted bydeclining average selling prices and rising raw material costs. This yearaverage selling prices have declined at a lower rate and raw material costshave stabilized somewhat.

 

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| ** **       | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **       | ** ** | **2009**                                            | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **       | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Gross profit     |       | $                                                   | 7,817      |         | $          | 17,202         |       | $ | (9,385 | ) | (54.6 | )% |
| *Gross Margin %* |       | 20.8                                                | %          | 30.0         | %          |           |       |   |   |
|                  |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

Grossmargin decreased to 20.8% of total revenue for the nine months ended September 30,2009 from 30.0% of total revenue for the nine months ended September 30,2008. Gross margins in the nine months ended September 30, 2009 and 2008were positively impacted by net sales of approximately $0.5 million and $1.2million, respectively, of GaAs wafers that were previously fully reserved. Inthe past we reported the gross sale of fully reserved wafers and its effects ongross margin without taking into account the charge to cost of goods sold andits effect on gross margin for wafers that were added to fully reserved wafers.We are now reporting the net sale of fully reserved wafers and its effects ongross margin. The net sale is derived from the gross sale of fully reservedwafers less the charge to cost of goods sold for wafers that were added tofully reserved wafers. We have done this retroactively for all prior periodsreported. The 20.8 % gross margin for the nine months ended September 30,2009 was primarily due to the lower absorption rates as a result of reducedsales since the fourth quarter of 2008 due to the worldwide economic slowdown,and hence lower production volume. Since late 2008, our gallium joint venturein China also continued to source finished products from an independent thirdparty supplier, resulting in low gross margin. Our gallium joint venturecontinues to discuss with this third party supplier an agreement to purchaseand distribute a certain amount of its product on an ongoing basis, in amountsrepresenting up to 50% of our joint venture’s total customer commitments.  This third-party provider has a substantialshare of the available gallium and is interested in partnering with our jointventure in order to leverage its distribution capabilities. Although thispotential partnership would provide additional capacity to our joint ventureand increase its competitive position, should an agreement be formalized, ourraw materials gross margin would be negatively impacted. In addition, grossmargins were negatively impacted by declining average selling prices and risingraw material costs, as well as an increase in depreciation as a result of ourpurchase of equipment acquired for our capacity expansion.

 

Conversely,product mix contributed to higher gross profit for the nine months ended September 30,2008 as we sold a greater amount of larger diameter substrates whichcontributed higher gross profit.

 

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

 
| ** **                                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                    | ** ** | **2009**                                             | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                    | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Selling, general and  administrative expenses |       | $                                                    | 3,323      |         | $          | 4,901          |       | $ | 1,578 |   | 32.2 | % |
| *% of total revenue*                          |       | 19.8                                                 | %          | 27.4         | %          |           |       |   |   |
|                                               |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

Selling, generaland administrative expenses decreased $1.6 million, or 32.2%, to $3.3 millionfor the three months ended September 30, 2009 from $4.9 million for thethree months ended September 30, 2008. The decrease was primarily from theabsence in 2009 of the $0.7 million rent deposit forfeited in 2008 and of the$0.1 million higher bank fees in connection with our paydown of our revenuebond in July 2008. In 2009, we also had $0.4 million lower bad debtexpenses as we improved collections from slow paying customers in China andNorth America. In 2009, we had $0.1 million less rent expense at our Fremont,CA facility, $0.1 million lower consulting and insurance costs in our Chinajoint ventures, $0.1 million lower employee costs from the departure of keyexecutives, and $0.1 million lower legal and professional fees. The $700,000rent deposit forfeited in 2008 was a result of a termination of our existinglease. We entered into a new lease in 2008 with the same landlord for smallerheadquarters facilities at a saving of approximately $2.5 million over thefollowing seven years.

 
| ** **                                    | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                    | ** ** | **2009**                                            | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                    | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Selling, general and  administrative expenses |       | $                                                   | 10,815     |         | $          | 12,146         |       | $ | 1,331 |   | 11.0 | % |
| *% of total revenue*                          |       | 28.9                                                | %          | 21.1         | %          |           |       |   |   |
|                                               |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

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Selling, generaland administrative expenses decreased $1.3 million, or 11.0%, to $10.8 millionfor the nine months ended September 30, 2009 from $12.1 million for thenine months ended September 30, 2008. The decrease was primarily from theabsence in 2009 of the $0.7 million rent deposit forfeited in 2008 and of the$0.1 million higher bank fees in connection with our paydown of our revenuebond in July 2008. In 2009, we also had $0.4 million lower bad debtexpenses as we improved collections from slow paying customers in China andNorth America, $0.5 million from the absence of bonus accruals primarily in thefirst half of 2009, $0.4 million less rent expense at our Fremont, CA facility,$0.3 million lower labor, consulting and insurance costs in our China jointventures, $0.2 million lower employee costs from the departure of key executives,and $0.2 million less travel expenses from cost cutting and from no travel byour former executives, partially offset by $0.7 million severance pay for ourformer chief executive officer and former chief operating officer, $0.5 millionincreased legal fees as a result of matters relating to the change inmanagement in March 2009, $0.3 million in related stock compensationexpense for his stock option acceleration. The $700,000 rent deposit forfeitedin 2008 was a result of a termination of our existing lease. We entered into anew lease in 2008 with the same landlord for smaller headquarters facilities ata saving of approximately $2.5 million over the following seven years.

 

***Researchand Development***

 
| ** **               | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **2009**                                             | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Research and development |       | $                                                    | 360        |         | $          | 562            |       | $ | (202 | ) | (35.9 | )% |
| *% of total revenue*     |       | 2.1                                                  | %          | 3.1          | %          |           |       |   |   |
|                          |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

Research anddevelopment expenses decreased $0.2 million, or 35.9% to $0.4 million for thethree months ended September 30, 2009 from $0.6 million for the threemonths ended September 30, 2008. The decrease was primarily due to $0.1million less labor costs as a result of our restructuring in March 2009and the absence of bonus accruals beginning in 2009, and $0.1 million lessoutside consulting costs.

 
| ** **               | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **2009**                                            | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Research and development |       | $                                                   | 1,175      |         | $          | 1,635          |       | $ | (460 | ) | (28.1 | )% |
| *% of total revenue*     |       | 3.1                                                 | %          | 2.8          | %          |           |       |   |   |
|                          |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

Research and development expenses decreased $0.5million, or 28.1%, to $1.2 million for the nine months ended September 30,2009 from $1.6 million for the nine months ended September 30, 2008. Thedecrease was primarily due to $0.3 million less labor costs as a result of ourrestructuring in March 2009 and the absence of bonus accruals beginning in2009, and $0.2 million less outside consulting costs and new products testingcosts.

 

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

*** ***
| ** **                                     | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                                     | ** ** | **2009**                                            | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                                     | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Impairment (Recovery) on  assets held for sale |       | $                                                   | —     |         | $          | 83             |       | $ | (83 | ) | NM |   |
| *% of total revenue*                           |       | 0.0                                                 | %          | 0.1          | %          |           |       |   |   |
|                                                |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

NM = % notmeaningful

 

During the firstquarter of 2008, we completed the sale of our property in Fremont, California.The escrow 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 nine month periods ended September 30,2009.

 

***Restructuring Charge***

 
| ** **           | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2009**                                            | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Restructuring charge |       | $                                                   |  507  |         | $          | —         |       | $ | 507 |   | NM |   |
| *% of total revenue* |       | 1.4                                                 | %          | 0.0          | %          |           |       |   |   |
|                      |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

NM = % notmeaningful

 

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During the firstquarter of 2009, we further reduced the workforce at our Fremont and Beijingfacilities by approximately 11 positions that are no longer required to supportcertain production and administrative operations. This measure was being takenas part of our 2009 operating plan. Accordingly, we recorded a restructuringcharge 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 nine months of 2008.

 

***Interest Income, net***

 
| ** **           | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2009**                                             | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Interest income, net |       | $                                                    | 39         |         | $          | 68             |       | $ | (29 | ) | (42.6 | )% |
| *% of total revenue* |       | 0.2                                                  | %          | 0.4          | %          |           |       |   |   |
|                      |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

Interest income,net decreased $29,000 to $39,000 for the three months ended September 30,2009 from $68,000 for the three months ended September 30, 2008 due tolower yields.

 
| ** **           | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2009**                                            | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Interest income, net |       | $                                                   | 117        |         | $          | 433            |       | $ | (316 | ) | (73.0 | )% |
| *% of total revenue* |       | 0.3                                                 | %          | 0.8          | %          |           |       |   |   |
|                      |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

Interest income, net decreased $0.3 million to $117,000for the nine months ended September 30, 2009 from $0.4 million for thenine months ended September 30, 2008. Interest income, net for the nine months ended September 30, 2009was lower compared to the prior year primarily from accrued interest that waspaid out from two investments that we had sold in the first half of 2008.

 

***Other Income, net***

 
| ** **           | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2009**                                             | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Other income, net    |       | $                                                    | 638        |         | $          | 298            |       | $ | 340 |   | 114.1 | % |
| *% of total revenue* |       | 3.8                                                  | %          | 1.7          | %          |           |       |   |   |
|                      |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

Other income, netwas $0.6 million for the three months ended September 30, 2009 primarilydue to unrealized foreign exchange gains of $0.3 million and investment incomeof $0.3 million from the two minority-owned joint ventures that are notconsolidated. Other income, net was $0.3 million for the three months ended September 30,2008 primarily due to investment income of $0.4 million from the sameminority-owned joint ventures that are not consolidated, partially offset byprimarily unrealized foreign exchange losses of $0.1 million.

 
| ** **           | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **           | ** ** | **2009**                                            | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **           | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Other income, net    |       | $                                                   | 537        |         | $          | 707            |       | $ | (170 | ) | (24.0 | )% |
| *% of total revenue* |       | 1.4                                                 | %          | 1.2          | %          |           |       |   |   |
|                      |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

Other income, netwas $0.5 million for the nine months ended September 30, 2009 primarilydue to investment income of $0.4 million from the two minority-owned jointventures that are not consolidated and unrealized foreign exchange gains of$0.1 million. Other income, net was $0.7 million for the nine months ended September 30,2008 primarily due to investment income of $1.2 million from the sameminority-owned joint ventures that are not consolidated, and partially offsetby primarily unrealized foreign exchange losses of $0.5 million.

 

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***Noncontrolling interest***

 
| ** **              | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **              | ** ** | **2009**                                             | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **              | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Noncontrolling interest |       | $                                                    | (210       | )            | $          | (277           | )          | $ | (67 | ) | (24.2 | )% |
| *% of total revenue*    |       | 1.2                                                  | %          | (1.6         | )%         |           |       |   |   |
|                         |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

Noncontrollinginterest decreased $0.1 million to $0.2 million for the three months ended September 30,2009 from $0.3 million for the three months ended September 30, 2008indicating less profitability from our China joint venture operations as rawmaterials sales have declined due to weaker demand environment causing ourcustomers to continue to utilize their excess inventory.

 
| ** **              | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **              | ** ** | **2009**                                            | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **              | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Noncontrolling interest |       | $                                                   | (136       | )            | $          | (1,424         | )          | $ | 1,288 |   | 90.4 | % |
| *% of total revenue*    |       | 0.0                                                 | %          | (2.5         | )%         |           |       |   |   |
|                         |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

Noncontrollinginterest decreased $1.3 million to $0.1 million for the nine months ended September 30,2009 from $1.4 million for the nine months ended September 30, 2008indicating less profitability from our China joint venture operations as rawmaterials sales have declined due to weaker demand environment causing ourcustomers to continue to utilize their excess inventory.

 

***Provision for IncomeTaxes***

 
| ** **                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------------|------------|------------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **2009**                                             | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                 | ** ** | **($ in thousands)**                       | ** ** | ** **   | ** ** | ** **     | ** ** |
| Provision for income taxes |       | $                                                    | 201        |         | $          | 177            |       | $ | 24 |   | 13.6 | % |
| *% of total revenue*       |       | 1.2                                                  | %          | 1.0          | %          |           |       |   |   |
|                            |            |                                                      |            |              |            |                |            |  |  |  |  |  |

 

We provided forincome taxes of $201,000 for the three months ended September 30, 2009compared to $177,000 for the three months ended September 30, 2008. Theincrease in tax provision was primarily due to our higher tax position for ourChina operations for the three months ended September 30, 2009 compared tothe same period last year.

 
| ** **                 | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase** | ** ** | ** **     | ** ** |
|----------------------------|------------|-----------------------------------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **2009**                                            | ** ** | **2008**     | ** ** | **(Decrease)** | ** ** | **% Change** | ** ** |
| ** **                 | ** ** | **($ in thousands)**                      | ** ** | ** **   | ** ** | ** **     | ** ** |
| Provision for income taxes |       | $                                                   | 513        |         | $          | 1,372          |       | $ | (859 | ) | (62.6 | )% |
| *% of total revenue*       |       | 1.4                                                 | %          | 2.4          | %          |           |       |   |   |
|                            |            |                                                     |            |              |            |                |            |  |  |  |  |  |

 

We provided forincome taxes of $0.5 million for the nine months ended September 30, 2009compared to $1.4 million for the nine months ended September 30, 2008. Thedecrease in tax provision was primarily due to our overall lower tax positionfor our China operations for the first nine months of 2009 compared to the sameperiod last year.

 

**Liquidity and Capital Resources**

 

As of September 30,2009, our principal sources of liquidity were $34.8 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 to our condensed consolidated financial statements)are invested in Citigroup guaranteed instruments.

 

Cashand cash equivalents and short-term investments of $34.8 million increased by$4.2 million in the third quarter of 2009 compared to the second quarter of2009.

 

Net cash providedby operating activities of $3.8 million for the nine months ended September 30,2009 was primarily comprised of our net loss of $4.5 million, adjusted fornon-cash items of depreciation of $2.3 million, stock-based compensation of$0.7 million, and a restructuring charge of $0.5 million, partially offset by anet decrease of $4.8 million in assets and liabilities. The $4.8 million netdecrease in assets and liabilities primarily resulted from a $6.4 milliondecrease in inventory, a $1.1 million decrease in prepaid expenses and a $0.5million increase in accounts payable, partially offset by a $2.5 millionincrease in accounts receivable, a $0.3 million increase in other assets, a $0.2million decrease in other long-term liabilities, and a $0.2 million decrease inaccrued liabilities.

 

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Accountsreceivable, net increased by $2.5 million as of September 30, 2009compared to December 31, 2008 due to higher sales volume. Our days salesoutstanding (DSO) is 76 days as of September 30, 2009 and was 68 days asof December 31, 2008. Our DSO was lower in 2008 as we had higher rawmaterial sales which have quicker collection cycles than our substrate sales,as well as our improved collections in 2009.

 

Inventories, net,decreased by $6.4 million as of September 30, 2009, as we decreased rawmaterials by $6.0 million as we held back on purchasing and consumed what weneeded from existing inventory, and we decreased work-in-process and finishedgoods by $0.4 million as we shipped these out as sales.

 

Net cash used inoperating activities of $6.3 million for the nine months ended September 30,2008 was primarily comprised of our net income of $3.1 million, adjusted fornon-cash items of depreciation of $1.5 million, stock-based compensation of$0.5 million, partially offset by a realized gain on sale of investments of$0.3 million, and offset by a net increase of $11.1 million in assets andliabilities. The $11.1 million net increase in assets and liabilities primarilyresulted from a $13.9 million increase in inventories, $1.1 million increase inaccounts receivable, $1.0 million decrease in accrued liabilities, partiallyoffset by a $4.1 million increase in accounts payable, and a $0.8 milliondecrease in prepaid and other assets.

 

Inventories, net,increased by $13.9 million, as of September 30, 2008, as we increasedinventory in raw materials and work-in-process to increase production inanticipation of increased forecast sales, and finished goods for consignmentorders. Inventory in raw materials in our joint ventures as of September 30,2008, increased due to transportation restrictions during the Beijing Olympicsand Paralympics.

 

Accounts receivable, netincreased by $1.1 million, as a result of increased sales partially offset byan increase in our allowance for doubtful accounts. Our days sales outstanding(DSO) is 68 days as of September 30, 2008, compared to 64 days as of December31, 2007.

 

Net cash used ininvesting activities of $0.6 million for the nine months ended September 30,2009 was primarily from the purchase of property, plant and equipment of $1.0million partially offset by the proceeds on sale of marketable securities of$0.4 million.

 

Net cash provided byinvesting activities of $4.6 million for the nine months ended September 30,2008 was primarily from the proceeds from the sale of investments of $24.4million, proceeds from sale of assets held for sale of $5.1 million and thedecrease of restricted cash of $3.7 million, partially offset by the purchaseof investments totaling $22.6 million, and the purchase of property, plant andequipment of $6.0 million.

 

We expect to invest up toapproximately $2.7 million in capital projects at our China facilities forthe remainder of 2009, having delayed certain expansion activities as a resultof the impact of the current worldwide economic conditions.

 

Net cash used infinancing activities of $0.8 million for the nine months ended September 30,2009 consisted of $0.8 million dividends paid, and payments of $67,000 relatedto our tenant improvement loan, partially offset by net proceeds of $48,000 onthe issuance of common stock.

 

Net cash used infinancing activities of $5.6 million for the nine months ended September 30,2008 consisted of payments of $6.7 million related to long-term borrowings, and$2.1 million dividends paid, partially offset by $3.0 million proceeds from ourexpress line of credit, and $0.2 million from the proceeds from the exercise ofemployee stock options.

 

We believe that we haveadequate cash and investments to meet our needs over the next 12 months.If our sales decrease, however, our ability to generate cash from operationswill be adversely affected which could adversely affect our future liquidity,require us to use cash at a more rapid rate than expected, and require us toseek additional capital. There can be no assurance that such additional capitalwill be available or, if available it will be at terms acceptable to us. Cashfrom operations could be affected by various risks and uncertainties,including, but not limited to those set forth below under Item 1A “RisksFactors.”

 

Outstandingcontractual obligations as of September 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          |       | 514                                       |       | 75 |   | 159 |   | 173 |   | 107 |   |
| Operating leases                 |       | 1,815                                     |       | 306 |   | 564 |   | 583 |   | 362 |   |
| Total                            |       | $                                         | 5,329      |   | $ | 3,381 |   | $ | 723 |   | $ | 756 |   | $ | 469 |   |

 

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We lease certain officespace, manufacturing facilities and property under long-term operating leasesexpiring at various dates through November 2013. On July 2, 2008, weentered into a new lease agreement with the landlord of the facility at 4281Technology Drive, Fremont, California with approximately 27,760 square feet.The new lease commenced December 1, 2008 for a term of seven years, withan option by us to cancel the new lease after five years, upon forfeiture ofthe security deposit and payment of one-half of the fifth year’s rent. Totalrent expenses under these operating leases were approximately $0.1 millionand $0.2 million for the three months ended September 30, 2009 and2008, respectively.

 

**RecentAccounting Pronouncements**

 

In September 2006,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 157, *FairValue Measurements*(“Statement 157”) (and as required by FASBAccounting Standards Codification (“ASC”) topic 820, *Fair Value Measurements and Disclosures*).Statement 157 provides guidance for using fair value to measure assets andliabilities and also responds to investors’ requests for expanded informationabout the extent to which companies measure assets and liabilities at fairvalue, the information used to measure fair value and the effect of fair valuemeasurements on earnings. Statement 157 applies whenever other standardsrequire (or permit) assets or liabilities to be measured at fair value.Statement 157 does not expand the use of fair value in any newcircumstances. The Company adopted Statement 157 on January 1, 2008for all financial assets and liabilities recognized or disclosed at fair valuein its consolidated financial statements on a recurring basis (at leastannually). Refer to Note 6. In February 2008, the FASB issued FASB StaffPosition No. 157-2, *Effective Date ofFASB Statement No. 157*(and as required by ASC topic 820, *Fair Value Measurements and Disclosures*),which delayed the effective date for nonfinancial assets and nonfinancialliabilities, except for items that are recognized or disclosed at fair value inthe financial statements on a recurring basis (at least annually). The Companyadopted Statement 157 on January 1, 2009 for nonfinancial assets andliabilities. The Company’s adoption of Statement 157 did not have a materialimpact on its nonfinancial assets and liabilities or on its financial positionand results of operations.

 

In December 2007, the FASB issued Statement ofFinancial Accounting Standards No. 141(R), *Business Combinations*(“Statement 141(R)”) (and as requiredby ASC topic 805, *Business Combinations*).Statement 141(R) establishes revised principles and requirements for therecognition and measurement of assets and liabilities in a businesscombination. Statement 141(R) requires (i) recognition of 100% of thefair value of acquired assets, including goodwill, and assumed liabilities uponobtaining control, (ii) contingent consideration to be recorded at fairvalue at the acquisition date, (iii) transaction costs to be expensed asincurred, (iv) pre-acquisition contingencies to be accounted for at theacquisition date at fair value and (v) costs of a plan to exit an activityor terminate or relocate employees to be accounted for as post-combinationcosts. The Company adopted Statement 141(R) on January 1, 2009. There was noimpact 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 issued Statement ofFinancial Accounting Standards No. 160, *NoncontrollingInterests in Consolidated Financial Statements—an amendment of ARB No. 51*(“Statement160”) (and as required by ASC topic 810, *Consolidation*). Statement 160 clarifies the classification of noncontrollinginterests in consolidated statements of financial position and the accountingfor and reporting of transactions between the reporting entity and holders ofsuch noncontrolling interests. The Company adopted Statement 160 on January 1,2009. The presentation and disclosures required of SFAS 160, which must beapplied retrospectively for all periods presented, have resulted inreclassifications to our prior period consolidated financial statements.

 

In March 2008, the FASB issued Statement ofFinancial Accounting Standards No. 161, *Disclosuresabout Derivative Instruments and Hedging Activities—an amendment of FASBStatement No. 133*(“Statement 161”) (and as required by ASCtopic 815, *Derivatives and Hedging*).Statement 161 requires expanded disclosures about (i) how and why anentity uses derivative instruments, (ii) how derivative instruments andrelated hedged items are accounted for under FASB Statement of FinancialAccounting Standards No. 133, *Accountingfor Derivative Instruments and Hedging Activities*(“Statement 133”)and its related interpretations, and (iii) how derivative instruments andrelated hedged items affect an entity’s financial position, financialperformance and cash flows. We have determined that there is no impactfrom adopting this statement on our consolidated financial statements.

 

In May 2008, the FASB issued FASB Staff Position(“FSP”) No. APB 14-1, *Accounting forConvertible Debt Instruments That May Be Settled in Cash upon Conversion(Including Partial Cash Settlement)*(“FSP APB 14-1”) (and asrequired by ASC topic 470, Debt, topic 815, *Derivativesand Hedging*, and topic 825, *FinancialInstruments*). We have determined that there is no impactfrom adopting this statement on our consolidated financial statements.

 

In June 2008, the FASB issued FSP Emerging IssuesTask Force 03-6-1, *Determining WhetherInstruments Granted in Share-Based Payment Transactions Are ParticipatingSecurities*(“FSP EITF 03-6-1”) (and as required by ASC topic 260, *Earnings per Share*). FSP EITF 03-6-1 wasissued to clarify that unvested share-based payment awards with a right toreceive nonforfeitable dividends are participating securities and to provideguidance on how to allocate earnings to participating securities and computebasic earnings per share using the two-class method. The Company adopted FSPEITF 03-6-1 on January 1, 2009 and applied it retrospectively to allperiods presented. We have determined that there is no impact fromadopting this statement on our consolidated financial statements.

 

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In April2009, 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” andFASB Interpretation No. 14, “Reasonable Estimation of the Amount of a Loss”.Further, the FASB removed the subsequent accounting guidance for assets and liabilitiesarising from contingencies from SFAS No. 141(R). The requirements of this FSPcarry forward without significant revision the guidance on contingencies ofSFAS No. 141, “Business Combinations”, which was superseded by SFAS No. 141(R).The FSP also eliminates the requirement to disclose an estimate of the range ofpossible outcomes of recognized contingencies at the acquisition date. Forunrecognized contingencies, the FASB requires that entities include only thedisclosures required by SFAS No. 5. SFAS 141(R), as modified by FSP 141(R)-1,is required to be applied prospectively to business combinations for which theacquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008. The adoption of SFAS 141(R), as modified by FSP 141(R)-1, as of January 1,2009 had no impact on our consolidated financial statements and its effects onfuture periods will depend on the nature and extent of business combinationsthat we complete, if any, in or after fiscal 2009.

 

In April2009, the FASB issued FSP FAS No. 107-1 and APB 28-1, *Interim Disclosures about Fair Value of FinancialInstruments*(“FSP 107-1”) (and as required by ASC topic 825, *Financial Instruments*). FSP 107-1 amendsStatement of Financial Accounting Standards No. 107, *Disclosures about Fair Value of Financial Instruments,*torequire disclosures about fair value of financial instruments in interimreporting periods. Such disclosures were previously required only in annualfinancial statements. The Company adopted FSP 107-1 in the first quarter of2009 and has included the required disclosures in its consolidated financialstatements. Refer to Note 3.

 

In May 2009, the FASBissued Statement of Financial Accounting Standards No. 165, *Subsequent Events*(“Statement 165”) (andas required by ASC topic 855, *SubsequentEvents*). Statement 165 establishes general standards of accountingfor and disclosure of events that occur after the balance sheet date but beforethe date the financial statements are issued or available to be issued. Disclosuresshould include the nature of the event and either an estimate of its financialeffect or a statement that an estimate cannot be made and the date throughwhich an entity has evaluated subsequent events. The Company adopted Statement165 in the second quarter of 2009 and has applied its guidance prospectively. Theimplementation of this standard did not have a significant impact on theCompany’s consolidated financial statements and the Company has included the requireddisclosures in its consolidated financial statements. Accordingly, we adoptedthe provisions of SFAS 165 in the second quarter of 2009 and it did not have amaterial impact on our consolidated financial statements. Refer to Note 15 forour disclosure on subsequent events.

 

In June 2009, the FASBapproved the “*FASB Accounting Standards Codification*”(the “Codification”) which establishes the Codification as the single source ofauthoritative nongovernmental U.S. GAAP (and as required by ASC topic 105,Generally Accepted Accounting Principles). The Codification does not changecurrent U.S. GAAP, but is intended to simplify user access to all authoritativeU.S. GAAP by providing all the authoritative literature related to a particulartopic in one place. All existing accounting standard documents will besuperseded and all other accounting literature not included in the Codificationwill be considered nonauthoritative. The Codification combines allauthoritative standards into a comprehensive, topically organized database. Sincethe Codification will completely replace existing standards, all futurereferences to authoritative accounting literature references in the Company’sfinancial statements will be in accordance with the Codification. The Codificationis effective for interim and annual periods ending after September 15, 2009.The Company will apply the Codification beginning in the third quarter of 2009;however, references to both current GAAP and the Codification are included inthis filing. We have determined that there is no impact fromadopting the Codification on our consolidated financial statements.

 

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 as theycurrently exist. However, any changes to accounting principles generallyaccepted in the United States of America in these areas could impact the futureaccounting of our operations.

 

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**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 our foreignoperations is the renminbi, the local currency of China, where our operatingexpenses are predominantly in the local currency. Since most of our operationsare conducted in China, most of our costs are incurred in Chinese currency,which subjects us to fluctuations in the exchange rates between the U.S. dollarand the Chinese renminbi. We incur transaction gains or losses resulting fromconsolidation of expenses incurred in local currencies for these subsidiaries,as well as in translation of the assets and liabilities of these assets at eachbalance sheet date. These risks may be increased by the fluctuations andrevaluations of the Chinese renminbi. Our financial results could be adverselyaffected by factors such as changes in foreign currency exchange rates or weakeconomic conditions in foreign markets, including the revaluation by China ofthe renminbi, and any future adjustments that China may make to its currencysuch as any move it might make to a managed float systems with opportunistic interventions.In the future we may experience foreign exchange losses on our non-functionalcurrency denominated receivables and payables to the extent that we have notmitigated our exposure utilizing foreign currency forward exchange contracts.Foreign exchange losses could have a materially adverse effect on our operatingresults 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 September 30,2009, we had no outstanding commitments with respect to foreign exchangecontracts.

 

During the third quarter of 2009, we recorded a netrealized foreign exchange gain of $38,000, 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 third quarter of 2009, we recorded unrealized foreign currency gainof $ 21,000, included in the balance of accumulated other comprehensive incomeon 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 ourcosts are incurred in Chinese currency, which subjects us to fluctuations inthe exchange 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.

 

***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  Sept. 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                                      |       | $                                  | 15,999     |                        | 0.50       | %                                                | $          | 80                                                         |       | $                                                           | 72         |   | $ | 88 |   |
| Cash equivalents                          |       | 43                                 |       | 1.45                        |       | 1                                                |       | 1                                                          |       | 1                                                           |       |
| Investment in debt and equity instruments |       | 21,737                             |       | 4.76                        |       | 1,035                                            |       | 931                                                        |       | 1,138                                                       |       |
| Line of credit                            |       | (3,000                             | )          | 1.50                        |       | (45                                              | )          | (41                                                        | )          | (49                                                         | )          |
| Tenant improvement loan                   |       | (514                               | )          | 4.00                        |       | (21                                              | )          | (19                                                        | )          | (23                                                         | )          |
|                                      |       |                               |       |                        |       | $                                                | 1,050      |                                                       | $          | 944                                                         |       | $ | 1,155 |   |
|                                           |            |                                    |            |                             |            |                                                  |            |                                                            |            |                                                             |            |  |  |  |  |

 

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 other 

 

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comprehensiveincome (loss), net of estimated tax. Our cash, cash equivalents and short-terminvestments are in high-quality securities placed with Citicorp. We have noinvestments in auction rate securities. As of September 30, 2009, we have approximately$21.7 million in principal protected notes with Citicorp Smith Barney with afair value of approximately $21.7 million. We expect to decrease our exposureto Citicorp as these principal protected notes come due and the underlyingassets are placed into diversified securities.

 

***Accounts Receivable Risk***

 

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 receivable balanceas of September 30, 2009 at 24%, and 13%, 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 September 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 Rule13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934,as amended. Based upon that evaluation, our Chief Executive Officer and ourChief Financial Officer concluded that our disclosure controls and procedureswere effective as of the end of the period covered by this quarterly report.

 

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

 

During the quarter ended September30, 2009, we conducted training for our employees concerning matters relatingto understanding of and compliance with our code of conduct, our process forreporting matters to our audit committee, and compliance with applicable rules andregulations. In addition, in August 2009, our former chief financial officer and corporatesecretary resigned from the Company and Mr. Raymond A. Low, vice president andcorporate controller was appointed acting chief financial officer.  On October 29, 2009, Mr. Low wasappointed vice president and chief financial officer.

 

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**PART II.OTHER INFORMATION**

 

**Item 1.Legal Proceedings**

 

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

 

**Item 1A.Risk Factors**

 

There are no materialchanges from the risk factors set forth under Part I, Item 1A. “Risk Factors”in our Annual Report on Form 10-K for 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**

 

None

 

**Item 5.Other Information**

 

None

 

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**Item 6.Exhibits**

 

**a. Exhibits**

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

 

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(1) 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.

 

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**SIGNATURES**

 

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

 
|                     | AXT, INC. |
|--------------------------|-----------|
|                     |      |   |
| Dated:  November 9, 2009 | By:       | /s/  MORRIS S. YOUNG |
|                     |      | Morris S. Young |
| * *                 | * *  | *Chief  Executive Officer* |
| * *                 | * *  | *(Principal  Executive Officer)* |
|                     |      |   |
|                     |      | /s/  RAYMOND A. LOW |
|                     |      | Raymond  A. Low |
| * *                 | * *  | *Chief Financial Officer* |
| * *                 | * *  | *(Principal  Financial Officer and**Principal  Accounting Officer)* |

 

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**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                         |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                               |
| 3.1(1)      |       | Restated Certificate of  Incorporation                                                                                                                                                             |
|        |       |                                                                                                                                                                                               |
| 3.2(2)      |       | Certificate of  Designation, Preferences and Rights of Series A Preferred Stock (which is  incorporated herein by reference to Exhibit 2.1 to the registrant’s form 8-K  dated May 28, 1999). |
|        |       |                                                                                                                                                                                               |
| 3.3(3)      |       | Second Amended and  Restated By Laws                                                                                                                                                               |
|        |       |                                                                                                                                                                                               |
| 4.2(4)      |       | Rights Agreement dated  April 24, 2001 by and between AXT, Inc. and ComputerShare Trust Company, Inc.                                                                                              |
|        |       |                                                                                                                                                                                               |
| 31.1        |       | Certification by Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                               |
|        |       |                                                                                                                                                                                               |
| 31.2        |       | Certification by Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                               |
|        |       |                                                                                                                                                                                               |
| 32.1        |       | Certification by Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                               |
|        |       |                                                                                                                                                                                               |
| 32.2        |       | Certification by Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                               |

 

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(1) 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 by referenceto 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

 

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