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Applied MaterialsTable of ContentsUNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549Form 10-K(Mark One) ☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934For the fiscal year ended December 31, 2018OR☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934For the transition period from to Commission file number: 000-24085AXT, INC.(Exact name of registrant as specified in its charter)Delaware94-3031310(State or other jurisdiction ofincorporation or organization)(I.R.S. EmployerIdentification No.)4281 Technology Drive, Fremont, California94538(Address of principal executive offices)(Zip Code) Registrant’s telephone number, including area code: (510) 438-4700Securities registered pursuant to Section 12(b) of the Act:Title of each className of each exchange on which registeredCommon Stock, $0.001 par valueThe NASDAQ Stock Market LLCSecurities registered pursuant to Section 12(g) of the Act:NoneIndicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act ☐ Yes ☒ NoIndicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ☐ Yes ☒ NoIndicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirementsfor the past 90 days. ☒ Yes ☐ NoIndicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 ofRegulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit suchfiles). ☒ Yes ☐ NoIndicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, andwill not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K. ☐ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or anemerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule12b-2 of the Exchange Act.reporting company)Large accelerated filer ☐Accelerated filer ☒Non‑accelerated filer ☐ Smaller reporting company ☐Emerging growth company ☐ If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any newor revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ☐ Yes ☒ NoThe aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of $7.05 for the common stock onJune 30, 2018 as reported on the Nasdaq Global Select Market, was approximately $268,264,873. Shares of common stock held by each officer, director and byeach person who owns 10% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determinationof affiliate status is not a conclusive determination for other purposes.As of March 4, 2019, 39,983,959 shares, $0.001 par value, of the registrant’s common stock were outstanding. Table of ContentsTABLE OF CONTENTS Page PART I Item 1. Business3Item 1A. Risk Factors 15Item 1B. Unresolved Staff Comments 36Item 2. Properties 37Item 3. Legal Proceedings 37Item 4. Mine Safety Disclosures 37 PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities 38Item 6. Selected Consolidated Financial Data 40Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 41Item 7A. Quantitative and Qualitative Disclosures About Market Risk 56Item 8. Consolidated Financial Statements and Supplementary Data 59Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 59Item 9A. Controls and Procedures 59Item 9B. Other Information 60 PART III Item 10. Directors, Executive Officers and Corporate Governance 62Item 11. Executive Compensation 62Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 62Item 13. Certain Relationships and Related Transactions and Director Independence 62Item 14. Principal Accountant Fees and Services 62 PART IV Item 15. Exhibits and Financial Statement Schedules 63Item 16. Form 10-K Summary 100 1 Table of Contents PART IThis Annual Report on Form 10-K (including the following section regarding Management’s Discussion andAnalysis of Financial Condition and Results of Operations) contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, asamended. Statements relating to our expectations regarding results of operations, market and customer demand for ourproducts, our competitors, customer qualifications of our products, our ability to expand our markets or increase sales,emerging applications using chips or devices fabricated on our substrates, the development of new products, applications,enhancements or technologies, the life cycles of our products and applications, product yields and gross margins, expenselevels, the impact of the adoption of certain accounting pronouncements, our investments in capital projects, our ability torelocate our gallium arsenide production line in a timely and orderly manner, our ability to have customers re-qualifysubstrates from our new manufacturing location in Dingxing, China, our ability to increase and utilize our manufacturingcapacity and our belief that we have adequate cash and investments to meet our needs over the next 12 months are forward-looking statements. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “goals,”“should,” “continues,” “would,” “could” and similar expressions or variations of such words are intended to identifyforward‑looking statements, but are not the exclusive means of identifying forward‑looking statements in this Annual Reporton Form 10-K. Additionally, statements concerning future matters such as our strategy and plans, industry trends and theimpact of trends, tariffs and trade wars, mandatory factory shutdowns in China, policies and regulations in China andeconomic cycles on our business are forward-looking statements. All forward-looking statements are based uponmanagement’s views as of the date of this Annual Report on Form 10-K and are subject to risks and uncertainties that couldcause actual results to differ materially from historical results or those anticipated in such forward-looking statements. Suchrisks and uncertainties include those set forth under the section entitled “Risk Factors” in Item 1A below, as well as thosediscussed elsewhere in this Annual Report on Form 10-K, and identify important factors that could disrupt or injure ourbusiness or cause actual results to differ materially from those predicted in any such forward-looking statements. These forward-looking statements are not guarantees of future performance. Readers are cautioned not to placeundue reliance on these forward-looking statements, which speak only as of the date hereof. Readers are urged to carefullyreview and consider the various disclosures made in this report, which attempt to advise interested parties of the risks andfactors that may affect our business, financial condition, results of operations and prospects. We undertake no obligation torevise or update any forward‑looking statements in order to reflect any development, event or circumstance that may ariseafter the date of this report. 2 Table of Contents Item 1. BusinessAXT, Inc. (“AXT”, “the Company”, “we,” “us,” and “our” refer to AXT, Inc. and its consolidated subsidiaries) is aworldwide materials science company that develops and produces high-performance compound and single elementsemiconductor substrates, also known as wafers. Our consolidated subsidiaries produce and sell certain raw materials some ofwhich are used in our substrate manufacturing process and some of which are sold to other companies.Our substrate wafers are used when a typical silicon substrate wafer cannot meet the performance requirements of asemiconductor or optoelectronic device. The dominant substrates used in producing semiconductor chips and otherelectronic circuits are made from silicon. However, certain chips may become too hot or perform their function too slowly ifsilicon is used as the base material. In addition, optoelectronic applications, such as LED lighting and chip-based lasers, donot use silicon substrates because they require a wave form frequency that cannot be achieved using silicon. Alternative orspecialty materials are used to replace silicon as the preferred base in these situations. Our wafers provide such alternative orspecialty materials. We do not design or manufacture the chips. We add value by researching, developing and producing thespecialty material wafers. We have two product lines: specialty material substrates and raw materials integral to thesesubstrates. Our compound substrates combine indium with phosphorous (indium phosphide: InP) or gallium with arsenic(gallium arsenide: GaAs). Our single element substrates are made from germanium (Ge).Our raw materials include both raw gallium and purified gallium. We use purified gallium in producing our GaAssubstrates and sell both raw gallium and purified gallium in the open market to other companies for use in producingmagnetic materials, high temperature thermometers, single crystal ingots, including gallium arsenide, gallium nitride,gallium antimonide and gallium phosphide ingots, and other materials and alloys. We also produce pyrolytic boron nitride(pBN) crucibles used in the high temperature (typically in the range 500 C to 1,500 C) growth process of single crystal ingotsand epitaxial layer growth in MBE (Molecular Beam Epitaxy) reactors. We use these pBN crucibles in our own ingot growthprocesses and also sell them in the open market to other companies. Our substrate product group generated 79%, 80% and81% of our revenue and our raw materials product group generated 21%, 20% and 19% for 2018, 2017 and 2016,respectively. 3 Table of ContentsThe following chart shows our substrate products and their materials, diameters and illustrative applications andshows our raw materials group primary products and their illustrative uses and applications. Products Substrate Group Wafer Diameter Sample of Applications Indium Phosphide 2”, 3”, 4” • Fiber optic lasers and detectors (InP) • Passive Optical Networks (PONs) • Data center connectivity using light/lasers • Silicon photonics • Photonic Integrated circuits (PICs) • High efficiency terrestrial solar cells (CPV) • RF amplifier and switching • Infrared light-emitting diode (LEDs) motion control • Infrared thermal imaging Gallium Arsenide 1”, 2”, 3”, 4”, 5”, 6” • Power amplifiers for wireless devices (GaAs - semi-insulating) • Direct broadcast television • High-performance transistors • Satellite communications • High efficiency solar cells for drones and automobiles Gallium Arsenide 1”, 2”, 3”, 4”, 5", 6” • 3-D sensing using VCSELs (GaAs - semi-conducting) • Data center communication using VCSELs • High brightness LEDs • Lasers • Near-infrared sensors • Printer head lasers and LEDs • Laser machining, cutting and drilling • Optical couplers • High efficiency solar cells for drones and automobiles • Night vision goggles Germanium 2”, 4”, 6” • Satellite solar cells (Ge) • Optical sensors and detectors • Terrestrial concentrated photo voltaic (CPV) cells • Multi-junction solar cells for satellites • Infrared detectors Raw Materials Group 4N raw gallium • Magnetic materials • High temperature thermometers • Low melting point alloys • Optical glass • Infrared detectors 6N+ purified gallium • Key material in single crystal ingots such as: - Gallium Arsenide (GaAs) - Gallium Nitride (GaN) - Gallium Antimonide (GaSb) - Gallium Phosphide (GaP) Boron trioxide (B2O3) • Encapsulant in the ingot growth of III-V compoundsemiconductors Gallium-Magnesium alloy • Used for the synthesis of organo-gallium compounds inepitaxial growth on semiconductor wafers pyrolytic boron nitride (pBN)crucibles • Used when growing single-crystal compoundsemiconductor ingots • Used when growing epitaxial layers in MBE reactors pBN insulating parts • Metal-Organic Chemical Vapour Deposition (MOCVD)reactors and organic light-emitting diode (OLED) rings 4 Table of ContentsWe manufacture all of our products in the People’s Republic of China (PRC or China), which generally hasfavorable costs for facilities and labor compared with comparable facilities in the United States, Europe or Japan. Our supplychain includes partial ownership of 10 companies in China (subsidiaries/joint ventures). We believe this supply chainarrangement provides us with pricing advantages, reliable supply, market trend visibility and better sourcing lead-times forkey raw materials central to manufacturing our substrates. Our subsidiaries and joint venture companies produce materials,including raw gallium (4N Ga), high purity gallium (6N Ga), arsenic, germanium, germanium dioxide, pyrolytic boron nitride(pBN) crucibles and boron oxide (B2O3). Our ownership and the ownership held by our consolidated subsidiaries in thesecompanies range from 97% to 20%. We have board representation in all 10 of these companies. We consolidate thecompanies in which we have either a controlling financial interest, or majority financial interest combined with the ability toexercise substantive control over the operations, or financial decisions, of such companies. We use the equity method toaccount for companies in which we have smaller financial interest and have the ability to exercise significant influence, butnot control, over such companies. We purchase portions of the materials produced by these companies for our own use andthey sell the remainder of their production to third parties. The Beijing city government is moving its offices into the area where our original manufacturing facility iscurrently located and is in the process of moving thousands of government employees into this area. The government hasconstructed showcase tower buildings and overseen the establishment of new apartment complexes, retail stores andrestaurants. An amusement park is being constructed within a few miles of our facility. To create room and upgrade thedistrict, the city instructed virtually all existing manufacturing companies, including AXT, to relocate all or some of theirmanufacturing lines. In 2018, we achieved every major milestone established in the relocation of our gallium arsenide andgermanium production lines. We intend to secure additional permits and approvals in 2019. The new facilities give us thelong-term capacity and a new level of technological sophistication in our manufacturing capabilities to support the majortrends that we believe are likely to drive demand for our products in the years ahead. Our indium phosphide production line,as well as various administrative and sales functions will remain primarily at our original site in the near future. To mitigate our risks and maintain our production schedule, we are moving our gallium arsenide equipment instages so that we will continue to produce our gallium arsenide products at our Beijing site, and then subsequently transferincreasing volume to the new sites. This approach will also minimize any disruption to our customers. We intend to completethis relocation in 2019. In 2018, we provided qualification wafers and our own internal characterization data from the newfacilities to our customers. Our major customers are in the process of qualifying the wafer substrates before placing volumepurchase orders for products from the new facilities. The relocation of our gallium arsenide production line requires us tocontinue to accurately execute our relocation plan. A failure to properly complete our relocation plan could result indisruption to our production and have a material adverse impact on our revenue, our results of operations and our financialcondition. If we fail to meet the product qualification requirements of a customer, we may lose sales to that customer. Ourreputation may also be damaged. Any loss of sales could have a material adverse effect on our revenue, our results ofoperations and our financial condition. On September 24, 2018, the Trump Administration announced a list of thousands of categories of goods that willface tariffs of 10%. All of our wafer substrates are manufactured in China and for the year ended December 31, 2018,approximately 10% of our revenue was generated by sales to customers in North America, primarily in the U.S. Our inboundproducts to the U.S. are now subject to a 10% tariff assessed on the customs value of the goods as imported by us, effectiveapproximately September 24, 2018. Although we do not believe the initial impact of approximately $150,000 per quarter ismaterial, the future impact of tariffs and trade wars is uncertain. The tariffs could be increased to 25% sometime in the future.We may be required to raise prices, which may result in the loss of customers and our business, financial condition and resultsof operations may be materially harmed. Additionally, the Trump Administration continues to signal that it may alter tradeagreements and terms between China and the United States, including limiting trade with China, and may impose additionaltariffs on imports from China. We were incorporated in California in December 1986 and reincorporated in Delaware in May 1998. The Companywent public in 1998. We changed our name from American Xtal Technology, Inc. to AXT, Inc. in July 2000. Our principalcorporate office is located at 4281 Technology Drive, Fremont, California 94538, and our telephone number at this address is(510) 438-4700. We have approximately 780 employees. In addition, our three consolidated5 Table of Contentssubsidiaries have, in total, approximately 300 employees. In aggregate, we and our subsidiaries have approximately 1080employees. Industry BackgroundCertain electronic and opto-electronic applications have performance requirements that exceed the capabilities ofconventional silicon substrates, also known as wafers, and often require high-performance compound wafers (mixture of twomaterials) or single element wafer substrates. Examples of higher performance non-silicon based wafer substrates includeGaAs, InP, gallium nitride (GaN), silicon carbide (SiC) and Ge. One of the earliest broadly used alternative wafer substrateswas GaAs and GaAs wafer substrates were the earliest wafer substrates we produced.Semi-insulating GaAs is used to create various high speed microwave components, including power amplifier chipsused in cell phones, satellite communications and broadcast television applications. Semi-conducting GaAs substrates areused to create opto-electronic products, including high brightness light-emitting diodes (HBLEDs) that are often used tobacklight wireless handsets and liquid crystal display (LCD) TVs and also used for automotive panels, signage, display andlighting applications. A new application for semi-conducting GaAs is 3-D sensing chips using VCSELs (vertical cavitysurface emitting lasers) as an array of lasers on a single chip that could be used in cell phones and other devices. InP is a highperformance semiconductor substrate used in broadband and fiber optic applications and data center connectivity. In recentyears, InP demand has increased. Ge substrates are used in applications such as solar cells for space and terrestrialphotovoltaic applications.The AXT AdvantagesWe believe that we benefit from the following advantages:·Key leadership in InP technology and revenue growth. We have invested in InP research and development fora number of years and have developed a strong base of proprietary technology that we continue to expand.There are significant barriers to entry in the InP substrate market and currently there are only three primaryproviders, including AXT. Further, we believe that this market will continue to expand and grow and we havebeen adding capacity to take advantage of this expansion.·Key provider of low defect density GaAs which can be used to make 3-D sensing chips. The deployment of 3-Dsensing facial recognition technology in cell phones and other devices requires GaAs substrates with low etchpit density (“EPD”) (i.e., low defect densities). The requirement of low EPD is a barrier to entry and we believethere are a limited number of potential substrate providers that can meet this requirement, which includes AXT.Several companies in Asia are already using our low EPD wafers for development although we are not yetselling wafers into the one program that we believe is in production. However, when we qualify low EPD wafersfrom our new location, we believe the quality of our low EPD wafers and our ability to expand manufacturingcapacity quickly will enable us to support new applications and generate additional revenue.·Proprietary process technology drives manufacturing. In our industry, the single crystal growth process andthe wafer manufacturing process incorporate proprietary process technology. We have a substantial body ofproprietary process technology and this creates a barrier to entry as evidenced by the small number of suppliersof InP wafers or GaAs low EPD wafers.·Low-cost manufacturing operation in China. Since 2004, we have manufactured all of our products in China,which generally has favorable costs for facilities and labor compared to costs of comparable facilities and laborin the United States, Japan or Europe. As of December 31, 2018, approximately 1,053 of our 1,080 employees(including employees at our Beijing and Dingxing facilities as well as our consolidated joint venturecompanies) were located in China. Our primary competitors have their major manufacturing operations inGermany or Japan. Our presence in China also enables us to closely manage our raw materials supply chain.6 Table of Contents·We are experienced at adding capacity quickly to take advantage of growing and changing market trends. Inrecent years, we have quickly added capacity for InP substrates, enabling us to grow that business. We believethat expansion is less difficult in China than in Japan or Germany where our major competitors arelocated. High volume emerging market applications may require rapid expansion and we believe we are well-positioned to respond to increased demand.·We are the only compound semiconductor substrate supplier to have a position in raw materials. We havepartial ownership of 10 companies in China that form an integral part of our supply chain. We believe oursubsidiaries and joint venture companies in China provide us with a more reliable supply of, and shorter lead-times for, the raw materials central to our final manufactured products compared to third party providers. Webelieve that this dedicated supply chain will enable us to meet increases in demand from our customers byproviding an increased volume of raw materials quickly, efficiently and cost effectively.·Our diverse product offering results in a broader range of customers and applications. We offer a diverserange of products. We are able to provide custom defined products that meet our customers’ specifications andwe have the technical sales support team to engage with our customers and understand theirproduct requirements. A significant percentage of the members of our team that engage with customers havePhDs in physics or materials science. Our product diversity gives us a greater opportunity to expand ourbusiness into new applications and markets, generating more revenue.·Enhanced revenue diversity through the sale of raw materials. Because our strategy allows our consolidatedsubsidiaries to also sell raw materials in the open market to third parties, approximately one fifth of our totalsales are from non-substrate products, providing further diversity in our customer base and business model.·Business model unique among current competitors. We believe we are the only publicly traded companyproducing InP, GaAs and Ge wafer substrates. Our direct competitors are either privately owned companies ordivisions within very large companies that are publicly listed in Japan. We believe the combination of accessto U.S. capital markets, U.S.-based product quality standards, but China-based manufacturing and a uniquestrategy for the supply of many of the raw materials we need is a competitive advantage as well as an attractivebusiness model to our customers.7 Table of ContentsStrategyOur goal is to become the leading worldwide supplier of high-performance compound and single elementsemiconductor substrates. Key elements of our strategy include:Promote our strengths in InP. As cloud-based data centers continue to combine integrated circuits and InP-basedlasers to transfer data through light, we believe there could be increased demand for InP substrates. We believe there are alsoother possible applications for InP substrates in the future, which could include driverless cars, 5G cell phones andinfrastructure.Add InP capacity and continue InP R&D. We are continuing to add manufacturing capacity for InP to support ourgrowth for this product line. Our wafer substrate products often have long product life cycles and we believe the InP productlife cycle could be similar to the long product life cycle of GaAs. In addition to adding manufacturing capacity, we arecontinuing to invest in InP crystal growth technology and wafer processing technology. For example, we are developing six-inch diameter ingots and improving the relative flatness of the wafer surface to improve performance.Position AXT to benefit from 3-D sensing applications in mobile devices. The GaAs substrate requirements for 3-Dsensing/facial recognition applications include very low defect densities or etch pitch densities. We are continuing todevelop semi-conducting GaAs six-inch diameter wafers with low EPD to support such applications. Establish the ability to rapidly add GaAs capacity. The relocation of our GaAs manufacturing lines presents astrategic opportunity to ensure our ability to increase capacity at our new site in the future should market demands justifysuch capacity expansion.Offer diverse products, including custom products. We believe AXT has a reputation in the market for providing abroad range of products, including custom products that are supported by a team of technical sales support professionals, themajority of whom hold advanced graduate degrees in physics or materials science. We plan to further promote this brandimage as a way to differentiate ourselves in the market. We believe this strategy will lead to a more diverse customer base.Sustain manufacturing efficiencies. We seek to continue to leverage our China-based manufacturing advantage byincreasing efficiencies in our manufacturing methods, systems and processes. Our strategy is to combine the benefits of U.S.-based quality control and access to U.S. capital markets with our China-based manufacturing operations.Increase productivity and seek profitability in our 10 subsidiaries/joint venture companies. The supply anddemand equation for specialty materials can be complex and volatile. Over the years, we have established or invested in 10companies that are an integral part of our supply chain. We will continue to provide strategic support to these companies andthey, in turn, will continue to be the backbone of our supply chain. We plan to work closely with these companies to increasetheir productivity and improve their financial performance as they continue to support our supply chain.Materials of the future. The specialty materials substrate market is dynamic and subject to continued changes andcycles. We plan to use our deep knowledge and experience in specialty materials and wafer substrates to seek newapplications for existing substrates in our portfolio and explore additional materials that may be synergistic with ourknowledge base, customer needs and manufacturing lines.TechnologyWafers serve as a cornerstone in semiconductor device fabrication, on which integrated circuits and optical devicesare fabricated. Wafers are derived from semi-conducting ingots that are grown in a cylindrical form. The diameter and lengthof an ingot will vary depending on the type of material and the growth process used. An ingot may be either single-crystalline (also referred to as single element) or multi-crystalline (also referred to as compound8 Table of Contentselements). Single-crystalline wafers typically have better material parameters. Depending on physical properties of thematerials in a wafer, the performance of devices and circuits can be remarkably different.AXT uses its proprietary vertical gradient freeze (VGF) technology for growing single crystal Indium Phosphide(InP), Gallium Arsenide (GaAs) and Germanium (Ge) ingots. After growing the crystalline ingot, the ingot is then sliced intoindividual substrates or wafers. Before specialty material wafers can be used, a thin layer of structured chemicals is grown onthe surface of the substrate. This is called an epitaxial layer. We sell the majority of our substrates to companies thatspecialize in applying the epitaxial layer. The wafers are then used to produce state-of-the-art electronic and opto-electronicdevices and circuit applications.InP and GaAs semi-conducting compounds are formed by combining elements from Groups III and V in the periodictable of elements, whereas Ge is a Group IV elemental material. Each of these materials has unique properties that determinethe best device and/or circuit applications. As a result of their special high electron mobility combined with their direct ban-gap properties, both InP and GaAs wafers have enjoyed dominant roles in the production of light-emitting diodes (LEDs),solid-state lasers and power amplifiers for mobile phones, to name a few applications. Ge wafers, on the other hand, haveplayed a key role in the manufacturing of special solar cells known as triple junction solar cells (TJSCs) for space andterrestrial power generation. With the recent evolution in several applications, InP lasers are projected to play a dominant role in theoptoelectronics arena, e.g. silicon photonics (where InP lasers are a key component) and autonomous cars (where specialwavelength InP-based lasers are used for object sensing and collision avoidance). Crystal growth process technologyfrequently contains steps and procedures that are considered proprietary secrets held by the producer, often includingmethods to control the temperature within the crucible. InP crystal growth relies on extreme pressure within the crucible. Assuch it requires not only temperature control methodologies, but also pressure control and stabilization processmethodologies, many of which AXT considers proprietary trade secrets. It is this combination of variables and the requiredmethods to control them that create a barrier to entry. We believe our long-term investment in InP research and developmenthas resulted in a substantive body of proprietary knowledge.After growing the crystalline ingot, the material is then sliced into individual substrates or wafers. We havecontinued to invest in wafer processing technology covering each step in the process from sawing to edge smoothing to finalcleaning and we believe we have technology and trade secrets addressing the scope of wafer processing. One focus in ourrecent development programs has been on automation, particularly in cleaning the wafers.Ideally, all the atoms in a wafer or substrate are arrayed in a specific periodic order. However, sensitivities in theingot growth process will cause some atoms to be improperly aligned and these are referred to as dislocations. The aggregatenumber of dislocations in a wafer is referred to as the dislocation density. Dislocation densities can be seen as a group of tinymarks or pits under a microscope by etching the wafer with acid and each wafer has an etch pit density or EPD. Certain microdevices, such as the array used for 3-D sensing, require wafers with very low EPD. AXT considers the process technology weuse to achieve low EPD as proprietary process technology and we believe we are one of only a few substrate manufacturingcompanies that can produce low EPD wafers.ProductsWe have two product lines: specialty material substrates and raw materials integral to these substrates. We design,develop, manufacture and distribute high-performance semiconductor substrates, also known as wafers. Through oursubsidiaries in our supply chain, we also sell certain raw materials. InP is a high-performance semiconductor substrate used infiber optic lasers and detectors, passive optical networks (PONs), telecommunication, metro and data center connectivity,silicon photonics, photonic ICs (PICs), terrestrial solar cell (CPV), lasers, RF amplifiers (military wireless), infrared motioncontrol and infrared thermal imaging. We make semi-insulating GaAs substrates used in making semiconductor chips inapplications such as power amplifiers for wireless devices, high-performance transistors and high efficiency solar cells fordrones. Our semi-conducting GaAs substrates are used to create opto-electronic products, which include High BrightnessLEDs that are often used to backlight wireless handsets and LCD TVs and for automotive, signage, display and lightingapplications, as well as high power industrial lasers for material processing (welding, cutting, drilling, soldering, marking andsurface modification). Our semi-conducting GaAs substrates could be9 Table of Contentsused to create opto-electronic products for 3-D sensing using VCSELs. Ge substrates are used in emerging applications, suchas triple junction solar cells for space and terrestrial photovoltaic applications and for optical applications. Substrates. We currently sell compound substrates manufactured from InP and GaAs, as well as single‑elementsubstrates manufactured from Ge. We supply InP substrates in two-, three‑ and four-inch diameters, and Ge substrates in two-,four- and six-inch diameters. We supply both semi-insulating and semi-conducting GaAs substrates in one-, two-, three‑, four-, five- and six-inch diameters. Many of our customers require customized specifications, such as special levels of iron orsulfur dopants or a special wafer thickness.Raw Materials. Our consolidated subsidiaries produce and sell certain raw materials, some of which are used in oursubstrate manufacturing process and some of which are sold to other companies. Our raw materials include both raw galliumand purified gallium. We use purified gallium to produce our GaAs substrates and sell both raw gallium and purified galliumin the open market to other companies for use in magnetic materials, high temperature thermometers and single crystalingots, including gallium arsenide, gallium nitride, gallium antimonide, gallium phosphide and other materials andalloys. We also produce pBN crucibles used in the high temperature (typically in the range 500 C to 1,500 C) growth processof single crystal ingots and epitaxial layer growth in MBE reactors. We use these pBN crucibles in our own ingot growthprocesses and also sell them in the open market to other companies. We promote our product diversity as a way to differentiate ourselves in the market. Some competitors provide onlygallium arsenide substrates. We provide gallium arsenide and also indium phosphide and germanium substrates. Somecompetitors limit their wafer diameters to only a few sizes. Our wafers range from one inch to up to six inches indiameter. We also produce substrates with customer defined specifications, which may range in thickness, smoothness orflatness and may include adding special additional materials, such as iron or sulfur. In addition to our wafers or substrates, wealso generate revenue from our consolidated subsidiaries that sell raw materials. Product diversity can mitigate some of thedown cycles in our market because we are not dependent on a single product or application for revenue. CustomersBefore specialty material wafers can be processed in a typical wafer manufacturing facility that constructs theelectronic circuit, laser or optical device on a chip, a thin layer of structured chemicals is grown on the surface of thesubstrate. This is called an epitaxial layer. We sell our substrates to companies that apply the epitaxial layer, who then inturn sell the modified wafers to the wafer fabs, chip design companies, LED manufacturers and others. Some customers doboth the epitaxial layer and wafer fabrication.Epitaxial layer companies that form our customer base are located in Asia, the United States and Europe. We alsosell our products to universities and other research organizations that use specialty materials for experimentation in variousaspects of semi-conducting and semi-insulating applications. Our customers that purchase raw materials are located in Asia,the United States and Europe.We have at times sold a significant portion of our products in any particular period to a limited number ofcustomers. One customer, Landmark represented 13% of our revenue for the year ended December 31, 2018. Two customers,Landmark and Osram, represented 12% and 11%, respectively, of our revenue for the year ended December 31, 2017. Nocustomer represented more than 10% of our revenue for the year ended December 31, 2016. Our top five customers, althoughnot the same five customers for each period, represented 35% of our revenue for each of the years ended December 31, 2018,2017 and 2016, respectively.For each of the years ended December 31, 2018 and 2017, three customers with our consolidated subsidiaries, inaggregate, accounted for over 30% of raw material sales. For the year ended December 31, 2016, four customers with ourconsolidated subsidiaries, in aggregate, accounted for over 40% of raw material sales. Our subsidiaries and joint ventures area key strategic benefit for us as they further diversify our sources of revenue.10 Table of ContentsManufacturing, Raw Materials and SuppliesWe manufacture all of our products in China. We believe this location generally has favorable costs for facilities andlabor compared to the United States or compared to the location of some of our competitors in Japan and Germany.We use a two-stage wafer manufacturing process. The first stage deploys our VGF technology for the crystal growthof single element or compound element ingots in diameters currently ranging from one inch to six inches. The growthprocess occurs in high temperature furnaces built using our proprietary designs. Growing the crystalline elements intocylindrical ingots takes a number of days, depending on the diameter and length of the ingot produced. The crystal growthstage utilizes AXT proprietary process technology. The second stage includes slicing or sawing the ingot into wafers orsubstrates, then processing each substrate to strict specifications, including grinding to reduce the thickness and thenpolishing, beveling the edges and cleaning each substrate. Many of the wafer processing steps use chemical baths andproperly cleaning the wafer is a critical process. The wafer processing stage also utilizes AXT proprietary process technology.Wafers from each ingot will include some material that does not meet specifications or quality standards. Defectsmay occur as a result of inherent factors in the materials used in the crystalline growth process. They may also result fromvariances in the manufacturing process. We have many steps in our line that are partially or fully automated but othermanufacturing steps are performed manually. We intend to increase the level of automation, particularly in cleaning thewafers. In 2015, we purchased wafer processing equipment from Hitachi Metals to help us increase automation in ourproduction line and, therefore, reduce variability and defects. In addition, we secured a manufacturing license from HitachiMetals. This license includes detailed work instructions for using the equipment purchased and allows us to apply thelicensed proprietary wafer processing technology at any step and on any form of equipment in our line. Due to potentialdefects, yield is a key factor in our manufacturing cost. Other key elements are the initial cost of the raw material elements,manufacturing equipment, factory loading, facilities and labor.We have 10 partially owned subsidiaries and joint ventures companies in China that form the backbone of oursupply chain model. These companies provide us with reliable supply, market trend visibility, and shorter lead-times for rawmaterials central to our manufactured products, including gallium, gallium alloys, indium phosphide poly-crystal, arsenic,germanium, germanium dioxide, high purity arsenic, pBN and boron oxide. We believe that these subsidiaries and jointventures have been and will continue to be advantageous in allowing us to procure materials to support our planned growth.In addition, we purchase supply parts, components and raw materials from several other domestic and international suppliers.We depend on a single or limited number of suppliers for certain critical materials used in the production of our substrates,such as quartz tubing, arsenic and polishing solutions. We generally purchase our materials through standard purchase ordersand not pursuant to long-term supply contracts.Sales and MarketingWe sell our substrate products directly to customers through our direct salesforce in the United States, China andEurope. We use independent sales representatives and distributors in Japan, Taiwan, Korea and other areas. Our directsalesforce is knowledgeable in the use of compound and single‑element substrates. Specialty material wafers arescientifically complicated. Our application engineers must work closely with customers during all stages of our wafersubstrate manufacturing process, from developing the precise composition of the wafer substrate through manufacturing andprocessing the wafer substrate to the customer’s specifications. We believe that maintaining a close relationship withcustomers and providing them with engineering support improves customer satisfaction and provides us with a competitiveadvantage in selling. A significant percentage of the members of our technical sales support team who frequently engagewith customers have PhDs in physics or materials science.International Sales. International sales are a substantial part of our business. Sales to customers outside NorthAmerica (primarily the United States) accounted for approximately 90%, 91% and 90% of our revenue during 2018, 2017and 2016, respectively. The primary markets for sales of our substrate products outside of North America are to customerslocated in Asia and Western Europe. We occasionally receive small orders from customers located in Israel and Russia.11 Table of ContentsOur subsidiaries and joint venture companies sell specialty raw materials including 4N, 5N, 6N, 7N and 8N gallium,boron oxide, germanium, arsenic, germanium dioxide, pyrolytic boron nitride crucibles used in crystal growth, parts for MBEand parts used in manufacturing OLED rings. These subsidiaries and joint ventures have their own separate sales forces andsell directly to their own customers in addition to selling raw materials to us.Research and DevelopmentTo maintain and improve our competitive position, we focus our research and development efforts on designing newproprietary processes and products, improving the performance of existing products, achieving new lows in EPD, increasingyields and reducing manufacturing costs. We also conduct research and development focusing on larger diameter wafers and,in our history, we have consistently developed new products based on larger wafer diameters. Crystal growth of specialtyearth materials becomes significantly more difficult as the ingot diameter increases because a consistent temperature, and inthe case of InP, consistent control of pressure, must be applied over a larger surface area. In 2015, we acquired certainproprietary InP crystal growth technology and equipment from Crystacomm.Certain micro devices, such as the array used for 3-D sensing, require GaAs wafers with very low etch pit density. Inanticipation of a growth in demand for low EPD six-inch wafers, we have focused our development efforts on increasing ouryield of such wafers. Our current substrate research and development activities focus on continued development and enhancement ofGaAs, InP and Ge substrates, including improved yield, enhanced surface and electrical characteristics and uniformity,greater substrate strength and increased crystal length. In 2015, we acquired proprietary wafer processing equipment fromHitachi Metals. The Hitachi Metals purchase includes a license covering the use of the proprietary equipment and HitachiMetals’ proprietary wafer processing technology. A particular focus of the equipment and process technology is on cleaningthe wafers. It is important to remove any residual cleaning agents from each wafer to ensure that the epitaxial growth processis not encumbered by residual chemicals on the wafer.Our three consolidated subsidiaries conduct research and development, focusing on gallium alloys, galliumrefinement and pyrolytic boron nitride crucibles used in high temperature crystal growth.We have assembled a multi‑disciplinary team of skilled scientists, engineers and technicians to meet our researchand development objectives. Research and development expenses were $5.9 million in 2018, compared with $4.8 million in2017 and $5.9 million in 2016. Wafer substrate research and development increased in 2018 and this increase was offset by adecrease in one of our three consolidated subsidiaries. Development work focusing on yield improvement and other mattersrelated to our research and development efforts also occurs within regular manufacturing processes. These costs are includedin our cost of revenue because it is difficult to isolate them as research and development.CompetitionThe semiconductor substrate industry is characterized by narrow technological boundaries, price erosion andgenerally intense competition. Certain wafer substrates, such as low quality wafer substrates for consumer products usingLED lighting, compete almost entirely on price. Other products, such as InP and low EPD GaAs wafers, have fewercompetitors and quality is a key competitive factor in addition to price. We face actual and potential competition from anumber of established companies who have the advantage of greater name recognition and more established relationships inthe industry. In some cases, our competitors have substantially greater financial, technical and marketing resources as theyare divisions of much larger companies. They may utilize these advantages to expand their product offerings more quickly,adapt to new or emerging technologies and changes in customer requirements more quickly, and devote greater resources tothe marketing and sale of their products. We believe a critical factor in our business is technical support extended to thecustomer or prospective customer and we attempt to counter possible advantages of name recognition or size with superiortechnical support through the use of our team of technical sales support professionals, the majority of whom hold PhDs inphysics or materials science.12 Table of ContentsWe believe that the primary competitive factors in the markets in which our substrate products compete are:·quality;·price;·customer technical support;·performance;·meeting customer specifications; and·manufacturing capacity.Our ability to compete in target markets also depends on factors such as:·the timing and success of the development and introduction of new products, including larger diameter wafers,and product features by us and our competitors;·the availability of adequate sources of raw materials;·protection of our proprietary methods, systems and process;·protection of our products by effective use of intellectual property laws; and·general economic conditions, which impact end markets using substrates.A majority of our customers specialize in epitaxial growth, a complex series of chemical layers grown on top of ourwafers. Typically, our customer or prospective customer has at least two qualified substrate suppliers. Qualified suppliersmust meet industry‑standard specifications for quality, on-time delivery and customer support. Once a substrate supplier hasqualified with a customer, price, consistent quality and current and future product delivery lead times become the mostimportant competitive factors. A supplier that cannot meet a customer’s current lead times or that a customer perceives willnot be able to meet future demand and provide consistent quality can lose market share. Our primary competition in themarket for compound and single element semiconductor substrates includes Sumitomo Electric Industries (“Sumitomo”),Japan Energy (“JX”), Freiberger Compound Materials (“Freiberger”), Umicore, and China Crystal Technology Corp.(“CCTC”). We believe that at least two of our competitors are shipping high volumes of GaAs substrates manufactured usinga process similar to our VGF technology. In addition, we also face competition from semiconductor device manufacturers thatmay use other specialty material substrates that are not GaAs, InP or Ge based materials and that are actively exploringalternative materials. For example, silicon-on-insulator (“SOI”) technology, a silicon wafer technology that producessatisfactory devices at lower cost, has been proven in the market. From 2012 to 2015, SOI technology displaced GaAs chipsin key sectors, primarily the radio frequency (RF) switching function in cell phones. Because of our vertically integrated, sophisticated supply chain through our subsidiaries and joint venturecompanies, we believe we are the only compound semiconductor substrate supplier to offer a broad suite of raw materials. Webelieve this gives us a unique competitive advantage because we have greater control and stability over many of our neededmaterials. Further, we believe we have some advantage in manufacturing costs. In the event of a significant increase indemand we believe our raw materials supply chain strategy and our ability to rapidly increase capacity can provide us someadvantage. 13 Table of ContentsIntellectual PropertyOur success and the competitive position of our VGF technology depend on our ability to maintain our proprietaryprocess technology secrets and other intellectual property protections. We rely on a combination of patents, trademark andtrade secret laws, non-disclosure agreements and other intellectual property protection methods to protect our proprietarytechnology. We believe that, due to the rapid pace of technological innovation in the markets for our products, our ability toestablish and maintain a position of technology leadership depends as much on the skills of our research and developmentpersonnel as upon the legal protections afforded our existing technologies. To protect our trade secrets, we take certainmeasures to ensure their secrecy, such as executing non-disclosure agreements with our employees, customers and suppliers.However, reliance on trade secrets is only an effective business practice insofar as trade secrets remain undisclosed and aproprietary product or process is not reverse engineered or independently developed.In addition to proprietary process trade secrets, we also file patents. To date, we have been issued 51 patents relatedto our VGF products and processes; 30 in China, nine in the United States, seven in Japan, two in Taiwan, one in theEuropean Union, one in Canada and one in South Korea. Patents have a protected life of 20 years from their filing dates. Ourpatents have expiration dates ranging from one expiration in 2018 to 2035. In some cases we may consider filing divisional,continuation or continuation-in-part of the existing patents for additional claims. We have 15 patent applications pending,including 10 in China, three in the Patent Cooperation Treaty stage and two in Europe. We also have two provisional patentsfiled in 2018 in the United States. Furthermore, in aggregate, our three consolidated joint venture companies have beenissued 53 patents in China, including 28 patents issued to Beijing BoYu Semiconductor Vessel Craftwork Technology Co.Ltd. (“BoYu”), 22 patents issued to Nanjing JinMei Gallium Co. Ltd. (“JinMei”) and 3 patents issued to Beijing JiYaSemiconductor material Co. Ltd. (“JiYa”).We entered into a technology license and royalty agreement with Sumitomo, effective December 3, 2010, with aterm of eight years, terminating December 31, 2018. We, and our related companies, were granted a worldwide,nonexclusive, royalty bearing, irrevocable license to certain patents for the term of the agreement. We are reviewing a requestfrom Sumitomo to renew this license.In the normal course of business, we periodically receive and make inquiries regarding possible patent infringement.In dealing with such inquiries, it may become necessary or useful for us to obtain or grant licenses or other rights. However,there can be no assurance that such licenses or rights will be available to us on commercially reasonable terms. If we are notable to resolve or settle claims, obtain necessary licenses on commercially reasonable terms and/or successfully prosecute ordefend our position, our business, financial condition and results of operations could be materially and adversely affected.Environmental RegulationsWe are subject to federal, state and local environmental and safety laws and regulations in all of our operatinglocations, including laws and regulations of China, such as laws and regulations related to the development, manufacture anduse of our products, the use of hazardous materials, the operation of our facilities, and the use of our real property. These lawsand regulations govern the use, storage, discharge and disposal of hazardous materials during manufacturing, research anddevelopment and sales demonstrations. We maintain a number of environmental, health and safety programs that areprimarily preventive in nature. As part of these programs, we regularly monitor ongoing compliance. If we fail to comply withapplicable regulations, we could be subject to substantial liability for clean-up efforts, personal injury, fines or suspension orbe forced to cease our operations, and/or suspend or terminate the development, manufacture or use of certain of ourproducts, the use of our facilities, or the use of our real property, each of which could have a material adverse effect on ourbusiness, financial condition and results of operations. The regulatory landscape shifts and changes in China as that countryattempts to address its environmental pollution. Because we manufacture all of our products in China, we are subject to anevolving set of regulations that could require changes in our equipment and processes and require us to obtain new permits.In 2017, China increased its focus on environmental concerns which increased pressure on manufacturing companies. Duringperiods of severe air pollution in Beijing, manufacturing companies, including AXT, may be ordered by the localgovernment to stop production for several days. 14 Table of ContentsFor example, in the first quarter of 2018, over 300 manufacturing companies, including AXT, were intermittently shut downby the local government for a total of ten days from February 27 to March 31, due to severe air pollution.EmployeesAs of December 31, 2018, we had 781 employees, which consisted of 26 employees in our headquarters in Fremont,California, one sales professional in France and 754 employees in our factory in China. In addition, our three consolidatedsubsidiaries had, in total, 299 employees. In aggregate, we and our subsidiaries had 1,080 employees, of whom 886 wereprincipally engaged in manufacturing, 141 in sales and administration and 53 in research and development. Of these 1,080employees, 26 were located in the United States, one in France and 1,053 in China.Most workers in China are represented by unions. As of December 31, 2018, 877 employees in China includingemployees of our subsidiaries were represented by unions. We have never experienced a work stoppage and we consider ourrelations with our employees to be good.Geographical InformationPlease see Note 14 of our Notes to Consolidated Financial Statements for information regarding our foreignoperations, and see “Risks related to international aspects of our business” under Item 1A. Risk Factors for furtherinformation on risks attendant to our foreign operations and dependence.Available InformationOur principal executive offices are located at 4281 Technology Drive, Fremont, CA 94538, and our main telephonenumber at this address is (510) 438-4700. Our Internet website address is www.axt.com. Our website address is given solelyfor informational purposes; we do not intend, by this reference, that our website should be deemed to be part of this AnnualReport on Form 10-K or to incorporate the information available at our Internet address into this Annual Report onForm 10‑K.We file electronically with the Securities and Exchange Commission, or SEC, our annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant toSection 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. We make these reports available free of chargethrough our Internet website as soon as reasonably practicable after we have electronically filed such material with the SEC.These reports can also be obtained from the SEC’s Internet website at www.sec.gov or at the SEC's Public Reference Room at100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public ReferenceRoom by calling the SEC at 1-800-SEC-0330. Item 1A. Risk Factors For ease of reference, we have divided these risks and uncertainties into the following general categories:I.Risks related to our general business;II.Risks related to international aspects of our business;III.Risks related to our financial results and capital structure;IV.Risks related to our intellectual property; andV.Risks related to compliance, environmental regulations and other legal matters.15 Table of ContentsI. Risks Related to Our General BusinessSilicon substrates (wafers) are significantly lower in cost compared to substrates made from specialty materials, and newsilicon-based technologies could enable silicon-based substrates to replace specialty material based substrates for certainapplications.Historically silicon wafers or substrates are less expensive than specialty material substrates, such as those that weproduce. Electronic circuit designers will generally consider silicon first and only turn to alternative materials if siliconcannot provide the required functionality in terms of power consumption, speed, wave lengths or otherspecifications. Beginning in 2011, certain applications that had previously used GaAs substrates adopted a new silicon-based technology called silicon on insulator, or SOI. SOI technology uses a silicon-insulator-silicon layered substrate inplace of conventional silicon substrates in semiconductor manufacturing. SOI substrates cost less than GaAs substrates and,although their performance is not as robust as GaAs substrates in terms of power consumption, heat generation and speed,they became acceptable in mobile phones and other applications that were previously dominated by GaAs substrates. Theadoption of SOI resulted in decreased GaAs wafer demand, and decreased revenue. If SOI or new silicon-based technologiesgain more widespread market acceptance, or are used in more applications, our sales of specialty material based substratescould be reduced and our business and operating results could be significantly and adversely affected.Our gross margin has fluctuated historically and may decline due to several factors.Our gross margin has fluctuated from period to period as a result of increases or decreases in total revenue, shifts inthe cost of raw materials, shifts in product mix, costs related to the relocation of our gallium arsenide and germaniumproduction lines, including costs related to the hiring additional manufacturing employees at our new locations, tariffsimposed by the U.S. government, the introduction of new products, decreases in average selling prices for products,utilization of our manufacturing capacity, fluctuations in manufacturing yields and our ability to reduce product costs. Thesefactors and other variables change from period to period and these fluctuations are expected to continue in the future. Arecent example is that in the third quarter of 2018 our gross margin was 37.1% but it dropped to 26.3% in fourth quarter of2018 as a result of several of these factors.In recent months, the prices of many of the raw materials that we use in our substrate manufacturing process haveincreased. Such price increases can increase our cost of revenue and reduce our gross margin.Further, we do not control the prices at which our subsidiaries and other joint venture companies sell their rawmaterial products to third parties and we do not control their production process. However, because we consolidate the resultsof three of these companies with our own, any reduction in their gross margins could have a significant, adverse impact onour overall gross margins. One or more of our companies has in the past sold, and may in the future sell, raw materials atsignificantly reduced prices in order to gain volume sales or sales to new customers. In addition, at some points in the lastthree years, the market price of gallium dropped below our per unit inventory cost and we incurred an inventory write downunder the lower of cost or net realizable value accounting rules. In this regard, in the first quarter of 2018 our consolidatedraw gallium company incurred a $295,000 charge. In such events, our gross margin is adversely impacted.Underutilizing our manufacturing facilities may result in declines in our gross margins.An important factor in our success is the extent to which we are able to utilize the available capacity in ourmanufacturing facilities. A number of factors and circumstances may reduce utilization rates, including periods of industryovercapacity, low levels of customer orders, operating inefficiencies, mechanical failures and disruption of operations due toexpansion, power interruptions, fire, flood, other natural disasters or calamities or government-ordered mandatory factoryshutdowns. Severe air pollution in Beijing can trigger mandatory factory shutdowns. For example, in the first quarter of 2018,over 300 manufacturing companies, including AXT, were intermittently shut down by the local government for a total of tendays from February 27 to March 31, due to severe air pollution. Further, we are increasing capacity by adding two new sites,which may reduce our utilization rate and increase our depreciation charges, at least until we de-commission part of ourBeijing site. Because many portions of our manufacturing costs are relatively fixed,16 Table of Contentshigh utilization rates are critical to our gross margins and operating results. If we fail to achieve acceptable manufacturingvolumes or experience product shipment delays, our results of operations will be negatively affected. During periods ofdecreased demand, we have underutilized our manufacturing lines. If we are unable to improve utilization levels at ourfacilities during periods of decreased demand and correctly manage capacity, the fixed expense levels will have an adverseeffect on our business, financial condition and results of operations. For example, in the three months ended December 31,2018, our revenue dropped to $22.2 million and our gross margin was only 26.3%.If we are unable to utilize the available capacity in or manufacturing facilities, we may need to implement arestructuring plan, which could have a material adverse effect on our revenue, our results of operations and our financialcondition. For example, in 2013, we concluded that incoming orders were insufficient and that we were significantlyunderutilizing our factory capacity. As a result, in February 2014, we announced a restructuring plan with respect to ourwholly-owned subsidiary, Beijing Tongmei Xtal Technology Co, Ltd., in order to better align manufacturing capacity withdemand. Under the restructuring plan, we recorded a charge of approximately $907,000 in the first quarter of 2014. In thesecond quarter of 2016, we restructured the operations of Beijing JiYa Semiconductor Material Co., Ltd., one of our partiallyowned consolidated subsidiaries, which resulted in a reduction in force of 28 positions that were no longer required tosupport production and operations. If we receive fewer customer orders than forecasted or if our customers delay or cancel orders, we may not be able toreduce our manufacturing costs in the short-term and our gross margins would be negatively affected. In addition, lead timesrequired by our customers are shrinking, which reduces our ability to forecast orders and properly balance our capacityutilization.If we have low product yields, the shipment of our products may be delayed and our product cost and operating results maybe adversely impacted.A critical factor in our product cost is yield. Our products are manufactured using complex crystal growth and waferprocessing technologies, and the number of usable wafer substrates we produce can fluctuate as a result of many factors,including:·poor control of furnace temperature and pressure;·impurities in the materials used;·contamination of the manufacturing environment;·quality control and inconsistency in quality levels;·lack of automation and inconsistent processing requiring manual manufacturing steps;·substrate breakage during the manufacturing process; and·equipment failure, power outages or variations in the manufacturing process.A current example where yield is of special concern is for our six-inch semi-conducting gallium arsenide substrates,which can be used for manufacturing opto-electronic devices in cell phones, enabling 3-D sensing. This application requiresvery low defect densities, also called etch pit densities, or EPD, and our yields will be lower than the yields achieved for thesame substrate when it will be used in other applications. If we are unable to achieve the targeted quantity of low defectdensity substrates, then our manufacturing costs would increase and our gross margins would be negatively impacted.In addition, we may modify our process to meet a customer specification, but this can impact our yields. If our yieldsdecrease, our revenue could decline if we are unable to produce products to our customers’ requirements. At the same time,our manufacturing costs could remain fixed, or could increase. Lower yields negatively impact our gross17 Table of Contentsmargin. We have experienced product shipment delays and difficulties in achieving acceptable yields on both new and olderproducts, and delays and poor yields have adversely affected our operating results. We may experience similar problems inthe future and we cannot predict when they may occur, their duration or severity.If our manufacturing processes result in defects in our products making them unfit for use by our customers, ourproducts would be rejected, resulting in compensation costs paid to our customers, and possible disqualification. This couldlead to revenue loss and market share loss.Risks exist in relocating our gallium arsenide manufacturing operations. The Chinese government has imposed, and may impose in the future, manufacturing restrictions and regulations thatrequire us to move part of our manufacturing operations to a different location or temporarily cease or limit manufacturing.Such relocation, or other restrictions on manufacturing, could materially and adversely impact our results of operations andour financial condition. The Beijing city government is moving its offices into the area where our original manufacturing facility iscurrently located and is in the process of moving thousands of government employees into this area. The government hasconstructed showcase tower buildings and overseen the establishment of new apartment complexes, retail stores andrestaurants. An amusement park is being constructed within a few miles of our facility. To create room and upgrade thedistrict, the city instructed virtually all existing manufacturing companies, including AXT, to relocate all or some of theirmanufacturing lines. In 2018, we made significant progress in the relocation of our gallium arsenide and germaniumproduction lines and we intend to complete this relocation in 2019. The relocation of our gallium arsenide production line requires us to continue to accurately execute our relocationplan. A failure to properly complete our relocation could result in disruption to our production and have a material adverseimpact on our revenue, our results of operations and our financial condition. We intend to secure additional permits andapprovals in 2019. Given the fluidity and ever-increasing review of environmental and regulatory ordinances in China, therecan be no assurance that these matters will be satisfactorily completed. In 2018, we provided qualification wafers and our own internal characterization data from the new facilities to ourcustomers. Our major customers are in the process of qualifying the wafer substrates before placing volume purchase ordersfor products from the new facilities. If we fail to meet the product qualification requirements of a customer, we may lose salesto that customer. Our reputation may also be damaged. Any loss of sales could have a material adverse effect on our revenue,our results of operations and our financial condition. We expect many of the key employees who are employed at our current manufacturing facility to relocate to the newsites or commute under a program we are developing. There can be no assurances that the key employees will relocate. Aloss of key employees or our inability to hire qualified employees could disrupt our production, which could materially andadversely impact our results of operations and our financial condition. The Chinese government has in the past imposed temporary restrictions on manufacturing facilities, such as therestrictions imposed on polluting factories for the 2008 Olympics and the 2014 Asian Pacific Economic Cooperationevent. These restrictions included a shutdown of the transportation of materials and power plants to reduce air pollution. Toreduce air pollution in Beijing, the Chinese government has sometimes limited the construction of new, or expansion ofexisting, facilities by manufacturing companies in the Beijing area or required mandatory factory shutdowns. For example, in the first quarter of 2018, over 300 manufacturing companies, including AXT, were intermittently shut down by the localgovernment for a total of ten days from February 27 to March 31 due to severe air pollution. If the government applies similarrestrictions to us or requires mandatory factory shutdowns in the future, then such restrictions or shutdowns could have anadverse impact on our results of operations and our financial condition. Our ability to supply current or new orders could besignificantly impacted. Customers could then be required to purchase products from our competitors, causing ourcompetitors to take market share from us. In addition, from time to time, the Chinese government issues new regulations, which may require additional actionson our part to comply. On February 27, 2015, the China State Administration of Work Safety updated its list of18 Table of Contentshazardous substances. The previous list, which was published in 2002, did not restrict the materials that we use in ourwafers. The new list added gallium arsenide. As a result of the newly published list, we were instructed to obtain a permit tocontinue to manufacture our gallium arsenide substrate wafers. The Beijing municipal authority accepted our permitapplication in May 2015, but has not issued to us the requisite permit while we continue to execute our plan to relocate ourgallium arsenide production. If our application is denied in the future before we complete our relocation, then our galliumarsenide production could be disrupted, which could materially and adversely impact our results of operations and ourfinancial condition. Customers may require that they re-qualify our gallium arsenide wafer substrates from the new manufacturing line. As required by the Beijing city government we are relocating gallium arsenide production so that it is not withinBeijing. In 2018, we provided qualification wafers and our own internal characterization data from the new facilities to ourcustomers. Most of our major customers will view this as a process engineering change and their internal quality controlsystem will require them to re-qualify the wafer substrates produced at our new manufacturing site to ensure that the productcharacteristics still conform to their specification. Delays in the qualification process or failures to re-qualify could result ina reduction of orders and have a material adverse effect on our revenue. Global economic and political conditions, including trade tariffs and restrictions, have an impact on our business andfinancial condition in ways that we currently cannot predict.Recent tariffs and threats of trade tariffs and restrictions between China and the United States may, in our view,create an unstable environment. In September 2018, the Trump Administration announced a list of thousands of categoriesof goods that are now subject to tariffs when imported into the United States. This pronouncement imposed 10% tariffs onour products and will have a negative impact on our operations and financial performance. Although we do not believe theinitial impact of approximately $150,000 per quarter is material, the future impact of tariffs and trade wars is uncertain. Our operations and financial results depend on worldwide economic and political conditions and their impact onlevels of business spending, which has deteriorated significantly in many countries and regions. Uncertainties in thepolitical, financial and credit markets may cause our customers to postpone deliveries. Delays in the placement of new ordersand extended uncertainties may reduce future sales of our products and services. The revenue growth and profitability of ourbusiness depends on the overall demand for our substrates, and we are particularly dependent on the market conditions inwireless, solid‑state illumination, fiber optics and telecommunications industries. Because the end users of our products areprimarily large companies whose businesses fluctuate with general economic and business conditions, a softening of demandfor products that use our substrates, caused by a weakening economy, may result in decreased revenue. Customers may findthemselves facing excess inventory from earlier purchases, and may defer or reconsider purchasing products due to thedownturn in their business and in the general economy. If market conditions deteriorate, we may experience increasedcollection times and greater write-offs, either of which could have a material adverse effect on our profitability and our cashflow. Future tightening of credit markets and concerns regarding the availability of credit may make it more difficult forour customers to raise capital, whether debt or equity, to finance their purchases of capital equipment or of the products wesell. Delays in our customers’ ability to obtain such financing, or the unavailability of such financing, would adversely affectour product sales and revenues and, therefore, harm our business and operating results. We cannot predict the timing,duration of or effect on our business of any future economic downturn or the timing or strength of any subsequent recovery.If any of our facilities are damaged by occurrences such as fire, explosion, power outage or natural disaster, we might notbe able to manufacture our products.The ongoing operation of our manufacturing and production facilities in China is critical to our ability to meetdemand for our products. If we are not able to use all or a significant portion of our facilities for prolonged periods for anyreason, we would not be able to manufacture products for our customers. For example, a fire or explosion caused by our use ofcombustible chemicals, high furnace temperatures or, in the case of InP, high pressure during our19 Table of Contentsmanufacturing processes could render some or all of our facilities inoperable for an indefinite period of time. Actions outsideof our control, such as earthquakes or other natural disasters, could also damage our facilities, rendering them inoperable. Ifwe are unable to operate our facilities and manufacture our products, we would lose customers and revenue and our businesswould be harmed.On the evening of March 15, 2017, an electrical short-circuit fire occurred at our Beijing manufacturingfacility. The electrical power supply supporting 2-inch, 3-inch and 4-inch gallium arsenide and germanium crystal growthwas damaged and production in that area was stopped. In addition, a waste water pipe was damaged resulting in a halt towafer processing for four days until the pipe could be repaired. We were able to rotate key furnace hardware and use some ofthe 6-inch capacity for smaller diameter crystal growth production to mitigate the impact of the fire and resume production. Ifwe are unable to recover from a fire or natural disaster, our business and operating results could be materially and adverselyaffected.Demand for our products may decrease if demand for the end-user applications decrease or if manufacturers downstreamin our supply chain experience difficulty manufacturing, marketing or selling their products.Our products are used to produce components for electronic and opto-electronic products. Accordingly, demand forour products is subject to the demand for end-user applications which utilize our products, as well as factors affecting theability of the manufacturers downstream in our supply chain to introduce and market their products successfully, including:·worldwide economic and political conditions and their impact on levels of business spending;·the competition such manufacturers face in their particular industries;·the technical, manufacturing, sales, marketing and management capabilities of such manufacturers;·the financial and other resources of such manufacturers; and·the inability of such manufacturers to sell their products if they infringe third‑party intellectual property rights.If demand for the end-user applications for which our products are used decreases, or if manufacturers downstream inour supply chain are unable to develop, market and sell their products, demand for our products will decrease. For example,in the fourth quarter of 2018, widespread political and economic instability and trade war concerns resulted in a generalslowdown and our revenue decreased significantly. Additionally, in the second half of 2016, manufacturers producing andselling passive optical network devices known as EPONs and GPONs experienced a slowdown in demand resulting in surplusinventory on hand. The slowdown persisted until late in 2017. This resulted in a slowdown of sales of our InP substrates usedin the PON market. We expect similar cycles of strong demand followed by lower demand will occur for various InP, GaAs orGe substrates in the future.Our revenue, gross margins and profitability can be hurt if the average sales price of the various raw materials in ourpartially owned companies decreases. Although the companies in our vertically integrated supply chain have historically made a positive contribution toour financial performance, when the average selling prices for the raw materials produced decline, this results in a negativeimpact on our revenue, gross margin and profitability. For example, the average selling prices for 4N gallium and forgermanium were driven down by oversupply in 2015, 2016 and 2017, and negatively impacted our financial results. In 2018,2017 and 2016, the seven companies accounted for under the equity method of accounting contributed a loss of $1.1million, $1.7 million and $2.0 million, respectively, to our consolidated financial statements. There can be no assurance thatthe oversupply will be corrected by the market. Further, in several quarters over the past three years, one of our consolidatedsubsidiaries incurred a lower of cost or net realizable value inventory write down, which negatively impacted ourconsolidated gross margin. For example, in the first quarter of 2018, our consolidated raw gallium company incurred aninventory write-down charge of $295,000. In the first quarter of 2017, we incurred an20 Table of Contentsimpairment charge of $313,000 against one of our partially owned companies, writing down our investment to zero value. Ifthe pricing environment remains stressed by oversupply and our joint venture companies cannot reduce their productioncosts, then the reduced average selling prices of the raw materials produced by our joint venture companies will have acontinuing adverse impact on our revenue, gross margins and net profit. Problems incurred in our 10 partially owned joint venture companies or investment partners could result in a materialadverse impact on our financial condition or results of operations.We have invested in 10 partially owned subsidiaries and joint venture companies in China that produce materials,including 99.99% pure gallium (4N Ga), high purity gallium (7N Ga), arsenic, germanium, germanium dioxide, pyrolyticboron nitride (pBN) crucibles and boron oxide (B2O3). We purchase a portion of the materials produced by these companiesfor our use and they sell the remainder of their production to third parties. Our ownership and the ownership held by ourconsolidated subsidiaries in these companies range from 20% to 97%. We consolidate the companies in which we have amajority or controlling financial interest and employ equity accounting for the companies in which we have a smallerownership interest. Several of these companies occupy space within larger facilities owned and/or operated by one of theother investment partners. Several of these partners are engaged in other manufacturing activities at or near the same facility.In some facilities, we share access to certain functions, including water, hazardous waste treatment or air quality treatment. Ifa partner in any of these ventures experiences problems with its operations, or deliberately withholds or disrupts services,disruptions in the operations of our companies could result, having a material adverse effect on the financial condition andresults of operation in these companies, and correspondingly on our financial condition or results of operations. For example,since gallium is a by-product of aluminum, our raw gallium joint venture in China, which is housed in and receives servicesfrom an affiliated aluminum plant, could generate lower production and shipments of gallium as a result of reduced servicesprovided by the aluminum plant. Accordingly, in order to meet customer supply obligations, our supply chain may have tosource materials from another independent third party supplier, resulting in higher costs and reduced gross margin.The China central government has become increasingly concerned about environmental hazards. Air pollution is awell-known problem in Beijing and other parts of China. In days of severe air pollution, the government has orderedmanufacturing companies to stop all production. The central government is also tightening control over hazardouschemicals and other hazardous elements such as arsenic, which is produced by two of our unconsolidated joint venturecompanies. Regular use in the normal course of business of hazardous chemicals or hazardous elements or a company’sfailure to meet the ever tightening standards for control of hazardous chemicals or hazardous elements could result in ordersto shut down permanently, fines or other severe measures. Any such orders directed at one of our joint venture companiescould result in impairment charges if the company is forced to close its business, cease operations or incurs fines or operatinglosses, which would have a material adverse effect on our financial results.Further, if any of our joint venture companies or investment partners with which our joint ventures share facilities isdeemed to have violated applicable laws, rules or regulations governing the use, storage, discharge or disposal of hazardouschemicals, the operations of that joint venture could be adversely affected and we could be subject to substantial liability forclean-up efforts, personal injury, fines or suspension or termination of our joint venture’s operations. Employees working forour joint ventures or any of the other investment partners could bring litigation against us as a result of actions taken at thejoint venture or investment partner facilities, even though we are not directly controlling those operations. While we wouldexpect to defend ourselves vigorously in any litigation that is brought against us, litigation is inherently uncertain and it ispossible that our business, financial condition, results of operations or cash flows could be affected. Even if we are notdeemed responsible for the actions of the joint ventures or investment partners, litigation could be costly, time consuming todefend and divert management attention; in addition, if we are deemed to be the most financially viable of the partners,plaintiffs may decide to pursue us for damages.Intense competition in the markets for our products could prevent us from increasing revenue and sustaining profitability.The markets for our products are intensely competitive. We face competition for our substrate products from othermanufacturers of substrates, such as Sumitomo, JX, Freiberger, Umicore, and CCTC, and from companies, such as Qorvo andSkyworks, that are actively considering alternative materials to GaAs and marketing semiconductor devices21 Table of Contentsusing these alternative materials. We believe that at least two of our major competitors are shipping high volumes of GaAssubstrates manufactured using a process similar to our VGF process technology. Other competitors may develop and beginusing similar technology. Sumitomo and JX also compete with us in the InP market. If we are unable to compete effectively,our revenue may decrease and we may not maintain profitability. We face many competitors that have a number ofsignificant advantages over us, including:·greater name recognition and market share in the business;·more manufacturing experience;·extensive intellectual property; and·significantly greater financial, technical and marketing resources.Our competitors could develop new or enhanced products that are more effective than our products.The level and intensity of competition has increased over the past years and we expect competition to continue toincrease in the future. Competitive pressures have resulted in reductions in the prices of our products, and continued orincreased competition could reduce our market share, require us to further reduce the prices of our products, affect our abilityto recover costs and result in reduced gross margins and profitability.In addition, new competitors have and may continue to emerge, such as a crystal growing company established by aformer employee in China that is supplying semi-conducting GaAs wafers to the LED market. Competition from sources suchas this could increase, particularly if these competitors are able to obtain large capital investments.Cyber-attacks, system security risks and data protection issues could disrupt our internal operations and cause a reductionin revenue, increase in expenses, negatively impact our results of operation or result in other adverse consequences. Like most technology companies, we could be targeted in cyber-attacks. We face a risk that experienced computerprogrammers and hackers may be able to penetrate our network security and misappropriate or compromise our confidentialand proprietary information, potentially without being detected. Computer programmers and hackers also may be able todevelop and deploy viruses, worms, and other malicious software programs that attack our information technologyinfrastructure. The costs to us to eliminate or alleviate cyber or other security problems, bugs, viruses, worms, malicioussoftware programs and security vulnerabilities could be significant, and our efforts to address these problems may not besuccessful and could result in interruptions and delays that may impede our sales, manufacturing, distribution, accounting orother critical functions.Breaches of our security measures could create system disruptions or cause shutdowns or result in the accidentalloss, inadvertent disclosure or unapproved dissemination of proprietary information or sensitive or confidential data aboutus. Cyber-attacks could use fraud, trickery or other forms of deception. A cyber-attack could expose us to a risk of loss ormisuse of information, result in litigation and potential liability, damage our reputation or otherwise harm our business. Inaddition, the cost and operational consequences of implementing further data protection measures could be significant.Portions of our information technology infrastructure might also experience interruptions, delays or cessations ofservice or produce errors in connection with systems integration or migration work that takes place from time to time, whichmay have a material impact on our business. We may not be successful in implementing new systems and transitioning data,which could cause business disruptions and be more expensive, time consuming, disruptive and resource-intensive thanoriginally anticipated. Such disruptions could adversely impact our ability to fulfill orders and interrupt other processes.Delayed sales, lower margins or lost customers could adversely affect our financial results and reputation.22 Table of ContentsThe average selling prices of our substrates may decline over relatively short periods, which may reduce our revenue andgross margins.Since the market for our products is characterized by declining average selling prices resulting from various factors,such as increased competition, overcapacity, the introduction of new products and decreased sales of products incorporatingour products, the average selling prices for our products may decline over relatively short time periods. We have in the pastexperienced, and in the future may experience, substantial period-to-period fluctuations in operating results due to decliningaverage selling prices. In certain years, we have experienced an average selling price decline of our substrate selling prices ofapproximately 5% to 10%, depending on the substrate product. It is possible that the pace of the decline of average sellingprices could accelerate beyond these levels for certain products in a commoditizing market. We anticipate that averageselling prices will decrease in the future in response to the unstable demand environment, price reductions by competitors, orby other factors, including pricing pressures from significant customers. When our average selling prices decline, ourrevenue and gross profit decline, unless we are able to sell more products or reduce the cost to manufacture our products. Wegenerally attempt to combat an average selling price decline by improving yields and manufacturing efficiencies andworking to reduce the costs of our raw materials and of manufacturing our products. We also need to sell our current productsin increasing volumes to offset any decline in their average selling prices, and introduce new products, which we may not beable to do, or do on a timely basis.In order to remain competitive, we must continually work to reduce the cost of manufacturing our products andimprove our yields and manufacturing efficiencies. Our efforts may not allow us to keep pace with competitive pricingpressures which could adversely affect our margins. There is no assurance that any changes effected by us will result insufficient cost reductions to allow us to reduce the price of our products to remain competitive or improve our gross margins.Defects in our products could diminish demand for our products.Our wafer products are complex and may contain defects, including defects resulting from impurities inherent in ourraw materials or inconsistencies in our manufacturing processes. We have experienced quality control problems with some ofour products, which caused customers to return products to us, reduce orders for our products, or both. If we experiencequality control problems, or experience other manufacturing problems, customers may return product for credit, cancel orreduce orders or purchase products from our competitors. We may be unable to maintain or increase sales to our customersand sales of our products could decline. Defects in our products could cause us to incur higher manufacturing costs and sufferproduct returns and additional service expenses, all of which could adversely impact our operating results. If new productsdeveloped by us contain defects when released, our customers may be dissatisfied and we may suffer negative publicity orcustomer claims against us, lose sales or experience delays in market acceptance of our new products.Our substrate products have a long qualification cycle that makes it difficult to forecast revenue from new customers or fornew products sold to existing customers.New customers typically place orders with us for our substrate products three months to a year or more after ourinitial contact with them. The sale of our products is subject to our customers’ lengthy internal evaluation and approvalprocesses. During this time, we may incur substantial expenses and expend selling, marketing and management efforts whilethe customers evaluate our products. These expenditures may not result in sales of our products. If we do not achieveanticipated sales in a period as expected, we may experience an unplanned shortfall in our revenue. As a result, our operatingresults would be adversely affected. In addition, if we fail to meet the product qualification requirements of the customer, wemay not have another opportunity to sell that product to that customer for many months or even years. In the currentcompetitive climate, the average qualification and sales cycle for our products has lengthened even further and is expected tocontinue to make it difficult for us to forecast our future sales accurately. We anticipate that sales of any future substrateproducts will also have lengthy qualification periods and will, therefore, be subject to risks substantially similar to thoseinherent in the lengthy sales cycles of our current substrate products.23 Table of ContentsThe loss of one or more of our key substrate customers would significantly hurt our operating results.From time to time, sales to one or more of our customers individually represent more than 10% of our revenue and ifwe were to lose a major customer the loss would negatively impact our revenue. Most of our customers are not obligated topurchase a specified quantity of our products or to provide us with binding forecasts of product purchases. In addition, ourcustomers may reduce, delay or cancel orders. In the past, we have experienced a slowdown in bookings, significant push-outs and cancellation of orders from customers. If we lose a major customer or if a customer cancels, reduces or delays orders,our revenue would decline. In addition, customers that have accounted for significant revenue in the past may not continueto generate revenue for us in any future period. Any loss of customers or any delay in scheduled shipments of our productscould cause revenue to fall below our expectations and the expectations of market analysts or investors, causing our stockprice to decline.The cyclical nature of the semiconductor industry may limit our ability to maintain or increase net sales and operatingresults during industry downturns.The semiconductor industry is highly cyclical and periodically experiences significant economic downturnscharacterized by diminished product demand, resulting in production overcapacity and excess inventory in the markets weserve. A downturn can result in lower unit volumes and rapid erosion of average selling prices. The semiconductor industryhas experienced significant downturns, often in connection with, or in anticipation of, maturing product cycles of bothsemiconductor companies’ and their customers’ products or a decline in general economic conditions. This may adverselyaffect our results of operations and the value of our business.Our continuing business depends in significant part upon manufacturers of electronic and opto-electroniccompound semiconductor devices, as well as the current and anticipated market demand for these devices and products usingthese devices. As a supplier to the semiconductor industry, we are subject to the business cycles that characterize theindustry. The timing, length and volatility of these cycles are difficult to predict. The compound semiconductor industry hashistorically been cyclical due to sudden changes in demand, the amount of manufacturing capacity and changes in thetechnology employed in compound semiconductors. The rate of changes in demand, including end demand, is high, and theeffect of these changes upon us occurs quickly, exacerbating the volatility of these cycles. These changes have affected thetiming and amounts of customers’ purchases and investments in new technology. These industry cycles create pressure onour revenue, gross margin and net income.Our industry has in the past experienced periods of oversupply and that has resulted in significantly reduced pricesfor compound semiconductor devices and components, including our products, both as a result of general economic changesand overcapacity. Oversupply causes greater price competition and can cause our revenue, gross margins and net income todecline. During periods of weak demand, customers typically reduce purchases, delay delivery of products and/or cancelorders for our products. Order cancellations, reductions in order size or delays in orders could occur and would materiallyadversely affect our business and results of operations. Actions to reduce our costs may be insufficient to align our structurewith prevailing business conditions. We may be required to undertake additional cost-cutting measures, and may be unableto invest in marketing, research and development and engineering at the levels we believe are necessary to maintain ourcompetitive position. Our failure to make these investments could seriously harm our business.A significant portion of our operating expense and manufacturing costs are relatively fixed. If revenue for aparticular quarter is lower than we expect, we likely will be unable to proportionately reduce our operating expenses or fixedmanufacturing costs for that quarter, which would harm our operating results. If we do not successfully develop new product features and improvements and new products that respond to customerrequirements, our ability to generate revenue, obtain new customers, and retain existing customers may suffer.Our success depends on our ability to offer new product features, improved performance characteristics and newproducts, such as larger diameter substrates, low defect density substrates, thicker or thinner substrates, substrates withextreme surface flatness specifications, substrates that are manufactured with a doped crystal growth process or substrates thatincorporate leading technology and other technological advances. New products must meet customer24 Table of Contentsneeds and compete effectively on quality, price and performance. The markets for our products are characterized by rapidtechnological change, changing customer needs and evolving industry standards. If our competitors introduce productsemploying new technologies or performance characteristics, our existing products could become obsolete and unmarketable.Over time, we have seen our competitors selling more substrates manufactured using a crystal growth technology similar toours, which has eroded our technological differentiation.The development of new product features, improved performance characteristics and new products can be a highlycomplex process, and we may experience delays in developing and introducing them. Any significant delay could cause usto fail to timely introduce and gain market acceptance of new products. Further, the costs involved in researching,developing and engineering new products could be greater than anticipated. If we fail to offer new products or productenhancements or fail to achieve higher quality products, we may not generate sufficient revenue to offset our developmentcosts and other expenses or meet our customers’ requirements.We have made and may continue to make strategic investments in raw materials suppliers, which may not be successful andmay result in the loss of all or part of our investment.We have made direct investments or investments through our subsidiaries in 10 raw material suppliers in China,which provide us with opportunities to gain supplies of key raw materials that are important to our substrate business. Theseaffiliates each have a market beyond that provided by us. We do not have significant influence over every one of thesecompanies and in some we have made only a strategic, minority investment. We may not be successful in achieving thefinancial, technological or commercial advantage upon which any given investment is premised, and we could end up losingall or part of our investment which would have a negative impact on our results of operations. In the first quarter of 2017, weincurred an impairment charge of $313,000 against one of our partially owned suppliers, writing down our investment to zerovalue. The significant decline in the selling prices of raw materials which began in 2015 and continued through 2017 hasweakened some of these companies and their losses have negatively impacted our financial results. Further, the increasingconcern and restrictions in China of hazardous chemicals and other hazardous elements could result in orders to shut downpermanently, fines or other severe measures. Any such orders directed at one of our joint venture companies could result inimpairment charges if the company is forced to close its business, cease operations or incurs fines, or operating losses, whichwould have a material adverse effect on our financial results.We purchase critical raw materials and parts for our equipment from single or limited sources, and could lose sales if thesesources fail to fill our needs.We depend on a limited number of suppliers for certain raw materials, components and equipment used inmanufacturing our products, including key materials such as quartz tubing, and polishing solutions. We generally purchasethese materials through standard purchase orders and not pursuant to long-term supply contracts, and no supplier guaranteessupply of raw materials or equipment to us. If we lose any of our key suppliers, our manufacturing efforts could besignificantly hampered and we could be prevented from timely producing and delivering products to our customers. Prior toinvesting in our subsidiaries and joint ventures, we sometimes experienced delays obtaining critical raw materials and spareparts, including gallium, and we could experience such delays again in the future due to shortages of materials or for otherreasons. Delays in receiving equipment or materials could result in higher costs and cause us to delay or reduce production ofour products. If we have to delay or reduce production, we could fail to meet customer delivery schedules and our revenueand operating results could suffer.We may not be able to identify or form additional complementary joint ventures.We might invest in additional joint venture companies in order to remain competitive in our marketplace and ensurea supply of critical raw materials. However, we may not be able to identify additional complementary joint ventureopportunities or, even once opportunities are identified, we may not be able to reach agreement on the terms of the businessventure with the other investment partners. Further, geopolitical tensions and trade wars could result in government agenciesblocking such new joint ventures. New joint ventures could require cash investments or cause us to incur additionalliabilities or other expenses, any of which could adversely affect our financial condition and operating results.25 Table of ContentsThe financial condition of our customers may affect their ability to pay amounts owed to us.Some of our customers may be undercapitalized and cope with cash flow issues. Because of competitive marketconditions, we may grant our customers extended payment terms when selling products to them. Subsequent to our fulfillingan order, some customers have been unable to make payments when due, reducing our cash balances and causing us to incurcharges to allow for a possibility that some accounts might not be paid. We have had some customers file for bankruptcy. Ifour customers do not pay amounts owed to us then we will incur charges that would reduce our earnings.We depend on the continuing efforts of our senior management team and other key personnel. If we lose members of oursenior management team or other key personnel, or are unable to successfully recruit and train qualified personnel, ourability to manufacture and sell our products could be harmed.Our future success depends on the continuing services of members of our senior management team and other keypersonnel. Our industry is characterized by high demand and intense competition for talent, and the turnover rate can behigh. We compete for qualified management and other personnel with other specialty material companies andsemiconductor companies. Our employees could leave our company with little or no prior notice and would be free to workfor a competitor. If one or more of our senior executives or other key personnel were unable or unwilling to continue in theirpresent positions, we may not be able to replace them easily or at all, and other senior management may be required to divertattention from other aspects of the business. The loss of any of these individuals or our ability to attract or retain qualifiedpersonnel could adversely affect our business.Our results of operations may suffer if we do not effectively manage our inventory.We must manage our inventory of raw materials, work in process and finished goods effectively to meet changingcustomer requirements, while keeping inventory costs down and improving gross margins. Although we seek to maintainsufficient inventory levels of certain materials to guard against interruptions in supply and to meet our near term needs, wemay experience shortages of certain key materials. Some of our products and supplies have in the past and may in the futurebecome obsolete while in inventory due to changing customer specifications, or become excess inventory due to decreaseddemand for our products and an inability to sell the inventory within a foreseeable period. This would result in charges thatreduce our gross profit and gross margin. Furthermore, if market prices drop below the prices at which we value inventory, wewould need to take a charge for a reduction in inventory values in accordance with the lower of cost or net realizable valuevaluation rule. We have in the past had to take inventory valuation and impairment charges. Any future unexpected changesin demand or increases in costs of production that cause us to take additional charges for un-saleable, obsolete or excessinventory, or to reduce inventory values, would adversely affect our results of operations.Financial market volatility and adverse changes in the domestic, global, political and economic environment could have asignificant adverse impact on our business, financial condition and operating results.We are subject to the risks arising from adverse changes and uncertainty in domestic and global economies.Uncertain global economic and political conditions or low or negative growth in China, Europe or the United States, alongwith volatility in the financial markets, increasing national debt and fiscal concerns in various regions, pose challenges toour industry. Currently China’s economy is slowing and this could impact our financial performance. In addition, tariffs,trade restrictions, trade wars and Brexit are creating an unstable environment and can disrupt or restrict commerce. Althoughwe remain well-capitalized, the cost and availability of funds may be adversely affected by illiquid credit markets.Turbulence in U.S. and international markets and economies may adversely affect our liquidity, financial condition andprofitability. Another severe or prolonged economic downturn could result in a variety of risks to our business, including:·increased volatility in our stock price;·increased volatility in foreign currency exchange rates;26 Table of Contents·delays in, or curtailment of, purchasing decisions by our customers or potential customers;·increased credit risk associated with our customers or potential customers, particularly those that may operate inindustries most affected by the economic downturn; and·impairment of our tangible or intangible assets.In the past we experienced delays in customer purchasing decisions and disruptions in normal volume of customerorders that we believe were in part due to the uncertainties in the global economy and an adverse impact on consumerspending. During challenging and uncertain economic times and in tight credit markets, many customers delay or reducetechnology purchases. Should similar events occur again, our business and operating results could be significantly andadversely affected.The effect of terrorist threats and actions on the general economy could decrease our revenue.Countries such as the United States and China continue to be on alert for terrorist activity. The potential near andlong-term impact terrorist activities may have in regards to our suppliers, customers and markets for our products and theeconomy is uncertain. There may be embargos of ports or products, or destruction of shipments or our facilities, or attacksthat affect our personnel. There may be other potentially adverse effects on our operating results due to significant eventsthat we cannot foresee. Since we perform all of our manufacturing operations in China, terrorist activity or threats againstU.S.‑owned enterprises are a particular concern to us. II. Risks Related to International Aspects of Our BusinessThe Chinese central government is increasingly aware of air pollution and other forms of environmental pollution andtheir reform efforts can impact our manufacturing, including intermittent mandatory shutdowns. The Chinese central government is demonstrating strong leadership to improve air quality and reduceenvironmental pollution. These efforts have impacted manufacturing companies through mandatory shutdowns, increasedinspections and regulatory reforms. In the fourth quarter of 2017, many manufacturing companies in the greater Beijing area,including AXT, were instructed by the local government to cease most manufacturing for several days until the air qualityimproved. In the first quarter of 2018, from February 27 to March 31 over 300 manufacturing companies were againintermittently shut down by the local government for a total of ten days, or 30 percent of the remaining calendar days, due tosevere air pollution. Our shipments were delayed and our revenue for the quarter was negatively impacted. We expect thatmandatory factory shutdowns will occur in the future. If the frequency of such shutdowns increases, especially at the end of aquarter, or if the total number of days of shutdowns prevents us from producing enough wafers to ship, then these shutdownswill have a material adverse effect on our manufacturing output, revenue and factory utilization. We are currently relocatingour gallium arsenide and germanium manufacturing and are adding capacity at our new sites. We believe these efforts willmitigate our exposure to mandatory factory shutdowns. However, until the majority of our relocation is completed and ournew facilities are in volume production, there is no mitigation of the risk of mandatory factory shutdowns. Each of our tenraw material supply chain companies could also be impacted by environmental related orders from the central government. Enhanced trade tariffs, import restrictions, export restrictions, Chinese regulations or other trade barriers may materiallyharm our business.All of our wafer substrates are manufactured in China and in 2018, approximately 10% of our revenue was generatedby sales to customers in North America, primarily in the U.S. In September 2018, the Trump Administration announced a listof thousands of categories of goods that will face tariffs of 10%. Our inbound products to the U.S. are subject to a 10% tariffassessed on the customs value of the goods as imported by us, effective approximately September 24, 2018. Although we donot believe the initial impact of approximately $150,000 per quarter is material, the future impact of tariffs and trade wars isuncertain. The tariffs could be increased to 25% in the future. We may be required to raise prices, which may result in theloss of customers and our business, financial condition and results of operations27 Table of Contentsmay be materially harmed. Additionally, the Trump Administration continues to signal that it may alter trade agreementsand terms between China and the United States, including limiting trade with China, and may impose additional tariffs onimports from China. It is possible that our business could be adversely impacted by retaliatory trade measures taken byChina or other countries in response to existing or future tariffs, which could cause us to raise prices or make changes to ouroperations, which could materially harm our business, financial condition and results of operations. Further, the continuedthreats of tariffs and other trade restrictions could have a generally disruptive impact on the global economy and, therefore,negatively impact our sales. In addition, we may incur increases in costs and other adverse business consequences, including loss of revenue ordecreased gross margins, due to changes in tariffs, import or export restrictions, further trade barriers, or unexpected changesin regulatory requirements. For example, in July 2012, we received notice of retroactive value-added taxes (VATs) levied bythe tax authorities in China, which applied for the period from July 1, 2011 to June 30, 2012. We expensed the retroactiveVATs of approximately $1.3 million in the quarter ended June 30, 2012, which resulted in a decrease in our grossmargins. These VATs will continue to negatively impact our gross margins for the future quarters. Given the relatively fluidregulatory environment in China and the United States, there could be additional tax or other regulatory changes in thefuture. Any such changes could directly and materially adversely impact our financial results and general business condition. We derive a significant portion of our revenue from international sales, and our ability to sustain and increase ourinternational sales involves significant risks.Approximately 90% of our revenue is from international sales. We expect that sales to customers outside the UnitedStates, particularly sales to customers in Japan, Taiwan and China, will continue to represent a significant portion of ourrevenue. Therefore, our revenue growth depends significantly on the expansion of our international sales and operations.All of our manufacturing facilities and most of our suppliers are also located outside the United States. Managingour overseas operations presents challenges, including periodic regional economic downturns, trade balance issues, threats oftrade wars, varying business conditions and demands, political instability, variations in enforcement of intellectual propertyand contract rights in different jurisdictions, differences in the ability to develop relationships with suppliers and other localbusinesses, changes in U.S. and international laws and regulations, including U.S. export restrictions, fluctuations in interestand currency exchange rates, the ability to provide sufficient levels of technical support in different locations, culturaldifferences and perceptions of U.S. companies, shipping delays and terrorist acts or acts of war, among other risks. Many ofthese challenges are present in China, which represents a large potential market for semiconductor devices. Globaluncertainties with respect to: (i) economic growth rates in various countries; (ii) sustainability of demand for electronicproducts; (iii) capital spending by semiconductor manufacturers; (iv) price weakness for certain semiconductor devices; (v)changing and tightening environmental regulations; (vi) political instability in regions where we have operations and (vii)trade wars may also affect our business, financial condition and results of operations.Our dependence on international sales involves a number of risks, including:·changes in tariffs, import restrictions, export restrictions, or other trade barriers;·unexpected changes in regulatory requirements;·longer periods to collect accounts receivable;·foreign exchange rate fluctuations;·changes in export license requirements;·political and economic instability; and28 Table of Contents·unexpected changes in diplomatic and trade relationships.Most of our sales are denominated in U.S. dollars, except for sales to our Chinese customers which are denominatedin renminbi and our Japanese customers which are denominated in Japanese yen. We also have some small sales denominatedin Euro. Increases in the value of the U.S. dollar could increase the price of our products in non-U.S. markets and make ourproducts more expensive than competitors’ products in these markets.We are subject to foreign exchange gains and losses that materially impact our income statement. We are subject to foreign exchange gains and losses that materially impact our statement of operations. Forexample, in 2017 we incurred a loss of $602,000. The functional currency of our wholly owned Chinese subsidiary and our partially owned joint venture companiesis the Chinese renminbi, the local currency. We can incur foreign exchange gains or losses when we pay dollars to one of ourChina-based companies or a third party supplier in China. Similarly, if a company in China pays renminbi into one of ourbank accounts transacting in dollars the renminbi will be converted to dollars and we can incur a foreign exchange gain orloss. Hedging renminbi will be considered in the future but it is complicated by the number of companies involved, thediversity of transactions and restrictions imposed by the banking system in China. Sales to Japanese customers are denominated in Japanese yen. This subjects us to fluctuations in the exchange ratesbetween the U.S. dollar and the Japanese yen and can result in foreign exchange gains and losses. This has been problematicin the past and, therefore, we instituted a foreign currency hedging program dealing with yen which has mitigated theproblem. Joint venture companies in China bring certain risks. Since our wholly owned subsidiaries and all of our partially owned companies reside in China, their activities couldsubject us to a number of risks associated with conducting operations internationally, including:·unexpected changes in regulatory requirements that may limit our ability to manufacture, export the productsof these companies or sell into particular jurisdictions or impose multiple conflicting tax laws and regulations;·the imposition of tariffs, trade barriers and duties;·difficulties in managing geographically disparate operations;·difficulties in enforcing agreements through non-U.S. legal systems;·political and economic instability, civil unrest or war;·terrorist activities that impact international commerce;·difficulties in protecting our intellectual property rights, particularly in countries where the laws and practicesdo not protect proprietary rights to as great an extent as do the laws and practices of the United States;·changing laws and policies affecting economic liberalization, foreign investment, currency convertibility orexchange rates, taxation or employment; and·nationalization of foreign‑owned assets, including intellectual property.29 Table of ContentsUncertainty regarding the United States’ foreign policy under the current administration could disrupt our business. We manufacture our substrates in China and, in 2018, approximately 90% of our sales were to customers locatedoutside of the United States. Further, we have partial ownership of 10 companies in China as part of our supply chain. TheUnited States’ current foreign policy could create uncertainty and caution in the international business community, resultingin possible disruptions in manufacturing, import/export, trade tariffs, sales, investments or other business activity. Suchdisruptions could have an adverse impact on our financial performance. If China places restrictions on freight and transportation routes and on port of entry and departure this could result inshipping delays or increased costs for shipping. In August 2015, there was an explosion at the Port of Tianjin, China. As a result of this incident the governmentplaced restrictions on importing certain materials and on freight routes used to transport these materials. We experiencedsome modest disruption from these restrictions. If the government were to place additional restrictions on the transportationof materials, then our ability to transport our raw materials or products could be limited and result in manufacturing delays orbottlenecks at shipping ports, affecting our ability to deliver products to our customers. During periods of such restrictions,we may increase our stock of critical materials (such as arsenic, gallium, and other chemicals) for use during the period thatthese restrictions are likely to last, which will increase our use of cash and increase our inventory level. Any of theserestrictions could materially and adversely impact our results of operations and our financial condition.Our operating results depend in large part on continued customer acceptance of our substrate products manufactured inChina and continued improvements in product quality.We manufacture all of our products in China, and source most of our raw materials in China. We have in the pastexperienced quality problems with our China‑manufactured products. Our previous quality problems caused us to losemarket share to our competitors, as some of our customers reduced their orders until our wafer surface quality was as good andas consistent as that offered by our competitors and instead allocated their requirements for compound semiconductorsubstrates to our competitors. If we are unable to continue to achieve customer qualifications for our products, or if we areunable to control product quality, customers may not increase purchases of our products, our China facilities will becomeunderutilized, and we will be unable to achieve revenue growth.Changes in China’s political, social, regulatory or economic environments may affect our financial performance.Our financial performance may be affected by changes in China’s political, social, regulatory or economicenvironments. The role of the Chinese central and local governments in the Chinese economy is significant. Chinese policiestoward hazardous materials, including arsenic, environmental controls, air pollution, economic liberalization, laws andpolicies affecting technology companies, foreign investment, currency exchange rates, taxation structure and other matterscould change, resulting in greater restrictions on our ability to do business and operate our manufacturing facilities in China.We have observed a growing fluidity and tightening of regulations concerning hazardous materials, other environmentalcontrols and air pollution. The Chinese government could revoke, terminate or suspend our operating licenses for reasonsrelated to environmental control over the use of hazardous materials, air pollution, labor complaints, national security andsimilar reasons without compensation to us. In days of severe air pollution the government has ordered manufacturingcompanies to stop all production. For example, in the fourth quarter of 2017 many manufacturing companies in the greaterBeijing area, including AXT, were instructed by the local government to cease most manufacturing for several days until theair quality improved. In the first quarter of 2018, from February 27 to March 31 over 300 manufacturing companies,including us, were again intermittently shut down by the local government for a total of ten days due to severe airpollution. Our shipments were delayed and our revenue for the quarter was negatively impacted. We expect that mandatoryfactory shutdowns will occur in the future. Any failure on our part to comply with governmental regulations could result inthe loss of our ability to manufacture our products. Further, any imposition of surcharges or any increase in Chinese tax ratesor reduction or elimination of Chinese tax benefits could hurt our financial results.30 Table of ContentsAn important example of some of these factors is seen in a change underway in Beijing. The Beijing citygovernment is moving its offices into the area where our original manufacturing facility is currently located and is in theprocess of moving thousands of government employees into this area. To create room and upgrade the district, the cityinstructed virtually all existing manufacturing companies, including AXT, to relocate all or some of their manufacturinglines. In 2018, AXT made significant progress in the relocation of our gallium arsenide and germanium production lines andwe intend to complete this relocation in 2019. The relocation of our gallium arsenide production line requires us to continue to accurately execute our relocationplan. A failure to properly complete our relocation could result in disruption to our production and have a material adverseimpact on our revenue, our results of operations and our financial condition. We intend to secure additional permits andapprovals in 2019. Given the fluidity and ever-increasing review of environmental and regulatory ordinances in China, therecan be no assurance that these matters will be satisfactorily completed. Further, our major customers are in the process of qualifying the wafer substrates from the new sites before placingvolume purchase orders for products from the new facilities. If we fail to meet the product qualification requirements of acustomer, we may lose sales to that customer. Our reputation may also be damaged. Any loss of sales could have a materialadverse effect on our revenue, our results of operations and our financial condition. Our international operations are exposed to potential adverse tax consequence in China. Our international operations create a risk of potential adverse tax consequences. Taxes on income in our China-based companies are dependent upon acceptance of our operational practices and intercompany transfer pricing by local taxauthorities as being on an arm's length basis. Due to inconsistencies among taxing authorities in application of the arm'slength standard, transfer pricing challenges by tax authorities could, if successful, materially increase our consolidatedincome tax expense. We are subject to tax audits in China and an audit could result in the assessment of additional incometax against us. This could have a material adverse effect on our operating results or cash flows in the period or periods forwhich that determination is made and could result in increases to our overall tax expense in subsequent periods. Varioustaxing agencies in China are increasingly focused on tax reform and other legislative action to increase tax revenue. Inaddition to risks regarding income tax we have in the past been retroactively assessed value added taxes (“VAT” or sales tax)and such VAT assessments could occur again in the future.If there are power shortages in China, we may have to temporarily close our China operations, which would adverselyimpact our ability to manufacture our products and meet customer orders, and would result in reduced revenue.In the past, China has faced power shortages resulting in power demand outstripping supply in peak periods.Instability in electrical supply has caused sporadic outages among residential and commercial consumers causing theChinese government to implement tough measures to ease the energy shortage. If further problems with power shortagesoccur in the future, we may be required to make temporary closures of our operations or of our subsidiary and joint ventureoperations. We may be unable to manufacture our products and would then be unable to meet customer orders except fromfinished goods inventory on hand. As a result, our revenue could be adversely impacted, and our relationships with ourcustomers could suffer, impacting our ability to generate future revenue. In addition, if power is shut off at any of ourfacilities at any time, either voluntarily or as a result of unplanned brownouts, during certain phases of our manufacturingprocess including our crystal growth phase, the work in process may be ruined and rendered unusable, causing us to incurcosts that will not be covered by revenue, and negatively impacting our cost of revenue and gross margins.An outbreak of a contagious disease such as Ebola, Severe Acute Respiratory Syndrome (SARS) or the Avian Flu mayadversely impact our manufacturing operations and some of our key suppliers and customers.Any reoccurrence of SARS or an outbreak of a contagious disease, such as Avian Flu or Ebola, may cause us totemporarily close our manufacturing operations. Similarly, if one or more of our key suppliers is required to close for anextended period, we might not have enough raw material inventories to continue manufacturing operations. In addition,31 Table of Contentswhile we possess management skills among our China staff that enable us to maintain our manufacturing operations withminimal on-site supervision from our U.S.‑based staff, our business could also be harmed if travel to or from China and theUnited States is restricted or inadvisable. If our manufacturing operations were closed for a significant period, we could loserevenue and market share, which would depress our financial performance and could be difficult to recapture. Finally, if oneof our key customers is required to close for an extended period, we might not be able to ship product to them, our revenuewould decline and our financial performance would suffer.III. Risks Related to Our Financial Results and Capital StructureWe may utilize our cash balances for relocation, expansion, or to offset a business downturn resulting in the decline of ourexisting cash, cash equivalents and investment balances, and if we need additional capital, those funds may not beavailable on acceptable terms, or at all.Our liquidity is affected by many factors including, among others, the relocation of our gallium arsenidemanufacturing operations, the extent to which we pursue on-going capital expenditures, the acquisition and build out of thesites at Dingxing and Kazuo, the level of our production, the level of profits or losses, and other factors related to theuncertainties of the industry and global economies. Our relocation expenditures and any negative cash flow effects of theseother factors will draw down our cash reserves, which could adversely affect our financial condition, reduce our value andpossibly impinge our ability to raise debt and equity funding in the future, at a time when we might need to raise additionalcash or elect to raise additional cash. Accordingly, there can be no assurance that events will not require us to seek additionalcapital or, if required, that such capital would be available on terms acceptable to us, if at all.Unpredictable fluctuations in our operating results could disappoint analysts or our investors, which could cause our stockprice to decline.We have experienced, and may continue to experience, significant fluctuations in our revenue, gross margins andearnings. Our quarterly and annual revenue and operating results have varied significantly in the past and may varysignificantly in the future due to a number of factors, including:·our ability to develop, manufacture and deliver high quality products in a timely and cost-effective manner;·disruptions during the relocation of our gallium arsenide product line;·disruptions in manufacturing if air pollution or another environmental hazard causes the government to orderwork stoppages;·fluctuation of our manufacturing yields;·decreases in the prices of our or our competitors’ products;·fluctuations in demand for our products;·the volume and timing of orders from our customers, and cancellations, push-outs and delays of customer ordersonce booked;·decline in general economic conditions or downturns in the industry in which we compete;·expansion of our manufacturing capacity;·expansion of our operations in China;·limited availability and increased cost of raw materials;32 Table of Contents·costs incurred in connection with any future acquisitions of businesses or technologies; and·increases in our expenses, including expenses for research and development.Due to these factors, we believe that period-to-period comparisons of our operating results may not be meaningfulindicators of our future performance.A substantial percentage of our operating expenses are fixed, and we may be unable to adjust spending tocompensate for an unexpected shortfall in revenue. As a result, any delay in generating revenue could cause our operatingresults to fall below the expectations of market analysts or investors, which could also cause our stock price to decline.If our operating results and financial performance do not meet the guidance that we have provided to the public, our stockprice may decline.We provide public guidance on our expected operating and financial results. Although we believe that thisguidance provides our stockholders, investors and analysts with a better understanding of our expectations for the future,such guidance is comprised of forward-looking statements subject to the risks and uncertainties described in this report andin our other public filings and public statements. Our actual results may not meet the guidance we have provided. If ouroperating or financial results do not meet our guidance or the expectations of investment analysts, our stock price maydecline.We have adopted certain anti-takeover measures that may make it more difficult for a third party to acquire us.Our board of directors has the authority to issue up to 800,000 shares of preferred stock in addition to theoutstanding shares of Series A preferred stock and to determine the price, rights, preferences and privileges of those shareswithout any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and maybe adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance ofshares of preferred stock could have the effect of making it more difficult for a third party to acquire a majority of ouroutstanding voting stock. We have no present intention to issue additional shares of preferred stock.Provisions in our restated certificate of incorporation and amended and restated bylaws may have the effect ofdelaying or preventing a merger, acquisition or change of control, or changes in our management, which could adverselyaffect the market price of our common stock. The following are some examples of these provisions:·the division of our board of directors into three separate classes, each with three-year terms;·the right of our board to elect a director to fill a space created by a board vacancy or the expansion of the board;·the ability of our board to alter our amended and restated bylaws; and·the requirement that only our board or the holders of at least 10% of our outstanding shares may call a specialmeeting of our stockholders.Furthermore, because we are incorporated in Delaware, we are subject to the provisions of Section 203 of theDelaware General Corporation Law. These provisions prohibit us from engaging in any business combination with anyinterested stockholder (a stockholder who owns 15% or more of our outstanding voting stock) for a period of three yearsfollowing the time that such stockholder became an interested stockholder, unless:·66/3% of the shares of voting stock not owned by the interested stockholder approve the merger orcombination, or33 2 Table of Contents·the board of directors approves the merger or combination or the transaction which resulted in the stockholderbecoming an interested stockholder.Our common stock may be delisted from The Nasdaq Global Select Market, which could negatively impact the price of ourcommon stock and our ability to access the capital markets.Our common stock is listed on The Nasdaq Global Select Market. The bid price of our common stock has in the pastclosed below the $1.00 minimum per share bid price required for continued inclusion on The Nasdaq Global Select Marketunder Marketplace Rule 5450(a). If the bid price of our common stock remains below $1.00 per share for thirty consecutivebusiness days, we could be subject to delisting from the Nasdaq Global Select Market.Any delisting from The Nasdaq Global Select Market could have an adverse effect on our business and on thetrading of our common stock. If a delisting of our common stock were to occur, our common stock would trade in the over-the-counter market and be quoted on a service such as those provided by OTC Markets Group, Inc. Such alternatives aregenerally considered to be less efficient markets, and our stock price, as well as the liquidity of our common stock, may beadversely impacted as a result. Delisting from The Nasdaq Global Select Market could also have other negative results,including the potential loss of confidence by customers, suppliers and employees, the loss of institutional investor interestand fewer business development opportunities, as well as the loss of liquidity for our stockholders.Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited. As of December 31, 2018, we had U.S. federal net operating loss carryforwards of approximately $64.3 million andstate net operating loss carryforwards of approximately $0.3 million, which begin expiring in varying amounts from 2022 ifunused. Under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, if a corporation undergoes an“ownership change,” the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change taxattributes, such as research tax credits, to offset its post-change income and taxes may be limited. In general, an “ownershipchange” occurs if there is a cumulative change in our ownership by “5% shareholders” that exceeds 50 percentage pointsover a rolling three-year period. Similar rules may apply under state tax laws. We might have undergone prior ownershipchanges, and we may undergo ownership changes in the future, which may result in limitations on our net operating losscarryforwards and other tax attributes. Any such limitations on our ability to use our net operating loss carryforwards andother tax attributes could adversely impact our business, financial condition and results of operations. IV. Risks Related to Our Intellectual PropertyIntellectual property infringement claims may be costly to resolve and could divert management attention.Other companies may hold or obtain patents on inventions or may otherwise claim proprietary rights to technologynecessary to our business. The markets in which we compete are comprised of competitors that in some cases hold substantialpatent portfolios covering aspects of products that could be similar to ours. We could become subject to claims that we areinfringing patent, trademark, copyright or other proprietary rights of others. We have in the past been involved in lawsuitsalleging patent infringement, and could in the future be involved in similar litigation. For example, we entered into asettlement agreement with Sumitomo in 2011 to settle its claim of patent infringement, which resulted in AXT paying themroyalties.If we are unable to protect our intellectual property, including our non-patented proprietary process technology, we maylose valuable assets or incur costly litigation.We rely on a combination of patents, copyrights, trademarks, trade secrets and trade secret laws, non-disclosureagreements and other intellectual property protection methods to protect our proprietary technology. We believe that ourinternal, non-patented proprietary process technology methods, systems and processes are a valuable and critical element ofour intellectual property. We must establish and maintain safeguards to avoid the theft of these processes. Our ability toestablish and maintain a position of technology leadership also depends on the skills of our development personnel. 34 Table of ContentsDespite our efforts to protect our intellectual property, third parties can develop products or processes similar to ours. Ourmeans of protecting our proprietary rights may not be adequate, and our competitors may independently develop similartechnology, duplicate our products or design around our patents. We believe that at least two of our competitors ship GaAssubstrates produced using a process similar to our VGF process. Our competitors may also develop and patent improvementsto the VGF technology upon which we rely, and thus may limit any exclusivity we enjoy by virtue of our patents or tradesecrets.It is possible that pending or future United States or foreign patent applications made by us will not be approved,that our issued patents will not protect our intellectual property, or that third parties will challenge our ownership rights orthe validity of our patents. In addition, the laws of some foreign countries may not protect our proprietary rights to as great anextent as do the laws of the United States and it may be more difficult to monitor the use of our intellectual property. Ourcompetitors may be able to legitimately ascertain non-patented proprietary technology embedded in our systems. If thisoccurs, we may not be able to prevent the development of technology substantially similar to ours.We may have to resort to costly litigation to enforce our intellectual property rights, to protect our trade secrets orknow-how or to determine their scope, validity or enforceability. Enforcing or defending our proprietary technology isexpensive, could cause us to divert resources and may not prove successful. Our protective measures may prove inadequateto protect our proprietary rights, and if we fail to enforce or protect our rights, we could lose valuable assets.V. Risks Related to Compliance, Environmental Regulations and Other Legal MattersIf we, or any of our partially owned supply chain companies, fail to comply with environmental and safety regulations, wemay be subject to significant fines or forced to cease our operations.We are subject to federal, state and local environmental and safety laws and regulations in all of our operatinglocations, including laws and regulations of China, such as laws and regulations related to the development, manufacture anduse of our products, the use of hazardous materials, the operation of our facilities, and the use of our real property. These lawsand regulations govern the use, storage, discharge and disposal of hazardous materials during manufacturing, research anddevelopment, and sales demonstrations. If we, or any of our partially owned supply chain companies, fail to comply withapplicable regulations, we could be subject to substantial liability for clean-up efforts, personal injury, fines or suspension orbe forced to close or temporarily cease our operations, and/or suspend or terminate the development, manufacture or use ofcertain of our products, the use of our facilities, or the use of our real property, each of which could have a material adverseeffect on our business, financial condition and results of operations.The Chinese central government is demonstrating strong leadership to improve air quality and reduceenvironmental pollution. These efforts have impacted manufacturing companies through mandatory shutdowns, increasedinspections and regulatory reforms. In the fourth quarter of 2017, many manufacturing companies in the greater Beijing area,including AXT, were instructed by the local government to cease most manufacturing for several days until the air qualityimproved. In the first quarter of 2018, from February 27 to March 31 over 300 manufacturing companies were againintermittently shut down by the local government for a total of ten days, or 30 percent of the remaining calendar days, due tosevere air pollution. Our shipments were delayed and our revenue for the quarter was negatively impacted. We expect thatmandatory factory shutdowns will occur in the future. If the frequency of such shutdowns increases, especially at the end of aquarter, or if the total number of days of shutdowns prevents us from producing enough wafers to ship, then the shutdownswill have a material adverse effect on our manufacturing output, revenue and factory utilization. We are currently relocatingour gallium arsenide and germanium manufacturing and are adding capacity at our new sites. We believe these efforts willmitigate our exposure to factory shutdowns. However, until the majority of our relocation is completed and our new facilitiesare in volume production, there is no mitigation of the risk of mandatory factory shutdowns. Each of our 10 raw materialsupply chain companies could also be impacted by environmental related orders from the central government.In addition, from time to time, the Chinese government issues new regulations, which may require additional actionson our part to comply. On February 27, 2015, the China State Administration of Work Safety updated its list of hazardoussubstances. The previous list, which was published in 2002, did not restrict the materials that we use in our35 Table of Contentswafers. The new list added gallium arsenide. As a result of the newly published list, we were instructed to obtain a permit tocontinue to manufacture our gallium arsenide substrate wafers. The Beijing municipal authority accepted our permitapplication in May 2015, but has not yet issued to us the requisite permit while we continue to show good faith and, morerecently, significant progress in relocating our gallium arsenide production. If our application is denied in the future beforewe complete our relocation, then our gallium arsenide production could be disrupted, which could materially and adverselyimpact our results of operations and our financial condition.We could be subject to suits for personal injuries caused by hazardous materials.In 2005, a complaint was filed against us alleging personal injury, general negligence, intentional tort, wage lossand other damages, including punitive damages, as a result of exposure of plaintiffs to high levels of gallium arsenide ingallium arsenide wafers, and methanol. Other current and/or former employees could bring litigation against us in the future.Although we have in place engineering, administrative and personnel protective equipment programs to address these issues,our ability to expand or continue to operate our present locations could be restricted or we could be required to acquirecostly remediation equipment or incur other significant expenses if we were found liable for failure to comply withenvironmental and safety regulations. Existing or future changes in laws or regulations in the United States and China mayrequire us to incur significant expenditures or liabilities, or may restrict our operations. In addition, our employees could beexposed to chemicals or other hazardous materials at our facilities and we may be subject to lawsuits seeking damages forwrongful death or personal injuries allegedly caused by exposure to chemicals or hazardous materials at our facilities. Litigation is inherently uncertain and while we would expect to defend ourselves vigorously, it is possible that ourbusiness, financial condition, results of operations or cash flows could be affected in any particular period by litigationpending and any additional litigation brought against us. In addition, future litigation could divert management’s attentionfrom our business and operations, causing our business and financial results to suffer. We could incur defense or settlementcosts in excess of the insurance covering these litigation matters, or that could result in significant judgments against us orcause us to incur costly settlements, in excess of our insurance limits. We are subject to internal control evaluations and attestation requirements of Section 404 of the Sarbanes‑Oxley Act.Pursuant to Section 404 of the Sarbanes‑Oxley Act of 2002, we must include in our Annual Report on Form 10-K areport of management on the effectiveness of our internal control over financial reporting. Ongoing compliance with thisrequirement is complex, costly and time-consuming and it extends to our companies in China. If: (1) we fail to maintaineffective internal control over financial reporting; or (2) our management does not timely assess the adequacy of suchinternal control, we could be subject to regulatory sanctions and the public’s perception of us may be adversely impacted.We need to continue to improve or implement our systems, procedures and controls.We rely on certain manual processes for data collection and information processing, as do our joint venturecompanies. If we fail to manage these procedures properly or fail to effectively manage a transition from manual processes toautomated processes, our systems and controls may be disrupted. To manage our business effectively, we may need toimplement additional management information systems, further develop our operating, administrative, financial andaccounting systems and controls, add experienced senior level managers, and maintain close coordination among ourexecutive, engineering, accounting, marketing, sales and operations organizations. Item 1B. Unresolved Staff CommentsNone.36 Table of Contents Item 2. PropertiesOur principal properties as of March 11, 2019 are as follows: Square Location Feet Principal Use OwnershipFremont, CA 19,467 Administration Operating lease, expires November 2020Beijing, China 256,000 Production andAdministration Owned by AXT / TongmeiDingXing, China 190,000 Production Owned by AXT / TongmeiKazuo, China 69,000 Production Owned by AXT / TongmeiXianxi, China 54,000 Production Owned by Beijing JiYa Semiconductor Material Co., Ltd.*Xianxi, China 7,100 Administration Owned by Beijing JiYa Semiconductor Material Co., Ltd.*Beijing, China 1,500 Administration Operating lease by Beijing JiYa SemiconductorMaterial Co., Ltd., expires April 2019Nanjing, China 5,400 R&D andAdministration Owned by Nanjing JinMei Gallium Co., Ltd.*Kazuo, China 7,500 Production Operating lease by Nanjing JinMei Gallium Co. Ltd. expiresDecember 2019.*Kazuo, China 71,000 Production andAdministration Owned by Beijing BoYu Semiconductor Vessel CraftworkTechnology Co., Ltd.*Beijing, China 37,660 Production andAdministration Operating leases by Beijing BoYu Semiconductor VesselCraftwork Technology Co., Ltd., expire on various dates untilNovember 2019.* *Joint ventures in which we hold an interest and consolidate in our consolidated financial statements. We hold a 46%interest in Beijing JiYa Semiconductor Material Co., Ltd., a 97% interest in Nanjing JinMei Gallium Co., Ltd., and a63% interest in Beijing BoYu Semiconductor Vessel Craftwork Technology Co., Ltd.We consider each facility to be in good operating condition and adequate for its present use, and believe that eachfacility has sufficient plant capacity to meet its current and anticipated operating requirements. Item 3. Legal ProceedingsFrom time to time we may be involved in judicial or administrative proceedings concerning matters arising in theordinary course of business. We do not expect that any of these matters, individually or in the aggregate, will have a materialadverse effect on our business, financial condition, cash flows or results of operation. Item 4. Mine Safety DisclosuresNot applicable. 37 Table of Contents PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesOur common stock has been trading publicly on the NASDAQ Global Select Market (NASDAQ) under the symbol“AXTI” since May 20, 1998, the date we consummated our initial public offering, and beginning on January 3, 2011, ourcommon stock began trading on the NASDAQ Global Select Market under the same symbol. The following table sets forththe range of high and low sales prices of the common stock for the periods indicated, as reported by NASDAQ. High Low 2018 First Quarter$9.45$6.90Second Quarter $8.60 $5.80 Third Quarter $9.38 $6.80 Fourth Quarter $7.24 $3.93 2017 First Quarter $8.65 $4.68 Second Quarter $7.83 $5.50 Third Quarter $9.50 $5.95 Fourth Quarter $10.75 $7.65 As of March 11, 2019, there were 133 holders of record of our common stock. Because many shares of AXT’scommon stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the totalnumber of beneficial owners of our common stock.We have never paid or declared any cash dividends on our common stock and do not anticipate paying cashdividends in the foreseeable future. Dividends accrue on our outstanding Series A preferred stock at the rate of $0.20 perannum per share of Series A preferred stock. The 883,000 shares of Series A preferred stock issued and outstanding as ofDecember 31, 2018 are valued at $3,532,000 and are non-voting and non-convertible preferred stock with a 5.0% cumulativeannual dividend rate payable when declared by our board of directors, and a $4.00 per share liquidation preference overcommon stock that must be paid before any distribution is made to the holders of our common stock. These shares ofpreferred stock were issued to shareholders of Lyte Optronics, Inc. in connection with the completion of our acquisition ofLyte Optronics, Inc. on May 28, 1999. By the terms of the Series A preferred stock, so long as any shares of Series A preferredstock are outstanding, neither the Company nor any subsidiary of the Company shall redeem, repurchase or otherwise acquireany shares of common stock, unless all accrued dividends on the Series A preferred stock have been paid. During 2013 and2015, we repurchased shares of our outstanding common stock. As of December 31, 2015, the Series A preferred stock hadcumulative dividends of $2.9 million and we include such cumulative dividends in “Accrued liabilities” in our consolidatedbalance sheets. No shares were repurchased during 2018, 2017 and 2016 under this program. If we are required to pay thecumulative dividends on the Series A preferred stock, our cash and cash equivalents would be reduced. We account for thecumulative year to date dividends on the Series A preferred stock when calculating our earnings per share. Issuer Purchases of Equity SecuritiesOn February 21, 2013, our Board of Directors approved a stock repurchase program pursuant to which we couldrepurchase up to $6.0 million of our outstanding common stock through February 27, 2014. The purchases could be madefrom time to time in the open market and were to be funded from our existing cash balances and cash generated fromoperations. During 2013, we repurchased approximately 285,000 shares at an average price of $2.52 per share for a totalpurchase price of $716,000 under the stock repurchase program. As of December 31, 2013, approximately $5.3 millionremained available for future repurchases under this program. No shares were repurchased in 2014 under this program and theplan expired on February 27, 2014.38 Table of ContentsOn October 27, 2014, our Board of Directors approved a stock repurchase program pursuant to which we mayrepurchase up to $5.0 million of our outstanding common stock. These repurchases can be made from time to time in theopen market and are funded from our existing cash balances and cash generated from operations. During 2015, werepurchased approximately 908,000 shares at an average price of $2.52 per share for a total purchase price of approximately$2.3 million under the stock repurchase program. No shares were repurchased during 2018 or 2017 under this program. As ofDecember 31, 2018 and 2017, approximately $2.7 million remained available for future repurchases under this program,respectively.Comparison of Stockholder ReturnSet forth below is a line graph comparing the annual percentage change in the cumulative total return to thestockholders of the Company on our common stock with the CRSP Total Return Index for the Nasdaq Stock Market (U.S.Companies) and the Nasdaq Electronic Components Index for the period commencing December 31, 2013 and endingDecember 31, 2018. 12/13 12/14 12/15 12/16 12/17 12/18 AXT, Inc.100107.2895.02183.91333.33166.67NASDAQ Composite100114.62122.8133172.11165.84NASDAQ Electronic Components100133.28130.82169.00240.33213.45 39 Table of Contents Item 6. Selected Consolidated Financial DataThe following selected consolidated financial data is derived from and should be read in conjunction with ourconsolidated financial statements and related notes set forth in Item 8 below, and in our previously filed reports onForm 10‑K. See also Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” forfurther information relating to items reflecting our results of operations and financial condition. Year Ended December 31, 2018 2017 2016 2015 2014 (in thousands, except per share data) Statements of Operations Data: Revenue $102,397 $98,673 $81,349 $77,502 $83,499 Cost of revenue 65,350 64,198 54,968 60,673 66,332 Gross profit 37,047 34,475 26,381 16,829 17,167 Operating expenses: Selling, general and administrative 19,003 17,009 13,880 16,064 14,970 Research and development 5,897 4,827 5,850 5,664 4,144 Restructuring charge — — 226 — 907 Total operating expenses 24,900 21,836 19,956 21,728 20,021 Income (loss) from operations 12,147 12,639 6,425 (4,899) (2,854) Interest income, net 528 461 409 412 483 Equity in (loss) earnings of unconsolidated joint ventures (1,080) (1,694) (1,995) 462 1,528 Other income (expense), net 352 (553) 860 2,023 361 Income (loss) before provision for income taxes 11,947 10,853 5,699 (2,002) (482) Provision for income taxes 938 792 733 531 215 Net income (loss) 11,009 10,061 4,966 (2,533) (697) Less: Net (income) loss attributable to noncontrolling interests (1,355) 87 670 305 (691) Net income (loss) attributable to AXT, Inc. $9,654 $10,148 $5,636 $(2,228) $(1,388) Net income (loss) attributable to AXT, Inc. per common share: Basic $0.24 $0.27 $0.17 $(0.07) $(0.05) Diluted $0.24 $0.26 $0.17 $(0.07) $(0.05) Shares used in per share calculations: Basic 39,049 37,444 32,139 32,183 32,452 Diluted 40,265 38,966 32,894 32,183 32,452 December 31, 2018 2017 2016 2015 2014 (in thousands) Balance Sheet Data: Cash and cash equivalents $16,526 $44,352 $36,152 $24,875 $28,814 Investments 22,846 32,608 17,571 19,128 20,123 Working capital 99,831 117,927 91,335 81,146 85,668 Total assets 223,524 211,200 154,246 151,896 161,517 Current liabilities 28,709 22,594 15,951 15,742 17,525 Stockholders’ equity 194,532 188,317 137,390 134,660 141,934 40 Table of Contents Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsIn addition to historical information, the following discussion contains forward‑looking statements that are subjectto risks and uncertainties. Actual results may differ substantially from those referred to herein due to a number of factors,including but not limited to risks described in the section entitled Item 1A. “Risk Factors” and elsewhere in this AnnualReport on Form 10-K. This discussion should be read in conjunction with Item 6. “Selected Consolidated Financial Data”and our consolidated financial statements and related notes included elsewhere in this Form 10-K.Restructuring ChargesIn the second quarter of 2016, we restructured the operations of Beijing JiYa Semiconductor Material Co., Ltd., oneof our partially owned consolidated subsidiaries, which resulted in a reduction in force of 28 positions that were no longerrequired to support production and operations. Accordingly, we recorded a restructuring charge of approximately $226,000related to the reduction in force for severance-related expenses. As of June 30, 2016, we had completed this restructuring planand the reduction in force. We did not have any restructuring charges in 2018 and 2017.Critical Accounting Policies and EstimatesWe prepare our consolidated financial statements in accordance with accounting principles generally accepted inthe United States of America. Accordingly, we make estimates, assumptions and judgments that affect the amounts reportedon our consolidated financial statements. These estimates, assumptions and judgments about future events and their effectson our results cannot be determined with certainty, and are made based upon our historical experience and on otherassumptions that are believed to be reasonable under the circumstances. These estimates may change as new events occur oradditional information is obtained, and we may periodically be faced with uncertainties, the outcomes of which are notwithin our control and may not be known for a prolonged period of time.We have identified the policies below as critical to our business operations and understanding of our financialcondition and results of operations. Critical accounting policies are material to the presentation of our consolidated financialstatements and require us to make difficult, subjective or complex judgments that could have a material effect on ourfinancial condition and results of operations. They may require us to make assumptions about matters that are highlyuncertain at the time of the estimate. Different estimates that we could have used, or changes in the estimate that arereasonably likely to occur, may have a material impact on our financial condition or results of operations. We also refer youto Note 1 to our consolidated financial statements included elsewhere in this Form 10-K.Revenue RecognitionWe manufacture and sell high-performance compound semiconductor substrates including indium phosphide,gallium arsenide and germanium wafers, and our three consolidated subsidiaries sell certain raw materials, including 99.99%pure gallium (4N Ga), high purity gallium (7N Ga), pyrolytic boron nitride (pBN) crucibles and boron oxide (B2O3). After weship our products, there are no remaining obligations or customer acceptance requirements that would preclude revenuerecognition. Our products are typically sold pursuant to purchase orders placed by our customers, and our terms andconditions of sale do not require customer acceptance. We account for a contract with a customer when there is a legallyenforceable contract, which could be the customer’s purchase order, the rights of the parties are identified, the contract hascommercial terms, and collectibility of the contract consideration is probable. The majority of our contracts have a singleperformance obligation to transfer products and are short term in nature, usually less than six months. Our revenue ismeasured based on the consideration specified in the contract with each customer in exchange for transferring products thatare generally based upon a negotiated, formula, list or fixed price. Revenue is recognized when control of the promisedgoods is transferred to our customer, which is either upon shipment from our dock, receipt at the customer’s dock, or removalfrom consignment inventory at the customer’s location, in an amount that reflects the consideration we expect to be entitledto receive in exchange for those goods. 41 Table of ContentsWe have elected to account for shipping and handling as activities to fulfill the promise to transfer the goods. Assuch, shipping and handling fees billed to customers in a sales transaction are recorded in revenue. Shipping and handlingcosts incurred are recorded in cost of revenue. Sales taxes and value added taxes in foreign jurisdictions that are collectedfrom customers and remitted to governmental authorities are accounted for on a net basis and, therefore, are excluded fromnet sales. We do not provide training, installation or commissioning services. We accrue for future returns based on historicaldata, prior experience, current economic trends and changes in customer demand at the time revenue is recognized. We donot recognize any asset associated with the incremental cost of obtaining revenue generating customer contracts. As such,sales commissions and other related expenses are expensed as incurred, given that the expected period of benefit is less thanone year. On January 1, 2018, we adopted Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contractswith Customers (“ASC 606”), and its related amendments, using the modified retrospective method applied to those contractswhich were not completed as of January 1, 2018. The adoption of ASC 606, using the modified retrospective approach, hadno significant impact to our accumulated deficit as of January 1, 2018 and no significant impact to the total net cash from orused in operating, investing, or financing activities within the consolidated statements of cash flows. In connection with thisadoption on January 1, 2018, we reclassified our refund liabilities relating to sales with a right of return in the amount of$169,000 to present it separately from “Accounts receivables” and included it in “Accrued liabilities” on the consolidatedbalance sheets. See Note 1 for the required disclosures related to the impact of adopting this standard and a discussion of theCompany’s updated policies related to revenue recognition. Accounts Receivable, Allowance for Doubtful Accounts and Allowance for sales returnsAccounts receivables are recorded at the invoiced amount and are not interest bearing. We periodically review thelikelihood of collection on our accounts receivable balances and provide an allowance for doubtful accounts receivableprimarily based upon the age of these accounts. We evaluate receivables from U.S. customers with an emphasis onbalances in excess of 90 days and for receivables from customers located outside the U.S. with an emphasis on balances inexcess of 120 days and establish a reserve allowance on the receivable balances if needed. The reason for the difference in theevaluation of receivables between foreign and U.S. customers is that U.S. customers have historically made payments in ashorter period of time than foreign customers. Foreign business practices generally require us to allow customer paymentterms that are longer than those accepted in the United States. We assess the probability of collection based on a number offactors, including the length of time a receivable balance has been outstanding, our past history with the customer and thecustomer’s credit-worthiness. We exercise judgment when determining the adequacy of our reserves as we evaluate historical bad debt trends,general economic conditions in the United States and internationally, and changes in customer financial conditions.Uncollectible receivables are recorded as bad debt expense when all efforts to collect have been exhausted and recoveries arerecognized when they are received. As of December 31, 2018 and 2017, our accounts receivable, net balance was $19.6million and $22.8 million, respectively, which was net of an allowance for doubtful accounts of $358,000 in both December31, 2018 and 2017. There were no changes in the allowance of doubtful accounts in 2018. During 2017, we decreased theallowance for doubtful accounts by $295,000 due to $138,000 from bad debt recovery and $157,000 from bad debts writtenoff in 2017. If actual uncollectible accounts differ substantially from our estimates, revisions to the estimated allowance fordoubtful accounts would be required, which could have a material impact on our financial results. Historically, our allowance for sales returns reserve was deducted from gross accounts receivable. In connection withthe adoption of ASC Topic 606, on January 1, 2018, we reclassified our refund liabilities relating to sales with a right ofreturn in the amount of $169,000 to present it separately from “Accounts receivables” and included it in “Accrued liabilities”on the consolidated balance sheets. As of December 31, 2018 and 2017, the balance was $47,000 and $169,000, respectively. 42 Table of ContentsWarranty ReserveWe maintain a warranty reserve based upon our claims experience during the prior twelve months and any pendingclaims and returns of which we are aware. Warranty costs are accrued at the time revenue is recognized. As of December 31,2018 and 2017, accrued product warranties totaled $236,000 and $133,000, respectively. The increase in accrued productwarranties is primarily attributable to increased claims for quality issues experienced by customers. If actual warranty costs orpending new claims differ substantially from our estimates, revisions to the estimated warranty liability would be required,which could have a material impact on our financial condition and results of operations for future periods.Inventory ValuationInventories are stated at the lower of cost (approximated by standard cost) or net realizable value. Cost is determinedusing the weighted average cost method. Our inventory consists of raw materials as well as finished goods and work-in-process that include material, labor and manufacturing overhead costs. We routinely evaluate the levels of our inventory inlight of current market conditions in order to identify excess and obsolete inventory, and we provide a valuation allowancefor certain inventories based upon the age and quality of the product and the projections for sale of the completed products.As of December 31, 2018 and 2017, we had an inventory reserve of $14.8 million and $13.3 million, respectively, for excessand obsolete inventory and $18,000 and $291,000, respectively, for lower of cost or net realizable value reserves. If actualdemand for our products were to be substantially lower than estimated, additional inventory adjustments for excess orobsolete inventory might be required, which could have a material impact on our business, financial condition and results ofoperations.Impairment of InvestmentsWe classify marketable investments in debt and equity securities as available-for-sale securities in accordance withASC Topic 320, Investments—Debt and Equity Securities. All available-for-sale securities with a quoted market value belowcost (or adjusted cost) are reviewed in order to determine whether the decline is other-than-temporary. Factors considered indetermining whether a loss is temporary include the magnitude of the decline in market value, the length of time the marketvalue has been below cost (or adjusted cost), credit quality, and our ability and intent to hold the securities for a period oftime sufficient to allow for any anticipated recovery in market value.We also invest in equity instruments of privately-held companies in China for business and strategic purposes.Investments in our unconsolidated joint venture companies are classified as other assets and accounted for under either theequity or cost method, depending on whether we have the ability to exercise significant influence over their operations orfinancial decisions. We monitor our investments for impairment and record reductions in carrying value when events orchanges in circumstances indicate that the carrying value may not be recoverable. Determination of impairment is highlysubjective and is based on a number of factors, including an assessment of the strength of the subsidiary’s management, thelength of time and extent to which the fair value has been less than our cost basis, the financial condition and near-termprospects of the subsidiary, fundamental changes to the business prospects of the subsidiary, share prices of subsequentofferings, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipatedrecovery in our carrying value.For the year ended December 31, 2018, we have no impairment charges. For the year ended December 31, 2017, wehad included an impairment charge of $313,000 for one of the gallium companies. During the first quarter of 2017,management determined it unlikely that this company will recover from the difficult pricing environment and we wrote theinvestment down to zero. We had no impairment charges during 2016.Fair Value of InvestmentsASC Topic 820, Fair Value Measurement establishes three levels of inputs that may be used to measure fair value.43 Table of ContentsLevel 1 instruments represent quoted prices in active markets. Therefore, determining fair value for Level 1instruments does not require significant management judgment, and the estimation is not difficult.Level 2 instruments include observable inputs other than Level 1 prices, such as quoted prices for similarinstruments in markets with insufficient volume or infrequent transactions (less active markets), issuer bank statements, creditratings, non-binding market consensus prices that can be corroborated with observable market data, model-derivedvaluations in which all significant inputs are observable or can be derived principally from or corroborated with observablemarket data for substantially the full term of the assets or liabilities, or quoted prices for similar assets or liabilities. TheseLevel 2 instruments require more management judgment and subjectivity compared to Level 1 instruments, including:·Determining which instruments are most comparable to the instrument being priced requires management toidentify a sample of similar securities based on the coupon rates, maturity, issuer, credit rating, and instrument type,and subjectively select an individual security or multiple securities that are deemed most similar to the securitybeing priced.·Determining which model-derived valuations to use in determining fair value requires management judgment.When observable market prices for similar securities or similar securities are not available, we price our marketabledebt instruments using non-binding market consensus prices that are corroborated with observable market data orpricing models, such as discounted cash flow models, with all significant inputs derived from or corroborated withobservable market data.Level 3 instruments include unobservable inputs to the valuation methodology that are significant to themeasurement of fair value of assets or liabilities. The determination of fair value for Level 3 instruments requires the mostmanagement judgment and subjectivity.We place short-term foreign currency hedges that are intended to offset the potential cash exposure related tofluctuations in the exchange rate between the United States dollar and Japanese yen. We measure the fair value of theseforeign currency hedges at each month end and quarter end using current exchange rates and in accordance with generallyaccepted accounting principles. At quarter end any foreign currency hedges not settled are netted in “Accrued liabilities” onthe consolidated balance sheet and classified as Level 3 assets and liabilities. As of December 31, 2018 and 2017, the netchange in fair value from the placement of the hedge to settlement at each month end during the quarter had a de minimisimpact to the consolidated results. Impairment of Long-Lived AssetsWe evaluate the recoverability of property, equipment and intangible assets in accordance with ASC Topic 360,Property, Plant and Equipment. When events and circumstances indicate that long-lived assets may be impaired, we comparethe carrying value of the long-lived assets to the projection of future undiscounted cash flows attributable to such assets. Inthe event that the carrying value exceeds the future undiscounted cash flows, we record an impairment charge against incomeequal to the excess of the carrying value over the asset’s fair value. Fair values are determined based on quoted marketvalues, discounted cash flows or internal and external appraisals, as applicable. Assets held for sale are carried at the lower ofcarrying value or estimated net realizable value. We had no “Assets held for sale” or any impairment of long-lived assets onthe consolidated balance sheets as of December 31, 2018 and 2017. Stock-Based CompensationWe account for stock-based compensation in accordance with ASC Topic 718, Stock-based Compensation. Share-based awards granted include stock options and restricted stock awards. We utilize the Black‑Scholes option pricing modelto estimate the grant date fair value of stock options, which requires the input of highly subjective assumptions, includingestimating stock price volatility and expected term. Historical volatility of our stock price was used while the expected termfor our options was estimated based on historical option exercise behavior and post-vesting forfeitures of options, and thecontractual term, the vesting period and the expected term of the outstanding options. Further, we apply an expectedforfeiture rate in determining the amount of share-based compensation. We use historical44 Table of Contentsforfeitures to estimate the rate of future forfeitures. Changes in these inputs and assumptions can materially affect the measureof estimated fair value of our stock compensation. The cost of restricted stock awards is determined using the fair value of ourcommon stock on the date of grant.We recognize the compensation costs net of an estimated forfeiture rate over the requisite service period of theoptions award, which is generally the vesting term of four years. Compensation expense for restricted stock awards isrecognized over the vesting period, which is generally one, three or four years. Stock-based compensation expense isrecorded in cost of revenue, research and development, and selling, general and administrative expenses. (see Note 1—Summary of Significant Accounting Policies—Stock‑Based Compensation).In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)2016-09, Improvements to Employee Share-Based Payment Accounting. This ASU affects entities that issue share-basedpayment awards to their employees. The ASU is designed to simplify several aspects of accounting for share-based paymentaward transactions which include the income tax consequences, classification of awards as either equity or liabilities,classification on the statement of cash flows and forfeiture rate calculations. ASU 2016-09 was effective for publiccompanies for annual periods and interim periods within those annual periods beginning after December 15, 2016. Weadopted this ASU as of January 1, 2017. The adoption of ASU 2016-09 did not have a material effect on our consolidatedfinancial statements.Income TaxesWe account for income taxes in accordance with ASC topic 740, Income Taxes (“ASC 740”), which requires thatdeferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between thebook and tax bases of recorded assets and liabilities. ASC 740 also requires that deferred tax assets be reduced by a valuationallowance if it is more likely than not that a portion of the deferred tax asset will not be realized. Our deferred tax assets havebeen reduced to zero by valuation allowance.We provide for income taxes based upon the geographic composition of worldwide earnings and tax regulationsgoverning each region, particularly China. The calculation of tax liabilities involves significant judgment in estimating theimpact of uncertainties in the application of complex tax laws, particularly in foreign countries such as China.See Note 12—”Income Taxes” in the consolidated financial statements for additional information.Results of OperationsOverviewWe were founded in 1986 to commercialize and enhance our proprietary vertical gradient freeze (VGF) technologyfor producing high-performance compound semiconductor substrates or wafers. We have one operating segment and twoproduct lines: specialty material substrates and raw materials used to make such substrates or other related products. Werecorded our first substrate sales in 1990 and our substrate products currently include indium phosphide (InP), galliumarsenide (GaAs) and germanium (Ge) substrates used to produce semiconductor devices for use in applications such as fiberoptic and wireless telecommunications, light emitting diodes (LEDs), lasers and for solar cells for space and terrestrialphotovoltaic applications. We also sell raw materials, including gallium and germanium, through our participation inmajority‑ and minority‑owned subsidiaries and joint ventures.Operating ResultsWe manufacture all of our products in the People’s Republic of China (PRC or China), which generally hasfavorable costs for facilities and labor compared with comparable facilities in the United States, Europe or Japan. Our supplychain includes partial ownership of 10 companies in China (joint ventures). We believe this supply chain arrangementprovides us with pricing advantages, reliable supply and enhanced sourcing lead-times for key raw materials which arecentral to our final manufactured products.45 Table of ContentsOur annual revenue has grown for the last three consecutive years. Our revenue increased in 2018 by 4 percent to$102.4 million, in 2017 by 21 percent to $98.7 million and in 2016 our revenue increased by 5 percent to $81.3million. Gross margins also improved to 36.2% of total revenue in 2018 from 34.9% of total revenue in 2017 and from32.4% of total revenue in 2016. During the four years from 2012 to 2015 our revenue declined, primarily as a result of theadoption of an alternative technology, SOI, which entered the market in 2011. SOI enabled the RF switching chip in cellphones to function satisfactorily at a reduced cost. Before 2011, silicon did not perform adequately in this function due topower consumption, heat and speed issues. In 2014, our revenue from InP began to grow and, in 2014 and 2015, the InP annual growth rate exceeded 50% yearon year. This mitigated the reduction in revenue from gallium arsenide and enabled us to return to annual growth in2016. During this period, we believe our GaAs wafer business stabilized and our manufacturing yields improved. Ouroutlook for GaAs wafer substrates today is positive, as it is for InP and Ge substrates. Each of these substrates has end marketapplications that we believe are growing. We are continuing to improve our six-inch low defect density or low EPD GaAssubstrates that are required for 3D-sensing using VCSELs. We are in the process of relocating our GaAs and Gemanufacturing lines and believe this will enable us to add capacity quickly in the future if market demands so require. Revenue 2017 to 2018 2016 to 2017 Years Ended Dec. 31 Increase Increase 2018 2017 2016 (Decrease) % Change (Decrease) % Change Product Type: Substrates $81,008 $78,619 $65,633 $2,389 3.0%$12,986 19.8%Raw Materials and Others 21,389 20,054 15,716 1,335 6.7% 4,338 27.6%Total revenue $102,397 $98,673 $81,349 $3,724 3.8%$17,324 21.3% Revenue increased $3.7 million, or 3.8% in 2018 from $98.7 million in 2017. The $2.4 million increase in substratesales primarily came from growth of our InP and Ge wafer substrate sales in 2018, which is partially offset by a modestdecrease of our GaAs wafer substrate sales as compared to the same period of 2017. The $1.3 million increase in raw materialssales from our consolidated subsidiaries came from a 31% increase in raw gallium sales and a 28% increase in pBN sales ascompared to 2017, which is partially offset by the decrease in purified gallium sales from one of our consolidatedsubsidiaries. During 2018, the average selling prices of our wafers decreased slightly. The revenue increase was the result ofhigher unit volume in 2018 as compared to the same period in 2017.Revenue increased $17.3 million, or 21.3% in 2017 from $81.3 million in 2016. The $13.0 million increase insubstrate sales came from a 17% or more increase in sales from each of our wafer substrate products while the $4.3 millionincrease in raw materials sales from our consolidated subsidiaries came from a 40% increase in pBN sales and a 29% increasein refined gallium sales as compared to 2016. Except for the average selling price of Ge wafers, the average selling prices ofour wafers increased slightly in 2017. The revenue increase was the result of higher unit volume and higher average sellingprices.46 Table of ContentsRevenue by Geographic Region Year Ended Dec. 31, 2017 to 2018 2016 to 2017 Increase Increase 2018 2017 2016 (Decrease) % Change (Decrease) % Change ($ in thousands) China$31,492 $24,962 $17,448 $6,530 26.2%$7,514 43.1%% of total revenue 31% 25% 21% Europe (primarily Germany) 22,013 23,956 18,637 (1,943) (8.1)% 5,319 28.5%% of total revenue 21% 24% 23% Taiwan 20,078 18,279 15,369 1,799 9.8% 2,910 18.9%% of total revenue 20% 19% 19% Japan 10,305 13,258 11,015 (2,953) (22.3)% 2,243 20.4%% of total revenue 10% 13% 14% North America (primarily the UnitedStates) 10,021 8,352 8,084 1,669 20.0% 268 3.3%% of total revenue 10% 9% 10% Asia Pacific (excluding China, Taiwanand Japan) 8,488 9,866 10,796 (1,378) (14.0)% (930) (8.6)%% of total revenue 8% 10% 13% Total revenue$102,397 $98,673 $81,349 $3,724 3.8%$17,324 21.3% Sales to customers located outside of North America represented approximately 90%, 91% and 90% of our revenueduring 2018, 2017 and 2016, respectively.Revenue from customers in China increased in 2018 by 26.2%, primarily due to an increase of $1.2 million, or 12%,from raw materials sales and an increase of $5.3 million, or 36%, from wafer substrate sales. Sales of all three of our wafersubstrate products in China increased in 2018. Revenue from customers in Europe decreased by 8.1%, primarily due to adecrease of $1.6 million, or 75.5%, in gallium sales from our consolidated joint ventures and from a decrease of $0.7 million,or 3%, from wafer substrate sales. Revenue from customers in Japan decreased in 2018 by 22.3% due to a decrease of $3.9million in GaAs wafer substrate sales. However, sales from InP and Ge wafer substrates and raw materials in Japan allincreased in 2018 as compared to 2017. Revenue from customers in Taiwan increased by 9.8%, primarily due to strongdemand for InP substrates used in silicon photonics, specifically in data center expansions and upgrades.Revenue from customers in China increased by 43.1% in 2017, primarily due to an increase of $5.0 million, or 93%,from raw materials sales and an increase of $2.5 million, or 21%, from wafer substrate sales. Sales of all three of our wafersubstrate products in China grew in 2017. The growth of Ge substrates that we experienced in 2016 continued into 2017 asthe satellite solar cell market remained strong in 2017. GaAs substrate sales in 2017 also increased, primarily due to anincrease from our semi-conducting GaAs substrates, which was partially offset by decreased sales of semi-insulating GaAssubstrates. Revenue from customers in Europe increased by 28.5%, primarily due to an increase of $5.3 million, or 35%, fromwafer substrate sales, while raw materials sales from our consolidated joint ventures sales remained the same in 2017.Revenue from customers in Taiwan increased by 18.9%, primarily due to strong demand for InP substrates used in siliconphotonics, specifically in data center expansions and upgrades. Revenue from customers in Japan increased in 2017 by20.4% due to increases in both substrate and raw material sales.Gross Margin 2017 to 2018 2016 to 2017 Year Ended Dec. 31, Increase Increase 2018 2017 2016 (Decrease) % Change (Decrease) % Change ($ in thousands) Gross profit$37,047 $34,475 $26,381 $2,572 7.5%$8,094 30.7%Gross Margin % 36.2% 34.9% 32.4% 47 Table of ContentsGross margin increased to 36.2% of total revenue in 2018 from 34.9% of total revenue in 2017. Gross marginincreased in 2018 as a result of an increase in gross margins from raw materials sales, particularly pBN crucibles, and InPwafer substrates offset by a slight decrease in gross margins from sales of GaAs wafer substrates. Substrate gross marginslightly decreased to 36.2% of substrate revenue in 2018 from 37.4% of revenue in 2017 and raw materials gross marginincreased to 36.2% of raw materials revenue in 2018 from 25.5% of raw materials revenue in 2017. Gross profit increasedprimarily due to favorable substrate product mix, increased revenue and improvement in raw materials gross margin. Gross margin increased to 34.9% of total revenue in 2017 from 32.4% of total revenue in 2016. Gross marginincreased in 2017 as a result of an increase in gross margins from sales of raw materials and GaAs and Ge wafer substrates.Substrate gross margin increased to 37.4% of substrate revenue in 2017 from 34.7% of revenue in 2016 and raw materialsgross margin increased to 25.5% of raw materials revenue in 2017 from 23.0% of raw materials revenue in 2016. Gross profitincreased primarily due to favorable product mix, higher production volume, overall improvements in yield andmanufacturing efficiencies and lower raw material costs used in our wafer substrates in 2017 as compared to 2016. However,the effect of these favorable factors was partially offset by higher excess and obsolescence charges in 2017 as compared to2016.Selling, General and Administrative Expenses 2017 to 2018 2016 to 2017 Years Ended Dec. 31 Increase Increase 2018 2017 2016 (Decrease) % Change (Decrease) % Change ($ in thousands) Selling, general and administrativeexpenses$19,003 $17,009 $13,880 $1,994 11.7%$3,129 22.5%% of total revenue 18.6% 17.2% 17.1% Selling, general and administrative expenses increased $2.0 million, or 11.7%, to $19.0 million for 2018 comparedto $17.0 million for 2017. The higher selling, general and administrative expenses were primarily from higher personnel-related costs from hiring additional staff in China in connection with the relocation of our gallium arsenide and germaniumproduction lines and a new direct sales professional in Europe, higher travel expenses related to traveling for customer visitsand to our new manufacturing sites and higher stock compensation expenses, which were partially offset by lowerprofessional service fees and lower sales commission expense that resulted from the termination of our European salesrepresentative.Selling, general and administrative expenses increased $3.1 million, or 22.5%, to $17.0 million for 2017 comparedto $13.9 million for 2016. The higher selling, general and administrative expenses were primarily from higher legal fees,marketing consultants, severance pay and personnel related costs as well as from expenses incurred as a result of the businessinterruption caused by the electrical fire in our Beijing facility on the evening of March 15, 2017.Research and Development Expenses 2017 to 2018 2016 to 2017 Years Ended Dec. 31 Increase Increase 2018 2017 2016 (Decrease) % Change (Decrease) % Change ($ in thousands) Research and development$5,897 $4,827 $5,850 $1,070 22.2% $(1,023) (17.5)%% of total revenue 5.8% 4.9% 7.2% Research and development expenses increased $1.1 million, or 22.2%, to $5.9 million in 2018 from $4.8 million in2017. The increase in research and development expenses in 2018 was primarily due to the increased use of raw materials forproduct development programs, particularly for low EPD-related programs and for improving Ge performance specifications,higher personnel-related costs and higher depreciation expenses.48 Table of ContentsResearch and development expenses decreased $1.0 million, or 17.5%, to $4.8 million for 2017 from $5.9 million for 2016.The decrease in research and development expenses in 2017 was primarily due to the reduced use of raw materials forproduct development and lower personnel-related costs at our consolidated subsidiaries. Research and development for AXTsubstrates increased in 2017 by approximately 8%. Restructuring ChargesWe had no restructuring charges in 2018 and 2017. In the second quarter of 2016, we restructured the operations ofBeijing JiYa Semiconductor Material Co., Ltd., which resulted in a reduction in force of 28 positions that were no longerrequired to support production and operations. Accordingly, we recorded a restructuring charge of approximately $226,000related to the reduction in force for severance-related expenses. As of June 30, 2016, we had completed this restructuring planand the reduction in force.Interest Income, Net 2017 to 2018 2016 to 2017 Years Ended Dec. 31 Increase Increase 2018 2017 2016 (Decrease) % Change (Decrease) % Change ($ in thousands) Interest income, net$528 $461 $409 $67 14.5%$52 12.7%% of total revenue 0.5% 0.5% 0.5% Interest income, net increased in 2018 as compared to the same period in 2017, primarily due to higher marketinterest rates. Interest income, net increased in 2017 as compared to 2016, primarily due to increased cash balances as a resultof the secondary public offering in March 2017. Equity in Loss of Unconsolidated Joint Venture Companies 2017 to 2018 2016 to 2017 Years Ended Dec. 31 Increase Increase 2018 2017 2016 (Decrease) % Change (Decrease) % Change ($ in thousands) Equity in loss ofunconsolidated joint ventures$(1,080) $(1,694) $(1,995) $(614) (36.2)%$(301) 15.1%% of total revenue (1.1)% (1.7)% (2.5)% Equity in loss of unconsolidated joint ventures is the aggregate net loss from our seven minority-owned supplychain joint venture companies that are not consolidated. Equity in loss of unconsolidated joint ventures decreased $0.6million to a loss of $1.1 million in 2018 from a loss of $1.7 million in 2017 as our unconsolidated joint ventures reportedbetter performance in 2018 as compared to 2017. The loss in 2018 primarily came from a single minority-owned supplychain joint venture company that was required to temporarily shut down during the fourth quarter of 2018 to installmanufacturing improvements mandated by a regional environmental agency. This resulted in a $1.1 million charge in thefourth quarter and a cumulative loss of $1.4 million for this entity in 2018. The decrease of $0.6 million in 2018 from 2017resulted from price increases of raw materials in 2018. Further, there were no impairment charges in 2018 as compared to acharge of $313,000 in 2017. Equity in loss of unconsolidated joint ventures decreased $0.3 million to a loss of $1.7 million for 2017 from a lossof $2.0 million for 2016 as our unconsolidated joint ventures had reported better performance in 2017 as compared to2016. The loss in 2017 is the result of continuing low average selling prices for raw materials. The $1.7 million net loss fromour unconsolidated joint ventures included an impairment charge of $313,000 for one of the gallium companies. During thefirst quarter of 2017, management determined it was unlikely that this company would recover from the difficult pricingenvironment and we wrote the investment down to zero.49 Table of ContentsOther Income (expense), Net 2017 to 2018 2016 to 2017 Years Ended Dec. 31 Increase Increase 2018 2017 2016 (Decrease) % Change (Decrease) % Change ($ in thousands) Other income (expense), net$352 $(553) $860 $905 163.7%$(1,413) (164.3)%% of total revenue 0.3% (0.6)% 1.1% Other income, net increased $0.9 million to an income of $0.4 million for 2018 as compared to a loss of $0.6 millionin 2017, primarily due to a higher foreign exchange gain in 2018 as compared to 2017.Other expense, net decreased $1.4 million to a loss of $0.6 million for 2017 from income of $0.9 million for 2016,primarily due to a lower realized gain recognized from sales of stock of GCS Holdings, Inc. (“GHI”) in 2017 as compared to2016. As of December 31, 2017, we no longer held any GHI stock.Provision for Income Taxes 2017 to 2018 2016 to 2017 Years Ended Dec. 31 Increase Increase 2018 2017 2016 (Decrease) % Change (Decrease) % Change ($ in thousands) Provision for income taxes$938 $792 $733 $146 18.4%$59 8.0%% of total revenue 0.9% 0.8% 0.9% Provision for income taxes for 2018 and 2017 were $0.9 million and $0.8 million, respectively, which were mostlyrelated to our wholly owned subsidiary in China and our three partially owned consolidated raw material companies. Noincome taxes or benefits have been provided for U.S. operations as the income in the U.S. had been fully offset by utilizationof federal and state net operating loss carryforwards. Additionally, there is uncertainty of generating future profit in the U.S.,which has resulted in our deferred tax assets being fully reserved. Our estimated tax rate can vary greatly from year to yearbecause of the change or benefit in the mix of taxable income between our U.S. and China-based operations.Due to our uncertainty regarding our future profitability in the U.S., we recorded a full valuation allowance againstour net deferred tax assets of $20 million in 2018, $22 million in 2017 and $68 million in 2016.Net Loss Attributable to Noncontrolling Interests 2017 to 2018 2016 to 2017 Years Ended Dec. 31 Net Income Net Income 2018 2017 2016 (Increase) % Change (Increase) % Change ($ in thousands) Net (income) loss attributableto noncontrolling interests$(1,355) $87 $670 $(1,442) 1,657.5%$(583) (87.0)%% of total revenue (1.3)% 0.1% 0.8% The increase in noncontrolling interests’ share of income for 2018 as compared to the 2017 was due to higherprofitability from all of our three consolidated subsidiaries in China.The decrease in noncontrolling interests’ share of losses for 2017 as compared to the 2016 was due to higherprofitability from two of our three consolidated subsidiaries in China, which was partially offset with lower profitability fromour other consolidated subsidiary in China.50 Table of ContentsLiquidity and Capital Resources Year Ended December 31, 2018 2017 2016 ($ in thousands) Net cash provided by (used in): Operating activities $3,218 $8,615 $12,504 Investing activities (30,827) (36,458) (1,113) Financing activities 213 35,638 1,298 Effect of exchange rate changes (430) 405 (1,412) Net change in cash and cash equivalents (27,826) 8,200 11,277 Cash and cash equivalents—beginning year 44,352 36,152 24,875 Cash and cash equivalents—end of year 16,526 44,352 36,152 Short and long-term investments—end of year 22,846 32,608 17,571 Total cash, cash equivalents and short-term and long-term investments $39,372 $76,960 $53,723 We consider cash and cash equivalents, short-term investments and long-term investments as liquid and availablefor use within two years in our current operations. Short-term investments and long-term investments are comprised of moneymarket accounts, certificates of deposit, corporate bonds and notes, and government securities. Also included in short-terminvestments is our investment in common stock of Intelligent Epitaxy Technology, Inc. (“IntelliEpi”) and GHI. We beganclassifying IntelliEpi stock as an available-for-sale security upon its initial public offering in 2013 and sold our remainingIntelliEpi stock in the second quarter of 2015. In 2015, we re-categorized our GHI investment from the cost method to short-term investments when we determined that there was sufficient trading volume in the exchange for the stock to be determinedreadily marketable. During the three months ended March 31, 2017, we sold the remainder of our GHI stock. As of December31, 2018, we and our consolidated joint ventures held approximately $12.4 million in cash and investments in foreign bankaccounts. This consists of $6.6 million held by our wholly owned subsidiary in China and $5.9 million held by our threepartially-owned consolidated subsidiaries in China.Total cash and cash equivalents, short-term and long-term investments decreased by $37.6 million in 2018. Asof December 31, 2018, our principal source of liquidity was $39.4 million, which consisted of cash and cash equivalents of$16.5 million, short-term investments of $22.1 million and long-term investments of $0.7 million. In 2018, cash and cashequivalents decreased by $27.8 million and short-term and long-term investments decreased by $9.8 million. The decrease incash and cash equivalents of $27.8 million in 2018 was primarily due to net cash used in investing activities of $30.8million, primarily due to property, plant and equipment activities for the new manufacturing sites in China, and the effect ofexchange rate changes of $0.4 million, and was partially offset by net cash provided by operating activities of $3.2 millionand net cash provided by financing activities of $0.2 million.Total cash and cash equivalents, short-term and long-term investments increased by $23.2 million in 2017. Asof December 31, 2017, our principal source of liquidity was $77.0 million, which consisted of cash and cash equivalents of$44.4 million, short-term investments of $20.0 million and long-term investments of $12.6 million. In 2017, cash and cashequivalents increased by $8.2 million and short-term and long-term investments increased by $15.0 million. The increase incash and cash equivalents of $8.2 million in 2017 was primarily due to net cash provided by operating activities of $8.6million and net cash provided by financing activities of $35.6 million, primarily due to the net proceeds of $31.9 millionreceived from the public offering of 5,307,692 shares of our common stock in March 2017, proceeds of $2.5 million from theexercise of common stock options and proceeds from sales of subsidiary shares to noncontrolling interest of $1.8 millionpartially offset by the net dividends paid by our joint ventures of $0.5 million, and was partially offset by net cash used ininvesting activities of $36.5 million. As of December 31, 2017, we and our consolidated joint ventures heldapproximately $21.4 million in cash and investments in foreign bank accounts. This consists of $11.5 million held by ourwholly owned subsidiary in China and $9.9 million held by our three partially-owned consolidated subsidiaries in China.Net cash provided by operating activities of $3.2 million for 2018 was primarily comprised of our net income of$11.0 million, adjusted for non-cash items of depreciation and amortization of $4.9 million, stock-based compensation of51 Table of Contents$1.9 million, loss on equity method investments of $1.1 million, amortization of marketable securities premium of $0.2million offset in part by gain on disposal of property, plant and equipment of $0.1 million, which were partially offset by anet change of $15.7 million in operating assets and liabilities. The $15.7 million net change in operating assets andliabilities primarily resulted from a $14.6 million increase in inventories, a $4.6 million increase in prepaid expenses andother current assets, a $1.9 million increase in other assets, a $0.3 million decrease in other long-term liabilities offset in partby a $0.5 million increase in accrued liabilities, a $2.8 million decrease in accounts receivable, and a $2.3 million increase inaccounts payable.Net cash provided by operating activities of $8.6 million for 2017 was primarily comprised of our net income of$10.1 million, adjusted for non-cash items of depreciation and amortization of $4.4 million, loss on equity methodinvestments of $1.4 million, stock-based compensation of $1.4 million, impairment charge on equity investee of $0.3million, amortization of marketable securities premium of $0.2 million, which were partially offset by a net change of $9.1million in operating assets and liabilities. The $9.1 million net change in operating assets and liabilities primarily resultedfrom a $8.0 million increase in accounts receivable, a $4.7 million increase in inventories, a $2.3 million increase in prepaidexpenses and other current assets, offset in part by a $4.4 million increase in accounts payable and a $1.6 million increase inaccrued liabilities.Net cash provided by operating activities of $12.5 million for 2016 was primarily comprised of our net income of$5.0 million, an adjustment of non-cash items of depreciation of $4.9 million, loss on equity method investments of $2.0million, stock-based compensation of $1.1 million, provision for doubtful accounts of $0.3 million, amortization ofmarketable securities premium of $94,000, loss on disposal property and equipment of $5,000, which were partially offset byrealized gain on sales of investments of $0.4 million and a net change of $0.4 million in assets and liabilities. The$0.4 million net change in operating assets and liabilities primarily resulted from a $3.0 million increase in inventories, a$1.2 million increase in prepaid expenses and other current assets, a $0.9 million decrease in other long-term liabilities, offsetin part by a $3.5 million decrease in accounts receivable, a $0.5 million decrease in other assets, a $0.5 million increase inaccounts payable and a $0.2 million increase in accrued liabilities.Net cash used in investing activities of $30.8 million for 2018 was primarily due to property, plant and equipmentof $40.6 million in preparation for our new manufacturing sites, additional equipment for our Beijing site and equipment andfacility costs incurred by our three partially owned subsidiaries and the purchases of marketable investment securities of $9.9million, which were partially offset by proceeds from maturities and sales of available-for-sale securities of $19.6 million andproceeds from sale of property, plant and equipment of $0.1 million.Net cash used in investing activities of $36.5 million for 2017 was primarily from the purchases of marketableinvestment securities of $30.0 million and investments in property, plant and equipment of $21.4 million in preparation forour new manufacturing sites, additional equipment for our Beijing site and equipment and facility costs incurred by our threepartially owned subsidiaries, which were partially offset by proceeds from maturities and sales of available-for-sale securitiesof $14.8 million.Net cash used in investing activities of $1.1 million for 2016 was primarily from the purchases of marketableinvestment securities of $11.9 million and the purchase of property, plant and equipment of $2.7 million, which werepartially offset by proceeds from maturities and sales of available-for-sale securities of $13.5 million.Net cash provided by financing activities was $0.2 million for 2018, which mainly consisted of the proceeds of $0.6million from the exercise of common stock options, partially offset by the considerations paid in cash to repurchasesubsidiary shares from noncontrolling interests of $0.4 million.Net cash provided by financing activities was $35.6 million for 2017, which mainly consisted of the net proceeds of$31.9 million received from the public offering of 5,307,692 shares of our common stock in March 2017, proceeds of $2.5million from the exercise of common stock options and proceeds from sales of subsidiary shares to noncontrolling interest of$1.8 million, partially offset by the net dividends paid by our joint ventures of $0.5 million, which mainly consisted ofproceeds from common stock options exercised.52 Table of ContentsNet cash provided by financing activities was $1.3 million for 2016, which mainly consisted of proceeds fromcommon stock options exercised.On October 27, 2014, our Board of Directors approved a stock repurchase program pursuant to which we mayrepurchase up to $5.0 million of our outstanding common stock. These repurchases can be made from time to time in theopen market and are funded from our existing cash balances and cash generated from operations. During 2015, werepurchased approximately 908,000 shares at an average price of $2.52 per share for a total purchase price of approximately$2.3 million under the stock repurchase program. No shares were repurchased during 2018, 2017 and 2016 under thisprogram. As of December 31, 2018, approximately $2.7 million remained available for future repurchases under thisprogram. Currently, we do not plan to repurchase additional shares. Dividends accrue on our outstanding Series A preferred stock, and are payable as and when declared by our board ofdirectors. We have never paid or declared any dividends on the Series A preferred stock. By the terms of the Series Apreferred stock, so long as any shares of Series A preferred stock are outstanding, neither the Company nor any subsidiary ofthe Company shall redeem, repurchase or otherwise acquire any shares of common stock, unless all accrued dividends on theSeries A preferred stock have been paid. During 2013 and 2015, we repurchased shares of our outstanding common stock. As of December 31, 2015, the Series A preferred stock had cumulative dividends of $2.9 million and we included this amountin “Accrued liabilities” in our consolidated balance sheets. At the time we pay this accrued liability, our cash and cashequivalents would be reduced. We account for the cumulative year to date dividends on the Series A preferred stock whencalculating our earnings per share. See Item 5, Market for Registrant’s Common Equity, Related Stockholder Matters andIssuer Purchases of Equity Securities in Part II.The Beijing city government is moving its offices into the area where our original manufacturing facility iscurrently located and is in the process of moving thousands of government employees into this area. To create room andupgrade the district, the city instructed virtually all existing manufacturing companies, including AXT, to relocate all orsome of their manufacturing lines. In 2018, we made significant progress in the relocation of our gallium arsenide andgermanium production lines. One new site, the city of Kazuo, located in the province in Liaoning near the Inner MongoliaAutonomous Region, will initially be used for poly synthesis and ingot growth for gallium arsenide and germanium as wellas possible expansion of indium phosphide ingot growth. A second site, the city of Dingxing, located in the province ofHebei and under the jurisdiction of the prefecture-level city of Baoding, will be used for wafer processing. We expect toinvest approximately $21 million related to the new facilities in 2019. We intend to complete the relocation process forGaAs and Ge in 2019. One of our consolidated joint ventures, JinMei, is in the process of relocating its headquarters and manufacturingoperations to the city of Kazuo, located in the province in Liaoning near the Inner Mongolia Autonomous Region, very nearour own location. Currently, JinMei expects to invest approximately $2.5 to 3.5 million related to the new facilities in 2019.In July 2017, our wholly-owned subsidiary, Tongmei, provided an inter-company loan to JinMei in the amount of $768,000in preparation for the acquisition of the land use rights and the construction of a new building. The inter-company loancarries an interest rate of 4.9% per annum and is due on June 30, 2023. During 2018, JinMei repaid principal and interesttotaling $453,000 to Tongmei. As of December 31, 2018, the remaining balance of principal and interest totaled $316,000. We believe that we have adequate cash and investments to meet our operating needs over the next twelve months. Ifour sales decrease, however, our ability to generate cash from operations will be adversely affected which could adverselyaffect our future liquidity, require us to use cash at a more rapid rate than expected, and require us to seek additional capital. On October 24, 2016, we filed with the SEC a registration statement on Form S-3, pursuant to which we may offer upto $60 million of common stock, preferred stock, depositary shares, warrants, debt securities and/or units in one or moreofferings and in any combination. On November 4, 2016, the SEC declared the registration statement effective. A prospectussupplement, which we will provide each time we offer securities, will describe the specific amounts, prices and terms of thesecurities we determine to offer. 53 Table of ContentsOn March 2, 2017, we filed with the SEC a final prospectus supplement, pursuant to which we offered and sold5,307,692 shares of our common stock. The net proceeds are being used for the relocation of our gallium arsenideproduction line, for equipment capital expenditures, working capital for accounts receivable and inventory, possibleacquisitions of complementary products, technologies or businesses and other general purposes. Cash from operations could be affected by various risks and uncertainties, including, but not limited to those setforth below under Item 1A. “Risk Factors” above.Bank Loans and Line of Credit In September 2018, Tongmei entered into a credit facility with Industrial and Commercial Bank of China (“ICBC”)in China with a $2.9 million line of credit at an annual interest rate of approximately 0.4% over the current Loan Prime Ratepublished by ICBC. Accrued interest is calculated and paid monthly. The annual interest rate was approximately 4.4%. Thiscredit line was secured by Tongmei’s land-use right and all of its buildings located at its facility in Beijing. The primaryintended use of the credit facility was for general purposes, which may include working capital, capital expenditures andother corporate expenses. In September 2018, we borrowed $291,000 against this credit line. The repayment of the fullamount was due in September 2019. However, on December 26, 2018, we repaid the principal of $291,000 and interest of$3,000 and terminated this credit line. We decided to terminate this loan because we were able to secure a larger bank loan inthe U.S. and our management believed that to secure bank loans in the future based on the two new manufacturing sites mayhave more strategic advantages as compared to have a loan based on the Beijing site. On November 6, 2018, the Company entered into a Credit Agreement (the “Credit Agreement”), by and between theCompany and Wells Fargo Bank, National Association, which established a $10 million secured revolving line of credit witha $1.0 million letter of credit sublimit facility. The revolving credit facility is collateralized by substantially all of the assetsof the Company located within the United States, subject to certain exceptions. The commitments under the CreditAgreement expire on November 30, 2020 and any loans thereunder will bear interest at a rate based on the daily one-monthLondon Inter-bank Offered Rate (“LIBOR”) for the applicable interest period plus a margin of 2.00%. As of December 31,2018, no loans or letters of credit were outstanding under the Credit Agreement. Off-Balance Sheet ArrangementsWe did not have any off-balance sheet financing arrangements and have never established any special purposeentities as defined under SEC Regulation S-K Item 303(a)(4)(ii). We have not entered into any options on non-financialassets.Contractual ObligationsWe lease certain office space, warehouse facilities and equipment under long-term operating leases expiring atvarious dates through August 2022. The majority of our lease obligations relate to our lease agreement for the facility inFremont, California with approximately 19,467 square feet. The term of the original lease for this facility would have expiredin 2017. According to the lease agreement, we had an option to extend the term of the lease for an additional three years. InMay 2017, we exercised this option and the lease was extended for an additional three year term. All terms of this leaseremain the same and the term of this lease will expire in 2020 at which point we have an option to extend an additional threeyears. Total rent expenses under these operating leases were approximately $319,000, $302,000 and $331,000 for the yearsended December 31, 2018, 2017 and 2016, respectively.54 Table of ContentsWe entered into a royalty agreement with Sumitomo effective December 3, 2010 with a term of eight years,terminating December 31, 2018. We and our related companies were granted a worldwide, nonexclusive, royalty bearing,irrevocable license to certain patents for the term on the agreement. Under this agreement we could have paid up to $7.0million in royalty payments over eight years beginning in 2011 based on future royalty bearing sales. This agreementcontained a clause that allowed us to claim a credit, starting in 2013, in the event that the royalty bearing sales for the year islower than a pre-determined amount set forth in this agreement. For the year ended December 31, 2018, royalty expenseunder this agreement was $565,000, which was net of claim for credit of $10,000. Royalty expense for the year endedDecember 31, 2017 was $526,000, which was net of claim for credit of $49,000. Royalty expense for the year endedDecember 31, 2016 was $447,000, which was net of claim for credit of $128,000. Sumitomo has asked that we renew thislicense and the need to do so is under review. The following table summarizes our contractual obligations as of December 31, 2017 (in thousands): Payments due by period 1-3 4-5 More than Contractual Obligations Total Less than 1 year years years 5 years Operating leases $374 $198 $170 $ 6 $ — Land Purchase and Investment Agreement We are in the process of relocating our gallium arsenide production line to Dingxing, China. In addition to a landrights and building purchase agreement that we entered into with a private real estate development company to acquire ournew manufacturing facility, we also entered into a cooperation agreement with the Dingxing local government. In additionto pledging its full support and cooperation, the Dingxing local government will issue certain credits or rebates to us as weachieve certain milestones. We, in turn, agreed to hire local workers over time, pay taxes when due and eventuallydemonstrate a total investment of approximately $90 million in value, assets and capital. The investment will include cashpaid for the land and buildings, cash on deposit in our name at local banks, the gross value of new and used equipment(including future equipment that might be used for indium phosphide and germanium substrates production), the deemedvalue for our customer list or the end user of our substrates (for example, the end users of the 3-D sensing VCSELs), a deemedvalue for employment of local citizens, a deemed value for our proprietary process technology, other intellectual property,other intangibles and additional items of value. There is no timeline or deadline by which this must be accomplished, ratherit is a good faith covenant entered into between AXT and the Dingxing local government. Further, there is no specificpenalty contemplated if either party breaches the agreement, however the agreement does state that each party has a right toseek from the other party compensation for losses. Under certain conditions, the Dingxing local government may purchasethe land and building at the appraised value. We believe that such cooperation agreements are normal, customary and usualin China and that the future valuation is flexible. We have a similar agreement with the city of Kazuo, China, although on asmaller scale. The total investment targeted by AXT in Kazuo is approximately $15 million in value, assets and capital. Purchase Obligations with Penalties for Cancellation In the normal course of business, we issue purchase orders to various suppliers. In certain cases, we may incur apenalty if we cancel the purchase order. As of December 31, 2018, we do not have any outstanding purchase orders that willincur a penalty if cancelled by the Company. Selected Quarterly Results of Operations The following table sets forth unaudited quarterly results for the eight quarters ended December 31, 2018. Theinformation for each of these quarters is unaudited but has been prepared on the same basis as the audited consolidatedfinancial statements. We believe that all necessary adjustments, consisting only of normal recurring adjustments, have beenincluded in the amounts stated below to present fairly such quarterly information. The operating results for any quarter arenot necessarily indicative of results for any subsequent period.55 Table of Contents Quarters Ended (in thousands, except Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31, for per share amounts) 2018 2018 2018 2018 2017 2017 2017 2017 Revenue $22,232 $28,626 $27,120 $24,419 $26,332 $28,168 $23,557 $20,616 Cost of revenue 16,382 18,012 16,110 14,846 16,534 17,035 16,301 14,328 Gross profit 5,850 10,614 11,010 9,573 9,798 11,133 7,256 6,288 Operating expenses: Selling, general andadministrative 5,179 4,615 4,987 4,222 4,790 4,484 3,942 3,793 Research and development 1,309 1,668 1,500 1,420 1,274 1,410 1,019 1,124 Total operating expenses 6,488 6,283 6,487 5,642 6,064 5,894 4,961 4,917 Income (loss) from operations (638) 4,331 4,523 3,931 3,734 5,239 2,295 1,371 Interest income, net 114 133 139 142 127 122 114 98 Equity in earnings (loss) ofunconsolidated joint ventures (1,059) 6 307 (334) (307) (266) (188) (933) Other (expense) income, net 531 87 (51) (215) (150) (349) (102) 48 Income (loss) before provision forincome taxes (1,052) 4,557 4,918 3,524 3,404 4,746 2,119 584 Provision for (benefits from)income taxes (173) 410 367 334 131 181 321 159 Net income (loss) (879) 4,147 4,551 3,190 3,273 4,565 1,798 425 Less: Net (income) lossattributable to noncontrollinginterests (182) (208) (650) (315) (139) (146) 132 240 Net income (loss) attributable toAXT, Inc $(1,061) $3,939 $3,901 $2,875 $3,134 $4,419 $1,930 $665 Net income (loss) attributable toAXT, Inc. per common share: Basic $(0.03) $0.10 $0.10 $0.07 $0.08 $0.11 $0.05 $0.02 Diluted $(0.03) $0.10 $0.10 $0.07 $0.08 $0.11 $0.05 $0.02 Weighted average number ofcommon shares outstanding: Basic 39,197 39,008 39,001 38,941 38,766 38,499 38,306 34,210 Diluted 39,197 40,331 40,216 40,364 40,448 40,095 39,706 35,624 Recent Accounting PronouncementsRecent accounting pronouncements are detailed in Note 1 to our Consolidated Financial Statements included inthis Annual Report on Form 10-K. Item 7A. Quantitative and Qualitative Disclosures about Market RiskForeign Currency RiskA significant portion of our business is conducted in currencies other than the U.S. dollar. Foreign exchange losseshave had a material adverse effect on our operating results and cash flows in the past and could have a material adverse effecton our operating results and cash flows in the future. If we do not effectively manage the risks associated56 Table of Contentswith this currency risk, our revenue, cash flows and financial condition could be adversely affected. Although during 2018and 2016, we recorded a foreign exchange gain of $165,000 and $232,000, respectively, during 2017 we recorded netforeign exchange loss of $602,000, included as part of other (expense) income, net in our consolidated statements ofoperation. We incur foreign currency transaction exchange gains and losses due to operations in general. In the future wemay experience foreign exchange losses on our non-functional currency denominated receivables and payables to the extentthat we have not mitigated our exposure. Foreign exchange losses could have a materially adverse effect on our operatingresults and cash flows. Our product sales to Japanese customers are typically invoiced in Japanese yen. As such we have foreign exchangeexposure on our accounts receivable and on any Japanese yen denominated cash deposits. To partially protect us againstfluctuations in foreign currency resulting from accounts receivable in Japanese yen, starting in 2015, we instituted a foreigncurrency hedging program. We place short term hedges that are intended to offset the potential cash exposure related tofluctuations in the exchange rate between the United States dollar and Japanese yen. We measure the fair value of thesehedges at each month end and quarter end using current exchange rates and in accordance with generally acceptedaccounting principles. At quarter end and year end any foreign currency hedges not settled are netted on the condensedconsolidated balance sheet and consolidated balance sheet, respectively, and classified as Level 3 assets and liabilities. Asof December 31, 2018 the net change in fair value from the placement of the hedge to settlement at each month end duringthe quarter had a de minimis impact to the consolidated results. The functional currency for our foreign operations is the renminbi, the local currency of China, and in the future wemay establish short term hedges covering renminbi. Most of our operations are conducted in China and most of our costs areincurred in Chinese renminbi, which subjects us to fluctuations in the exchange rates between the U.S. dollar and the Chineserenminbi. We incur transaction gains or losses resulting from consolidation of expenses incurred in local currencies for ourChinese subsidiaries, as well as in translation of the assets and liabilities at each balance sheet date. Our financial resultscould be adversely affected by factors such as changes in foreign currency exchange rates or weak economic conditions inforeign markets, including the revaluation by China of the renminbi, and any future adjustments that China may make to itscurrency such as any move it might make to a managed float system with opportunistic interventions. We may alsoexperience foreign exchange losses on our non-functional currency denominated receivables and payables. We currently are using a hedging program to minimize the effects of currency fluctuations relating to theJapanese yen. While we may apply this program to other currencies, such as the Chinese renminbi, our hedging position ispartial and may not exist at all in the future. It may not succeed in minimizing our foreign currency fluctuationrisks. Our primary objective in holding these instruments is to reduce the volatility of earnings and cash flows associatedwith changes in foreign currency. The program is not designated for trading or speculative purposes. The company maychoose not to hedge certain foreign exchange exposures for a variety of reasons, including but not limited to accountingconsiderations and the prohibitive economic cost of hedging particular exposures. However, even with our hedging program,we still experience losses on foreign exchange from time to time. Interest Rate RiskCash and cash equivalents earning interest and certain variable rate debt instruments are subject to interest ratefluctuations. The following table sets forth the probable impact of a 10% change in interest rates (in thousands): Proforma 10% Proforma 10% Balance as of Current Projected Annual Interest Rate Interest Rate December 31, Interest Interest Decline Increase Instrument 2018 Rate Income Income Income Cash and cash equivalents $16,526 0.22% $36 $32 $40 Investments in marketable debt 22,846 2.46% 562 506 618 $598 $538 $658 The primary objective of our investment activities is to preserve principal while maximizing income withoutsignificantly increasing risk. Financial instruments that potentially subject us to concentration of credit risk consist57 Table of Contentsprimarily of cash and cash equivalents, short-term investments, and trade accounts receivable. We invest primarily in moneymarket accounts, certificates of deposit, corporate bonds and notes, and government securities. We are exposed to credit risksin the event of default by the issuers to the extent of the amount recorded on the consolidated balance sheets. Thesesecurities are generally classified as available-for-sale and consequently are recorded on the balance sheet at fair value withunrealized gains or losses reported as a separate component of accumulated other comprehensive income, net of estimatedtax. Our cash, cash equivalents and short-term investments and long-term investments are in high-quality securities placedwith major banks and financial institutions and commercial paper. We have no investments in auction rate securities.Credit RiskWe perform ongoing credit evaluations of our customers’ financial condition, and limit the amount of creditextended when deemed necessary, but generally do not require collateral. The credit risk in our accounts receivableis mitigated by our credit evaluation process and the geographical dispersion of sales transactions. Three customersaccounted for 17%, 12% and 10% of our trade accounts receivable as of December 31, 2018 and one customer accounted for12% of our trade accounts receivable as of December 31, 2017.Equity RiskAs part of our supply chain strategy, we maintain minority investments in privately-held companies located inChina either invested directly by us and our wholly-own subsidiary or indirectly through our three consolidated jointventure companies. These minority investments are reviewed for other than temporary declines in value on a quarterly basis.These investments are classified as other assets in the consolidated balance sheets and accounted for under either the equityor cost method, depending on whether we have the ability to exercise significant influence over their operations or financialdecisions. We monitor our investments for impairment and record reductions in carrying value when events or changes incircumstances indicate that the carrying value may not be recoverable. Reasons for other than temporary declines in valueinclude whether the related company would have insufficient cash flow to operate for the next twelve months, significantchanges in the operating performance and changes in market conditions. As of December 31, 2018 and 2017, we did notmaintain any direct investments under the cost method. Our direct minority investments under the equitymethod totaled $4.0 million and $5.6 million, respectively, and our indirect minority investments through our consolidatedjoint ventures totaled $4.5 million and $4.3 million, respectively. In aggregate, as of December 31, 2018 and 2017 the totalof our direct and indirect investments in the seven companies under the equity method totaled $8.4 million and $9.8 million,respectively.58 Table of ContentsItem 8. Consolidated Financial Statements and Supplementary DataThe consolidated financial statements, related notes thereto and financial statement schedules required by this itemare listed and set forth beginning on page 70, and are incorporated by reference here. Supplementary financial informationregarding quarterly financial information required by this item is set forth under the caption “Selected Quarterly Results ofOperations” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and isincorporated by reference here. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureNone. Item 9A. Controls and ProceduresEvaluation of Disclosure Controls and Procedures Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluatedthe effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered bythis Annual Report on Form 10-K. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that our disclosure controls and procedures as defined under Exchange Act Rules 13a-15(e) and 15d-15(e) wereeffective at the reasonable assurance level to ensure that information required to be disclosed in our Securities Exchange Actreports is recorded, processed, summarized and reported within the time periods specified by the Securities and ExchangeCommission and is accumulated and communicated to management, including our Chief Executive Officer and our ChiefFinancial Officer, as appropriate to allow timely decisions regarding required disclosure.Our disclosure controls and procedures include components of our internal control over financial reporting.Management’s assessment of the effectiveness of our internal control over financial reporting is expressed at the level ofreasonable assurance because a control system, no matter how well designed and operated, can provide only reasonableassurance that the control system’s objectives will be met.Management’s Report on Internal Control over Financial ReportingOur management is responsible for establishing and maintaining adequate internal control over financial reporting,as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is aprocess designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and implementedby our Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for external purposes in accordance with accounting principlesgenerally accepted in the United States of America (“U.S. GAAP”). Internal control over financial reporting includes thosepolicies and procedures that:·pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions anddispositions of our assets;·provide reasonable assurance that transactions are recorded as necessary to permit preparation of financialstatements in accordance with U.S. GAAP, and that receipts and expenditures are being made only inaccordance with authorizations of our management and directors; and·provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use ordisposition of our assets that could have a material effect on the consolidated financial statements.Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements.Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls59 Table of Contentsmay become inadequate because of changes in conditions, or that the degree of compliance with the policies or proceduresmay deteriorate.Our management, under the supervision and with the participation of our Chief Executive Officer and ChiefFinancial Officer, has assessed the effectiveness of our internal control over financial reporting as of December 31, 2018based on the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Management has concluded that our internal control over financialreporting was effective as of December 31, 2018.Our independent registered public accounting firm, BPM LLP, has audited the consolidated financial statementsincluded in this Annual Report on Form 10-K and has issued its report on the effectiveness of our internal control overfinancial reporting as of December 31, 2018.Changes in Internal Control over Financial ReportingBeginning December 31, 2017, we implemented ASC 606, Revenue from Contracts with Customers. Weimplemented changes to our processes related to revenue recognition and the control activities within them. These includedthe development of new policies based on the five-step model provided in the new revenue standard, ongoing contractreview requirements, and gathering of information provided for disclosures. There was no change in our internal control over financial reporting during our fourth quarter of fiscal 2018 that hasmaterially affected, or is reasonably likely to materially affect, AXT’s internal control over financial reporting. Item 9B. Other InformationNone.60 Table of ContentsReport of Independent Registered Public Accounting FirmTo the Board of Directors and Stockholders of AXT, Inc. Opinion on Internal Control over Financial Reporting We have audited the internal control over financial reporting of AXT, Inc. and its subsidiaries (the “Company”) asof December 31, 2018, based on criteria established in Internal Control—Integrated Framework (2013) issued by theCommittee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). In our opinion, the Companymaintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on theCOSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board(United States) (“PCAOB”), the consolidated balance sheets as of December 31, 2018 and 2017 and the related consolidatedstatements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in theperiod ended December 31, 2018, and the related notes (collectively referred to as the “consolidated financial statements”) ofthe Company, and our report dated March 11, 2019, expressed an unqualified opinion on those consolidated financialstatements.Basis for Opinion The Company’s management is responsible for maintaining effective internal control over financial reporting, andfor its assessment of the effectiveness of internal control over financial reporting, included in the accompanyingManagement’s Report on Internal Controls over Financial Reporting. Our responsibility is to express an opinion on theCompany’s internal control over financial reporting based on our audit. We are a public accounting firm registered with thePCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities lawsand the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan andperform the audit to obtain reasonable assurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit of internal control over financial reporting included obtaining anunderstanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing andevaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also includedperforming such other procedures as we considered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal control over financial reporting includes those policiesand procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and thatreceipts and expenditures of the company are being made only in accordance with authorizations of management anddirectors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detectmisstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures maydeteriorate. /s/ BPM LLPSan Jose, CaliforniaMarch 11, 2019 61 Table of Contents PART IIIThe United States Securities and Exchange Commission (“SEC”) allows us to include information required in thisreport by referring to other documents or reports we have already or will soon be filing. This is called “Incorporation byReference.” We intend to file our definitive proxy statement for our annual meeting of stockholders to be held on May 23, 2019 (the “Proxy Statement”) pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered bythis report, and certain information therein is incorporated in this report by reference. Item 10. Directors, Executive Officers and Corporate GovernanceThe information required by this item with respect to identification of directors is incorporated by reference to theinformation contained in the section captioned “Information About our Board of Directors” in the Proxy Statement. Theinformation with respect to our executive officers, is incorporated by reference to the information contained in the sectioncaptioned “Executive Officers” in the Proxy Statement. Information with respect to Items 405 of Regulation S-K isincorporated by reference to the information contained in the sections of the Proxy Statement captioned “Section 16(a)Beneficial Ownership Reporting Compliance.” There will be no disclosure under Item 407(c)(3). Information with respect toItems 407(d)(4) and 407(d)(5) is incorporated by reference to the information contained in the sections of the ProxyStatement captioned “Corporate Governance—Committees of the Board of Directors.”The Board of Directors of AXT, Inc. has adopted a Code of Conduct and Ethics (the “Code”) that applies to ourprincipal executive officers, principal financial officer, and corporate controller, as well as other employees. A copy of thisCode has been posted on our Internet website at www.axt.com. Any amendments to, or waivers from, a provision of our Codethat applies to our principal executive officer, principal financial officer, controller, or persons performing similar functionsand that relates to any element of the Code enumerated in paragraph (b) of Item 406 of Regulation S-K shall be disclosed byposting such information on our website. Item 11. Executive CompensationThe information required by this Item is incorporated herein by reference to information set forth in our ProxyStatement under the section entitled “Executive Compensation and Other Matters.”· · Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersThe information required by this Item is incorporated herein by reference to information set forth in our ProxyStatement under the section entitled “Security Ownership of Certain Beneficial Owners and Management” and “EquityCompensation Plan Information.” Item 13. Certain Relationships and Related Transactions and Director IndependenceInformation required by this item will be set forth in our Proxy Statement under the headings “CompensationCommittee Interlocks and Insider Participation” and “Certain Relationships and Related Transactions,” which information isincorporated herein by reference. Item 14. Principal Accountant Fees and ServicesThe information required by this Item is incorporated herein by reference to information set forth in our ProxyStatement under the section entitled “Ratification of Appointment of Independent Registered Public Accountants.”62 Table of Contents PART IV Item 15. Exhibits and Financial Statement Schedules(a)The following documents are filed as part of this report:(1)Financial Statements:INDEX TO CONSOLIDATED FINANCIAL STATEMENTSReport of Independent Registered Public Accounting Firm 64Consolidated Balance Sheets 65Consolidated Statements of Operations 66Consolidated Statements of Comprehensive Income 67Consolidated Statements of Stockholders’ Equity 68Consolidated Statements of Cash Flows 69Notes to Consolidated Financial Statements 70 (2)Financial Statement SchedulesAll schedules have been omitted because the required information is not applicable or because the informationrequired is included in the consolidated financial statements or notes thereto.(b)ExhibitsSee Index to Exhibits attached elsewhere to this Form 10-K. The exhibits listed in the accompanying Index toExhibits are filed as part of, or incorporated by reference into, this report on Form 10-K.63 Table of ContentsReport of Independent Registered Public Accounting FirmTo the Board of Directors and Stockholders of AXT, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of AXT, Inc. (a Delaware corporation) and itssubsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of operations,comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31,2018, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, theconsolidated financial statements present fairly, in all material respects, the financial position of the Company as ofDecember 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the periodended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board(United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2018, based oncriteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizationsof the Treadway Commission (COSO), and our report dated March 11, 2019, expressed an unqualified opinion. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility isto express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accountingfirm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S.federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of materialmisstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of materialmisstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respondto those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in theconsolidated financial statements. Our audits also included evaluating the accounting principles used and significantestimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Webelieve that our audits provide a reasonable basis for our opinion. /s/ BPM LLP We have served as the Company’s auditor since 2004.San Jose, CaliforniaMarch 11, 2019 64 Table of ContentsAXT, INC.CONSOLIDATED BALANCE SHEETS(In thousands, except per share data) December 31, 2018 2017 ASSETS Current assets: Cash and cash equivalents $16,526 $44,352 Short-term investments 22,129 20,032 Accounts receivable, net of allowances of $358 and $527 as of December 31, 2018 andDecember 31, 2017 19,586 22,778 Inventories 58,571 45,840 Prepaid expenses and other current assets 11,728 7,519 Total current assets 128,540 140,521 Long-term investments 717 12,576 Property, plant and equipment, net 82,280 46,530 Other assets 11,987 11,573 Total assets $223,524 $211,200 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable $13,338 $11,445 Accrued liabilities 15,371 11,149 Total current liabilities 28,709 22,594 Other long-term liabilities 283 289 Total liabilities 28,992 22,883 Commitments and contingencies (Note 16) Stockholders’ equity: Preferred stock Series A, $0.001 par value; 2,000 shares authorized; 883 shares issuedand outstanding as of December 31, 2018 and December 31, 2017 (Liquidationpreference of $6,992 and $6,815 as of December 31, 2018 and December 31, 2017) 3,532 3,532 Common stock, $0.001 par value; 70,000 shares authorized; 39,985 and 39,413 sharesissued and outstanding as of December 31, 2018 and December 31, 2017 39 39 Additional paid-in capital 234,419 231,679 Accumulated deficit (45,183) (54,837) Accumulated other comprehensive income (loss) (1,972) 3,407 Total AXT, Inc. stockholders’ equity 190,835 183,820 Noncontrolling interests 3,697 4,497 Total stockholders’ equity 194,532 188,317 Total liabilities and stockholders’ equity $223,524 $211,200 See accompanying notes to consolidated financial statements.65 Table of ContentsAXT, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share data) Year Ended December 31, 2018 2017 2016 Revenue $102,397 $98,673 $81,349 Cost of revenue 65,350 64,198 54,968 Gross profit 37,047 34,475 26,381 Operating expenses: Selling, general and administrative 19,003 17,009 13,880 Research and development 5,897 4,827 5,850 Restructuring charge — — 226 Total operating expenses 24,900 21,836 19,956 Income from operations 12,147 12,639 6,425 Interest income, net 528 461 409 Equity in loss of unconsolidated joint ventures (1,080) (1,694) (1,995) Other income (expense), net 352 (553) 860 Income before provision for income taxes 11,947 10,853 5,699 Provision for income taxes 938 792 733 Net income 11,009 10,061 4,966 Less: Net loss (income) attributable to noncontrolling interests (1,355) 87 670 Net income attributable to AXT, Inc. $9,654 $10,148 $5,636 Net income attributable to AXT, Inc. per common share: Basic $0.24 $0.27 $0.17 Diluted $0.24 $0.26 $0.17 Weighted-average number of common shares outstanding: Basic 39,049 37,444 32,139 Diluted 40,265 38,966 32,894 See accompanying notes to consolidated financial statements.66 Table of ContentsAXT, INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(In thousands) Year Ended December 31, 2018 2017 2016 Net income $11,009 $10,061 $4,966 Other comprehensive income (loss), net of tax: Change in foreign currency translation gain (loss), net of tax (5,749) 3,726 (4,305) Change in unrealized gain (loss) on available-for-sale investments, net of tax 9 (138) (312) Total other comprehensive income (loss), net of tax (5,740) 3,588 (4,617) Comprehensive income 5,269 13,649 349 Less: Comprehensive loss (income) attributable to noncontrolling interests (994) (347) 1,158 Comprehensive income attributable to AXT, Inc. $4,275 $13,302 $1,507 See accompanying notes to consolidated financial statements. 67 Table of ContentsAXT, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(In thousands) Common Stock Preferred Additional AccumulatedOther AXT, Inc. Total Stock Paid-In Accumulated Comprehensive Stockholders’ Noncontrolling Stockholders’ Shares $ Shares $ Capital Deficit Income (Loss) Equity Interests Equity January 1, 2016$883 $3,532 $32,548 $32 $191,745 $(70,621) $4,382 $129,070 $5,590 $134,660 Common stockoptions exercised 555 1 1,336 1,337 1,337 Restricted stockawards canceled (207) — — Stock-basedcompensation 1,096 1,096 1,096 Issuance ofcommonstock in the form ofrestricted stock 136 — — Net income 5,636 5,636 (670) 4,966 Net dividenddeclared by jointventures — (52) (52) Othercomprehensive loss (4,129) (4,129) (488) (4,617) Balance as ofDecember 31, 2016 883 3,532 33,032 33 194,177 (64,985) 253 133,010 4,380 137,390 Common stockoptions exercised 762 1 2,476 2,477 2,477 Sale of subsidiaryshares tononcontrollinginterests 1,765 1,765 235 2,000 Stock-basedcompensation 1,405 1,405 1,405 Issuance ofcommonstock in the form ofrestricted stock 312 — — Issuance ofcommon stock, netof stock issuancecosts of $2,639 5,307 5 31,856 31,861 31,861 Net income 10,148 10,148 (87) 10,061 Net dividenddeclared by jointventures — (465) (465) Othercomprehensiveincome 3,154 3,154 434 3,588 Balance as ofDecember 31, 2017 883 3,532 39,413 39 231,679 (54,837) 3,407 183,820 4,497 188,317 Common stockoptions exercised 238 628 628 628 Purchase ofsubsidiary sharesfromnoncontrollinginterest — 187 187 (1,794) (1,607) Restricted stockawards canceled (10) — — Stock-basedcompensation — 1,925 1,925 1,925 Issuance ofcommon stock inthe form ofrestricted stock 344 — — Net income 9,654 9,654 1,355 11,009 Othercomprehensive loss (5,379) (5,379) (361) (5,740) Balance as ofDecember 31, 2018$883 $3,532 $39,985 $39 $234,419 $(45,183) $(1,972) $190,835 $3,697 $194,532 See accompanying notes to consolidated financial statements. 68 Table of ContentsAXT, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, 2018 2017 2016 Cash flows from operating activities: Net income $11,009 $10,061 $4,966 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,871 4,422 4,865 Amortization of marketable securities premium 158 173 94 Impairment charge on equity investee — 313 — Stock-based compensation 1,925 1,405 1,096 Provision for doubtful accounts — — 313 Realized gain on sale of available-for-sale securities — (77) (429) Loss (gain) on disposal of equipment (99) 57 5 Loss from equity method investments, net 1,080 1,381 1,995 Changes in operating assets and liabilities: Accounts receivable 2,819 (7,977) 3,465 Inventories (14,629) (4,740) (2,959) Prepaid expenses and other current assets (4,600) (2,309) (1,223) Other assets (1,888) (52) 458 Accounts payable 2,314 4,401 524 Accrued liabilities* 518 1,642 205 Other long-term liabilities, including royalties (260) (85) (871) Net cash provided by operating activities 3,218 8,615 12,504 Cash flows from investing activities: Purchases of property, plant and equipment (40,539) (21,356) (2,728) Proceeds from sale of equipment 99 — 35 Purchases of available-for-sale securities (9,937) (30,021) (11,936) Proceeds from sales and maturities of available-for-sale securities 19,550 14,750 13,516 Repayment of related party notes receivable — 169 — Net cash used in investing activities (30,827) (36,458) (1,113) Cash flows from financing activities: Proceeds from issuance of common stock and options exercised, net of issuance costs 628 34,338 1,337 Proceeds from sale of subsidiary shares to noncontrolling interests, net of portionallocated to noncontrolling interests — 1,765 — Considerations paid in cash to repurchase subsidiary shares from noncontrolling interests (415) — — Dividends paid by joint ventures to their minority shareholders — (465) (39) Net cash provided by financing activities 213 35,638 1,298 Effect of exchange rate changes on cash and cash equivalents (430) 405 (1,412) Net (decrease) increase in cash and cash equivalents (27,826) 8,200 11,277 Cash and cash equivalents at the beginning of the year 44,352 36,152 24,875 Cash and cash equivalents at the end of the year $16,526 $44,352 $36,152 Supplemental disclosures: Income taxes paid, net of refunds $1,134 $714 $788 Supplemental disclosure of non-cash flow information: Consideration payable to repurchase subsidiary shares from noncontrolling interests,included in accrued liabilities $1,192 $ — $ — Reduction of noncontrolling interests in excess of total consideration paid and payable inconnection with the repurchase of subsidiaries shares from noncontrolling interests $187 $ — $ — Consideration payable in connection with constructions, included in accrued liabilities $2,912 $ — $ — * Dividend accrued but not paid by joint ventures of $504, $533 and $499 was included in accrued liabilities as of December 31, 2018, 2017 and 2016, respectively. See accompanying notes to consolidated financial statements.69 Table of Contents AXT, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSNote 1. The Company and Summary of Significant Accounting PoliciesThe CompanyAXT, Inc. (“AXT”, “the Company”, “we,” “us,” and “our” refer to AXT, Inc. and its consolidated subsidiaries) is aworldwide materials science company that develops and produces high-performance compound and single elementsemiconductor substrates, also known as wafers. Our consolidated subsidiaries produce and sell certain raw materials some ofwhich are used in our substrate manufacturing process and some of which are sold to other companies. Our substrate wafers are used when a typical silicon substrate wafer cannot meet the conductive requirements of asemiconductor or optoelectronic device. The dominant substrates used in producing semiconductor chips and otherelectronic circuits are made from silicon. However, certain chips may become too hot or perform their function too slowly ifsilicon is used as the base material. In addition, optoelectronic applications, such as LED lighting and chip-based lasers, donot use silicon substrates because they require a wave form frequency that cannot be achieved using silicon. Alternative orspecialty materials are used to replace silicon as the preferred base in these situations. Our wafers provide such alternative orspecialty materials. We do not design or manufacture the chips. We add value by researching, developing and producing thespecialty material wafers. We have two product lines: specialty material substrates and raw materials integral to thesesubstrates. In 2018, our substrate product group generated 79% of our revenue and raw materials product group generated21%. Our compound substrates combine indium with phosphorous (indium phosphide: InP) or gallium with arsenic (galliumarsenide: GaAs). Our single element substrates are made from germanium (Ge).Our raw materials include both raw gallium and purified gallium. We use purified gallium in producing our GaAssubstrates and sell both raw gallium and purified gallium in the open market to other companies for use in magneticmaterials, high temperature thermometers and growing single crystal ingots including gallium arsenide, gallium nitride,gallium antimonide, gallium phosphide and other materials and alloys. We also produce pyrolytic boron nitride (pBN)crucibles used in the high temperature (typically in the range 500 C to 1,500 C) growth process of single crystal ingots andepitaxial layer growth in MBE reactors. We use these pBN crucibles in our own ingot growth processes and also sell them inthe open market to other companies.Principles of ConsolidationThe consolidated financial statements include the accounts of AXT, our wholly-owned subsidiary, Beijing TongmeiXtal Technology Co., Ltd., and our majority-owned, or significantly controlled subsidiaries, Beijing JiYa SemiconductorMaterial Co., Ltd., Nanjing JinMei Gallium Co., Ltd. and Beijing BoYu Semiconductor Vessel Craftwork Technology Co.,Ltd. All significant inter‑company accounts and transactions have been eliminated. Investments in business entities in whichwe do not have controlling interest, but have the ability to exercise significant influence over operating and financialpolicies (generally 20-50% ownership), are accounted for by the equity method. We have seven companies accounted for bythe equity method. For subsidiaries that we consolidate, we reflect the portion we do not own on our consolidated balancesheets in stockholders' equity and in our consolidated statements of operations.70 Table of ContentsUse of EstimatesThe preparation of financial statements in conformity with accounting principles generally accepted in the UnitedStates of America (“U.S. GAAP”) requires management to make estimates, judgments and assumptions. We believe that theestimates, judgments, and assumptions upon which management relies are reasonable based on information available at thetime that these estimates, judgments, and assumptions are made. These estimates, judgments, and assumptions can affect thereported amounts of assets and liabilities as of the date of the consolidated financial statements as well as the reportedamounts of revenues and expenses during the periods presented. To the extent there are material differences between theseestimates and actual results, our consolidated financial statements would be affected.Fair Value of Financial InstrumentsThe carrying amounts of certain of our financial instruments including cash and cash equivalents, short-terminvestments and long-term investments, accounts receivable, accounts payable and accrued liabilities approximate fair valuedue to their short maturities. Certain cash equivalents and investments are required to be adjusted to fair value on a recurringbasis. See Note 2.Fair Value of InvestmentsAccounting Standards Codification ("ASC") topic 820, Fair value measurement (“ASC 820”) establishes threelevels 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 1instruments does not require significant management judgment, and the estimation is not difficult.Level 2 instruments include observable inputs other than Level 1 prices, such as quoted prices for similarinstruments in markets with insufficient volume or infrequent transactions (less active markets), issuer bank statements, creditratings, non-binding market consensus prices that can be corroborated with observable market data, model-derivedvaluations in which all significant inputs are observable or can be derived principally from or corroborated with observablemarket data for substantially the full term of the assets or liabilities, or quoted prices for similar assets or liabilities. TheseLevel 2 instruments require more management judgment and subjectivity compared to Level 1 instruments, including:·Determining which instruments are most comparable to the instrument being priced requires management toidentify a sample of similar securities based on the coupon rates, maturity, issuer, credit rating, and instrument type,and subjectively select an individual security or multiple securities that are deemed most similar to the securitybeing priced.·Determining which model-derived valuations to use in determining fair value requires management judgment.When observable market prices for similar securities or comparable securities are not available, we price ourmarketable debt instruments using non-binding market consensus prices that are corroborated with observablemarket data or pricing models, such as discounted cash flow models, with all significant inputs derived from orcorroborated with observable market data.Level 3 instruments include unobservable inputs to the valuation methodology that are significant to themeasurement of fair value of assets or liabilities. The determination of fair value for Level 3 instruments requires the mostmanagement judgment and subjectivity.We place short-term foreign currency hedges that are intended to offset the potential cash exposure related tofluctuations in the exchange rate between the United States dollar and Japanese yen. We measure the fair value of theseforeign currency hedges at each month end and quarter end using current exchange rates and in accordance with generallyaccepted accounting principles. At quarter end any foreign currency hedges not settled are netted in “Accrued liabilities” onthe consolidated balance sheets and classified as Level 3 assets and liabilities. As of December 31, 201871 Table of Contentsand 2017, the net change in fair value from the placement of the hedge to settlement had a de minimis impact to theconsolidated results.Foreign Currency TranslationThe functional currency of our Chinese subsidiaries is the renminbi, the local currency of China. Transaction gainsand losses resulting from transactions denominated in currencies other than the U.S. dollar or in the functional currencies ofour subsidiaries are included in “Other (expense) income, net” for the years presented. The transaction gain for the year endedDecember 31, 2018 totaled $165,000 whereas the transaction loss for the year ended December 31, 2017 totaled $602,000.The transaction gain totaled $232,000 for the year ended December 31, 2016.The assets and liabilities of the subsidiaries are translated at the rates of exchange on the balance sheet date.Revenue and expense items are translated at the average rate of exchange for the period. Gains and losses from foreigncurrency translation are included in “Other comprehensive income (loss)” in the consolidated statements of comprehensiveincome, net of tax.Revenue RecognitionWe manufacture and sell high-performance compound semiconductor substrates including indium phosphide,gallium arsenide and germanium wafers, and our three consolidated subsidiaries sell certain raw materials, including 99.99%pure gallium (4N Ga), high purity gallium (7N Ga), pyrolytic boron nitride (pBN) crucibles and boron oxide (B2O3). After weship our products, there are no remaining obligations or customer acceptance requirements that would preclude revenuerecognition. Our products are typically sold pursuant to purchase orders placed by our customers, and our terms andconditions of sale do not require customer acceptance. We account for a contract with a customer when there is a legallyenforceable contract, which could be the customer’s purchase order, the rights of the parties are identified, the contract hascommercial terms, and collectibility of the contract consideration is probable. The majority of our contracts have a singleperformance obligation to transfer products and are short term in nature, usually less than one year. Our revenue is measuredbased on the consideration specified in the contract with each customer in exchange for transferring products that isgenerally based upon a negotiated, formula, list or fixed price. Revenue is recognized when control of the promised goods istransferred to our customer, which is either upon shipment from our dock, receipt at the customer’s dock, or removal fromconsignment inventory at the customer’s location, in an amount that reflects the consideration we expect to be entitled toreceive in exchange for those goods. We have elected to account for shipping and handling as activities to fulfill the promise to transfer the goods. Assuch, shipping and handling fees billed to customers in a sales transaction are recorded in revenue and shipping andhandling costs incurred are recorded in cost of revenue. Sales taxes and value added taxes in foreign jurisdictions that arecollected from customers and remitted to governmental authorities are accounted for on a net basis and, therefore, areexcluded from net sales. We do not provide training, installation or commissioning services. We provide for future returns based on historicaldata, prior experience, current economic trends and changes in customer demand at the time revenue is recognized. We donot recognize any asset associated with the incremental cost of obtaining revenue generating customer contracts. As such,sales commissions are expensed as incurred, given that the expected period of benefit is less than one year. On January 1, 2018, we adopted ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”), and itsrelated amendments, using the modified retrospective method applied to those contracts which were not completed as ofJanuary 1, 2018. The adoption of ASC 606, using the modified retrospective approach, had no significant impact to ouraccumulated deficit as of January 1, 2018 and no significant impact to the total net cash from or used in operating, investing,or financing activities within the consolidated statements of cash flows. In connection with this adoption on January 1, 2018,we reclassified our refund liabilities relating to sales with a right of return in the amount of $169,000 to present it separatelyfrom “Accounts receivables” and included it in “Accrued liabilities” on the consolidated balance sheets. 72 Table of ContentsContract Balances We receive payments from customers based on a billing schedule as established in our contracts. Contract assets arerecorded when we have a conditional right to consideration for our completed performance under the contracts. Accountsreceivables are recorded when the right to this consideration becomes unconditional. We do not have any material contractassets as of December 31, 2018. December 31, December 31, 2018 2017Contract liabilities $(476) $(924)Revenue recognized in the year ended Amounts included in contract liabilities at the beginning of the period $834 Not Applicable Disaggregated Revenue In general, revenue disaggregated by product types and geography (See Note 14) is aligned according to the natureand economic characteristics of our business and provides meaningful disaggregation of our results of operations. Since weoperate in one segment, all financial segment and product line information can be found in the consolidated financialstatements. Practical Expedients and Exemptions As part of our adoption of ASC 606, we elected to use the following practical expedients: (i) not to adjust thepromised amount of consideration for the effects of a significant financing component when we expect, at contract inception,that the period between our transfer of a promised product or service to a customer and when the customer pays for thatproduct or service will be one year or less; (ii) to expense costs as incurred for costs to obtain a contract when theamortization period would have been one year or less; (iii) not to assess whether promised goods or services are performanceobligations if they are immaterial in the context of the contract with the customer. In addition, we do not disclose the value of unsatisfied performance obligations for contracts with an original expectedlength of one year or less. Accounting for Sales Taxes in Net RevenuesWe record sales taxes collected on sales of our products and for amounts not yet remitted to tax authorities asaccrued liabilities on our consolidated balance sheets.Risks and Concentration of Credit RiskOur business is very dependent on the semiconductor, lasers and optical industries which can be highly cyclical andexperience downturns as a result of economic changes, overcapacity, and technological advancements. Significanttechnological changes in the industry or customer requirements, or the emergence of competitive products with newcapabilities or technologies, could adversely affect our operating results. In addition, a significant portion of our revenuesand net income is derived from international sales. Fluctuations of the United States dollar against foreign currencies andchanges in local regulatory or economic conditions, particularly in an emerging market such as China, could adversely affectoperating results.We depend on a limited number of suppliers for certain raw materials, components and equipment used inmanufacturing our products, including quartz tubing and polishing solutions. We generally purchase these materials throughstandard purchase orders and not pursuant to long-term supply contracts.Financial instruments that potentially subject us to concentration of credit risk consist primarily of cash and cashequivalents, short-term investments, and trade accounts receivable. We invest primarily in money market accounts,certificates of deposit, corporate bonds and equity securities. The composition and maturities are regularly monitored bymanagement. Such deposits are in excess of the amount of the insurance provided by the federal government on such73 Table of Contentsdeposits. We are exposed to credit risks in the event of default by the issuers to the extent of the amount recorded on theconsolidated balance sheets. We perform ongoing credit evaluations of our customers’ financial condition, and limit the amount of creditextended when deemed necessary, but generally do not require collateral. The credit risk in our accounts receivableis mitigated by our credit evaluation process and the geographical dispersion of sales transactions. Three customersaccounted for 17%, 12% and 10% of our trade accounts receivable as of December 31, 2018 and one customer accounted for12% of our trade accounts receivable as of December 31, 2017. One customer represented 13% of our revenue for the year ended December 31, 2018. Two customers represented12% and 11%, respectively, of our revenue for the year ended December 31, 2017. No customer represented more than 10%of our revenue for the year ended December 31, 2016. Our top five customers, although not the same five customers for eachperiod, represented 35% of our revenue for each of the years ended December 31, 2018, 2017 and 2016.For the year ended December 31, 2018, each of three third-party customers for the raw materials products from ourconsolidated subsidiaries accounted for over 10% of the revenue from raw materials sales. For the year ended December 31,2017, each of three third-party customers for the raw materials products from our consolidated subsidiaries accounted for over10% of the revenue from raw materials sales while there were four third-party customers for the year ended December 31,2016. Our subsidiaries and joint ventures are a key strategic benefit for us as they further diversify our sources of revenue.Cash and Cash EquivalentsWe consider investments in highly liquid instruments purchased with an original maturity of three months or less tobe cash equivalents. Cash equivalents consist primarily of certificate of deposits. Cash and cash equivalents are stated at cost,which approximates fair value.Short-Term and Long-Term InvestmentsWe classify our investments in marketable debt and equity securities as available-for-sale securities. Short-term andlong-term investments are comprised of available-for-sale marketable debt and equity securities, which consist primarily ofcertificates of deposit, corporate bonds and equity securities. These investments are reported at fair value as of the respectivebalance sheet dates with unrealized gains and losses included in accumulated other comprehensive income (loss) withinstockholders’ equity on the consolidated balance sheets. The amortized cost of securities is adjusted for amortization ofpremiums and accretion of discounts to maturity. Such amortization is included in “Other (expense) income, net” in theconsolidated statements of operations. Realized gains and losses and declines in value judged to be other than temporary onavailable-for-sale securities are also included in “Other (expense) income, net” in the consolidated statements of operations.The cost of securities sold is based upon the specific identification method.Accounts Receivable and Allowance for Doubtful Accounts and Sales ReturnsAccounts receivable are recorded at the invoiced amount and are not interest bearing. We periodically review thelikelihood of collection on our accounts receivable balances and provide an allowance for doubtful accounts receivableprimarily based upon the age of these accounts. We evaluate receivables from U.S. customers with an emphasis onbalances in excess of 90 days and for receivables from customers located outside the U.S. with an emphasis on balances inexcess of 120 days and establish a reserve allowance on the receivable balances if needed. The reason for the difference in theevaluation of receivables between foreign and U.S. customers is that U.S. customers have historically made payments in ashorter period of time than foreign customers. Foreign business practices generally require us to allow customer paymentterms that are longer than those accepted in the United States. We assess the probability of collection based on a number offactors, including the length of time a receivable balance has been outstanding, our past history with the customer and theircredit worthiness.74 Table of ContentsWe exercise judgment when determining the adequacy of these reserves as we evaluate historical bad debt trends,general economic conditions in the United States and internationally, and changes in customer financial conditions.Uncollectible receivables are recorded as bad debt expense when all efforts to collect have been exhausted and recoveries arerecognized when they are received. As of December 31, 2018 and 2017, our accounts receivable, net balance was $19.6million and $22.8 million, respectively, which was net of an allowance for doubtful accounts of $358,000 in both December31, 2018 and 2017. There were no changes in the allowance of doubtful accounts in 2018. During 2017, we decreased theallowance for doubtful accounts by $295,000 due to $138,000 from bad debt recovery and $157,000 from bad debts writtenoff in 2017. If actual uncollectible accounts differ substantially from our estimates, revisions to the estimated allowance fordoubtful accounts would be required, which could have a material impact on our financial results for the future periods. Ifactual uncollectible accounts differ substantially from our estimates, revisions to the estimated allowance for doubtfulaccounts would be required, which could have a material impact on our financial results for future periods.Historically, our allowance for sales returns reserve was deducted from gross accounts receivable. In connection withthe adoption of ASC Topic 606, on January 1, 2018, we reclassified our refund liabilities relating to sales with a right ofreturn in the amount of $169,000 to present it separately from “Accounts receivables” and included it in “Accrued liabilities”on the consolidated balance sheets. As of December 31, 2018 and 2017, the balance was $47,000 and $169,000, respectively.During 2018, we utilized $47,000 and reduced an additional $75,000 and during 2017, we utilized $119,000 and reduced anadditional $72,000. Warranty ReserveWe maintain a warranty reserve based upon our claims experience during the prior twelve months and any pendingclaims and returns of which we are aware. Warranty costs are accrued at the time revenue is recognized. As of December 31,2018 and 2017, accrued product warranties totaled $236,000 and $133,000, respectively. The increase in accrued productwarranties is primarily attributable to increased claims for quality issues experienced by customers. If actual warranty costs orpending new claims differ substantially from our estimates, revisions to the estimated warranty liability would be required,which could have a material impact on our financial condition and results of operations for future periods.InventoriesInventories are stated at the lower of cost (approximated by standard cost) or net realizable value. Cost is determinedusing the weighted average cost method. Our inventory consists of raw materials as well as finished goods and work-in-process that include material, labor and manufacturing overhead costs. We routinely evaluate the levels of our inventory inlight of current market conditions in order to identify excess and obsolete inventory, and we provide a valuation allowancefor certain inventories to their estimated net realizable value based upon the age and quality of the product and theprojections for sale of the completed products.Property, Plant and EquipmentProperty, plant and equipment are stated at cost less accumulated depreciation computed using the straight-linemethod over the estimated economic lives of the assets, which vary from 1 to 27.5 years. Leasehold improvements areamortized using the straight-line method over the shorter of the estimated useful life or the term of the lease. We generallydepreciate computer, software, office equipment, furniture and fixtures 3 to 5 years, machinery and equipment 1 to 5 years,automobiles 5 to 10 years, leasehold and building improvements over 10 years, or lease term if shorter, and buildings over27.5 years. Repairs and maintenance costs are expensed as incurred.Impairment of Long-Lived AssetsWe evaluate property, plant and equipment and intangible assets for impairment. When events and circumstancesindicate that long-lived assets may be impaired, we compare the carrying value of the long-lived assets to the projection offuture undiscounted cash flows attributable to these assets. In the event that the carrying value exceeds the futureundiscounted cash flows, we record an impairment charge against income equal to the excess of the carrying75 Table of Contentsvalue over the assets’ fair value. Fair values are determined based on quoted market values, discounted cash flows or internaland external appraisals, as applicable. We did not recognize any impairment charges of long-lived assets in 2018, 2017 and2016.Impairment of InvestmentsAll available-for-sale securities are periodically reviewed for impairment. An investment is considered to beimpaired when its fair value is less than its amortized cost basis and it is more likely than not that we will be required to sellthe impaired security before recovery of its amortized cost basis. Factors considered in determining whether a loss istemporary include the magnitude of the decline in market value, the length of time the market value has been below cost (oradjusted cost), credit quality, and our ability and intent to hold the securities for a period of time sufficient to allow for anyanticipated recovery in market value.We also invest in equity instruments of privately-held companies in China for business and strategic purposes.Investments in our unconsolidated joint venture companies are classified as other assets and accounted for under either theequity or cost method, depending on whether we have the ability to exercise significant influence over their operations orfinancial decisions. We monitor our investments for impairment and record reductions in carrying value when events orchanges in circumstances indicate that the carrying value may not be recoverable. Determination of impairment is highlysubjective and is based on a number of factors, including an assessment of the strength of each company’s management, thelength of time and extent to which the fair value has been less than our cost basis, the financial condition and near-termprospects of the subsidiary, fundamental changes to the business prospects of the company, share prices of subsequentofferings, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipatedrecovery in our carrying value. We estimate fair value of our cost method investments considering available information suchas pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operationalperformance and any other readily available market data.Segment ReportingWe operate in one segment for the design, development, manufacture and distribution of high-performancecompound and single element semiconductor substrates and sale of raw materials integral to these substrates. Our chiefoperating decision-maker has been identified as our Chief Executive Officer, who reviews operating results to make decisionsabout allocating resources and assessing our performance for the Company. We discuss revenue and capacity for both AXTand our joint ventures collectively, when determining capacity constraints and need for raw materials in our business, andconsider their capacity when determining our strategic and product marketing and advertising strategies. While weconsolidate our majority-owned or significantly controlled joint ventures, we do not allocate any portion of overhead,interest and other income, interest expense or taxes to them. We therefore have determined that our joint venture operationsdo not constitute an operating segment. Since we operate in one segment, all financial segment and product line informationcan be found in the consolidated financial statements.Stock‑Based CompensationWe have employee stock option plans, which are described more fully in Note 10—Employee Benefit Plans andStock-based Compensation. We account for stock‑based compensation in accordance with the provisions of ASC Topic 718,Compensation-Stock Compensation (“ASC 718”). We utilize the Black‑Scholes option pricing model to estimate the grantdate fair value of stock options, which requires the input of highly subjective assumptions, including estimating stock pricevolatility and expected term. Stock‑based compensation cost is measured at each grant date, based on the fair value of theaward, and is recognized as expense and as an increase in additional paid-in capital over the requisite service period of theaward.Research and DevelopmentResearch and development costs consist primarily of salaries, including stock-based compensation expense and relatedpersonnel costs, depreciation, materials and product testing which are expensed as incurred. Tangible assets acquired forresearch and development purposes are capitalized if they have alternative future use.76 Table of Contents Advertising CostsAdvertising costs, included in selling, general and administrative expenses, are expensed as incurred. Advertisingcosts for the years ended December 31, 2018, 2017 and 2016 were less than $10,000.Income TaxesWe account for income taxes in accordance with ASC topic 740, Income Taxes (“ASC 740”), which requires thatdeferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between thebook and tax bases of recorded assets and liabilities. ASC 740 also requires that deferred tax assets be reduced by a valuationallowance if it is more likely than not that a portion of the deferred tax asset will not be realized. The impact of ASC 740 ismore fully described in Note 12.We have completed the accounting associated with the December 22, 2017 enactment of the U.S. Tax Cuts and JobsAct (“Tax Reform”). The U.S. Securities and Exchange Commission (“SEC”) had provided accounting and reportingguidance that allowed us to report provisional amounts within a measurement period up to one year from the enactment date.Complexities inherent in adopting the changes included additional guidance, interpretations of the law, and further analysisof data and tax positions. As of December 2018, we do not expect there will be any significant adjustment to the impact ofthe Tax Reform.Effective in 2018, the Tax Reform reduces the U.S. statutory tax rate from 35% to 21% and creates new taxes oncertain foreign-sourced earnings and certain related-party payments, which are referred to as the global intangible low-taxedincome tax and the base erosion tax, respectively. We have considered the impact of these new taxes in the current year’sprovision calculation.Comprehensive Income (Loss)The components of other comprehensive income (loss) include unrealized gains and losses on marketable securitiesand foreign currency translation adjustments. Comprehensive income (loss) is presented in the consolidated statements ofcomprehensive income, net of tax. The balance of accumulated other comprehensive income (loss) is as follows (inthousands): As of December 31, 2018 2017Accumulated other comprehensive income (loss): Unrealized loss on investments, net $(84) $(93)Cumulative translation adjustment (1,845) 3,904 (1,929) 3,811Less: Cumulative translation adjustment attributable to noncontrollinginterests 43 404Accumulated other comprehensive income (loss) attributable to AXT, Inc. $(1,972) $3,407 Net Income (Loss) Per ShareBasic net income (loss) per share is computed using the weighted average number of common shares outstandingduring the periods less shares of common stock subject to repurchase and non-vested stock awards. Diluted net income (loss)per share is computed using the weighted average number of common shares outstanding and potentially dilutive commonshares outstanding during the periods. The dilutive effect of outstanding stock options and restricted stock awards isreflected in diluted earnings per share by application of the treasury stock method. Potentially dilutive common sharesconsist of common shares issuable upon the exercise of stock options and vesting of restricted stock awards. Potentiallydilutive common shares are excluded from the computation of weighted average number of common shares outstanding innet loss years, as their effect would be anti-dilutive to the computation.77 Table of ContentsRecent Accounting PronouncementsIn January 2016, the FASB issued ASU 2016-01, which made changes to the accounting for financial instrumentsthat primarily affect equity investments, financial liabilities under the fair value option, and the presentation and disclosurerequirements for financial instruments. The amendments in this update supersede the guidance to classify equity securitieswith readily determinable fair values into different categories (that is, trading or available-for-sale) and require equitysecurities to be measured at fair value with changes in the fair value recognized through net income. The standard amendsfinancial reporting by providing relevant information about an entity’s equity investments and reducing the number of itemsthat are recognized in other comprehensive income. This update became effective for annual periods beginning afterDecember 15, 2017, and interim periods within those annual periods. We adopted this guidance effective January 1, 2018and it did not have a significant impact on our consolidated financial statements. In February 2016, the FASB issued ASU 2016-02, which replaces the existing guidance for leases. The new standardestablishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheetfor all leases with terms longer than twelve months. Leases will be classified as either finance or operating, with classificationaffecting the pattern of expense recognition in the income statement. The guidance is effective for fiscal years beginningafter December 15, 2018, including interim periods within those fiscal years and requires retrospective application. The Company will adopt the new lease standard as of January 1, 2019 and plans to utilize the retrospectivecumulative effect adjustment transition method with a cumulative effect adjustment being recorded as of the adoption date.The Company expects to elect certain available practical expedients including the package of practical expedients permittedunder the transition guidance within the new standard, which among other things, will allow the Company to carry forwardthe historical lease classification. Additionally, the Company will make an accounting policy election to not record ROUassets and lease liabilities for leases with an initial term of twelve months or less on its consolidated balance sheet. The Company has established a cross-functional implementation team and is in the process of finalizing the scopeof arrangements that will be subject to this standard as well as assessing the impact to the Company’s systems, processes, andinternal controls over financial reporting. While the Company is still evaluating the impact of adopting ASU 2016-02, theCompany anticipate this standard will have a material impact on the consolidated balance sheet. The primary impact will beto record ROU assets and lease liabilities for existing operating leases on the consolidated balance sheets. The Company does not expect the adoption to have a material impact on its consolidated statements of operationsor its consolidated statements of cash flows. The Company does not believe the standard will have a notable impact on itsliquidity. The Company’s analysis and evaluation of the new standard will continue through its effective date in the firstquarter of 2019, including continuing to monitor any potential changes in the standard proposed by the FASB. In August 2016, the FASB issued ASU No. 2016-15, which reduces diversity in practice where the FASB was eitherunclear or did not provide specific guidance for classifying cash payments and receipts in the statement of cash flows foreight specific transactions. The guidance is effective for fiscal years beginning after December 15, 2017, including interimperiods within those fiscal years and requires retrospective application with early application permitted. We adopted thisguidance effective January 1, 2018 and it did not have a significant impact on our consolidated financial statements. In October 2016, the FASB issued ASU No. 2016-16, which clarifies the accounting for the current and deferredincome taxes for an intra-entity transfer of an asset other than inventory. The guidance is effective for fiscal years beginningafter December 15, 2017, including periods within those fiscal years and requires retrospective application with earlyapplication permitted. We adopted this guidance effective January 1, 2018 and it did not have a significant impact on ourconsolidated financial statements. 78 Table of ContentsIn January 2017, the FASB issued ASU No. 2017-01, which clarifies the definition of a business with the objectiveof adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (ordisposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions,disposals, goodwill, and consolidation. The guidance is effective for fiscal years beginning after December 15, 2017,including periods within those fiscal years and requires retrospective application with early application permitted. Weadopted this guidance effective January 1, 2018 and it did not have a significant impact on our consolidated financialstatements.In May 2017, the FASB issued ASU No. 2017-09, Compensation - Stock Compensation (Topic 718): Scope ofModification Accounting. The guidance provides clarity and reduces diversity in practice and cost and complexity whenaccounting for a change to the terms or conditions of a share-based payment award. The guidance is effective for fiscal yearsbeginning after December 15, 2017. We adopted this guidance effective January 1, 2018 and it did not have a significantimpact on our consolidated financial statements.Note 2. Cash, Cash Equivalents and InvestmentsOur cash and cash equivalents consist of cash and instruments with original maturities of less than three months. Ourinvestments consist of instruments with original maturities of more than three months. As of December 31, 2018 and 2017,our cash, cash equivalents and investments are classified as follows (in thousands): December 31, 2018 December 31, 2017 Gross Gross Gross Gross Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair Cost Gain (Loss) Value Cost Gain (Loss) Value Classified as: Cash $16,526 $ — $ — $16,526 $43,610 $ — $ — $43,610 Cash equivalents: Certificates of deposit — — — — 742 — — 742 Total cash and cashequivalents 16,526 — — 16,526 44,352 — — 44,352 Investments (available-for-sale): Certificates of deposit 4,508 — (27) 4,481 7,099 — (24) 7,075 Corporate bonds 18,422 — (57) 18,365 25,602 — (69) 25,533 Total investments 22,930 — (84) 22,846 32,701 — (93) 32,608 Total cash, cash equivalentsand investments $39,456 $ — $(84) $39,372 $77,053 $ — $(93) $76,960 Contractual maturities oninvestments: Due within 1 year $22,210 $22,129 $20,056 $20,032 Due after 1 through 5 years 720 717 12,645 12,576 $22,930 $22,846 $32,701 $32,608 1.Certificate of deposit with original maturities of less than three months.2.Certificate of deposit with original maturities of more than three months.3.Classified as “Short-term investments” in our consolidated balance sheets.4.Classified as “Long-term investments” in our consolidated balance sheets. We manage our investments as a single portfolio of highly marketable securities that is intended to be available tomeet our current cash requirements. Certificates of deposit and corporate bonds are typically held until maturity. Corporateequity securities have no maturity and may be sold at any time. Our holding of corporate equity securities consisted ofcommon stock of GCS Holdings, Inc. (“GHI”) (previously Global Communication Semiconductors, Inc), a Taiwan publicly-traded company. Previously, we also owned the common stock of Intelligent Epitaxy Technology, Inc.79 1234 Table of Contents(“IntelliEpi”). We began classifying IntelliEpi stock as an available-for-sale security upon its initial public offering in 2013and sold our remaining IntelliEpi stock in the second quarter of 2015 and we no longer hold any IntelliEpi stock as ofDecember 31, 2018.We began classifying GHI as an available-for-sale security in the second quarter of 2015 when we determined thatthere was sufficient trading volume in the exchange for the stock to be deemed readily marketable. As of December 31, 2018and 2017, we no longer hold any GHI stock. During 2017, our cash proceeds from sales of GHI stock were $125,000. Our costwas $48,000 and our gross realized gain from sales of GHI stock was $77,000. During the three months ended March 31,2017, we sold the remainder of our GHI stock. An unrealized gain of $111,000, net of tax, was recorded as of December 31,2016. In 2016, we sold some of our GHI stock and our cash proceeds from sales of this available-for-sale investment was$581,000. Our cost was $152,000 and our gross realized gain from sales of this available-for-sale investment was $429,000. The gross unrealized losses related to our portfolio of available-for-sale securities were primarily due to changes ininterest rates and market and credit conditions of the underlying securities. We have determined that the gross unrealizedlosses on some of our available-for-sale securities as of December 31, 2018 are temporary in nature. We periodically reviewour investment portfolio to identify and evaluate investments that have indications of possible impairment. Factorsconsidered in determining whether a loss is temporary include the magnitude of the decline in market value, the length oftime the market value has been below cost (or adjusted cost), credit quality, and our ability and intent to hold the securitiesfor a period of time sufficient to allow for any anticipated recovery in market value.A portion of our investments would generate a loss if we sold them on December 31, 2018. The following tablesummarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investmentcategory and length of time that individual securities have been in a continuous unrealized loss position as of December 31,2018 (in thousands): In Loss Position In Loss Position Total In < 12 months > 12 months Loss Position Gross Gross Gross Fair Unrealized Fair Unrealized Fair Unrealized As of December 31, 2018 Value (Losses) Value (Losses) Value (Losses) Investments: Certificates of deposit $717 $(3) $3,746 $(24) $4,463 $(27) Corporate bonds 9,175 (29) 9,189 (28) 18,364 (57) Total in loss position $9,892 $(32) $12,935 $(52) $22,827 $(84) The following table summarizes the fair value and gross unrealized losses related to available-for-sale securities,aggregated by investment category and length of time that individual securities have been in a continuous unrealized lossposition as of December 31, 2017 (in thousands): In Loss Position In Loss Position Total In < 12 months > 12 months Loss Position Gross Gross Gross Fair Unrealized Fair Unrealized Fair Unrealized As of December 31, 2017 Value (Loss) Value (Loss) Value (Loss) Investments: Certificates of deposit $3,994 $(16) $2,342 $(8) $6,336 $(24) Corporate bonds 25,533 (69) — — 25,533 (69) Total in loss position $29,527 $(85) $2,342 $(8) $31,869 $(93) Investments in Privately-held CompaniesWe have made strategic investments in private companies located in China in order to gain access at a competitivecost to raw materials that are critical to our substrate business (see Note 6). The investment balances for all of thesecompanies, including minority investments indirectly in privately-held companies made by our consolidated80 Table of Contentssubsidiaries, are accounted for under the equity method and included in “Other assets” in the consolidated balance sheetsand totaled $8.4 million and $9.8 million as of December 31, 2018 and 2017, respectively. As of December 31, 2018 therewere seven companies accounted for under the equity method. We had no impairment charges during 2018. For the yearended December 31, 2017, we recognized an impairment charge of $313,000 for one of the gallium companies. During thefirst quarter of 2017, management determined it unlikely that this company will recover from the difficult pricingenvironment and we wrote the investment down to zero. We had no impairment charges during 2016.As noted above, in the second quarter of 2015, we re-classified our minority investment in GHI, whichwas accounted for under the cost method, as an available-for-sale security and valued the security at fair market value. As ofDecember 31, 2018 and 2017, we no longer maintain any investments under the cost method.Fair Value MeasurementsWe invest primarily in money market accounts, certificates of deposit, corporate bonds and notes, and governmentsecurities. ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), establishes three levels of inputs that maybe used to measure fair value. Level 1 instrument valuations are obtained from real-time quotes for transactions in activeexchange markets of the asset or identical assets. Level 2 instrument valuations are obtained from readily-available, observable pricing sources for comparable instruments. Level 3 instrument valuations are obtained fromunobservable inputs in which there is little or no market data, which require us to develop our own assumptions. On arecurring basis, we measure certain financial assets and liabilities at fair value, primarily consisting of our short-term andlong-term investments.The type of instrument valued based on quoted market prices in active markets include our money market funds,which are generally classified within Level 1 of the fair value hierarchy. Other than corporate equity securities which arebased on quoted market prices and classified as Level 1, we classify our available-for-sale securities including certificates ofdeposit and corporate bonds as having Level 2 inputs. The valuation techniques used to measure the fair value of thesefinancial instruments having Level 2 inputs were derived from bank statements, quoted market prices, broker or dealerstatements or quotations, or alternative pricing sources with reasonable levels of price transparency. There were no changesin valuation techniques or related inputs in the year ended December 31, 2018. There have been no transfers between fairvalue measurement levels during the year ended December 31, 2018.We place short-term foreign currency hedges that are intended to offset the potential cash exposure related tofluctuations in the exchange rate between the United States dollar and Japanese yen. We measure the fair value of theseforeign currency hedges at each month end and quarter end using current exchange rates and in accordance with generallyaccepted accounting principles. At quarter end any foreign currency hedges not settled are netted in “Accrued liabilities” onthe consolidated balance sheets and classified as Level 3 assets and liabilities. As of December 31, 2018, the net change infair value from the placement of the hedge to settlement at each month end during the quarter had a de minimis impact to theconsolidated results.The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis inaccordance with ASC 820 as of December 31, 2018 (in thousands): Quoted Prices in Significant Active Markets of Significant Other Unobservable Balance as of Identical Assets Observable Inputs Inputs December 31, 2018 (Level 1) (Level 2) (Level 3) Assets: Cash equivalents and investments: Certificates of deposit $4,481 $ — $4,481 $ — Corporate bonds 18,365 — 18,365 — Total $22,846 $ — $22,846 $ — 81 Table of ContentsThe following table summarizes our financial assets and liabilities measured at fair value on a recurring basis inaccordance with ASC 820 as of December 31, 2017 (in thousands): Quoted Prices in Significant Active Markets of Significant Other Unobservable Balance as of Identical Assets Observable Inputs Inputs December 31, 2017 (Level 1) (Level 2) (Level 3) Assets: Cash equivalents and investments: Certificates of deposit $7,817 $ — $7,817 $ — Corporate bonds 25,533 — 25,533 — Total $33,350 $ — $33,350 $ — Items Measured at Fair Value on a Nonrecurring BasisCertain assets that are subject to nonrecurring fair value measurements are not included in the table above. Theseassets include investments in privately-held companies accounted for by equity and cost method (See Note 6).We had noimpairment charges 2018. For the year ended in December 31, 2017, we recognized an impairment charge of $313,000 forone of the gallium companies. During the first quarter of 2017, management determined it was unlikely that this companywould recover from the difficult pricing environment and we wrote the investment down to zero. We had no impairmentcharges 2016.Note 3. InventoriesThe components of inventory are summarized below (in thousands): December 31, December 31, 2018 2017 Inventories: Raw materials $26,966 $23,554 Work in process 28,217 20,135 Finished goods 3,388 2,151 $58,571 $45,840 As of December 31, 2018 and 2017, carrying values of inventories were net of inventory reserves of $14.8 millionand $13.3 million, respectively, for excess and obsolete inventory and $18,000 and $291,000, respectively, for lower of costor net realizable value reserves.Note 4. Related Party TransactionsIn August 2011, our consolidated joint venture, Beijing JiYa Semiconductor Material Co., Ltd. (“JiYa”), enteredinto a non-interest bearing note agreement in the amount of $1.6 million for a loan to one of its equity investment entities.The original term of the loan was for two years and ten months with three periodic principal payments required. After variousamendments to the terms of the note, in December 2013 the parties agreed to delay all principal repayment until December2017. In December 2016, we determined that this receivable was in substance an investment and began re-classifying thislong-term loan from “Related party notes receivable – long-term” to “Other assets” in our consolidated balance sheets. As ofDecember 31, 2018 and 2017, we included $1.0 million and $1.2 million, respectively, in “Other assets” in our consolidatedbalance sheets.JiYa also purchases raw materials from one of its equity investment entities for production in the ordinary course ofbusiness. The general manager of JiYa has a family member who has a 10% ownership position in this equity investmententity. As of December 31, 2018 and 2017, amounts payable of $1.9 million and $2.1 million, respectively, were included in“Accounts payable” in our consolidated balance sheets.82 Table of ContentsJiYa also sells raw materials to one of its equity investment entities for production in the ordinary course ofbusiness. As of December 31, 2018 and 2017, amounts receivable of $316,000 and $334,000, respectively, were included in“Accounts receivable” in our consolidated balance sheets. During the three months ended December 31, 2016, we deemedthe collection of the outstanding amount to be improbable and established an allowance in full. There have since been noadditional sales made on credit to the customer and as of December 31, 2018 the existing outstanding amount continues tobe fully reserved.Beginning in 2012, our consolidated joint venture, Nanjing JinMei Gallium Co., Ltd. (“JinMei”), is contractuallyobligated under an agency sales agreement to sell raw material on behalf of its equity investment entity. JinMei bills thecustomers and remits the receipts, net of its portions of sales commission, to this equity investment entity. For the yearsended December 31, 2018 and 2017, JinMei recorded $24,000 and $3,000 of income from agency sales, respectively, whichwere included in “Other (expense) income, net” in the consolidated statements of operations.In March 2012, our wholly-owned subsidiary, Beijing Tongmei Xtal Technology Co., Ltd. (“Tongmei”), enteredinto an operating lease for the land it owns with our consolidated joint venture, Beijing BoYu Semiconductor VesselCraftwork Technology Co., Ltd. (“BoYu”). The lease agreement for the land of approximately 22,081 square feet commencedon January 1, 2012 for a term of 10 years with annual lease payments of $24,000 subject to a 5% increase at each third yearanniversary. The annual lease payment is due by January 31 of each year.Tongmei has paid certain amounts on behalf of Donghai County Dongfang High Purity Electronic Materials Co.,Ltd. (“Dongfang”), its equity investment entity, to purchase materials. The original agreement was signed between Tongmeiand Dongfang in 2014 and the date of repayment was set as December 31, 2015. In 2015, both parties agreed to delay thedate of repayment to December 31, 2017. During 2017, the repayment of the full amount of principal and interest totaling$114,000 was received by our wholly owned subsidiary. In April 2014, Tongmei loaned an additional of $46,000 to Dongfang. The loan bears interest at 6.15% per annumand comes due on December 31, 2017. During 2017, the repayment of the full amount of principal and interest totaling$55,000 was received by our wholly owned subsidiary. Tongmei also purchases raw materials from Dongfang for production in the ordinary course of business. As ofDecember 31, 2018 and 2017, amount payable of $59,000 and $0, respectively, were included in “Accounts payable” in ourconsolidated balance sheets.Tongmei also purchases raw materials from one of our equity investment entities, Emei Shan Jiamei Materials Co.Ltd. (“Jiamei”), for production in the ordinary course of business. As of December 31, 2018 and 2017, amount payable of $0and $370,000, respectively, were included in “Accounts payable” in our consolidated balance sheets. Tongmei also purchases raw materials from one of our equity investment entities, Xilingol Tongli GermaniumRefine Co. Ltd. (“Tongli”), for production in the ordinary course of business. As of December 31, 2018 and 2017, amountpayable of $0 and $219,000, respectively, were included in “Accounts payable” in our consolidated balance sheets. In July 2017, Tongmei, provided an inter-company loan to JinMei in the amount of $768,000 in preparation for theacquisition of the land use rights and the construction of a new building. The inter-company loan carries an interest rateof 4.9% per annum. The principle is due in three installments between December 2021 and December 2023 while the interestis due in December of each year. During 2018, JinMei repaid principal and interest totaling $453,000 to Tongmei. As ofDecember 31, 2018, the remaining balance of principal and interest totaled $316,000. JinMei, is in the process of relocatingits headquarters and manufacturing operations to the city of Kazuo, located in the province of Liaoning near the InnerMongolia Autonomous Region, very near our own location. Currently, JinMei expects to invest approximately $2.5 to $3.5million related to the new facilities in 2019. In April 2016, our consolidated joint venture, BoYu, provided a personal loan of $177,000 to one of its executiveemployees. This loan is secured by the officer’s shares in BoYu. The loan bears interest at 2.75% per annum. Principal andaccrued interest are due on March 31, 2019. During the three months ended June 30, 2017, the repayment83 st Table of Contentsof the principal and interest totaling $180,000 was received by our consolidated joint venture. In November 2017, BoYuprovided another personal loan of $291,000 to the same executive employee. The loan bears interest at 2.75% per annum.Principal and accrued interest are due on November 30, 2020. As of December, 2018 and 2017, the balances, including bothprincipal and accrued interest, were $299,000 and $291,000, respectively, and included in “Other assets” and “Prepaidexpenses and other current assets”, respectively, in our consolidated balance sheets. On November 2, 2017, our consolidated joint venture, BoYu, raised additional capital in the amount of $2 millionin cash from a third-party investor through the issuance of shares equivalent to 10% ownership of BoYu. This third-partyinvestor is an immediate family member to the owner of one of BoYu's customers. For the years ended December 31, 2018and 2017, BoYu has recorded $1.5 million and $1.2 million in revenue from this customer, respectively. As of December 31,2018 and 2017, amounts receivable of $0 and $635,000, respectively, were included in “Accounts receivable” in ourconsolidated balance sheets. Our Related Party Transactions Policy seeks to prohibit all conflicts of interest in transactions between relatedparties and us, unless they have been approved by our Board of Directors. This policy applies to all of ouremployees, directors, and our consolidated subsidiaries. Our executive officers retain board seats on the Board of Directors ofthe companies in which we have invested in our China joint ventures. See Note 6 for further details.Note 5. Property, Plant and Equipment, NetThe components of our property, plant and equipment are summarized below (in thousands): December 31, December 31, 2018 2017 Property, plant and equipment: Machinery and equipment, at cost $51,496 $44,549 Less: accumulated depreciation and amortization (41,431) (40,845) Building, at cost 39,775 32,461 Less: accumulated depreciation and amortization (12,147) (11,501) Leasehold improvements, at cost 5,464 5,539 Less: accumulated depreciation and amortization (4,497) (4,288) Construction in progress 43,620 20,615 $82,280 $46,530 As of December 31, 2018, the balance of construction in progress was $43.6 million, of which $31.7 million wasrelated to our buildings in our new Dingxing and Chaoyang locations, $2.2 million was for manufacturing equipmentpurchases not yet placed in service and $9.7 million was from our construction in progress for our other consolidatedsubsidiaries. As of December 31, 2017, the balance of construction in progress was $20.6 million, of which, $14.8 millionwas for our buildings in our new Dingxing location, $3.6 million was for manufacturing equipment purchases not yet placedin service, and $2.2 million was for our construction in progress at our other consolidated subsidiaries.Depreciation and amortization expense was $4.9 million, $4.4 million and $4.9 million for the years ended 2018,2017 and 2016, respectively.Note 6. Investments in Privately-held CompaniesWe have made strategic investments in private companies located in China in order to gain access at a competitivecost to raw materials that are critical to our substrate business. We have six direct investments. Our consolidated subsidiarieshave also made investments in private companies. We have four indirect investments. These companies form part of ouroverall supply chain.84 Table of ContentsOur direct investments are summarized below (in thousands): Investment Balance as of December 31, December 31, Accounting Ownership Company 2018 2017 Method Percentage Beijing JiYa Semiconductor Material Co., Ltd. $3,331 $3,331 Consolidated 46%Nanjing JinMei Gallium Co., Ltd. 592 592 Consolidated 97%Beijing BoYu Semiconductor Vessel Craftwork TechnologyCo., Ltd. 1,346 1,346 Consolidated 63% $5,269 $5,269 Donghai County Dongfang High Purity Electronic MaterialsCo., Ltd. $1,416 $1,473 Equity 46%Xilingol Tongli Germanium Co. Ltd. 1,700 3,190 Equity 25%Emeishan Jia Mei High Purity Metals Co., Ltd. 842 915 Equity 25% $3,958 $5,578 Our ownership of JiYa is 46%. We continue to consolidate JiYa as we are the founding and largest shareholder, weappoint the general manager and controller and have the ability to exercise control in substance over the long-term strategicdecisions made. Our Chief Executive Officer is chairman of the JiYa board and we have appointed one other representative,Davis Zhang, to serve on the board. Mr. Zhang was an executive officer of AXT for 27 years. Further, our Chief FinancialOfficer, Gary Fischer, is on the board of supervisors of JiYa.Our ownership of JinMei is 97%. Before June 15, 2018, our ownership of JinMei was 83%. On June 15, 2018, wepurchased a 12% ownership interest from one of the minority owners for $1.4 million. The $1.4 million is scheduled to bepaid in two installments. On June 15, 2018, we paid the first installment of $163,000. The second installment of $1.2 millionis scheduled to be paid after the completion of the relocation of JinMei’s headquarters and manufacturing operations andwas included in “Accrued liabilities” in our consolidated balance sheets. As a result, our ownership of JinMei increased from83% to 95%. In September 2018, we purchased a 2% ownership interest from one of the three remaining minority owners for$252,000. As a result, our ownership of JinMei increased from 95% to 97%. We continue to consolidate JinMei as we have acontrolling financial interest and have majority control of the board. Our Chief Executive Officer is chairman of the JinMeiboard and we have appointed two other representatives to serve on the board.Our ownership of BoYu is 63%. On November 2, 2017, BoYu raised additional capital in the amount of $2 millionin cash from a third-party investor through the issuance of shares equivalent to 10% ownership of BoYu. As a result, ourownership of BoYu was diluted from 70% to 63%. We continue to consolidate BoYu as we have a controlling financialinterest and have majority control of the board and accordingly no gain was recognized as a result of this equitytransaction. Our Chief Executive Officer is chairman of the BoYu board and we have appointed two other representatives toserve on the board.Although we have representation on the boards of directors of each of these companies, the daily operations of eachof these companies are managed by local management and not by us. Decisions concerning their respective short- termstrategy and operations, ordinary course of business capital expenditures, and decisions concerning sales of finished product,are made by local management with regular guidance and input from us.During 2018, 2017 and 2016, the three consolidated joint ventures generated $5.5 million, $2.1 million and$0.1 million of income, respectively, of which an income of $1.4 million, a loss of $0.1 million and a loss of $0.7 million,respectively were allocated to noncontrolling interests, resulting in $4.1 million, $2.2 million and $0.8 million of income,respectively, to our net income.For AXT’s three direct minority investment entities that are not consolidated, the investment balances are includedin “Other assets” in our consolidated balance sheets and totaled $4.0 million and $5.6 million as of December85 Table of Contents31, 2018 and 2017, respectively. We own 46% of the ownership interests in one of these companies and 25% in each of theother two companies. These three companies are not considered variable interest entities because:·all three companies have sustainable businesses of their own;·our voting power is proportionate to our ownership interests;·we only recognize our respective share of the losses and/or residual returns generated by the companies if theyoccur; and·we do not have controlling financial interest in, do not maintain operational or management control of, do notcontrol the board of directors of, and are not required to provide additional investment or financial support to any ofthese companies.These three equity investment entities generated for AXT an equity loss of $1.6 million, $0.9 million and $1.2million for the year ended December 31, 2018, 2017 and 2016, respectively, which was recorded as “Equity in (loss) earningsof unconsolidated joint ventures” in the consolidated statements of operations.Net income recorded from all of the consolidated joint ventures and these three equity investment entities was $2.6million for the year ended December 31, 2018. Net income recorded from all of the consolidated joint ventures and thesethree equity investment entities was $1.3 million for the year ended December 31, 2017. Net loss recorded from all of theconsolidated joint ventures and these three equity investment entities was $0.4 million for the year ended December 31,2016.We also maintain four minority investments indirectly in privately-held companies through our consolidated jointventures. JiYa holds three investments and JinMei holds one investment. These minority investments are accounted for underthe equity method in the books of our consolidated joint ventures. As of December 31, 2018 and 2017, our consolidatedjoint ventures included these minority investments in “Other assets” in the consolidated balance sheets with a carrying valueof $4.5 million and $4.3 million, respectively.AXT’s three direct minority investment entities and the three minority investments of JiYa and the one minorityinvestment of JinMei are not consolidated and are accounted for under the equity method. Excluding one fully impairedentity, the equity entities had the following summarized income information (in thousands) for the years ended December 31,2018, 2017 and 2016, respectively: Our share for the Year Ended Year Ended December 31, December 31, 2018 20172016 2018 2017 2016 Net revenue $33,212 $24,053$23,266 $8,549 $6,152 $6,124 Gross profit (loss) 6,457 1,739 (2,191) 1,675 482 (511) Operating (loss) (3,152) (3,676) (6,869) (778) (938) (1,724) Net (loss) (4,750) (4,798) (7,428) (1,080) (1,381) (1,891) 86 Table of ContentsExcluding one fully impaired entity, these minority investment entities that are not consolidated, but rather areaccounted for under the equity method, had the following summarized balance sheet information (in thousands) asof December 31, 2018 and 2017, respectively: As of December 31, 2018 2017 Current assets $31,525 $33,415 Noncurrent assets 26,889 28,964 Current liabilities 24,670 27,274 Noncurrent liabilities 112 180 Our portion of the entity loss, excluding impairment charges, from all seven minority investment entities that are notconsolidated and are accounted for under the equity method were a loss of $1.1 million, $1.4 million, and $2.0 million forthe years ended December 31, 2018, 2017 and 2016, respectively. Dividends received from these minority investmententities were $0 for each of the years ended December 31, 2018, 2017 and 2016. Excluding one fully impaired entity,undistributed retained earnings relating to our investments in these minority investment entities amounted to $2.5 millionand $3.6 million as of December 31, 2018 and 2017, respectively.Note 7. Balance Sheets Details Other AssetsThe components of other assets are summarized below (in thousands): As of December 31, 2018 2017Equity method investments 8,422 9,849Value added tax receivable, long term 1,845 —Other intangible assets 1,048 1,148Other assets 672 576 $11,987 $11,573Accrued LiabilitiesThe components of accrued liabilities are summarized below (in thousands): As of December 31, 2018 2017 Accrued compensation and related charges 3,440 3,205 Preferred stock dividends payable 2,901 2,901 Payable in connection with constructions 2,912 — Payable in connection with repurchase of subsidiaries shares 1,147 — Deferred government grant income in connection with purchase of land 1,000 — Accrued professional services 706 583 Dividends payable by consolidated joint ventures 504 533 Advance from customers 476 924 Other tax payable 261 395 Accrued product warranty 236 133 Other personnel related costs 202 230 Accrued income taxes 99 270 Accrual for sales refund liabilities 47 — Current portion of royalty payments — 575 Other accrued liabilities 1,440 1,400 $15,371 $11,149 87 Table of ContentsNote 8. Bank Loans and Line of CreditIn September 2018, Tongmei entered into a credit facility with Industrial and Commercial Bank of China (“ICBC”)in China with a $2.9 million line of credit at an annual interest rate of approximately 0.04% over the current Loan Prime Ratepublished by ICBC. Accrued interest is calculated and paid monthly. The annual interest rate was approximately 4.4%. Thiscredit line is secured by Tongmei’s land-use right and all of its buildings located at its facility in Beijing. The primaryintended use of the credit facility is for general purposes, which may include working capital, capital expenditures and othercorporate expenses. In September 2018, we borrowed $291,000 against this credit line. The repayment of the full amount isdue in September 2019. On December 26, 2018, we repaid the principal of $291,000 and interest of $3,000 of this loan to thebank. This credit line was terminated in December 2018, after we repaid both principal and interest to ICBC. We havedecided to terminate this loan because we were able to secure a larger bank loan in the U.S. and our management believedthat to secure bank loans from the two new manufacturing sites have more strategic advantages as compared to have onesingle loan from Beijing. On November 6, 2018, the Company entered into the Credit Agreement, which established a $10 million securedrevolving line of credit with a $1.0 million letter of credit sublimit facility. The revolving credit facility is collateralized bysubstantially all of the assets of the Company located within the United States, subject to certain exceptions. Thecommitments under the Credit Agreement expire on November 30, 2020 and any loans thereunder will bear interest at a ratebased on the daily one-month LIBOR for the applicable interest period plus a margin of 2%. As of December 31, 2018, noloans or letters of credit were outstanding under the Credit Agreement. Note 9. Stockholders’ Equity and Stock Repurchase ProgramStockholders’ EquityThe 883,000 shares of $0.001 par value Series A preferred stock issued and outstanding as of December 31, 2018and 2017, valued at $3,532,000 are non-voting and non-convertible preferred stock with a 5.0% cumulative annual dividendrate payable when declared by the Board of Directors and $4 per share liquidation preference over common stock, and mustbe paid before any distribution is made to common stockholders. These preferred shares were issued to Lyte Optronics, Inc.stockholders in connection with the completion of our acquisition of Lyte Optronics, Inc. on May 28, 1999.Changes in AXT, Inc.’s ownership interest in consolidated subsidiaries.The effects of changes in the Company’s ownership interests in its less than 100% owned subsidiaries on theCompany’s equity are as follows: As of December 31, 2018 2017Net income attributable to AXT, Inc. $9,654 $10,148Changes in paid-in capital for: Sales of subsidiary shares to noncontrollling interest — 1,765Purchase of subsidiary shares from noncontrollling interest 187 —Net transfers to noncontrolling interests 187 1,765Net income attributable to AXT, Inc., net of transfers to noncontrolling interests $9,841 $11,913 Stock Repurchase ProgramOn February 21, 2013, our Board of Directors approved a stock repurchase program pursuant to which we mayrepurchase up to $6.0 million of our outstanding common stock through February 27, 2014. These purchases were to be madefrom time to time in the open market and were funded from our existing cash balances and cash generated from operations.During 2013, we repurchased approximately 285,000 shares at an average price of $2.51 per share for a total88 Table of Contentspurchase price of $716,000 under the stock repurchase program. As of December 31, 2013, approximately $5.3 millionremained available for future repurchases under this program. No shares were repurchased in 2014 under this program and theplan expired on February 27, 2014.On October 27, 2014, our Board of Directors approved a stock repurchase program pursuant to which we mayrepurchase up to $5.0 million of our outstanding common stock. These repurchases can be made from time to time in theopen market and are funded from our existing cash balances and cash generated from operations. During 2015, werepurchased approximately 908,000 shares at an average price of $2.52 per share for a total purchase price of approximately$2.3 million under the stock repurchase program. No shares were repurchased during 2018, 2017 and 2016 under thisprogram. As of December 31, 2018, approximately $2.7 million remained available for future repurchases under thisprogram. By the terms of the Series A preferred stock, so long as any shares of Series A preferred stock are outstanding, neitherthe Company nor any subsidiary of the Company shall redeem, repurchase or otherwise acquire any shares of common stock,unless all accrued dividends on the Series A preferred stock have been paid. During 2013 and 2015, we repurchased shares ofour outstanding common stock. As of December 31, 2015, the Series A preferred stock had cumulative dividends of $2.9million and we included this amount in “Accrued liabilities” in our consolidated balance sheets. In 2016, 2017 and 2018, wedid not repurchase any of our outstanding common stock. If we are required to pay the cumulative dividends on the Series Apreferred stock, our cash and cash equivalents would be reduced. We account for the cumulative year to date dividends onthe Series A preferred stock when calculating our earnings per share.Note 10. Employee Benefit Plans and Stock-based CompensationStock Option Plans and Equity Incentive PlansIn May 2007, our stockholders approved our 2007 Equity Incentive Plan (the “2007 Plan”), which provides for thegrant of incentive and non-qualified stock options to our employees, consultants and directors. The 2007 Plan is arestatement of the 1997 Stock Option Plan which expired in 2007. The 1,928,994 share reserve of the 1997 Stock OptionPlan became the reserve of the 2007 Plan, together with 1,300,000 additional shares approved for issuance under the 2007Plan. In May 2013, the stockholders approved an additional 2,000,000 shares to be issued under the 2007 plan. Awards maybe made under the 2007 Plan are stock options, stock appreciation rights, restricted stock, restricted stock units, performanceshares, performance units, deferred compensation awards and other stock‑based awards. Stock options and stock appreciationrights awarded under the 2007 Plan may not be repriced without stockholder approval. Stock options and stock appreciationrights may not be granted below fair market value. Stock options or stock appreciation rights generally shall not be fullyvested over a period of less than three years from the date of grant and cannot be exercised more than 10 years from the dateof grant. Restricted stock, restricted stock units, and performance awards generally shall not vest faster than over a three-yearperiod (or a twelve‑month period if vesting is based on a performance measure). In December 2008, the 2007 Plan wasamended to comply with the applicable requirements under Section 409A of the Internal Revenue Code.In May 2015, our stockholders approved our 2015 Equity Incentive Plan (the “2015 Plan”). The 2015 Plan is areplacement of the 2007 Plan. The 399,562 share reserve of the 2007 Plan became the reserve of the 2015 Plan, together with3,000,000 additional shares approved for issuance under the 2015 Plan. Awards that may be made under the 2015 Plan arestock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units,deferred compensation awards and other stock‑based awards. Stock options and stock appreciation rights awarded under the2015 Plan may not be repriced without stockholder approval. Stock options and stock appreciation rights may not be grantedbelow fair market value. Stock options or stock appreciation rights generally shall not be fully vested over a period of lessthan four years from the date of grant and cannot be exercised more than 10 years from the date of grant. Restricted stock,restricted stock units, and performance awards generally shall not vest faster than over a three-year period (or a twelve‑monthperiod if vesting is based on a performance measure). However, options granted to consultants and restricted stock awardsgranted to independent board members typically vest in one year and the 2015 Plan does allow for similar vesting toemployees. As of December 31, 2018, approximately 662,481 shares were available for grant under the 2015 Plan.89 Table of ContentsStock OptionsThe following table summarizes the stock option transactions for each of the years ended December 31, 2016, 2017and 2018 (in thousands, except per share data): Weighted average Weighted- Remaining Number of average Contractual Aggregate Options Exercise Life Intrinsic Stock Options Outstanding Price (in years) Value Balance as of January 1, 2016 3,779 $2.97 6.26 $764 Granted 624 4.92 Exercised (555) 2.41 Canceled and expired (554) 3.26 Balance as of December 31, 2016 3,294 $3.38 7.23 $5,301 Granted 184 8.99 Exercised (762) 3.25 Canceled and expired (50) 3.47 Balance as of December 31, 2017 2,666 $3.81 6.87 $13,149 Granted 246 5.77 Exercised (238) 2.64 Canceled and expired (20) 4.40 Balance as of December 31, 2018 2,654 $4.09 6.28 $2,720 Options vested as of December 31, 2018 and unvested options expectedto vest, net of forfeitures 2,626 $4.07 6.25 $2,718 Options exercisable as of December 31, 2018 1,863 $3.60 5.41 $2,314 The options outstanding and exercisable as of December 31, 2018 were in the following exercise price ranges (inthousands, except per share data): Options Vested and Options Outstanding as of Exercisable as of December 31, 2018 December 31, 2018 Weighted‑‑average Range of Weighted‑‑average Remaining Weighted‑‑Average Exercise Price Shares Exercise Price Contractual Life Shares Exercise Price $2.14-$2.14 21 $2.14 5.33 21 $2.14 $2.18-$2.18 593 $2.18 6.84 420 $2.18 $2.29-$2.36 374 $2.32 5.13 374 $2.32 $2.47-$2.91 378 $2.69 5.05 360 $2.69 $4.79-$4.79 129 $4.79 2.82 129 $4.79 $5.21-$5.21 487 $5.21 7.82 251 $5.21 $5.61-$5.77 325 $5.73 8.21 80 $5.61 $5.83-$7.82 163 $5.85 1.59 163 $5.85 $7.95-$7.95 60 $7.95 8.08 29 $7.95 $9.50-$9.50 124 $9.50 8.82 36 $9.50 2,654 $4.09 6.28 1,863 $$3.60 There were 238,000, 762,000 and 555,000 options exercised in the years ended December 31, 2018, 2017 and 2016,respectively. The total intrinsic value of options exercised for the years ended December 31, 2018, 2017 and 2016, was$666,000, $4,030,000 and $1,302,000, respectively.As of December 31, 2018, the unamortized compensation costs related to unvested stock options granted toemployees under our 2015 plan was approximately $1.6 million, net of estimated forfeitures of $167,000. These costs90 Table of Contentswill be amortized on a straight-line basis over a weighted-average period of approximately 2.3 years and will be adjusted forsubsequent changes in estimated forfeitures. We did not capitalize any stock‑based compensation to inventory as ofDecember 31, 2018 and 2017, due to the immateriality of the amount.Restricted Stock AwardsA summary of activity related to restricted stock awards for the years ended December 31, 2016, 2017 and 2018 ispresented below (in thousands, except per share data): Weighted-Average Grant Date Stock Awards Shares Fair Value Non-vested as of January 1, 2016 546 $2.39 Granted 136 $4.66 Vested (150) $2.34 Forfeited (207) $2.55 Non-vested as of December 31, 2016 325 $3.27 Granted 312 $9.15 Vested (157) $3.13 Forfeited — $ — Non-vested as of December 31, 2017 480 $7.13 Granted 344 $6.02 Vested (181) $6.04 Forfeited (10) $6.65 Non-vested as of December 31, 2018 633 $6.85 Total fair value of stock awards vested during the years ended December 31, 2018, 2017 and 2016 was $1.1 million,$490,000 and $351,000, respectively. As of December 31, 2018, we had $3.9 million of unrecognized compensation expenserelated to restricted stock awards, which will be recognized over the weighted average period of 1.8 years.Common StockThe following number of shares of common stock were reserved and available for future issuance as of December 31,2018 (in thousands, except per share data):Options outstanding 2,654 Restricted stock awards outstanding 633 Stock available for future grant: 2015 Equity Incentive Plan 662 Total 3,949 91 Table of ContentsStock-based CompensationWe recorded $1.9 million, $1.4 million and $1.1 million of stock‑based compensation in our consolidatedstatements of operations for the years ended December 31, 2018, 2017 and 2016, respectively. The following tablesummarizes compensation costs related to our stock‑based compensation awards (in thousands, except per share data): Year Ended December 31, 2018 2017 2016 Stock‑based compensation in the form of employee stock options andrestricted stock, included in: Cost of revenue $92 $39 $23 Selling, general and administrative 1,520 1,146 908 Research and development 313 220 165 Total stock-based compensation 1,925 1,405 1,096 Tax effect on stock-based compensation — — — Net effect on net income $1,925 $1,405 $1,096 Shares used in computing basic net income per share 39,049 37,444 32,139 Shares used in computing diluted net income per share 40,265 38,966 32,894 Effect on basic net income per share $(0.05) $(0.04) $(0.03) Effect on diluted net income per share $(0.05) $(0.04) $(0.03) We estimate the fair value of stock options using a Black‑Scholes valuation model. There were 246,000, 184,000and 624,000 stock options granted with a weighted-average grant date fair value of $2.74, $3.67 and $1.85 per share during2018, 2017 and 2016, respectively. The fair value of options granted was estimated at the date of grant using the followingweighted‑average assumptions: Year Ended December 31, 2018 2017 2016 Expected term (in years) 5.8 5.8 4.0 Volatility 46.6% 46.5% 46.5% Expected dividend —% —% —% Risk-free interest rate 3.09% 2.10% 1.47% The expected term for stock options is based on the observed historical option exercise behavior and post-vestingforfeitures of options by our employees, and the contractual term, the vesting period and the expected term of theoutstanding options. Expected volatility is based on the historical volatility of our common stock. The dividend yield ofzero is based on the fact that we have never paid cash dividends and have no present intention to pay cash dividends. Therisk-free interest rates are taken from the Daily Federal Yield Curve Rates as of the grant dates as published by the FederalReserve and represent the yields on actively traded Treasury securities for terms equal to the expected term of the options.Retirement Savings PlanWe have a 401(k) Savings Plan (“Savings Plan”) which qualifies as a thrift plan under Section 401(k) of the InternalRevenue Code. All full-time U.S. employees are eligible to participate in the Savings Plan after 90 days from the date of hire.Employees may elect to reduce their current compensation by up to the statutory prescribed annual limit and have theamount of such reduction contributed to the 401(k) Plan. We provide matching to employee contributions up to 4% of theemployees’ base pay if employees contribute at least 6% of their base pay. If the contribution rate is less than 6% of the basepay, the matching percentage is prorated. Our contributions to the Savings Plan were $180,000, $149,000 and $133,000 forthe years ended December 31, 2018, 2017 and 2016, respectively.92 Table of ContentsNote 11. GuaranteesIndemnification AgreementsWe have entered into indemnification agreements with our directors and officers that require us to indemnify ourdirectors and officers against liabilities that may arise by reason of their status or service as directors or officers, other thanliabilities arising from willful misconduct of a culpable nature; to advance their expenses incurred as a result of anyproceeding against them as to which they could be indemnified; and to obtain directors’ and officers’ insurance if availableon reasonable terms, which we currently have in place.Product WarrantyWe provide warranties for our products for a specific period of time, generally twelve months, against materialdefects. We provide for the estimated future costs of warranty obligations in cost of sales when the related revenue isrecognized. The accrued warranty costs represent the best estimate at the time of sale of the total costs that we expect to incurto repair or replace product parts that fail while still under warranty. The amount of accrued estimated warranty costs areprimarily based on historical experience as to product failures as well as current information on repair costs. On a quarterlybasis, we review the accrued balances and update the historical warranty cost trends. The following table reflects the changein our warranty accrual which is included in “Accrued liabilities” on the consolidated balance sheets, during 2018 and 2017(in thousands): Year Ended December 31, 2018 2017 Beginning accrued product warranty $133 $251 Accruals for warranties issued 289 125 Adjustments related to pre-existing warranties including expirations and changes in estimates 87 (150) Cost of warranty repair (273) (93) Ending accrued product warranty $236 $133 93 Table of ContentsNote 12. Income TaxesConsolidated income before provision for income taxes includes non-U.S. income of approximately $6.5 million,$6.4 million and $15.0 million for the years ended December 31, 2018, 2017 and 2016, respectively. We recorded a currenttax provision of $938,000, $792,000 and $733,000 for the years ended December 31, 2018, 2017 and 2016, respectively.The components of the provision for income taxes are summarized below (in thousands): Year EndedDecember 31, 2018 2017 2016 Current: Federal $— $— $— State 5 2 4 Foreign 933 790 729 Total current 938 792 733 Deferred: Federal — — — State — — — Total deferred — — — Total provision for income taxes $938 $792 $733 A reconciliation of the effective income tax rates and the U.S. statutory federal income tax rate is summarized below: Year Ended December 31, 2018 2017 2016 Statutory federal income tax rate 21.0% 35.0% 35.0% State income taxes, net of federal tax benefits — — — Valuation allowance (2.6) (139.5) (7.1) Rate change — 100.8 — Stock-based compensation 0.3 (10.4) 1.2 Foreign tax rate differential (11.4) (10.3) (12.2) Foreign tax incentives (2.9) (7.0) (13.6) Dividend from unconsolidated affiliates — — 1.5 Foreign income inclusion 2.6 55.6 — Section 78 gross up — 11.7 — Foreign tax credit — (30.6) — Tax effect in equity method loss or gain from unconsolidated affiliates 3.2 2.9 8.3 Foreign-derived intangible income (2.4) — — Other 0.1 (0.9) (0.2) Effective tax rate 7.9% 7.3% 12.9% 94 Table of ContentsDeferred tax assets and liabilities are summarized below (in thousands): As of December 31, 2018 2017 Deferred tax assets: Net operating loss $15,735 $14,203 Accruals and reserves not yet deductible 2,100 3,133 Credits 1,685 4,809 19,520 22,145 Deferred tax liabilities: Valuation of investment portfolio — — — — Net deferred tax assets 19,520 22,145 Valuation allowance (19,520) (22,145) Net deferred tax assets $— $— As of December 31, 2018, we have federal and state net operating loss (“NOL”) carryforwards of approximately$64.3 million and $0.3 million, respectively, which will expire beginning in 2022 and 2033, respectively. In addition, wehave federal tax credit carryforwards of approximately $1.7 million, which will expire beginning in 2027.The deferred tax assets valuation allowance as of December 31, 2018 is attributed to U.S. federal, and state deferredtax assets, which result primarily from future deductible accruals, reserves, NOL carryforwards, and tax credit carryforwards.We believe that, based on a number of factors, the available objective evidence creates sufficient uncertainty regarding therealizability of the deferred tax assets such that a full valuation allowance has been recorded. These factors include ourhistory of losses related to domestic operations, and the lack of carryback capacity to realize deferred tax assets. Thevaluation allowance decreased by $2.6 million and $46.3 million for the years ended December 31, 2018 and 2017,respectively, whereas the valuation allowance increased by $2.7 million for the year ended December 31, 2016.The China Enterprise Income Tax Law (“EIT”) imposes a single uniform income tax rate of 25% on all Chineseenterprises. Our subsidiaries in China have qualified for a preferential 15% tax rate that is available for High and NewTechnology Enterprises (“HTE”). In order to retain the preferential tax rate, we must meet certain operating conditions,satisfy certain product requirements, meet certain headcount requirements and maintain certain levels of researchexpenditures. We realized benefits from this 10% reduction in tax rate of $764,000, $599,000 and $489,000 for 2018, 2017and 2016, respectively. As of December 31, 2018, the favorable tax rate is still valid for the Company and it will stay thesame for next year if there is no change of the business nature. The preferential tax rate that we enjoy could be modified ordiscontinued altogether at any time, which could materially and adversely affect our financial condition and results ofoperations.Our subsidiaries in China also qualify for reduction in their taxable income in China for research and development(“R&D”) expenditures. Government pre-approval is required to claim R&D tax benefits. Any R&D claim is then submittedwith the annual corporate income tax for the taxing authorities’ approval. We do not record such benefit until we receive therefund from the Chinese government. Our consolidated subsidiaries in China have enjoyed various tax holidays since 2000. Benefits under the tax holidays vary by jurisdiction.Utilization of the NOL and R&D credit carryforwards may be subject to a substantial annual limitation due toownership changes that might have occurred previously or that could occur in the future, as provided by Section 382 of theInternal Revenue Code of 1986 (“Section 382”), as well as similar state provisions. Ownership changes may limit the amountof NOL and tax credit carryforwards that can be utilized to offset future taxable income and tax, respectively. In general, anownership change, as defined by Section 382, results from transactions increasing the ownership of certain shareholders orpublic groups in the stock of a corporation by more than 50 percentage points over a three-year period. If there is a change ofcontrol, utilization of our NOL or tax credit carryforwards would be subject to an annual limitation under Section 382. Anylimitation may result in expiration of a portion of the NOL or research and development credit95 Table of Contentscarryforwards before utilization. Subsequent ownership changes could further impact the limitation in future years. Until aSection 382 study is completed and any limitation known, no amounts are being presented as an uncertain tax position. Afull valuation allowance has been provided against our NOL carryforwards and R&D credit carryforwards and, if anadjustment is required, this adjustment would be offset by an adjustment to the valuation allowance. Thus, there would be nonet impact to the consolidated balance sheets or statements of operations if an adjustment were required.We have completed the accounting associated with the December 22, 2017 enactment of the Tax Reform. The SEChad provided accounting and reporting guidance that allowed us to report provisional amounts within a measurement periodup to one year from the enactment date. Complexities inherent in adopting the changes included additional guidance,interpretations of the law, and further analysis of data and tax positions. During 2018, we trued up approximately $3.1million foreign tax credit related to the Tax Reform, due to the deferred tax assets are all under full valuation allowance, thetrue up has no direct tax impact.During fiscal year 2018, 2017 and 2016, the amount of gross unrecognized tax benefits remains unchanged. Thetotal amount of unrecognized tax benefits was $14.6 million as of December 31, 2018 and 2017. The Company recognizesinterest and penalties related to uncertain tax positions as part of the provision for income taxes. To date, such interest andpenalties have not been material. We comply with the laws, regulations, and filing requirements of all jurisdictions in which we conduct business. Weregularly engage in discussions and negotiations with tax authorities regarding tax matters in various jurisdictions.We file income tax returns in the U.S. federal, various states and foreign jurisdictions. Currently, there is no tax auditin any of the jurisdictions and we do not expect there will be any significant change to this.A reconciliation of the beginning and ending amount of the gross unrecognized tax benefits is as follows (inthousands): Year Ended December 31, 2018 2017 2016 Gross unrecognized tax benefits balance at beginning of the year $ 14,557 $ 14,557 $ 14,557 Add: Additions based on tax positions related to the current year — — — Additions for tax positions of prior years — — — Less: Decrease related to lapse of statute of limitations — — — Gross unrecognized tax benefits balance at end of the year $ 14,557 $ 14,557 $ 14,557 Excluding the effects of recorded valuation allowances for deferred tax assets, $14.6 million of the unrecognized taxbenefit would favorably impact the effective tax rate in future periods if recognized. Note 13. Net Income (Loss) per ShareBasic net income (loss) per share is computed using the weighted average number of common shares outstandingduring the periods less shares of common stock subject to repurchase and non-vested stock awards. Diluted net income (loss)per share is computed using the weighted average number of common shares outstanding and potentially dilutive commonshares outstanding during the periods. The dilutive effect of outstanding stock options and restricted stock awards isreflected in diluted earnings per share by application of the treasury stock method. Potentially dilutive common sharesconsist of common shares issuable upon the exercise of stock options. Potentially dilutive common shares are excluded innet loss periods, as their effect would be anti-dilutive.96 Table of ContentsA reconciliation of the numerators and denominators of the basic and diluted net income (loss) per sharecalculations is as follows (in thousands, except per share data): Year ended December 31, 2018 2017 2016 Numerator: Net income attributable to AXT, Inc. $9,654 $10,148 $5,636 Less: Preferred stock dividends (177) (177) (177) Net income available to common stockholders $9,477 $9,971 $5,459 Denominator: Denominator for basic net income per share - weighted-average commonshares 39,049 37,444 32,139 Effect of dilutive securities: Common stock options 1,106 1,339 596 Restricted stock awards 110 183 159 Denominator for dilutive net income per common shares 40,265 38,966 32,894 Basic net income per share: Net income attributable to AXT, Inc. $0.24 $0.27 $0.17 Net income to common stockholders $0.24 $0.27 $0.17 Diluted net income per share: Net income attributable to AXT, Inc. $0.24 $0.26 $0.17 Net income to common stockholders $0.24 $0.26 $0.17 Options excluded from diluted net income per share as the impact is anti-dilutive 266 86 779 Restricted stock excluded from diluted net income per share as the impact is anti-dilutive 227 63 15 Note 14. Segment Information and Foreign OperationsSegment InformationWe operate in one segment for the design, development, manufacture and distribution of high-performancecompound and single element semiconductor substrates and sale of raw materials integral to these substrates. In accordancewith ASC topic 280, Segment Reporting, our chief operating decision‑maker has been identified as the Chief ExecutiveOfficer, who reviews operating results to make decisions about allocating resources and assessing performance for theCompany. Since we operate in one segment, all financial segment and product line information can be found in theconsolidated financial statements.Product InformationThe following table represents revenue amounts (in thousands) by product type: Year Ended December 31, 2018 2017 2016 Product Type: Substrates$81,008 $78,619 $65,633 Raw Materials and Others 21,389 20,054 15,716 Total$102,397 $98,673 $81,349 97 Table of ContentsGeographical InformationThe following table represents revenue amounts (in thousands) reported for products shipped to customers in thecorresponding geographic region: Year Ended December 31, 2018 2017 2016 Geographical region: China $31,492 $24,962 $17,448 Europe (primarily Germany) 22,013 23,956 18,637 Taiwan 20,078 18,279 15,369 Japan 10,305 13,258 11,015 North America (primarily the United States) 10,021 8,352 8,084 Asia Pacific (excluding China, Taiwan and Japan) 8,488 9,866 10,796 Total $102,397 $98,673 $81,349 Long-lived assets consist primarily of property, plant and equipment, and are attributed to the geographic locationin which they are located. Long-lived assets, net of depreciation, by geographic region were as follows (in thousands): As of December 31, 2018 2017 Long-lived assets by geographic region, net of depreciation: North America$445 $1,410 China 81,835 45,120 $82,280 $46,530 Note 15. Other (expense) incomeThe components of other (expense) income are summarized below (in thousands): Year Ended December 31, 2018 2017 2016Foreign exchange gain (loss) $165 $(602) $232Gain on available-for-sales securities — 77 429Other income (expense) 187 (28) 199 $352 $(553) $860 Note 16. Commitments and ContingenciesLegal ProceedingsFrom time to time we may be involved in judicial or administrative proceedings concerning matters arising in theordinary course of business. We do not expect that any of these matters, individually or in the aggregate, will have a materialadverse effect on our business, financial condition, cash flows or results of operations.98 Table of ContentsLeasesWe lease certain office space, warehouse facilities and equipment under long-term operating leases expiring atvarious dates through December 2025. The majority of our lease obligations relates to our lease agreement for the facility inFremont, California with approximately 19,467 square feet which expires in 2020. Total rent expense under these operatingleases were $319,000, $302,000 and $331,000 for the years ended December 31, 2018, 2017 and 2016, respectively. Totalminimum lease payments under these leases as of December 31, 2018 are summarized below (in thousands): Lease Payments 2019 $198 2020 161 2021 9 2022 6 $374 Royalty AgreementWe entered into a royalty agreement with a competitor effective December 3, 2010 with a term of eight years,terminating December 31, 2018. We and our related companies are granted a worldwide, nonexclusive, royalty bearing,irrevocable license to certain patents for the term on the agreement. We shall pay up to $7.0 million royalty payment overeight years that began in 2011 based on future royalty bearing sales. This agreement contains a clause that allows us to claima credit, starting in 2013, in the event that the royalty bearing sales for the year is lower than a pre-determined amount setforth in this agreement. For the year ended December 31, 2018, royalty expense under this agreement was $565,000, whichwas net of claim for credit of $10,000. Royalty expense for year ended December 31, 2017 was $526,000, which was net ofclaim for credit of $49,000. Royalty expense under this agreement was $447,000, which was net of claim for credit of$128,000 for the year ended December 31, 2016. These expenses were included in cost of revenue. Sumitomo has asked thatwe renew this license and the need to do so is under review.Land Purchase and Investment Agreement We are in the process of relocating our gallium arsenide production line to Dingxing, China. In addition to a landrights and building purchase agreement that we entered into with a private real estate development company to acquire ournew manufacturing facility, we also entered into a cooperation agreement with the Dingxing local government. In additionto pledging its full support and cooperation, the Dingxing local government will issue certain credits or rebates to us as weachieve certain milestones. We, in turn, agreed to hire local workers over time, pay taxes when due and eventuallydemonstrate a total investment of approximately $90 million in value, assets and capital. The investment will include cashpaid for the land and buildings, cash on deposit in our name at local banks, the gross value of new and used equipment(including future equipment that might be used for indium phosphide and germanium substrates production), the deemedvalue for our customer list or the end user of our substrates (for example, the end users of the 3-D sensing VCSELs), a deemedvalue for employment of local citizens, a deemed value for our proprietary process technology, other intellectual property,other intangibles and additional items of value. There is no timeline or deadline by which this must be accomplished, ratherit is a good faith covenant entered into between AXT and the Dingxing local government. Further, there is no specificpenalty contemplated if either party breaches the agreement, however the agreement does state that each party has a right toseek from the other party compensation for losses. Under certain conditions, the Dingxing local government may purchasethe land and building at the appraised value. We believe that such cooperation agreements are normal, customary and usualin China and that the future valuation is flexible. We have a similar agreement with the city of Kazuo, China, although on asmaller scale. The total investment targeted by AXT in Kazuo is approximately $15 million in value, assets and capital. 99 Table of ContentsNote 17. Unaudited Quarterly Consolidated Financial Data Quarter First Second Third Fourth (in thousands, except per share data) 2018: Revenue $24,419 $27,120 $28,626 $22,232 Gross profit 9,573 11,010 10,614 5,850 Net income (loss) attributable to AXT, Inc 2,875 3,901 3,939 (1,061) Net income (loss) attributable to AXT, Inc per share, basic $0.07 $0.10 $0.10 $(0.03) Net income (loss) attributable to AXT, Inc per share, diluted $0.07 $0.10 $0.10 $(0.03) 2017: Revenue $20,616 $23,557 $28,168 $26,332 Gross profit 6,288 7,256 11,133 9,798 Net income attributable to AXT, Inc 665 1,930 4,419 3,134 Net (loss) attributable to AXT, Inc per share, basic $0.02 $0.05 $0.11 $0.08 Net (loss) attributable to AXT, Inc per share, diluted $0.02 $0.05 $0.11 $0.08 Note 18. Restructuring ChargesIn the second quarter of 2016, we restructured the operations of JiYa which resulted in a reduction in force of 28positions that were no longer required to support production and operations. Accordingly, we recorded a restructuring chargeof approximately $226,000 related to the reduction in force for severance-related expenses. As of June 30, 2016, we hadcompleted this restructuring plan and the reduction in force. We did not have any restructuring charges in 2018 and 2017.Item 16. Form 10-K SummaryNot applicable.100 Table of ContentsAXT, Inc.EXHIBITSTOFORM 10-K ANNUAL REPORTFor the Year Ended December 31, 2018ExhibitNumber Description3.1(1) Restated Certificate of Incorporation3.2(2) Certificate of Amendment of Certificate of Incorporation3.3(3) Certificate of Amendment to the Restated Certificate of Incorporation3.4(4) Certificate of Designation, Preferences and Rights of Series A Preferred Stock (which is incorporated hereinby reference to Exhibit 2.1 to the registrant’s form 8-K dated May 28, 1999).3.5(5) Second Amended and Restated By Laws3.6(6) Amended and Restated Section 5.1 of Article V of the Second Amended and Restated Bylaws of AXT, Inc.3.7(7) Certificate of Amendment to By Laws10.1(8)* Form of Indemnification Agreement for directors and officers10.3(9)** 6-inch Supply Agreement dated December 31, 2008 between AXT, Inc. and IQE plc10.4(10)** 4-inch Supply Agreement dated December 31, 2008 between AXT, Inc. and IQE plc10.5(11)* 2007 Equity Incentive Plan (amended December 8, 2008)10.6(12)* Forms of agreements under the 2007 Equity Incentive Plan10.7(13)* Amended and Restated Employment Offer Letter between the Company and Dr. Morris S. Young datedDecember 4, 201210.8(14)* Employment Letter Agreement between the Company and Mr. Gary L. Fischer10.9(15)* 2015 Equity Incentive Plan10.10(16)* Executive Incentive Plan10.11(17)* Credit Agreement, dated as of November 2, 2018, by and between AXT, Inc. and Wells Fargo Bank, NationalAssociation12.1 Computation of Ratio of Earnings to Fixed Charges21.1 List of Subsidiaries23.1 Consent of Independent Registered Public Accounting Firm, BPM LLP24.1 Power of Attorney (see signature page)31.1 Certification by principal executive officer pursuant to Section 302 of the Sarbanes‑Oxley Act of 200231.2 Certification by principal financial officer pursuant to Section 302 of the Sarbanes‑Oxley Act of 200232.1 Certification by Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant toSection 906 of the Sarbanes‑Oxley Act of 200232.2 Certification by Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant toSection 906 of the Sarbanes‑Oxley Act of 2002101.INS XBRL Instance.101.SCH XBRL Taxonomy Extension Schema.101.CAL XBRL Taxonomy Extension Calculation Linkbase.101.DEF XBRL Taxonomy Extension Definition Linkbase.101.LAB XBRL Taxonomy Extension Label Linkbase.101.PRE XBRL Taxonomy Extension Presentation Linkbase. (1)Incorporated by reference to exhibit 3.1 to registrant’s Form 10-K filed with the SEC on March 31, 1999.(2)Incorporated by reference to exhibit 3.1 to registrant’s Form 10-Q filed with the SEC on August 14, 2000.(3)Incorporated by reference to exhibit 3.4 to registrant’s Form 10-Q filed with SEC on August 5, 2004.101 Table of Contents(4)Incorporated by reference to exhibit 3.1 to registrant’s Form 8-K filed with the SEC on June 14, 1999.(5)Incorporated by reference to exhibit 3.4 to registrant’s Form 8-K filed with the SEC on May 30, 2001.(6)Incorporated by reference to exhibit 99.2 to registrant’s Form 8-K filed with the SEC on August 1, 2007.(7)Incorporated by reference to exhibit 3.1 to registrant’s Form 8-K filed with the SEC on October 26, 2010.(8)Incorporated by reference to exhibit 10.1 to registrant’s Form 8-K filed with the SEC on October 31, 2014.(9)Incorporated by reference to exhibit 10.29 to registrant’s Form 8-K filed with the SEC on January 5, 2009.(10)Incorporated by reference to exhibit 10.30 to registrant’s Form 8-K filed with the SEC on January 5, 2009.(11)Incorporated by reference to exhibit 10.31 to registrant’s Form 10-K filed with the SEC on March 31, 2009.(12)Incorporated by reference to exhibit 10.20 to registrant’s Form 10-K filed with the SEC on March 22, 2010.(13)Incorporated by reference to exhibit 10.1 to registrant’s Form 8-K filed with the SEC on December 4, 2012.(14)Incorporated by reference to exhibit 10.1 to registrant’s Form 8-K filed with the SEC on August 12, 2014.(15)Incorporated by reference to appendix A to the registrant’s Definitive Proxy Statement on Schedule 14A filed with the SEC on April 8,2015.(16)Incorporated by reference to exhibit 10.1 to registrant’s Form 8-K filed with the SEC on February 26, 2016.(17)Incorporated by reference to exhibit 10.1 registrant’s Form 8-K filed with the SEC on November 9, 2018. *Management contract or compensatory plan.**Confidential treatment has been requested of the SEC for portions of the exhibit.102 Table of Contents SIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereto duly authorized. AXT, Inc. By:/s/ GARY L. FISCHER Chief Financial Officer and Corporate Secretary(Principal Financial Officer) Date: March 11, 2019POWER OF ATTORNEYKNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutesand appoints Morris S. Young and Gary L. Fischer, and each of them, his true and lawful attorney-in-fact and agent, with fullpower of substitution, each with power to act alone, to sign and execute on behalf of the undersigned any and allamendments to this Report on Form 10-K, and to perform any acts necessary in order to file the same, with all exhibits theretoand other documents in connection therewith with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requested and necessary to be done inconnection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirmingall that said attorney-in-fact and agent, or their or his or her substitutes, shall do or cause to be done by virtue hereof.Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on the dates indicated.Signature Title Date /s/ MORRIS S. YOUNG Chief Executive Officer and Director March 11, 2019Morris S. Young (Principal Executive Officer) /s/ GARY L. FISCHER Chief Financial Officer and Corporate Secretary March 11, 2019Gary L. Fischer (Principal Financial Officer andPrincipal Accounting Officer) /s/ JESSE CHEN Chairman of the Board of Directors March 11, 2019Jesse Chen /s/ DAVID C. CHANG Director March 11, 2019David C. Chang /s/ LEONARD LEBLANC Director March 11, 2019Leonard LeBlanc 103 Exhibit 12.1 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES Year Ended December 31, 2018 2017 2016 2015 2014 (in thousands) Earnings: Income (loss) before income taxes$11,947$10,853$5,699$(2,002)$(482) Less: Equity in loss (earnings) of investees 1,080 1,694 1,995 (462) (1,528) Less: Pre-tax net (income) loss attributable to noncontrolling interest (1,355) 87 670 305 (691) Add: Distributions paid by equity investees - - - 305 327 Fixed charges and preferred stock dividends, as calculated below 283 278 287 281 264 Total earnings$11,955$12,912$8,651$(1,573)$(2,110) Computation of fixed charges and preferred stock dividends: Interest expense$ $ -$ -$ -$ - Preferred stock dividends 177 177 177 177 177 Interest component of rent expense 106 101 110 104 87 Total combined fixed charges and preferred stock dividends$283$278$287$281$264 Ratio of earnings to combined fixed charges and preferred stock dividends42.2446.4530.14 N/A N/A Deficiency of earnings to combined fixed charges and preferred stock dividends N/A N/A N/A (1,854) (2,374) (1)Dividends accrue on our outstanding Series A preferred stock at the rate of $0.20 per annum per share of Series A preferred stock. Wehave not paid any dividends on preferred stock. 883,000 shares of our preferred stock were issued and outstanding for all of theperiods presented.(2)Represents one-third of total rent expense which we believe is a reasonable estimate of the interest component of rent expense. Interestcomponent of rental expense is estimated based on interest on tenant improvement loan at 4%, which is considered a reasonableapproximation of the interest factor. In 2010, the full amount of the tenant improvement was paid off.(3)For periods in which there is a deficiency of earnings available to cover combined fixed charges and preferred stock dividends, theratio information is not applicable. (3)(1)(2) Exhibit 21.1Subsidiaries of the Registrant OwnershipName PercentageBeijing Tongmei Xtal Technology 100Beijing Ji Ya Semiconductor Material Co., Ltd * 46Nanjing Jin Mei Gallium Co., Ltd** 97Beijing BoYu Manufacturing Co., Ltd*** 63 * AXT’s ownership of this subsidiary was 51% at inception, reduced to 46% at December 31, 2005 as 5% ownershipwas given to JiYa’s management upon fulfillment of certain conditions. AXT continues to consolidate JiYa as weare the founding and largest shareholder, we appoint the general manager and controller and have the ability toexercise control in substance over the long-term strategic decisions made. Our Chief Executive Officer is chairmanof the JiYa board and we have appointed one other representative, Davis Zhang, to serve on the board. Mr. Zhangwas an executive officer of AXT for 27 years. Further, our Chief Financial Officer, Gary Fischer, is on the board ofsupervisors of JiYa. **AXT’s ownership of this subsidiary was 83%. On June 15, 2018, we purchased a 12% ownership interest from oneof the minority owners for $1.4 million. The $1.4 million is scheduled to be paid in two installments. On June 15,2018, we paid the first installment of $163,000. The second installment of $1.2 million is scheduled to be paid afterthe completion of the relocation of JinMei’s headquarters and manufacturing operations and was included in“Accrued liabilities” in our condensed consolidated balance sheets. As a result, our ownership of JinMei increasedfrom 83% to 95%. In September 2018, we purchased a 2% ownership interest from one of the three remainingminority owners for $252,000. As a result, our ownership of JinMei increased from 95% to 97%. AXT continue toconsolidate JinMei as we have a controlling financial interest and have majority control of the board. Our ChiefExecutive Officer is chairman of the JinMei board and we have appointed two other representatives to serve on theboard. *** AXT’s ownership of this subsidiary was 70% at inception. On November 2, 2017, BoYu, raised additionalcapital in the amount of $2 million in cash from a third-party investor through the issuance of shares equivalent to10% ownership of BoYu. As a result, our ownership of BoYu was diluted from 70% to 63%. AXT continues toconsolidate BoYu as we have a controlling financial interest and have majority control of the board and,accordingly, no gain was recognized as a result of this equity transaction. Our Chief Executive Officer is chairmanof the BoYu board and we have appointed two other representatives to serve on the board. Exhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (No. 333-214211)and Form S-8 (Nos. 333-38858, 333-67297, 333-143366, 333-188788 and 333-204478) of AXT, Inc. of our reportsdated March 11, 2019 relating to the consolidated financial statements and the effectiveness of internal control overfinancial reporting as of December 31, 2018, which appear in this Form 10-K. /s/ BPM LLPSan Jose, CaliforniaMarch 11, 2019 Exhibit 31.1CERTIFICATION PURSUANT TO 18 U.S.C. RULE 13a-14(a)/15d-14(a)AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES‑OXLEY ACT OF 2002I, Morris S. Young, certify that:1.I have reviewed this annual report on Form 10-K of AXT, Inc.;2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this report;3.Based on my knowledge, the financial statements, and other financial information included in this report, fairlypresent in all material respects, the financial condition, results of operations and cash flows of the registrant as of,and for, the periods presented in this report;4.The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controlsand procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financialreporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designedunder our supervision, to ensure that material information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularly during the period in which this reportis being prepared;(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting tobe designed under our supervision, to provide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordance with generally accepted accountingprinciples;(c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report ourconclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered bythis report based on such evaluation; and(d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred duringthe registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that hasmaterially affected, or is reasonably likely to materially affect, the registrant’s internal control over financialreporting; and5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internalcontrol over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board ofdirectors (or persons performing the equivalent functions):(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financialreporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize andreport financial information; and(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in theregistrant’s internal control over financial reporting.March 11, 2019/s/ MORRIS S. YOUNG Morris S. Young Chief Executive Officer (Principal Executive Officer) Exhibit 31.2CERTIFICATION PURSUANT TO 18 U.S.C. RULE 13a-14(a)/15d-14(a)AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES‑OXLEY ACT OF 2002I, Gary L. Fischer, certify that:1.I have reviewed this annual report on Form 10-K of AXT, Inc.;2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material factnecessary to make the statements made, in light of the circumstances under which such statements were made, not misleadingwith respect to the period covered by this report;3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in allmaterial respects, the financial condition, results of operations and cash flows of the registrant as of, and for, the periodspresented in this report;4.The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as definedin Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period in which this report is being prepared;(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designedunder our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generally accepted accounting principles;(c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusionsabout the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based onsuch evaluation; and(d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during theregistrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materiallyaffected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control overfinancial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or personsperforming the equivalent functions):(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reportingwhich are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financialinformation; and(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’sinternal control over financial reporting.March 11, 2019/s/ GARY L. FISCHER Gary L. Fischer Chief Financial Officer and Corporate Secretary (Principal Financial Officer and Principal Accounting Officer) Exhibit 32.1CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES‑OXLEY ACT OF 2002In connection with the Annual Report of AXT, Inc. (the “Company”) on Form 10-K for the year ended December 31,2018 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned herebycertifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes‑Oxley Act of 2002, that, tothe best of my knowledge:(1)The Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934(15 U.S.C. 78m); and(2)The information contained in the Report fairly presents, in all material respects, the financial conditionand results of operations of the Company.Date: March 11, 2019By:/s/ Morris S. Young Morris S. Young Chief Executive Officer (Principal Executive Officer) Exhibit 32.2CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES‑OXLEY ACT OF 2002In connection with the Annual Report of AXT, Inc. (the “Company”) on Form 10-K for the year ended December 31,2018 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned herebycertifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes‑Oxley Act of 2002, that, tothe best of my knowledge:(1)The Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934(15 U.S.C. 78m); and(2)The information contained in the Report fairly presents, in all material respects, the financial conditionand results of operations of the Company.Date: March 11, 2019By:/s/ Gary L. Fischer Gary L. Fischer Chief Financial Officer and Corporate Secretary (Principal Financial Officer and Principal Accounting Officer)
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