UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-Q

(Mark One)

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

for the quarterly period ended September 30, 2013

Or

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

for the transition period from                 to

Commission File Number 000-24085



AXT, INC.
(Exact name of registrant as specified in its charter)

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

4281 Technology Drive, Fremont, California 94538
(Address of principal executive offices) (Zip code)

(510) 683-5900
(Registrant’s telephone number, including area code)
 


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during 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 requirements for the past 90 days.  Yes x No o

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

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

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

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

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

Class
 
Outstanding at November 2, 2013
Common Stock, $0.001 par value
 
32,598,197
 


AXT, INC.
FORM 10-Q
TABLE OF CONTENTS

 
Page
PART I. FINANCIAL INFORMATION
2
2
2
3
4
5
6
20
32
34
PART II. OTHER INFORMATION
34
34
Item 1A. Risk Factors
34
47
48
48
48
Item 6. Exhibits
48
49

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)

AXT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except per share data)

 
 
September 30,
   
December 31,
 
 
 
2013
   
2012 (1)
 
ASSETS
 
   
 
Current assets:
 
   
 
Cash and cash equivalents
 
$
27,723
   
$
30,634
 
Short-term investments
   
8,412
     
10,270
 
Accounts receivable, net of allowances of $928 and $245 as of September 30, 2013 and December 31, 2012, respectively
   
16,266
     
17,912
 
Inventories
   
38,376
     
40,352
 
Related party notes receivable – current
   
2,517
     
2,036
 
Prepaid expenses and other current assets
   
7,412
     
5,268
 
Total current assets
   
100,706
     
106,472
 
Long-term investments
   
12,287
     
9,191
 
Property, plant and equipment, net
   
37,450
     
37,235
 
Related party notes receivable – long-term
   
     
416
 
Other assets
   
14,830
     
14,275
 
Total assets
 
$
165,273
   
$
167,589
 
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
 
$
8,596
   
$
5,894
 
Accrued liabilities
   
9,208
     
7,202
 
Total current liabilities
   
17,804
     
13,096
 
Long-term portion of royalty payments
   
2,725
     
3,325
 
Other long-term liabilities
   
155
     
254
 
Total liabilities
   
20,684
     
16,675
 
Commitments and contingencies
               
Stockholders’ equity:
               
Preferred stock, $0.001 par value; 2,000 shares authorized; 883 shares issued and outstanding as of September 30, 2013 and December 31, 2012, respectively (Liquidation preference of $6.1 million and $5.9 million as of September 30, 2013 and December 31, 2012, respectively)
   
3,532
     
3,532
 
Common stock, $0.001 par value per share; 70,000 shares authorized; 32,612 and 32,471 shares issued and outstanding as of September 30, 2013 and December 31, 2012, respectively
   
32
     
32
 
Additional paid-in capital
   
194,058
     
193,063
 
Accumulated deficit
   
(65,777
)
   
(59,047
)
Accumulated other comprehensive income
   
6,988
     
6,033
 
Total AXT, Inc. stockholders’ equity
   
138,833
     
143,613
 
Noncontrolling interests
   
5,756
     
7,301
 
Total stockholders’ equity
   
144,589
     
150,914
 
 
               
Total liabilities and stockholders’ equity
 
$
165,273
   
$
167,589
 

See accompanying notes to condensed consolidated financial statements.


(1) The condensed consolidated balance sheet at December 31, 2012 has been derived from the audited consolidated financial statements at that date.
AXT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share data)

 
 
Three Months Ended
   
Nine Months Ended
 
 
 
September 30,
   
September 30,
 
 
 
2013
   
2012
   
2013
   
2012
 
 
 
   
   
   
 
Revenue
 
$
20,521
   
$
20,808
   
$
66,732
   
$
69,447
 
Cost of revenue
   
18,075
     
15,342
     
57,717
     
48,279
 
Gross profit
   
2,446
     
5,466
     
9,015
     
21,168
 
 
                               
Operating expenses:
                               
Selling, general and administrative
   
4,303
     
3,950
     
12,435
     
11,709
 
Research and development
   
766
     
844
     
2,627
     
2,593
 
Total operating expenses
   
5,069
     
4,794
     
15,062
     
14,302
 
Income (loss) from operations
   
(2,623
)
   
672
     
(6,047
)
   
6,866
 
Interest income, net
   
55
     
52
     
136
     
202
 
Equity in earnings of unconsolidated joint ventures
   
346
     
348
     
1,099
     
786
 
Other income (expense), net
   
(47
)
   
144
     
(491
)
   
(472
)
 
                               
Income (loss) before provision for income taxes
   
(2,269
)
   
1,216
     
(5,303
)
   
7,382
 
Provision for (benefit from) income taxes
   
(204
)
   
(228
)
   
322
     
559
 
Net income (loss)
   
(2,065
)
   
1,444
     
(5,625
)
   
6,823
 
Less: Net income attributable to noncontrolling interest
   
(230
)
   
(512
)
   
(1,105
)
   
(2,957
)
Net income (loss) attributable to AXT, Inc.
 
$
(2,295
)
 
$
932
   
$
(6,730
)
 
$
3,866
 
 
                               
Net income (loss) attributable to AXT, Inc. per common share:
                               
Basic
 
$
(0.07
)
 
$
0.03
   
$
(0.21
)
 
$
0.12
 
Diluted
 
$
(0.07
)
 
$
0.03
   
$
(0.21
)
 
$
0.11
 
 
                               
Weighted average number of common shares outstanding:
                               
Basic
   
32,366
     
32,183
     
32,407
     
32,118
 
Diluted
   
32,366
     
32,769
     
32,407
     
32,911
 
 
See accompanying notes to condensed consolidated financial statements.
AXT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited, in thousands)

 
 
Three Months Ended
   
Nine Months Ended
 
 
 
September 30,
   
September 30,
 
 
 
2013
   
2012
   
2013
   
2012
 
 
 
   
   
   
 
Net income (loss)
 
$
(2,065
)
 
$
1,444
   
$
(5,625
)
 
$
6,823
 
Other comprehensive income (loss), net of tax:
                               
Change in foreign currency translation gain (loss), net of tax
   
307
     
(192
)
   
1,177
     
119
 
Change in unrealized gain (loss) on available-for-sale investments, net of tax
   
73
     
9
     
26
     
115
 
Total other comprehensive income (loss), net of tax
   
380
     
(183
)
   
1,203
     
234
 
Comprehensive income (loss)
   
(1,685
)
   
1,261
     
(4,422
)
   
7,057
 
Less: Comprehensive income attributable to noncontrolling interest
   
(272
)
   
(486
)
   
(1,353
)
   
(3,003
)
Comprehensive income (loss) attributable to AXT, Inc.
 
$
(1,957
)
 
$
775
   
$
(5,775
)
 
$
4,054
 
 
See accompanying notes to condensed consolidated financial statements
AXT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)

 
 
Nine Months Ended
September 30,
 
 
 
2013
   
2012
 
Cash flows from operating activities:
 
   
 
Net income (loss)
 
$
(5,625
)
 
$
6,823
 
 
               
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Depreciation and amortization
   
4,075
     
2,832
 
Amortization of marketable securities premium
   
394
     
220
 
Stock-based compensation
   
1,004
     
873
 
Provision for doubtful accounts
   
627
     
 
Gain on sale of cost method investment
   
(811
)
   
 
(Gain) loss on disposal of property, plant and equipment, net
   
(7
)
   
176
 
Changes in assets and liabilities:
               
Accounts receivable, net
   
1,083
     
1,076
 
Inventories
   
2,147
     
6,071
 
Prepaid expenses and other current assets
   
(1,730
)
   
1,923
 
Other assets
   
(77
)
   
(97
)
Accounts payable
   
2,647
     
1,287
 
Accrued liabilities
   
774
   
(795
)
Other long-term liabilities
   
(494
)
   
(824
)
Net cash provided by operating activities
   
4,007
     
19,565
 
 
               
Cash flows from investing activities:
               
Purchases of property, plant and equipment
   
(3,919
)
   
(4,951
)
Proceeds from sale of property, plant and equipment
   
9
     
 
Purchases of available for sale securities
   
(14,091
)
   
(8,225
)
Proceeds from maturities of available for sale securities
   
12,486
     
6,660
 
Net cash used in investing activities
   
(5,515
)
   
(6,516
)
 
               
Cash flows from financing activities:
               
Proceeds from common stock options exercised
   
278
     
276
 
Repurchase of the Company’s common stock, including commission
   
(287
)
   
 
Dividends paid by joint ventures
   
(1,730
)
   
(4,086
)
Net cash used in financing activities
   
(1,739
)
   
(3,810
)
Effect of exchange rate changes on cash and cash equivalents
   
336
     
108
 
Net increase (decrease) in cash and cash equivalents
   
(2,911
)
   
9,347
 
Cash and cash equivalents at the beginning of the period
   
30,634
     
26,156
 
Cash and cash equivalents at the end of the period
 
$
27,723
   
$
35,503
 
 
See accompanying notes to condensed consolidated financial statements.
AXT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Basis of Presentation

The accompanying condensed consolidated financial statements of AXT, Inc. (“AXT,” the “Company,” “we,” “us,” and “our” refer to AXT, Inc. and all of its consolidated subsidiaries) are unaudited, and have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the year-end condensed consolidated balance sheet data was derived from our audited consolidated financial statements, but does not include all disclosures required by GAAP. In the opinion of our management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, considered necessary to present fairly the financial position, results of operations and cash flows of AXT and our consolidated subsidiaries for all periods presented.

Our management has made certain estimates, judgments and assumptions to prepare these condensed consolidated financial statements in conformity with GAAP. We believe that the estimates, judgments, and assumptions upon which it relies are reasonable based on information available at the time that these estimates, judgments, and assumptions are made. These estimates, judgments, and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenues and expenses during the periods presented. Actual results could differ materially from those estimates.

The results of operations are not necessarily indicative of the results to be expected in the future or for the full fiscal year. It is recommended that these condensed consolidated financial statements be read in conjunction with our consolidated financial statements and the notes thereto included in our 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on March 15, 2013 and our Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 2013 and June 30, 2013 filed with the SEC on May 10, 2013 and August 9, 2013, respectively.

The condensed consolidated financial statements include the accounts of AXT, our majority-owned subsidiaries and certain joint ventures which we control. All significant inter-company accounts and transactions have been eliminated. Investments in business entities in which we do not have control, but have the ability to exercise significant influence over operating and financial policies (generally 20-50% ownership), are accounted for by the equity method. For majority-owned subsidiaries, we reflect the noncontrolling interests for the portion we do not own on our condensed consolidated balance sheets in stockholders’ equity and in our condensed consolidated statements of operations and comprehensive income (loss).

Certain prior period amounts in our condensed consolidated statements of operations have been reclassified to conform to the current period presentation. We reclassified $348,000 and $786,000 from “other income (expense), net” to “equity in earnings of unconsolidated joint ventures” for the three and nine months ended September 30, 2012, respectively, due to significance of the amounts.

Note 2. Investments in Marketable Securities and Fair Value Measurements

Our cash, cash equivalents and investments are classified as follows (in thousands):

 
 
September 30, 2013
   
December 31, 2012
 
 
 
   
Gross
   
Gross
   
   
   
Gross
   
Gross
   
 
 
 
Amortized
   
Unrealized
   
Unrealized
   
Fair
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
 
 
Cost
   
Gains
   
(Losses)
   
Value
   
Cost
   
Gains
   
(Losses)
   
Value
 
Classified as:
 
   
   
   
   
   
   
   
 
Cash
 
$
24,114
   
$
   
$
   
$
24,114
   
$
26,250
   
$
   
$
   
$
26,250
 
Cash equivalents:
                                                               
Money market fund
   
3,609
     
     
     
3,609
     
4,384
     
     
     
4,384
 
 
                                                               
Total cash and cash equivalents
   
27,723
     
     
     
27,723
     
30,634
     
     
     
30,634
 
 
                                                               
Investments (Available-for-sale):
                                                               
Certificates of deposit
   
6,320
     
5
     
(9
)
   
6,316
     
6,638
     
9
     
(2
)
   
6,645
 
Corporate bonds
   
14,402
     
6
     
(25
)
   
14,383
     
12,872
     
7
     
(63
)
   
12,816
 
Total investments
   
20,722
     
11
     
(34
)
   
20,699
     
19,510
     
16
     
(65
)
   
19,461
 
Total cash, cash equivalents and investments
 
$
48,445
   
$
11
   
$
(34
)
 
$
48,422
   
$
50,144
   
$
16
   
$
(65
)
 
$
50,095
 
Contractual maturities on investments:
                                                               
Due within 1 year
 
$
8,405
                   
$
8,412
   
$
10,288
                   
$
10,270
 
Due after 1 through 5 years
   
12,317
                     
12,287
     
9,222
                     
9,191
 
 
 
$
20,722
                   
$
20,699
   
$
19,510
                   
$
19,461
 

We manage our investments as a single portfolio of highly marketable securities that is intended to be available to meet our current cash requirements. We have no investments in auction rate securities. There were no sales of available-for-sales securities and no realized gains and losses for the three and nine months ended September 30, 2013 and 2012.

The gross unrealized losses related to our portfolio of available-for-sale securities were primarily due to changes in interest rates and credit conditions of the underlying securities. We have determined that the gross unrealized losses on our available-for-sale securities as of September 30, 2013 are temporary in nature. We periodically review our investment portfolio to identify and evaluate investments that have indications of possible impairment. Factors considered in determining whether a loss is temporary include the magnitude of the decline in market value, the length of time the market value has been below cost (or adjusted cost), credit quality and our ability and intent to hold the securities for a period of time sufficient to allow for any anticipated recovery in market value.

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 loss position as of September 30, 2013 (in thousands):

 
 
In Loss Position
< 12 months
   
In Loss Position
> 12 months
   
Total In
Loss Position
 
 
 
   
Gross
   
   
Gross
   
   
Gross
 
 
 
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
 
 
Value
   
(Losses)
   
Value
   
(Losses)
   
Value
   
(Losses)
 
Investments:
 
   
   
   
   
   
 
Certificates of deposit
 
$
3,671
   
$
(9
)
 
$
   
$
   
$
3,671
   
$
(9
)
Corporate bonds
   
11,738
     
(25
)
   
     
     
11,738
     
(25
)
Total in loss position
 
$
15,409
   
$
(34
)
 
$
   
$
   
$
15,409
   
$
(34
)

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 loss position as of December 31, 2012 (in thousands):

 
 
In Loss Position
< 12 Months
   
In Loss Position
> 12 Months
   
Total In
Loss Position
 
 
 
Fair
Value
   
Gross
Unrealized
(Losses)
   
Fair
Value
   
Gross
Unrealized
(Losses)
   
Fair
Value
   
Gross
Unrealized
(Losses)
 
Investments:
 
   
   
   
   
   
 
Certificates of deposit
 
$
1,877
   
$
(1
)
 
$
199
   
$
(1
)
 
$
2,076
   
$
(2
)
Corporate bonds
   
6,446
     
(40
)
   
1,502
     
(23
)
   
7,948
     
(63
)
Total in loss position
 
$
8,323
   
$
(41
)
 
$
1,701
   
$
(24
)
 
$
10,024
   
$
(65
)

Minority Investments

We have made strategic investments in private companies located in China in order to gain access at a competitive cost to raw materials that are critical to our substrate business (see Note 6). The investment balances for these companies, including minority investments in privately-held companies made indirectly through our consolidated joint ventures, are accounted for under the equity method and are included in “other assets” in the condensed consolidated balance sheets and totaled $10.6 million and $9.4 million as of September 30, 2013 and December 31, 2012, respectively.

We also maintain minority investments in two other companies which are accounted for under the cost method as we do not have the ability to exercise significant influence over their operations. Our investments in these two companies are reviewed for other than temporary declines in value on a quarterly basis. We monitor our investments for impairment and record reductions in carrying value when events or changes in circumstances indicate that the carrying value may not be recoverable. As of September 30, 2013 and December 31, 2012, our investments in these two unconsolidated companies had a carrying value of $325,000 and $392,000, respectively, and were also included in “other assets” in the condensed consolidated balance sheets.

Fair Value Measurements

ASC topic 820, Fair value measurement (“ASC 820”) establishes three levels of inputs that may be used to measure fair value. Level 1 instrument valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 instrument valuations are obtained from readily-available pricing sources for comparable instruments. Level 3 instrument valuations are obtained from unobservable inputs in which there is little or no market data, which require us to develop our own assumptions. As of September 30, 2013, we did not have any Level 3 assets or liabilities. On a recurring basis, we measure certain financial assets and liabilities at fair value, primarily consisting of our short-term and long-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. We classify all of our available-for-sale securities including certificates of deposit and corporate bonds as having Level 2 inputs. The valuation techniques used to measure the fair value of these financial instruments having Level 2 inputs were derived from quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. There were no changes in valuation techniques or related inputs in the three and nine months ended September 30, 2013. There have been no transfers between fair value measurement levels during the three and nine months ended September 30, 2013.

The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2013 (in thousands):

 
 
Balance as of
September 30, 2013
   
Quoted Prices in
Active Markets of
Identical Assets
(Level 1)
   
Significant Other
Observable
Inputs
(Level 2)
 
Assets:
 
   
   
 
Cash equivalents and investments:
 
   
   
 
Money market fund
 
$
3,609
   
$
3,609
   
$
 
Certificates of deposit
   
6,316
     
     
6,316
 
Corporate bonds
   
14,383
     
     
14,383
 
Total
 
$
24,308
   
$
3,609
   
$
20,699
 
Liabilities
 
$
   
$
   
$
 

The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2012 (in thousands):

 
 
Balance as of
December 31, 2012
   
Quoted Prices in
Active Markets of
Identical Assets
(Level 1)
   
Significant Other
Observable
Inputs
(Level 2)
 
Assets:
 
   
   
 
Cash equivalents and investments:
 
   
   
 
Money market fund
 
$
4,384
   
$
4,384
   
$
 
Certificates of deposit
   
6,645
     
     
6,645
 
Corporate bonds
   
12,816
     
     
12,816
 
Total
 
$
23,845
   
$
4,384
   
$
19,461
 
Liabilities
 
$
   
$
   
$
 

Items Measured at Fair Value on a Nonrecurring Basis

Certain assets that are subject to nonrecurring fair value measurements are not included in the table above. These assets include investments in companies accounted for by equity and cost methods (See Note 6). We did not record any other-than-temporary impairment charges for any of these investments during the three and nine months ended September 30, 2013 and 2012.

Note 3. Inventories

The components of inventories are summarized below (in thousands):

 
 
September 30,
   
December 31,
 
 
 
2013
   
2012
 
Raw materials
 
$
21,009
   
$
20,003
 
Work in process
   
13,265
     
15,608
 
Finished goods
   
4,102
     
4,741
 
 
 
$
38,376
   
$
40,352
 

As of September 30, 2013 and December 31, 2012, carrying values of inventories were net of inventory reserves of $10.5 million and $10.1 million, respectively, for excess and obsolete inventory.

Note 4. Accrued Liabilities
 
The components of accrued liabilities are summarized below (in thousands):
 
 
 
 
 
 
 
September 30,
   
December 31,
 
 
 
2013
   
2012
 
 
 
   
 
Accrued compensation and related charges
 
$
1,817
   
$
2,066
 
Dividends payable by consolidated joint ventures
   
1,175
     
 
Accrued product warranty
   
895
     
588
 
Current portion of royalty payments
   
800
     
800
 
Accrued professional services
654
609
Accrued income taxes
   
156
     
640
 
Other accrued liabilities
   
3,711
     
2,499
 
 
 
$
9,208
   
$
7,202
 

Note 5. Related Party Transactions

In August 2011, our consolidated joint venture, Beijing JiYa Semiconductor Material Co., Ltd (JiYa), entered into a non-interest bearing note agreement for $1.7 million (Rmb 10,485,200) with one of its equity investment entities. Under the loan agreement, JiYa loaned $801,000 (Rmb 4,959,000) to its equity investment entity in August 2011 and the remaining amount of $893,000 (Rmb 5,526,200) was loaned during the three months ended March 31, 2012. The original term of the loan was two years and ten months and the loan was payable to JiYa in three installments with the first installment of $423,000 (Rmb 2,620,000) due in December 2012, the second installment of $847,000 (Rmb 5,240,000) due in December 2013, and the third installment of $424,000 (Rmb 2,625,200) due in May 2014. In December, 2012, the parties signed an addendum to the note agreement to delay the first repayment of $423,000 (Rmb 2,620,000) to June 2013. In June, 2013 the parties signed another addendum to the note agreement to delay this first repayment of $423,000 (Rmb 2,620,000) to June 2014 as the last installment.  As of September 30, 2013, we included $1.7 million (Rmb 10.5 million) in “Related party notes receivable – short term” in our condensed consolidated balance sheets.
 
In August 2011, our consolidated joint venture, Nanjing Jin Mei Gallium Co., Ltd. (Jin Mei) loaned $813,000 (Rmb 5,000,000) to its equity investment entity for construction purposes. As of September 30, 2013, this balance was included in “related party notes receivable – short term” in our condensed consolidated balance sheets. During the three months ended December 31, 2012, the parties signed a note agreement retroactively to set forth the terms for the loan. The loan bears interest at 6.7% per annum, subject to adjustment to market rate, and the principal is due on December 31, 2013.

Beginning in 2012, JiYa is contractually obligated under an agency sales agreement to sell raw material on behalf of one of its equity investment entities. JiYa bills to the customers and remits the receipts, net of its portions of sales commission, to this equity investment entity. For the three months ended September 30, 2013 and 2012, JiYa has recorded $0 and $10,000 of income from agency sales, respectively, which was included in “other income (expense), net” in our condensed consolidated statements of operations. For the nine months ended September 30, 2013 and 2012, $20,000 and $15,000 of income from agency sales was recorded in “other income (expense), net” respectively, in our condensed consolidated statements of operations. As of September 30, 2013 and December 31, 2012, amounts payable of $521,000 and $257,000, respectively, to this equity investment entity for delivery in transit was included in “accrued liabilities” in our condensed consolidated balance sheets.

JiYa also purchases raw materials from one of its equity investment entities for production in the ordinary course of business. As of September 30, 2013 and December 31, 2012, amounts payable of $827,000 and $1.1 million, respectively, were included in “accounts payable” in our condensed consolidated balance sheets.

Beginning in 2012, Jin Mei is contractually obligated under an agency sales agreement to sell raw material on behalf of its equity investment entity. Jin Mei bills to the customers and remits the receipts, net of its portions of sales commission, to this equity investment entity.   For the three months ended September 30, 2013 and 2012, Jin Mei has recorded $29,000 and $18,000 of income from agency sales, respectively, which were included in “other income (expense), net” in our condensed consolidated statements of operations. For the nine months ended September 30, 2013 and 2012, $123,000 and $113,000 of income from agency sales was recorded in “other expense, net” respectively, in our condensed consolidated statements of operations.
Our wholly-owned subsidiary, Beijing Tongmei Xtal Technology Co, Ltd., has paid $120,000 (Rmb 740,924) on behalf of Donghai County Dongfang High Purity Electronic Materials Co., Ltd. its equity investment entity, to purchase materials. As of September 30, 2013, this balance was included in "prepaid expenses and other current assets" in our condensed consolidated balance sheets.
 
Our Related Party Transactions Policy seeks to prohibit all conflicts of interest in transactions between related parties and us, unless they have been approved by our Board of Directors. This policy applies to all of our employees and directors, our subsidiaries and our joint ventures. Our executive officers retain board seats on the Board of Directors of the companies in which we have invested in our China joint ventures. See Note 6 for further details.

Note 6. Investments in Companies

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

The investments are summarized below (in thousands):

 
Investment Balance as of
 
 
 
 
 
September 30,
   
December 31,
 
Accounting
 
Ownership
 
Company
 
2013
   
2012
 
Method
 
Percentage
 
Beijing JiYa Semiconductor Material Co., Ltd
 
$
3,331
   
$
3,331
 
Consolidated
   
46
%
Nanjing Jin Mei Gallium Co., Ltd
   
592
     
592
 
Consolidated
   
83
%
Beijing BoYu Semiconductor Vessel Craftwork Technology Co., Ltd
   
410
     
410
 
Consolidated
   
70
%
 
 
$
4,333
   
$
4,333
 
 
       
 
               
 
       
Donghai County Dongfang High Purity Electronic Materials Co., Ltd.
 
$
1,950
   
$
2,038
 
Equity
   
46
%
Xilingol Tongli Germanium Co. Ltd
   
4,618
     
4,246
 
Equity
   
25
%
Emeishan Jia Mei High Purity Metals Co., Ltd
   
942
     
1,042
 
Equity
   
25
%
 
 
$
7,510
   
$
7,326
 
 
       

Our ownership of Beijing JiYa Semiconductor Material Co., Ltd. (JiYa) is 46%. We continue to consolidate JiYa as we have significant influence in management and have majority control of the board. Our Chief Executive Officer is chairman of the JiYa board, while our president of China operations and our vice president of China administration and our vice president of wafer production are also members of the board.

Our ownership of Nanjing Jin Mei Gallium Co., Ltd. (Jin Mei) is 83%. We continue to consolidate Jin Mei as we have significant influence in management and have majority control of the board. Our Chief Executive Officer is chairman of the Jin Mei board, while our president of China operations and our vice president of China administration are also members of the board.

Our ownership of Beijing BoYu Semiconductor Vessel Craftwork Technology Co., Ltd (BoYu) is 70%. We continue to consolidate BoYu as we have a significant influence in management and have majority control of the board. Our Chief Executive Officer is chairman of the BoYu board, while our president of China operations and our vice president of China administration are also members of the board.

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

During the three months ended September 30, 2013 and 2012, the three consolidated joint ventures generated $565,000 and $1.8 million of income, respectively, of which $230,000 and $512,000, respectively, were allocated to minority interests, resulting in $335,000 and $1.2 million of income, respectively, included in our net income (loss). During the nine months ended September 30, 2013 and 2012, the three consolidated joint ventures generated $3.3 million and $7.0 million of income, respectively, of which $1.1 million and $3.0 million, respectively, was allocated to minority interests, resulting in $2.2 million and $4.0 million of income, respectively, included in our net income (loss).
For the three minority investment entities that are not consolidated, the investment balances are included in “other assets” in our condensed consolidated balance sheets and totaled $7.5 million and $7.3 million as of September 30, 2013 and December 31, 2012, respectively. We own 46% of the ownership interests in one of these companies and 25% in each of the other 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 they occur; and

· we do not have controlling financial interest in, do not maintain operational or management control of, do not control the board of directors of, and are not required to provide additional investment or financial support to, any of these companies.

We also maintain minority investments in privately-held companies made indirectly through our consolidated joint ventures.  These minority investments are accounted for under the equity method in the books of our consolidated joint ventures. As of September 30, 2013 and December 31, 2012, our consolidated joint ventures included these minority investments in “other assets” in the condensed consolidated balance sheets with a carrying value of $3.1 million and $2.0 million, respectively.

During the three months ended September 30, 2013, our consolidated joint venture JiYa invested $460,000 (Rmb 2.8 million) for a 20% equity investment in Shanxi Jia Hua Galaxy Electronic Materials Co., Ltd, a gallium producer.

All of the minority investment entities that are not consolidated and accounted for under the equity method had the following summarized income information (in thousands) for the three and nine months ended September 30, 2013 and 2012.

 
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
 
 
2013
   
2012
   
2013
   
2012
 
 
 
   
   
   
 
Net revenue
 
$
11,024
   
$
9,394
   
$
29,938
   
$
23,676
 
Gross profit
  $
3,628
    $
3,377
    $
10,516
    $
8,137
 
Operating income
  $
2,393
    $
2,018
    $
6,566
    $
4,542
 
Net income
  $
1,631
    $
1,897
    $
4,960
    $
3,915
 

Our gross entity earnings from all the minority investment entities that are not consolidated and accounted for under the equity method were $346,000 and $348,000 for the three months ended September 30, 2013 and 2012, respectively, and $1.1 million and $786,000 for the nine months ended September 30, 2013 and 2012, respectively.

We also maintain minority investments directly in two other companies accounted for under the cost method and we do not have the ability to exercise significant influence over their operations. As of September 30, 2013 and December 31, 2012, our investments in these two unconsolidated companies had a carrying value of $325,000 and $392,000, respectively, and were included in “other assets” in the condensed consolidated balance sheets.

Note 7. Stockholders’ Equity

Consolidated Statement of Changes in Equity
(in thousands)

 
 
Preferred
Stock
   
Common
Stock
   
Additional
Paid In Capital
   
Accumulated
Deficit
   
Other
Comprehensive
Income/(loss)
   
AXT, Inc.
Stockholders’
Equity
   
Noncontrolling
Interests
   
Total
Stockholders’
Equity
 
Balance as of December 31, 2012
 
$
3,532
   
$
32
   
$
193,063
   
$
(59,047
)
 
$
6,033
   
$
143,613
   
$
7,301
   
$
150,914
 
Common stock options exercised
                   
278
                     
278
             
278
 
Common stock repurchased
                   
(287
)
                   
(287
)
           
(287
)
Stock-based compensation
                   
1,004
                     
1,004
             
1,004
 
Net income (loss)
                           
(6,730
)
           
(6,730
)
   
1,105
     
(5,625
)
Dividends declared by joint ventures
                                                   
(2,898
)
   
(2,898
)
Change in unrealized (loss) gain on marketable securities
                                   
26
     
26
             
26
 
Currency translation adjustment
                                   
929
     
929
     
248
     
1,177
 
Balance as of September 30, 2013
 
$
3,532
   
$
32
   
$
194,058
   
$
(65,777
)
 
$
6,988
   
$
138,833
   
$
5,756
   
$
144,589
 

There were no reclassification adjustments from accumulated other comprehensive income for the nine months ended September 30, 2013 and 2012.

Note 8. Stock Repurchase Program

On February 21, 2013, our Board of Directors approved a stock repurchase program, pursuant to which we may repurchase up to $6.0 million of our outstanding common stock through February 27, 2014. These purchases can be made from time to time in the open market and are funded from our existing cash balances and cash generated from operations. During the nine months ended September 30, 2013, we repurchased approximately 103,000 shares at an average price of $2.79 per share for a total purchase price of $287,000 under the stock repurchase program.

As of September 30, 2013, approximately $5.7 million remained available for future repurchases under this program. See Item 2, Unregistered Sales of Equity Securities and Use of Proceeds in Part II, Other Information, for additional information.

Note 9. Stock-Based Compensation

We account for stock-based compensation in accordance with the provisions of FASB Accounting Standards Codification (“ASC”) topic 718, Compensation-Stock Compensation (“ASC 718”), which established accounting for stock-based awards exchanged for employee services. Stock-based compensation cost is measured at each grant date, based on the fair value of the award, and is recognized as expense over the employee’s requisite service period of the award. All of our stock compensation is accounted for as an equity instrument.

The following table summarizes compensation costs related to our stock-based awards (in thousands):

 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
 
2013
   
2012
   
2013
   
2012
 
               
Cost of revenue
 
$
6
   
$
19
   
$
17
   
$
56
 
Selling, general and administrative
   
285
     
245
     
860
     
721
 
Research and development
   
43
     
36
     
127
     
96
 
Total stock-based compensation
   
334
     
300
     
1,004
     
873
 
Tax effect on stock-based compensation
   
     
     
     
 
Net effect on net income (loss)
 
$
334
   
$
300
   
$
1,004
   
$
873
 

As of September 30, 2013, the unamortized compensation costs related to unvested stock options granted to employees under our stock option plan was approximately $1.5 million, net of estimated forfeitures of $30,000. These costs will be amortized on a straight-line basis over a weighted-average period of approximately 2.4 years and will be adjusted for subsequent changes in estimated forfeitures. We elected not to capitalize any stock-based compensation to inventory as of September 30, 2013 due to the immateriality of the amount.
 
We estimate the fair value of stock options using the Black-Scholes valuation model. There were 60,000 and 0 stock options granted with weighted average grant date fair values of $1.21 and $0 in the three months ended September 30, 2013 and 2012, respectively. There were 60,000 and 104,000 stock options granted with weighted average grant date fair values of $1.21 and $2.84 in the nine months ended September 30, 2013 and 2012, respectively. The fair value of our stock options granted to employees for the three and nine months ended September 30, 2013 was estimated using the following weighted-average assumptions:

 
Three Months
Ended
Nine Months
Ended
 
September 30, 2013
   
September 30,
2013
 
       
Expected term (in years)    
4.0
     
4.0
 
Volatility
   
61.86
%
   
61.86
%
Expected dividend
   
0
%
   
0
%
Risk-free interest rate
   
1.00
%
   
1.00
%

The following table summarizes the stock option transactions during the nine months ended September 30, 2013 (in thousands, except per share data):

Stock Options
 
Shares
   
Weighted-
average
Exercise
Price
   
Weighted-
average
Remaining
Contractual
Life
(in years)
   
Aggregate
Intrinsic
Value
 
 
 
   
   
   
 
Outstanding at January 1, 2013
   
2,727
   
$
3.28
     
6.71
   
$
1,353
 
Granted
   
60
     
2.55
                 
Exercised
   
(200
)
 
$
1.40
                 
Canceled and expired
   
(48
)
 
$
4.42
                 
Outstanding at September 30, 2013
   
2,539
   
$
3.39
     
6.44
   
$
610
 
 
                               
Options vested and expected to vest as of September 30, 2013
   
2,522
   
$
3.39
     
6.42
   
$
610
 
 
                               
Options exercisable as of September 30, 2013
   
1,682
   
$
3.22
     
5.30
   
$
607
 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on our closing price of $2.34 on September 30, 2013, which would have been received by the option holder had all option holders exercised their options on that date.

Restricted stock awards

A summary of activity related to restricted stock awards for the nine months ended September 30, 2013 is presented below:

Stock Awards
 
Shares
   
Weighted-Average
Grant Date Fair Value
 
Non-vested as of January 1, 2013
   
238,723
   
$
4.27
 
Granted
   
43,636
   
$
2.75
 
Vested
   
(47,767
)
 
$
5.13
 
Non-vested as of September 30, 2013
   
234,592
   
$
3.82
 

As of September 30, 2013, the unamortized compensation costs related to unvested restricted stock awards was approximately $687,000, which is to be amortized on a straight-line basis over a weighted average period of approximately 2.4 years.

Note 10. Net Income (loss) Per Share

Basic net income (loss) per share is computed using the weighted average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted average number of common shares outstanding and potentially dilutive common shares outstanding during the period. The dilutive effect of outstanding stock options and restricted stock awards is reflected in diluted earnings per share by application of the treasury stock method. Potentially dilutive common shares consist of common shares issuable upon the exercise of stock options and vesting of restricted stock awards. Potentially dilutive common shares are excluded in net loss periods, as their effect would be anti-dilutive.
A reconciliation of the numerators and denominators of the basic and diluted net income (loss) per share calculations is as follows (in thousands, except per share data):

 
 
Three Months Ended
   
Nine Months Ended
 
 
 
September 30,
   
September 30,
 
 
 
2013
   
2012
   
2013
   
2012
 
Numerator:
 
   
   
   
 
Net income (loss) attributable to AXT, Inc.
 
$
(2,295
)
 
$
932
   
$
(6,730
)
 
$
3,866
 
Less: Preferred stock dividends
   
(44
)
   
(44
)
   
(132
)
   
(132
)
 
                               
Net income (loss) available to common stockholders
 
$
(2,339
)
 
$
888
   
$
(6,862
)
 
$
3,734
 
Denominator:
                               
Weighted average common shares (basic)
   
32,366
     
32,183
     
32,407
     
32,118
 
Effect of dilutive securities:
                               
Common stock options
   
     
582
     
     
754
 
Restricted stock awards
   
     
4
     
     
39
 
Weighted average common shares (dilutive)
   
32,366
     
32,769
     
32,407
     
32,911
 
Net income (loss) attributable to AXT, Inc. per common share:
                               
Basic
 
$
(0.07
)
 
$
0.03
   
$
(0.21
)
 
$
0.12
 
Diluted
 
$
(0.07
)
 
$
0.03
   
$
(0.21
)
 
$
0.11
 
Options excluded from diluted net income (loss)  per share as the impact is anti-dilutive
   
2,524
     
992
     
2,563
     
977
 
Restricted stock excluded from diluted net income (loss) per share as the impact is anti-dilutive
   
243
     
172
     
242
     
14
 

The 883,000 shares of $0.001 par value Series A preferred stock issued and outstanding as of both September 30, 2013 and December 31, 2012, valued at $3,532,000 are non-voting and non-convertible preferred stock with a 5.0% cumulative annual dividend rate payable when declared by the board of directors and $4 per share liquidation preference over common stock, and must be 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.
 
Note 11. Segment Information and Foreign Operations

Segment Information

We operate in one segment for the design, development, manufacture and distribution of high-performance compound semiconductor substrates and sale of materials. In accordance with ASC topic 280, Segment Reporting, our chief operating decision-maker has been identified as our Chief Executive Officer, who reviews operating results to make decisions about allocating resources and assessing performance for the Company. Since we operate in one segment, all financial segment and product line information can be found in the condensed consolidated financial statements.
The following table represents revenue amounts (in thousands) by product type:

 
 
Three Months Ended
   
Nine Months Ended
 
 
 
September 30,
   
September 30,
 
 
 
2013
   
2012
   
2013
   
2012
 
Product type:
 
   
   
   
 
GaAs substrates
 
$
9,013
   
$
12,901
   
$
31,378
   
$
39,994
 
InP substrates
   
1,420
     
1,649
     
5,286
     
4,433
 
Ge substrates
   
5,472
     
2,007
     
13,370
     
7,078
 
Raw materials and other
   
4,616
     
4,251
     
16,698
     
17,942
 
Total
 
$
20,521
   
$
20,808
   
$
66,732
   
$
69,447
 

The following table represents revenue amounts (in thousands) reported for products shipped to customers in the corresponding geographic region:

 
 
Three Months Ended
   
Nine Months Ended
 
 
 
September 30,
   
September 30
 
 
 
2013
   
2012
   
2013
   
2012
 
Geographical region:
 
   
   
   
 
China
 
$
6,611
   
$
3,063
   
$
20,344
   
$
15,031
 
Europe (primarily Germany)
   
5,732
     
5,148
     
16,043
     
14,519
 
Taiwan
   
1,536
     
3,490
     
8,474
     
9,130
 
North America (primarily the United States)
   
2,298
     
3,230
     
7,810
     
12,663
 
Japan
   
1,931
     
2,404
     
7,233
     
7,196
 
Asia Pacific (excluding China, Taiwan and Japan)
   
2,413
     
3,473
     
6,828
     
10,908
 
Total
 
$
20,521
   
$
20,808
   
$
66,732
   
$
69,447
 

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

 
 
As of
 
 
 
September 30,
   
December 31,
 
 
 
2013
   
2012
 
 
 
   
 
North America
 
$
228
   
$
430
 
China
   
37,222
     
36,805
 
 
 
$
37,450
   
$
37,235
 

Significant Customers

No customer represented more than 10% of our revenue for the three months ended September 30, 2013 while one customer represented 14.3% of our revenue for the three months ended September 30, 2012. No customer represented more than 10% of our revenue for the nine months ended September 30, 2013 while one customer represented 15.6% of our revenue for the nine months ended September 30, 2012. Our top five customers, although not the same five customers for each period, represented 36.8% and 37.3% of our revenue for the three months ended September 30, 2013 and 2012, respectively. Our top five customers, although not the same five customers for each period, represented 30.9% and 37.0% of our revenue for the nine months ended September 30, 2013 and 2012, respectively.

We perform ongoing credit evaluations of our customers’ financial condition, and limit the amount of credit extended when deemed necessary, but generally do not require collateral. One customer accounted for 11% and 28% of our trade accounts receivable balance as of September 30, 2013 and December 31, 2012, respectively.

 Note 12. Commitments and Contingencies

Indemnification Agreements

We enter into standard indemnification arrangements with our customers in the ordinary course of business. Pursuant to these arrangements, we indemnify, hold harmless, and agree to reimburse the indemnified parties for losses suffered or incurred by the indemnified party, generally their business partners or customers, in connection with any U.S. patent, or any copyright or other intellectual property infringement claim by any third party with respect to our products. The term of these indemnification agreements is generally perpetual anytime after the execution of the agreement. The maximum potential amount of future payments we could be required to make under these agreements is unlimited. We have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the estimated fair value of these agreements is minimal.

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

Product Warranty

We provide warranties for our products for a specific period of time, generally twelve months, against material defects. We provide for the estimated future costs of warranty obligations in cost of sales when the related revenue is recognized. The accrued warranty costs represent the best estimate at the time of sale of the total costs that we expect to incur to repair or replace product parts that fail while still under warranty. The amount of accrued estimated warranty costs are primarily based on historical experience as to product failures as well as current information on repair costs. On a quarterly basis, we review the accrued balances and update these based on the historical warranty cost trends. The following table reflects the change in our warranty accrual which is included in “accrued liabilities” on the condensed consolidated balance sheets, during the three and nine months ended September 30, 2013 and 2012 (in thousands):

 
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
 
 
2013
   
2012
   
2013
   
2012
 
 
 
   
   
   
 
Beginning accrued warranty and related costs
 
$
804
   
$
740
   
$
588
   
$
1,003
 
Accruals for warranties issued
   
183
     
92
     
558
     
331
 
Adjustments related to pre-existing warranties including expirations and changes in estimates
   
14
     
(57
)
   
351
     
(338
)
Cost of warranty repair
   
(106
)
   
(78
)
   
(602
)
   
(299
)
Ending accrued warranty and related costs
 
$
895
   
$
697
   
$
895
   
$
697
 

Contractual Obligations

We lease certain office space, manufacturing facilities and equipment under long-term operating leases expiring at various dates through February 2016. The majority of our lease obligation relates to our lease agreement for the facility at Fremont, California with approximately 27,760 square feet, which commenced on December 1, 2008 for a term of seven years, with an option by us to cancel the lease after five years, upon forfeiture of the security deposit and payment of one-half of the fifth year’s rent. On June 28, 2013, we sent a notice to terminate the lease effective November 30, 2013 with an early termination penalty of $142,000 which was recorded as an expense in the third quarter of 2013. On August 2, 2013, we signed a new lease agreement for the current facility with reduced footage of 20,767 square feet, which will commence on December 1, 2013 for a term of two years. The reduced square footage, the reduced rate per square foot, and the expected reduced operating costs, would save us approximately $382,000 during 2014 and 2015.

We entered into a royalty agreement with a vendor 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 of the agreement. We shall pay a total of $7.0 million royalty payment over eight years beginning in 2011 based on future royalty bearing sales.

Outstanding contractual obligations as of September 30, 2013 are summarized as follows (in thousands):

 
 
Payments due by period
 
Contractual Obligations
 
Total
   
Less than 1 year
   
1-3
years
   
4-5
years
   
More than
5 years
 
Operating leases
 
$
379
   
$
210
   
$
169
   
$
   
$
 
Royalty agreement
   
3,525
     
800
     
1,431
     
1,150
     
144
 
Total
 
$
3,904
   
$
1,010
   
$
1,600
   
$
1,150
   
$
144
 

Purchase Obligations

In the normal course of business, we purchase or place orders for the necessary materials for our products from various suppliers and we commit to purchase products where we may incur a penalty if the agreement was canceled. As of September 30, 2013, we did not have any outstanding material purchase obligations.

Legal Proceedings

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

Note 13. Foreign Exchange Transaction Gains/Losses

We incurred foreign currency transaction exchange losses of $67,000 and gains of $114,000 for the three months ended September 30, 2013 and 2012, respectively. We incurred foreign currency transaction exchange losses of $964,000 and gains of $55,000 for the nine months ended September 30, 2013 and 2012, respectively. These amounts are included in “other income (expense), net” on our condensed consolidated statements of operations.

Note 14. Income Taxes
 
We account for income taxes in accordance with ASC topic 740, Income Taxes (“ASC 740”) which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. ASC 740 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized.  We recognize interest and penalties related to uncertain tax positions in income tax expense. As of September 30, 2013, we do not have any gross unrecognized tax benefits, nor accrued interest and penalties related to uncertain tax positions. As of December 31, 2012, we had $16.4 million for unrecognized tax benefits. Of this amount, none was accounted for as a reduction to the balance of retained earnings. No material changes have occurred in our tax position taken as of December 31, 2012 in the three and nine months ended September 30, 2013. We file income tax returns in the U.S. federal, various states and foreign jurisdictions. We have substantially concluded all U.S. federal and state income tax matters through December 31, 2012. Provision for income taxes for three and nine months ended September 30, 2013 and 2012 was mostly related to our China subsidiary and our China joint venture operations. We have made a tax election in China whereby certain minimum foreign withholding taxes are treated as an expense and not a tax credit. Besides the state tax liabilities, no federal income tax benefit or expense has been provided for the three and nine months ended September 30, 2013 due to our net loss. No federal income tax benefit or expense has been provided for the three and nine months ended September 30, 2012 due to our valuation allowance being utilized and the uncertainty of future profits in the U.S.

Note 15. Recent Accounting Pronouncements

In July 2013, the FASB issued ASU No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” This standard provides guidance on financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This standard applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. This standard will become effective for us for the three months ending March 31, 2014. We are currently evaluating the potential impact, if any, of the adoption of the standard on our consolidated results of operations and financial condition.

In March 2013, the FASB issued ASU No. 2013-05, “Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity.” This standard addresses the accounting for the cumulative translation adjustment when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. The standard is effective as of the beginning of a fiscal year that begins after December 15, 2013 and interim and annual periods thereafter. The standard will become effective for us for the three months ending March 31, 2014. We are currently evaluating the potential impact, if any, of the adoption of the standard on our consolidated results of operations and financial condition.
 
In February 2013, the FASB issued ASU No. 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”. This standard requires entities to present information about reclassification adjustments from accumulated other comprehensive income in the annual financial statements in a single note or on the face of the financial statements. Public companies will also have to provide this information in their interim financial statements.  The new requirements are effective as of the beginning of a fiscal year that begins after December 15, 2012 and interim and annual periods thereafter. The standard has been effective for us since the beginning of fiscal 2013 and did not have any significant impact on our consolidated results of operations and footnote disclosures.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This quarterly report on Form 10-Q, including the following sections, contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, particularly statements relating to our expectations regarding results of operations, outlook, customer demand, our ability to expand our markets and increase sales, industry trends, customer qualifications of our products, gross margins, the impact of the adoption of certain accounting pronouncements, our investments in capital projects, and our belief that we have adequate cash and investments to meet our needs over the next 12 months. These forward-looking statements are based upon management’s current views with respect to future events and financial performance, and are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated in such forward-looking statements. Such risks and uncertainties include those set forth under the section entitled “Risk Factors” below, which identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. We caution investors that actual results may differ materially from those projected in the forward-looking statements as a result of certain risk factors identified in this Form 10-Q and other filings we have made with the Securities and Exchange Commission. Forward-looking statements may be identified by the use of terms such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” and similar expressions. Statements concerning our future or expected financial results and condition, business strategy and plans or objectives for future operations are forward-looking statements.

These forward-looking statements are not guarantees of future performance. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. This discussion should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2012 and the condensed consolidated financial statements included elsewhere in this report.

Overview

We are a leading worldwide developer and producer of high-performance compound and single element semiconductor substrates including substrates made from gallium arsenide (GaAs), indium phosphide (InP) and germanium (Ge). We currently sell the following substrate products in the sizes and for the applications indicated:

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

We manufacture all of our semiconductor substrates using our proprietary vertical gradient freeze (VGF) technology. Most of our revenue is from sales of GaAs substrates. We manufacture all of our products in the People’s Republic of China (PRC or China), which generally has favorable costs for facilities and labor compared to comparable facilities in the United States, Europe or Japan. We also have joint ventures in China which provide us with pricing advantages, reliable supply and enhanced sourcing lead-times for key raw materials which are central to our final manufactured products. These joint ventures produce products including 99.99% pure gallium (4N Ga), high purity gallium, arsenic, germanium, germanium dioxide, pyrolytic boron nitride (pBN) crucibles and boron oxide (B2O3). Our ownership interest in these entities ranges from 20% to 83%. We consolidate, for accounting purposes, the joint ventures in which we have majority or controlling financial interest, and employ equity accounting for the joint ventures in which we have a smaller ownership interest and significant influence on management. We purchase portions of the materials produced by these ventures for our own use and the joint ventures sell the remainder of their production to third parties. We use our direct sales force in the United States and China and independent sales representatives in Europe and other parts of Asia to market and sell our substrates.
Critical Accounting Policies and Estimates

We prepared our condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. As such, we make estimates, assumptions and judgments that affect the amounts reported on our financial statements. These estimates, assumptions and judgments about future events and their effects on our results cannot be determined with certainty, and are made based upon our historical experience and on other assumptions that are believed to be reasonable under the circumstances. These estimates may change as new events occur or additional information is obtained, and we may periodically be faced with uncertainties, the outcomes of which are not within our control and may not be known for a prolonged period of time. The discussion and analysis of our results of operations and financial condition are based upon these condensed consolidated financial statements.

We have identified the policies below as critical to our business operations and understanding of our financial condition and results of operations. A critical accounting policy is one that is both material to the presentation of our financial statements and requires us to make difficult, subjective or complex judgments that could have a material effect on our financial condition and results of operations. They may require us to make assumptions about matters that are highly uncertain at the time of the estimate, and different estimates that we could have used, or changes in the estimate that are reasonably likely to occur, may have a material impact on our financial condition or results of operations.

Revenue Recognition

We manufacture and sell high-performance compound semiconductor substrates and sell certain raw materials including gallium, germanium dioxide, and pBN crucibles. After we ship our products, there are no remaining obligations or customer acceptance requirements that would preclude revenue recognition. Our products are typically sold pursuant to a purchase order placed by our customers, and our terms and conditions of sale do not require customer acceptance. We recognize revenue upon shipment and transfer of title of products to our customers, which is either upon shipment from our dock, receipt at the customer’s dock, or removal from consignment inventory at the customer’s location, provided that we have received a signed purchase order, the price is fixed or determinable, title and risk of ownership have transferred, collection of resulting receivables is probable, and product returns are reasonably estimable. We do not provide training, installation or commissioning services.

We provide allowance for future returns based on historical experience, current economic trends and changes in customer demand at the time revenue is recognized.

Accounts Receivable and Allowance for Doubtful Accounts

We periodically review the likelihood of collection on our accounts receivable balances and provide an allowance for doubtful accounts receivable primarily based upon the age of these accounts. We evaluate receivables from U.S. customers with an emphasis on balances in excess of 90 days and for receivables from customers located outside the U.S. with an emphasis on balances in excess of 120 days and reserve allowance on the receivable balances if needed. We assess the probability of collection based on a number of factors, including the length of time a receivable balance has been outstanding, our past history with the customer and their creditworthiness.

As of September 30, 2013 and December 31, 2012, our accounts receivable, net, balance was $16.3 million and $17.9 million, respectively, which was net of an allowance for doubtful accounts of $627,000 and zero, respectively. If actual uncollectible accounts differ substantially from our estimates, revisions to the estimated allowance for doubtful accounts would be required, which could have a material impact on our financial results for the affected period.

The allowance for sales returns is also deducted from gross accounts receivable. As of September 30, 2013 and December 31, 2012, our allowance for sales returns was $301,000 and $245,000, respectively.

Warranty Reserve

We maintain a warranty reserve based upon our claims experience during the prior twelve months. Warranty costs are accrued at the time revenue is recognized. As of September 30, 2013 and December 31, 2012, accrued product warranties totaled $895,000 and $588,000, respectively. If actual warranty costs 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 Valuation

Inventories are stated at the lower of cost or market. Cost is determined using 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. Given the nature of our substrate products, and the materials used in the manufacturing process, the wafers and ingots comprising work-in-process may be held in inventory for up to two years and three years, respectively, as the risk of obsolescence for these materials is low. We routinely evaluate the levels of our inventory in light of current market conditions in order to identify excess and obsolete inventory, and we provide a valuation allowance for certain inventories based upon the age and quality of the product and the projections for sale of the completed products. As of September 30, 2013 and December 31, 2012, we had an inventory reserve of $10.5 million and $10.1 million, respectively, for excess and obsolete inventory. If actual demand for our products were to be substantially lower than estimated, additional inventory adjustments for excess or obsolete inventory might be required, which could have a material impact on our business, financial condition and results of operations.

Impairment of Investments

We classify our investments in debt and equity securities as available-for-sale securities in accordance with ASC topic 320, Investments - Debt and Equity Securities (“ASC 320”). All available-for-sale securities with a quoted market value below cost (or adjusted cost) are reviewed in order to determine whether the decline is other-than-temporary. Factors considered in determining whether a loss is temporary include the magnitude of the decline in market value, the length of time the market value has been below cost (or adjusted cost), credit quality, and our ability and intent to hold the securities for a period of time sufficient to allow for any anticipated recovery in market value.

We invest in equity instruments of privately held or pre-IPO companies for business and strategic purposes. These investments are classified as other assets and are accounted for under the cost method as we do not have the ability to exercise significant influence over their operations. We monitor our investments for impairment and record reductions in carrying value when events or changes in circumstances indicate that the carrying value may not be recoverable. Determination of impairment is highly subjective and is based on a number of factors, including an assessment of the strength of investee’s management, the length of time and extent to which the fair value has been less than our cost basis, the financial condition and near-term prospects of the investee, fundamental changes to the business prospects of the investee, share prices of subsequent offerings, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in our carrying value. We had no write‑downs for the three and nine months ended September 30, 2013 and 2012.
 
Fair Value of Investments

ASC 820, Fair Value Measurement (“ASC 820”) establishes three levels of inputs that may be used to measure fair value.

Level 1 instruments represent quoted prices in active markets. Therefore, determining fair value for Level 1 instruments does not 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 identical instruments in markets with insufficient volume or infrequent transactions (less active markets), issuer credit ratings, non-binding market consensus prices that can be corroborated with observable market data, model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated with observable market data for substantially the full term of the assets or liabilities, or quoted prices for similar assets or liabilities. These Level 2 instruments require more management judgment and subjectivity compared to Level 1 instruments, including:

· Determining which instruments are most similar to the instrument being priced requires management to identify 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 security being priced.

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

Level 3 instruments include unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities. The determination of fair value for Level 3 instruments requires the most management judgment and subjectivity. As of September 30, 2013, we did not have any assets or liabilities without observable market values that would require a high level of judgment to determine fair value (Level 3 assets). There have been no transfers between fair value measurement levels during the three and nine months ended September 30, 2013.
Impairment of Long-Lived Assets

We evaluate the recoverability of property, equipment and intangible assets in accordance with ASC topic 360, Property, Plant and Equipment (“ASC 360”). When events and circumstances indicate that long-lived assets may be impaired, we compare the carrying value of the long-lived assets to the projection of future undiscounted cash flows attributable to these assets. In the event that the carrying value exceeds the future undiscounted cash flows, we record an impairment charge against income equal to the excess of the carrying value over the assets’ fair value. Fair values are determined based on quoted market values, discounted cash flows or internal and external appraisals, as applicable. We had no “Assets held for sale” on the condensed consolidated balance sheet as of September 30, 2013 or December 31, 2012.

Stock-based Compensation

We account for stock-based compensation in accordance with ASC topic 718, Stock-based Compensation (“ASC 718”), using the modified prospective method. Share-based awards granted include stock options and restricted stock awards. We utilize the Black‑Scholes option pricing model to estimate the grant date fair value of stock options, which requires the input of highly subjective assumptions, including expected volatility and expected term. Historical volatility was used while the expected term for our options was estimated based on historical option exercise behavior and post-vesting forfeitures of options, and the contractual term, the vesting period and the expected term of the outstanding options. Further, we apply an expected forfeiture rate in determining the amount of share-based compensation. We use historical forfeitures to estimate the forfeitures for stock compensation awards that are not expected to vest. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our stock compensation. The cost of restricted stock awards is determined using the fair value of our common stock on the date of grant.
 
We recognize the compensation costs for stock options net of an estimated forfeiture rate over the requisite service period of the options award, which is generally the vesting term of four years. Compensation expense for restricted stock awards is recognized over the vesting period, which is generally three years or four years. Stock-based compensation expense is recorded in cost of revenue, research and development, and selling, general and administrative expenses.
 
Income Taxes

We account for income taxes in accordance with ASC topic 740, Income Taxes (“ASC 740”) which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. ASC 740 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized.
 
We provide for income taxes based upon the geographic composition of worldwide earnings and tax regulations governing each region, particularly China. The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws, particularly in foreign countries such as China.
 
See Note 14—“Income Taxes” in the notes to condensed financial statements for additional information.

Results of Operations

Revenue
 
 
 
Three Months Ended
September 30,
   
Increase
   
 
 
 
2013
   
2012
   
(Decrease)
   
% Change
 
($ in thousands)
 
   
 
   
   
 
GaAs
 
$
9,013
   
$
12,901
   
$
(3,888
)
   
(30.1
)%
InP
   
1,420
     
1,649
     
(229
)
   
(13.9
)%
Ge
   
5,472
     
2,007
     
3,465
     
172.6
%
Raw materials and other
   
4,616
     
4,251
     
365
     
8.6
%
Total revenue
 
$
20,521
   
$
20,808
   
$
(287
)
   
(1.4
)%

The decrease in GaAs substrate revenue was primarily due to the weaker demand environment from our current customer base in both the light emitting diode (LED) market and wireless devices market.

Sales of 2 inch, 3 inch and 4 inch diameter GaAs substrates, which are mainly semi-conducting substrates used in LED applications, decreased $2.4 million to $6.9 million for the three months ended September 30, 2013 from $9.3 million for the three months ended September 30, 2012. The decrease in revenue from smaller diameter substrates was primarily due to weaker demand from our current customers in the LED market. We expect revenue from semi-conducting GaAs substrates to remain flat in the fourth  quarter as the markets in Asia and China in particular, remain weak.

Sales of 5 inch and 6 inch diameter GaAs substrates, which are mainly semi-insulating substrates used in wireless devices, decreased $1.4 million to $2.2 million for the three months ended September 30, 2013 from $3.6 million for the three months ended September 30, 2012. The decrease in revenue from larger diameter substrates was primarily due to weaker demand from our major customers in the wireless devices market. We expect revenue from semi-insulating GaAs substrate to remain flat in the fourth quarter and should improve in 2014.

InP substrate revenue decreased primarily due to reduction in orders from a major customer utilizing excess inventory in the optical networking industry. We expect revenue from InP substrate to improve in the fourth quarter.

Ge substrate revenue increased $3.5 million to $5.5 million for the three months ended September 30, 2013 from $2.0 million for the three months ended September 30, 2012 primarily due to more planned satellite launches compared to the same period prior year and from increased demand from concentrated photovoltaic applications for solar terrestrial cells. We expect Ge substrate revenue to increase in the future as we are seeing increased demand from concentrated photovoltaic applications for solar terrestrial cells.

Raw materials and other revenue increased primarily due to increased sales of pBN crucibles while revenue from raw gallium sales remains flat. We expect our third party raw material revenue to remain flat in the fourth quarter as demand remains soft.

 
 
Nine Months Ended
September 30,
   
Increase
   
 
 
 
2013
   
2012
   
(Decrease)
   
% Change
 
($ in thousands)
 
   
 
   
   
 
GaAs
 
$
31,378
   
$
39,994
   
$
(8,616
)
   
(21.5
)%
InP
   
5,286
     
4,433
     
853
     
19.2
%
Ge
   
13,370
     
7,078
     
6,292
     
88.9
%
Raw materials and other
   
16,698
     
17,942
     
(1,244
)
   
(6.9
)%
Total revenue
 
$
66,732
   
$
69,447
   
$
(2,715
)
   
(3.9
)%

The decrease in GaAs substrate revenue was primarily due to the weaker demand environment from our current customer base in both the light emitting diode (LED) market and wireless devices market.

Sales of 2 inch, 3 inch and 4 inch diameter GaAs substrates decreased $6.0 million to $21.8 million for the nine months ended September 30, 2013 from $27.8 million for the nine months ended September 30, 2012. The decrease in revenue from smaller diameter substrates was primarily due to weaker demand from our current customers in the LED market as the markets became weak in Asia, and China in particular.

Sales of 5 inch and 6 inch diameter GaAs substrates decreased $2.6 million to $9.6 million for the nine months ended September 30, 2013 compared to $12.2 million for the nine months ended September 30, 2012. The decrease in revenue from larger diameter substrates was primarily due to weaker demand from our major customers in the wireless devices market.

InP substrate revenue increased primarily due to stronger demand from a major customer in the optical networking industry.

Ge substrate revenue increased primarily due to more planned satellite launches compared to the same period prior year as well as increased demand from concentrated photovoltaic applications for solar terrestrial cells.

Raw materials and other revenue decreased primarily due to decreased selling prices which was partially offset by increased tonnage sold of 4N gallium.

Revenue by Geographic Region

 
Three Months Ended
September 30,
   
Increase
     
 
2013
   
2012
   
(Decrease)
   
% Change
 
 
($ in thousands)
         
China
 
$
6,611
   
$
3,059
   
$
3,552
     
116.1
%
% of total revenue
   
32.2
%
   
14.7
%
               
Europe (primarily Germany)
   
5,732
     
5,148
     
584
     
11.3
%
% of total revenue
   
27.9
%
   
24.7
%
               
Taiwan
   
1,536
     
3,490
     
(1,954
)
   
(56.0
)%
% of total revenue
   
7.5
%
   
16.8
%
               
North America (primarily the United States)
   
2,298
     
3,230
     
(932
)
   
(28.9
)%
% of total revenue
   
11.2
%
   
15.5
%
               
Japan
   
1,931
     
2,404
     
(473
)
   
(19.7
)%
% of total revenue
   
9.4
%
   
11.6
%
               
Asia Pacific (excluding China, Taiwan and Japan)
   
2,413
     
3,477
     
(1,064
)
   
(30.6
)%
% of total revenue
   
11.8
%
   
16.7
%
               
Total revenue
 
$
20,521
   
$
20,808
   
$
(287
)
   
(1.4
)%

Revenue from customers in China increased primarily due to increased Ge substrate revenue and raw materials revenue.

Revenue from customers in Europe increased primarily due to increased Ge substrate revenue partially offset by decreased semi-conducting GaAs substrate and raw materials revenue.

Revenue from customers in Taiwan decreased primarily due to decreased semi-conducting GaAs substrate revenue and decreased InP substrate revenue.

Revenue from customers in North America decreased primarily due to decreased raw material revenue of 4N gallium and semi-insulating GaAs substrates.

Revenue from customers in Japan decreased primarily due to decreased semi-conducting GaAs substrate revenue.

Revenue from customers in Asia Pacific (excluding China, Taiwan and Japan) decreased primarily due to decreased semi-insulating GaAs substrate revenue and decreased sales of pBN crucibles partially offset by increased Ge substrate revenue.
 
Nine Months Ended
September 30,
   
Increase
     
 
2013
   
2012
   
(Decrease)
   
% Change
 
 
($ in thousands)
         
China
 
$
20,344
   
$
15,028
   
$
5,316
     
35.4
%
% of total revenue
   
30.5
%
   
21.6
%
               
Europe (primarily Germany)
   
16,043
     
14,519
     
1,524
     
10.5
%
% of total revenue
   
24.1
%
   
20.9
%
               
Taiwan
   
8,474
     
9,130
     
(656
)
   
(7.2
)%
% of total revenue
   
12.7
%
   
13.2
%
               
North America (primarily the United States)
   
7,810
     
12,663
     
(4,853
)
   
(38.3
)%
% of total revenue
   
11.7
%
   
18.2
%
               
Japan
   
7,233
     
7,196
     
37
     
0.5
%
% of total revenue
   
10.8
%
   
10.4
%
               
Asia Pacific (excluding China, Taiwan and Japan)
   
6,828
     
10,911
     
(4,083
)
   
(37.4
)%
% of total revenue
   
10.2
%
   
15.7
%
               
Total revenue
 
$
66,732
   
$
69,447
   
$
(2,715
)
   
(3.9
)%

Revenue from customers in China increased primarily due to increased Ge substrate revenue and raw material revenue.

Revenue from customers in Europe increased primarily due to increased Ge substrate revenue and semi-insulating GaAs substrate revenue offset by increased semi-conducting GaAs substrate revenue.

Revenue from customers in Taiwan decreased primarily due to decreased semi-conducting GaAs substrate revenue offset by increased semi-insulating GaAs substrate revenue and InP substrate revenue.

Revenue from customers in North America decreased primarily due to decreased semi-insulating GaAs substrates and  decreased raw materials revenue of 4N gallium offset by increased semi-insulating GaAs substrates and increased InP substrate revenue.

Revenue from customers in Japan increased slightly primarily due to increased sales of pBN crucibles and semi-insulating GaAs substrate revenue offset by semi-conducting GaAs substrate revenue.

Revenue from customers in Asia Pacific (excluding China, Japan and Taiwan) decreased primarily due to decreased semi-insulating GaAs substrates and decreased sales of pBN crucibles offset by increased Ge substrate revenue.

Gross Margin
 
 
 
Three Months Ended
September 30,
   
Increase
   
 
 
 
2013
   
2012
   
(Decrease)
   
% Change
 
 
 
($ in thousands)
   
   
 
Gross profit
 
$
2,446
   
$
5,466
   
$
(3,020
)
   
(55.3
)%
Gross Margin %
   
11.9
%
   
26.3
%
               

Gross margin decreased primarily due to higher priced raw material and lower average selling prices for substrates. Gross margins for raw material sales also decreased due to decreased selling prices of 4N raw gallium.

 
 
Nine Months Ended
September 30,
   
Increase
   
 
 
 
2013
   
2012
   
(Decrease)
   
% Change
 
 
 
($ in thousands)
   
   
 
Gross profit
 
$
9,015
   
$
21,168
   
$
(12,153
)
   
(57.4
)%
Gross Margin %
   
13.5
%
   
30.5
%
               

Gross margin decreased primarily due to higher priced raw material and lower average selling prices for substrates. Gross margins for raw material sales also decreased due to decreased selling prices of 4N raw gallium.
Selling, General and Administrative Expenses

 
Three Months Ended
September 30,
   
Increase
     
 
2013
   
2012
   
(Decrease)
   
% Change
 
 
($ in thousands)
         
Selling, general and administrative expenses
 
$
4,303
   
$
3,950
   
$
353
     
8.9
%
% of total revenue
   
21.0
%
   
19.0
%
               

Selling, general and administrative expenses increased primarily due to an increase in allowance for doubtful accounts, and increased personnel related cost, partially offset by decreased sales commission expenses resulting from lower revenue.

 
Nine Months Ended
September 30,
   
Increase
     
 
2013
   
2012
   
(Decrease)
   
% Change
 
 
($ in thousands)
         
Selling, general and administrative expenses
 
$
12,435
   
$
11,709
   
$
726
     
6.2
%
% of total revenue
   
18.6
%
   
16.9
%
               

Selling, general and administrative expenses increased primarily due to an increase in allowance for doubtful accounts, higher personnel related cost, higher health insurance from our joint ventures in China and higher stock-based compensation expenses resulting from the options and stock awards granted in 2012, partially offset by decreased bonus and sales commission expenses resulting from lower revenue.

Research and Development

 
 
Three Months Ended
September 30,
   
Increase
   
 
 
 
2013
   
2012
   
(Decrease)
   
% Change
 
 
 
($ in thousands)
   
   
 
Research and development
 
$
766
   
$
844
   
$
(78
)
   
(9.2
)%
% of total revenue
   
3.7
%
   
4.1
%
               

Research and development expenses decreased primarily due to lower product testing related costs.

 
 
Nine Months Ended
September 30,
   
Increase
   
 
 
 
2013
   
2012
   
(Decrease)
   
% Change
 
 
 
($ in thousands)
   
   
 
Research and development
 
$
2,627
   
$
2,593
   
$
34
     
1.3
%
% of total revenue
   
3.9
%
   
3.7
%
               

Research and development expenses increased slightly primarily due to consulting expenses for product testing, partially offset by lower product testing related costs.

Interest Income, Net
 
 
 
Three Months Ended
September 30,
   
Increase
   
 
 
 
2013
   
2012
   
(Decrease)
   
% Change
 
 
 
($ in thousands)
   
   
 
Interest income, net
 
$
55
   
$
52
   
$
3
     
5.8
%
% of total revenue
   
0.3
%
   
0.2
%
               

Interest income, net increased slightly primarily due to slightly higher returns from the mix of investment securities.
 
 
Nine Months Ended
September 30,
   
Increase
   
 
 
 
2013
   
2012
   
(Decrease)
   
% Change
 
 
 
($ in thousands)
   
   
 
Interest income, net
 
$
136
   
$
202
   
$
(66
)
   
(32.7
)%
% of total revenue
   
0.2
%
   
0.3
%
               

Interest income, net decreased primarily due to the timing of receiving interest income in our joint ventures in China.

Equity in Earnings of Unconsolidated Joint Ventures

 
 
Three Months Ended
September 30,
   
Increase