UNITED STATES
SECURITIES AND EXCHANGE COMMISSION


Washington, DC. 20549


FORM 10-Q

(Mark One)

   
XBOX(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period
ended June 30, 2002
period ended March 31, 2002

or

  
BOX[   ] 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 0-24085


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
Incorporation or organization)
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  XBOX[X]      NO  BOX[   ]

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

22,443,052
   
Class

 Outstanding at March 31,June 30, 2002

Common Stock, $.001 par value 22,432,192

1




AXT, INC.

TABLE OF CONTENTS

Page

PART I.FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at June 30, 2002 and December 31, 20013
Condensed Consolidated Income Statements for the three and six months ended June 30, 2002 and 20014
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 20015
Notes To Condensed Consolidated Financial Statements6-12
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations13-31
Item 3.Quantitative and Qualitative Disclosures About Market Risk32
PART II.OTHER INFORMATION
Item 1.Legal Proceedings33
Item 4.Submission of Matters to a Vote of Security Holders33
Item 6.Exhibits and Reports on Form 8-K34
Signatures35

2


TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
CONDENSED CONSOLIDATED INCOME STATEMENTS (Unaudited)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Qualitative and Quantitative Disclosures About Market Risk
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
Item 6.  Exhibits and reports on Form 8-K
SIGNATURES


AXT, INC.

TABLE OF CONTENTS

EXHIBIT 99.2
EXHIBIT 99.1
PART IFINANCIAL INFORMATIONPage
Item 1.Financial Statements
Condensed Consolidated Balance Sheets at March 31, 2002 and December 31, 20013
Condensed Consolidated Income Statements for the three months ended March 31, 2002 and 20014
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 20015
Notes To Condensed Consolidated Financial Statements6-11
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations12-27
Item 3.Quantitative and Qualitative Disclosures About Market Risk28
PART IIOTHER INFORMATION
Item 1.Legal Proceedings29
Item 6.Exhibits and Reports on Form 8-K29
Signatures30

2


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

AXT, INC.

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

                
 March 31, December 31, June 30, December 31,
 2002 2001 2002 2001
 
 
 
 
 (Unaudited)  (Unaudited) 
Assets:Assets: Assets: 
Current assets 
 Cash and cash equivalents $25,116 $37,538 
Current assets Cash and cash equivalents $37,745 $37,538  Short-term investments 13,820 25,673 
 Short-term investments 19,473 25,673  Accounts receivable 14,440 15,684 
 Accounts receivable 14,409 15,684  Inventories 52,332 55,587 
 Inventories 52,453 55,587  Prepaid expenses and other current assets 5,873 3,577 
 Prepaid expenses and other current assets 3,322 3,577  Income tax receivable 3,667  
 Deferred income taxes 3,695 2,458  Deferred income taxes 10,584 10,557 
 
 
   
 
 
 Total current assets 131,097 140,517  Total current assets 125,832 148,616 
Property, plant and equipment 82,282 82,573 Property, plant and equipment 59,337 82,573 
Other assets 5,411 4,511 Other assets 5,088 4,511 
Goodwill 1,107 1,107 Goodwill 1,107 1,107 
Long-term investments 8,102 6,552 Long-term investments 14,281 6,552 
 
 
   
 
 
 Total assets $227,999 $235,260  Total assets $205,645 $243,359 
 
 
   
 
 
Liabilities and Stockholders’ Equity:Liabilities and Stockholders’ Equity: Liabilities and Stockholders’ Equity: 
Current liabilities Accounts payable $3,950 $2,943 Current liabilities 
 Accrued liabilities 11,858 13,670  Accounts payable $5,108 $2,943 
 Current portion of long-term debt 2,180 2,336  Accrued liabilities 11,784 13,362 
 Current portion of capital lease obligation 4,485 4,372  Income tax payable 2,208 308 
 
 
  Current portion of long-term debt 14,750 2,336 
 Total current liabilities 22,473 23,321  Current portion of capital lease obligation 4,554 4,372 
 Long-term debt, net of current portion 14,169 14,342   
 
 
 Long-term capital lease, net of current portion 8,720 10,002  Total current liabilities 38,404 23,321 
 Other long-term liabilities 1,218 1,273  Long-term debt, net of current portion 1,760 14,342 
 
 
  Long-term capital lease, net of current portion 7,555 10,002 
 Total liabilities 46,580 48,938  Other long-term liabilities 1,526 1,273 
 
 
  Deferred income taxes 4,418 8,099 
Stockholders’ equity:   
 
 
 Preferred stock, $.001 par value; 2,000 shares authorized; 883 shares issued and outstanding 3,532 3,532  Total liabilities 53,663 57,037 
 Common stock, $.001 par value per share; 70,000 shares authorized; 22,432 and 22,383 shares issued and outstanding 154,064 153,635   
 
 
 Retained earnings 25,426 28,984 Stockholders’ equity: 
 Other comprehensive income (loss)  (1,603) 171  Preferred stock, $.001 par value; 2,000 shares authorized; 883 shares issued and outstanding 3,532 3,532 
 
 
  Common stock, $.001 par value per share; 70,000 shares authorized; 22,443 and 22,383 shares issued and outstanding 154,145 153,635 
 Total stockholders’ equity 181,419 186,322  Retained earnings  (5,992) 28,984 
 
 
  Other comprehensive income 297 171 
 Total liabilities and stockholders’ equity $227,999 $235,260   
 
 
  
 
  Total stockholders’ equity 151,982 186,322 
 
 
 
 Total liabilities and stockholders’ equity $205,645 $243,359 
 
 
 

See accompanying notes to these unaudited condensed consolidated financial statements.

3


AXT, INC.

AXT, INC.

CONDENSED CONSOLIDATED INCOME STATEMENTS (Unaudited)
(In thousands, except per share data)

                           
 Three Months Ended Three Months Ended Six Months Ended
 March 31, June 30, June 30,
 
 
 
 2002 2001 2002 2001 2002 2001
 
 
 
 
 
 
RevenueRevenue $16,777 $40,103 Revenue $19,194 $41,272 $35,971 $81,376 
Cost of revenueCost of revenue 16,484 23,810 Cost of revenue 16,266 25,067 32,750 48,877 
 
 
   
 
 
 
 
Gross profitGross profit 293 16,293 Gross profit 2,928 16,205 3,221 32,499 
Operating expenses:Operating expenses: Operating expenses: 
Selling, general and administrative 4,658 5,412 9,860 11,279 
Selling, general and administrative 5,202 5,867 Research and development 1,095 2,430 2,448 5,133 
Research and development 1,353 2,703 Property, plant and equipment impairment loss 23,979  23,979  
 
 
   
 
 
 
 
 Total operating expenses 6,555 8,570  Total operating expenses 29,732 7,842 36,287 16,412 
 
 
   
 
 
 
 
Income (loss) from operationsIncome (loss) from operations  (6,262) 7,723 Income (loss) from operations  (26,804) 8,363  (33,066) 16,087 
Interest expenseInterest expense 385 629 Interest expense 365 515 750 1,144 
Other (income)/expenseOther (income)/expense  (717)  (709)Other (income)/expense 9,208  (345) 8,491  (1,054)
 
 
   
 
 
 
 
Income (loss) before provision for income taxesIncome (loss) before provision for income taxes  (5,930) 7,803 Income (loss) before provision for income taxes  (36,377) 8,193  (42,307) 15,997 
Provision (benefit) for income taxesProvision (benefit) for income taxes  (2,372) 2,809 Provision (benefit) for income taxes  (4,959) 2,949  (7,331) 5,759 
 
 
   
 
 
 
 
Net income (loss)Net income (loss) $(3,558) $4,994 Net income (loss) $(31,418) $5,244 $(34,976) $10,238 
 
 
   
 
 
 
 
Basic income (loss) per shareBasic income (loss) per share  (0.16) 0.23 Basic income (loss) per share  (1.40) 0.24  (1.56) 0.46 
Diluted income (loss) per shareDiluted income (loss) per share  (0.16) 0.22 Diluted income (loss) per share  (1.40) 0.23  (1.56) 0.45 
Shares used in per share calculations:Shares used in per share calculations: Shares used in per share calculations: 
Basic 22,414 22,097 Basic 22,437 22,289 22,425 22,194 
Diluted 22,414 22,790 Diluted 22,437 23,073 22,425 22,943 

See accompanying notes to these unaudited condensed consolidated financial statements.

4


AXT, INC.

AXT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)

                   
 Three Months Ended Six Months Ended
 March 31, June 30,
 
 
 2002 2001 2002 2001
 
 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES:CASH FLOWS FROM OPERATING ACTIVITIES: CASH FLOWS FROM OPERATING ACTIVITIES: 
Net income (loss): $(34,976) $10,238 
Adjustments to reconcile net income to cash provided by operations: 
 Depreciation 5,084 3,815 
 Deferred income taxes  (3,664)  
 Income taxes  (3,667)  
Net income (loss): $(3,558) $4,994  Amortization 158 162 
Adjustments to reconcile net income to cash provided by operations:  Stock compensation  55 
 Depreciation 2,582 1,778  Impairment write-down on marketable equity securities 8,909  
 Amortization of goodwill and other non-cash charges 66 99  Loss on disposal of property, plant and equipment 298  
 Non-cash (gain)/loss on marketable securities  (251)   Impairment loss on property, plant and equipment 23,979  
 Loss on disposal of Property, plant and equipment 296   Changes in assets and liabilities: 
 Changes in assets and liabilities:  Accounts receivable 1,244  (2,154)
 Accounts receivable 1,275 1,390  Inventories 3,255  (11,088)
 Inventories 3,134  (6,041) Prepaid expenses  (2,296)  (2,064)
 Prepaid expenses 255  (1,707) Other assets  (109) 185 
 Other assets  (432) 355  Accounts payable 2,165 1,447 
 Accounts payable 1,007 1,865  Accrued liabilities  (1,577) 7,950 
 Accrued liabilities  (1,812) 5,800  Income taxes 1,900  
 Other long-term liabilities  (55) 127  Other long-term liabilities 253 356 
 
 
   
 
 
 Net cash provided by operating activities 2,507 8,660  Net cash provided by operating activities 956 8,902 
 
 
   
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:CASH FLOWS FROM INVESTING ACTIVITIES: CASH FLOWS FROM INVESTING ACTIVITIES: 
Purchases of property, plant and equipment  (2,760)  (7,215)Purchases of property, plant and equipment  (6,016)  (16,894)
Investment in marketable securities  (1,911)  (18,722)Investment in marketable securities  (9,940)  (21,196)
Proceeds from sale of marketable securities 3,632 1,034 Proceeds from sale of marketable securities 4,874 1,034 
 
 
   
 
 
 Net cash used in investing activities  (1,039)  (24,903) Net cash used in investing activities  (11,082)  (37,056)
 
 
   
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:CASH FLOWS FROM FINANCING ACTIVITIES: CASH FLOWS FROM FINANCING ACTIVITIES: 
Proceeds from (payments of): Proceeds from (payments of): 
 Issuance of common stock 429 2,233  Issuance of common stock 510 4,100 
 Capital leases payments  (1,169)  (712) Capital leases payments  (2,265)  (2,255)
 Short-term bank borrowings  121  Short-term bank borrowings   (966)
 Long-term debt payments  (624)  (881) Long-term debt borrowings 637  
 
 
  Long-term debt payments  (1,382)  (1,516)
 Net cash provided by (used in) financing activities  (1,364) 761   
 
 
 Net cash used in financing activities  (2,500)  (637)
Effect of exchange rate changesEffect of exchange rate changes 103  (465)Effect of exchange rate changes 204  (132)
 
 
   
 
 
Net increase (decrease) in cash and cash equivalents 207  (15,947)
Net decrease in cash and cash equivalentsNet decrease in cash and cash equivalents  (12,422)  (28,923)
Cash and cash equivalents at the beginning of the periodCash and cash equivalents at the beginning of the period 37,538 68,585 Cash and cash equivalents at the beginning of the period 37,538 68,585 
 
 
   
 
 
Cash and cash equivalents at the end of the periodCash and cash equivalents at the end of the period $37,745 $52,638 Cash and cash equivalents at the end of the period $25,116 $39,662 
 
 
   
 
 
Non cash activity:Non cash activity: Non cash activity: 
Purchase of PP&E through financing $295 $1,442 Purchase of property, plant and equipment through financing $577 $2,170 
 
 
   
 
 

See accompanying notes to these unaudited condensed consolidated financial statements.

5


AXT, INC.

AXT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

     The accompanying condensed consolidated financialbalance sheets as of June 30, 2002 and December 31, 2001, the condensed consolidated statements of operations for the three and six months ended March 31,June 30, 2002 and 2001, and the condensed consolidated statements of cash flows for the six months ended June 30, 2002 and 2001 have been prepared by the Company and are unaudited. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of thecertain information and footnotes required byfootnote disclosure normally included in financial statements prepared in accordance with generally accepted accounting principles for complete financial statements.in the United States have been condensed or omitted. In the opinion of 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, Inc. (“AXT” or the “Company”) and its subsidiaries for all periods presented. Certain prior period reclassifications have been made to conform to the current period presentation.

     Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these condensed consolidated financial statements in conformity with generally accepted accounting principles. 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 the Company’s consolidated financial statements and the notes thereto included in its 2001 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 26, 2002.

     Certain reclassifications have been made to the prior years consolidated financial statements to conform to current period presentation.

Note 2. Gain on Demeter Warrants

     In August 2000, the Company entered into a business transfer and acquisition agreement with Demeter Technologies, Inc., a Delaware corporation founded by Theodore S. Young, the former president of the Company’s fiber optic division and a former member of the Company’s board of directors, and Robert Shih, the former chief technology officer of the Company’s opto-electronics division. Under this agreement, the Company agreed to transfer certain non-core rights to Demeter relating to research and development activities in the field of fiber optics. The Company receivedentered into non-competition agreements with Messrs. Shih and Young that prohibit them from certain activities, including the manufacture of certain VCSEL devices. The Company leased to Demeter a portion of its owned facility in El Monte, California, subleased a portion of its rented facility in El Monte, California, leased certain equipment, including an MOCVD machine, and sold certain inventory relating to fiber optics. In exchange, Demeter granted to the Company a warrant to purchase up to 4.5 million shares of its Series A convertible preferred stock at a price of $0.5714 per share. Demeter was purchased by Finisar Corporation and as a result, AXT converted its Demeter warrant for approximately 1.1 million shares of Finisar Corporation common stock as a result of the acquisition by Finisar Corporation of all of the outstanding capital stock of Demeter Technologies. AXT held a warrant in Demeter that it received in exchange for certain leases and transferred technology.on November 21, 2000. On November 21, 2000, a gain of $27.3 million was recorded in other income as a result of the transaction. On December 10, 2001, the Company received approximately 86,000 additional shares of common stock of Finisar Corporation that had been held in escrow in accordance with the terms of the acquisition agreement between Demeter and Finisar. A gain of $1.1 million was recorded in other income as a result of receiving these additional shares. On December 31, 2001, the Company wrote its investment in Finisar Corporation down to current market value, in accordance with SFAS 115, resulting in a realized loss of $16.7 million recorded in other income.income and expense. On February 4, 2002, the Company received approximately 24,000 additional shares of common stock of Finisar Corporation that had been held in escrow in accordance with the terms of the acquisition agreement between Demeter and Finisar. A gain of $251,000 was recorded in other income as a result of receiving these additional shares. The investment in the Finisar Corporation common stock is accounted for as available for sale and classified as a short-term investment.

6


a short-term investment. On June 30, 2002, the Company wrote its investment in Finisar Corporation down to current market value, in accordance with SFAS 115, resulting in a realized loss of $9.2 million recorded in other income and expense.

Note 3.  Long-Lived Asset Impairment

     In the second quarter of 2002, the Company completed an impairment review of certain machinery and equipment used in the substrate and opto-electronics divisions. The review was undertaken due to the recent history of operating losses, declines in the demand for our products due to macro economic conditions and excess capacity resulting in part from the relocation of certain manufacturing operations in our substrate division to China.

     Upon completion of the review, the Company determined that the carrying value of the machinery and equipment was not expected to be recoverable and accordingly recorded an impairment charge in order to write-down the related assets to their fair value. The Company determined the amount of the impairment charge by estimating the net present value of expected future cash flows to be generated by the assets. Based on this analysis, we recorded non-cash impairment charges of $14.1 million in the substrate segment and $9.9 million in the opto-electronics segment for the laser diode operating unit.

Note 4.  Investments

     The Company classifies all of its investment securities as available-for-sale securities as prescribed by Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities.Securities, and does not hold any debt securities with the positive intent and ability to hold to maturity, or trading securities bought and held principally for the purpose of selling in the near term. All investments considered to be strategic in nature are carried at fair market value, which is determined based on quoted market prices, with net unrealized gains and losses included in comprehensive income, net of tax. The components of investments at March 31,June 30, 2002 are summarized below (in thousands):

                      
 Aggregate Unrealized Aggregate Unrealized Realized
Available for sale Cost Fair value Gain/(loss) Cost Fair value Gain/(loss) Gain/(loss)

 
 
 
 
 
 
 
Money market $7,552 $7,552   $14,070 $14,070 $ $ 
Corporate bonds 14,713 14,713   19,514 19,570 56  
Government agency bonds 3,825 3,822  (3) 5,720 5,749 29  
Corporate equity securities 11,943 9,040  (2,903) 11,691 2,782   (8,909)
 
 
 
  
 
 
 
 
 $38,033 $35,127 $(2,906) $50,995 $42,171 $85 $(8,909)
 
 
 
  
 
 
 
 
Recorded as:  
Cash equivalents $7,552  $14,070 
Short-term investments 19,473  13,820 
Long-term investments 8,102  14,281 
 
  
 
 $35,127  $42,171 
 
  
 

7


Note 4.5.  Inventories

     Inventories are stated at the lower of cost or net realizable value. Cost is determined using the weighted average cost method. Finished goods and work-in-process inventories include material, labor and manufacturing overhead costs. 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. The components of inventory are summarized below (in thousands):

           
    March 31, December 31,
    2002 2001
    
 
Inventories, net:        
 Raw materials $22,030  $21,308 
 Work in process  28,904   30,265 
 Finished goods  12,556   17,368 
  Valuation allowances  (11,037)  (13,354)
       
 
   
     
  $52,453  $55,587 
   
   
 
           
    June 30, December 31,
    2002 2001
    
 
Inventories, net:        
 Raw materials $21,633  $21,308 
 Work in process  29,036   30,265 
 Finished goods  13,677   17,368 
  Valuation allowances  (12,014)  (13,354)
   
   
 
  $52,332  $55,587 
   
   
 

         During the three months ended March 31, 2002, the gross value of HBLED work in process and finished goods inventory was written down to current cost and the valuation allowance associated with this inventory was released. The decrease in gross inventory offset by the decrease in the valuation allowance had no effect on gross profit for the three months ended March 31, 2002.

Note 5.6.  Net Income (loss) Per Share

     Basic earnings per common share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common andshare include dilutive potential common equivalent shares include the dilutive effect of common stock equivalents outstanding during the period calculated using the treasury stock method. Common stock equivalentsDilutive potential common shares consist of the shares issuable upon the exercise of stock options.

7


     A reconciliation of the numerators and denominators of the basic and diluted earnings per share calculations is summarized below (in thousands except per share data):

                          
 Three Months Ended Three Months Ended Six Months Ended
 March 31, June 30, June 30,
 
 
 
 2002 2001 2002 2001 2002 2001
 
 
 
 
 
 
Numerator:Numerator: Numerator: 
Net income (loss) $(3,558) $4,994 Net income (loss) $(31,418) $5,244 $(34,976) $10,238 
Less: Preferred stock dividends  (44)  Less: Preferred stock dividends  (44)   (88)  
Net income (loss) available to common stockholders $(3,602) $4,994 Net income (loss) available to common stockholders $(31,462) $5,244 $(35,064) $10,238 
 
 
   
 
 
 
 
Denominator:Denominator: Denominator: 
Denominator for basic earnings per share — weighted average common shares 22,414 22,097 Denominator for basic earnings per share — weighted average common shares 22,437 22,289 22,425 22,194 
Effect of dilutive securities: Effect of dilutive securities: 
 Common stock options  693  Common stock options  784  749 
 
 
   
 
 
 
 
Denominator for dilutive earnings per shareDenominator for dilutive earnings per share $22,414 $22,790 Denominator for dilutive earnings per share 22,437 23,073 22,425 22,943 
 
 
   
 
 
 
 
Basic earnings per shareBasic earnings per share $(0.16) $0.23 Basic earnings per share $(1.40) $40.24 $(1.56) $0.46 
Diluted earnings per shareDiluted earnings per share $(0.16) $0.22 Diluted earnings per share $(1.40) $0.23 $(1.56) $0.45 
Options excluded from diluted net income per share as the impact is antidilutiveOptions excluded from diluted net income per share as the impact is antidilutive 2,981 818 Options excluded from diluted net income per share as the impact is antidilutive 2,911 1,069 2,902 975 

8


Note 6.7.  Comprehensive Income

     The components of comprehensive income are summarized below (in thousands):

                     
 Three Months Ended Three Months Ended Six Months Ended
 March 31, June 30, June 30,
 
 
 
 2002 2001 2002 2001 2002 2001
 
 
 
 
 
 
Net Income (loss) $(3,558) $4,994  $(31,418) $5,244 $(34,976) $10,238 
Foreign currency translation gain (loss) 103  (465) 101 333 204  (132)
Unrealized gain (loss) on available for sale investments  (1,877)  (12,839) 1,799 6,232  (78)  (6,607)
 
 
  
 
 
 
 
Comprehensive income (loss) $(5,332) $(8,310) $(29,518) $11,809 $(34,850) $3,499 
 
 
  
 
 
 
 

Note 7.8.  Segment Information

     The Company has threetwo reportable segments:segments as of June 30, 2002: substrates opto-electronics and opto-electronics. As of June 30, 2001, the now discontinued consumer products.products division was also a segment. The segments in which the Company operates are subject to rapid technological change and significant competition. Also, the number of suppliers of certain materials used by the Company and the number of customers are limited.

8


     Selected industry segment information is summarized below (in thousands):

                       
 Three Months Ended Three Months Ended Six Months Ended
 March 31, June 30, June 30,
 
 
 
 2002 2001 2002 2001 2002 2001
 
 
 
 
 
 
Substrates DivisionSubstrates Division Substrates Division 
Net revenues from external customers $11,739 $38,821 Net revenues from external customers $12,897 $38,050 $24,636 $76,871 
Gross profit 206 17,934 Gross profit 1,810 16,803 2,016 34,737 
Operating income (loss)  (4,709) 12,037 Operating income (loss)  (16,234) 10,981  (20,943) 23,018 
Identifiable assets 183,617 211,047 Identifiable assets 167,478 204,328 167,478 204,328 
Opto-electronics DivisionOpto-electronics Division Opto-electronics Division 
Net revenues from external customers $5,038 $1,282 Net revenues from external customers $6,297 $3,222 $11,335 $4,505 
Gross profit (loss) 87  (1,641)Gross profit (loss) 1,118  (598) 1,205  (2,238)
Operating income (loss)  (1,553)  (4,314)Operating income (loss)  (10,570)  (2,618)  (12,123)  (6,931)
Identifiable assets 44,382 36,960 Identifiable assets 38,167 38,335 38,167 38,335 
Discontinued Consumer Products DivisionDiscontinued Consumer Products Division Discontinued Consumer Products Division 
Identifiable assets $ $1,193 Identifiable assets $ $696 $ $696 
TotalTotal Total 
Net revenues from external customers $16,777 $40,103 Net revenues from external customers $19,194 $41,272 $35,971 $81,376 
Gross profit 293 16,293 Gross profit 2,928 16,205 3,221 32,499 
Operating income (loss)  (6,262) 7,723 Operating income (loss)  (26,804) 8,363  (33,066) 16,087 
Identifiable assets 227,999 249,200 Identifiable assets 205,645 243,359 205,645 243,359 

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     The Company sells its substrates in the United States and in other parts of the world. Also,world, and maintains operations in the Company has operations inUnited States, Japan and China. Revenues by geographic location, based on the country ofin which the customer is located, were as follows (in thousands):

          
   Three Months Ended
   March 31,
   
   2002 2001
   
 
Net revenues:        
 United States $7,332  $20,802 
 Europe  1,081   7,480 
 Canada  690   1,254 
 Japan  451   4,001 
 Malaysia  2,545    
 Taiwan  1,496    
 Asia Pacific and other  3,182   6,566 
   
   
 
 Consolidated $16,777  $40,103 
   
   
 
                  
   Three Months Ended Six Months Ended
   June 30, June 30,
   
 
   2002 2001 2002 2001
   
 
 
 
Net revenues:                
 United States $8,086  $20,708  $15,418  $41,511 
 Europe  1,470   8,147   2,551   15,627 
 Canada  272   2,020   962   3,274 
 Japan  520   2,491   971   6,492 
 Malaysia  3,732      6,277    
 Taiwan  3,441      4,937    
 Asia Pacific and other  1,673   7,906   4,855   14,472 
   
   
   
   
 
 Consolidated $19,194  $41,272  $35,971  $81,376 
   
   
   
   
 

Note 8.9.  Corporate Affiliates

     The Company’s corporate affiliates are summarized below (in thousands):

                        
 Investment Investment  Investment Investment 
 Balance Balance  Balance Balance 
 March 31, December 31, Accounting Ownership June 30, December 31, Accounting Ownership
Affiliate 2002 2001 Method Percentage 2002 2001 Method Percentage

 
 
 
 
 
 
 
 
Xilingol Tongli Ge Co. Ltd. $800 $810 Equity  25% $821 $810 Equity  25%
Emeishan Jia Mei High Pure Metals Co., Ltd. 624 629 Equity  25% 618 629 Equity  25%
Beijing Ji Ya Semiconductor Material Co., Ltd. 1,599 1,599 Consolidated  51% 1,071 1,071 Consolidated  51%
Nanjing Jin Mei Gallium Co., Ltd. 700 700 Consolidated  88% 616 616 Consolidated  88%

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     Undistributed retained earnings relating to the Company’s corporate affiliates was $515,000$961,000 at March 31,June 30, 2002. Net lossincome recorded from the Company’s corporate affiliates was $164,000$395,000 and $231,000 for the three and six months ended March 31, 2002.June 30, 2002 respectively.

Note 9.10.  Restructuring Costs

     On December 14, 2000, the Company’s Board of Directors approved management’s plan to exit its unprofitable 650 nm laser diode product line within its opto-electronics division. As a result, during the fourth quarter of 2000, the Company recorded a pre-tax restructuring charge of $8.2 million. The restructuring charge included $2.1 million for incremental costs and contractual obligations for such items as leasehold termination payments and other facility exit costs incurred as a direct result of this plan.

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     Certain information with respect to restructuring costs is summarized below (in thousands):

                       
 Utilized Balance Utilized Balance
 Reserve Cash Non-cash March 31, 2002 Reserve Cash Non-cash June 30, 2002
 
 
 
 
 
 
 
 
Inventory write-off $1,844 $ $1,844 $  $1,844 $ $1,844 $ 
Property, plant and equipment write-off 3,436  3,436   3,436  3,436  
Goodwill write-off 848  848   848  848  
Other restructuring costs 2,124 484 121 1,519  2,124 878 121 1,125 
 
 
 
 
  
 
 
 
 
 $8,252 $484 $6,249 $1,519  $8,252 $878 $6,249 $1,125 
 
 
 
 
  
 
 
 
 

     The fair value of assets determined to be impaired in accordance with the guidance for assets to be disposed ofset forth in SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,” were thedetermined in accordance with management estimates, and exit costs incurred as a direct result of management estimates. The above noted exit coststhe restructuring plan were determined in accordance with EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.” The restructuring actions, as outlined by the plan, are substantially complete. The remaining costs, which relate to clean up of a leased facility, are expected to be executed to completioncompleted in 2002.

Note 10.11.  Commitments

     From time to time the Company is involved in litigation in the normal course of business. Management believes that the outcome of matters to date will not have a material adverse effect on the Company’s financial position, or results of operations.operations or cash flows.

     On May 1, 2001, the Santa Clara Center for Occupational Safety and Health filed a complaint for injunctive relief and civil penalties against AXTthe Company in the Superior Court of California, County of Alameda, Hayward Division, Case No. H218237-5. The complaint alleges violations of California Business and Professions Code section 17200 et seq., and violations under Proposition 65 and California Health and Safety Code section 25249 et seq. as a result of AXT’s use of arsenic and inorganic arsenic compounds in its workplace. The complaint seeks injunctive relief, an order requiring the Company to set up and pay for a medical surveillance program for individuals exposed to arsenic compounds, an order requiring the Company provide warnings, information and training to workers exposed to arsenic compounds, and for civil penalties and attorneys fees. Mediation has been scheduled forOn June 24, 2002, andthe Company participated in a trial date of October 25, 2002 has been set. We believe that we have meritorious defenses against the alleged claims,private mediation, and intend to defend ourselves vigorously. However, due to the nature of litigation and fact that the case is still in its early stages, we cannot determine the possible loss, if any, that may ultimately be incurred either in the context of a trial or as a result, reached a settlement of all claims, pursuant to which the Company agreed to pay the Santa Clara Center for Occupational Safety and Health an amount equal to $175,000. The parties have executed a negotiated settlement. We may also incur substantial legal fees in this matter. However, we do not believesettlement agreement, but that this action is likely to have a material adverse effect on our business, financial condition or resultsagreement requires approval of operation.

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both the Attorney General of California and the forum court. These approvals are pending.

     The Company has entered into contracts to supply several large customers with GaAs wafers. The contracts guarantee the delivery of a certain number of wafers between January 1, 2001 and December 31, 2002 with a current contract value of $15.7$11.4 million. The contract sales prices are subject to review quarterly and can be adjusted in the event that raw material prices change. In the event of non-delivery of the determined wafer quantities in any monthly delivery period, the Company could be subject to non-performance penalties of between 5% and 10% of the value of the delinquent monthly deliveries. Partial prepayments received for these supply contracts totaling $5.7$4.0 million are included in accrued liabilities at March 31,June 30, 2002. As of March 31,June 30, 2002 the Company has met all of its delivery obligations under these contracts and expects to do so for the remainder of the contract terms.

Note 11. Recent Accounting Pronouncements

         In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 141 and No. 142, or SFAS 141, “Business Combinations”, and SFAS 142, “Goodwill and Other Intangible Assets.” Under SFAS 141, all business combinations must be accounted for using the purchase method of accounting; use of the pooling-of-interests (pooling) method is prohibited. The provisions of the statement will apply to all business combinations initiated after June 30, 2001. SFAS 142 will apply to all acquired intangible assets whether acquired singly, as a part of a group, or in a business combination. The statement will supersede APB Opinion No. 17, “Intangible Assets”, and will carry forward provisions in APB Opinion No. 17 relating to internally developed intangible assets. Adoption of SFAS 142 will result in ceasing amortization of goodwill. All of the statement should be applied in fiscal years beginning after December 31, 2001 to all goodwill and other intangible assets recognized in an entity’s statement of financial position at that date, regardless of when those assets were initially recognized. We have tested all goodwill and intangible assets for impairment upon adoption of SFAS 142 and have determined that as of March 31, 2002, no impairment charge is necessary. As a result of adopting SFAS 142, $81,000 of goodwill amortization was not recorded for the three months ended March 31, 2002. Adoption of the provisions of SFAS 141 and SFAS 142 has not had a material effect on the Company’s financial position or results of operations.

         In October 2001, the FASB issued Statement of Accounting Standards No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 supercedes SFAS 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.” SFAS 144 applies to all long-lived assets (including discontinued operations) and consequently amends Accounting Principles Board Opinion No. 30 (APB 30),Reporting Results of Operations Reporting the Effects of Disposal of a Segment of a Business.SFAS 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS 144 requires the long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of the entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS 144 is effective for the Company for all financial statements issued in fiscal 2002. We believe adoption of the provisions of SFAS 144 has not had a material effect on the Company’s financial position or results of operations.

Note 12.  Foreign Exchange Contracts and Transaction Losses

     Since our Japanese and some Taiwanese invoices are denominated in Japanese yen, doing business in Japan subjects usThe Company uses short-term forward exchange contracts for hedging purposes to fluctuations inreduce the effects of adverse foreign exchange rates between the U.S. dollar and the Japanese yen. We incurred a foreign transaction exchange gain of $40,000 for the three months ended March 31, 2002 and a loss of $223,000 for the three months ended March 31, 2001. We purchaserate movements. The Company has purchased foreign exchange contracts to hedge against certain trade accounts receivable denominated in Japanese yen. Under theseThe change in the fair value of the forward contracts increases or decreases inis recognized as part of the related foreign currency commitments and balance sheet positions,transactions as translated into U.S. dollars, are primarily offset by realized gains or losses onthey occur. As of June 30, 2002, the hedging contracts. TheCompany’s outstanding commitments with respect to suchthe foreign exchange contracts, which were commitments to sell Japanese yen, had a total contract value of approximately $4.7 million as of March 31, 2002. Many of the contracts were entered into six months prior to the due date and the dates coincide with the receivable terms on customer invoices. By matching the receivable collection date and contract due date, we attempt to economically minimize the impact of foreign exchange fluctuations.$3.7 million.

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     The Company incurred foreign transaction exchange losses of $83,540 and $43,197 for the three and six months ended June 30, 2002 respectively and losses of $86,500 and $309,750 for the three and six months ended June 30, 2001 respectively.

Note 13.  Credit Facility

     The credit facility that we have with our bank includes the line of credit, term loans in the amount of $4.8 million and the letter of credit supporting repayment of our bonds. The credit facility is subject to certain financial covenants regarding current financial ratios and cash flow requirements. As of June 30, 2002, we are out of compliance with our tangible net worth covenant. Accordingly, we have classified the long-term debt as current. We have requested a waiver from our bank and are working with our bank to restructure our credit facility. If our bank refuses to grant us a waiver in the future, the amounts due under this credit facility would become immediately due and payable. The total amount outstanding under the credit facility at June 30, 2002 was $14.2 million.

Note 14.  Income taxes

     The Company recorded an income tax provision benefit of $4.9 million and $7.3 million for the three and six months ended June 30, 2002 respectively. The tax benefits were reduced by a $9.6 million valuation allowance due to uncertainties regarding the realizability of deferred tax assets arising from the asset impairment charges recorded during the second quarter. A provision for income tax expense of $2.9 million and $5.8 million was recorded for the three and six months ended June 30, 2001 respectively. No valuation allowance was recorded as of June 30, 2001.

Note 15.  Recent Accounting Pronouncements

     In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 141 and No. 142, or SFAS 141, “Business Combinations”, and SFAS 142, “Goodwill and Other Intangible Assets.” Under SFAS 141, all business combinations must be accounted for using the purchase method of accounting; use of the pooling-of-interests (pooling) method is prohibited. The provisions of the statement will apply to all business combinations initiated after June 30, 2001. SFAS 142 will apply to all acquired intangible assets whether acquired singly, as a part of a group, or in a business combination. The statement will supersede APB Opinion No. 17, “Intangible Assets”, and will carry forward provisions in APB Opinion No. 17 relating to internally developed intangible assets. Adoption of SFAS 142 will result in ceasing amortization of goodwill. All of the statement should be applied in fiscal years beginning after December 31, 2001 to all goodwill and other intangible assets recognized in an entity’s statement of financial position at that date, regardless of when those assets were initially recognized. We have tested all goodwill for impairment upon adoption of SFAS 142 and have determined that as of June 30, 2002, no impairment charge is necessary. As a result of adopting SFAS 142, $162,000 of goodwill amortization was not recorded for the six months ended June 30, 2002. Adoption of the provisions of SFAS 141 and SFAS 142 has not had a material effect on the Company’s financial position or results of operations.

     In October 2001, the FASB issued Statement of Accounting Standards No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 supercedes SFAS 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.” SFAS 144 applies to all long-lived assets (including discontinued operations) and consequently amends Accounting Principles Board Opinion No. 30 (APB 30),Reporting Results of Operations Reporting the Effects of Disposal of a Segment of a Business.SFAS 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS 144 requires the long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of the entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS 144 is effective for the Company for all financial statements issued in fiscal 2002. In the second quarter of 2002, the Company recorded non-cash impairment charges of $24.0 million to write down to fair value, idle manufacturing assets to be held for disposal.

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes a number of forward-looking statements that reflectmade pursuant to the provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based upon management’s current views with respect to future events and financial performance. These forward-looking statementsperformance, and are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated. In this report,Such risks and uncertainties include those set forth under “Risks Related to our Business” below. Forward-looking statements may be identified by the wordsuse of terms such as “anticipates,” “believes,” “expects,“estimates,“future,“expects,” “intends,” and similar expressions identifyexpressions. Statements concerning our financial position, 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2001 and the condensed consolidated financial statements included elsewhere in this report.

Overview

     We were founded in 1986 to commercialize and enhance our proprietary VGF technique for producing high-performance compound semiconductor substrates. We currently operate two divisions: our substrate division and our opto-electronics division. We made our first substrate sales in 1990 and our substrate division currently sells GaAsgallium arsenide (GaAs) and InPindium phosphide (InP) substrates to manufacturers of semiconductor devices for use in applications such as fiber optic and wireless telecommunications, LEDslight emitting diodes (LEDs) and lasers. We also sell germanium substrates for use in satellite solar cells. We acquired Lyte Optronics, Inc., on May 28, 1999, and currently operate part of Lyte’s historical business as our opto-electronics division. The opto-electronics division manufactures HBLEDs, VCSELshigh-brightness LED’s (HBLEDs), vertical cavity surface emitting lasers (VCSELs) and laser diodes for the illumination markets, including full-color displays, automobile lighting and traffic signals, as well as fiber optic communications. We previously operated the consumer products division, discontinued in December 2000, which had focused on the design and manufacture of laser-pointing and alignment products for the consumer, commercial and industrial markets.

Critical Accounting Policies and Estimates

     We have prepared our consolidated financial statements in accordance with accounting principles generally accepted in the United States. As such, we have made estimates and judgments that affect the preparation of these statements based upon historical experience and on other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. The discussion and analysis of our results of operations and financial condition are based upon these statements. Actual results may differ from these estimates under different assumptions or conditions. We have identified the policies below as critical to our business operations and understanding of our financial condition and results of operations.

     We recognize revenue upon shipment of products to our customers, provided that we have received a signed purchase order, the price is fixed, title has transferred, collection of resulting receivables is probable, product returns are reasonably estimable, there are no customer acceptance requirements and there are no remaining significant obligations. We assess the probability of collection based on a number of factors including past history with the customer and credit worthiness. We provide for future returns at the time revenue is recognized, based on historical experience, current economic trends and changes in customer demand. Except for sales in Japan and some sales in Taiwan, which in both cases are denominated in Japanese yen, we denominate and collect our international sales in U.S. dollars.

     We periodically review the collectability of our accounts receivable balances and provide an allowance for doubtful accounts receivable based upon the age of these accounts. We provide a 100% allowance for U.S.

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receivables in excess of 90 days and for foreign receivables in excess of 120 days. At March 31,June 30, 2002 our accounts receivable balance was $14.4 million net of an allowance for doubtful accounts of $7.6$7.2 million.

     Inventories are stated at the lower of cost or net realizable value. Cost is determined using the weighted average cost method. Finished goods and work-in-process inventories include material, labor and manufacturing overhead costs. 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

12


age and quality of the product. The lives of our substrate products are relatively long and accordingly, obsolescence has historically not been a significant factor. We also review our inventory to ensure costs can be realized upon ultimate sale to our customers. If we determine that the value of any items in ending inventory plus any related selling costs exceeds the sales value, a reserve is established for the difference.

     Our industry requires substantial investments in property and equipment in order to meet demand and changes in technology. In addition, we occasionally make investments in companies, which are developing promising relevant technologies. We review the carrying value of our long-lived assets and investments in order to identify any impairment. Long-lived assets are written down when the carrying value of an asset exceeds their related undiscounted future cash flows. Key assumptions in estimating future cash flows include estimates of sales volumes, changes in selling prices, cost of materials, etc. It is possible that actual results will differ from these estimates and such differences may be material and require future adjustments to the carrying value of our long-lived assets. In the second quarter of 2002, we completed an impairment review of certain machinery and equipment used in the substrate and opto-electronics divisions. The review was undertaken due to the recent history of operating losses, declines in the demand for our products due to macro economic conditions and excess capacity resulting in part from the relocation of certain manufacturing operations in our substrate division to China. Upon completion of the review, we determined that the carrying value of the machinery and equipment was not expected to be recoverable and accordingly recorded an impairment charge in order to write-down the related assets to their fair value. We have notdetermined the amount of the impairment charge by estimating the net present value of expected future cash flows to be generated by the assets. Based on this analysis, we recorded long-lived assetnon-cash impairment charges during Q1 2002.of $14.1 million in the substrate segment and $9.9 million in the opto-electronics segment for the laser diode operating unit.

     As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes by jurisdiction in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue and/or expense, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We record investment impairment charges whenmust then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an investment has experiencedexpense within the tax provision in the statement of operations.

     Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against our net deferred tax assets. We have recorded a declinevaluation allowance of $9.6 million as of June 30, 2002, due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of certain net operating losses carried forward and tax credits, before they expire. The valuation allowance is based on our estimates of taxable income by jurisdiction in market valuewhich we operate and the period over which our deferred tax assets will be recoverable. In the event that is other than temporary.actual results differ from these estimates or we adjust these estimates in future periods, we may need to establish an additional valuation allowance which could materially impact our financial position and results of operations.

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Results of Operations

     The following table sets forth certain information relating to the operations of the Company expressed as a percentage of total revenues for the periods indicated:

                         
 Three Months Ended Three Months Ended Six Months Ended
 March 31, June 30, June 30,
 
 
 
 2002 2001 2002 2001 2002 2001
 
 
 
 
 
 
RevenuesRevenues  100.0%  100.0%Revenues  100.0%  100.0%  100.0%  100.0%
Cost of revenuesCost of revenues 98.3 59.4 Cost of revenues 84.7 60.7 91.0 60.1 
 
 
   
 
 
 
 
Gross profitGross profit 1.7 40.6 Gross profit 15.3 39.3 9.0 39.9 
Operating expenses:Operating expenses: Operating expenses: 
Selling, general and administrative 31.0 14.6 Selling, general and administrative 24.3 13.1 27.4 13.9 
Research and development 8.1 6.7 Research and development 5.7 5.9 6.8 6.3 
 
 
 Impairment costs 124.9 66.7 
 Total operating expenses 39.1 21.3   
 
 
 
 
 
 
  Total operating expenses 154.9 19.0 100.9 20.2 
 
 
 
 
 
Income (loss) from operationsIncome (loss) from operations  (37.4) 19.3 Income (loss) from operations  (139.6) 20.3  (91.9) 19.7 
Interest expenseInterest expense 2.3 1.6 Interest expense 1.9 1.2 2.1 1.4 
Other (income)/expenseOther (income)/expense  (4.3)  (1.8)Other (income)/expense 48.0  (0.8) 23.6  (1.3)
 
 
   
 
 
 
 
Income (loss) before provision for income taxesIncome (loss) before provision for income taxes  (35.4) 19.5 Income (loss) before provision for income taxes  (189.5) 19.9  (117.6) 19.6 
Provision (benefit) for income taxesProvision (benefit) for income taxes  (14.1) 7.0 Provision (benefit) for income taxes  (25.8) 7.1  (20.4) 7.1 
 
 
   
 
 
 
 
Net Income (loss)Net Income (loss)  (21.3)%  12.5%Net Income (loss)  (163.7)%  12.8%  (97.2)%  12.5%
 
 
 
 
 

Three months ended March 31,Months Ended June 30, 2002 comparedCompared to three months ended March 31,Three Months Ended June 30, 2001

     Revenue.Revenue decreased $23.3$22.1 million, or 58.2%53.5%, to $16.8$19.2 million for the three months ended March 31,June 30, 2002 compared to $40.1$41.3 million for the three months ended March 31,June 30, 2001. Revenue from our substrate division, which represents 70.0%67.2% of total revenue for the three months ended March 31,June 30, 2002, decreased $27.0$25.2 million, or 69.8%66.1%, to $11.8$12.9 million compared to $38.8$38.1 million for the three months ended March 31,June 30, 2001. Total GaAs substrate revenue decreased $23.0$17.0 million, or 75.2%63.4%, to $7.6$9.8 million for the three months ended March 31,June 30, 2002 compared to $30.6$26.8 million for the three months ended March 31,June 30, 2001. Sales of 5”5 inch and 6”6 inch GaAs subtratessubstrates decreased $9.2$5.1 million, or 87.6%60.3%, to $1.3$3.4 million for the three months ended March 31,June 30, 2002 compared to $10.5$8.5 million for the three months ended March 31,June 30, 2001. InP substrate revenue decreased $4.5$7.8 million, or 60.0%82.5%, to $3.0$1.7 million for the three months ended March 31,June 30, 2002 compared to $7.5$9.5 million for the three months ended March 31,

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June 30, 2001. The decrease in GaAs and InP substrate sales was due to a decline in the wireless and fiber optic telecommunication markets.

     Revenue from our opto-electronics division, which represents 30%32.8% of total revenue for the three months ended March 31,June 30, 2002, increased $3.7$3.1 million, or 293.0%95.4% to $5.0$6.3 million compared to $1.3$3.2 million for the three months ended March 31,June 30, 2001. The increase was a result of higher sales volume of high brightness light emitting diode (“HBLED”)HBLED products. HBLED revenue increased $3.8$3.7 million, or 578.8%193.0%, to $4.4$5.6 million for the three months ended March 31,June 30, 2002 compared to $651,000$1.9 million for the three months ended March 31,June 30, 2001. Vertical cavity surface emitting laser (“VCSEL”)The higher sales volume of HBLED was primarily concentrated with one customer, Agilent. We are currently experiencing a slow-down in orders from Agilent. Accordingly, the current revenue growth in HBLED revenue is not indicative of future HBLED revenue growth. VCSEL revenue decreased $63,000,$320,000, or 28.3%63.6%, to $160,000$183,000 for the three months ended March 31,June 30, 2002 compared to $223,000$503,000 for the three months ended March 31,June 30, 2001. LDLaser diode revenue increased $50,000,decreased $305,000, or 12.2%38.0%, to $459,000$497,000 for the three months ended March 31,June 30, 2002 compared to $409,000$802,000 for the three months ended March 31,June 30, 2001.

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     International revenue increased to 56.3%57.9% of total revenue for the three months ended March 31,June 30, 2002 compared to 48.1%49.8% of total revenue for the three months ended March 31,June 30, 2001. The increase was primarily due to increased sales of HBLED products to customers in Asia.

     Gross margin.Gross margin decreased to 1.75%15.3% of total revenue for the three months ended March 31,June 30, 2002 compared to 40.6%39.3% of total revenue for the three months ended March 31,June 30, 2001. Gross margin at the substrate division decreased to 1.75%14.0% of substrate revenue for the three months ended March 31,June 30, 2002 compared to 46.2%44.2% of substrate revenue for the three months ended March 31,June 30, 2001. The decrease was primarily due to lower unit sales and lower average sales prices of GaAs substrates spread over a relatively fixed manufacturing overhead base. As a result, we have initiated manufacturing costs reductions in order to align our costs with lower expected sales volumes and prices. We are currently shifting much of our substrate manufacturing to China, where costs are lower, and reducing capacity at our Fremont, California facility. Gross margin at the opto-electronics division increased to 1.73%17.8% of opto-electronics revenue for the three months ended March 31,June 30, 2002 compared to negative 128.0%18.6% of opto-electronics revenue for the three months ended March 31,June 30, 2001. The increase was primarily due to increased unit sales of our HBLED products.

     Selling, general and administrative expenses.Selling, general and administrative expenses decreased $665,000,$754,000, or 11.3%13.9%, to $5.2$4.7 million for the three months ended March 31,June 30, 2002 compared to $5.9$5.4 million for the three months ended March 31,June 30, 2001. As a percentage of total revenue, selling, general and administrative expenses were 31.0%24.3% for the three months ended March 31,June 30, 2002 compared to 14.6%13.1% for the three months ended March 31,June 30, 2001. The increase in selling, general and administrative expenses as a percentage of total revenue was primarily due to revenue decreasing faster than the decrease in our fixed costs associated with selling, general and administrative expenses. As we adjust our fixed costs in line with our lower expected sales volumes, we expect this percentage to decrease.

     Research and development expenses.Research and development expenses decreased $1.3 million, or 49.9%54.9%, to $1.4$1.1 million for the three months ended March 31,June 30, 2002 compared to $2.7$2.4 million for the three months ended March 31,June 30, 2001. As a percentage of total revenue, , research and development expenses were 8.1%5.7% for the three months ended March 31,June 30, 2002 compared to 6.7%5.9% for the three months ended March 31,June 30, 2001. The decrease in research and development expenses was primarily the result of our decision to reduce expenses in line with lower revenues. We feel that this decrease will not compromise our efforts to remain a leading supplier of GaAs and InP substrates in the future or to make further enhancements in our opto-electronic products.

     Long-Lived Asset Impairment.In the second quarter of 2002, we completed an impairment review of certain machinery and equipment used in the substrate and opto-electronics divisions. The review was undertaken due to the recent history of operating losses, declines in the demand for our products due to macro economic conditions and excess capacity resulting in part from the relocation of certain manufacturing operations in our substrate division to China. Upon completion of the review, we determined that the carrying value of the machinery and equipment was not expected to be recoverable and accordingly recorded an impairment charge in order to write-down the related assets to their fair value. We determined the amount of the impairment charge by estimating the net present value of expected future cash flows to be generated by the assets. Based on this analysis, we recorded non-cash impairment charges of $14.1 million in the substrate segment and $9.9 million in the opto-electronics segment for the laser diode operating unit.

Interest expense.Interest expense decreased $244,000,$150,000, or 38.8%29.1%, to $385,000$365,000 for the three months ended March 31,June 30, 2002 compared to $629,000$515,000 for the three months ended March 31,June 30, 2001 due to the repayment of debt and a reduction of rates on our variable interest rate debt.debts over the period.

     OtherOther income and expense.Other incomeexpense increased $8,000$9.6 million to $717,000$9.2 million for the three months ended March 31,June 30, 2002 compared to $709,000income of $345,000 for the three months ended March 31,June 30, 2001. The balance for the three months ended March 31,June 30, 2002 includes a non-cash gainloss of $251,000$9.2 million from the receiptwrite-down to current market value of additional shares ofour investment in Finisar Corporation common stock that were held in escrow.,which is the primary cause of the increase.

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     Provision for income taxes.TheOur effective tax rate increaseddecreased to 40.0%13.6% for the three months ended March 31,June 30, 2002 compared to 36.0% for the three months ended March 31,June 30, 2001. The 40.0%decrease was primarily the result of applying a valuation allowance against the tax benefit related to the asset impairment charges for the write-down of

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manufacturing assets of $24.0 million. The valuation allowance was applied to the benefit due to uncertainty regarding its recoverability.

Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001

Revenue.Revenue decreased $45.4 million, or 55.8%, to $36.0 million for the six months ended June 30, 2002 compared to $81.4 million for the six months ended June 30, 2001. Revenue from our substrate division, which represents 68.5% of total revenue for the six months ended June 30, 2002, decreased $52.2 million, or 68.0%, to $24.6 million compared to $76.9 million for the six months ended June 30, 2001. Total GaAs substrate revenue decreased $40.0 million, or 69.7%, to $17.4 million for the six months ended June 30, 2002 compared to $57.4 million for the six months ended June 30, 2001. Sales of 5 inch and 6 inch GaAs substrates decreased $14.3 million, or 75.3%, to $4.7 million for the six months ended June 30, 2002 compared to $19.0 million for the six months ended June 30, 2001. InP substrate revenue decreased $12.3 million, or 72.5%, to $4.7 million for the six months ended June 31, 2002 compared to $17.0 million for the six months ended June 30, 2001. The decrease in GaAs and InP substrate sales was due to a decline in the wireless and fiber optic telecommunication markets.

     Revenue from our opto-electronics division, which represents 31.5% of total revenue for the six months ended June 30, 2002, increased $6.8 million, or 151.6% to $11.3 million compared to $4.5 million for the six months ended June 30, 2001. The increase was a result of higher sales volume of HBLED products. HBLED revenue increased $7.5 million, or 290.8%, to $10.0 million for the six months ended June 30, 2002 compared to $2.6 million for the six months ended June 30, 2001. The higher sales volume of HBLED was primarily concentrated with one customer, Agilent. We are currently experiencing a slow-down in orders from Agilent. Accordingly, the current revenue growth in HBLED revenue is not indicative of future HBLED revenue growth. VCSEL revenue decreased $383,000, or 52.8%, to $343,000 for the six months ended June 30, 2002 compared to $726,000 for the six months ended June 30, 2001. Laser diode revenue decreased $255,000, or 21.1%, to $956,000 for the six months ended June 31, 2002 compared to $1.2 million for the six months ended June 30, 2001.

     International revenue increased to 57.1% of total revenue for the six months ended June 30, 2002 compared to 49.0% of total revenue for the six months ended June 30, 2001. The increase was primarily due to increased sales of HBLED products to customers in Asia.

Gross margin.Gross margin decreased to 9.0% of total revenue for the six months ended June 30, 2002 compared to 39.9% of total revenue for the six months ended June 30, 2001. Gross margin at the substrate division decreased to 8.2% of substrate revenue for the six months ended June 30, 2002 compared to 45.2% of substrate revenue for the six months ended June 30, 2001. The decrease was primarily due to lower unit sales and lower average sales prices of GaAs substrates spread over a relatively fixed manufacturing overhead base. As a result, we have initiated manufacturing costs reductions in order to align our costs with lower expected sales volumes and prices. We are currently shifting much of our substrate manufacturing to China, where costs are lower, and reducing capacity at our Fremont, California facility. Gross margin at the opto-electronics division increased to 10.6% of opto-electronics revenue for the six months ended June 30, 2002 compared to negative 49.7% of opto-electronics revenue for the six months ended June 30, 2001. The increase was primarily due to increased unit sales of our HBLED products.

Selling, general and administrative expenses.Selling, general and administrative expenses decreased $1.4 million, or 12.6%, to $9.9 million for the six months ended June 30, 2002 compared to $11.3 million for the six months ended June 30, 2001. As a percentage of total revenue, selling, general and administrative expenses were 27.4% for the six months ended June 30, 2002 compared to 13.9% for the six months ended June 30, 2001. The increase in selling, general and administrative expenses as a percentage of total revenue was primarily due to revenue decreasing faster than the decrease in our fixed costs associated with selling, general and administrative expenses. As we adjust our fixed costs in line with our lower expected sales volumes, we expect this percentage to decrease.

Research and development expenses.Research and development expenses decreased $2.7 million, or 52.3%, to $2.5 million for the six months ended June 30, 2002 compared to $5.1 million for the six months ended June 30, 2001. As a percentage of total revenue, research and development expenses were 6.8% for the six months ended June 30, 2002 compared to 6.3% for the six months ended June 30, 2001. The decrease in research and

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development expenses was primarily the result of our decision to reduce expenses in line with lower revenues. We feel that this decrease will not compromise our efforts to remain a leading supplier of GaAs and InP substrates in the future or to make further enhancements in our opto-electronic products.

Long-Lived Asset Impairment.In the second quarter of 2002, we completed an impairment review of certain machinery and equipment used in the substrate and opto-electronics divisions. The review was undertaken due to the recent history of operating losses, declines in the demand for our products due to macro economic conditions and excess capacity resulting in part from the relocation of certain manufacturing operations in our substrate division to China. Upon completion of the review, we determined that the carrying value of the machinery and equipment was not expected to be recoverable and accordingly recorded an impairment charge in order to write-down the related assets to their fair value. We determined the amount of the impairment charge by estimating the net present value of expected future cash flows to be generated by the assets. Based on this analysis, we recorded non-cash impairment charges of $14.1 million in the substrate segment and $9.9 million in the opto-electronics segment for the laser diode operating unit.

Interest expense.Interest expense decreased $394,000, or 34.4%, to $750,000 for the six months ended June 30, 2002 compared to $1.1 million for the six months ended June 30, 2001 due to the repayment of debt and a reduction of rates on our variable interest rate debt over the period.

Other income and expense.Other expense increased $9.6 million to $8.5 million for the six months ended June 30, 2002 compared to income of $1.1 million for the six months ended June 30, 2001. The balance for the six months ended June 30, 2002 includes a non-cash loss of $9.2 million from the write-down to current market value of our investment in Finisar Corporation common stock, which is the primary cause of the increase.

Provision for income taxes.Our effective tax rate is duedecreased to 17.3% for the six months ended June 30, 2002 compared to 36.0% for the six months ended June 30, 2001. The decrease was primarily the result of applying a valuation allowance against the tax benefit related to the asset impairment charges for the write-down of the Company’s projected losses increased bymanufacturing assets of $24.0 million. The valuation allowance was applied to the benefit of tax credits.due to uncertainty regarding its recoverability.

Liquidity and Capital Resources

     Cash and cash equivalents increased $207,000decreased $12.4 million to $37.7$25.1 million at March 31,June 30, 2002 compared to $37.5 million at December 31, 2001.

     Net cash provided by operating activities of $2.5 million$956,000 for the threesix months ended March 31,June 30, 2002 was comprised primarily of our net loss adjusted for non-cash items of $2.7$34.8 million, consisting primarily of depreciation expense, and by a $3.4$1.2 million net change in assets and liabilities. The net change in assets and liabilities resulted primarily from a decrease in accounts receivable and inventory, and an increase in accounts payable, offset by a decreasedecreases in accrued liabilities.liabilities, income taxes and prepaid expenses.

     Accounts receivable decreased $1.3$1.2 million, or 8.1%7.9%, to $14.4 million at March 31,June 30, 2002 compared to $15.7 million at December 31, 2001. The change reflects lower sales volume, collections of $17.1$36.7 million and an increase in our allowance for doubtful accounts of $1.0 million.$508,000. Inventories decreased $3.1million,$3.3 million, or 5.6%5.9% to $52.5$52.3 million at March 31,June 30, 2002 compared to $55.6 million at December 31, 2001. The decrease in inventory is due to a reduction in manufacturing output during the current period as a result of reduced demand caused by the economic downturn affecting our industry.

     If our sales continue to decrease, our ability to generate cash from operations will be adversely affected which could adversely affect our future liquidity and cause us to seek additional capital, if available on acceptable terms.

     Net cash used in investing activities of $1.0$11.1 million for the threesix months ended March 31,June 30, 2002 includes purchases of property and equipment of $2.7$6.0 million primarily used to increase wafer processing capacity in China

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for the substrate division, and to increase HBLED and VCSEL epitaxy growth and wafer processing capacity at the opto-electronics division. It also includes $1.9$9.9 million in purchases of high gradehigh-grade investment securities with maturities of less than two years offset by $3.6$4.9 million in sales of these securities.

     We are currently investing in certain equipment to expand HBLED production. We are also constructing minor improvements to our existing production facilities in China and California. We expect to invest approximately $12.0$6.0 million in additional facilities and equipment over the next 9six months.

     Net cash used in financing activities of $1.4$2.5 million for the threesix months ended March 31,June 30, 2002 includes proceeds of $429,000$510,000 from the sale of common stock through our employee stock compensation programs and proceeds of $637,000 from a new equipment loan, offset by payments of $624,000$1.4 million for payments on long-term debt and $1.2$2.3 million for capital lease payments.

     We have a $5.0 million bank line of credit that expires on September 30, 2003. TheThis line of credit is secured by our operating assets, excluding assets in China. Borrowings bear interest at 2.25%3.0% above LIBOR, which was 4.93%4.85% at March 31,June 30, 2002. The interest rate for future borrowings compared to LIBOR is dependent on our financial performance. No amounts were outstanding under thethis line of credit at March 31,June 30, 2002.

     We generally finance equipment purchases through secured equipment loans and capital leases over four or five-year terms at interest rates ranging from 5.6%4.6% to 8.8% per annum. Our main Fremont, California manufacturing facility is financed by long-term borrowings, which were refinanced by taxable variable rate revenue bonds in 1998. These bonds mature in 2023 and bear interest at 2.0% below the prime rate. The bonds are traded in the public market. Repayment of principal and interest under the bonds is supported by a letter of credit from our bank and is paid on a quarterly basis. We have the option to redeem the bonds in whole or in part during their term. At March 31,June 30, 2002, $9.6$9.4 million was outstanding under these bonds.

     The credit facility that we have with our bank includes the line of credit, term loans in the amount of $5.0$4.8 million and the letter of credit supporting repayment of our bonds. The credit facility is subject to certain financial

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covenants regarding current financial ratios and cash flow requirements thatrequirements. As of June 30, 2002, we are out of compliance with certain covenants. Accordingly, we have all been metclassified the long-term debt as of March 31, 2002. If we fail to comply with these covenants in the future and are unable to obtaincurrent. We have requested a waiver from our bank and are working with our bank to restructure our credit facility. If our bank refuses to grant us a waiver in the future, the amounts due under this credit facility would become immediately due and payable. The total amount outstanding under the credit facility at March 31,June 30, 2002 was $14.6$14.2 million.

Risks Related to Our Business

The semiconductor industry is cyclical and is currently experiencing a severe and prolonged downturn which has adversely impacted our operating results.

     Our business depends in significant part upon manufacturers of electronic and opto-electronic semiconductor devices, as well as the current and anticipated market demand for such devices and products using such devices. The semiconductor industry is highly cyclical. The industry has in the past, and will likely in the future, experience periods of oversupply that result in significantly reduced demand for semiconductor devices and components, including our products, both as a result of general economic changes and overcapacity. When these periods occur, our operating results and financial condition are adversely affected. Inventory buildups in telecommunications products and slower than expected sales of computer equipment have resulted in overcapacity and led to reduced sales by our customers. During periods of declining demand such as those experienced over the past year, customers typically reduce purchases, delay delivery of products and/or cancel orders of component parts such as our products. Increased price competition may result, causing pressure on our net sales, gross margin and net income. We have over the past year experienced cancellations, delays and push outs of orders, which have resulted in reduced revenues. If the economic downturn continues, further order cancellations, reductions in order size or delays in orders will materially adversely affect our business and results of operations. Although we have taken actions to reduce our costs, if our actions are insufficient to align our structure with prevailing business conditions, we may be required to undertake additional cost-cutting measures, and may be unable to invest in marketing,

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research and development and engineering at the levels we believe are necessary to maintain our competitive position. Our failure to make these investments could seriously harm our business.

The impact of changes in global economic conditions on our customers may cause us to fail to meet expectations, which would negatively impact the price of our stock.

     Our operating results can vary significantly based upon the impact of changes in global economic conditions on our customers. More specifically, the macro-economic environment that we have faced in the second half of 2001 and are continuing to face in 2002 is more uncertain than in prior periods and has materially and adversely affected us and our operating results and may continue to do so. The revenue growth and profitability of our business depends on the overall demand for our substrates, light-emitting diodesLED’s and laser diodes, and we are particularly dependant on the market conditions for the fiber optics and telecommunications industries. Because our sales are primarily to major corporate customers whose businesses fluctuate with general economic and business conditions, a softening of demand for products that use our substrates, LEDs and laser diodes caused by a weakening economy may result in decreased revenues. Customers may find themselves facing excess inventory from earlier purchases, and may defer or reconsider purchasing products due to the downturn in their business and in the general economy.

Unpredictable fluctuations in our operating results could disappoint analysts or our investors, which could cause our stock price to decline.

     We have not over the past year been able to sustain our historical growth rate, and may not be able to return to historic growth levels in the current economic environment. We have and may continue to experience significant fluctuations in our revenue and earnings. Our quarterly and annual revenue and operating results have varied significantly in the past and may vary significantly in the future due to a number of factors, including:

        decline in general economic conditions or downturns in the industry in which we compete;
 
        fluctuations in demand for our products;

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        expansion of our manufacturing capacity;
 
        expansion of our operations in China;
 
        limited availability and increased cost of raw materials;
 
        the volume and timing of orders from our customers, and cancellations, push outs and delays of customer orders;
 
        fluctuation of our manufacturing yields;
 
        decreases in the prices of our competitors’ products;
 
        costs incurred in connection with any future acquisitions of businesses or technologies;
 
        increases in our expenses, including expenses for research and development; and
 
        our ability to develop, manufacture and deliver high quality products in a timely and cost-effective manner.

     Due to these factors, we believe that period-to-period comparisons of our operating results may not be a meaningful indicator of our future performance. Our operating results have over the past year at times been below the expectations of securities analysts or investors. If this occurs again in future periods, the price of our common stock would likely decline or fluctuate.

     A substantial percentage of our operating expenses are fixed in the short term and we may be unable to adjust spending to compensate for an unexpected shortfall in revenues. As a result, any delay in generating revenue

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could cause our operating results to be below the expectations of market analysts or investors, which could also cause our stock price to fall.

     The lead-time for customer orders is generally shorter than it was a year ago. As a result, our visibility regarding future financial performance is uncertain and we may provide investors with financial guidance that we cannot meet. As a result, our operating results could be below the expectations of market analysts or investors, which could also cause our stock price to fall.

If the economy recovers and we are again in a period of high demand for our products, if we fail to expand our manufacturing capacity, we may not be able to meet increased demand, lower our costs or increase revenue.

     Although we are currently in a period of overcapacity, if the economy recovers, demand may increase rapidly as it has in prior years. In order to meet increased demand and maintain our market share, we may need to increase production, which could require us to build new facilities, expand our existing facilities, purchase additional manufacturing equipment, and add qualified staff. If we do not expand our manufacturing capacity, we will be unable to increase production, adversely impacting our ability to reduce unit costs, margins and improve our operating results.

     We are currently constructing facilities in California and China. Our construction activities subject us to a number of risks, including:

        unforeseen environmental or engineering problems;
 
        unavailability or late delivery of production equipment;
 
        delays in completing new facilities;
 
        delays in bringing production equipment on-line;

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        work stoppages or delays;
 
        inability to recruit and train qualified staff;
 
        unanticipated cost increases and restrictions imposed by requirements of local, state or federal regulatory agencies.

     If any of these risks occurs, construction may be costlier than anticipated and completion could be delayed, which could hurt our ability to expand capacity and increase our sales. In addition, if we experience delays in expanding our manufacturing capacity, we might not be able to timely meet customer requirements, and we could lose future sales. We are also making substantial investments in equipment and facilities as part of our capacity expansion. To offset the additional fixed operating expenses, we must increase our revenue by increasing production and improving yields. If demand for our products does not grow or if our yields do not improve as anticipated, we may be unable to offset these costs against increased revenue, which would adversely impact our operating results.

Our results of operations may suffer if we do not effectively manage our inventory.

     To achieve commercial success with our products, we will need to manage our inventory of component parts and finished goods effectively to meet changing customer requirements. Some of our products and supplies have in the past and may in the future become obsolete while in inventory due to changing customer specifications, excess inventory or decreased demand for our products. We have in the past had to take inventory valuation and impairment charges. If we are not successfully able to manage our inventory, we may need to write off unsaleable, obsolete or excess inventory, which could adversely affect our results of operations.

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Our HBLED and VCSEL products are in their early stages, and we may not be able to achieve anticipated sales of these products.

     We are continuing to ramp production and sale of our HBLED and VCSEL products, and we may be unable to successfully market and increase sales of these products. To market and increase sales of our HBLED and VCSEL products, we will have to continue to develop additional distribution channels. We must also continue our research and development efforts to apply our proprietary VGF technique to new substrate products and successfully introduce and market new opto-electronic semiconductor devices, including enhancements to our HBLED and VCSEL products.

If we do not successfully develop new products to respond to rapidly changing customer requirements, our ability to generate sales and obtain new customers may suffer.

     Our success depends on our ability to offer new products that incorporate leading technology and respond to technological advances. In addition, our new products must meet customer needs and compete effectively on quality, price and performance. The life cycles of our products are difficult to predict because the markets for our products are characterized by rapid technological change, changing customer needs and evolving industry standards. If our competitors introduce products employing new technologies, our existing products could become obsolete and unmarketable. If we fail to offer new products, we may not generate sufficient revenue to offset our development costs and other expenses or meet our customers’ requirements. Other companies, including IBM and Motorola, are actively developing substrate materials that could be used to manufacture devices that could provide the same high-performance, low-power capabilities as GaAs-based devices at competitive prices. If these substrate materials are successfully developed and semiconductor device manufacturers adopt them, demand for our GaAs substrates could decline and our revenue could suffer.

     The development of new products can be a highly complex process, and we may experience delays in developing and introducing new products. Any significant delays could cause us to 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.

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Our operating results depend in large part on further customer acceptance of our existing substrate products and on our ability to develop new products based on our core VGF technology.

     A large share of GaAs substrates are manufactured from crystals grown using the traditional Liquid Encapsulated Czochralski, or LEC, or Horizontal-Bridgeman, or HB, techniques. In order to expand sales of our products, we must continue to promote our VGF technique as a preferred process for producing substrates, and we must offer products with superior prices and performance on a timely basis and in sufficient volumes. If we fail to gain increased market acceptance of our VGF technique, we may not achieve anticipated revenue growth.

     To shift more of our substrate manufacturing operations to China successfully, we will need our customers to qualify products manufactured in China. If we are unable to achieve qualifications for these products, our China facility will be underutilized, our investments in China will not be recouped and we will be unable to lower our costs by moving to China. All of these events could reduce our revenue but increase our cost structure.

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 other manufacturers of substrates, such as Freiberger, Hitachi Cable, Japan Energy and Sumitomo Electric and from semiconductor device manufacturers that produce substrates for their own use, and from companies, such as IBM and Motorola, that are actively developing alternative materials to GaAs and some semiconductor devices are being marketed using these materials. We believe that at least one of our competitors is shipping GaAs substrates manufactured using a technique similar to our VGF technique. Other competitors may develop and begin using similar technology. If we are unable to compete effectively, our revenue may not increase and we may be unable to

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be profitable. We face many competitors that have a number of significant advantages over us, particularly in our compound semiconductor device products, including:

        greater experience in the business;
 
        more manufacturing experience;
 
        extensive intellectual property;
 
        broader name recognition; and
 
        significantly greater financial, technical and marketing resources.

     Our competitors could develop new or enhanced products that are more effective than the products that we have developed or may develop. For example, some competitors in the HBLED market offer devices that are brighter than our HBLEDs. Some of our competitors may also develop technologies that enable the production of commercial products with characteristics similar to or better than ours, but at a lower cost.

     The level and intensity of competition has increased over the past year and we expect competition to continue to increase in the future. Competitive pressures caused by the current economic conditions have resulted in reductions in the prices of some of our products, and continued or increased competition could reduce our market share, require us to further reduce the prices of our products, affect our ability to recover costs or result in reduced gross margins.

If we have low product yields, the shipment of our products may be delayed and our operating results may be adversely impacted.

     Our products are manufactured using complex technologies, and the number of usable substrates and devices we can produce can fluctuate as a result of many factors, including:

impurities in the materials used;

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impurities in the materials used;
        contamination of the manufacturing environment;
 
        substrate breakage;
 
        equipment failure, power outages or variations in the manufacturing process; and
 
        performance of personnel involved in the manufacturing process.

     Because many of our manufacturing costs are fixed, our revenue could decline if our yields decrease. We have experienced product shipment delays and difficulties in achieving acceptable yields on both new and older products, and delays and poor yields have adversely affected our operating results. We may experience similar problems in the future and we cannot predict when they may occur or their severity. In addition, many of our manufacturing processes are new and are still being refined, which can result in lower yields, particularly as we focus on producing higher diameter substrates and new opto-electronic semiconductor devices. For example, we recently made substantial investments in equipment and facilities to manufacture blue, green and cyan HBLEDs and VCSELs. If we are unable to produce adequate quantities of our high-brightness LEDs and VCSELs, we may not be able to meet customer demand and our revenue may decrease.

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Demand for our products may decrease if our customers experience difficulty manufacturing, marketing or selling their products.

     Our products are used as components in our customers’ products. Accordingly, demand for our products is subject to factors affecting the ability of our customers to successfully introduce and market their products, including:

        the competition our customers face in their particular industries;
 
        the technical, manufacturing, sales and marketing and management capabilities of our customers;
 
        the financial and other resources of our customers; and
 
        the inability of our customers to sell their products if they infringe third party intellectual property rights.

If demand for the products offered by our customers decreases, our customers may reduce purchases of our products.

     As inventory of telecommunication products and computer equipment has increased in the past year, resulting in overcapacity in the market, our customers have reduced sales of their products, causing them to reduce purchases of our products. As a result, our revenues have declined and may fail to recover until the overcapacity has been depleted and demand for our customers’ products once again increase.

We purchase critical raw materials from single or limited sources, and could lose sales if these sources fail to fill our needs.

     We depend on a limited number of suppliers for certain raw materials, components and equipment used in manufacturing our products, including key materials such as gallium, arsenic and quartz. We generally purchase these materials through standard purchase orders and not pursuant to long-term supply contracts and none of our suppliers guarantees supply of raw materials to us. If we lose any of our key suppliers, our manufacturing efforts could be significantly hampered and we could be prevented from timely producing and delivering products to our customers. We have experienced delays obtaining critical raw materials, including gallium, due to shortages of these materials. We may experience delays due to shortages of materials and may be unable to obtain an adequate supply of materials. These shortages and delays could result in higher materials costs and cause us to delay or reduce production of our products. If we have to delay or reduce production, we could fail to meet customer delivery schedules, and our revenue and operating results could suffer.

20


If we fail to comply with environmental and safety regulations, we may be subject to significant fines or cessation of our operations.

     We are subject to federal, state and local environmental and safety laws and regulations. These laws, rules and regulations govern the use, storage, discharge and disposal of hazardous chemicals during manufacturing, research and development and sales demonstrations. If we fail to comply with applicable regulations, we could be subject to substantial liability for clean-up efforts, personal injury and fines or suspension or cessation of our operations. In March 2001, we settled a claim made by the California Occupational Safety and Health Administration, or Cal-OSHA, in an investigation primarily regarding impermissible levels of potentially hazardous materials in certain areas of our manufacturing facility in Fremont, California for $204,415. Although we have put 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 acquire costly remediation equipment or incur other significant expenses. In addition, existing or future changes in laws or regulations may require us to incur significant expenditures or liabilities, or may restrict our operations.

     On May 1, 2001, the Santa Clara Center for Occupational Safety and Health filed a complaint for injunctive relief and civil penalties against AXTus in the Superior Court of California, County of Alameda, Hayward Division, Case No. H218237-5. The complaint alleges violations of California Business and Professions Code section 17200 et

24


seq., and violations under Proposition 65 and California Health and Safety Code section 25249 et seq. as a result of AXT’s use of arsenic and inorganic arsenic compounds in its workplace. The complaint seeks injunctive relief, an order requiring the Company to set up and pay for a medical surveillance program for individuals exposed to arsenic compounds, an order requiring the Company provide warnings, information and training to workers exposed to arsenic compounds, and for civil penalties and attorneys fees. Mediation has been scheduled forOn June 24, 2002, andwe participated in a trial date of October 25, 2002 has been set. We believe that we have meritorious defenses against the alleged claims,private mediation, and intend to defend ourselves vigorously. However, due to the nature of litigation and fact that the case is still in its early stages, we cannot determine the possible loss, if any, that may ultimately be incurred either in the context of a trial or as a result, reached a settlement of all claims, pursuant to which we agreed to pay the Santa Clara Center for Occupational Safety and Health an amount equal to $175,000. The parties have executed a negotiated settlement. We may also incur substantial legal fees in this matter. However, we do not believesettlement agreement, but that this action is likely to have a material adverse effect on our business, financial condition or resultsagreement requires approval of operation.both the Attorney General of California and the forum court. These approvals are pending.

The loss of one or more of our key substrate customers would significantly hurt our operating results.

     A small number of substrate and HBLED customers have historically accounted for a substantial portion of our total revenue. Five customers accounted for 38.9%43.6% of our total revenue for the three months ended March 31,June 30, 2002 and 32.9%35.2% for the three months ended March 31,June 30, 2001. One substrate and one HBLED customer each accounted for greater than 10% of total revenue for the three months ended March 31,June 30, 2002 and no one customertwo substrate customers each accounted for greater then 10% of total revenue for the three months ended March 31,June 30, 2001. Our substrate revenue accounted for 70.0%67.2% of our total revenue for the three months ended March 31,June 30, 2002 and 96.8%92.2% for the three months ended March 31,June 30, 2001. We expect that a significant portion of our future revenue will continue to be derived from a limited number of substrate customers. Ourand HBLED revenue is currently concentrated with a few customers. Our customers are not obligated to purchase a specified quantity of our products or to provide us with binding forecasts of product purchases. In addition, our customers may reduce, delay or cancel orders at any time without any significant penalty, and during the past year, we have experienced slower bookings, significant push outs and cancellation of orders. 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 continue to generate revenue for us in any future period. Any delay in scheduled shipments of our products could cause net sales to fall below our expectations and the expectations of market analysts or investors, causing our stock price to decline.

Defects in our products could diminish demand for our products.

     Our products are complex and may contain defects. In the past we have experienced quality control problems with some of our products, which caused customers to return products to us. If we continue to experience quality control problems, or experience these problems in new products, customers may cancel or reduce orders or purchase

21


products from our competitors. Defects in our products could cause us to incur higher manufacturing costs and suffer product returns and additional service expenses, all of which could adversely impact our operating results.

     We are also developing new products and product enhancements, including substrates and compound semiconductor device products. If our new products contain defects when released, our customers may be dissatisfied and we may suffer negative publicity or customer claims against us, lose sales or experience delays in market acceptance of our new products.

Our substrate and opto-electronic semiconductor device products have a long sales cycle that makes it difficult to plan our expenses and forecast our results.

     Customers typically place orders with us for our substrate and opto-electronic semiconductor device products three months to a year or more after our initial contact with them. The sale of our products may be subject to delays due to our customers’ lengthy internal budgeting, approval and evaluation processes. During this time, we may incur substantial expenses and expend sales, marketing and management efforts while the customers evaluate our products. These expenditures may not result in sales of our products. If we do not achieve anticipated sales in a period as expected, we may experience an unplanned shortfall in our revenue. As a result, we may not be able to cover expenses, causing our operating results to vary. In addition, if a customer decides not to incorporate our products into its initial design, we may not have another opportunity to sell products to this customer for many months or even years. In this difficult economic climate, the average sales cycle for our products has lengthened even further and is expected to continue to make it difficult to accurately forecast our future sales. We anticipate that sales of any future substrate and opto-electronic semiconductor device products under development will also have lengthy sales cycles and will, therefore, be subject to risks substantially similar to those inherent in the lengthy sales cycle of our current substrate and opto-electronic semiconductor device products.

25


As our business matures, we may need to upgrade our systems.

     In the past, periods of rapid growth and expansion has strained our management and other resources. The expansion of our manufacturing capacity and the shift of manufacturing operations to China has placed and continues to place a significant strain on our operations and management resources. If we fail to manage these changes effectively, our operations may be disrupted. To manage our business effectively, we may need to implement additional and improved management information systems, further develop our operating, administrative, financial and accounting systems and controls, add experienced senior level managers, and maintain close coordination among our executive, engineering, accounting, marketing, sales and operations organizations.

     If necessary, we will spend substantial sums to support our future growth and shift to China and may incur additional unexpected costs. Our systems, procedures or controls may not be adequate to support our operations, and we may be unable to expand quickly enough to exploit potential market opportunities. Our future operating results will also depend on expanding sales and marketing, research and development and administrative support. If we cannot attract qualified people or manage growth effectively, our business and operating results could be adversely affected.

If we fail to manage periodic contractions, we may utilize our cash balances.

     We have experienced a period of rapid contraction in our business that caused us to reduce our costs in order to conserve our cash resources. If we fail to manage our contractions successfully we may draw down our cash reserves, which would reduce our value and may impinge our ability to raise debt and equity funding in the future. As part of our effort to reduce costs, we may lose key staff, production resources, and technology that we will need to grow when end markets recover. These events could reduce our ability to grow profitably as markets recover.

As a result of the difficult economic conditions, we have implemented restructuring and workforce reductions, which may adversely affect the moral and performance of our personnel and our ability to hire new personnel.

     In connection with our efforts to streamline operations, reduce costs and bring staffing and structure in line with current demand for our products, we implemented a corporate restructuring beginning last year and reduced our

22


workforce, shifted production activities to China and reduced capital expenditures. Our restructuring may yield unanticipated consequences, such as attrition beyond our planned reduction in workforce and loss of employee moral and decreased performance. In addition, the recent trading levels of our stock have decreased the value of our stock options granted to employees under our stock option plan. As a result of these factors, our remaining personnel may seek employment with larger, more established companies or companies that they perceive as having less volatile stock prices. Continuity of personnel can be very important factors in the sales and production of our products and completion of our research and development efforts.

Any future acquisitions may disrupt our business, dilute stockholder value or distract management attention.

     As part of our strategy, we may consider acquisitions of, or significant investments in, businesses that offer products, services and technologies complementary to ours, such as our acquisition of Lyte Optronics in May 1999. Acquisitions entail numerous risks, including:

        we may have difficulty assimilating the operations, products and personnel of the acquired businesses;
 
        our ongoing business may be disrupted;
 
        we may incur unanticipated costs;
 
        our management may be unable to manage the financial and strategic position of acquired or developed products, services and technologies;
 
        we may be unable to maintain uniform standards, controls and procedures and policies; and
our relationships with employees and customers may be impaired as a result of any integration.

26


our relationships with employees and customers may be impaired as a result of any integration.

     For example, we incurred substantial costs in connection with our acquisition of Lyte Optronics, including the assumption of approximately $10.0 million of debt, much of which has been repaid or renegotiated, resulting in a decline of cash available. We incurred one-time charges and merger-related expenses of $2.8 million and an extraordinary item of $508,000 relating to the early extinguishment of debt in the quarter ended September 30, 1999 as a result of the acquisition.

     To the extent that we issue shares of our stock or other rights to purchase stock in connection with any future acquisitions, dilution to our existing stockholders will result and our earnings per share may suffer. Any future acquisitions may not generate additional revenue or provide any benefit to our business.

If any of our facilities is damaged by actions such as fire, explosion, or natural disaster, we may not be able to manufacture our products.

     The ongoing operation of our manufacturing and production facilities in California and China is critical to our ability to meet demand for our products. If we are not able to use all or a significant portion of our facilities for prolonged periods for any reason, we will not be able to manufacture products for our customers. For example, a natural disaster, fire or explosion caused by our use of combustible chemicals and high temperatures during our manufacturing processes would render some or all of our facilities inoperable for an indefinite period of time. Actions outside of our control, such as earthquakes, could also damage our facilities, rendering them inoperable. All of our crystal growth is currently performed at our Fremont, California facilities, which are located near an active seismic fault line. If we are unable to operate our facilities and manufacture our products, we will lose customers and revenue and our business will be harmed.

23


If we lose key personnel or are unable to hire additional qualified personnel as necessary, we may not be able to successfully manage our business or achieve our objectives.

     Our success depends upon the continued service of Morris S. Young, Ph.D., our president, chairman of the board and chief executive officer, as well as other key management and technical personnel. We do not have long-term employment contracts with, or key person life insurance on, any of our key personnel.

We believe our future success will also depend in large part upon our ability to attract and retain highly skilled managerial, engineering, sales and marketing, finance and manufacturing personnel. The competition for these employees is intense, especially in Silicon Valley, and we cannot assure you that we will be successful in attracting and retaining new personnel. The loss of the services of any of our key personnel, the inability to attract or retain qualified personnel in the future or delays in hiring required personnel, particularly engineers, could make it difficult for us to manage our business and meet key objectives, including the timely introduction of new products.

If we are unable to protect our intellectual property, we may lose valuable assets or incur costly litigation.

     We rely on a combination of patents, copyrights, trademark and trade secret laws, non-disclosure agreements and other intellectual property protection methods to protect our proprietary technology. However, we believe that, due to the rapid pace of technological innovation in the markets for our products, our ability to establish and maintain a position of technology leadership also depends on the skills of our development personnel.

     Despite our efforts to protect our intellectual property, a third party could develop products or processes similar to ours. Our means of protecting our proprietary rights may not be adequate and our competitors may independently develop similar technology, duplicate our products or design around our patents. We believe that at least one of our competitors has begun to ship GaAs substrates produced using a process similar to our VGF technique. Our competitors may also develop and patent improvements to the VGF, LED and VCSEL technologies upon which we rely, and thus may limit any exclusivity we enjoy by virtue of our patents.

     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 the

27


ownership rights or the validity of our patents. In addition, the laws of some foreign countries may not protect our proprietary rights to as great an extent as do the laws of the United States and it may be more difficult to monitor the use of our intellectual property. Our competitors may be able to legitimately ascertain non-patented proprietary technology embedded in our systems. If this occurs, 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 or know-how or to determine their scope, validity or enforceability. Enforcing or defending our proprietary technology is expensive, could cause us to divert resources and may not prove successful. Our protective measures may prove inadequate to protect our proprietary rights, and if we fail to enforce or protect our rights, we could lose valuable assets.

We might face intellectual property infringement claims that 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 technology necessary to our business. The markets in which we compete are comprised of competitors who in some cases hold substantial patent portfolios covering aspects of products that could be similar to ours. We could become subject to claims that we are infringing patent, trademark, copyright or other proprietary rights of others, and are currently in discussions with one company concerning alleged patent infringement. Litigation to determine the validity of alleged claims could be time-consuming and result in significant expense to us and divert the efforts of our technical and management personnel, whether or not the litigation is ultimately determined in our favor. If a lawsuit is decided against us, we could be subject to significant liabilities, requiring us to seek costly licenses or preventing us from manufacturing and selling our products. We may not be able to obtain required licensing agreements on terms acceptable to us or at all.

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We derive a significant portion of our revenue from international sales, and our ability to sustain and increase our international sales involves significant risks.

     Our revenue growth depends in part on the expansion of our international sales and operations. International sales represented 56.3%57.9% of our total revenue for the three months ended March 31,June 30, 2002 and 48.12%49.8% for the three months ended March 31,June 30, 2001. We expect that sales to customers outside the U.S. will continue to represent a significant portion of our revenue.

     Our dependence on international sales involves a number of risks, including:

        changes in tariffs, import or export restrictions and other trade barriers;
 
        unexpected changes in regulatory requirements;
 
        longer periods to collect accounts receivable;
 
        changes in export license requirements;
 
        political and economic instability;
 
        unexpected changes in diplomatic and trade relationships; and
 
        foreign exchange rate fluctuations.

     Our sales are denominated in U.S. dollars, except for sales to our Japanese and some Taiwanese customers, which are denominated in Japanese yen. Thus, increases in the value of the U.S. dollar could increase the price of our products in non-U.S. markets and make our products more expensive than competitors’ products in these markets. Also, denominating some sales in Japanese yen subjects us to fluctuations in the exchange rates between the U.S. dollar and the Japanese yen. The functional currencies of our Japanese and Chinese subsidiaries are the local

28


currencies. We incur transaction gains or losses resulting from consolidation of expenses incurred in local currencies for these subsidiaries, as well as in translation of the assets and liabilities of these assets at each balance sheet date. If we do not effectively manage the risks associated with international sales, our revenue, cash flows and financial condition could be adversely affected.

If our expansion in China is more costly than we expect, our operating results will suffer.

     As part of our planned expansion of our manufacturing capacity, we are building new facilities and expanding existing facilities in China. If we are unable to build and expand our Chinese facilities in a timely manner, we may not be able to increase production of our products and increase revenue as planned. If our expansion in China proves more costly than we anticipate or we incur greater ongoing costs than we expect, our operating results would be adversely affected. If we do not realize expected cost savings once our expansion is complete in China, our margins may be negatively impacted and our operating results may suffer.

Changes in China’s political, social and economic environment may affect our financial performance.

     Our financial performance may be affected by changes in China’s political, social and economic environment. The role of the Chinese central and local governments in the Chinese economy is significant. Chinese policies toward economic liberalization, and laws and policies affecting technology companies, foreign investment, currency exchange rates and other matters could change, resulting in greater restrictions on our ability to do business and operate our manufacturing facilities in China. Any imposition of surcharges or any increase in Chinese tax rates could hurt our operating results. The Chinese government could revoke, terminate or suspend our license for national security and similar reasons without compensation to us. If the government of China were to take any of these actions, we would be prevented from conducting all or part of our business. Any failure on our part to comply with governmental regulations could result in the loss of our ability to manufacture our products in China.

25


     China has from time to time experienced instances of civil unrest and hostilities. Confrontations have occurred between the military and civilians. Events of this nature could influence the Chinese economy, result in nationalization of foreign-owned operations such as ours, and could negatively affect our ability to operate our facilities in China.

The effect of terrorist threats on the general economy could decrease our revenues.

     On September 11, 2001, the United States was subject to terrorist attacks at the World Trade Center buildings in New York and the Pentagon in Washington D.C. The potential near- and long-term impact these attacks may have in regards to our suppliers, customers and markets for our products and the U.S. economy, are uncertain. There may be other potential adverse effects on our operating results due to this significant event that we cannot foresee.

Our stock price has been and may continue to be volatile.

     Our stock price has fluctuated significantly since we began trading on the Nasdaq National Market. For the threesix months ended March 31,June 30, 2002, the high and low closing sales prices of our common stock were $16.89 and $8.85$7.00 respectively. A number of factors could cause the price of our common stock to continue to fluctuate substantially, including:

        actual or anticipated fluctuations in our quarterly or annual operating results;
 
        changes in expectations about our future financial performance or changes in financial estimates of securities analysts;
 
        announcements of technological innovations by us or our competitors;
 
        new product introduction by us or our competitors;

29


        large customer orders or order cancellations; and
 
        the operating and stock price performance of comparable companies.

     In addition, the stock market in general has experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect the trading price of our common stock, regardless of our actual operating performance.

We may need additional capital to fund expansion of our manufacturing capacity and our future operations, which may not be available.

     We may need additional capital to fund expansion of our manufacturing and production capacity and our future operations or acquisitions. If we raise additional capital through the sale of equity or debt securities, the issuance of such securities could result in dilution to existing stockholders. These securities could have rights, preferences and privileges that are senior to those of holders of our common stock. For example, in December 1998 we issued debt securities for the purchase and improvement of our facilities in Fremont, California.

     If we require additional capital in the future, it might not be available on acceptable terms, or at all. If we are unable to obtain additional capital when needed, we may be required to reduce the scope of our planned expansion of our manufacturing capacity or of our product development and marketing efforts, which could adversely affect our business and operating results.

26


Provisions in our charter, bylaws or Delaware law may delay or prevent a change in control of our company.

     Provisions in our amended and restated certificate of incorporation and bylaws may have the effect of delaying or preventing a merger, acquisition or change of control of us, or changes in our management. These provisions include:

        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 bylaws;
 
        the ability of our board to authorize the issuance of up to 2,000,000 shares of blank check preferred stock; and
 
        the requirement that only our board or the holders of at least 10% of our outstanding shares may call a special meeting of our stockholders.

     Furthermore, because we are incorporated in Delaware, we are subject to the provisions of Section 203 of the Delaware General Corporation Law. These provisions prohibit large stockholders, in particular those owning 15% or more of the outstanding voting stock, from consummating a merger or combination with a corporation unless:

        66 2/3% of the shares of voting stock not owned by these large stockholders approve the merger or combination, or
 
        the board of directors approves the merger or combination or the transaction which resulted in the large stockholder owning 15% or more of our outstanding voting stock.

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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 2,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of shares of preferred stock, while potentially providing desirable flexibility in connection with possible acquisitions and for other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. We have no present intention to issue shares of preferred stock. Further, on April 24, 2001, our board of directors adopted a preferred stock purchase rights plan intended to guard against certain takeover tactics. The adoption of this plan was not in response to any proposal to acquire us, and the board is not aware of any such effort. The existence of this plan could also have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. In addition, certain provisions of our certificate of incorporation may have the effect of delaying or preventing a change of control, which could adversely affect the market price of our common stock.

The financial condition of our customers may affect their ability to pay amounts owed to us.

     Many of our customers are facing business downturns that have reduced their cash balances and their prospects. We frequently allow our customers to pay for products we ship to them within 30 to 90 days after delivery. Subsequent to our shipping a product some customers have been unable to make payments as due, reducing our cash balances and causing us to incur charges to allow for a possibility that some accounts might not be paid. At least one customer that owed us a significant amount has filed for bankruptcy protection and we are unlikely to receive a substantial portion of the amount owed to us as part of a bankruptcy settlement. Other customers may also be forced to file for bankruptcy. If our customers do not pay their accounts when due, we will be required to incur charges that would reduce our earnings.

27Legislative actions, higher insurance cost and potential new accounting pronouncements are likely to cause our general and administrative expenses to increase and impact our future financial position and results of operations.

     In order to comply with the newly adopted Sarbanes-Oxley Act of 2002, as well as proposed changes to listing standards by Nasdaq, and proposed accounting changes by the Securities and Exchange Commission, we may be required to increase our internal controls, hire additional personnel and additional outside legal, accounting and advisory services, all of which will cause our general and administrative costs to increase. Insurers are also likely to increase premiums as a result of the high claims rates incurred over the past year, and so our premiums for our various insurance policies, including our directors’ and officers’ insurance policies, are likely to increase. Proposed changes in the accounting rules, including legislative and other proposals to account for employee stock options as a compensation expense among others, could materially increase the expense that we report under generally accepted accounting principles and adversely affect our operating results.

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Item 3.3.  Qualitative and Quantitative Disclosures About Market Risk

Foreign Currency Risk

     Since our Japanese and some Taiwanese invoices are denominated in Japanese yen, doing business in Japan subjects usWe use short-term forward exchange contracts for hedging purposes to fluctuations inreduce the effects of adverse foreign exchange rates between the U.S. dollar and the Japanese yen.rate movements. We incurred a foreign transaction exchange gain of $40,000 for the three months ended March 31, 2002 and a loss of $223,000 for the three months ended March 31, 2001. We purchasehave purchased foreign exchange contracts to hedge against certain trade accounts receivable denominated in Japanese yen. Under theseThe change in the fair value of the forward contracts increases or decreasesis recognized as part of the related foreign currency transactions as they occur. Because the effect of movements in currency commitmentsexchange rates on forward exchange and balance sheet positions, as translated into U.S. dollars,currency options contracts generally offset the related effect of the underlying items being hedged, these financial instruments are primarily offset by realized gains or losses on the hedging contracts. Thenot expected to subject AXT to risks that would otherwise result from changes in currency exchange rates. As of June 30, 2002, our outstanding commitments with respect to suchthe foreign exchange contracts, which were commitments to sell Japanese yen, had a total contract value of approximately $4.7 million as$3.7 million.

     We incurred foreign transaction exchange losses of March 31, 2002. Many of$83,540 and $43,197 for the contracts were entered intothree and six months prior toended June 30, 2002 respectively and losses of $86,500 and $309,750 for the due datethree and the dates coincide with the receivable terms on customer invoices. By matching the receivable collection date and contract due date, we attempt to economically minimize the impact of foreign exchange fluctuations.six months ended June 30, 2001 respectively.

Interest Rate Risk

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

                    
Instrument Balance Current Current Proforma Proforma

 March 31, Interest Interest 10% Interest 10% Interest            
 2002 Rate Income/ Rate Decline Rate Increase Current Proforma Proforma
 
 
 (Expense) Income/(Expense) Income/(Expense) Balance Current Interest 10% Interest 10% Interest
 June 30, Interest Income/ Rate Decline Rate Increase
Instrument 2002 Rate (Expense) Income/(Expense) Income/(Expense)
 
 
 
 
 
 
 
 
Cash and cash equivalents $37,745  2.00% $755 $679 $830  $25,116  2.01% $505 $454 $555 
Bonds 9,550  1.96%  (187)  (168)  (206) 9,385  1.97%  (185)  (166)  (203)
Notes 4,990  6.02%  (300)  (270)  (330) 4,795  5.78%  (277)  (249)  (305)
 
 
 
  
 
 
 
 $267 $241 $294  $43 $39 $47 
 
 
 
  
 
 
 

Equity Risk

     We also maintain minority investments in private and publicly traded companies. These investments are reviewed for other than temporary declines in value on a quarterly basis. Reasons for other than temporary declines in value include whether the related company would have insufficient cash flow to operate for the next twelve months, significant changes in the operating performance and changes in market conditions. Investments in publicly traded companies are carried at fair market value based on quoted market prices of the investments as of June 30, 2002. These investments are subject to market risk of equity price changes. As of March 31,June 30, 2002, the minority investments we continue to hold totaled $12.8$6.6 million at estimated fair value.value of which investments in publicly traded companies was $2.8 million and investments in private companies was $3.4 million.

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PART II  OTHER INFORMATION

Item 1.  Legal Proceedings

     From time to time the Company iswe may be involved in litigation in the normal course of business. Management believes that the outcome of matters to date will not have a material adverse effect on the Company’sour financial position or results of operations.operations or cash flows.

     On May 1, 2001, the Santa Clara Center for Occupational Safety and Health filed a complaint for injunctive relief and civil penalties against AXTus in the Superior Court of California, County of Alameda, Hayward Division, Case No. H218237-5. The complaint alleges violations of California Business and Professions Code section 17200 et seq., and violations under Proposition 65 and California Health and Safety Code section 25249 et seq. as a result of AXT’s use of arsenic and inorganic arsenic compounds in its workplace. The complaint seeks injunctive relief, an order requiring the Company to set up and pay for a medical surveillance program for individuals exposed to arsenic compounds, an order requiring the Company provide warnings, information and training to workers exposed to arsenic compounds, and for civil penalties and attorneys fees. Mediation has been scheduled forOn June 24, 2002, andwe participated in a trial date of October 25, 2002 has been set. We believe that we have meritorious defenses against the alleged claims,private mediation, and intend to defend ourselves vigorously. However, due to the nature of litigation and fact that the case is still in its early stages, we cannot determine the possible loss, if any, that may ultimately be incurred either in the context of a trial or as a result, reached a settlement of all claims, pursuant to which we agreed to pay the Santa Clara Center for Occupational Safety and Health an amount equal to $175,000. The parties have executed a negotiated settlement. We may also incur substantial legal fees in this matter. However, we do not believesettlement agreement, but that this action is likely to have a material adverse effect on our business, financial condition or resultsagreement requires approval of operation.both the Attorney General of California and the forum court. These approvals are pending.

Item 2. Changes in Securities and Use of Proceeds

     None

Item 3.  Defaults upon Senior Securities

         None
     None

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

     AXT held its annual meeting of stockholders at its headquarters in Fremont, California on May 21, 2002. Of the 22,432,192 shares outstanding as of the record date, 18,771,934 shares were represented by proxy at the meeting. Proxies were solicited by the Company pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended. At the meeting, AXT’s stockholders voted on the following matters:

                None(1)Proposal to elect two class I directors to hold office for a three-year term and until their successors are elected and qualified.

         
  For Withheld
  
 
Morris S. Young  16,858,444   1,913,490 
David C. Chang  18,759,687   12,247 

(2)Proposal to ratify the selection of PricewaterhouseCoopers LLP as our independent auditors for the fiscal year ending December 31, 2002.

         
For Against Abstain

 
 
18,762,697  3,513   5,724 

Item 5.  Other Information

         None
     None

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Item 6.  Exhibits and reports on Form 8-K

a. Exhibits

a.Exhibits

  None3.1(1)Restated Certificate of Incorporation
3.2(2)Certificate of Designation, Preferences and Rights of Series A Preferred Stock, as filed with the Secretary of State of the state of Delaware on May 27, 1999 (which is incorporated herein by reference to Exhibit 2.1 to the registrant’s Form 8-K dated May 28, 1999)
3.3(3)Second Amended and Restated Bylaws
4.1(4)Registration Rights Agreement dated as of May 27, 1999, by and among American Xtal Technology, Inc., Lyte Optronics, Inc. and Keith Halsey and Robert Shih
4.2(3)Rights Agreement dated as of April 24, 2001, by and between AXT, Inc. and Computershare Trust Company
99.1Certification by Chief Executive Officer
99.2Certification by Chief Financial Officer


(1)As filed with the SEC in our Annual Report on Form 10-K for the year ended December 31, 1998.
(2)As filed with the SEC in our Form 8-K on June 14, 1999.
(3)As filed with the SEC in our Form 8-K on May 30, 2001.
(4)As filed with the SEC in our Annual Report on Form 10-K for the year ended December 31, 1999.

b.      Reports on Form 8-K

         None
          On May 31, 2002, we filed a report on Form 8-K reporting certain asset impairment charges.

2934


SIGNATURES

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

AXT, INC.

     
AXT, INC.
 
Dated: May 3,August 14, 2002 By: By:          /s//s/ Morris S. Young
            Morris S. Young
Chief Executive Officer
    
Dated:  May 3, 2002By:       /s/            Donald L. Tatzin       
            Donald L. Tatzin
  Chief Financial Officer
    Morris S. Young
Chief Executive Officer
 
Dated: May 3,August 14, 2002 By:/s/ Donald L. Tatzin
  By:      /s/                     John Drury         
  Donald L. Tatzin
Chief Financial Officer
Dated: August 14, 2002By:/s/ John E. Drury

John E. Drury
Corporate Controller

3035


EXHIBIT INDEX

Exhibit
Number

Description

3.1(1)Restated Certificate of Incorporation
3.2(2)Certificate of Designation, Preferences and Rights of Series A Preferred Stock, as filed with the Secretary of State of the state of Delaware on May 27, 1999 (which is incorporated herein by reference to Exhibit 2.1 to the registrant’s Form 8-K dated May 28, 1999)
3.3(3)Second Amended and Restated Bylaws
4.1(4)Registration Rights Agreement dated as of May 27, 1999, by and among American Xtal Technology, Inc., Lyte Optronics, Inc. and Keith Halsey and Robert Shih
4.2(3)Rights Agreement dated as of April 24, 2001, by and between AXT, Inc. and Computershare Trust Company
99.1Certification by Chief Executive Officer
99.2Certification by Chief Financial Officer


(1)As filed with the SEC in our Annual Report on Form 10-K for the year ended December 31, 1998.
(2)As filed with the SEC in our Form 8-K on June 14, 1999.
(3)As filed with the SEC in our Form 8-K on May 30, 2001.
(4)As filed with the SEC in our Annual Report on Form 10-K for the year ended December 31, 1999.