UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC. 20549

FORM 10-Q

(Mark One)

(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

[   ]		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.

4281 Technology Drive, Fremont, California 94538

(510) 683-5900

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   YES  [X]      NO  [   ]

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

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AXT, INC.

TABLE OF CONTENTS

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AXT, INC.

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

AXT, INC.

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

See accompanying notes to these unaudited condensed consolidated financial statements.

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AXT, INC.

AXT, INC.

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

See accompanying notes to these unaudited condensed consolidated financial statements.

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AXT, INC.

AXT, INC.

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

See accompanying notes to these unaudited condensed consolidated financial statements.

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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.

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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):

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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):

         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.

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     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):

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Note 6.7.  Comprehensive Income

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

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.

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

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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):

Note 8.9.  Corporate Affiliates

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

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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):

     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

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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 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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