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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC. 20549




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FORM 10-Q


|           |  |                                                                                                                                           
|---------- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                                                                           
|x          |  | Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the quarterly 
period ended September 30, 2003
|           |  |                                                                                                                                           
|or         |  |                                                                                                                                           
|o          |  | Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the transition
period from______to_________  

Commission File Number 0-24085




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AXT, INC.

(Exact name of registrant as specified in its charter)


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

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

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




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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.

YES x       NO o

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

YES o      NO x

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

|                              |  |                                   |            | 
|----------------------------- |  | --------------------------------- | ---------- | 
|Class                         |  | Outstanding at September 30, 2003
|                              |  |                                  
|Common Stock, $.001 par value |  |                                   | 22,931,338 | 



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TABLE OF CONTENTS



|                              |                                                                                               |                                                      |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | Item 1. Financial Statements                                                                 
|                              |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF INCOME         
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                              |                                                                                               | 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                           
|                              | Item 4. Controls and Procedures                                                              
|PART II OTHER INFORMATION    
|                              | Item 1. Legal Proceedings                                                                    
|                              | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                   
|INDEX TO EXHIBITS            
|EXHIBIT 10.16                
|EXHIBIT 31.1                 
|EXHIBIT 31.2                 
|EXHIBIT 32.1                 
|EXHIBIT 32.2                 



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##### Table of Contents



AXT, INC.

TABLE OF CONTENTS

|                              |  |         |  |                                                                                       |  |                                                                                                             |       |      |      | 
|----------------------------- |  | ------- |  | ------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------- | ----- | ---- | ---- | 
|                              |  |         |  |                                                                                       |  |                                                                                                             |       | Page
|PART
I. FINANCIAL INFORMATION
|                              |  | Item 1. |  | Financial Statements                                                                  |  |                                                                                                             |       |     
|                              |  |         |  |                                                                                       |  | Condensed Consolidated Balance Sheets at September 30, 2003 and December 31, 2002                           |       |      | 3    | 
|                              |  |         |  |                                                                                       |  | Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2003 and 2002 |       |      | 4    | 
|                              |  |         |  |                                                                                       |  | Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2002       |       |      | 5    | 
|                              |  |         |  |                                                                                       |  | Notes To Condensed Consolidated Financial Statements                                                        |       |      | 6-14 | 
|                              |  | Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  |                                                                                                             | 14-34 |     
|                              |  | Item 3. |  | Quantitative and Qualitative Disclosures About Market Risk                            |  |                                                                                                             | 34    |     
|                              |  | Item 4. |  | Controls and Procedures                                                               |  |                                                                                                             | 34-35 |     
|PART
II. OTHER INFORMATION   
|                              |  | Item 1. |  | Legal Proceedings                                                                     |  |                                                                                                             | 35    |     
|                              |  | Item 6. |  | Exhibits and Reports on Form 8-K                                                      |  |                                                                                                             | 36    |     
|                              |  |         |  |                                                                                       |  | Signatures                                                                                                  |       |      | 37   | 
|                              |  |         |  |                                                                                       |  | Exhibits                                                                                                    |       |      |      | 

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##### Table of Contents






PART I. FINANCIAL INFORMATION




Item 1. Financial Statements




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

|                                      |                               |                                                                                                                    |                            |        |              |         |              |        |         |         | 
|------------------------------------- | ----------------------------- | ------------------------------------------------------------------------------------------------------------------ | -------------------------- | ------ | ------------ | ------- | ------------ | ------ | ------- | ------- | 
|                                      |                               |                                                                                                                    |                            |        | September 30 |         | December 31,
|                                      |                               |                                                                                                                    |                            |        | 2003         |         | 2002        
|                                      |                               |                                                                                                                    |                            |        |              |         |             
|                                      |                               |                                                                                                                    |                            |        | (Unaudited)  |         |              |        |        
|Assets:                               |                               |                                                                                                                    |                            |        |              |         |              |       
|                                      | Current assets                |                                                                                                                    |                            |        |              |         |              |        |        
|                                      |                               | Cash and cash equivalents                                                                                          |                            | $      | 21,486       |         |              | $      | 13,797  |        
|                                      |                               | Short-term investments                                                                                             |                            |        | 14,010       |         |              |        | 8,205   |        
|                                      |                               | Accounts receivable                                                                                                |                            |        | 4,953        |         |              |        | 7,195   |        
|                                      |                               | Inventories                                                                                                        |                            |        | 26,095       |         |              |        | 37,598  |        
|                                      |                               | Prepaid expenses and other current assets                                                                          |                            |        | 1,804        |         |              |        | 4,002   |        
|                                      |                               | Income tax receivable                                                                                              |                            |        | 72           |         |              |        | 8,783   |        
|                                      |                               | Assets held for sale                                                                                               |                            |        | 1,000        |         |              |        | 5,957   |        
|                                      |                               |                                                                                                                    |                            |        |              |         |              |        |        
|                                      |                               |                                                                                                                    | Total current assets       |        |              | 69,420  |              |        |         | 85,537  | 
|                                      | Property, plant and equipment |                                                                                                                    |                            | 22,730 |              |         |              | 39,982 |        
|                                      | Other assets                  |                                                                                                                    |                            | 4,773  |              |         |              | 5,341  |        
|                                      | Restricted deposits           |                                                                                                                    |                            | 9,402  |              |         |              | 11,150 |        
|                                      | Long-term investments         |                                                                                                                    |                            | 2,406  |              |         |              | 3,657  |        
|                                      |                               |                                                                                                                    |                            |        |              |         |              |        |        
|                                      |                               |                                                                                                                    | Total assets               |        | $            | 108,731 |              |        | $       | 145,667 | 
|                                      |                               |                                                                                                                    |                            |        |              |         |              |        |        
|Liabilities and Stockholders Equity: |                               |                                                                                                                    |                            |        |              |         |              |       
|                                      | Current liabilities           |                                                                                                                    |                            |        |              |         |              |        |        
|                                      |                               | Accounts payable                                                                                                   |                            | $      | 1,899        |         |              | $      | 4,228   |        
|                                      |                               | Accrued liabilities                                                                                                |                            |        | 9,483        |         |              |        | 11,407  |        
|                                      |                               | Current portion of long-term debt                                                                                  |                            |        | 1,765        |         |              |        | 965     |        
|                                      |                               | Current portion of capital lease obligation                                                                        |                            |        |             |         |              |        | 3,562   |        
|                                      |                               |                                                                                                                    |                            |        |              |         |              |        |        
|                                      |                               |                                                                                                                    | Total current liabilities  |        |              | 13,147  |              |        |         | 20,162  | 
|                                      |                               | Long-term debt, net of current portion                                                                             |                            |        | 10,874       |         |              |        | 13,289  |        
|                                      |                               | Long-term capital lease, net of current portion                                                                    |                            |        |             |         |              |        | 4,847   |        
|                                      |                               | Other long-term liabilities                                                                                        |                            |        | 1,583        |         |              |        | 1,712   |        
|                                      |                               |                                                                                                                    |                            |        |              |         |              |        |        
|                                      |                               |                                                                                                                    | Total liabilities          |        |              | 25,604  |              |        |         | 40,010  | 
|                                      |                               |                                                                                                                    |                            |        |              |         |              |        |        
|                                      | Stockholders equity:         |                                                                                                                    |                            |        |              |         |              |        |        
|                                      |                               | Preferred stock, $.001 par value per share; 2,000 shares authorized; 883
shares issued and outstanding             |                            |        | 3,532        |         |              |        | 3,532   |        
|                                      |                               | Common stock, $.001 par value per share; 70,000 shares authorized;
22,931 and 22,495 shares issued and outstanding |                            |        | 154,937      |         |              |        | 154,485 |        
|                                      |                               | Accumulated deficit                                                                                                |                            |        | (76,813      | )       |              |        | (52,197 | )      
|                                      |                               | Other comprehensive income (loss)                                                                                  |                            |        | 1,471        |         |              |        | (163    | )      
|                                      |                               |                                                                                                                    |                            |        |              |         |              |        |        
|                                      |                               |                                                                                                                    | Total stockholders equity |        |              | 83,127  |              |        |         | 105,657 | 
|                                      |                               |                                                                                                                    |                            |        |              |         |              |        |        
|                                      |                               | Total liabilities and stockholders equity                                                                         |                            | $      | 108,731      |         |              | $      | 145,667 |        
|                                      |                               |                                                                                                                    |                            |        |              |         |              |        |        

See accompanying notes to these unaudited condensed consolidated financial statements.

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AXT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In thousands, except per share data)

|                                          |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |         |        | 
|----------------------------------------- | --------------------------------------------- | ------------------------ | ------ | ------------------ | ----- | ----------------- | ------- | ------- | ----- | ---- | ------- | ------ | ----- | - | ------- | ------- | ------ | 
|                                          |                                               |                          |        | Three Months Ended |       | Nine Months Ended
|                                          |                                               |                          |        | September 30,      |       | September 30,    
|                                          |                                               |                          |        | 2003               |       | 2002              |         | 2003    |       | 2002
|                                          |                                               |                          |        |                    |       |                   |         |         |       |     
|Revenue                                   |                                               | $                        | 8,529  |                    |       | $                 | 11,726  |         |       | $    | 25,583  |        |       | $ | 36,362  |        
|Cost of revenue                           |                                               |                          | 8,029  |                    |       |                   | 12,885  |         |       |      | 24,135  |        |       |   | 35,505  |        
|                                          |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |        
|Gross profit                              |                                               |                          | 500    |                    |       |                   | (1,159  | )       |       |      | 1,448   |        |       |   | 857     |        
|Operating expenses:                       |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |        
|                                          | Selling, general and administrative           |                          |        | 2,654              |       |                   |         | 3,495   |       |      |         | 7,973  |       |   |         | 11,108  |       
|                                          | Research and development                      |                          |        | 301                |       |                   |         | 486     |       |      |         | 1,048  |       |   |         | 1,742   |       
|                                          | Property, plant and equipment impairment loss |                          |        |                   |       |                   |         | 542     |       |      |         |       |       |   |         | 14,632  |       
|                                          |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |        
|                                          |                                               | Total operating expenses |        |                    | 2,955 |                   |         |         | 4,523 |      |         |        | 9,021 |   |         |         | 27,482 | 
|                                          |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |        
|Loss from operations                      |                                               |                          | (2,455 | )                  |       |                   | (5,682  | )       |       |      | (7,573  | )      |       |   | (26,625 | )      
|Interest expense                          |                                               |                          | 145    |                    |       |                   | 105     |         |       |      | 368     |        |       |   | 362     |        
|Other (income)/expense, net               |                                               |                          | (3     | )                  |       |                   | (308    | )       |       |      | 1,035   |        |       |   | 8,183   |        
|                                          |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |        
|Loss before income tax benefit            |                                               |                          | (2,597 | )                  |       |                   | (5,479  | )       |       |      | (8,976  | )      |       |   | (35,170 | )      
|Income tax provision                      |                                               |                          |       |                    |       |                   | 10,673  |         |       |      |        |        |       |   | 4,433   |        
|                                          |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |        
|Loss from continuing operations           |                                               |                          | (2,597 | )                  |       |                   | (16,152 | )       |       |      | (8,976  | )      |       |   | (39,603 | )      
|Discontinued operations:                  |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |        
|                                          | Loss from operations                          |                          |        | (1,591             | )     |                   |         | (19,533 | )     |      |         | (6,165 | )     |   |         | (32,149 | )     
|                                          | Gain /(loss) on disposal                      |                          |        | 1,625              |       |                   |         |        |       |      |         | (9,475 | )     |   |         |        |       
|                                          | Income tax (benefit)                          |                          |        |                   |       |                   |         | (7,012  | )     |      |         |       |       |   |         | (8,103  | )     
|                                          |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |        
|Gain /(loss) from discontinued operations |                                               |                          | 34     |                    |       |                   | (12,521 | )       |       |      | (15,640 | )      |       |   | (24,046 | )      
|                                          |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |        
|Net loss                                  |                                               | $                        | (2,563 | )                  |       | $                 | (28,673 | )       |       | $    | (24,616 | )      |       | $ | (63,649 | )      
|                                          |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |        
|Basic and diluted loss per share:         |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |        
|                                          | Loss from continuing operations               |                          |        | (0.11              | )     |                   |         | (0.72   | )     |      |         | (0.39  | )     |   |         | (1.76   | )     
|                                          | Loss from discontinued operations             |                          |        | 0.00               |       |                   |         | (0.56   | )     |      |         | (0.69  | )     |   |         | (1.07   | )     
|                                          | Net loss                                      |                          |        | (0.11              | )     |                   |         | (1.28   | )     |      |         | (1.08  | )     |   |         | (2.84   | )     
|Shares used in per share calculations:    |                                               |                          |        |                    |       |                   |         |         |       |      |         |        |       |   |         |        
|                                          | Basic                                         |                          |        | 22,857             |       |                   |         | 22,478  |       |      |         | 22,727 |       |   |         | 22,443  |       
|                                          | Diluted                                       |                          |        | 22,857             |       |                   |         | 22,478  |       |      |         | 22,727 |       |   |         | 22,443  |       

See accompanying notes to these unaudited condensed consolidated financial statements.

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AXT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)

|                                                         |                                                                                                 |                                                          |                             |                                                     |        |                   |         |         |        |        |         |  
|-------------------------------------------------------- | ----------------------------------------------------------------------------------------------- | -------------------------------------------------------- | --------------------------- | --------------------------------------------------- | ------ | ----------------- | ------- | ------- | ------ | ------ | ------- | -
|                                                         |                                                                                                 |                                                          |                             |                                                     |        | Nine Months Ended
|                                                         |                                                                                                 |                                                          |                             |                                                     |        | September 30     
|                                                         |                                                                                                 |                                                          |                             |                                                     |        | 2003              |         | 2002   
|                                                         |                                                                                                 |                                                          |                             |                                                     |        |                   |         |        
|CASH FLOWS FROM OPERATING ACTIVITIES:                    |                                                                                                 |                                                          |                             |                                                     |        |                   |         |        
|                                                         | Net loss:                                                                                       |                                                          | $                           | (24,616                                             | )      |                   | $       | (63,649 | )     
|                                                         | Adjustments to reconcile net loss to cash provided by operations:                               |                                                          |                             |                                                     |        |                   |         |         |       
|                                                         |                                                                                                 | Depreciation                                             |                             |                                                     | 4,583  |                   |         |         | 7,498  |       
|                                                         |                                                                                                 | Amortization                                             |                             |                                                     | 279    |                   |         |         | 299    |       
|                                                         |                                                                                                 | Deferred income taxes                                    |                             |                                                     |       |                   |         |         | 3,259  |       
|                                                         |                                                                                                 | Loss on disposal                                         |                             |                                                     | 9,475  |                   |         |         |       |       
|                                                         |                                                                                                 | Impairment write-down on investments                     |                             |                                                     |       |                   |         |         | 9,160  |       
|                                                         |                                                                                                 | Impairment write-down on property, plant and equipment   |                             |                                                     |       |                   |         |         | 39,086 |       
|                                                         |                                                                                                 | Non-cash (gain)\loss on marketable equity securities     |                             |                                                     | 1,320  |                   |         |         | (251   | )     
|                                                         |                                                                                                 | (Gain) loss on disposal of property, plant and equipment |                             |                                                     | (11    | )                 |         |         | 323    |       
|                                                         |                                                                                                 | Stock based compensation                                 |                             |                                                     | 28     |                   |         |         |       |       
|                                                         |                                                                                                 | Changes in assets and liabilities:                       |                             |                                                     |        |                   |         |         |        |       
|                                                         |                                                                                                 |                                                          | Accounts receivable         |                                                     |        | 1,576             |         |         |        | 3,816  |        
|                                                         |                                                                                                 |                                                          | Inventories                 |                                                     |        | 9,529             |         |         |        | 5,017  |        
|                                                         |                                                                                                 |                                                          | Prepaid expenses            |                                                     |        | 1,988             |         |         |        | (2,341 | )      
|                                                         |                                                                                                 |                                                          | Other assets                |                                                     |        | (139              | )       |         |        | (125   | )      
|                                                         |                                                                                                 |                                                          | Accounts payable            |                                                     |        | (2,329            | )       |         |        | 1,959  |        
|                                                         |                                                                                                 |                                                          | Accrued liabilities         |                                                     |        | (4,306            | )       |         |        | (3,336 | )      
|                                                         |                                                                                                 |                                                          | Income taxes                |                                                     |        | 8,711             |         |         |        | (5,031 | )      
|                                                         |                                                                                                 |                                                          | Other long-term liabilities |                                                     |        | (129              | )       |         |        | 294    |        
|                                                         |                                                                                                 |                                                          |                             |                                                     |        |                   |         |         |       
|                                                         |                                                                                                 |                                                          |                             | Net cash provided by (used in) operating activities |        |                   | 5,959   |         |        |        | (4,022  | )
|                                                         |                                                                                                 |                                                          |                             |                                                     |        |                   |         |         |       
|CASH FLOWS FROM INVESTING ACTIVITIES:                    |                                                                                                 |                                                          |                             |                                                     |        |                   |         |        
|                                                         | Purchases
of property, plant and equipment                                                      |                                                          |                             | (1,911                                              | )      |                   |         | (10,412 | )     
|                                                         | Proceeds from sale of property, plant and equipment from discontinued opto-electronics
business |                                                          |                             | 9,600                                               |        |                   |         |        |       
|                                                         | Proceeds
from sale of property located in Fremont, California                                   |                                                          |                             | 5,172                                               |        |                   |         |         |       
|                                                         | Purchases of marketable securities                                                              |                                                          |                             | (3,305                                              | )      |                   |         | (16,366 | )     
|                                                         | Proceeds from sale of marketable securities                                                     |                                                          |                             | 5,700                                               |        |                   |         | 15,570  |       
|                                                         | Increase in restricted cash                                                                     |                                                          |                             | (4,012                                              | )      |                   |         |        |       
|                                                         |                                                                                                 |                                                          |                             |                                                     |        |                   |         |         |       
|                                                         |                                                                                                 |                                                          |                             | Net cash provided by (used in) investing activities |        |                   | 11,244  |         |        |        | (11,208 | )
|                                                         |                                                                                                 |                                                          |                             |                                                     |        |                   |         |         |       
|CASH FLOWS FROM FINANCING ACTIVITIES:                    |                                                                                                 |                                                          |                             |                                                     |        |                   |         |        
|                                                         | Proceeds from (payments of):                                                                    |                                                          |                             |                                                     |        |                   |         |         |       
|                                                         |                                                                                                 | Issuance of common stock                                 |                             |                                                     | 424    |                   |         |         | 850    |       
|                                                         |                                                                                                 | Capital leases payments                                  |                             |                                                     | (8,409 | )                 |         |         | (4,620 | )     
|                                                         |                                                                                                 | Long-term debt borrowings                                |                             |                                                     |       |                   |         |         | 637    |       
|                                                         |                                                                                                 | Long-term debt payments                                  |                             |                                                     | (1,615 | )                 |         |         | (6,699 | )     
|                                                         |                                                                                                 |                                                          |                             |                                                     |        |                   |         |         |       
|                                                         |                                                                                                 |                                                          |                             | Net cash used in financing activities               |        |                   | (9,600  | )       |        |        | (9,832  | )
|Effect of exchange rate changes                          |                                                                                                 |                                                          | 86                          |                                                     |        |                   | 171     |        
|                                                         |                                                                                                 |                                                          |                             |                                                     |        |                   |         |         |       
|Net increase (decrease) in cash and cash equivalents     |                                                                                                 |                                                          | 7,689                       |                                                     |        |                   | (24,891 | )      
|Cash and cash equivalents at the beginning of the period |                                                                                                 |                                                          | 13,797                      |                                                     |        |                   | 37,538  |        
|                                                         |                                                                                                 |                                                          |                             |                                                     |        |                   |         |         |       
|Cash and cash equivalents at the end of the period       |                                                                                                 | $                                                        | 21,486                      |                                                     |        | $                 | 12,647  |        
|                                                         |                                                                                                 |                                                          |                             |                                                     |        |                   |         |         |       
|Non cash activity:                                       |                                                                                                 |                                                          |                             |                                                     |        |                   |         |        
|                                                         | Purchase of PP&E through financing                                                              |                                                          | $                           |                                                    |        |                   | $       | 577     |       
|                                                         |                                                                                                 |                                                          |                             |                                                     |        |                   |         |         |       

See accompanying notes to these unaudited condensed consolidated financial statements.

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AXT, INC.




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

The accompanying condensed consolidated balance sheets as of September 30,
2003 and December 31, 2002, the condensed consolidated statements of income for
the three and nine months ended September 30, 2003 and 2002, and the condensed
consolidated statements of cash flows for the nine months ended September 30,
2003 and 2002 have been prepared by AXT, Inc. (AXT or the Company) and are
unaudited. The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with generally accepted accounting
principles and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, certain information and footnote disclosure normally included
in financial statements prepared in accordance with generally accepted
accounting principles 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 and its subsidiaries for all
periods presented.

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 2002 Annual Report on Form 10-K filed with the Securities and Exchange
Commission on March 21, 2003.

As a result of the significant revenue declines experienced over the past
eight quarters, the Company has taken cost reduction measures and continues to
pursue additional alternatives to reduce costs and increase cash flows. At
September 30, 2003, the Company had available cash, cash equivalents and liquid
short and long-term investments of $35.2 million. The Company believes that
its existing cash and liquid investments, cash generated from operations,
coupled with additional efforts to reduce expenditures in support of the
continuing substrate business will be sufficient to meet working capital
expenditure requirements for the next 12 months. However, existing cash and
liquid investments could decline during the remainder of 2003 due to a
continued or further weakening of the economy or changes in our planned cash
outlay.

If the Companys sales continue to decrease, the ability to generate cash
from operations will be adversely affected which could impact its future
liquidity, requiring it to use cash at a more rapid rate than expected, and
require it to seek additional capital. There can be no assurance that such
additional capital will be available or, if available, on terms acceptable to
the Company.

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

Note 2. Discontinued Operations

On June 24, 2003, the Companys Board of Directors approved managements
plan to exit the Companys unprofitable opto-electronics business. On
September 27, 2003 the Company completed a sale of substantially all of the
assets of its opto-electronics business to Lumei-Optoelectronics, Corporation
and Dalian Luming Science and Technology Group, Co., Ltd. for the RMB
equivalent of $9.6 million. The company retains a building located in Monterey
Park, CA, that it expects to sell in 2004. This asset is classified as Held
for Sale on the Companys consolidated balance sheet at September 30, 2003.
One million dollars of the sale proceeds will be held in escrow for up to one year and
accordingly, has been excluded from the determination of gain/(loss)
on disposal.

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The Company recorded a gain on disposal of $1.6 million due to excess
proceeds received over net carrying value of assets sold.

The Companys financial statements have been presented to reflect the
opto-electronics business as a discontinued operation for all periods
presented. Operating results of the discontinued operation are as follows:

|                                                          |                                     |                          |        |                    |     |                   |         |        |        |      |         |       |       |  |         |        |        | 
|--------------------------------------------------------- | ----------------------------------- | ------------------------ | ------ | ------------------ | --- | ----------------- | ------- | ------ | ------ | ---- | ------- | ----- | ----- |  | ------- | ------ | ------ | 
|                                                          |                                     |                          |        | Three months ended |     | Nine months ended
|                                                          |                                     |                          |        | September 30,      |     | September 30,    
|                                                          |                                     |                          |        |                    |     |                  
|                                                          |                                     |                          |        | 2003               |     | 2002              |         | 2003   |        | 2002
|                                                          |                                     |                          |        |                    |     |                   |         |        |        |     
|Revenue                                                   |                                     |                          | 227    |                    |     |                   | 3,222   |        |        |      | 7,246   |       |       |  | 14,557  |       
|Cost of revenue                                           |                                     |                          | 854    |                    |     |                   | 5,606   |        |        |      | 9,973   |       |       |  | 15,736  |       
|                                                          |                                     |                          |        |                    |     |                   |         |        |        |      |         |       |       |  |         |       
|Gross profit (loss)                                       |                                     |                          | (627   | )                  |     |                   | (2,384  | )      |        |      | (2,727  | )     |       |  | (1,179  | )     
|Operating expenses:                                       |                                     |                          |        |                    |     |                   |         |        |        |      |         |       |       |  |         |       
|                                                          | Selling, general and administrative |                          |        | 761                |     |                   |         | 1,498  |        |      |         | 2,297 |       |  |         | 3,745  |       
|                                                          | Research and development            |                          |        | 107                |     |                   |         | 822    |        |      |         | 814   |       |  |         | 2,014  |       
|                                                          | Impairment costs                    |                          |        |                   |     |                   |         | 14,565 |        |      |         |      |       |  |         | 24,454 |       
|                                                          |                                     |                          |        |                    |     |                   |         |        |        |      |         |       |       |  |         |       
|                                                          |                                     | Total operating expenses |        |                    | 868 |                   |         |        | 16,885 |      |         |       | 3,111 |  |         |        | 30,213 | 
|                                                          |                                     |                          |        |                    |     |                   |         |        |        |      |         |       |       |  |         |       
|Loss from operations                                      |                                     |                          | (1,495 | )                  |     |                   | (19,269 | )      |        |      | (5,838  | )     |       |  | (31,392 | )     
|Interest expense                                          |                                     |                          | 96     |                    |     |                   | 264     |        |        |      | 327     |       |       |  | 757     |       
|                                                          |                                     |                          |        |                    |     |                   |         |        |        |      |         |       |       |  |         |       
|Loss before benefit for income taxes and loss on disposal |                                     |                          | (1,591 | )                  |     |                   | (19,533 | )      |        |      | (6,165  | )     |       |  | (32,149 | )     
|Income tax (benefit)                                      |                                     |                          |       |                    |     |                   | (7,012  | )      |        |      |        |       |       |  | (8,103  | )     
|Gain/(loss) on disposal                                   |                                     |                          | 1,625  |                    |     |                   |        |        |        |      | (9,475  | )     |       |  |        |       
|                                                          |                                     |                          |        |                    |     |                   |         |        |        |      |         |       |       |  |         |       
|Net income/(loss)                                         |                                     |                          | 34     |                    |     |                   | (12,521 | )      |        |      | (15,640 | )     |       |  | (24,046 | )     
|                                                          |                                     |                          |        |                    |     |                   |         |        |        |      |         |       |       |  |         |       

The carrying value of the assets and liabilities of the discontinued
opto-electronics business included in the consolidated balance sheets are as
follows:

|                                 |                          |                      |       |               |       |              |        |       |        | 
|-------------------------------- | ------------------------ | -------------------- | ----- | ------------- | ----- | ------------ | ------ | ----- | ------ | 
|                                 |                          |                      |       | September 30, |       | December 31,
|                                 |                          |                      |       | 2003          |       | 2002        
|                                 |                          |                      |       |               |       |             
|Current assets:                  |                          |                      |       |               |       |              |        |      
|                                 | Cash                     |                      | $     | 352           |       |              | $      | 336   |       
|                                 | Accounts receivable, net |                      |       | 322           |       |              |        | 3,224 |       
|                                 | Inventories              |                      |       |              |       |              |        | 3,439 |       
|                                 | Assets held for sale     |                      |       | 1,000         |       |              |        |      |       
|                                 | Other current assets     |                      |       |              |       |              |        | 2,482 |       
|                                 |                          |                      |       |               |       |              |        |       |       
|                                 |                          | Total current assets |       |               | 1,674 |              |        |       | 9,481  | 
|Property, plant and equipment    |                          |                      |      |               |       |              | 14,854 |      
|Other assets                     |                          |                      | 200   |               |       |              | 200    |      
|                                 |                          |                      |       |               |       |              |        |       |       
|                                 |                          | Total assets         |       | $             | 1,874 |              |        | $     | 24,535 | 
|                                 |                          |                      |       |               |       |              |        |       |       
|Current liabilities:             |                          |                      |       |               |       |              |        |      
|                                 | Accounts payable         |                      | $     | 98            |       |              | $      | 1,975 |       
|                                 | Accrued liabilities      |                      |       | 1,778         |       |              |        | 2,806 |       
|                                 |                          |                      |       |               |       |              |        |       |       
|                                 |                          | Total liabilities    |       |               | 1,876 |              |        |       | 4,781  | 
|Net assets                       |                          |                      | (2    | )             |       |              | 19,754 |      
|                                 |                          |                      |       |               |       |              |        |       |       
|Total liabilities and net assets |                          | $                    | 1,874 |               |       | $            | 24,535 |      
|                                 |                          |                      |       |               |       |              |        |       |       

Assets held for sale, at managements estimated fair value less costs to
sell, totaling $1.0 million at September 30, 2003 consist of a building.

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Note 3. Accounting for Stock Options

The Company records compensation expense for employee stock options based
upon their intrinsic value on the date of grant pursuant to Accounting
Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to
Employees. Because the Company establishes the exercise price based on the
fair market value of the Companys stock at the date of grant, the options have
no intrinsic value upon grant, and therefore no expense is recorded. Each
quarter, the Company reports the potential dilutive impact of stock options in
its diluted earnings per share using the treasury-stock method.
Out-of-the-money stock options (i.e., the average stock price during the period
is below the strike price of the option) are not included in diluted earnings
per share.

As required under Statement of Financial Accounting Standards No. 123
(SFAS 123), Accounting for Stock-Based Compensation, and Statement of
Financial Accounting Standards No. 148 (SFAS 148), Accounting for Stock-Based
Compensation Transition and Disclosure, the pro forma effects of stock-based
compensation on net income and net earnings per common share have been
estimated at the date of grant using the Black-Scholes option-pricing model.

The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options that have no restrictions and are fully
transferable and negotiable in a free trading market. Black-Scholes does not
consider the employment, transfer or vesting restrictions that are inherent in
the Companys employee options. Use of an option valuation model, as required
by SFAS 123, includes highly subjective assumptions based on long-term
predictions, including the expected stock price volatility and average life of
each option grant. Because the Companys employee options have characteristics
significantly different from those of freely traded options, and because
changes in the assumptions underlying the option-pricing model can materially
affect the Companys estimate of the fair value of those options, in the
Companys opinion, the existing valuation models, including Black-Scholes, are
not reliable single measures and may misstate the fair value of the Companys
employee options.

The Company calculated the fair value of each option grant on the date of
grant using the Black-Scholes option pricing model as prescribed by SFAS 123
using the following
assumptions:

|                         |  |                   |       |      |  |  |       |  
|------------------------ |  | ----------------- | ----- | ---- |  |  | ----- | -
|                         |  | Nine Months Ended
|                         |  | September 30,    
|                         |  |                  
|                         |  | 2003              |       | 2002
|                         |  |                   |       |     
|Risk free interest rate  |  |                   | 2.7   | %    |  |  | 3.0   | %
|Expected life (in years) |  |                   | 5.0   |      |  |  | 5.0   |  
|Dividend yield           |  |                   | 0.0   | %    |  |  | 0.0   | %
|Volatility               |  |                   | 117.0 | %    |  |  | 101.0 | %

The weighted average fair value of options as of the date of grant granted
during the nine months ended September 30, 2003 and 2002 were $1.15 and $7.85
respectively.

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Had compensation cost for the Companys options been determined based on
the fair value at the grant dates, as prescribed in SFAS 123 and SFAS 148, the
Companys pro forma net income and net income per share would have been as
summarized below (in thousands except per share data):

|          |                                        |                          |                   |   |                    |        |                   |   |         |        |      |   |         |        |   |   |         |        |  
|--------- | -------------------------------------- | ------------------------ | ----------------- | - | ------------------ | ------ | ----------------- | - | ------- | ------ | ---- | - | ------- | ------ | - | - | ------- | ------ | -
|          |                                        |                          |                   |   | Three Months Ended |        | Nine Months Ended
|          |                                        |                          |                   |   | September 30,      |        | September 30,    
|          |                                        |                          |                   |   |                    |        |                  
|          |                                        |                          |                   |   | 2003               |        | 2002              |   | 2003    |        | 2002
|          |                                        |                          |                   |   |                    |        |                   |   |         |        |     
|Net loss: |                                        |                          |                   |   |                    |        |                   |   |         |        |      |   |         |        |   |  
|          |                                        | As reported              |                   | $ | (2,563             | )      |                   | $ | (28,673 | )      |      | $ | (24,616 | )      |   | $ | (63,649 | )     
|          |                                        | Pro forma option expense |                   |   | (1,996             | )      |                   |   | (2,269  | )      |      |   | (5,562  | )      |   |   | (6,928  | )     
|          |                                        |                          |                   |   |                    |        |                   |   |         |        |      |   |         |        |   |   |         |       
|          |                                        | Pro forma net loss       |                   | $ | (4,559             | )      |                   | $ | (30,942 | )      |      | $ | (30,178 | )      |   | $ | (70,577 | )     
|          | Net loss per share as reported:        |                          |                   |   |                    |        |                   |   |         |        |      |   |         |        |   |   |        
|          |                                        |                          | Basic and diluted |   | $                  | (0.11  | )                 |   | $       | (1.28  | )    |   | $       | (1.08  | ) |   | $       | (2.84  | )
|          | Pro forma net loss:                    |                          |                   |   |                    |        |                   |   |         |        |      |   |         |        |   |   |        
|          |                                        |                          | Basic and diluted |   | $                  | (0.20  | )                 |   | $       | (1.38  | )    |   | $       | (1.33  | ) |   | $       | (3.14  | )
|          | Shares used in per share calculations: |                          |                   |   |                    |        |                   |   |         |        |      |   |         |        |   |   |        
|          |                                        |                          | Basic             |   |                    | 22,857 |                   |   |         | 22,478 |      |   |         | 22,727 |   |   |         | 22,443 |  
|          |                                        |                          | Diluted           |   |                    | 22,857 |                   |   |         | 22,478 |      |   |         | 22,727 |   |   |         | 22,443 |  

Note 4. Asset Held for Sale

During
the fourth quarter of 2002, the Company began to market its property
located at 4281 Technology Drive, Fremont, California, and in
November of 2002, entered into a contract to sell the property to a
third party. On March 11, 2003, the Company completed the sale
of its property located at 4281 Technology Drive, Fremont,
California, for $6.3 million. Net cash proceeds from the sale
were $5.2 million. Under the terms of the sale agreement, the
Company has agreed to lease back the property for a five-year period.
Accordingly, on March 11, 2003, the company signed an operating
lease for 4281 Technology Drive through March 2008. Annual rent
under this operating lease is approximately $600,000.

Note 5. Investments

The Company classifies its investment securities as available-for-sale as
prescribed by Statement of Financial Accounting Standards No. 115 (SFAS 115),
Accounting for Certain Investments in Debt and Equity Securities. All
investments 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 September
30, 2003 are summarized below (in thousands):

|                            |  |      |        |            |  |             |        |            |  |   |       | 
|--------------------------- |  | ---- | ------ | ---------- |  | ----------- | ------ | ---------- |  | - | ----- | 
|                            |  |      |        |            |  | Aggregate   |        | Unrealized
|Available for sale          |  | Cost |        | Fair value |  | Gain/(loss)
|                            |  |      |        |            |  |            
|Money market                |  | $    | 8,628  |            |  | $           | 8,628  |            |  |   |      | 
|Corporate bonds             |  |      | 13,748 |            |  |             | 13,831 |            |  |   | 83    | 
|Government agency bonds     |  |      | 4,503  |            |  |             | 4,507  |            |  |   | 4     | 
|Corporate equity securities |  |      | 1,115  |            |  |             | 2,688  |            |  |   | 1,573 | 
|                            |  |      |        |            |  |             |        |            |  |   |       | 
|                            |  | $    | 27,994 |            |  | $           | 29,654 |            |  | $ | 1,660 | 
|                            |  |      |        |            |  |             |        |            |  |   |       | 
|Recorded as:                |  |      |        |            |  |             |        |            |  |   |       | 
|Cash equivalents            |  | $    | 8,628  |            |  |             |        |            |  |   |       | 
|Short-term investments      |  |      | 14,010 |            |  |             |        |            |  |   |       | 
|Restricted deposits         |  |      | 4,610  |            |  |             |        |            |  |   |       | 
|Long-term investments       |  |      | 2,406  |            |  |             |        |            |  |   |       | 
|                            |  |      |        |            |  |             |        |            |  |   |       | 
|                            |  | $    | 29,654 |            |  |             |        |            |  |   |       | 
|                            |  |      |        |            |  |             |        |            |  |   |       | 

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Note 6. Inventories

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

|             |                      |   |               |              |      |   |        |        | 
|------------ | -------------------- | - | ------------- | ------------ | ---- | - | ------ | ------ | 
|             |                      |   | September 30, | December 31,
|             |                      |   | 2003          |              | 2002
|             |                      |   |               |              |     
|Inventories: |                      |   |               |              |      |   |        |       
|             | Raw materials, net   |   | $             | 9,190        |      |   | $      | 12,396 | 
|             | Work in process, net |   |               | 12,119       |      |   |        | 16,651 | 
|             | Finished goods, net  |   |               | 4,786        |      |   |        | 8,551  | 
|             |                      |   |               |              |      |   |        |        | 
|             |                      | $ | 26,095        |              |      | $ | 37,598 |       
|             |                      |   |               |              |      |   |        |        | 

Note 7. Net 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 and
common equivalent shares include the dilutive effect of common stock
equivalents outstanding during the period calculated using the treasury stock
method. Common stock equivalents consist of the shares issuable upon the
exercise of stock options.

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 |   | Nine Months Ended
|                                                                                 |                                                                           |                      |        | September 30,      |   | September 30,    
|                                                                                 |                                                                           |                      |        |                    |   |                  
|                                                                                 |                                                                           |                      |        | 2003               |   | 2002              |        | 2003    |   | 2002
|                                                                                 |                                                                           |                      |        |                    |   |                   |        |         |   |     
|Numerator:                                                                       |                                                                           |                      |        |                    |   |                   |        |         |   |      |        |         |   |   |        |        
|                                                                                 | Net loss                                                                  |                      | $      | (2,563             | ) |                   | $      | (28,673 | ) |      | $      | (24,616 | ) |   | $      | (63,649 | )
|                                                                                 | Less: Preferred stock dividends                                           |                      |        | (44                | ) |                   |        | (44     | ) |      |        | (133    | ) |   |        | (133    | )
|                                                                                 | Net loss available to common stockholders                                 |                      | $      | (2,607             | ) |                   | $      | (28,717 | ) |      | $      | (24,749 | ) |   | $      | (63,782 | )
|                                                                                 |                                                                           |                      |        |                    |   |                   |        |         |   |      |        |         |   |   |        |         |  
|Denominator:                                                                     |                                                                           |                      |        |                    |   |                   |        |         |   |      |        |         |   |   |        |        
|                                                                                 | Denominator for basic earnings per share - weighted
average common shares |                      |        | 22,857             |   |                   |        | 22,478  |   |      |        | 22,727  |   |   |        | 22,443  |  
|                                                                                 | Effect of dilutive securities:                                            |                      |        |                    |   |                   |        |         |   |      |        |         |   |   |        |         |  
|                                                                                 |                                                                           | Common stock options |        |                    |  |                   |        |         |  |      |        |         |  |   |        |         |  | 
|                                                                                 |                                                                           |                      |        |                    |   |                   |        |         |   |      |        |         |   |   |        |         |  
|Denominator for dilutive earnings per share                                      |                                                                           |                      | 22,857 |                    |   |                   | 22,478 |         |   |      | 22,727 |         |   |   | 22,443 |        
|                                                                                 |                                                                           |                      |        |                    |   |                   |        |         |   |      |        |         |   |   |        |         |  
|Basic
and diluted net loss per share                                             |                                                                           | $                    | (0.11  | )                  |   | $                 | (1.28  | )       |   | $    | (1.09  | )       |   | $ | (2.84  | )      
|Options excluded from diluted net income per share as
the impact is antidilutive |                                                                           |                      | 2,361  |                    |   |                   | 2,757  |         |   |      | 2,411  |         |   |   | 2,845  |        

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Note 8. Comprehensive Loss

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

|                                                         |  |                    |        |                   |  |      |         |      |  |   |         |   |  |   |         |  
|-------------------------------------------------------- |  | ------------------ | ------ | ----------------- |  | ---- | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                         |  | Three Months Ended |        | Nine Months Ended
|                                                         |  | September 30,      |        | September 30,    
|                                                         |  |                    |        |                  
|                                                         |  | 2003               |        | 2002              |  | 2003 |         | 2002
|                                                         |  |                    |        |                   |  |      |         |     
|Net loss                                                 |  | $                  | (2,563 | )                 |  | $    | (28,673 | )    |  | $ | (24,616 | ) |  | $ | (63,649 | )
|Foreign currency translation gain (loss)                 |  |                    | 131    |                   |  |      | (33     | )    |  |   | 86      |   |  |   | 171     |  
|Unrealized gain (loss) on available for sale investments |  |                    | 871    |                   |  |      | (1,123  | )    |  |   | 1,548   |   |  |   | (1,201  | )
|                                                         |  |                    |        |                   |  |      |         |      |  |   |         |   |  |   |         |  
|Comprehensive loss                                       |  | $                  | (1,561 | )                 |  | $    | (29,829 | )    |  | $ | (22,982 | ) |  | $ | (64,679 | )
|                                                         |  |                    |        |                   |  |      |         |      |  |   |         |   |  |   |         |  

Note 9. Segment Information

The Company has two reportable segments: substrates and discontinued opto-electronics.

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

|                                       |                                      |  |                    |         |                   |  |      |         |      |  |   |         |   |  |   |         |  
|-------------------------------------- | ------------------------------------ |  | ------------------ | ------- | ----------------- |  | ---- | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                       |                                      |  | Three Months Ended |         | Nine Months Ended
|                                       |                                      |  | September 30,      |         | September 30,    
|                                       |                                      |  |                    |         |                  
|                                       |                                      |  | 2003               |         | 2002              |  | 2003 |         | 2002
|                                       |                                      |  |                    |         |                   |  |      |         |     
|Substrates Division                    |                                      |  |                    |         |                   |  |      |         |      |  |   |         |   |  |   |        
|                                       | Net revenues from external customers |  | $                  | 8,529   |                   |  | $    | 11,726  |      |  | $ | 25,583  |   |  | $ | 36,362  |  
|                                       | Gross profit                         |  |                    | 500     |                   |  |      | (1,159  | )    |  |   | 1,448   |   |  |   | 857     |  
|                                       | Operating loss                       |  |                    | (2,455  | )                 |  |      | (5,682  | )    |  |   | (7,573  | ) |  |   | (26,625 | )
|                                       | Identifiable assets                  |  |                    | 106,857 |                   |  |      | 138,776 |      |  |   | 106,857 |   |  |   | 138,776 |  
|Discontinued Opto-electronics Division |                                      |  |                    |         |                   |  |      |         |      |  |   |         |   |  |   |        
|                                       | Identifiable assets                  |  | $                  | 1,874   |                   |  | $    | 24,158  |      |  | $ | 1,874   |   |  | $ | 24,158  |  
|Total                                  |                                      |  |                    |         |                   |  |      |         |      |  |   |         |   |  |   |        
|                                       | Net revenues from external customers |  | $                  | 8,529   |                   |  | $    | 11,726  |      |  | $ | 25,583  |   |  | $ | 36,362  |  
|                                       | Gross profit (loss)                  |  |                    | 500     |                   |  |      | (1,159  | )    |  |   | 1,448   |   |  |   | 857     |  
|                                       | Operating loss                       |  |                    | (2,455  | )                 |  |      | (5,682  | )    |  |   | (7,573  | ) |  |   | (26,625 | )
|                                       | Identifiable assets                  |  |                    | 108,731 |                   |  |      | 162,934 |      |  |   | 108,731 |   |  |   | 162,934 |  

The Company sells its substrates to customers located in the United States
and in other parts of the world. In addition, the Company maintains operations
in Japan and China. Revenues from continuing operations by geographic location
based on the country in which the customer is located were as follows (in
thousands):

|              |                        |  |                    |       |                   |  |      |        |      |  |   |        |  |  |   |        | 
|------------- | ---------------------- |  | ------------------ | ----- | ----------------- |  | ---- | ------ | ---- |  | - | ------ |  |  | - | ------ | 
|              |                        |  | Three Months Ended |       | Nine Months Ended
|              |                        |  | September 30,      |       | September 30,    
|              |                        |  |                    |       |                  
|              |                        |  | 2003               |       | 2002              |  | 2003 |        | 2002
|              |                        |  |                    |       |                   |  |      |        |     
|Net revenues: |                        |  |                    |       |                   |  |      |        |      |  |   |        |  |  |   |       
|              | United States          |  | $                  | 3,030 |                   |  | $    | 6,232  |      |  | $ | 8,947  |  |  | $ | 21,050 | 
|              | Canada                 |  |                    | 40    |                   |  |      | 71     |      |  |   | 147    |  |  |   | 982    | 
|              | Europe                 |  |                    | 1,621 |                   |  |      | 1,549  |      |  |   | 4,661  |  |  |   | 3,990  | 
|              | Japan                  |  |                    | 1,080 |                   |  |      | 1,299  |      |  |   | 2,866  |  |  |   | 2,270  | 
|              | Taiwan                 |  |                    | 1,405 |                   |  |      | 1,436  |      |  |   | 4,549  |  |  |   | 3,267  | 
|              | Asia Pacific and other |  |                    | 1,353 |                   |  |      | 1,139  |      |  |   | 4,413  |  |  |   | 4,803  | 
|              |                        |  |                    |       |                   |  |      |        |      |  |   |        |  |  |   |        | 
|              | Consolidated           |  | $                  | 8,529 |                   |  | $    | 11,726 |      |  | $ | 25,583 |  |  | $ | 36,362 | 
|              |                        |  |                    |       |                   |  |      |        |      |  |   |        |  |  |   |        | 

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Note 10. Corporate Affiliates

The Companys investments in its corporate affiliates are summarized below (in thousands):

|                                               |  |               |     |              |  |            |       |            |  |              |  |  |    |   |  | 
|---------------------------------------------- |  | ------------- | --- | ------------ |  | ---------- | ----- | ---------- |  | ------------ |  |  | -- | - |  | 
|                                               |  | Investment    |     | Investment   |  |            |       |            |  |              |  | 
|                                               |  | Balance       |     | Balance      |  |            |       |            |  |              |  | 
|                                               |  | September 30, |     | December 31, |  | Accounting |       | Ownership 
|Affiliate                                      |  | 2003          |     | 2002         |  | Method     |       | Percentage
|                                               |  |               |     |              |  |            |       |           
|Xilingol Tongli Ge Co. Ltd.                    |  | $             | 794 |              |  | $          | 773   |            |  | Equity       |  |  | 25 | %
|Emeishan Jia Mei High Pure Metals Co., Ltd.    |  |               | 605 |              |  |            | 614   |            |  | Equity       |  |  | 25 | %
|Beijing Ji Ya Semiconductor Material Co., Ltd. |  |               | 959 |              |  |            | 1,071 |            |  | Consolidated |  |  | 51 | %
|Nanjing Jin Mei Gallium Co., Ltd.              |  |               | 510 |              |  |            | 616   |            |  | Consolidated |  |  | 88 | %
|Beijing BoYu Manufacturing Co., Ltd.           |  |               | 409 |              |  |            | 409   |            |  | Consolidated |  |  | 70 | %

The investment balances for those affiliates accounted for under the
equity method are included within Other assets in the consolidated balance
sheets.

Undistributed retained earnings relating to the Companys corporate
affiliates were $739,000 at September 30, 2003 and $986,000 at September 30,
2002. Net loss recorded from the Companys corporate affiliates was $54,000 and
$121,000 for the three and nine months ended September 30, 2003 respectively.
Net income recorded for the Companys corporate affiliates was $25,000 and
$256,000 for the three and nine months ended September 30, 2002 respectively.

The Company invested in these companies because each provides materials
that are important to the Companys substrate business, each can supply
products generally at lower cost than other suppliers, and each has a
market beyond that represented by sales to the Company. At September 30,
2003, the Company had no obligations to make further investments in any of
these companies, although it may choose to do so under certain conditions.

Note 11. Commitments and Contingencies

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, 2003 with a current contract
value of $2.2 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. The
Company has not received any claims for non-performance penalties due to
non-delivery. Partial prepayments received for these supply contracts totaling
$1.1 million are included in accrued liabilities at September 30, 2003. As of
September 30, 2003, the Company has met all of its delivery obligations under
these contracts and expects to do so for the remainder of the contract terms.

In the ordinary course of business, the Company is subject to claims and
litigation, including claims that it infringes third party patents, trademarks
and other intellectual property rights. Although the Company believes that it
is unlikely that any current claims or actions will have a material adverse
impact on its operating results or financial position, given the uncertainty of
litigation, we can not be certain of this. Moreover, the defense of claims or
actions against the Company, even if not meritorious, could result in the
expenditure of significant financial and managerial resources.

On April 15, 2003, Sumitomo Electric Industries, Ltd., (SEI) filed a
complaint in the Tokyo District Court, Civil Division against us and our
Japanese distributor alleging patent infringement of two patents held by SEI in
Japan. The suit seeks penalties from AXT in the amount of $1.67 million plus
interest and court costs and the cessation of AXTs sales of gallium arsenide
substrates in Japan. AXT intends to defend itself vigorously in these lawsuits
and continues to sell its products in Japan.

On June 11, 2003, Cree, Inc. filed a complaint in the United States Court
for Northern District of California against us alleging patent infringement.
The complaint seeks damages and injunction against infringement. On July

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23,
2003, we filed a counter complaint in the United States Court for Northern
District of California, denying any patent infringement and alleging that
Crees actions were intentionally designed to interfere with our prospective
business relationships. A court hearing is scheduled for late February 2004.

Note 12. Recent Accounting Pronouncements

In November 2002, the FASB issued FASB Interpretation No. 45 ( FIN 45 ),
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others.FIN No. 45 requires that a
liability be recorded in the guarantors balance sheet upon issuance of a
guarantee. In addition, FIN No. 45 requires disclosures about the guarantees
that an entity has issued, including a reconciliation of changes in the
entitys product warranty liabilities. The initial recognition and initial
measurement provisions of FIN No. 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002, irrespective of the
guarantors fiscal year-end. The disclosure requirements of FIN No. 45 are
effective for financial statements of interim or annual periods ending after
December 15, 2002. Our adoption of FIN No. 45 did not have a material effect on
our consolidated financial statements.

In January 2003, the FASB issued FASB Interpretation No. 46 ( FIN 46 ),
Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51.
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective immediately for all new variable interest entities created or
acquired after January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, the provisions of FIN 46 must be applied
for the first interim or annual
period beginning after December 15, 2003. Our adoption of FIN No. 46 did not
have a material effect on our consolidated financial statements.

In March 2003, the Emerging Issues Task Force, or EITF, reached a
consensus on EITF Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables. EITF Issue No. 00-21 requires revenue arrangements with multiple
deliverables to be divided into separate units of accounting if the
deliverables in the arrangement meet certain criteria. The arrangements
consideration should be allocated among the separate units of accounting based
on their relative fair values. Applicable revenue recognition criteria should
be considered separately for each unit. The provisions of EITF Issue No. 00-21
are effective for revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. Our adoption of EITF Issue No. 00-21 did not have a
material effect on our consolidated financial statements.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives), and for hedging activities under
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities.
This Statement is effective for contracts entered into or modified after June
30, 2003, and for hedging relationships designated after June 30, 2003. Our
adoption of SFAS No. 149 did not have a material effect on our consolidated
financial statements.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity.
SFAS No. 150 establishes standards for an issuer to classify and measure
certain financial instruments with characteristics of both liabilities and
equity. This Statement requires an issuer to classify a financial instrument
that meets certain characteristics as a liability (or an asset in some
circumstances). This Statement is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. Our
adoption of SFAS No. 150 did not have a material effect on our consolidated
financial statements.

Note 13. Foreign Exchange Contracts and Transaction Gains/Losses

The Company uses short-term forward exchange contracts for hedging
purposes to reduce the effects of adverse foreign exchange rate movements. The
Company has purchased foreign exchange contracts to hedge against

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certain trade
accounts receivable denominated in Japanese yen. The change in the fair value
of the forward contracts is recognized as part of the related foreign currency
transactions as they occur. As of September 30, 2003, the Company had no
outstanding commitments with respect to foreign exchange contracts.

Note 14. Related Party Transactions

Since January 2002, there has not been, nor is there currently proposed,
any transaction or series of similar transactions to which we were or are to be
a party in which the amount involved exceeds $60,000, and in which any
director, executive officer or holder of more than 5% of any class of our
voting securities or members of that persons immediate family had or will have
a direct or indirect material interest other than the transactions described
below.

The Company entered into an operating lease for warehouse space in
Fremont, CA with 4160 Business Center, LLC, a real estate holding company, in
which Davis Zhang, the president of our substrate division, is the sole
shareholder. Lease payments to 4160 Business Center, LLC were approximately
$121,000 for the three months ended March 31, 2003. In April of 2003, Mr.
Zhang sold this warehouse to a party unrelated to the Company. The Company
began leasing this warehouse from the new owner on the date of sale. Mr. Zhang
will continue to hold a $3.7 million note on the property through April 2005.




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 made
pursuant to the provisions of 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, and are subject
to certain risks and uncertainties that could cause actual results to differ
materially from historical results or those anticipated. Such risks and
uncertainties include those set forth under Risks Related to our Business
below. Forward-looking statements may be identified by the use of terms such as
anticipates, believes, estimates, expects,
 intends, and
similar expressions. 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, 2002 and
the condensed consolidated financial statements included elsewhere in this
report.

Overview

We were founded in 1986 to commercialize and enhance our proprietary
vertical gradient freeze (VGF) technique for producing high-performance
compound semiconductor substrates. We currently have two divisions: our
substrate division and our discontinued opto-electronics division. We made our
first substrate sales in 1990 and our substrate division currently sells
gallium arsenide (GaAs) and indium phosphide (InP) substrates to manufacturers
of semiconductor devices for use in applications such as fiber optic and
wireless telecommunications, light emitting diodes (LEDs) and lasers. We also
sell germanium substrates for use in satellite solar cells.

On June 24, 2003, we announced the discontinuation of our opto-electronics
division, which we established as part of our acquisition of Lyte Optronics,
Inc. in May 1999. Accordingly, the results of operations of the
opto-electronics division have been segregated from continuing operations and
are reported separately as discontinued operations in our statements of income
(see Note 2 to our consolidated financial statements for details regarding the
accounting for discontinued operations). The discontinued opto-electronics
division manufactured high-brightness light emitting diodes (HBLEDs) for the
illumination markets, including full-color displays, wireless handset
backlighting and traffic signals, and also manufactured vertical cavity surface
emitting lasers (VCSELs) and laser diodes for fiber optic communications and
storage area networks.

On September 27, 2003 the Company completed a sale of substantially all of
the assets of its opto-electronics business to Lumei-Optoelectronics,
Corporation and Dalian Luming Science and Technology Group, Co.,

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Ltd. for the
RMB equivalent of $9.6 million. The company retains a building located in
Monterey Park, CA, that it expects to sell in 2004. This asset is classified
as Held for Sale on our consolidated balance sheet at
September 30, 2003. One million dollars of the sale
proceeds will be held in escrow for up to one year and accordingly,
has been excluded from the determination of gain/(loss) on disposal.

The Company recorded a gain on disposal of $1.6 million due to excess
proceeds received over net carrying value of assets sold.

Critical Accounting Policies and Estimates

We have prepared our consolidated financial statements in accordance with
accounting principals generally accepted in the United States of America. As
such, we have had to make estimates, assumptions and judgments that affect the
amounts reported on our financial statements. These estimates, assumptions and
judgments about future events and their effects on our results cannot be
determined with certainty, and are made based upon our historical experience
and on other assumptions that are believed to be reasonable under the
circumstances. These estimates may change as new events occur or additional
information is obtained, and we may periodically be faced with uncertainties,
the outcomes of which are not within our control and may not be known for a
prolonged period of time. The discussion and analysis of our results of
operations and financial condition are
based upon these statements. We have identified the policies below as
critical to our business operations and understanding of our financial
condition and results of operations. A critical accounting policy is one that
is both material to the presentation of our financial statements and requires
us to make difficult, subjective or complex judgments that could have a
material effect on our financial condition and results of operations. They may
require us to make assumptions about matters that are highly uncertain at the
time of the estimate, and different estimates that we could have used, or
changes in the estimate that are reasonably likely to occur, may have a
material impact on our financial condition or results of operations.

We believe that the following are our critical accounting policies:

Revenue Recognition

We recognize revenue upon shipment of products to our customers provided
that we have received a signed purchase order, the price is fixed or
determinable, 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 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 based on
historical experience, current economic trends and changes in customer demand
at the time revenue is recognized. 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 do not provide for
warranty related exposure as such exposure has historically been immaterial.

Allowance for Doubtful Accounts

We periodically review the likelihood of collecting our accounts
receivable balances and provide an allowance for doubtful accounts receivable
primarily based upon the age of these accounts. We provide a 100% allowance for
U.S. receivables outstanding in excess of 90 days and for foreign receivables
outstanding in excess of 120 days. At September 30, 2003, our accounts
receivable balance was $5.4 million net of an allowance for doubtful accounts
of $5.9 million.

Inventory

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 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

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ultimate sale
to our customers. If we determine that the value of any items in ending
inventory exceeds the sales value less any related selling costs, a reserve is
established for the difference.

Impairment of Long-Lived Assets

We review the carrying value of our long-lived assets and investments in
order to identify any impairment. Long-lived assets are written down to their
current fair market value when the carrying value of an asset exceeds their
related undiscounted future cash flows. To determine the fair market value of
our long-lived assets, we obtain appraisals from outside consultants.

Investments

We classify our investments in marketable securities as available-for-sale
securities as prescribed in Financial Accounting Standard No. 115, Accounting
for Certain Investments in Debt and Equity Securities. All investments 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. If a decline in fair value is judged to be
other than temporary, the cost basis of the individual security is written
down to fair value as a new cost basis with the amount of the write down
included in other income and expense, net. We recorded an impairment charge of
$1.3 million in Q2 of 2003 to write down our investment in two US companies.

Income Taxes

We account for deferred income taxes using the liability method, under
which the expected future tax consequences of timing differences between the
book and tax basis of assets and liabilities are recognized as deferred tax
assets and liabilities. Valuation allowances are established when necessary to
reduce net deferred tax assets when management estimates, based on available
objective evidence, that it is more likely than not that the future income tax
benefit represented by the net deferred tax asset will not be realized. At
September 30, 2003, a full valuation allowance has been recorded against our
net deferred tax asset.

Voluntary Stock option exchange program

On May 27, 2003, we announced a voluntary stock option exchange program
for our employees. Under the program, our option holders, excluding our
executive officers and independent directors, had the opportunity to cancel
outstanding options with an exercise price in excess of $2.10 per share in
exchange for new options to be granted at a future date that is at least six
months and one day after the date of cancellation, which was June 30, 2003.
The number of shares of common stock subject to the new options will be equal
to 75% of the number subject to the exchanged options. Under the exchange
program, options to purchase an aggregate of 738,027 shares of our common
stock, representing approximately 48% of the options that were eligible to be
tendered in the Offer as of May 27, 2003, were tendered and cancelled. The new
options will vest at the same rate as the exchanged options and will have an
exercise price equal to the fair market value of our common stock at the new
grant date, which is expected to be on or after December 31, 2003. Subject to
the terms and conditions of the offer, the Company will grant options to
purchase an aggregate of 553,520 shares of our common stock in exchange for
such tendered options. We do not expect to incur accounting charges as a
result of this stock option exchange program.

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Results of Operations

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

|                                       |                                            |                          |       |                    |      |                   |        |        |      |      |       |       |      |  |        |       |      | 
|-------------------------------------- | ------------------------------------------ | ------------------------ | ----- | ------------------ | ---- | ----------------- | ------ | ------ | ---- | ---- | ----- | ----- | ---- |  | ------ | ----- | ---- | 
|                                       |                                            |                          |       | Three Months Ended |      | Nine Months Ended
|                                       |                                            |                          |       | September 30,      |      | September 30,    
|                                       |                                            |                          |       |                    |      |                  
|                                       |                                            |                          |       | 2003               |      | 2002              |        | 2003   |      | 2002
|                                       |                                            |                          |       |                    |      |                   |        |        |      |     
|Revenues                               |                                            |                          | 100.0 | %                  |      |                   | 100.0  | %      |      |      | 100.0 | %     |      |  | 100.0  | %    
|Cost of revenues                       |                                            |                          | 94.1  |                    |      |                   | 109.9  |        |      |      | 94.3  |       |      |  | 97.6   |      
|                                       |                                            |                          |       |                    |      |                   |        |        |      |      |       |       |      |  |        |      
|Gross profit                           |                                            |                          | 5.9   |                    |      |                   | (9.9   | )      |      |      | 5.7   |       |      |  | 2.4    |      
|Operating expenses:                    |                                            |                          |       |                    |      |                   |        |        |      |      |       |       |      |  |        |      
|                                       | Selling, general and administrative        |                          |       | 31.1               |      |                   |        | 29.8   |      |      |       | 31.2  |      |  |        | 30.5  |     
|                                       | Research and development                   |                          |       | 3.5                |      |                   |        | 4.1    |      |      |       | 4.1   |      |  |        | 4.8   |     
|                                       | Property, plan & equipment impairment loss |                          |       |                   |      |                   |        | 4.6    |      |      |       |      |      |  |        | 40.2  |     
|                                       |                                            |                          |       |                    |      |                   |        |        |      |      |       |       |      |  |        |      
|                                       |                                            | Total operating expenses |       |                    | 34.6 |                   |        |        | 38.5 |      |       |       | 35.3 |  |        |       | 75.5 | 
|                                       |                                            |                          |       |                    |      |                   |        |        |      |      |       |       |      |  |        |      
|Loss from operations                   |                                            |                          | (28.7 | )                  |      |                   | (48.4  | )      |      |      | (29.6 | )     |      |  | (73.1  | )    
|Interest expense                       |                                            |                          | 1.7   |                    |      |                   | 0.9    |        |      |      | 1.4   |       |      |  | 1.0    |      
|Other (income)/expense, net            |                                            |                          |      |                    |      |                   | (2.6   | )      |      |      | 4.0   |       |      |  | 22.5   |      
|                                       |                                            |                          |       |                    |      |                   |        |        |      |      |       |       |      |  |        |      
|Loss before income tax benefit         |                                            |                          | (30.4 | )                  |      |                   | (46.7  | )      |      |      | (35.0 | )     |      |  | (96.7  | )    
|Income tax provision                   |                                            |                          |      |                    |      |                   | 91.0   |        |      |      |      |       |      |  | 12.2   |      
|                                       |                                            |                          |       |                    |      |                   |        |        |      |      |       |       |      |  |        |      
|Loss from continuing operations        |                                            |                          | (30.4 | )                  |      |                   | (137.7 | )      |      |      | (35.0 | )     |      |  | (108.9 | )    
|Discontinued operations:               |                                            |                          |       |                    |      |                   |        |        |      |      |       |       |      |  |        |      
|                                       | Loss from operations                       |                          |       | (18.7              | )    |                   |        | (166.6 | )    |      |       | (24.1 | )    |  |        | (88.4 | )   
|                                       | Gain/(loss) on disposal                    |                          |       | 19.0               |      |                   |        |       |      |      |       | (37.1 | )    |  |        |      |     
|                                       | Income tax (benefit)                       |                          |       |                   |      |                   |        | (59.8  | )    |      |       |      |      |  |        | (22.3 | )   
|                                       |                                            |                          |       |                    |      |                   |        |        |      |      |       |       |      |  |        |      
|Gain/(loss) on discontinued operations |                                            |                          | 0.3   |                    |      |                   | (106.8 | )      |      |      | (61.2 | )     |      |  | (66.1  | )    
|                                       |                                            |                          |       |                    |      |                   |        |        |      |      |       |       |      |  |        |      
|Net loss                               |                                            |                          | (30.1 | )%                 |      |                   | (244.5 | )%     |      |      | (96.2 | )%    |      |  | (175.0 | )%   
|                                       |                                            |                          |       |                    |      |                   |        |        |      |      |       |       |      |  |        |      

Three months ended
September 30, 2003 compared to three months ended September 30, 2002

Revenue from continuing operations.Revenue from continuing operations
decreased $3.2 million, or 27.3%, to $8.5 million for the three months ended
September 30, 2003 compared to $11.7 million for the three months ended
September 30, 2002.

Total GaAs substrate revenue decreased $2.2 million, or 24.0%, to $6.9
million for the three months ended September 30, 2003 compared to $9.1 million
for the three months ended September 30, 2002. Sales of 5 and 6 GaAs
subtrates decreased $1.3 million, or 43.0%, to $1.7 million for the three
months ended September 30, 2003 compared to $3.0 million for the three months
ended September 30, 2002. InP substrate revenue decreased $588,000, or 54.2%,
to $496,000 for the three months ended September 30, 2003 compared to $1.1
million for the three months ended September 30, 2002. The decrease in GaAs and
InP substrate revenue is due to decreased volume and lower average sales prices
as a result of the slowdown in our target markets including telecommunications,
high speed electronic devices, and short wavelength lasers, and the
introduction of VGF like substrates from our competitors that caused some
customers to purchase substrates from our competitors.

International revenue increased to 64.5% of total revenue from continuing
operations for the three months ended September 30, 2003 compared to 46.9% of
total revenue from continuing operations for the three months ended September
30, 2002. The increase was primarily due to a greater share of our GaAs
substrates being used in opto-electronics applications and the majority of our
customers for these applications being in Asia.

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Gross margin.Gross margin increased to 5.9% of total revenue for the
three months ended September 30, 2003 compared to negative 14.0% of total
revenue for the three months ended September 30, 2002. The increase was
primarily due to reduced costs associated with moving most of our production to
China.

Selling, general and administrative expenses.Selling, general and
administrative expenses decreased $841,000, or 21.4%, to $2.7 million for the
three months ended September 30, 2003 compared to $3.5 million for the three
months ended September 30, 2002. The decrease in selling, general and
administrative expenses is the result of our efforts to adjust costs in line
with our current business. As a percentage of total revenue, selling, general
and administrative expenses were 31.1% for the three months ended September 30,
2003 compared to 29.8% for the three months ended September 30, 2002.

Research and development expenses.Research and development expenses
decreased $185,000, or 38.1%, to $301,000 for the three months ended September
30, 2003 compared to $486,000 for the three months ended September 30, 2002.
As a percentage of total revenue , research and development expenses were 3.5%
for the three months ended September 30, 2003 compared to 4.1% for the three
months ended September 30, 2002. Although we reduced research and development
expenses as part of our effort to adjust costs in line with our current
business, we believe that continued investment in product development is
critical to attaining our strategic objectives of maintaining and increasing
our technology leadership, and as a result, we expect research and development
expenses to remain at current levels or increase in future periods. Research
and development efforts during the third quarter of 2003 were focused primarily
on improving the yield and surface quality of our GaAs substrates.

Interest expense.Interest expense increased $40,000, or 38.1%, to
$145,000 for the three months ended September 30, 2003 compared to $105,000 for
the three months ended September 30, 2002 due to prepayment penalties incurred
in Q3 2003 for paying off all equipment loans.

Other income and expense, net.Other income decreased $305,000, to $3,000
for the three months ended September 30, 2003 compared to income of $308,000
for the three months ended September 30, 2002.

Provision for income taxes.Due to our continuing operating losses and
uncertainty regarding future profitability, we recorded a full valuation
allowance against our net deferred tax assets of $31.2 million in 2002. As a
result, our effective tax rate decreased to 0.0% for the three months ended
September 30, 2003

Nine months ended September 30, 2003 compared to nine months ended September
30, 2002

Revenue from continuing operations.Revenue from continuing operations
decreased $10.8 million, or 29.6%, to $25.6 million for the nine months ended
September 30, 2003 compared to $36.4 million for the nine months ended
September 30, 2002.

Total GaAs substrate revenue decreased $5.5 million, or 21.1%, to $20.9
million for the nine months ended September 30, 2003 compared to $26.4 million
for the nine months ended September 30, 2002. Sales of 5 and 6 GaAs
subtrates decreased $3.9 million, or 51.1%, to $3.8 million for the nine months
ended September 30, 2003 compared to $7.7 million for the nine months ended
September 30, 2002. InP substrate revenue decreased $4.2 million, or 72.9%, to
$1.6 million for the nine months ended September 30, 2003 compared to $5.8
million for the nine months ended September 30, 2002. The decrease in GaAs and
InP substrate revenue was due to decreased volume and lower average sales
prices as a result of the slowdown in our target markets including
telecommunications, high speed electronic devices, and short wavelength lasers,
and the introduction of VGF like substrates from our competitors that caused
some customers to purchase substrates from our competitors.

International revenue increased to 65.0% of total revenue from continuing
operations for the nine months ended September 30, 2003 compared to 42.1% of
total revenue from continuing operations for the nine months ended September
30, 2002. The increase was primarily due to a greater share of our GaAs
substrates being used in opto-electronics applications and the majority of our
customers for these applications being in Asia.

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Gross margin.Gross margin increased to 5.7% of total revenue for the nine
months ended September 30, 2003 compared to 2.4% of total revenue for the nine
months ended September 30, 2002. The increase was primarily due to reduced
costs associated with moving most of our production to China.

Selling, general and administrative expenses.Selling, general and
administrative expenses decreased $3.1 million, or 28.2%, to $8.0 million for
the nine months ended September 30, 2003 compared to $11.1 million for the nine
months ended September 30, 2002. The decrease in selling, general and
administrative expenses is the result of our efforts to adjust costs in line
with our current business. As a percentage of total revenue, selling, general
and administrative expenses were 31.2% for the nine months ended September 30,
2003 compared to 30.5% for the nine months ended June 30, 2002.

Research and development expenses.Research and development expenses
decreased $694,000, or 39.8% to $1.1 million for the nine months ended
September 30, 2003 compared to $1.8 million for the nine months ended September
30, 2002. As a percentage of total revenue, research and development expenses
were 4.1% for the nine months ended September 30, 2003 compared to 4.8% for the
nine months ended September 30, 2002. Although we reduced research and
development expenses as part of our effort to adjust costs in line with our
current business , we believe that continued investment in product development
is critical to attaining our strategic objectives of maintaining and increasing
our technology leadership, and as a result, we expect research and development
expenses to remain at current levels or increase in future periods. Research
and development efforts during the first nine months of 2003 were focused
primarily on improving the yield and surface quality of our GaAs substrates.

Interest expense.Interest expense increased $6,000, or 1.7%, to $368,000
for the nine months ended September 30, 2003 compared to $362,000 for the nine
months ended September 30, 2002 due to prepayment penalties incurred in Q3
2003 for paying off all equipment loans offset by a reduction of rates on our
variable interest rate debt.

Other income and expense, net.Other expense decreased $7.2 million to
$1.0 million for the nine months ended September 30, 2003 compared to $8.2
million for the nine months ended September 30, 2002. Other expense for the
nine months ended September 30, 2003 includes a $1.3 million charge to write
down our investment in two US companies. Other expense for the nine months
ended September 30, 2002 includes a $9.2 million charge to write down our
investment in marketable equity securities.

Provision for income taxes.Due to our continuing operating losses and
uncertainty regarding future profitability, we recorded a full valuation
allowance against our net deferred tax assets of $31.2 million in 2002. As a
result, our effective tax rate decreased to 0.0% for the nine months ended
September 30, 2003.

Liquidity and Capital Resources

Cash and cash equivalents increased $7.7 million to $21.5 million at
September 30, 2003 compared to $13.8 million at December 31, 2002.

Net cash provided by operating activities of $6.0 million for the nine
months ended September 30, 2003 was comprised primarily of our net loss
adjusted for non-cash items of $15.7 million, consisting primarily of a loss on
disposal from our discontinued opto-electronics division of $9.5 million and
depreciation expense of $4.6 million, and by a $14.9 million net change in
assets and liabilities. The net change in assets and liabilities resulted
primarily from decreases in accounts receivable, inventory and income tax
receivable offset by a decrease in accrued liabilities.

Accounts receivable decreased $1.8 million, or 24.6%, to $5.4 million at
September 30, 2003 compared to $7.2 million at December 31, 2002. The decrease
includes $700,000 net write-down of opto-electronics accounts receivable
through loss on disposal. Inventories decreased $11.5 million, or 30.6% to
$37.6 million at September 30, 2003 compared to $37.6 million at December 31,
2002. The decrease in inventory is a result of our continued effort to
minimize cash outflows utilizing more effective inventory management policies.
The decrease also includes a $1.4 million net write-down of opto-electronics
inventory through loss on disposal, and $600,000 of inventory sold

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through the
asset sale of our discontinued opto electronics division. We expect our
inventory to continue to decrease throughout the remainder of 2003.

Net cash provided by investing activities of $11.2 million for the nine
months ended September 30, 2003 includes net proceeds from the sale of property
and equipment of $14.8 million and purchases of equipment of $1.9 million. It
also includes $3.3 million in purchases of high grade investment securities
with maturities of less than two years offset by $5.7 million in sales of these
securities, as well as an increase in restricted cash of $4.0 million.

We do not have any plans to initiate any major new capital spending
projects during 2003. We are currently completing certain projects at our
China facilities and are continuously constructing minor improvements to our
existing production facilities in China and the United States. We expect to
invest an additional $400,000 in capital projects throughout the remainder of
2003. We believe that our existing and planned facilities and equipment are
sufficient to fulfill current and expected future orders.

In February 2003, our Board of Directors authorized the repurchase of up
to 2 million shares of our common stock over a one-year period. To date we have
not repurchased any shares. If repurchased, repurchased shares will be
retired. We expect to sell shares of common stock of Finisar Corporation to
fund our stock repurchase program.

Net cash
used in financing activities of $9.6 million for the nine months
ended September 30, 2003 includes proceeds of $424,000 from the sale of common
stock through our employee stock compensation programs, offset by payments of
$1.6 million on long-term debt and to settle all equipment loans and $8.4
million to settle all capital leases.

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 a variable rate
that was 1.35% at September 30, 2003. 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 September
30, 2003, $8.6 million was outstanding under these bonds.

At September 30, 2002 the credit facility maintained by us with a bank
included a letter of credit supporting repayment of our industrial bonds with
an outstanding amount of $8.6 million. The Company has pledged and placed cash
and certain investment securities with the trust department of the bank as
additional collateral for this facility. We have also pledged cash for a
credit facility for our workers compensation insurance as well as $1 million of
the proceeds from the sale of the assets of our discontinued opto-electronics
division held in escrow. As a result, $10.4 million of cash and our long-term
investments are restricted.

At September 30, 2003, we had available cash, cash equivalents and liquid
short and long-term investments of $35.2 million. We believe that our existing
cash and liquid investments, cash generated from operations, coupled with
additional efforts to reduce our expenditures in support of our substrate
business, will be sufficient to meet our working capital expenditure
requirements for the next 12 months. However, our existing cash and liquid
investments could decline during the remainder of 2003 due to a continued or
further weakening of the economy or changes in our planned cash outlay.

If our sales continue to decrease, our ability to generate cash from
operations will be adversely affected which could adversely affect our future
liquidity, require us to use cash at a more rapid rate than expected, and
require us to seek additional capital. There can be no assurance that such
additional capital will be available or, if available it will be at terms
acceptable to the Company. Cash from operations could be affected by various
risks and uncertainties, including, but not limited to those set forth below
under Risks Related to Our Business.

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Risks Related to Our Business

The disposal of our opto-electronics business may fail to result in the
benefits we anticipate.

We may not obtain the benefits we expect as a result of discontinuation of
our opto-electronics business, such as greater strategic focus on our core
businesses. We may be required to return to the buyer some or all of the $1
million held in escrow should the buyer successfully claim that we breached one
of the representations or warranties made to it. The buyer may not reimburse us
for the limited set of continuing services and leases that we are providing.
Our building in Monterey Park may not be sold for the $1 million at which we
are carrying it on our balance sheet. We may incur additional costs associated
with the discontinued operations which could materially reduce our short term
earnings.

We may be required to raise additional capital in the future, which may not be
available.

We anticipate that our existing cash resources will fund any anticipated
operating losses, purchases of capital equipment and provide adequate working
capital for the next twelve months. However, our liquidity is affected by many
factors including, among others, the extent to which we pursues additional
capital expenditures,
the level of our production efforts, and other factors related to the
uncertainties of the industry and global economies. Accordingly, there can be
no assurance that events in the future will not require us to seek additional
capital, or, if so required, that such capital will be available on terms
acceptable to us, if at all.

Much of our cash resources are denominated in Chinese reminbi and held in
accounts in China and, under some circumstances, may not be easily exchanged
for US dollars. The value of our Chinese cash holdings are also subject to
changes in the exchange rate between Chinese reminbi and US dollars. If our US
dollar commitments exceeded the cash we have available in the United States, we
may be unable to access cash held in China to satisfy these commitments.

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

As a supplier to the semiconductor industry, we are subject to the
business cycles that characterize the industry-the timing, length and
volatility of these cycles are difficult to predict. The semiconductor industry
has historically been cyclical because of sudden changes in demand for
semiconductors and capacity requirements, including capacity utilizing the
latest technology. The rate of changes in demand, including end demand, is
accelerating, and the effect of these changes upon us is occurring sooner,
exacerbating the volatility of these cycles. These changes have affected the
timing and amounts of customers capital equipment purchases and investments in
new technology. These industry cycles create pressure on our net sales, gross
margin and net income.

Our continuing 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, and create pressure on our revenue, gross
margins and net income. Inventory buildups in telecommunications products and
slower than expected sales of computer equipment resulted in overcapacity and
led to reduced sales by our customers, and therefore reduced purchases of our
products. During periods of weak 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 has resulted, causing pressure on our net sales, gross margin and
net income. We have over the past year experienced cancellations, price
reductions, 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

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marketing, 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 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 three
customers that owed us a significant amount have filed for bankruptcy
protection and we are unlikely to receive a substantial portion or any of the
amounts 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.

A reoccurrence of Severe Acute Respiratory Syndrome (SARS) may adversely impact
our manufacturing operations and some of our key suppliers and customers

The majority of our substrate manufacturing activities are conducted in
China. In addition, we source key raw materials, including gallium, from our
joint ventures in China. The SARS outbreak was most notable in China. One
employee at our LED production facility in China contracted SARS in late April
prompting us to close the facility for ten days. There was no significant
impact to our ability to fill customer orders. If there were to be another
outbreak of SARS and if our employees contracted the disease, we may be
required to temporarily close our manufacturing operations. Similarly, if one
of our key suppliers is required to close for an extended period, we may not
have enough raw material inventory to continue manufacturing operations. In
addition, while we possess management skills among our China staff that enable
us to maintain our manufacturing operations with minimal on-site supervision
from our US-based staff, our business could also be harmed if travel to or from
Asia and the United States is restricted or inadvisable, as it was earlier in
2003. None of our substrate competitors is and few of our opto-electronics
competitors are as dependent on manufacturing facilities in China as we are.
If our manufacturing operations were closed for a significant period, we could
lose revenue and market share during that period which would depress our
financial performance and could be difficult to recapture. Finally, if one of
our key customers is required to close for an extended period, we may not be
able to ship product to them, our revenue would decline and our financial
performance would suffer.

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 faced in the second half of 2001 and
continued to face in 2003 is more uncertain than in prior periods, has lasted
longer than expected 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,
and we are particularly dependant on the market conditions for the wireless,
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, caused by a weakening economy may result in further or prolonged
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 growth, and may not be
able to return to historic growth levels in the current economic environment.
Our net loss in 2002 is the largest in our history and our losses have
continued during 2003. 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:

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| |  | decline in general economic conditions or downturns in the industry in
which we compete;                       
|- |  | ---------------------------------------------------------------------------------------------------------------
| 
| |  | fluctuations in demand for our products;                                                                       
| 
| |  | 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 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 less than three months. As
a result, our visibility regarding future financial performance is uncertain
and we have and may continue to 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, we may be unable to expand our manufacturing capacity quickly enough
to meet increased demand, and we may be unable to lower our costs or increase
revenue.

Although we are currently in a period of overcapacity, reduced sales, and
decreased margins, if the economy recovers, demand may increase rapidly as it
has in prior years after other cyclical downturns in the economy and the
industries in which we operate. If this happens, 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 and modify our existing
facilities, purchase additional manufacturing equipment, and add qualified
staff. If we are not at that time able to expand our manufacturing capacity, we
will be unable to increase production, which may adversely impact our ability
to meet increased production demand while reducing unit costs, margins and
improving our operating results.

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We are currently constructing and/or modifying 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;                                                                                                    
| 
| |  | 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 in the United States and
China.

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 completing
selective investments in equipment and facilities as part of our previously
planned 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.

We must manage our inventory of component parts and finished goods
effectively to meet changing customer requirements, while keeping inventory
costs down and improving gross margins. 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, or become excess inventory due to decreased
demand for our products and an inability to sell the inventory within a
foreseeable period. Furthermore, if current costs of production increase or
sales prices drop below the standard prices at which we value inventory, we may
need to take a charge for a reduction in inventory values. 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. On October 1, we implemented a new inventory control system that
may experience unexpected difficulties as we use it to develop reporting
information for the fourth quarter of 2003.

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 and product
features 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. During the past
year, we have seen our competitors selling more substrates manufactured using a
crystal growth technology similar to ours, which has eroded our technological
differentiation. 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, 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 or VGF derived
products are

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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.

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.

Some of our competitors have developed a crystal growth technique similar
to our VGF technology. Furthermore, some customers have reduced their orders
from us until our surface quality is as good and consistent as that offered by
competitors. As a result, some customers are now allocating their requirements
for VGF grown substrates across more competitors and we believe that we have
lost revenue and market share as a result of these customer decisions, which we
may be unable to recover. If we are unable to retain our market share, our
revenue and performance will decline.

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. We may lose sales
of our products to competitors who are not manufacturing in China, or whose
operations in China have already been qualified by customers. 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, that are actively developing alternative
materials to GaAs and some semiconductor devices are being marketed using these
materials. We believe that at least two of our competitors are shipping high
volumes of 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 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.

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 our products, and continued or increased competition could
reduce our market share,

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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 we can produce can fluctuate as a result of many factors,
including:



| |  | 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 but our costs would change little, if at all. 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, as have quality control problems
experienced on our substrate products. 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 larger diameter substrates.

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 a result of current levels of demand and inventory, some of our
customers have reduced sales of their products, causing them to reduce
purchases of our products for both production and research and development
purposes. 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 increases and their expenditures for research and development increase.

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We purchase critical raw materials and parts for our equipment 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 or
equipment 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 and spare parts, 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.

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 in all of our operating locations. 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.

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

A small number of substrate customers have historically accounted for a
substantial portion of our total revenue. Five customers accounted for 29.7% of
our total revenue for the three months ended September 30, 2003 and 35.7% for
the three months ended September 30, 2002. One customer accounted for 12.4% of
our revenue for the three months ended September 30, 2003. We expect that a
significant portion of our future revenue will continue to be derived from a
limited number of substrate 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. In addition, due to the difficult economic
environment, several of our previously large customers have stopped operations
entirely. 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. We have experienced
quality control problems with some of our products, which caused customers to
return products to us, to reduce orders for our products, or both. If we
continue to experience quality control problems, or experience these problems
in new products, customers may cancel or reduce orders or purchase 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.

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We are also developing new substrate products and product enhancements. 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 products have a long qualification cycle that makes it difficult
to plan our expenses and forecast our results.

Customers typically place orders with us for our substrate 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 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 products.

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 placed and continue to place a
significant strain on our operations and management resources, and we are in
the process of upgrading our inventory control systems and may implement
additional systems relating to consolidation of our financial results. 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 to comply with the reporting and attestation
requirements of the Sarbanes-Oxley Act of 2002. We 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.

We anticipate that our existing cash resources will fund any anticipated
operating losses, purchases of capital equipment and provide adequate working
capital for the next twelve months. The Companys liquidity is affected by
many factors including, among others, the extent to which the Company pursues
additional capital and business acquisition expenditures, the level of the
Companys production efforts, and other factors related to the uncertainties of
the industry and global economies.

If we fail to manage periodic contractions, we may utilize our cash balances
and our existing cash and cash equivalent balances could decline.

If we fail to manage our contractions successfully we may continue to draw
down our cash reserves, which would adversely affect our operating results and
financial condition, reduce our value and may impinge our ability to raise debt
and equity funding in the future, at a time when we may be required to raise
additional cash. 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.

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As a result of the difficult economic conditions, we have implemented
restructuring and workforce reductions, which may adversely affect the morale
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 in 2001 and reduced our
workforce, shifted production activities to China, reduced capital
expenditures, and discontinued our opto-electronics business. Our restructuring
may yield unanticipated consequences, such as attrition beyond our planned
reduction in workforce and loss of employee morale 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. 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.                                           

For example, we incurred substantial costs in connection with our
acquisition of Lyte Optronics in May 1999, including the assumption of
approximately $10.0 million of debt, which was subsequently repaid, resulting
in a decline of cash available. We have also incurred consistent operating
losses for the business since the acquisition, and have recently discontinued
all operations acquired in our acquisition of Lyte Optronics.

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. Some of our manufacturing and research and development 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.

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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 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 two of our competitors have 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 technology
upon which we rely, and thus may limit any exclusivity we enjoy by virtue of
our patents or trade secrets.

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
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.

Intellectual property infringement claims may be costly to resolve and could
divert management attention.

Other companies may hold or obtain patents on inventions or may otherwise
claim proprietary rights to 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 have
recently been sued by two competitors 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 64% of our total revenue
for the three months ended September 30, 2003 and 54% for the three months
ended September 30, 2002. We expect that sales to customers outside the U.S.
will continue to represent a significant portion of our revenue, particularly
sales to customers in Asia.

Currently, an increasing percentage of our sales are to customers
headquartered in Asia. Certain manufacturing facilities and suppliers are also
located outside the U.S. Managing our global operations presents challenges,
including periodic regional economic downturns, trade balance issues, varying
business conditions and demands, political instability, variations in
enforcement of intellectual property and contract rights in different
jurisdictions, differences in the ability to develop relationships with
suppliers and other local businesses, changes in U.S. and international laws
and regulations including U.S. export restrictions, fluctuations in interest
and currency exchange rates, the ability to provide sufficient levels of
technical support in different locations, cultural differences, shipping delays
and terrorist acts or acts of war, among other risks. Many of these challenges
are present in China, which represents a large potential market for
semiconductor equipment and where AXT anticipates significant opportunity for
growth. Global uncertainties with respect to: (i) economic growth rates in
various countries; (ii) sustainability of demand for electronics products;
(iii) capital spending by semiconductor manufacturers; (iv) price weakness for
certain semiconductor devices; and (v) political instability in regions where
we have operations may also affect our business, financial condition and
results of operations.

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



| |  | changes in tariffs, import 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 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 reduction of our cost structure, 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 reduce the costs of our products 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

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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.

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 and actions on the general economy could
decrease our revenues.

the United States continues to be on alert for terrorist activity. The
potential near- and long-term impact terrorist activities may have in regards
to our suppliers, customers and markets for our products and the U.S. economy
are uncertain. There may be embargos of ports or products, or destruction of
shipments or our facilities, or attacks that affect our personnel. There may be
other potential adverse effects on our operating results due to a 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 three months ended September 30, 2003, the high
and low closing sales prices of our common stock were $3.12 and $1.20,
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;                                                                      
| 
| |  | 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.

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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.

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.

Legislative actions, higher insurance costs 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

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advisory services, all of which will
cause our general and administrative costs to increase. Insurers are 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.




Item 3.Qualitative and Quantitative Disclosures About Market Risk

Foreign Currency Risk

We use short-term forward exchange contracts for hedging purposes to
reduce the effects of adverse foreign exchange rate movements. We have
purchased foreign exchange contracts to hedge against certain trade accounts
receivable denominated in Japanese yen. The change in the fair value of the
forward contracts is recognized as part of the related foreign currency
transactions as they occur. As of September 30, 2003, we had no outstanding
commitments with respect to foreign exchange contracts.

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):

|                          |  |               |        |          |  |           |      |                  |  |                  |      |          |  |          |      |   |  |   |      |  
|------------------------- |  | ------------- | ------ | -------- |  | --------- | ---- | ---------------- |  | ---------------- | ---- | -------- |  | -------- | ---- | - |  | - | ---- | -
|                          |  |               |        |          |  |           |      |                  |  | Current          |      | Proforma |  | Proforma
|                          |  | Balance       |        | Current  |  | Interest  |      | 10% Interest     |  | 10% Interest    
|                          |  | September 30, |        | Interest |  | Income/   |      | Rate Decline     |  | Rate Increase   
|Instrument                |  | 2003          |        | Rate     |  | (Expense) |      | Income/(Expense) |  | Income/(Expense)
|                          |  |               |        |          |  |           |      |                  |  |                 
|Cash and cash equivalents |  | $             | 21,486 |          |  |           | 1.80 | %                |  | $                | 387  |          |  | $        | 348  |   |  | $ | 425  |  
|Bonds                     |  |               | 8,550  |          |  |           | 1.35 | %                |  |                  | (115 | )        |  |          | (104 | ) |  |   | (127 | )
|                          |  |               |        |          |  |           |      |                  |  |                  |      |          |  |          |      |   |  |   |      |  
|                          |  |               |        |          |  |           |      |                  |  | $                | 271  |          |  | $        | 244  |   |  | $ | 298  |  
|                          |  |               |        |          |  |           |      |                  |  |                  |      |          |  |          |      |   |  |   |      |  

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. On June 30, 2003, we recorded
$1.3 million charge to other expense to write down our investment in two US
companies. As
of September 30, 2003, the minority investments we continue to hold
totaled $5.3 million. In 2000, we recorded a $27.3 million non-cash gain as a
result of acquiring Finisar Corporation common stock in connection with Finisar
Corporations acquisition of Demeter Technologies, a company in which we held
warrants to purchase preferred stock. In 2001 and 2002, we determined that
this investment had suffered a decline in market value that was other than
temporary and accordingly recorded a $15.6 million and $10.8 million non-cash
loss respectively, as a result of writing down our investment in Finisar
Corporation common stock to market value. These gains and losses were included
in other expense.




Item 4.Controls and Procedures

(a)  Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of our disclosure controls and procedures, as such term
is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act
of 1934, as amended (the Exchange Act), as of the end of the period covered
by this report. Based on their evaluation, our principal executive officer

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and
principal financial officer concluded that our disclosure controls and
procedures were effective as of the end of the period covered by this report.

(b)  As required by Rule 13a-15(d), our management, including our principal
executive officer and principal finance officer, also conducted an evaluation
of our internal control over financial reporting to determine whether any
changes occurred during the quarter covered by this report that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting. Based on that evaluation, there has been no such
change during the quarter covered by this report. It should be noted that any
system of controls, however well designed and operated, can provide only
reasonable and not absolute assurance that the objectives of the system will be
met.




PART II        OTHER INFORMATION




Item 1. Legal Proceedings

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

On April 15, 2003, Sumitomo Electric Industries, Ltd., (SEI) filed a
complaint in the Tokyo District Court, Civil Division against us and our
Japanese distributor alleging patent infringement of two patents held by SEI in
Japan. The suit seeks penalties from AXT in the amount of $1.67 million plus
interest and court costs and the cessation of AXTs sales of gallium arsenide
substrates in Japan. AXT intends to defend itself vigorously in these lawsuits
and continues to sell its products in Japan.

On June 11, 2003, Cree, Inc. filed a complaint in the United States Court
for Northern District of California against us alleging patent infringement.
The complaint seeks damages and injunction against infringement. On July 23,
2003, we filed a counter complaint in the United States Court for Northern
District of California, denying any patent infringement and alleging that
Crees actions were intentionally designed to interfere with our prospective
business relationships. A court hearing is scheduled for late February 2004.

Item 2. Changes in Securities and Use of Proceeds



| |     
| | ----
| | None

Item 3. Defaults upon Senior Securities



| |     
| | ----
| | None

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



| |     
| | ----
| | None

Item 5. Other Information



| |     
| | ----
| | None

35



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##### Table of Contents






Item 6. Exhibits and Reports on Form 8-K



|a. |  | Exhibits
|-- |  | --------

| |  |  |       |     |  |                                                                                                                                                                                                                                                                                                       
| |  |  | ----- | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | 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                                                                                                                                                                                                 
| |  |  |       |     |  |                                                                                                                                                                                                                                                                                                       
| |  |  | 10.14 | (5) |  | Second Modification to Credit Agreement between U.S. Bank
National Association and AXT, Inc. dated September 30, 2002                                                                                                                                                                                 
| |  |  |       |     |  |                                                                                                                                                                                                                                                                                                       
| |  |  | 10.15 | (6) |  | Reimbursement Agreement between Wells Fargo Bank National
Association and AXT, Inc. dated April 7, 2003                                                                                                                                                                                               
| |  |  |       |     |  |                                                                                                                                                                                                                                                                                                       
| |  |  | 10.16 |     |  | Asset purchase agreements dated September 4, 2003 by and
between Dalian Luming Science and Technology Group Co., Ltd and AXT,
Inc., and by and between Lumei Optoelectronics Corp., AXT, Inc.,
Lyte Optoelectronics, Inc., Beijing Tongmei Xtal Technology and
Xiamen Advanced Semiconductor Co., Ltd.
| |  |  |       |     |  |                                                                                                                                                                                                                                                                                                       
| |  |  | 31.1  |     |  | Certification by Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                    
| |  |  |       |     |  |                                                                                                                                                                                                                                                                                                       
| |  |  | 31.2  |     |  | Certification by Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                    
| |  |  |       |     |  |                                                                                                                                                                                                                                                                                                       
| |  |  | 32.1  |     |  | Certification by Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                    
| |  |  |       |     |  |                                                                                                                                                                                                                                                                                                       
| |  |  | 32.2  |     |  | Certification by Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                    



|(1) |  | Incorporated by reference to the Exhibit of the same number filed with
our Annual Report on Form 10-K for the year ended December 31, 1998.                     
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Incorporated by reference to the Exhibit number 3.1 filed with our Form
8-K on June 14, 1999.                                                                   
|   
|(3) |  | Incorporated by reference to the Exhibit number 3.4 filed with our Form
8-K on May 30, 2001.                                                                    
|   
|(4) |  | Incorporated by reference to the Exhibit of the same number filed with
our Annual Report on Form 10-K for the year ended December 31, 1999.                     
|   
|(5) |  | Incorporated by reference to the Exhibit of the same number filed with
our Quarterly Report on Form 10-Q for the three and nine months ended
September 30, 2002.
|   
|(6) |  | Incorporated by reference to the Exhibit of the same number filed with
our Quarterly Report on Form 10-Q for the three and six months ended June
30, 2003.      
|   
|b.  |  | Reports on Form 8-K                                                                                                                                             
|   
|    |  | None.                                                                                                                                                           

36



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##### Table of Contents






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.
|                         |  |           |                                                 | 
|                         |  |           |                                                 | 
|Dated: November 13, 2003 |  | By:       | /s/  Morris S. Young                            | 
|                         |  |           |                                                 | 
|                         |  |           | Morris S. Young                                 | 
|                         |  |           | Chief Executive Officer                         | 
|                         |  |           |                                                 | 
|Dated: November 13, 2003 |  | By:       | /s/  Donald L. Tatzin                           | 
|                         |  |           | Donald L. Tatzin                                | 
|                         |  |           | Chief Financial Officer                         | 
|                         |  |           |                                                 | 
|Dated: November 13, 2003 |  | By:       | /s/  John Drury
John Drury
Corporate Controller | 

37



---



##### Table of Contents






INDEX TO EXHIBITS

|         |  |                                                                                                                                                                                                                                                                                                       
|-------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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                                                                                                                                                                                                 
|         |  |                                                                                                                                                                                                                                                                                                       
|10.14(5) |  | Second Modification to Credit Agreement between U.S. Bank
National Association and AXT, Inc. dated September 30, 2002                                                                                                                                                                                 
|         |  |                                                                                                                                                                                                                                                                                                       
|10.15(6) |  | Reimbursement Agreement between Wells Fargo Bank National
Association and AXT, Inc. dated April 7, 2003                                                                                                                                                                                               
|         |  |                                                                                                                                                                                                                                                                                                       
|10.16    |  | Asset purchase agreements dated September 4, 2003 by and
between Dalian Luming Science and Technology Group Co., Ltd and AXT,
Inc., and by and between Lumei Optoelectronics Corp., AXT, Inc.,
Lyte Optoelectronics, Inc., Beijing Tongmei Xtal Technology and
Xiamen Advanced Semiconductor Co., Ltd.
|         |  |                                                                                                                                                                                                                                                                                                       
|31.1     |  | Certification by Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                    
|         |  |                                                                                                                                                                                                                                                                                                       
|31.2     |  | Certification by Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                    
|         |  |                                                                                                                                                                                                                                                                                                       
|32.1     |  | Certification by Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                    
|         |  |                                                                                                                                                                                                                                                                                                       
|32.2     |  | Certification by Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                    



|(1) |  | Incorporated by reference to the Exhibit of the same number filed with
our Annual Report on Form 10-K for the year ended December 31, 1998.                     
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Incorporated by reference to the Exhibit number 3.1 filed with our Form
8-K on June 14, 1999.                                                                   
|   
|(3) |  | Incorporated by reference to the Exhibit number 3.4 filed with our Form
8-K on May 30, 2001.                                                                    
|   
|(4) |  | Incorporated by reference to the Exhibit of the same number filed with
our Annual Report on Form 10-K for the year ended December 31, 1999.                     
|   
|(5) |  | Incorporated by reference to the Exhibit of the same number filed with
our Quarterly Report on Form 10-Q for the three and nine months ended
September 30, 2002.
|   
|(6) |  | Incorporated by reference to the Exhibit of the same number filed with
our Quarterly Report on Form 10-Q for the three and six months ended June
30, 2003.      
|   

38