##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, DC. 20549
   FORM 10-Q (Mark One) þ
    
    Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the
quarterly period ended March 31, 2004
 or o
    
    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the
transition period from ______________ to ______________
     AXT, INC. (Exact name of registrant as specified in its charter)
 DELAWARE
    
    94-3031310(State or other jurisdiction of
    
    (I.R.S. EmployerIncorporation or organization)
    
    Identification No.)
 4281 Technology Drive, Fremont, California 94538
(Address of principal executive offices) (Zip code)
(510) 683-5900
(Registrants telephone number, including area code)   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES 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 April 30, 2004Common Stock, $.001 par value
    
    23,045,003




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AXT, INC. TABLE OF CONTENTS PagePART I. FINANCIAL INFORMATIONItem 1.
Financial Statements (unaudited)Condensed
Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003
    
    
    2Condensed
Consolidated Statements of Operations for the three months ended March 31,
2004 and 2003
    
    
    3Condensed Consolidated Statements of Cash Flows for the three months ended March 31,
2004 and 2003
    
    
    4Notes To Condensed Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    36Item 4. Controls and Procedures
    
    
    36PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    37Item 2. Changes in Securities and Use of Proceeds
    
    
    37Item 3. Defaults upon Senior Securities
    
    
    37Item 4. Submission of Matters to a Vote of Security Holders
    
    
    37Item 5. Other Information
    
    
    38Item 6. Exhibits and Reports on Form 8-K
    
    
    38Signatures
    
    
    39EXHIBIT 31.1EXHIBIT 32.1
  1




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PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements AXT, INC.  
   March 31,
    
    December 31,2004
    
    2003(Unaudited)Assets:Current assetsCash and cash equivalents
    
    $
    16,653
    
    
    $
    24,339Short-term investments
    
    
    18,675
    
    
    
    14,669Accounts
receivable, net of allowance of $4,944 and $4,304 as of
March 31, 2004 and December 31, 2003, respectively
    
    
    6,914
    
    
    
    6,297Inventories
    
    
    22,894
    
    
    
    24,083Prepaid expenses and other current assets
    
    
    2,019
    
    
    
    1,301Assets held for sale
    
    
    1,000
    
    
    
    1,000Total current assets
    
    
    68,155
    
    
    
    71,689Property,
plant and equipment
    
    
    20,861
    
    
    
    21,795Other assets
    
    
    4,258
    
    
    
    4,237Restricted deposits
    
    
    9,302
    
    
    
    9,302Total assets
    
    $
    102,576
    
    
    $
    107,023Liabilities and Stockholders Equity:Current liabilitiesAccounts payable
    
    $
    2,893
    
    
    $
    2,638Accrued liabilities
    
    
    7,956
    
    
    
    8,296Current
portion of long-term debt
    
    
    3,758
    
    
    
    3,694Total
current liabilities
    
    
    14,607
    
    
    
    14,628Long-term debt, net of current portion
    
    
    7,985
    
    
    
    8,842Other
long-term liabilities
    
    
    1,306
    
    
    
    1,255Total
liabilities
    
    
    23,898
    
    
    
    24,725Stockholders equity:Preferred stock, $.001
par value per share; 2,000 shares
authorized; 833 shares issued and outstanding
    
    
    3,532
    
    
    
    3,532Common stock, $.001 par value per share; 70,000 shares
authorized; 23,032 and 22,957 shares issued and outstanding
    
    
    155,332
    
    
    
    155,178Accumulated deficit
    
    
    (81,488
    )
    
    
    (78,928
    )Other comprehensive income
    
    
    1,302
    
    
    
    2,516Total stockholders equity
    
    
    78,678
    
    
    
    82,298Total
liabilities and stockholders equity
    
    $
    102,576
    
    
    $
    107,023
 See accompanying notes to condensed consolidated financial statements. 2




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AXT, INC.




CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS  Three Months EndedMarch 31,2004
    
    2003(Unaudited)Revenue
    
    $
    9,776
    
    
    $
    8,536Cost of revenue
    
    
    9,243
    
    
    
    8,263Gross profit
    
    
    533
    
    
    
    273Operating expenses:Selling, general and administrative
    
    
    2,770
    
    
    
    2,500Research and development
    
    
    341
    
    
    
    379Total operating expenses
    
    
    3,111
    
    
    
    2,879Loss from operations
    
    
    (2,578
    )
    
    
    (2,606
    )Interest expense
    
    
    109
    
    
    
    117Other income, net
    
    
    (167
    )
    
    
    (231
    )Loss before income tax
    
    
    (2,520
    )
    
    
    (2,492
    )Provision for incomes taxes
    
    
    40
    
    
    
    Loss from continuing operations
    
    
    (2,560
    )
    
    
    (2,492
    )Loss from
discontinued operations
    
    
    
    
    
    
    (1,825
    )Net loss
    
    $
    (2,560
    )
    
    $
    (4,317
    )Basic and
diluted loss per share:Loss from
continuing operations
    
    $
    (0.11
    )
    
    $
    (0.11
    )Loss from
discontinued operations
    
    $
    
    
    
    $
    (0.08
    )Net loss
    
    $
    (0.11
    )
    
    $
    (0.19
    )Basic and diluted shares used in per
share calculations
    
    
    22,995
    
    
    
    22,628
 See accompanying notes to condensed consolidated financial statements. 3




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AXT, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS  Three Months EndedMarch 31,2004
    
    2003(Unaudited)CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (2,560
    )
    
    $
    (4,317
    )Adjustments to reconcile net loss to cash provided by
operations:Depreciation
    
    
    1,214
    
    
    
    1,722Amortization
of marketable securities premium/discount
    
    
    41
    
    
    
    79Gain on disposal of property, plant and equipment
    
    
    
    
    
    
    (11
    )Changes in assets and liabilities:Accounts receivable, net
    
    
    (617
    )
    
    
    (752
    )Inventories
    
    
    1,189
    
    
    
    3,111Prepaid expenses
    
    
    (718
    )
    
    
    1,268Other assets
    
    
    (21
    )
    
    
    (45
    )Accounts payable
    
    
    255
    
    
    
    (7
    )Accrued liabilities
    
    
    (340
    )
    
    
    (345
    )Other long-term liabilities
    
    
    51
    
    
    
    34Net cash (used in) provided by operating activities
    
    
    (1,506
    )
    
    
    737CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property, plant and equipment
    
    
    (280
    )
    
    
    (917
    )Investment in marketable securities
    
    
    (11,125
    )
    
    
    5,872Proceeds from sale of marketable securities
    
    
    5,922
    
    
    
    (37
    )Net cash (used in) provided by investing activities
    
    
    (5,483
    )
    
    
    4,918CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from (payments of):Issuance of common stock
    
    
    154
    
    
    
    185Capital leases payments
    
    
    
    
    
    
    (1,008
    )Long-term debt payments
    
    
    (793
    )
    
    
    (248
    )Net cash used in financing activities
    
    
    (639
    )
    
    
    (1,071
    )Effect of exchange rate changes
    
    
    (58
    )
    
    
    (46
    )Net
(decrease) increase in cash and cash equivalents
    
    
    (7,686
    )
    
    
    4,538Cash and cash equivalents at the beginning of the period
    
    
    24,339
    
    
    
    13,797Cash and cash equivalents at the end of the period
    
    $
    16,653
    
    
    $
    18,335
 See accompanying notes to condensed consolidated financial statements. 4




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AXT, INC. 
 
 Note 1. Basis of Presentation The accompanying condensed consolidated balance sheets as of March 31,
2004 and December 31, 2003, the condensed consolidated
statements of operations for
the three months ended March 31, 2004 and 2003, and the condensed consolidated
statements of cash flows for the three months ended March 31, 2004 and 2003
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 for
interim financial information 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 of
America 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 2003 Annual Report on Form 10-K filed with the Securities and Exchange
Commission on March 29, 2004. Revenues
from continuing operations have increased. In
response to continued net losses, the Company has taken cost reduction measures and continues to
pursue additional alternatives to reduce costs and increase cash
flows. As of
March 31, 2004, the Company had available cash, cash equivalents and liquid
short-term investments of $35.3
million, excluding restricted deposits. 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 2004 due to a weakening of the economy, a loss in revenue, or
changes in our planned cash outlay. If the Companys sales decrease, the ability to generate cash from
operations will be adversely affected which could adversely affect its future
liquidity, requiring it to use cash at a more rapid rate than expected and to
seek additional capital. There can be no assurance that such additional
capital will be available or, if available that it will be at 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. Significant
Accounting Policies Accounting policies are fully described in Note 1 to the notes to the
consolidated financial statements included in AXT, Inc.s Annual Report on Form
10-K filed with the Securities and Exchange Commission on March 29, 2004, and
there have been no material changes. 5




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AXT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTScontinued(unaudited) Note 3. Discontinued Operations On June 24, 2003, the Company announced the discontinuation of its
opto-electronics division, which was established as part of the 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 the consolidated
statements of operations. The discontinued opto-electronics division
manufactured blue, cyan, and green 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, Corp. and
Dalian Luming Science and Technology Group, Co., Ltd. for the Chinese Renminbi
equivalent of $9.6 million. Proceeds of $1.0 million will be held in escrow for
up to one year and will not be recorded until all claims, if any, are settled.
If unclaimed, up to $250,000 of the sale proceeds will be held in escrow for a
second year and will not be recorded until all claims, if any, are settled. The
Company retains a building located in Monterey Park, CA, that it
intends to sell
in 2004. This asset has been classified as Held for Sale on the
condensed consolidated balance
sheets as of March 31, 2004 and December 31, 2003. The Company recorded a loss on disposal of
$9.5 million during the nine months ended September 30, 2003. 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 March 31,2004
    
    2003(unaudited)Revenue
    
    $
    
    
    
    $
    4,121Cost of revenue
    
    
    
    
    
    
    4,675Gross loss
    
    
    
    
    
    
    (554
    )Operating expenses:Selling, general and administrative
    
    
    
    
    
    
    785Research and development
    
    
    
    
    
    
    366Impairment costs
    
    
    
    
    
    
    Total operating expenses
    
    
    
    
    
    
    1,151Loss from operations
    
    
    
    
    
    
    (1,704
    )Interest expense
    
    
    
    
    
    
    121Loss before benefit for income taxes and loss on
disposal
    
    
    
    
    
    
    (1,825
    )Income tax (benefit)
    
    
    
    
    
    
    Loss on disposal
    
    
    
    
    
    
    Net loss
    
    $
    
    
    
    $
    (1,825
    )
 6




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AXT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTScontinued(unaudited) The carrying value of the assets and liabilities of the discontinued
opto-electronics business included in the consolidated balance sheets are as follows: March 31, 2004
    
    December 31, 2003(unaudited)Current assets:Cash
    
    $
    701
    
    
    $
    539Accounts receivable, net
    
    
    19
    
    
    
    250Assets held for sale
    
    
    1,000
    
    
    
    1,000Total current assets
    
    
    1,720
    
    
    
    1,789Other assets
    
    
    200
    
    
    
    200Total assets
    
    $
    1,920
    
    
    $
    1,989Current liabilities:Accounts payable
    
    $
    
    
    
    $
    43Accrued liabilities
    
    
    890
    
    
    
    1,232Total liabilities
    
    
    890
    
    
    
    1,275Net assets
    
    
    1,030
    
    
    
    714Total liabilities and net assets
    
    $
    1,920
    
    
    $
    1,989
 Assets held for sale consist of a building and are carried at managements
estimated fair value less costs to sell. Note 4. 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 and has adopted the disclosure-only alternative of Statement of
Financial Accounting Standards No. 123 Accounting for Stock-Based
Compensation (SFAS 123). 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 SFAS 123 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 had the Company applied the fair value
recognition principles of SFAS 123 to employee stock options 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. 7




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\

AXT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTScontinued(unaudited) 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: Three Months EndedMarch 31,2004
    
    2003Weighted average risk free
interest rate
    
    
    2.8
    %
    
    
    3.0
    %Expected life (in years)
    
    
    5.0
    
    
    
    5.0Dividend yield
    
    
    
    
    
    
    Volatility
    
    
    92.4
    %
    
    
    110.2
    %
 The weighted average fair value as of the date of grant of options granted
during the three months ended March 31, 2004 and 2003 were $3.28 and $1.07,
respectively. 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 loss and net loss per share would have been as
summarized below (in thousands except per share data): March 31,2004
    
    2003Net loss :As reported
    
    $
    (2,560
    )
    
    $
    (4,317
    )Pro forma option expense
    
    
    (593
    )
    
    
    (1,904
    )Pro forma net loss
    
    $
    (3,153
    )
    
    $
    (6,221
    )Net loss per share:As reported:Basic and diluted
    
    $
    (0.11
    )
    
    $
    (0.19
    )Pro forma net loss :Basic and diluted
    
    $
    (0.14
    )
    
    $
    (0.27
    )
 Because additional option grants are expected to be made each quarter, the
above pro forma disclosures are not representative of pro forma effects on
reported net income (loss) for future quarters. Note 5. Investments The Company classifies its investment securities as available-for-sale
securities as prescribed by Statement of Financial Accounting Standards No. 115
or 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. A decline in the market value of
the security below cost that is deemed other than temporary is charged to
earnings, resulting in the establishment of a new cost basis for the security.
The components of investments as of March 31, 2004 are summarized below (in
thousands): 8




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AXT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTScontinued(unaudited) Unrealized
    
    AggregateAvailable for sale
    
    Cost
    
    Gain /(loss)
    
    Fair valueMoney market
    
    $
    13,007
    
    
    $
    
    
    
    $
    13,007Corporate bonds
    
    
    14,062
    
    
    
    14
    
    
    
    14,076Government agency
bonds
    
    
    5,100
    
    
    
    4
    
    
    
    5,104Corporate equity
securities
    
    
    1,115
    
    
    
    1,421
    
    
    
    2,536$
    33,284
    
    
    $
    1,439
    
    
    $
    34,723Recorded as :Cash equivalents
    
    $
    6,746Short-term investments
    
    
    18,675Restricted deposits
    
    
    9,302$
    34,723
 Note 6. Assets Held for Sale Assets
held for sale at March 31, 2004 consist of a building located in
Monterey Park, California, which is part of the Companys discontinued
opto-electronics division (see Note 3). This
building is carried at managements estimated fair value less costs to
sell, totaling $1.0 million as of both March 31, 2004 and December 31, 2003. Note 7. Inventories The components of inventory are summarized below (in thousands): March 31,
    
    December 31,2004
    
    2003(unaudited)Inventories:Raw Materials
    
    $
    5,467
    
    
    $
    7,086Work In Process
    
    
    16,685
    
    
    
    16,027Finished Goods
    
    
    742
    
    
    
    970$
    22,894
    
    
    $
    24,083
 Note 8. Net Loss Per Share Basic
loss per common share is calculated by dividing net loss available to common stockholders by the weighted average number of
common shares outstanding during the period. Diluted net loss 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 net loss per share calculations is summarized below (in thousands
except per share data): 9




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AXT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTScontinued(unaudited) Three Months EndedMarch 31,2004
    
    2003(unaudited)Numerator:Net loss
    
    $
    (2,560
    )
    
    $
    (4,317
    )Less : Preferred stock dividends
    
    
    (44
    )
    
    
    (44
    )Net loss available to common stockholders
    
    $
    (2,604
    )
    
    $
    (4,361
    )Denominator:Denominator
for basic net loss per share - weighted
average common shares
    
    
    22,995
    
    
    
    22,628Effect of dilutive securities:Common stock options
    
    
    
    
    
    
    Denominator
for dilutive net loss per share
    
    
    22,995
    
    
    
    22,628Basic and
diluted net loss per share
    
    $
    (0.11
    )
    
    $
    (0.19
    )Options
excluded from diluted net loss per share as
the impact is antidilutive
    
    
    547
    
    
    
    3,376
 Note 9. Comprehensive Loss The components of comprehensive loss are summarized below (in thousands): Three Months EndedMarch 31,2004
    
    2003(unaudited)Net loss
    
    $
    (2,560
    )
    
    $
    (4,317
    )Foreign
currency translation loss
    
    
    (58
    )
    
    
    (46
    )Unrealized
loss on available for
sale investments
    
    
    (1,156
    )
    
    
    (244
    )Comprehensive loss
    
    $
    (3,774
    )
    
    $
    (4,607
    )
 Note 10. Segment Information The Company has one operating segment comprising the design, development,
manufacture and distribution of high-performance compound semiconductor
substrates. The Companys operating segment reports to the
Interim Chief Executive
Officer. The Company sells its substrates products in the United States and in
other parts of the world, and maintains operations in the United States, Japan
and China. Revenues by geographic location based on the country where the
customer is located were as follows (in thousands): 10




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AXT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTScontinued(unaudited) Three Months EndedMarch 31,2004
    
    2003(unaudited)Net revenues:United States
    
    $
    2,056
    
    
    $
    3,906Europe
    
    
    1,416
    
    
    
    1,407Canada
    
    
    54
    
    
    
    23Japan
    
    
    1,236
    
    
    
    488Taiwan
    
    
    3,144
    
    
    
    1,489Asia Pacific and other
    
    
    1,870
    
    
    
    1,223Consolidated
    
    $
    9,776
    
    
    $
    8,536
 Note 11. Corporate Affiliates The Companys investments in its corporate affiliates are summarized
below (in thousands): Investment
    
    InvestmentBalance
    
    BalanceMarch 31,
    
    December 31,
    
    Accounting
    
    Owners hipAffiliate
    
    2004
    
    2003
    
    Method
    
    PercentageXilingol Tongli Ge Co. Ltd.
    
    $
    810
    
    
    $
    822
    
    
    Equity
    
    
    25
    %Emeis han Jia M ei High Pure Metals
Co., Ltd.
    
    
    601
    
    
    
    603
    
    
    Equity
    
    
    25
    %Beijing Ji Ya Semiconductor
Material Co., Ltd.
    
    
    1,071
    
    
    
    1,071
    
    
    Consolidated
    
    
    51
    %Nanjing Jin Mei Gallium Co., Ltd.
    
    
    616
    
    
    
    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 condensed consolidated balance sheets. The minority interest for those
affiliates that are consolidated is included within Other
long-term liabilities in the condensed consolidated balance
sheets and within Other income, net on the condensed
consolidated statements of operations. Undistributed retained earnings relating to the Companys corporate
affiliates was $999,000 as of March 31, 2004 and $835,000 as of March 31, 2003. Net
income recorded from the Companys corporate affiliates was $230,000 for the
three months ended March 31, 2004 and net loss recorded was $26,000 for the
three months ended March 31, 2003. The Company invested in these companies because each provides materials
that are important to the Companys substrate business, each can provide
products at lower cost than other suppliers, and each
has a market beyond that provided by the Company. As of March 31, 2004, 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 12. Commitments and Contingencies From time to time the Company is involved in judicial or administrative
proceedings concerning matters arising in the ordinary course of our business.
The Company does 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. 11




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AXT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTScontinued(unaudited) 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 the Company alleging patent
infringement. The complaint sought damages and injunction against infringement.
On July 23, 2003, the Company 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 the
Companys prospective business relationships. The Company reached an agreement
with Cree resolving the disputes between us and signed a settlement agreement
on March 5, 2004. The resolution of the disputes did not have a material
adverse impact on the Companys consolidated financial position or results of
operations. All parties signed a final release regarding all disputes between
them on April 15, 2004. 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, 2004 with a current contract
value of $1.7 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
$889,000 and $994,000 are included in accrued liabilities in the
accompanying condensed consolidated balance sheets as of
March 31, 2004 and December 31, 2003. As of March 31,
2004, the Company has met all of its delivery obligations under these contracts
and expects to do so for the remainder of the contract terms. We indemnify certain customers for attorney fees and damages and costs
awarded against these parties in certain circumstances if our products are
found to infringe certain patents and they are sued by the patent holder and
awarded damages. There are limits on and exceptions to our potential liability
for indemnification relating to intellectual patent infringement claims. We
cannot estimate the amount of potential future payments, if any, that we might
be required to make as a result of these agreements. To date, we have not paid
any claim or been required to defend any action related to our indemnification 12




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AXT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTScontinued(unaudited) obligations, and accordingly, we have not accrued any amounts for such
indemnification
  obligations. However, we may record charges in the future as a
result of these indemnification obligations. The Companys financial statements include accruals for potential product
liability and warranty claims based on the Companys claims experience. Such costs
are accrued at the time revenue is recognized. As of March 31,
2004 and December 31, 2003, accrued
product warranties totaled $135,000 and $0 respectively, and are included in Accrued
liabilities in the accompanying condensed consolidated balance sheets. If there is a material
increase in customer claims compared with our historical experience, or if
costs of servicing claims are greater than expected, we may record a charge
against cost of sales. During the first quarter of 2004, our revenue from continuing operations
increased to $9.8 million from $8.5 million in the first quarter
of 2003, primarily due to greater sales of GaAs substrates,
which benefited from increasing demand from our key end-use markets, read and
amber HBLEDs and wireless handsets. Our gross margin also increased to 5.5
percent due to higher yields and a greater share of our production being
completed in China. We have recently determined that we have not followed requirements for testing
of products and provision of testing data and information relating to customer
requirements for certain shipments made over the past several years. We are
notifying the affected customers concerning our findings. We have
established a reserve based on our best estimate of future returns
related to this matter. Although actual returns may differ, we do not
believe future claims in the aggregate will be material. One of our
customers has cancelled outstanding orders for scheduled future deliveries
totaling approximately $352,000. This customer represented approximately 4.5%
of our total consolidated revenue for the three months ended March 31, 2004 and
7.3% of our total consolidated revenue for the year ended December 31, 2003.
We have recorded a reserve for sale returns of $745,000 and believe
this is adequate to cover any product returns related
to this matter, however, we are unable to assess the impact that this matter
might have, if any, on our future revenues or gross margins. See Item 4
Controls and Procedures. Note 13. Recent Accounting Pronouncements In
January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46, or FIN 46, Consolidation of Variable
Interest Entities, which addresses consolidation by business
enterprises of variable interest entities, or VIEs, either: (1) that
do not have sufficient equity investment at risk to permit the entity
to finance its activities without additional subordinated financial
support, or (2) in which the equity investors lack an essential
characteristic of a controlling financial interest. In December 2003,
the FASB completed deliberations of proposed modifications to FIN 46,
or FIN 46(R), resulting in an effective date of no later than the
first interim or annual period ending after March 15, 2004. The
Companys adoption of FIN 46(R) did not have an impact on our results
of operations or financial position. 13




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AXT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTScontinued(unaudited) Note 14. 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 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 March 31, 2004, the Company had no
outstanding commitments with respect to foreign exchange contracts. The
Company incurred a foreign currency transaction exchange gain of
$63,000 for the three months ended March 31, 2004, and a gain of
$49,000 for
the three months ended March 31, 2003. Note 15. 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 in July, 2001 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. 14




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Managements Discussion and Analysis of Financial Condition and
Results of Operations includes a number of forward-looking statements 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, 2003 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. As a result of the discontinuance of our
opto-electronics division, and the sale of substantially all of the assets of
this business in 2003, we now have one operating segment: our substrate
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 raw materials including gallium and germanium through our
participation in majority- and minority-owned joint ventures. We have the
capability to manufacture germanium substrates for use in satellite solar cells
but withdrew from this business during 2000 so that we could more profitably
use our then constrained capacity. We are now trying to re-qualify our
germanium substrates with the few existing satellite solar cell system
manufacturers. Our
total revenue from continuing operations was $9.8 million for the
first quarter of 2004, $8.5 million for the first quarter of 2003 and $9.1
million for the fourth quarter of 2003. In the first quarter of 2004 we
incurred a loss from operations of $2.6 million compared with a loss of $2.6
million for the first quarter of 2003 and $2.0 million for the fourth quarter
of 2003. 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 consolidated
statements of operations for all periods presented (see Note 3 to our condensed
consolidated financial statements for details regarding the accounting for
discontinued operations). The discontinued opto-electronics division
manufactured blue, cyan, and green 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 we completed a sale of substantially all of the
assets of our opto-electronics business to Lumei Optoelectronics, Corp. and
Dalian Luming Science and Technology Group, Co., Ltd. for the China Renminbi
(RMB) equivalent of $9.6 million. During the first quarter
of 2004, $7.8 million was converted to US dollars. The remaining
funds were converted in early April, 2004. $1.0 million is
maintained in an escrow account for up to one year after the sale date 15




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and will not be recorded until all claims, if any, are settled. If
unclaimed, up to $250,000 of the sale proceeds will be held in escrow for a
second year and will not be recorded until all claims, if any, are settled. We
retain a building located in Monterey Park, CA, that we hope to sell in 2004.
This asset is classified as Held for Sale on our consolidated balance
sheet as of March 31, 2004. Our continuing business, primarily sales of our substrate products, is
dependant on the semiconductor industry, which is highly cyclical and has
historically experienced downturns both as a result of economic changes and of
overcapacity. We experienced a growth period that lasted from our initiation of
sales in 1990 through the first half of 2001. In the second half of 2001, we
experienced a $44.9 million, or 58.5% decrease in revenue compared with the
first half as a result of the rapid decline in the mobile and fiber optic
telecommunications markets. Together with other industry participants, we
experienced lower revenues, slower bookings, push outs and cancellation of
orders. As such, we recorded losses in the third and fourth quarters of 2001. During the first half of 2002 our revenues grew due to improvements in the
wireless market. In the second half of 2002 our revenue fell, however, because
the substrate industry was still facing excess capacity that caused prices to
decline, and because we experienced a loss of market share after two
competitors developed technologies similar to ours. In addition, certain
customers selected competitors products in order to diversify their supply
sources and due to the belief that the competitors substrates offered better
surface qualities. Full year 2002 revenue declined $63.9 million, or 58.8%
compared with 2001. We recorded losses in each quarter of 2002 and incurred
impairment charges against fixed assets and inventory due to the decline in
demand and prices. In reaction to the economic downturn, we initiated an
aggressive effort to reduce substrate manufacturing costs. This included moving
much of our substrate manufacturing operations to China, reducing capacity in
our Fremont, CA facility and developing and investing in key low-cost raw
material sources. In 2003, we believe that the wireless communications and HBLED markets
grew, but our revenue did not increase until the fourth quarter of 2003 due to
continued reductions in prices and the time required to improve our substrate
surface quality and regain some lost customers. Revenue for 2003 fell by $10.2
million, or 22.6% compared with 2002. We recorded net losses in each quarter of
2003. During 2003 we continued to shift more of our manufacturing operations to
China and reduced our costs incurred in the United States. We cannot predict the level of future industry demand or of our ability to
regain lost market share, but they have impacted our ability to sell our
products and operate profitably. If demand for our products remains depressed
for an extended period, our business will be harmed as a result. Our business
performance will be most influenced by market demand for compound
semi-conductor substrates, our ability to offer products that equal or exceed
the quality provided by competitors, product pricing, our ability to shift more
of our manufacturing production to China, and our ability to create and defend
our intellectual property while not infringing on the intellectual property of
others. During the first quarter of 2004, our revenue from continuing operations
increased to $9.8 million from $8.5 million in the first quarter
of 2003, primarily due to greater sales of GaAs substrates,
which benefited from increasing demand from our key end-use markets, read and
amber HBLEDs and wireless handsets. Our gross margin also increased
from the first quarter of 2003 to 5.5
percent due to higher yields and a greater share of our production being
completed in China, which was partially offset by an additional
warranty reserve of $135,000. We have recently determined that we have not followed requirements for testing
of products and provision of testing data and information relating to customer
requirements for certain shipments made over the past several years. We are
notifying the affected customers concerning our findings. We have
established a reserve based on our best estimate of future returns
related to this matter. Although actual returns may differ, we do not
believe future claims in the aggregate will be material. One of our
customers has cancelled outstanding orders for scheduled future deliveries
totaling approximately $352,000. This customer represented approximately 4.5%
of our total consolidated revenue for the three months ended March 31, 2004 and
7.3% of our total consolidated revenue for the year ended December 31, 2003.
We have recorded a reserve for sales returns of $745,000 and believe
this is adequate to cover any product returns related
to this matter, however, we are unable to assess the impact that this matter
might have, if any, on our future revenues or gross margins. See
Item 4.
Controls and Procedures. Critical Accounting Policies and Estimates We have prepared our consolidated financial statements in accordance with
accounting principles 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 16




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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 consolidated financial
statements. We have identified the policies below as critical to our business
operations and understanding of our financial condition and results of
operations. A critical accounting policy is one that is both material to the
presentation of our financial statements and requires us to make difficult,
subjective or complex judgments that could have a material effect on our
financial condition and results of operations. They may require us to make
assumptions about matters that are highly uncertain at the time of the
estimate, and different estimates that we could have used, or changes in the
estimate that are reasonably likely to occur, may have a material impact on our
financial condition or results of operations. 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 establish a reserve when
there is uncertainty regarding customer acceptance. 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. During the first quarter of 2004,
we increased our reserve for sales returns by $745,000 related to our
failure to follow certain testing requirements and provision of
testing data and information to certain customers. This reserve was
based on discussions with some of the affected customers and review
of specific shipments made during the quarter. 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. 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 in excess of 90 days and for foreign receivables in excess of
120 days. As of March 31, 2004 our accounts receivable
balance was $6.9 million, which is
net of an allowance for doubtful accounts of $4.9 million. Warranty Reserve We
maintain a warranty reserve
based upon our claims experience during the prior twelve months.
Such costs are accrued at the time revenue is recognized. As of March 31, 2004,
accrued product warranties totaled $135,000. Inventory Inventories are stated at the lower of cost or market. Cost is determined
using the standard 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. Competitive
delivery times are frequently less than the time required for us to manufacture
a product, requiring us to build some work-in-process inventories in
anticipation of orders. If orders are not obtained for the product built, the
products will ultimately be deemed obsolete and we will establish a reserve for
their value. We also review our inventory to ensure 17




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costs can be realized upon 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 evaluate the recoverability of property, equipment, and intangible
assets in accordance with Statement of Financial Accounting Standards No. 144,
or SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets. When events and circumstances indicate that long-lived assets may be
impaired, we compare the carrying value of the long-lived assets to the
projection of future undiscounted cash flows attributable to such assets and in
the event that the carrying value exceeds the future undiscounted cash flows,
we record an impairment charge against income equal to the excess of the
carrying value over the assets fair value. Investments We determine the appropriate classification of investments at the time of
purchase. Available-for-sale investments are carried at their fair value based
on quoted market prices as of the balance sheet date. The amortized cost of
securities is adjusted for amortization of premiums and accretion of discounts
to maturity. Such amortization is included in other (income) and expense,
net. Realized gains or losses are determined on the specific identification
method and are reflected in other (income) and expense, net. Net unrealized
gains or losses are recorded directly in stockholders equity. Those unrealized
losses that are deemed to be other than temporary are reflected in interest
and other income, net. We also maintain minority investments in private
companies which are accounted for under the cost basis. 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. 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. 18




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Results of Operations The following table sets forth certain information relating to the
operations of the Company expressed as a percentage of total revenues for the
periods indicated: Three Months EndedMarch 31,2004
    
    2003Revenues
    
    
    100.0
    %
    
    
    100.0
    %Cost of revenues
    
    
    94.5
    
    
    
    96.8Gross profit
    
    
    5.5
    %
    
    
    3.2
    %Operating expenses:Selling, general and administrative
    
    
    28.4
    
    
    
    29.3Research and development
    
    
    3.5
    
    
    
    4.4Total operating expenses
    
    
    31.9
    
    
    
    33.7Loss from operations
    
    
    (26.4
    )
    
    
    (30.5
    )Interest expense
    
    
    1.1
    
    
    
    1.4Other (income)/expense, net
    
    
    (1.7
    )
    
    
    (2.7
    )Loss from continuing operations before provision for income taxes
    
    
    (25.8
    )
    
    
    (29.2
    )Provision (benefit) for incomes taxes
    
    
    (0.4
    )
    
    
    Loss from continuing operations
    
    
    (26.2
    )
    
    
    (29.2
    )Discontinued operations:Loss from
discontinued operations
    
    
    
    
    
    
    (21.4
    )Net loss
    
    
    (26.2
    )%
    
    
    (50.6
    )%
 Three months ended March 31, 2004 compared with three months ended March 31,
2003 Revenue from continuing operations.Revenue from continuing operations
increased $1.2 million, or 14.5%, to $9.8 million for the three months ended
March 31, 2004 compared with $8.5 million for the three months ended March 31,
2003. Total
GaAs substrate revenue increased $1.0 million, or 15.5%, to
$8.0 million for the three months ended March 31, 2004 compared with $7.0 million
for the three months ended March 31, 2003. Sales of 5 and
6 diameter GaAs substrates
were at $1.5 million for the three months ended March 31, 2004 compared
with $1.3 million for the three months ended March 31, 2003. InP substrate
revenue decreased $48,000, or 8.5%, to $516,000 for the three months ended
March 31, 2004 compared with $564,000 for the three months ended March 31,
2003. The increase in GaAs substrate revenue during the past year is due to
market growth in the HBLED and wireless handset markets and to our ability to
gain share among some Asian customers. International
revenue increased to 78.4% of total revenue from continuing
operations for the three months ended March 31, 2004 compared with 54% of total
revenue from continuing operations for the three months ended March 31, 2003.
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. Gross
margin.Gross margin increased to 5.5% of total revenue for the three
months ended March 31, 2004 compared with 3.2% of total revenue for the three
months ended March 31, 2003. The increase 19




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was primarily due to a larger sales
volume that enabled us to cover more fixed costs as well as reduced costs that
we incurred as a result of moving most of our production to China, where we
incur lower production costs than in our California operations. The
increase was partially offset by an additional warranty reserve of
$135,000. Selling, general and administrative expenses.Selling, general and
administrative expenses increased to $2.8 million for the three months ended
March 31, 2004 compared with $2.5 million for the three months ended March 31,
2003. The increase is due to an accrual of $300,000 for auditing and
Sarbanes-Oxley expenses for 2004. As a percentage of revenue, selling, general and administrative expenses
were 28.4% for the three months ended March 31, 2004 compared with 29.3% for
the three months ended March 31, 2003. Research and development expenses.Research and development expenses
decreased $38,000, or 10.0%, to $341,000 for the three months ended March 31,
2004 compared with $379,000 for the three months ended March 31, 2003. As a
percentage of total revenue, research and development expenses were
3.5% for
the three months ended March 31, 2004 compared with 4.4% for the three months
ended March 31, 2003. 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 quarter of 2004 were focused primarily on
improving the yield and surface quality of our GaAs substrates. Interest expense.Interest expense decreased $8,000, or 6.8%, to $109,000
for the three months ended March 31, 2004 compared with $117,000 for the three
months ended March 31, 2003. Interest expense includes the prepayment penalty
incurred in voluntarily paying off a loan with an outstanding
principal balance of
$781,000, which we acquired in 1996. Other income and expense, net.Other income decreased $64,000, to $167,000
for the three months ended March 31, 2004 compared with income of $231,000 for
the three months ended March 31, 2003. Provision for income taxes.Due to our continuing operating losses in the
United States and uncertainty regarding future profitability, we recorded a
full valuation allowance for our US losses against our net deferred tax assets
of $31.2 million in 2002. We incurred a tax liability of $40,000 for our
overseas businesses for the three months ended March 31, 2004. Liquidity and Capital Resources We consider cash and cash equivalents, and short-term investments as
liquid and available for use. Short-term investments are comprised of
government bonds and high-grade commercial debt instruments. Also included in
short-term investments is our common stock investment in Finisar Corporation.
As of March 31, 2004, our principal sources of liquidity were
$35.3 million in
cash and cash equivalents and short-term investments, excluding
restricted deposits. Cash
and cash equivalents and short-term investments, excluding $2.5 million and $3.7 million for our investment in
Finisar common stock as of March 31, 2004 and December 31,
2003, respectively, decreased $2.5
million to $32.8 million as of March 31, 2004 compared with
$35.3 million as of
December 31, 2003. Cash
and cash equivalents decreased $7.7 million to $16.7 as of March 31,
2004 compared with $24.3 million as of December 31, 2003. Short-term investments
increased by $4.0 million to $18.7 million as of March 31, 2004 compared with
$14.7 million as of December 31, 2003. We converted
approximately $7.8 million of the total $9.6 million of Chinese Renminbi from the sale of our opto-electronic assets into
United States dollars during the first quarter of 2004 and invested most of that into
short-term investments. The remaining funds were converted in early
April, 2004. Net cash used by operating activities of $1.5 million for the quarter
ended March 31, 2004 was comprised primarily of our net loss adjusted for
non-cash items which netted to $1,054,000, consisting 20




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primarily of depreciation
of $1,214,000, and by a $160,000 net change in assets and liabilities. The net
change in assets and liabilities resulted primarily from a decrease in
inventory offset by increases in net accounts receivable and prepaid expenses
and increases in accounts payable and decreases in accrued liabilities. Net
accounts receivable increased by $617,000, or 9.8%, to
$6.9 million as of March 31, 2004 compared with
$6.3 million as of December 31, 2003. The
change reflects higher sales volume particularly to customers in Asia who are
generally given longer payment terms. Net
inventories decreased $1.2 million, or 4.9% to
$22.9 million as of March 31, 2004 compared with $24.1 million as of December 31, 2003. The Company adopted
a strategy of using inventory to conserve cash. During 2004 we do not expect to
maintain the same rate of net inventory decrease as we experienced in 2003. Net cash used by investing activities of $5.5 million for the quarter
ended March 31, 2004 includes sales of high grade investment securities
totaling $5.9 million and a change in the investments providing our restricted cash
of $1.4 million, offset by purchases of property and equipment of $280,000
primarily used to transfer production capacity to China for the substrate
division, and purchases of high grade investment securities with maturities of
less than two years totaling $11.1 million. We do not have any plans to initiate any major new capital spending
projects through 2004. We are currently completing certain projects at our
China facilities and are continuously constructing minor improvements to our
existing production facilities in Fremont. We expect to invest approximately $3.0 million
in capital projects in 2004. We believe that our existing and planned
facilities and equipment are sufficient to fulfill current and expected future
orders. Net cash used in financing activities of $639,000 consisted of proceeds
of $154,000 through our employee stock compensation programs, offset
by scheduled payments of $793,000 related to long-term borrowings. 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 1.19% at March 31, 2004. 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. As of March 31, 2004, $8.5
million was outstanding under these bonds. As
of March 31, 2004 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 $8.5 million. The Company has pledged and placed certain investment securities with an affiliate of the bank as additional
collateral for this facility. We have also pledged certain investments for a credit facility
for our workers compensation insurance. As a result, $9.3 million of our investments are restricted. We currently hold a note payable secured by certain building and land in
China totaling $3.3 million as of March 31, 2004. The balance on this note will be
due in June and December 2004. We believe that we have adequate cash and investments to meet the
Companys short- and long-term needs. If our sales decrease, however, our
ability to generate cash from operations will be adversely affected which could
adversely affect our future liquidity, require us to use more 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. 21




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Outstanding contractual obligations as of March 31, 2004 are summarized
below (in thousands): OperatingDebt
    
    Leases
    
    Total2004
(remaining nine months)
    
    $
    3,758
    
    
    $
    1,067
    
    
    $
    4,8252005
    
    
    420
    
    
    
    1,221
    
    
    
    1,6412006
    
    
    420
    
    
    
    901
    
    
    
    1,3212007
    
    
    420
    
    
    
    680
    
    
    
    1,1002008
    
    
    385
    
    
    
    681
    
    
    
    1,066Thereafter
    
    
    6,340
    
    
    
    2,855
    
    
    
    9,195$
    11,743
    
    
    $
    7,405
    
    
    $
    19,148
 We lease certain office space, manufacturing facilities and property under
long-term operating leases expiring at various dates through March 2013. Total
rent expense under these operating leases was approximately $352,000 for the
quarter ended March 31, 2004. Recent Accounting
Pronouncements In
January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46, or FIN 46, Consolidation of Variable
Interest Entities, which addresses consolidation by business
enterprises of variable interest entities, or VIEs, either: (1) that
do not have sufficient equity investment at risk to permit the entity
to finance its activities without additional subordinated financial
support, or (2) in which the equity investors lack an essential
characteristic of a controlling financial interest. In December 2003,
the FASB completed deliberations of proposed modifications to FIN 46,
or FIN 46(R), resulting in an effective date of no later than the
first interim or annual period ending after March 15, 2004. The
Companys adoption of FIN 46(R) did not have an impact on our results
of operations or financial position. Risks Related to Our Business We may incur claims or other liabilities or obligations related to our failure
to follow requirements for testing of products and provision of testing data
and information relating to customer requirements. Additionally,
customers may cancel or reduce future shipments in response to these
failures. We
have recently determined that we have not followed requirements for
testing of products and provision of testing data and information relating to
customer requirements. See preceeding Item 2. Overview and Item 4. Controls and Procedures below. Although
we are notifying affected customers concerning our findings, there can be no assurance
that we will not incur customer claims or other liabilities or obligations in
connection with this matter, nor, if we receive any such claims, that we
will not have to restate results from prior periods. In addition, revenue in future periods may be adversely impacted if customers
cancel or reduce orders or decide not to continue ordering from us as a result
of this disclosure. We have been notified of several cancellations of future
orders by customers pending further information regarding
enhancements to our product testing and quality control systems. We cannot
be sure that we will not receive additional cancellations of orders by other
customers, or fail to win expected future orders from customers, as a result of
our disclosure of our investigation conclusions. The semiconductor industry is cyclical and has experienced a downturn which has
adversely impacted our operating results. 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.
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
high, and the effect of these changes upon us occurs quickly, 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. The industry has previously experienced 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
years, 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 experienced cancellations, price reductions, delays and push
outs of orders, which have resulted in reduced revenues. If the economic
downturn were to continue, or occur again in the future, further order
cancellations, reductions in order size or delays in orders will materially
adversely affect our business and results of operations. Actions to reduce our
costs, such as those we have recently taken, may be insufficient to align our
structure with prevailing business conditions. We may be required to undertake
additional cost-cutting measures, and may be unable to invest in marketing,
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. During periods of increasing demand for semiconductor devices, we must
have sufficient manufacturing capacity and inventory to meet customer demand,
and must be able to attract, hire, train and retain qualified employees to meet
demand. It appears that the semiconductor industry is in the early stages of an
upturn and increasing demand. However, we cannot predict the sustainability of
a recovery, if any, 22




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and the industrys rate of growth in this recovery, if it occurs. If we
are unable to effectively manage our resources and production capacity during
an industry upturn, there could be a material adverse effect on our business,
financial condition and results of operations. 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, we may make decisions to expand capacity that are not
profitable, and we may be unable to lower our costs or increase revenue. It appears that the industry may be in an upturn, which may cause demand
to 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. We are currently constructing and 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; and
    
    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 may 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, if prices decline significantly, 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. 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 was the largest in our history and our losses continued
during 2003. We believe we will endure losses for at least part of 2004. 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: 23




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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 meaningful indicators 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 could 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. Our results of operations may suffer if we do not effectively manage our
inventory. We must manage our inventory of component parts, work-in-process, 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, 2003, we implemented a new inventory
control system that may experience unexpected difficulties. 24




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Decreases in average selling prices of our products may reduce gross margins. The market for compound semiconductor substrates is characterized by
pressures on average selling prices resulting from factors such as increased
competition or overcapacity. We may experience price pressures on our
products, and if average selling prices decline in the future, our revenues and
gross margins could decline. We may be unable to reduce the cost of our
products sufficiently to counter the effect of lower selling prices and allow
us to keep pace with competitive pricing pressures and our margins could be
adversely affected. 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 of the sale proceeds which will be held in escrow should the buyer
successfully claim that we breached one of the representations or warranties
made to it. 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. A reoccurrence of Severe Acute Respiratory Syndrome (SARS) or the outbreak of a
different contagious disease 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 and other suppliers in China. The 2003 SARS outbreak was most
notable in China and a small number of cases have been reported to date in
2004. One employee at our LED production facility in China contracted SARS in
late April 2003 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 or a different contagious disease 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 during parts of 2003. None of our
substrate competitors is 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 2003 was more uncertain than in
some prior periods, 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, solid-state illumination, 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. 25




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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 or
performance characteristics, 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 Triquent, are actively developing substrate materials that could be
used to manufacture devices that could provide the same high-performance,
low-power capabilities as GaAs- and InP-based devices at competitive prices. If
these substrate materials or VGF derived products are successfully developed
and semiconductor device manufacturers adopt them, demand for our GaAs
substrates could decline and our revenue could suffer. The development of new products can be a highly complex process, and we
may experience delays in developing and introducing new products. Any
significant delays could cause us to fail to timely introduce and gain market
acceptance of new products. Further, the costs involved in researching,
developing and engineering new products could be greater than anticipated. Our operating results depend in large part on further customer acceptance of
our existing substrate products manufactured in China. 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. In addition,
we may shift all of our production to China by the end of 2004, substantially
closing our California production. If customers do not fully qualify our China
production by the time we cease our California production, we may lose
additional customers. 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. 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 Triquent, 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, including: 26




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
    
    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 our products are. 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, require us to further reduce the prices of our
products, affect our ability to recover costs or result in reduced gross
margins. 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 over the past two years,
which caused customers to return products to us, reduce orders for our
products, or both. If we continue to experience quality control problems, or
experience these or other problems in new products, customers may cancel or
reduce orders or purchase products from our competitors and sales of our
products could decline. 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. If new products developed by us 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. 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. If our yields decrease, our revenue could decline because many of our
manufacturing costs are fixed, or would increase. We have experienced product
shipment delays and difficulties in achieving acceptable yields on both new and
older products, and delays and poor yields have adversely affected our
operating results. We may experience similar problems in the future and we
cannot predict when they may occur or their severity. In particular, many of
our manufacturing processes are new and are still being refined, which can
result in lower yields. 27




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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 65.9% of our total
revenue for the year ended December 31, 2003 and 43.9% for the year ended
December 31, 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. 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 28




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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 end user applications for which our products are used
decreases, or our customers are unable to develop, market and sell their
products, demand for our products will decrease. 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 120 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. 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 quartz tubing, polishing solutions, and paralytic boron
nitride. We generally purchase these materials through standard purchase orders
and not pursuant to long-term supply contracts and no supplier 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; in addition, we
could be subject to suits for personal injuries caused by exposure to hazardous
materials. 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 $200,415, and we have recently been the target of
press allegations concerning our environmental compliance programs and exposure
of our employees to hazardous materials. 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 29




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locations could be restricted or we could be required to acquire costly
remediation equipment or incur other significant expenses. Existing or future
changes in laws or regulations may require us to incur significant expenditures
or liabilities, or may restrict our operations. In addition, our employees
could be exposed to chemicals or other hazardous materials at our facilities
and we may be subject to lawsuits seeking damages for wrongful death or
personal injuries allegedly caused by exposure to chemicals or hazardous
materials at our facilities. If litigation is brought against us, litigation is inherently uncertain
and while we would expect to defend ourself vigorously, it is possible that our
business, financial condition, results of operations or cash flows, could be
affected in any particular period by such litigation if brought against us. 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 38.9% of
our total revenue for the quarter ended March 31, 2004 and 28.9% for the for
the year ended December 31, 2003. One customer accounted for 13.1% of our
revenue for the quarter ended March 31, 2004. 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. 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 the current competitive and 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 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. 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 30




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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 a substrate competitor 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. As our business matures, we may need to upgrade our systems, or incur
additional costs related to regulatory compliance. 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. We recently
upgraded 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. 31




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If we fail to manage periodic contractions, we may utilize our cash balances
and our existing cash and cash equivalent balances could decline. 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 pursue additional
capital expenditures, the level of our production, and other factors related to
the uncertainties of the industry and global economies. If we fail to manage
our contractions successfully we may 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.
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. 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. 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. Our liquidity is affected by many factors
including, among others, the extent to which we pursue 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 sooner, or, if so required, that such capital will be
available on terms acceptable to us if at all. We have made and may continue to make strategic investments in raw materials
suppliers, which may not be successful and may result in the loss of all or
part of our investment. Through fiscal 2003, we have recorded minority investments in raw material
suppliers in China, that provide us with opportunities to gain supply of key
raw materials that are important to our substrate business, and other products
at lower cost than other suppliers. These affiliates each have a market beyond
that provided by us. As of March 31, 2004, we had no obligations to make further
investments in any of these companies, although we may choose to do so under
certain conditions. We do not have influence over all of these companies,
each of which is located in China, and in some we have made only a strategic,
minority investment. We may not be successful in achieving the financial,
technological or commercial advantage upon which any given investment is
premised, and we could end up losing all or part of our investment. 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,
procedures, and policies; and 32




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
    
    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 also incurred consistent operating losses
for the business following the acquisition, and have discontinued all
operations and sold the related assets acquired in our acquisition of Lyte
Optronics during 2003. 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. 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 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. 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. 33




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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 twelve months ended March 31, 2004, the high
and low closing sales prices of our common stock were $4.58 and $0.67,
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. 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. 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. 34




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In addition, 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,
including:  
    
    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. 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 advisory services, all of which will
cause our general and administrative costs to increase. Insurers may increase
premiums as a result of the high claims rates they incurred over the past year,
and our premiums for our various insurance policies, including our directors
and officers insurance policies, increased during 2003. 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. We need to continue to improve or implement our systems, procedures and
controls and may not receive favorable attestation of our internal control
systems by our independent auditors. The new requirements adopted by the Securities and Exchange Commission in
response to the passage of the Sarbanes-Oxley Act of 2002 will require annual
review and evaluation of our internal control systems, and attestation of these
systems by our independent accountants. We are currently reviewing our internal
control procedures and considering further documentation of such procedures
that may be necessary. However, the guidelines for the evaluation and
attestation of internal control systems have not yet been finalized.
Furthermore, once the guidelines are finalized, the evaluation and attestation
processes will be new and untested. Therefore, we can give no assurances that
our systems will satisfy the new requirements of the Securities and Exchange
Commission or that we will receive a favorable review and attestation by our
independent auditors. 35




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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 March 31, 2004, 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
    
    ProformaBalance
    
    Current
    
    Interest
    
    10% Interest
    
    10% InterestMarch 31,
    
    Interest
    
    Income/
    
    Rate Decline
    
    Rate IncreaseInstrument
    
    2004
    
    Rate
    
    (Expense)
    
    Income/(Expense)
    
    Income/(Expense)Cash and cash
equivalents
    
    $
    16,653
    
    
    
    1.00
    %
    
    $
    167
    
    
    $
    150
    
    
    $
    183Bonds
    
    
    8,450
    
    
    
    1.19
    %
    
    
    (101
    )
    
    
    (90
    )
    
    
    (111
    )$
    66
    
    
    $
    60
    
    
    $
    72
 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. In 2003, we recorded $2.0 million
in charges to other expense to write down our investment in two private US
companies. As of March 31, 2004, the minority investments we continue to hold
totaled $3.1 million. 
 ITEM 4.CONTROLS AND PROCEDURES (a) Under the supervision and with the participation of our management,
our Interim Chief Executive Officer and Principal Financial Officer
has evaluated the effectiveness of our disclosure controls and procedures, as such
term is defined under Rule 13a-15(e) promulgated under the Securities Exchange
Act of 1934, as amended as of March 31, 2004, the end of the period covered by
this report. Based upon the evaluation, the Companys
management, our Interim Chief Executive Officer and Principal Financial Officer, concluded that the
Companys disclosure controls and procedures were effective, except as
described below relating to certain product testing procedures, as of the end
of the period covered by this quarterly report. In March 2004, as part of the Companys implementation of our Code of
Business Conduct and Ethics, we learned of certain failures to comply with
requirements for product testing and the provision of testing data and
information relating to requirements of certain customers. The Audit Committee of the
Companys 36




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Board of Directors conducted an investigation into our product testing
practices and procedures, with the assistance of outside counsel. The investigation confirmed that certain requirements for product testing
and the provision of testing data and information relating to certain customer
requirements were not being complied with. We implemented measures to ensure greater operational controls
and compliance with customer requirements. As a result of the investigation, the Audit Committee concluded that certain
executive management changes should be implemented. Donald L. Tatzin,
formerly Chief Financial Officer, has been appointed Interim Chief Executive Officer, Wilson W. Cheung, our Vice President, Corporate
Controller, has been promoted to Chief Financial Officer. Morris
Young, Ph.D.,
formerly our Chairman, President and Chief Executive Officer, will be
responsible for improving and expanding the Companys China operation. He
will also remain a director. The Board of Directors has also determined to separate
the role of Chairman and Chief Executive Officer, and accordingly, Jesse
Chen, a current AXT board member, has become Chairman of the Board. In
addition, the Audit Committee concluded that additional review of the
organization and performance of operations, quality control and product testing
would be conducted, resulting in possible additional changes in management and
non-management functions. The Audit Committee also instructed management to
implement additional training programs for employees involved in production,
testing and quality assurance. The Audit Committee believes that these
measures will address the issues raised above and provide the necessary
operational oversight and assurance that the Company is complying with the
requirements for product testing and the provision of testing data and other
customer information. (b) No significant changes in internal controls over financial reporting were
made during the quarter ended March 31, 2004, although as described above, we
implemented executive management changes, including a change in our Chief
Executive Officer and Chief Financial Officer roles, after the end of the
quarter, and are implementing operational changes and measures to improve our
operational controls over product testing, provision of testing and other
customer data and quality assurance. 
 PART II OTHER INFORMATION 
 Item 1. Legal Proceedings From time to time the Company is involved in judicial or administrative
proceedings concerning matters arising in the ordinary course of business. The
Company does not expect that any of these matters, individually or in the
aggregate, will have a material adverse effect on its 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 the Company and
its 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 the Company alleging patent
infringement. The complaint sought damages and injunction against infringement.
On July 23, 2003, the Company 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 the
Companys prospective business relationships. The Company reached an agreement
with Cree resolving the disputes between us and signed a settlement agreement
on March 5, 2004. The resolution of the disputes did not have a material
adverse impact on the Companys consolidated financial position or results of
operations. All parties signed a final release regarding all disputes between
them on April 15, 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 37




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Item 5. Other Information None 
 Item 6. Exhibits and Reports on Form 8-K a. Exhibits ExhibitNumber
    
    Description3.1(1)
    
    Restated Certificate of Incorporation3.2(2)
    
    Certificate of Designation, Preferences and Rights of Series
A Preferred Stock (which is incorporated herein by reference3.3(3)
    
    Second Amended and Restated Bylaws31.1
    
    Certification by Interim Chief
Executive Officer and Principal Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification by Interim Chief
Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
   (1)
    
    Incorporated by reference to the exhibit of the same number filed
with the SEC with our Annual Report on Form 10-K for the year ended December
31, 1998.(2)
    
    Incorporated by reference to Exhibit 2.1 to registrants Form 8-K filed
with the SEC on June 14, 1999.(3)
    
    Incorporated by reference to Exhibit 3.4 to registrants Form 8-K filed
with the SEC on May 30, 2001. b. Reports on Form 8-K We filed or furnished the following reports on Form 8-K during the quarter
ended March 31, 2004: 1. On February 4, 2004 we filed a report on form 8-K reporting our
earnings for the three and twelve months ended December 31, 2003. 38




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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:
May 24, 2003
    
    By:
    
    /s/ Donald L. TatzinDonald L. TatzinInterim Chief Executive Officer and
Principal Financial Officer
 39




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EXHIBIT INDEX ExhibitNumber
    
    Description3.1(1)
    
    Restated Certificate of Incorporation3.2(2)
    
    Certificate of Designation, Preferences and Rights of Series
A Preferred Stock (which is incorporated herein by reference3.3(3)
    
    Second Amended and Restated By Laws31.1
    
    Certification by Interim Chief
Executive Officer and Principal Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification by Interim Chief
Executive Officer and Principal Financial Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
   (1)
    
    Incorporated by reference to the exhibit as of the same number as filed
with the SEC in our Annual Report on Form 10-K for the year ended December
31, 1998.(2)
    
    Incorporated by reference to Exhibit 2.1 to registrants Form 8-K filed
with the SEC on June 14, 1999.(3)
    
    Incorporated by reference to Exhibit 3.4 to registrants Form 8-K filed
with the SEC on May 30, 2001.