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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC. 20549


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FORM 10-Q


|           |  |                                                                                                                                       
|---------- |  | --------------------------------------------------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                                                                       
|x          |  | Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the quarterly period
ended March 31, 2003 
|           |  |                                                                                                                                       
|or         |  |                                                                                                                                       
|o          |  | Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the transition period
from             to

Commission File Number 0-24085


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AXT, INC.

(Exact name of registrant as specified in its charter)


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

4281 Technology Drive, Fremont, California 94538

(Address of principal executive offices)    (Zip code)
(510) 683-5900
(Registrants telephone number, including area code)




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


YES x     NO o

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

YES x     NO o

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 March 31, 2003
|                              |  |                              
|Common Stock, $.001 par value |  | 22,693,984                   



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TABLE OF CONTENTS



|                              |                                                                                               |                                                      |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | Item 1. Financial Statements                                                                 
|                              |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF INCOME         
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                              |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              | Item 3. Qualitative and Quantitative Disclosures About Market Risk                           
|                              | Item 4. Controls and Procedures                                                              
|PART II OTHER INFORMATION    
|                              | Item 1. Legal Proceedings                                                                    
|                              | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                   
|CERTIFICATION                
|EXHIBIT INDEX                
|EXHIBIT 10.15                
|EXHIBIT 99.1                 
|EXHIBIT 99.2                 



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AXT, INC.

TABLE OF CONTENTS

|         |  |                       |  |                                                                                                    |  |      
|-------- |  | --------------------- |  | -------------------------------------------------------------------------------------------------- |  | -----
|         |  |                       |  |                                                                                                    |  | Page 
|PART I.  |  | FINANCIAL INFORMATION |  |                                                                                                   
|         |  | Item 1.               |  | Financial Statements                                                                               |  |      
|         |  |                       |  | Condensed Consolidated Balance Sheets at March 31, 2003 and December 31, 2002                      |  | 3    
|         |  |                       |  | Condensed
Consolidated Statements of Income for the three months ended March 31, 2003
and 2002     |  | 4    
|         |  |                       |  | Condensed Consolidated Statements of Cash Flows for the three months ended March 31,
2003 and 2002 |  | 5    
|         |  |                       |  | Notes To Condensed Consolidated Financial Statements                                               |  | 6-12 
|         |  | Item 2.               |  | Managements Discussion and Analysis of Financial Condition and Results of Operations              |  | 12-31
|         |  | Item 3.               |  | Quantitative and Qualitative Disclosures About Market Risk                                         |  | 31   
|         |  | Item 4.               |  | Controls and Procedures                                                                            |  | 32   
|PART II. |  | OTHER INFORMATION     |  |                                                                                                   
|         |  | Item 1.               |  | Legal Proceedings                                                                                  |  | 32   
|         |  | Item 6.               |  | Exhibits and Reports on Form 8-K                                                                   |  | 33   
|         |  |                       |  | Signatures                                                                                         |  | 34   
|         |  |                       |  | Certifications                                                                                     |  | 35-36

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PART I. FINANCIAL INFORMATION




Item 1. Financial Statements




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

|                                      |                               |                                                                                                                    |                            |        |             |         |              |        |         |         | 
|------------------------------------- | ----------------------------- | ------------------------------------------------------------------------------------------------------------------ | -------------------------- | ------ | ----------- | ------- | ------------ | ------ | ------- | ------- | 
|                                      |                               |                                                                                                                    |                            |        | March 31,   |         | December 31,
|                                      |                               |                                                                                                                    |                            |        | 2003        |         | 2002        
|                                      |                               |                                                                                                                    |                            |        |             |         |             
|                                      |                               |                                                                                                                    |                            |        | (Unaudited) |         |              |        |        
|Assets:                               |                               |                                                                                                                    |                            |        |             |         |              |       
|                                      | Current assets                |                                                                                                                    |                            |        |             |         |              |        |        
|                                      |                               | Cash and cash equivalents                                                                                          |                            | $      | 18,335      |         |              | $      | 13,797  |        
|                                      |                               | Short-term investments                                                                                             |                            |        | 9,107       |         |              |        | 8,205   |        
|                                      |                               | Accounts receivable, net                                                                                           |                            |        | 7,947       |         |              |        | 7,195   |        
|                                      |                               | Inventories                                                                                                        |                            |        | 34,487      |         |              |        | 37,598  |        
|                                      |                               | Prepaid expenses and other current assets                                                                          |                            |        | 2,979       |         |              |        | 4,002   |        
|                                      |                               | Income tax receivable                                                                                              |                            |        | 8,220       |         |              |        | 8,783   |        
|                                      |                               | Asset held for sale                                                                                                |                            |        |            |         |              |        | 5,957   |        
|                                      |                               |                                                                                                                    |                            |        |             |         |              |        |         |        
|                                      |                               |                                                                                                                    | Total current assets       |        |             | 81,075  |              |        |         | 85,537  | 
|                                      | Property, plant and equipment |                                                                                                                    |                            | 39,178 |             |         |              | 39,982 |        
|                                      | Other assets                  |                                                                                                                    |                            | 5,936  |             |         |              | 5,341  |        
|                                      | Restricted deposits           |                                                                                                                    |                            | 10,722 |             |         |              | 11,150 |        
|                                      | Long-term investments         |                                                                                                                    |                            | 2,197  |             |         |              | 3,657  |        
|                                      |                               |                                                                                                                    |                            |        |             |         |              |        |         |        
|                                      |                               |                                                                                                                    | Total assets               |        | $           | 139,108 |              |        | $       | 145,667 | 
|                                      |                               |                                                                                                                    |                            |        |             |         |              |        |         |        
|Liabilities and Stockholders Equity: |                               |                                                                                                                    |                            |        |             |         |              |       
|                                      | Current liabilities           |                                                                                                                    |                            |        |             |         |              |        |        
|                                      |                               | Accounts payable                                                                                                   |                            | $      | 4,221       |         |              | $      | 4,228   |        
|                                      |                               | Accrued liabilities                                                                                                |                            |        | 10,499      |         |              |        | 11,407  |        
|                                      |                               | Current portion of long-term debt                                                                                  |                            |        | 944         |         |              |        | 965     |        
|                                      |                               | Current portion of capital lease obligation                                                                        |                            |        | 3,411       |         |              |        | 3,562   |        
|                                      |                               |                                                                                                                    |                            |        |             |         |              |        |         |        
|                                      |                               |                                                                                                                    | Total current liabilities  |        |             | 19,075  |              |        |         | 20,162  | 
|                                      |                               | Long-term debt, net of current portion                                                                             |                            |        | 13,062      |         |              |        | 13,289  |        
|                                      |                               | Long-term capital lease, net of current portion                                                                    |                            |        | 3,990       |         |              |        | 4,847   |        
|                                      |                               | Other long-term liabilities                                                                                        |                            |        | 1,746       |         |              |        | 1,712   |        
|                                      |                               |                                                                                                                    |                            |        |             |         |              |        |         |        
|                                      |                               |                                                                                                                    | Total liabilities          |        |             | 37,873  |              |        |         | 40,010  | 
|                                      |                               |                                                                                                                    |                            |        |             |         |              |        |         |        
|                                      | Stockholders equity:         |                                                                                                                    |                            |        |             |         |              |        |        
|                                      |                               | Preferred stock, $.001 par value per share; 2,000
shares authorized; 883 shares issued and outstanding             |                            |        | 3,532       |         |              |        | 3,532   |        
|                                      |                               | Common stock, $.001 par value per share; 70,000 shares
authorized; 22,694 and 22,495 shares issued and
outstanding |                            |        | 154,670     |         |              |        | 154,485 |        
|                                      |                               | Accumulated deficit                                                                                                |                            |        | (56,514     | )       |              |        | (52,197 | )      
|                                      |                               | Other comprehensive income (loss)                                                                                  |                            |        | (453        | )       |              |        | (163    | )      
|                                      |                               |                                                                                                                    |                            |        |             |         |              |        |         |        
|                                      |                               |                                                                                                                    | Total stockholders equity |        |             | 101,235 |              |        |         | 105,657 | 
|                                      |                               |                                                                                                                    |                            |        |             |         |              |        |         |        
|                                      |                               | Total liabilities and stockholders equity                                                                         |                            | $      | 139,108     |         |              | $      | 145,667 |        
|                                      |                               |                                                                                                                    |                            |        |             |         |              |        |         |        

See accompanying notes to these unaudited condensed consolidated financial
statements.

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

|                                       |                                     |                          |        |                    |       |      |        |        |       | 
|-------------------------------------- | ----------------------------------- | ------------------------ | ------ | ------------------ | ----- | ---- | ------ | ------ | ----- | 
|                                       |                                     |                          |        | Three Months Ended
|                                       |                                     |                          |        | March 31,         
|                                       |                                     |                          |        | 2003               |       | 2002
|                                       |                                     |                          |        |                    |       |     
|Revenue                                |                                     | $                        | 12,657 |                    |       | $    | 16,777 |       
|Cost of revenue                        |                                     |                          | 12,938 |                    |       |      | 16,484 |       
|                                       |                                     |                          |        |                    |       |      |        |       
|Gross profit (loss)                    |                                     |                          | (281   | )                  |       |      | 293    |       
|Operating expenses:                    |                                     |                          |        |                    |       |      |        |       
|                                       | Selling, general and administrative |                          |        | 3,286              |       |      |        | 5,202  |      
|                                       | Research and development            |                          |        | 744                |       |      |        | 1,353  |      
|                                       |                                     |                          |        |                    |       |      |        |       
|                                       |                                     | Total operating expenses |        |                    | 4,030 |      |        |        | 6,555 | 
|                                       |                                     |                          |        |                    |       |      |        |       
|Loss from operations                   |                                     |                          | (4,311 | )                  |       |      | (6,262 | )     
|Interest expense                       |                                     |                          | 237    |                    |       |      | 385    |       
|Other (income)/expense, net            |                                     |                          | (231   | )                  |       |      | (717   | )     
|                                       |                                     |                          |        |                    |       |      |        |       
|Loss before income tax benefit         |                                     |                          | (4,317 | )                  |       |      | (5,930 | )     
|Income tax benefit                     |                                     |                          |       |                    |       |      | (2,372 | )     
|                                       |                                     |                          |        |                    |       |      |        |       
|Net loss                               |                                     | $                        | (4,317 | )                  |       | $    | (3,558 | )     
|                                       |                                     |                          |        |                    |       |      |        |       
|Basic loss per share                   |                                     |                          | (0.19  | )                  |       |      | (0.16  | )     
|Diluted loss per share                 |                                     |                          | (0.19  | )                  |       |      | (0.16  | )     
|Shares used in per share calculations: |                                     |                          |        |                    |       |      |        |       
|                                       | Basic                               |                          |        | 22,628             |       |      |        | 22,414 |      
|                                       | Diluted                             |                          |        | 22,628             |       |      |        | 22,414 |      

See accompanying notes to these unaudited condensed consolidated financial
statements.

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

|                                                         |                                                                   |                                                          |                             |                                                     |        |                    |        |        |        |        |        |  
|-------------------------------------------------------- | ----------------------------------------------------------------- | -------------------------------------------------------- | --------------------------- | --------------------------------------------------- | ------ | ------------------ | ------ | ------ | ------ | ------ | ------ | -
|                                                         |                                                                   |                                                          |                             |                                                     |        | Three Months Ended
|                                                         |                                                                   |                                                          |                             |                                                     |        | March 31,         
|                                                         |                                                                   |                                                          |                             |                                                     |        | 2003               |        | 2002  
|                                                         |                                                                   |                                                          |                             |                                                     |        |                    |        |       
|CASH FLOWS FROM OPERATING ACTIVITIES:                    |                                                                   |                                                          |                             |                                                     |        |                    |        |       
|                                                         | Net loss:                                                         |                                                          | $                           | (4,317                                              | )      |                    | $      | (3,558 | )     
|                                                         | Adjustments to reconcile net loss to cash provided
by operations: |                                                          |                             |                                                     |        |                    |        |        |       
|                                                         |                                                                   | Depreciation                                             |                             |                                                     | 1,722  |                    |        |        | 2,582  |       
|                                                         |                                                                   | Amortization                                             |                             |                                                     | 79     |                    |        |        | 66     |       
|                                                         |                                                                   | Non-cash gain on marketable securities                   |                             |                                                     |       |                    |        |        | (251   | )     
|                                                         |                                                                   | (Gain) loss on disposal of property, plant and
equipment |                             |                                                     | (11    | )                  |        |        | 296    |       
|                                                         |                                                                   | Changes in assets and liabilities:                       |                             |                                                     |        |                    |        |        |        |       
|                                                         |                                                                   |                                                          | Accounts receivable, net    |                                                     |        | (752               | )      |        |        | 1,275  |       
|                                                         |                                                                   |                                                          | Inventories                 |                                                     |        | 3,111              |        |        |        | 3,134  |       
|                                                         |                                                                   |                                                          | Prepaid expenses            |                                                     |        | 1,268              |        |        |        | 255    |       
|                                                         |                                                                   |                                                          | Other assets                |                                                     |        | (45                | )      |        |        | (432   | )     
|                                                         |                                                                   |                                                          | Accounts payable            |                                                     |        | (7                 | )      |        |        | 1,007  |       
|                                                         |                                                                   |                                                          | Accrued liabilities         |                                                     |        | (908               | )      |        |        | (1,812 | )     
|                                                         |                                                                   |                                                          | Income tax receivable       |                                                     |        | 563                |        |        |        |       |       
|                                                         |                                                                   |                                                          | Other long-term liabilities |                                                     |        | 34                 |        |        |        | (55    | )     
|                                                         |                                                                   |                                                          |                             |                                                     |        |                    |        |        |       
|                                                         |                                                                   |                                                          |                             | Net cash provided by operating activities           |        |                    | 737    |        |        |        | 2,507  |  
|                                                         |                                                                   |                                                          |                             |                                                     |        |                    |        |        |       
|CASH FLOWS FROM INVESTING ACTIVITIES:                    |                                                                   |                                                          |                             |                                                     |        |                    |        |       
|                                                         | Purchases of property, plant and equipment                        |                                                          |                             | (917                                                | )      |                    |        | (2,760 | )     
|                                                         | Proceeds from sale of property, plant and equipment               |                                                          |                             | 5,172                                               |        |                    |        |       |       
|                                                         | Investment in marketable securities                               |                                                          |                             | (37                                                 | )      |                    |        | (1,911 | )     
|                                                         | Proceeds from sale of marketable securities                       |                                                          |                             | 700                                                 |        |                    |        | 3,632  |       
|                                                         |                                                                   |                                                          |                             |                                                     |        |                    |        |        |       
|                                                         |                                                                   |                                                          |                             | Net cash provided by (used in) investing activities |        |                    | 4,918  |        |        |        | (1,039 | )
|                                                         |                                                                   |                                                          |                             |                                                     |        |                    |        |        |       
|CASH FLOWS FROM FINANCING ACTIVITIES:                    |                                                                   |                                                          |                             |                                                     |        |                    |        |       
|                                                         | Proceeds from (payments of):                                      |                                                          |                             |                                                     |        |                    |        |        |       
|                                                         |                                                                   | Issuance of common stock                                 |                             |                                                     | 185    |                    |        |        | 429    |       
|                                                         |                                                                   | Capital leases payments                                  |                             |                                                     | (1,008 | )                  |        |        | (1,169 | )     
|                                                         |                                                                   | Long-term debt payments                                  |                             |                                                     | (248   | )                  |        |        | (624   | )     
|                                                         |                                                                   |                                                          |                             |                                                     |        |                    |        |        |       
|                                                         |                                                                   |                                                          |                             | Net cash used in financing activities               |        |                    | (1,071 | )      |        |        | (1,364 | )
|Effect of exchange rate changes                          |                                                                   |                                                          | (46                         | )                                                   |        |                    | 103    |       
|                                                         |                                                                   |                                                          |                             |                                                     |        |                    |        |        |       
|Net increase in cash and cash equivalents                |                                                                   |                                                          | 4,538                       |                                                     |        |                    | 207    |       
|Cash and cash equivalents at the beginning of the
period |                                                                   |                                                          | 13,797                      |                                                     |        |                    | 37,538 |       
|                                                         |                                                                   |                                                          |                             |                                                     |        |                    |        |        |       
|Cash and cash equivalents at the end of the period       |                                                                   | $                                                        | 18,335                      |                                                     |        | $                  | 37,745 |       
|                                                         |                                                                   |                                                          |                             |                                                     |        |                    |        |        |       
|Non cash activity:                                       |                                                                   |                                                          |                             |                                                     |        |                    |        |       
|                                                         | Purchase of PP&E through financing                                |                                                          | $                           |                                                    |        |                    | $      | 295    |       
|                                                         |                                                                   |                                                          |                             |                                                     |        |                    |        |        |       

See accompanying notes to these unaudited condensed consolidated financial
statements.

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AXT, INC.




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

The accompanying condensed consolidated balance sheets as of March 31,
2003 and December 31, 2002, the condensed consolidated income statements for
the three months ended March 31, 2003 and 2002, and the condensed consolidated
statements of cash flows for the three months ended March 31, 2003 and 2002
have been prepared by AXT, Inc. (AXT or the Company) and are unaudited. The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles 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 have been
condensed or omitted. In the opinion of management, the unaudited condensed
consolidated financial statements reflect all adjustments, consisting only of
normal recurring adjustments, considered necessary to present fairly the
financial position, results of operations and cash flows of AXT and its
subsidiaries for all periods presented.

Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these condensed consolidated
financial statements in conformity with generally accepted accounting
principles. Actual results could differ materially from those estimates.

The results of operations are not necessarily indicative of the results to
be expected in the future or for the full fiscal year. It is recommended that
these condensed consolidated financial statements be read in conjunction with
the Companys consolidated financial statements and the notes thereto included
in its 2002 Annual Report on Form 10-K filed with the Securities and Exchange
Commission on March 21, 2003.

As a result of the significant revenue declines experienced over the past
six quarters, the Company has taken cost reduction measures and continues to
pursue additional measures to reduce costs and increase cash flows. At March
31, 2003, the Company had available cash, cash equivalents and liquid short and
long-term investments of $29.7 million. The Company believes that its existing
cash and liquid investments, cash generated from operations, coupled with
additional efforts to reduce expenditures in support of substrate and
opto-electronic businesses, will be sufficient to meet working capital
expenditure requirements for the next 12 months. However, existing cash and
liquid investments could continue to decline during 2003 due to a continued or
further weakening of the economy or changes in our planned cash outlay.

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

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

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

The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options that have no restrictions and are fully
transferable and negotiable in a free trading market. Black-Scholes does not
consider the employment, transfer or vesting restrictions that are inherent in
the Companys employee options. Use of an option valuation model, as required
by FAS 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 subjective input assumptions can materially affect the Companys
estimate of the fair value of those options, in the Companys opinion, the
existing valuation models, including Black-Scholes, are not reliable single
measures and may misstate the fair value of the Companys employee options.

The Company calculated the fair value of each option grant on the date of
grant using the Black-Scholes option pricing model as prescribed by SFAS No.
123 using the following assumptions:

|                         |  |                    |       |      |  |  |       |  
|------------------------ |  | ------------------ | ----- | ---- |  |  | ----- | -
|                         |  | Three Months Ended
|                         |  | March 31,         
|                         |  |                   
|                         |  | 2003               |       | 2002
|                         |  |                    |       |     
|Risk free interest rate  |  |                    | 3.0   | %    |  |  | 3.0   | %
|Expected life (in years) |  |                    | 5.0   |      |  |  | 5.0   |  
|Dividend yield           |  |                    | 0.0   | %    |  |  | 0.0   | %
|Volatility               |  |                    | 110.2 | %    |  |  | 101.0 | %

The weighted average grant-date fair value of options granted during the
three months ended March 31, 2003 and 2002 were $1.07 and $9.11 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 income and net income per share would have been as
summarized below (in thousands except per share data):

|                    |                          |         |   |                    |       |      |   |        |       |  
|------------------- | ------------------------ | ------- | - | ------------------ | ----- | ---- | - | ------ | ----- | -
|                    |                          |         |   | Three Months Ended
|                    |                          |         |   | March 31,         
|                    |                          |         |   |                   
|                    |                          |         |   | 2003               |       | 2002
|                    |                          |         |   |                    |       |     
|Net loss:           |                          |         |   |                    |       |      |   |       
|                    | As reported              |         | $ | (4,317             | )     |      | $ | (3,558 | )    
|                    | Pro forma option expense |         |   | (1,904             | )     |      |   | (2,337 | )    
|                    |                          |         |   |                    |       |      |   |        |       |  
|                    | Pro forma net loss       |         | $ | (6,221             | )     |      | $ | (5,895 | )    
|Net loss per share: |                          |         |   |                    |       |      |   |       
|                    | As reported:             |         |   |                    |       |      |   |        |      
|                    |                          | Basic   |   | $                  | (0.19 | )    |   | $      | (0.16 | )
|                    |                          | Diluted |   |                    | (0.19 | )    |   |        | (0.16 | )
|Pro forma net loss: |                          |         |   |                    |       |      |   |       
|                    |                          | Basic   |   | $                  | (0.27 | )    |   | $      | (0.26 | )
|                    |                          | Diluted |   |                    | (0.27 | )    |   |        | (0.26 | )

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Note 3. 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. The components of investments at
March 31, 2003 are summarized below (in thousands):

|                            |  |      |        |            |  |             |        |            |  |   |      |  
|--------------------------- |  | ---- | ------ | ---------- |  | ----------- | ------ | ---------- |  | - | ---- | -
|                            |  |      |        |            |  | Aggregate   |        | Unrealized
|Available for sale          |  | Cost |        | Fair value |  | Gain/(loss)
|                            |  |      |        |            |  |            
|Money market                |  | $    | 3,683  |            |  | $           | 3,683  |            |  |   |     |  
|Corporate bonds             |  |      | 13,634 |            |  |             | 13,718 |            |  |   | 84   |  
|Government agency bonds     |  |      | 6,346  |            |  |             | 6,392  |            |  |   | 46   |  
|Corporate equity securities |  |      | 1,115  |            |  |             | 916    |            |  |   | (199 | )
|                            |  |      |        |            |  |             |        |            |  |   |      |  
|                            |  | $    | 24,778 |            |  | $           | 24,709 |            |  | $ | (69  | )
|                            |  |      |        |            |  |             |        |            |  |   |      |  
|Recorded as:                |  |      |        |            |  |             |        |            |  |   |      |  
|Cash equivalents            |  | $    | 3,683  |            |  |             |        |            |  |   |      |  
|Short-term investments      |  |      | 9,107  |            |  |             |        |            |  |   |      |  
|Restricted deposits         |  |      | 9,722  |            |  |             |        |            |  |   |      |  
|Long-term investments       |  |      | 2,197  |            |  |             |        |            |  |   |      |  
|                            |  |      |        |            |  |             |        |            |  |   |      |  
|                            |  | $    | 24,709 |            |  |             |        |            |  |   |      |  
|                            |  |      |        |            |  |             |        |            |  |   |      |  

Note 4. Asset Held for Sale

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

Note 5. Inventories

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

|             |                 |                      |        |           |         |              |        |        |         |  
|------------ | --------------- | -------------------- | ------ | --------- | ------- | ------------ | ------ | ------ | ------- | -
|             |                 |                      |        | March 31, |         | December 31,
|             |                 |                      |        | 2003      |         | 2002        
|             |                 |                      |        |           |         |             
|Inventories: |                 |                      |        |           |         |              |        |       
|             | Raw materials   |                      | $      | 16,043    |         |              | $      | 17,566 |        
|             | Work in process |                      |        | 25,831    |         |              |        | 30,042 |        
|             | Finished goods  |                      |        | 14,736    |         |              |        | 15,108 |        
|             |                 | Valuation allowances |        |           | (22,123 | )            |        |        | (25,118 | )
|             |                 |                      |        |           |         |              |        |        |        
|             |                 | $                    | 34,487 |           |         | $            | 37,598 |       
|             |                 |                      |        |           |         |              |        |        |        

Note 6. Net Loss Per Share

Basic earnings per common share is calculated by dividing net income
(loss) available to common stockholders by the weighted average number of
common shares outstanding during the period. Diluted earnings per common and
common equivalent shares include the dilutive effect of common stock
equivalents outstanding during

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the period calculated using the treasury stock
method. Common stock equivalents consist of the shares issuable upon the
exercise of stock options.

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

|                                                                                 |                                                                           |                      |        |                    |   |      |        |        |   | 
|-------------------------------------------------------------------------------- | ------------------------------------------------------------------------- | -------------------- | ------ | ------------------ | - | ---- | ------ | ------ | - | 
|                                                                                 |                                                                           |                      |        | Three Months Ended
|                                                                                 |                                                                           |                      |        | March 31,         
|                                                                                 |                                                                           |                      |        |                   
|                                                                                 |                                                                           |                      |        | 2003               |   | 2002
|                                                                                 |                                                                           |                      |        |                    |   |     
|Numerator:                                                                       |                                                                           |                      |        |                    |   |      |        |       
|                                                                                 | Net loss                                                                  |                      | $      | (4,317             | ) |      | $      | (3,558 | )
|                                                                                 | Less: Preferred stock dividends                                           |                      |        | (44                | ) |      |        | (44    | )
|                                                                                 | Net loss available to common stockholders                                 |                      | $      | (4,361             | ) |      | $      | (3,602 | )
|                                                                                 |                                                                           |                      |        |                    |   |      |        |        |   | 
|Denominator:                                                                     |                                                                           |                      |        |                    |   |      |        |       
|                                                                                 | Denominator
for basic earnings per share - weighted
average common shares |                      |        | 22,628             |   |      |        | 22,414 |  
|                                                                                 | Effect of dilutive securities:                                            |                      |        |                    |   |      |        |        |  
|                                                                                 |                                                                           | Common stock options |        |                    |  |      |        |        |  | 
|                                                                                 |                                                                           |                      |        |                    |   |      |        |        |   | 
|Denominator for dilutive earnings per share                                      |                                                                           |                      | 22,628 |                    |   |      | 22,414 |       
|                                                                                 |                                                                           |                      |        |                    |   |      |        |        |   | 
|Basic loss per share                                                             |                                                                           | $                    | (0.19  | )                  |   | $    | (0.16  | )     
|Diluted loss per share                                                           |                                                                           | $                    | (0.19  | )                  |   | $    | (0.16  | )     
|Options excluded from diluted net income per share
as the impact is antidilutive |                                                                           |                      | 3,376  |                    |   |      | 2,981  |       

Note 7. Comprehensive Loss

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

|                                                         |  |                    |        |      |  |   |        |  
|-------------------------------------------------------- |  | ------------------ | ------ | ---- |  | - | ------ | -
|                                                         |  | Three Months Ended
|                                                         |  | March 31,         
|                                                         |  |                   
|                                                         |  | 2003               |        | 2002
|                                                         |  |                    |        |     
|Net loss                                                 |  | $                  | (4,317 | )    |  | $ | (3,558 | )
|Foreign currency translation gain (loss)                 |  |                    | (46    | )    |  |   | 103    |  
|Unrealized gain (loss) on available for sale investments |  |                    | (244   | )    |  |   | (1,877 | )
|                                                         |  |                    |        |      |  |   |        |  
|Comprehensive loss                                       |  | $                  | (4,607 | )    |  | $ | (5,332 | )
|                                                         |  |                    |        |      |  |   |        |  

Note 8. Segment Information


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

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

|                          |                                      |  |                    |         |      |  |   |         |  
|------------------------- | ------------------------------------ |  | ------------------ | ------- | ---- |  | - | ------- | -
|                          |                                      |  | Three Months Ended
|                          |                                      |  | March 31,         
|                          |                                      |  |                   
|                          |                                      |  | 2003               |         | 2002
|                          |                                      |  |                    |         |     
|Substrates Division       |                                      |  |                    |         |      |  |   |        
|                          | Net revenues from external customers |  | $                  | 8,535   |      |  | $ | 11,739  |  
|                          | Gross profit                         |  |                    | 273     |      |  |   | 206     |  
|                          | Operating loss                       |  |                    | (2,606  | )    |  |   | (4,709  | )
|                          | Identifiable assets                  |  |                    | 115,758 |      |  |   | 183,617 |  
|Opto-electronics Division |                                      |  |                    |         |      |  |   |        
|                          | Net revenues from external customers |  | $                  | 4,122   |      |  | $ | 5,038   |  
|                          | Gross profit (loss)                  |  |                    | (554    | )    |  |   | 87      |  
|                          | Operating loss                       |  |                    | (1,705  | )    |  |   | (1,553  | )
|                          | Identifiable assets                  |  |                    | 23,350  |      |  |   | 44,382  |  
|Total                     |                                      |  |                    |         |      |  |   |        
|                          | Net revenues from external customers |  | $                  | 12,657  |      |  | $ | 16,777  |  
|                          | Gross profit (loss)                  |  |                    | (281    | )    |  |   | 293     |  
|                          | Operating loss                       |  |                    | (4,311  | )    |  |   | (6,262  | )
|                          | Identifiable assets                  |  |                    | 139,108 |      |  |   | 227,999 |  

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The Company sells its substrates and opto-electronics products in the
United States and in other parts of the world. Also, the Company has operations
in Japan and China. Revenues by geographic location based on the country of the
customer were as follows (in thousands):

|              |                        |  |                    |        |      |  |   |        | 
|------------- | ---------------------- |  | ------------------ | ------ | ---- |  | - | ------ | 
|              |                        |  | Three Months Ended
|              |                        |  | March 31,         
|              |                        |  |                   
|              |                        |  | 2003               |        | 2002
|              |                        |  |                    |        |     
|Net revenues: |                        |  |                    |        |      |  |   |       
|              | United States          |  | $                  | 4,420  |      |  | $ | 7,332  | 
|              | Europe                 |  |                    | 1,309  |      |  |   | 1,081  | 
|              | Canada                 |  |                    | 61     |      |  |   | 690    | 
|              | Japan                  |  |                    | 529    |      |  |   | 451    | 
|              | Malaysia               |  |                    | 223    |      |  |   | 2,545  | 
|              | Taiwan                 |  |                    | 3,872  |      |  |   | 1,496  | 
|              | Asia Pacific and other |  |                    | 2,243  |      |  |   | 3,182  | 
|              |                        |  |                    |        |      |  |   |        | 
|              | Consolidated           |  | $                  | 12,657 |      |  | $ | 16,777 | 
|              |                        |  |                    |        |      |  |   |        | 

Note 9. Corporate Affiliates

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

|                                               |  |            |       |              |  |            |       |            |  |              |  |  |    |   |  | 
|---------------------------------------------- |  | ---------- | ----- | ------------ |  | ---------- | ----- | ---------- |  | ------------ |  |  | -- | - |  | 
|                                               |  | Investment |       | Investment   |  |            |       |            |  |              |  | 
|                                               |  | Balance    |       | Balance      |  |            |       |            |  |              |  | 
|                                               |  | March 31,  |       | December 31, |  | Accounting |       | Ownership 
|Affiliate                                      |  | 2003       |       | 2002         |  | Method     |       | Percentage
|                                               |  |            |       |              |  |            |       |           
|Xilingol Tongli Ge Co. Ltd.                    |  | $          | 764   |              |  | $          | 773   |            |  | Equity       |  |  | 25 | %
|Emeishan Jia Mei High Pure Metals
Co., Ltd.    |  |            | 612   |              |  |            | 614   |            |  | 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 consolidated balance
sheets.

Undistributed retained earnings relating to the Companys corporate
affiliates was $835,000 at March 31, 2003 and $515,000 at March 31, 2002. Net
loss recorded from the Companys corporate affiliates was $26,000 for the three
months ended March 31, 2003 and $164,000 for the three months ended March 31,
2002.

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. At March 31, 2003, the Company had no obligations to
make further investments in any of these companies, although it may choose to
do so under certain conditions.

Note 10. Commitments and Contingencies

From time to time we are involved in judicial or administrative
proceedings concerning matters arising in the ordinary course of our business,
including matters relating to workers compensation claims, claims of unlawful
termination or other employee-related claims. We do not expect that any of
these matters, individually or in the aggregate, will have a material adverse
effect on our business, financial condition, cash flows or results of
operation.

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

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section 17200 et seq., and violations under Proposition 65 and
California Health and Safety Code section 25249 et seq. as a result of AXTs
use of arsenic and inorganic arsenic compounds in its workplace. On June 24,
2002, the Company participated in a private mediation, and as a result, reached
a settlement of all claims, pursuant to which the Company agreed to pay the
Santa Clara Center for Occupational Safety and Health an amount equal to
$175,000. The parties have executed a settlement agreement, and the court
approved the settlement on December 31, 2002, and dismissal of the case is
pending.

The Company has entered into contracts to supply several large customers
with GaAs wafers. The contracts guarantee the delivery of a certain number of
wafers between January 1, 2001 and December 31, 2003 with a current contract
value of $3.2 million. The contract sales prices are subject to review
quarterly and can be adjusted in the event that raw material prices change. In
the event of non-delivery of the determined wafer quantities in any monthly
delivery period, the Company could be subject to non-performance penalties of
between 5% and 10% of the value of the delinquent monthly deliveries. The
Company has not received any claims for non-performance penalties due to
non-delivery. Partial prepayments received for these supply contracts totaling
$1.5 million are included in accrued liabilities at March 31, 2003. As of
March 31, 2003, the Company has met all of its delivery obligations under these
contracts and expects to do so for the remainder of the contract terms.

Note 11. Recent Accounting Pronouncements

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

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

Note 12. 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, 2003, the Companys outstanding
commitments with respect to the foreign exchange contracts, which were
commitments to sell Japanese yen, had a total contract value of approximately
$1.9 million.

The Company incurred a foreign currency transaction exchange gain of
$63,000 for the three months ended March 31, 2003, and a loss of $40,000 for
the three months ended March 31, 2002.

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Note 13. Related Party Transactions

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

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




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

This Managements Discussion and Analysis of Financial Condition and
Results of Operations includes a number of forward-looking statements made
pursuant to the provisions of Section 21E of the Securities Exchange Act of
1934. These forward-looking statements are based upon managements current
views with respect to future events and financial performance, and are subject
to certain risks and uncertainties that could cause actual results to differ
materially from historical results or those anticipated. Such risks and
uncertainties include those set forth under Risks Related to our Business
below. Forward-looking statements may be identified by the use of terms such as
anticipates, believes, estimates,
expects, intends, and
similar expressions. Statements concerning our financial position, business
strategy and plans or objectives for future operations are forward-looking
statements. These forward-looking statements are not guarantees of future
performance. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. This
discussion should be read in conjunction with Managements Discussion and
Analysis of Financial Condition and Results of Operations included in the
Companys Annual Report on Form 10-K for the year ended December 31, 2002 and
the condensed consolidated financial statements included elsewhere in this
report.

Overview

We were founded in 1986 to commercialize and enhance our proprietary
vertical gradient freeze (VGF) technique for producing high-performance
compound semiconductor substrates. We currently operate two divisions: our
substrate division and our opto-electronics division. We made our first
substrate sales in 1990 and our substrate division currently sells gallium
arsenide (GaAs) and indium phosphide (InP) substrates to manufacturers of
semiconductor devices for use in applications such as fiber optic and wireless
telecommunications, light emitting diodes (LEDs) and lasers. We also sell
germanium substrates for use in satellite solar cells. We acquired Lyte
Optronics, Inc., on May 28, 1999, and currently operate part of Lytes
historical business as our opto-electronics division. The opto-electronics
division manufactures high-brightness LEDs (HBLEDs) for the illumination
markets, including full-color displays, automobile lighting and traffic
signals, and also manufactures vertical cavity surface emitting lasers (VCSELs)
and laser diodes for fiber optic communications and storage area networks.

Critical Accounting Policies and Estimates

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

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

We believe that the following are our critical accounting policies:

Revenue Recognition

We recognize revenue upon shipment of products to our customers provided
that we have received a signed purchase order, the price is fixed or
determinable, title has transferred, collection of resulting receivables is
probable, product returns are reasonably estimable, there are no customer
acceptance requirements and there are no
remaining obligations. We assess the probability of collection based on a
number of factors including past history with the customer and credit
worthiness. We provide for future returns based on historical experience,
current economic trends and changes in customer demand at the time revenue is
recognized. Except for sales in Japan and some sales in Taiwan, which in both
cases are denominated in Japanese yen, we denominate and collect our
international sales in U.S. dollars. We do not provide for warranty related
exposure as such exposure has historically been immaterial.

Allowance for Doubtful Accounts

We periodically review the likelihood of collecting our accounts
receivable balances and provide an allowance for doubtful accounts receivable
primarily based upon the age of these accounts. We provide a 100% allowance for
U.S. receivables in excess of 90 days and for foreign receivables in excess of
120 days. At March 31, 2003, our accounts receivable balance was $7.9 million
net of an allowance for doubtful accounts of $6.3 million.

Inventory

Inventories are stated at the lower of cost or net realizable value. Cost
is determined using the weighted average cost method. Finished goods and
work-in-process inventories include material, labor and manufacturing overhead
costs. We routinely evaluate the levels of our inventory in light of current
market conditions in order to identify excess and obsolete inventory and we
provide a valuation allowance for certain inventories based upon the age and
quality of the product. The lives of our substrate products are relatively long
and accordingly, obsolescence has historically not been a significant factor.
We also review our inventory to ensure costs can be realized upon ultimate sale
to our customers. If we determine that the value of any items in ending
inventory exceeds the sales value less any related selling costs, a reserve is
established for the difference.

Impairment of Long-Lived Assets

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

Investments

The Company classifies its investments in marketable securities as
available-for-sale securities as prescribed in Financial Accounting Standard
No. 115, Accounting for Certain Investments in Debt and Equity Securities.
All investments are carried at fair market value, which is determined based on
quoted market prices, with net unrealized gains and losses included in
comprehensive income, net of tax. If a decline in fair value is judged to be
other than temporary, the cost basis of the individual security is written down
to fair value as a new cost basis with the amount of the write down included in
other (income) expense.

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Income Taxes

The Company accounts for deferred income taxes using the liability method,
under which the expected future tax consequences of timing differences between
the book and tax basis of assets and liabilities are recognized as deferred tax
assets and liabilities. Valuation allowances are established when necessary to
reduce net deferred tax assets when management estimates, based on available
objective evidence, that it is more likely than not that the future income tax
benefit represented by the net deferred tax asset will not be realized. At
March 31, 2003, a full valuation allowance has been recorded against our net
deferred tax asset.

Results of Operations

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

|                               |                                     |                          |       |                    |      |      |       |      |      | 
|------------------------------ | ----------------------------------- | ------------------------ | ----- | ------------------ | ---- | ---- | ----- | ---- | ---- | 
|                               |                                     |                          |       | Three Months Ended
|                               |                                     |                          |       | March 31,         
|                               |                                     |                          |       |                   
|                               |                                     |                          |       | 2003               |      | 2002
|                               |                                     |                          |       |                    |      |     
|Revenues                       |                                     |                          | 100.0 | %                  |      |      | 100.0 | %   
|Cost of revenues               |                                     |                          | 102.2 |                    |      |      | 98.3  |     
|                               |                                     |                          |       |                    |      |      |       |     
|Gross profit (loss)            |                                     |                          | (2.2  | )                  |      |      | 1.7   |     
|Operating expenses:            |                                     |                          |       |                    |      |      |       |     
|                               | Selling, general and administrative |                          |       | 26.0               |      |      |       | 31.0 |     
|                               | Research and development            |                          |       | 5.9                |      |      |       | 8.1  |     
|                               |                                     |                          |       |                    |      |      |       |     
|                               |                                     | Total operating expenses |       |                    | 31.9 |      |       |      | 39.1 | 
|                               |                                     |                          |       |                    |      |      |       |     
|Loss from operations           |                                     |                          | (34.1 | )                  |      |      | (37.4 | )   
|Interest expense               |                                     |                          | 1.9   |                    |      |      | 2.3   |     
|Other (income)/expense, net    |                                     |                          | (1.8  | )                  |      |      | (4.3  | )   
|                               |                                     |                          |       |                    |      |      |       |     
|Loss before income tax benefit |                                     |                          | (34.2 | )                  |      |      | (35.4 | )   
|Income tax benefit             |                                     |                          |      |                    |      |      | (14.1 | )   
|                               |                                     |                          |       |                    |      |      |       |     
|Net loss                       |                                     |                          | (34.2 | )%                 |      |      | (21.3 | )%  
|                               |                                     |                          |       |                    |      |      |       |     

Three months ended March 31, 2003 compared to three months ended March 31, 2002

Revenue.Revenue decreased $4.1 million, or 24.6%, to $12.7 million for
the three months ended March 31, 2003 compared to $16.8 million for the three
months ended March 31, 2002.

Revenue from our substrate division, which represents 67.4% of total
revenue for the three months ended March 31, 2003, decreased $3.3 million, or
27.3%, to $8.5 million compared to $11.8 million for the three months ended
March 31, 2002. Total GaAs substrate revenue decreased $630,000, or 8.3%, to
$7.0 million for the three months ended March 31, 2003 compared to $7.6 million
for the three months ended March 31, 2002. Sales of 5 and 6 GaAs subtrates
was unchanged at $1.3 million for the three months ended March 31, 2003
compared to $1.3 million for the three months ended March 31, 2002. InP
substrate revenue decreased $2.4 million, or 81.3%, to $564,000 for the three
months ended March 31, 2003 compared to $3.0 million for the three months ended
March 31, 2002. The decrease in GaAs and InP substrate revenue is due to
decreased volume and sales prices as a result of the slowdown in our markets
including telecommunications, high speed electronic devices, and short
wavelength lasers.

Revenue from our opto-electronics division, which represents 32.6% of
total revenue for the three months ended March 31, 2003, decreased $900,000, or
18.2% to $4.1 million compared to $5.0 million for the three months

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ended March 31, 2002. High-brightness light emitting diode (HBLED) revenue decreased $1.0
million, or 23.3%, to $3.4 million for the three months ended March 31, 2003
compared to $4.4 million for the three months ended March 31, 2002. The
decrease in HBLED revenue was primarily due to lower sales volume as a result
of losing a large customer in mid-2002 and a decline in average sales prices
during the quarter. Vertical cavity surface emitting laser (VCSEL) revenue
was unchanged at $160,000 for the three months ended March 31, 2003 and 2002.
Laser diode (LD) revenue increased $119,000, or 25.9%, to $578,000 for the
three months ended March 31, 2003 compared to $459,000 for the three months
ended March 31, 2002.

International revenue increased to 65.1% of total revenue for the three
months ended March 31, 2003 compared to 56.3% of total revenue for the three
months ended March 31, 2002. The increase was primarily due to increased sales
of HBLED products to customers in Asia.

The majority of our substrate manufacturing activities are conducted in
China, along with a portion of our opto-electronics manufacturing. In
addition, we source key raw materials, including gallium, from our joint
ventures in China. The SARS outbreak has been most notable in China. One
employee at our LED production facility in China contracted SARS in late April
prompting us to close the facility for ten days. There was no significant
impact to our ability to fill customer orders. If other employees contract
SARS, 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.
None of our substrate competitors is and few of our opto-electronics
competitors are as dependent on manufacturing facilities in China as we are.
If our manufacturing operations were closed for a significant period, we could
lose revenue and market share during that period which would depress our
financial performance and could be difficult to recapture. Finally, if one of
our key customers is required to close for an extended period, we may not be
able to ship product to them, our revenue would decline and our financial
performance would suffer.

Gross margin.Gross margin decreased to negative 2.2% of total revenue
for the three months ended March 31, 2003 compared to 1.7% of total revenue for
the three months ended March 31, 2002. Gross margin at the substrate division
increased to 3.2% of substrate revenue for the three months ended March 31,
2003 compared to 1.8% of substrate revenue for the three months ended March 31,
2002. The increase was primarily due to costs reductions implemented to align
our costs with lower expected sales volumes and prices. We continue shifting
much of our substrate manufacturing to China, where costs are lower, and
reducing capacity at our Fremont, California facility. Gross margin at the
opto-electronics division decreased to negative 13.4% of opto-electronics
revenue for the three months ended March 31, 2003 compared to 1.7% of
opto-electronics revenue for the three months ended March 31, 2002. The
decrease was primarily due to the decline in revenue and to a decrease in
average selling price.

Selling, general and administrative expenses.Selling, general and
administrative expenses decreased $1.9 million, or 36.8%, to $3.3 million for
the three months ended March 31, 2003 compared to $5.2 million for the three
months ended March 31, 2002. As a percentage of total revenue, selling,
general and administrative expenses were 26.0% for the three months ended March
31, 2003 compared to 31.0% for the three months ended March 31, 2002. In order
to align our cost structure with the rapid decline in revenues, we have
initiated and are aggressively pursuing cost reductions in this area, which led
to the decrease.

Research and development expenses.Research and development expenses
decreased $600,000, or 45.0%, to $744,000 for the three months ended March 31,
2003 compared to $1.4 million for the three months ended March 31, 2002. As a
percentage of total revenue, research and development expenses were 5.9% for
the three months ended March 31, 2003 compared to 8.1% for the three months
ended March 31, 2002. Although we reduced research and development expenses as
part of our effort to reduce costs, 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 in future
periods. Research and development efforts during the first quarter of 2003
were focused primarily on improving the yield and surface quality of our GaAs
substrates, and improving the brightness, reliability, and yield of our HBLED
products.

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Interest expense.Interest expense decreased $148,000, or 38.4%, to
$237,000 for the three months ended March 31, 2003 compared to $385,000 for the
three months ended March 31, 2002 due to the repayment of debt and a reduction
of rates on our variable interest rate debt.

Other income and expense, net.Other income decreased $486,000 to
$231,000 for the three months ended March 31, 2003 compared to $717,000 for the
three months ended March 31, 2002.

Provision for income taxes.Due to our continuing operating losses and
uncertainty regarding future profitability, we recorded a full valuation
allowance against our net deferred tax assets of $31.2 million in 2002. As a
result, our effective tax rate decreased to 0.0% for the three months ended
March 31, 2003 compared to 40% for the three months ended March 31, 2002.

Liquidity and Capital Resources

Cash and cash equivalents increased $4.5 million to $18.3 million at March
31, 2003 compared to $13.8 million at December 31, 2002.

Net cash provided by operating activities of $737,000 for the three months
ended March 31, 2003 was comprised primarily of our net loss adjusted for
non-cash items of $1.8 million, consisting primarily of depreciation expense of
$1.7 million, and by a $3.3 million net change in assets and liabilities. The
net change in assets and liabilities resulted primarily from decreases in
inventory and prepaid expenses.

Accounts receivable increased $752,000, or 10.0%, to $8.0 million at March
31, 2003 compared to $7.2 million at December 31, 2002. The change reflects
higher sales volume, collections of $12.7 million and a decrease in our
allowance for doubtful accounts of $412,000. Inventories decreased $3.1
million, or 8.3% to $34.5 million at March 31, 2003 compared to $37.6 million
at December 31, 2002. The decrease in inventory is a result of our continued
effort to minimize cash outflows utilizing more effective inventory management
policies. We expect this trend to continue throughout 2003.

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

Net cash from investing activities of $4.9 million for the three months
ended March 31, 2003 includes net proceeds from the sale of property and
equipment of $5.2 million and purchases of equipment of $917,000. It also
includes $37,000 in purchases of high grade investment securities with
maturities of less than two years offset by $700,000 in sales of these
securities.

We do not have any plans to initiate any major new capital spending
projects during 2003. We are currently completing certain projects at our
China facilities and are continuously constructing minor improvements to our
existing production facilities in China and California. We expect to invest an
additional $5.1 million in capital projects throughout the remainder of 2003.
We believe that our existing and planned facilities and equipment are
sufficient to fulfill current and expected future orders.

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

Net cash used in financing activities of $1.1 million for the three months
ended March 31, 2003 includes proceeds of $185,000 from the sale of common
stock through our employee stock compensation programs, offset by payments of
$248,000 on long-term debt and $1.0 million for capital lease payments.

We generally finance equipment purchases through secured equipment loans
and capital leases over four or five-year terms at interest rates ranging from
3.6% to 8.8% per annum. Our main Fremont, California manufacturing

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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 1.6% at March 31, 2003. The bonds are traded in the
public market. Repayment of principal and interest under the bonds is supported
by a letter of credit from our bank and is paid on a quarterly basis. We have
the option to redeem the bonds in whole or in part during their term. At March
31, 2003, $8.9 million was outstanding under these bonds.

At March 31, 2002 the credit facility maintained by the Company with a
bank included a letter of credit supporting repayment of our industrial bonds
with an outstanding amount of $8.9 million and foreign exchange obligations in
the amount of $570,000. The Company has pledged and placed certain investment
securities with the trust department of the bank as additional collateral for
this facility. As a result, $10.7 million of our long-term investments are
restricted. As of March 31, 2003, we were out of compliance with our tangible
net worth covenant. We obtained a waiver from our bank for this covenant
default through April 30, 2003. On April 7, 2003, we obtained a credit
facility with another bank which includes a letter of credit supporting our
industrial revenue bonds. The Company has pledged and placed certain investment
securities with the trust department of the bank as additional collateral for
this facility.

As a result of the significant revenue declines that we have experienced
over the past six quarters, we have taken cost reduction measures and continue
to pursue additional measures to reduce our costs and increase our cash flows.
At March 31, 2003, we had available cash, cash equivalents and liquid short and
long-term investments of $29.7 million. We believe that our existing cash and
liquid investments, cash generated from operations, coupled with additional
efforts to reduce our expenditures in support of our substrate and
opto-electronic businesses, will be sufficient to meet our working capital
expenditure requirements for the next 12 months. However, our existing cash
and liquid investments could continue to decline during 2003 due to a continued
or further weakening of the economy or changes in our planned cash outlay.

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

Risks Related to Our Business

The recent outbreak of Severe Acute Respiratory Syndrome (SARS) may adversely
impact our manufacturing operations and some of our key suppliers and customers

The majority of our substrate manufacturing activities are conducted in
China, along with a portion of our opto-electronics manufacturing. In
addition, we source key raw materials, including gallium, from our joint
ventures in China. The SARS outbreak has been most notable in China. One
employee at our LED production facility in China contracted SARS in late April
prompting us to close the facility for ten days. There was no significant
impact to our ability to fill customer orders. If other employees contract
SARS, 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.
None of our substrate competitors is and few of our opto-electronics
competitors are as dependent on manufacturing facilities in China as we are.
If our manufacturing operations were closed for a significant period, we could
lose revenue and market share during that period which would depress our
financial performance and could be difficult to recapture. Finally, if one of
our key customers is required to close for an extended period, we may not be
able to ship product to them, our revenue would decline and our financial
performance would suffer.

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Our Inability to Maintain Our Listing on the NASDAQ National Market Will Reduce
the Market and Liquidity of our Shares and Damage Our General Reputation

In connection with our listing on the Nasdaq National Market we must
maintain compliance with several requirements related to the trading price of
our stock, our financial condition and our board of directors, among
other factors. Our stock was trading beneath the $1.00 minimum bid price on the
Nasdaq National Market since February 24, 2003 and on April 7, 2003 we received
notice from the Nasdaq National Market that we will be delisted if we are
unable to meet the continued listing requirements during the 180 days ended
October 6, 2003. If we are unable to comply with the continued listing
requirements, we would be delisted from the Nasdaq National Market, and, if we
qualified, would move to the SmallCap listing of Nasdaq. This could reduce the
market and liquidity of our shares and consequently the ability of our
stockholders to purchase and sell our shares in an orderly manner. Furthermore,
our delisting from the Nasdaq National Market could damage our general business
reputation and harm our financial condition and operating results. The trading
price of our stock has been over $1.00 since April 25, 2003.

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

Our business depends in significant part upon manufacturers of electronic
and opto-electronic semiconductor devices, as well as the current and
anticipated market demand for such devices and products using such devices. The
semiconductor industry is highly cyclical. The industry has in the past, and
will likely in the future, experience periods of oversupply that result in
significantly reduced demand for semiconductor devices and components,
including our products, both as a result of general economic changes and
overcapacity. When these periods occur, our operating results and financial
condition are adversely affected, 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 declining demand such as those experienced over the
past year, customers typically reduce purchases, delay delivery of products
and/or cancel orders of component parts such as our products. Increased price
competition may result, causing pressure on our net sales, gross margin and net
income. We have over the past year experienced cancellations, delays and push
outs of orders, which have resulted in reduced revenues. If the economic
downturn continues, further order cancellations, reductions in order size or
delays in orders will materially adversely affect our business and results of
operations. Although we have taken actions to reduce our costs, if our actions
are insufficient to align our structure with prevailing business conditions, we
may be required to undertake additional cost-cutting measures, and may be
unable to invest in marketing, 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. In
addition, we may continue to experience a decline in our cash and cash
equivalents and therefore we may be required to seek additional sources of
cash, which may not be available on acceptable terms or at all.

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

Our operating results can vary significantly based upon the impact of
changes in global economic conditions on our customers. More specifically, the
macro-economic environment that we faced in the second half of 2001 and
continued to face in 2002 is more uncertain than in prior periods, has lasted
longer than expected and has materially and adversely affected us and our
operating results and may continue to do so. The revenue growth and
profitability of our business depends on the overall demand for our substrates,
LEDs and laser diodes, and we are particularly dependant on the market
conditions for the wireless, fiber optics and telecommunications industries.
Because our sales are primarily to major corporate customers whose businesses
fluctuate with general economic and business conditions, a softening of demand
for products that use our substrates, LEDs and laser diodes 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.

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

We have not over the past year been able to sustain growth, and may not be
able to return to historic growth levels in the current economic environment.
Our net loss in 2002 is the largest in our history. We have and may continue
to experience significant fluctuations in our revenue and earnings. Our
quarterly and annual revenue and operating results have varied significantly in
the past and may vary significantly in the future due to a number of factors,
including:



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

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

A substantial percentage of our operating expenses are fixed in the short
term and we may be unable to adjust spending to compensate for an unexpected
shortfall in revenues. As a result, any delay in generating revenue could cause
our operating results to be below the expectations of market analysts or
investors, which could also cause our stock price to fall.

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

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If the economy recovers and we are again in a period of high demand for our
products, we may be unable to expand our manufacturing capacity quickly enough
to meet increased demand, and we may be unable to lower our costs or increase
revenue.

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

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;                                                                                                     
| 
| |  | unanticipated cost increases and restrictions imposed by requirements
of local, state or federal regulatory agencies in the United States and
China.

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

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

We must manage our inventory of component parts and finished goods
effectively to meet changing customer requirements, while keeping inventory
costs down and improving gross margins. Some of our products and supplies have
in the past and may in the future become obsolete while in inventory due to
changing customer specifications, or become excess inventory due to decreased
demand for our products and an inability to sell the inventory within a
foreseeable period. Furthermore, if current costs of production increase or
sales prices drop below the standard prices at which we value inventory, we may
need to take a charge for a reduction in inventory values. We have in the past
had to take inventory valuation and impairment charges. If we are not
successfully able to manage our inventory, we may need to write off unsaleable,
obsolete or excess inventory, which could adversely affect our results of
operations.

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

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

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

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

We have experienced declining revenue for both our HBLED and laser diode
products as a result of a loss of revenue from our leading LED customer and a
decline in the market for our laser diode products, as well as due to quality
control problems experienced on these products. We may be unable to
successfully market and increase sales of these products. To market and
increase sales of our HBLED and VCSEL products, we will have to continue to
develop additional distribution channels and achieve certain product and
reliability specifications. We may be unable to obtain significant increases in
revenue and may seek potential investors for our opto-electronics business. We
must also continue our research and development efforts to apply our
proprietary VGF technique to new substrate products and successfully introduce
and market new opto-electronic semiconductor devices, including enhancements to
our HBLED and VCSEL products.

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

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

The development of new products can be a highly complex process, and we
may experience delays in developing and introducing new products. Any
significant delays could cause us to fail to timely introduce and gain market
acceptance of new products. Further, the costs involved in researching,
developing and engineering new products could be greater than anticipated.

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

Some of our competitors have developed a crystal growth technique similar
to our VGF technology. As a result, some customers are now allocating their
requirements for VGF grown substrates across more competitors and

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we believe
that we may have lost revenue and market share as a result of these customer
decisions, which we may be unable to recover. If we are unable to retain our
market share, our revenue and performance will decline.

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

Intense competition in the markets for our products could prevent us from
increasing revenue and sustaining profitability.

The markets for our products are intensely competitive. We face
competition for our substrate products from other manufacturers of substrates,
such as Freiberger, Hitachi Cable, Japan Energy and Sumitomo Electric and from
semiconductor device manufacturers that produce substrates for their own use,
and from companies, such as IBM and Motorola, that are actively developing
alternative materials to GaAs and some semiconductor devices are being marketed
using these materials. We believe that at least two of our competitors are
shipping GaAs substrates manufactured using a technique similar to our VGF
technique. Other competitors may develop and begin using similar technology. If
we are unable to compete effectively, our revenue may not increase and we may
be unable to be profitable. We face many competitors that have a number of
significant advantages over us, particularly in our compound semiconductor
device products, including:



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

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

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

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

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



| |  | impurities in the materials used;              
|- |  | -----------------------------------------------
| 
| |  | contamination of the manufacturing environment;

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| |  | substrate breakage;                                                             
|- |  | --------------------------------------------------------------------------------
| 
| |  | equipment failure, power outages or variations in the manufacturing
process; and
| 
| |  | performance of personnel involved in the manufacturing process.                 

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

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

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



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

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

As inventory of telecommunication products and computer equipment remained
high during the past year, resulting in overcapacity in the market, our
customers have reduced sales of their products, causing them to reduce
purchases of our products for both production and research and development
purposes. As a result, our revenues have declined and may fail to recover until
the overcapacity has been depleted and demand for our customers products once
again increases and their expenditures for research and development increase.

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

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

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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.

We have periodically encountered a decline in quality of parts that are
critical to the performance of our MOCVD reactors, which has led to lower
yields of our HBLED products. If these quality problems continue, our ability
to manufacture our HBLED products would be reduced, we could fail to meet
customer delivery schedules, and our revenue and operating results could
suffer.

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

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

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

A small number of substrate and HBLED customers have historically
accounted for a substantial portion of our total revenue. Five customers
accounted for 37.6% of our total revenue for the three months ended March 31,
2003 and 38.9% for the three months ended March 31, 2002. One customer
accounted for 16.7% of our revenue for the three months ended March 31, 2003.
Our substrate revenue accounted for 67.4% of our total revenue for the three
months ended March 31, 2003 and 70% for the three months ended March 31, 2002.
We expect that a significant portion of our future revenue will continue to be
derived from a limited number of substrate and HBLED customers. Our customers
are not obligated to purchase a specified quantity of our products or to
provide us with binding forecasts of product purchases. In addition, our
customers may reduce, delay or cancel orders at any time without any
significant penalty, and during the past year, we have experienced slower
bookings, significant push outs and cancellation of orders. In addition, due
to the difficult economic environment, several of our previously large
customers have stopped operations entirely. If we lose a major customer or if
a customer cancels, reduces or delays orders, our revenue would decline. In
addition, customers that have accounted for significant revenue in the past may
not continue to generate revenue for us in any future period. Any delay in
scheduled shipments of our products could cause net sales to fall below our
expectations and the expectations of market analysts or investors, causing our
stock price to decline.

Defects in our products could diminish demand for our products.

Our products are complex and may contain defects. In the past we have
experienced quality control problems with some of our products, which caused
customers to return products to us or reduce orders for our products, such as
our recent reduction in orders for our LED products by Agilent, and certain
quality control problems experience in our substrate products. If we continue
to experience quality control problems, or experience these problems in new
products, customers may cancel or reduce orders or purchase products from our
competitors. Defects in our products could cause us to incur higher
manufacturing costs and suffer product returns and additional service expenses,
all of which could adversely impact our operating results.

We are also developing new products and product enhancements, including
substrates and compound semiconductor device products. If our new products
contain defects when released, our customers may be

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dissatisfied and we may suffer negative publicity or
customer claims against us, lose sales or experience delays in market
acceptance of our new products.

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

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

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

In the past, periods of rapid growth and expansion has strained our
management and other resources. The expansion of our manufacturing capacity and
the shift of manufacturing operations to China has placed and continues to
place a significant strain on our operations and management resources, and we
are in the process of upgrading our inventory control systems and may implement
additional systems relating to consolidation of our financial results. If we
fail to manage these changes effectively, our operations may be disrupted. In
addition, the Sarbanes-Oxley Act of 2002 requires us to improve the quality of
our systems and procedures.

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.

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

If we fail to manage our contractions successfully we may continue to draw
down our cash reserves, which would adversely affect our operating results and
financial condition, reduce our value and may impinge our ability to raise debt
and equity funding in the future, at a time when we may be required to raise
additional cash. As part of our effort to reduce costs, we may lose key staff,
production resources, and technology that we will need to grow when end markets
recover. These events could reduce our ability to grow profitably as markets
recover.

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

In connection with our efforts to streamline operations, reduce costs and
bring staffing and structure in line with current demand for our products, we
implemented a corporate restructuring beginning in 2001 and reduced our
workforce, shifted production activities to China and reduced capital
expenditures. Our restructuring may yield unanticipated consequences, such as
attrition beyond our planned reduction in workforce and loss of employee

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morale and decreased performance. In addition, the recent trading levels of our
stock have decreased the value of our stock options granted to employees under
our stock option plan. As a result of these factors, our remaining personnel
may seek employment with larger, more established companies or companies that
they perceive as having less volatile stock prices. Continuity of personnel can
be very important factors in the sales and production of our products and
completion of our research and development efforts.

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

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



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

For example, we incurred substantial costs in connection with our
acquisition of Lyte Optronics, including the assumption of approximately $10.0
million of debt, much of which has been repaid or renegotiated, resulting in a
decline of cash available. We have also incurred consistent operating losses
for the business since the acquisition.

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

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

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

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

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

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

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

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

Despite our efforts to protect our intellectual property, a third party
could develop products or processes similar to ours. Our means of protecting
our proprietary rights may not be adequate and our competitors may
independently develop similar technology, duplicate our products or design
around our patents. We believe that at least two of our competitors have begun
to ship GaAs substrates produced using a process similar to our VGF technique.
Our competitors may also develop and patent improvements to the VGF, LED and
VCSEL technologies 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.

We might face intellectual property infringement claims that may be costly to
resolve and could divert management attention.

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

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 65.1% of our total
revenue for the three months ended March 31, 2003 and 56.3% for the three

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months ended March 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.

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



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

Our sales are denominated in U.S. dollars, except for sales to our
Japanese and some Taiwanese customers, which are denominated in Japanese yen.
Thus, increases in the value of the U.S. dollar could increase the price of our
products in non-U.S. markets and make our products more expensive than
competitors products in these markets. Also, denominating some sales in
Japanese yen subjects us to fluctuations in the exchange rates between the U.S.
dollar and the Japanese yen. The functional currencies of our Japanese and
Chinese subsidiaries are the local currencies. We incur transaction gains or
losses resulting from consolidation of expenses incurred in local currencies
for these subsidiaries, as well as in translation of the assets and liabilities
of these assets at each balance sheet date. If we do not effectively manage the
risks associated with international sales, our revenue, cash flows and
financial condition could be adversely affected.

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

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

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

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

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

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

On September 11, 2001, the United States was subject to terrorist attacks
at the World Trade Center buildings in New York and the Pentagon in Washington
D.C., and continues to be on alert for further terrorist activity. In addition,
the United States has invaded Iraq and may now be more subject to action by
terrorists. The potential near- and long-term impact of these attacks and
other 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
other potential adverse effects on our operating results due to a significant
event that we cannot foresee.

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

Our stock price has fluctuated significantly since we began trading on the
Nasdaq National Market. For the three months ended March 31, 2003, the high and
low closing sales prices of our common stock were $1.95 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.

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

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



| |  | the division of our board of directors into three separate classes,
each with three year terms;                                             
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | the right of our board to elect a director to fill a space created by
a board vacancy or the expansion of the board;                        
| 
| |  | the ability of our board to alter our bylaws;                                                                                               
| 
| |  | the ability of our board to authorize the issuance of up to 2,000,000
shares of blank check preferred stock; and                            
| 
| |  | the requirement that only our board or the holders of at least 10% of
our outstanding shares may call a special meeting of our stockholders.

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



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

We have adopted certain anti-takeover measures that may make it more difficult
for a third party to acquire us.

Our board of directors has the authority to issue up to 2,000,000 shares
of preferred stock and to determine the price, rights, preferences and
privileges of those shares without any further vote or action by the
stockholders. The rights of the holders of common stock will be subject to, and
may be adversely affected by, the rights of the holders of any preferred stock
that may be issued in the future. The issuance of shares of preferred stock,
while potentially providing desirable flexibility in connection with possible
acquisitions and for other corporate purposes, could have the effect of making
it more difficult for a third party to acquire a majority of our outstanding
voting stock. We have no present intention to issue shares of preferred stock.

Further, on April 24, 2001, our board of directors adopted a preferred
stock purchase rights plan intended to guard against certain takeover tactics.
The adoption of this plan was not in response to any proposal to acquire us,
and the board is not aware of any such effort. The existence of this plan could
also have the effect of making it more difficult for a third party to acquire a
majority of our outstanding voting stock. In addition, certain provisions of
our certificate of incorporation may have the effect of delaying or preventing
a change of control, which could adversely affect the market price of our
common stock.

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

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

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 are likely to
increase premiums as a result of the high claims rates incurred over the past
year, and so our premiums for our various insurance policies, including our
directors and officers insurance policies, are likely to increase. Proposed
changes in the accounting rules, including legislative and other proposals to
account for employee stock options as a compensation expense among others,
could materially increase the expense that we report under generally accepted
accounting principles and adversely affect our operating results.

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Liquidity

The Company anticipates that its existing cash resources will fund any
anticipated operating losses, purchases of capital equipment and provide
adequate working capital for the next twelve months. The Companys liquidity
is affected by many factors including, among others, the extent to which the
Company pursues additional capital expenditures, the level of the Companys
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 the Company to seek additional capital
sooner, or, if so required, that such capital will be available on terms
acceptable to the Company if at all.




Item 3.  Qualitative and Quantitative Disclosures About Market Risk

Foreign Currency Risk

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, 2003, the Companys outstanding
commitments with respect to the foreign exchange contracts, which were
commitments to sell Japanese yen, had a total contract value of approximately
$1.9 million.

The Company incurred a foreign currency transaction exchange gain of
$63,000 for the three months ended March 31, 2003, and a loss of $40,000 for
the three months ended March 31, 2002.

Interest Rate Risk

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

|                          |  |           |        |          |  |           |      |                  |  |                  |      |          |  |          |      |   |  |   |      |  
|------------------------- |  | --------- | ------ | -------- |  | --------- | ---- | ---------------- |  | ---------------- | ---- | -------- |  | -------- | ---- | - |  | - | ---- | -
|                          |  |           |        |          |  |           |      |                  |  | Current          |      | Proforma |  | Proforma
|                          |  | Balance   |        | Current  |  | Interest  |      | 10% Interest     |  | 10% Interest    
|                          |  | March 31, |        | Interest |  | Income/   |      | Rate Decline     |  | Rate Increase   
|Instrument                |  | 2003      |        | Rate     |  | (Expense) |      | Income/(Expense) |  | Income/(Expense)
|                          |  |           |        |          |  |           |      |                  |  |                 
|Cash and cash equivalents |  | $         | 18,335 |          |  |           | 3.80 | %                |  | $                | 697  |          |  | $        | 627  |   |  | $ | 766  |  
|Bonds                     |  |           | 8,880  |          |  |           | 1.60 | %                |  |                  | (142 | )        |  |          | (128 | ) |  |   | (156 | )
|Capital lease             |  |           | 556    |          |  |           | 4.20 | %                |  |                  | (23  | )        |  |          | (21  | ) |  |   | (26  | )
|Capital lease             |  |           | 2,195  |          |  |           | 3.60 | %                |  |                  | (79  | )        |  |          | (71  | ) |  |   | (87  | )
|                          |  |           |        |          |  |           |      |                  |  |                  |      |          |  |          |      |   |  |   |      |  
|                          |  |           |        |          |  |           |      |                  |  | $                | 452  |          |  | $        | 407  |   |  | $ | 498  |  
|                          |  |           |        |          |  |           |      |                  |  |                  |      |          |  |          |      |   |  |   |      |  

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. As of March 31, 2003, the
minority investments we continue to hold totaled $4.7 million at estimated fair
value. In 2000, we recorded a $27.3 million non-cash gain as a result of
acquiring Finisar Corporation common stock in connection with Finisar
Corporations acquisition of Demeter Technologies, a company in which we held
warrants to purchase preferred stock. In 2001 and 2002, we recorded a $15.6
million and $10.8 million non-cash loss respectively, as a result of writing
down our investment in Finisar Corporation common stock to market value. These
gains and losses were included in other expense.

31



---



##### Table of Contents






Item 4.  Controls and Procedures

(a)  Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of our disclosure controls and procedures, as such term
is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act
of 1934, as amended (the Exchange Act), within 90 days of the filing date of
this report. Based on their evaluation, our principal executive officer and
principal financial officer concluded that our disclosure controls and
procedures are effective.

(b)  There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation referenced in paragraph (a) above.




PART II  OTHER INFORMATION




Item 1.  Legal Proceedings

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

On May 1, 2001, the Santa Clara Center for Occupational Safety and Health
filed a complaint for injunctive relief and civil penalties against us in the
Superior Court of California, County of Alameda, Hayward Division, Case No.
H218237-5. The complaint alleged violations of California Business and
Professions Code section 17200 et seq., and violations under Proposition 65 and
California Health and Safety Code section 25249 et seq. as a result of AXTs
use of arsenic and inorganic arsenic compounds in its workplace. On June 24,
2002, we participated in a private mediation, and as a result, reached a
settlement of all claims, pursuant to which we agreed to pay the Santa Clara
Center for Occupational Safety and Health an amount equal to $175,000. The
parties have executed a settlement agreement, and the court approved the
settlement on December 31, 2002, and dismissal of the case is pending.

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.

Item 2.  Changes in Securities and Use of Proceeds



| |  |  | None
| |  |  | ----

Item 3.  Defaults upon Senior Securities



| |  |  | None
| |  |  | ----

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



| |  |  | None
| |  |  | ----

Item 5.  Other Information



| |  |  | None
| |  |  | ----




Item 6.  Exhibits and Reports on Form 8-K

a.     Exhibits

32



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##### Table of Contents



|         |  |                                                                                                                                                                                                                                                                             
|-------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1(1)   |  | Restated Certificate of Incorporation                                                                                                                                                                                                                                       
|         |  |                                                                                                                                                                                                                                                                             
|3.2(2)   |  | Certificate of Designation, Preferences and Rights of Series A
Preferred Stock, as filed with the Secretary of State of the state
of Delaware on May 27, 1999 (which is incorporated herein by
reference to Exhibit 2.1 to the registrants Form 8-K
filed on June 14, 1999)
|         |  |                                                                                                                                                                                                                                                                             
|3.3(3)   |  | Second Amended and Restated Bylaws                                                                                                                                                                                                                                          
|         |  |                                                                                                                                                                                                                                                                             
|4.1(4)   |  | Registration Rights Agreement dated as of May 27, 1999, by and
among American Xtal Technology, Inc., Lyte Optronics, Inc. and Keith
Halsey and Robert Shih                                                                                                                  
|         |  |                                                                                                                                                                                                                                                                             
|4.2(3)   |  | Rights Agreement dated as of April 24, 2001, by and between AXT,
Inc. and Computershare Trust Company                                                                                                                                                                       
|         |  |                                                                                                                                                                                                                                                                             
|10.14(5) |  | Second Modification to Credit Agreement between U.S. Bank
National Association and us dated September 30, 2002                                                                                                                                                              
|         |  |                                                                                                                                                                                                                                                                             
|10.15    |  | Reimbursement Agreement between Wells Fargo Bank National
Association and us dated March 14, 2003                                                                                                                                                                           
|         |  |                                                                                                                                                                                                                                                                             
|99.1     |  | Certification by Chief Executive Officer                                                                                                                                                                                                                                    
|         |  |                                                                                                                                                                                                                                                                             
|99.2     |  | Certification by Chief Financial Officer                                                                                                                                                                                                                                    



---



|(1) |  | As filed with the SEC in our Annual Report on Form 10-K for the year
ended December 31, 1998.                     
|--- |  | ------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | As filed with the SEC in our Form 8-K on June 14, 1999.                                                           
|   
|(3) |  | As filed with the SEC in our Form 8-K on May 30, 2001.                                                            
|   
|(4) |  | As filed with the SEC in our Annual Report on Form 10-K for the year
ended December 31, 1999.                     
|   
|(5) |  | As filed with the SEC in our Quarterly Report on Form 10-Q for the three
and nine months ended September 30, 2002.
|   
|b.  |  | Reports on Form 8-K                                                                                               

On March 14, 2003, we filed a report on form 8-K reporting earnings
guidance for the three months ended March 31, 2003 as required under Item 9 
Regulation FD Disclosures.

On April 23, 2003, we filed a report on form 8-K reporting our earnings
for the three months ended March 31, 2003 as required under Item 12 
Disclosure of Results of Operations and Financial Condition.

33



---



##### Table of Contents






SIGNATURES

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

|                   |  |           |                           | 
|------------------ |  | --------- | ------------------------- | 
|                   |  | AXT, INC.
|                   |  |           |                           | 
|Dated: May 9, 2003 |  | By:       | /s/   Morris S. Young     | 
|                   |  |           |                           | 
|                   |  |           | Morris S. Young           | 
|                   |  |           | Chief Executive Officer   | 
|                   |  |           |                           | 
|Dated: May 9, 2003 |  | By:       | /s/   Donald L. Tatzin    | 
|                   |  |           |                           | 
|                   |  |           | Donald L. Tatzin          | 
|                   |  |           | Chief Financial Officer   | 
|                   |  |           |                           | 
|Dated: May 9, 2003 |  | By:       | /s/            John Drury | 
|                   |  |           |                           | 
|                   |  |           | John Drury                | 
|                   |  |           | Corporate Controller      | 

34



---



##### Table of Contents






CERTIFICATION

I, Morris S. Young, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of AXT, Inc.;

2.     Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;

3.     Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in
all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this
quarterly report;

4.     The registrants other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:



| |                                                                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
|
| | b. evaluated the effectiveness of the registrants disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the Evaluation Date); and                                                                                                  
|
| | c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        

5.     The registrants other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants auditors and the
audit committee of registrants board of directors (or persons performing
the equivalent function):



| |                                                                                                                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrants ability
to record, process, summarize and report financial data and have
identified for the registrants auditors any material weaknesses in
internal controls; and
|
| | b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        

6.     The registrants other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.

|                   |  |     |  |                        
|------------------ |  | --- |  | -----------------------
|Dated: May 9, 2003 |  | By: |  | /s/    Morris S. Young 
|                   |  |     |  |                        
|                   |  |     |  | Morris S. Young        
|                   |  |     |  | Chief Executive Officer

35



---



##### Table of Contents



I, Donald L. Tatzin, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of AXT, Inc.;

2.     Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;

3.     Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in
all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this
quarterly report;

4.     The registrants other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:



| |                                                                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
|
| | b. evaluated the effectiveness of the registrants disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the Evaluation Date); and                                                                                                  
|
| | c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        

5.     The registrants other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants auditors and the
audit committee of registrants board of directors:



| |                                                                                                                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrants ability
to record, process, summarize and report financial data and have
identified for the registrants auditors any material weaknesses in
internal controls; and
|
| | b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        

6.     The registrants other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.

|                   |  |     |  |                        
|------------------ |  | --- |  | -----------------------
|Dated: May 9, 2003 |  | By: |  | /s/    Donald L. Tatzin
|                   |  |     |  |                        
|                   |  |     |  | Donald L. Tatzin       
|                   |  |     |  | Chief Financial Officer

36



---



##### Table of Contents






EXHIBIT INDEX

|         |  |                                                                                                                                                                                                                                                                             
|-------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1(1)   |  | Restated Certificate of Incorporation                                                                                                                                                                                                                                       
|         |  |                                                                                                                                                                                                                                                                             
|3.2(2)   |  | Certificate of Designation, Preferences and Rights of Series A
Preferred Stock, as filed with the Secretary of State of the state
of Delaware on May 27, 1999 (which is incorporated herein by
reference to Exhibit 2.1 to the registrants Form 8-K
filed on June 14, 1999)
|         |  |                                                                                                                                                                                                                                                                             
|3.3(3)   |  | Second Amended and Restated Bylaws                                                                                                                                                                                                                                          
|         |  |                                                                                                                                                                                                                                                                             
|4.1(4)   |  | Registration Rights Agreement dated as of May 27, 1999, by and
among American Xtal Technology, Inc., Lyte Optronics, Inc. and Keith
Halsey and Robert Shih                                                                                                                  
|         |  |                                                                                                                                                                                                                                                                             
|4.2(3)   |  | Rights Agreement dated as of March 14, 2003, by and between AXT,
Inc. and Computershare Trust Company                                                                                                                                                                       
|         |  |                                                                                                                                                                                                                                                                             
|10.14(5) |  | Second Modification to Credit Agreement between U.S. Bank
National Association and us dated September 30, 2002                                                                                                                                                              
|         |  |                                                                                                                                                                                                                                                                             
|10.15    |  | Reimbursement Agreement between Wells Fargo Bank National
Association and us dated March 14, 2003                                                                                                                                                                           
|         |  |                                                                                                                                                                                                                                                                             
|99.1     |  | Certification by Chief Executive Officer                                                                                                                                                                                                                                    
|         |  |                                                                                                                                                                                                                                                                             
|99.2     |  | Certification by Chief Financial Officer                                                                                                                                                                                                                                    



---



|(1) |  | As filed with the SEC in our Annual Report on Form 10-K for the year
ended December 31, 1998.                     
|--- |  | ------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | As filed with the SEC in our Form 8-K on June 14, 1999.                                                           
|   
|(3) |  | As filed with the SEC in our Form 8-K on May 30, 2001.                                                            
|   
|(4) |  | As filed with the SEC in our Annual Report on Form 10-K for the year
ended December 31, 1999.                     
|   
|(5) |  | As filed with the SEC in our Quarterly Report on Form 10-Q for the three
and nine months ended September 30, 2002.
|