##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-K

|           |  |                                                                                                 
|---------- |  | ------------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                                 
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended December 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

AXT, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                                           |  |                                         
|------------------------------------------------------------------------------------------ |  | ----------------------------------------
|Delaware                                                                                   |  | 94-3031310                              
|(State or other jurisdiction of
    incorporation or organization)                         |  | (I.R.S. Employer
    Identification No.)
|                                                                                          
|4281 Technology Drive,
    Fremont, California(Address of principal executive
    offices) |  | 94538(Zip Code)                         

Registrants telephone number, including
area code:

(510) 683-5900


Securities registered pursuant to
Section 12(b) of the Act:

None


Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, $.001 par value


Indicate by checkmark whether the registrant
(1) has filed all reports required to be filed by
Section 13 or 15 (d) of the Securities Exchange 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 þ          No o

Indicate by checkmark if disclosure of delinquent
filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any amendment to this
Form 10-K.     Yes o          No þ

Indicate by checkmark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Act.).     Yes o          No þ

The aggregate market value of the voting stock
held by non-affiliates of the registrant, based upon the closing
sale price of the common stock on June 30, 2003 as reported
on the Nasdaq National Market, was approximately $20,120,644.
Shares of common stock held by each officer, director and by
each person who owns 5% or more of the outstanding common stock
have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status is not a
conclusive determination for other purposes.

As of January 31, 2003,
22,960,606 shares, $.001 par value, of the
registrants common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement for
the registrants 2004 annual meeting of stockholders to be
filed with the Commission pursuant to Regulation 14A not later
than 120 days after the end of the fiscal year covered by
this form are incorporated by reference into Part III of
this Form 10-K report.



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TABLE OF CONTENTS

|              |  |                                                                                                        |  |   
|------------- |  | ------------------------------------------------------------------------------------------------------ |  | --
|PART I       
|Item 1.       |  | Business                                                                                               |  | 1 
|Item 2.       |  | Properties                                                                                             |  | 9 
|Item 3.       |  | Legal Proceedings                                                                                      |  | 9 
|Item 4.       |  | Submission of Matters to a
    Vote of Security Holders                                                |  | 10
|PART II      
|Item 5.       |  | Market for Registrants
    Common Equity and Related Stockholder Matters                              |  | 10
|Item 6.       |  | Selected Consolidated
    Financial Data                                                               |  | 10
|Item 7.       |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations              |  | 13
|Item 7A.      |  | Quantitative and Qualitative
    Disclosures About Market Risk                                         |  | 34
|Item 8.       |  | Consolidated Financial
    Statements and Supplementary Data                                           |  | 34
|Item 9.       |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosures              |  | 36
|Item 9A.      |  | Controls and Procedures                                                                                |  | 36
|PART III     
|Item 10.      |  | Directors and Executive
    Officers of the Registrant                                                 |  | 37
|Item 11.      |  | Executive Compensation                                                                                 |  | 37
|Item 12.      |  | Security Ownership of
    Certain Beneficial Owners and Management and Related Stockholder
    Matters |  | 37
|Item 13.      |  | Certain Relationships and
    Related Transactions                                                     |  | 37
|Item 14.      |  | Principal Accountant Fees
    and Services                                                             |  | 38
|PART IV      
|Item 15.      |  | Exhibits, Financial
    Statement Schedules, and Reports on Form 8-K                                   |  | 39
|EXHIBIT 10.17
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 
|EXHIBIT 32.2 





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PART I

Some of the information set forth in this
annual report are forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of
1995. Forward-looking statements, including statements as to
industry trends, our future expectations and other matters that
do not relate strictly to historical facts, are based on certain
assumptions made by management. These statements are often
identified by the use of words such as may,
will, expect, plans,
believe, anticipate, intend,
could, estimate, or continue
and similar expressions or variations, and are based on the
beliefs and assumptions of our management based on information
then currently available to management. Such forward-looking
statements are subject to risks, uncertainties and other factors
that could cause actual results to differ materially from future
results expressed or implied by such forward-looking statements.
Important factors that could cause actual results to differ
materially from the forward-looking statements include, among
others, the risks discussed below under Risks Related to
Our Business. These factors are not intended to represent
a complete list of the general or specific factors that may
affect us. It should be recognized that other factors, including
general economic factors and business strategies, may be
significant, presently or in the future, and may affect us to a
greater extent than indicated. Such forward-looking statements
speak only as of the date on which such statements are made;
except as required by law, we undertake no obligation to update
any forward-looking statements to reflect events or
circumstances after the date of such statements.






|        |                    
|------- | -------------------
|Item 1. | Business  Overview

We design, develop, manufacture and distribute
high-performance compound semiconductor substrates comprising
gallium arsenide (GaAs), indium phosphide (InP) and germanium
(Ge). Our substrate products are used primarily in wireless
communications, lighting display applications, and fiber optic
communications. We believe our proprietary vertical gradient
freeze, or VGF, technique for manufacturing compound
semiconductor substrates provides significant benefits over
other methods and has enabled us to become a leading
manufacturer of compound semiconductor substrates. We pioneered
the commercial use of VGF technology to manufacture GaAs
substrates and subsequently used VGF technology to manufacture
substrates from InP, and Ge. Some of our competitors followed
our lead by developing their own versions of VGF technology.
Customers for our substrates include United Epitaxy Company,
Motorola, Agilent Technologies, Samsung, EMCORE, Kopin, IQE, and
Sumika. Over the past four years, we have implemented an
initiative, which is now largely complete, to reduce the cost of
manufacturing our substrates by moving most of our operations to
China and by investing in sources of low cost raw materials.

On June 24, 2003, the Companys Board
of Directors approved managements plan to exit the
Companys unprofitable opto-electronics business. The
disposition was a result of continuing operating losses and
negative cash flows from the division and significant
uncertainty regarding future profitability.

We were incorporated in California in December
1986 and reincorporated in Delaware in May 1988. We changed our
name from American Xtal Technology, Inc. to AXT, Inc. in July
2000. Our principal offices are located at 4281 Technology
Drive, Fremont, California 94538, and our telephone number at
this address is (510) 683-5900. Our web site is
www.axt.com; however, the information on our web site does not
constitute a part of this annual report on Form 10-K and is
not incorporated herein. We make available, free of charge, on
or through our web site, our annual, quarterly and current
reports, and any amendments to those reports.

Industry Background

Historically, most semiconductors were created on
a single crystal base material, or substrate, of silicon. Today,
however, many electronic and opto-electronics semiconductors are
being developed with requirements that exceed the capabilities
of silicon. These semiconductors address the continually
increasing demand to send, receive and display information on
high-speed wireless and wireline networks. This demand creates a
growing need for power-efficient high-performance semiconductors
that can operate at high frequencies and can be produced
cost-effectively in large volumes. These semiconductors enable
the growth and development of a wide range of end user
applications. For example, Gartner, Inc., an independent
research firm, expects

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worldwide mobile terminal production to grow from
approximately 510 million units in 2003 to approximately
560 million units in 2004.


Other examples of applications for these systems
include:



| |   |                                                                                   
| | - | ----------------------------------------------------------------------------------
| |  | voice and high-speed wireless data systems;                                       
|
| |  | infrared emitters and optical detectors in
    computer systems;                  
|
| |  | fiber optic networks and optical systems within
    these networks;               
|
| |  | selected wi-fi networks                                                           
|
| |  | solid-state lighting, including exterior and
    interior automobile lighting; and
|
| |  | satellite communications systems.                                                 

As a result of the limitations of silicon-based
technologies, semiconductor device manufacturers use compound
semiconductor substrates to improve the performance of
semiconductor devices and to enable these new applications. This
use occurs even though these compound semiconductor substrates
are more expensive than silicon. Compound semiconductor
substrates are composed of multiple elements that include a
metal, such as gallium, aluminum or indium, and a non-metal,
such as arsenic, phosphorus or nitrogen. The resulting compounds
include gallium arsenide, indium phosphide and gallium nitride.
Advantages of devices manufactured on compound substrates over
devices manufactured using silicon substrates include:



| |   |                                                                             
| | - | ----------------------------------------------------------------------------
| |  | operation at higher speeds;                                                 
|
| |  | lower power consumption;                                                    
|
| |  | less noise and distortion; and                                              
|
| |  | opto-electronic properties that enable devices to
    emit and detect light.

A key step in producing a compound semiconductor
substrate is to grow a crystal of the materials. Historically,
two processes were used to grow crystals: the Liquid
Encapsulated Czochralski, or LEC, technique and the
Horizontal-Bridgeman, or HB, technique. We believe two trends
reduced the appeal of these techniques: more semiconductor
devices are being formed using an epitaxial process and
semiconductor device manufacturers are switching their
production lines to larger diameter substrates, including
six-inch diameters for electronic device applications and three-
and four-inch for opto-electronic device applications. The LEC
and HB techniques each have difficulties producing high quality,
low-cost compound semiconductor substrates for epitaxial
processing. Substrates produced using the LEC technique have a
high volume of defects as size increases beyond four-inches in
diameter. The HB technique has been unable to reliably produce
substrates more than three-inches in diameter.

We introduced our VGF technique in 1986 to
respond to the limitations inherent in the LEC and HB
techniques, and, in recent years, some of our competitors who
previously relied on the LEC or HB methods have also developed
their own versions of VGF. We believe that a majority of the
substrates sold commercially in 2003 for electronic device
applications were manufactured using the VGF or similar
techniques.

Compound semiconductor substrates enable the
development of a wide range of electronic products including
power amplifiers and radio frequency integrated circuits used in
wireless handsets. Compound substrates can also be used to
create opto-electronic products including high brightness light
emitting diodes, or HBLEDs, and vertical cavity surface emitting
lasers, or VCSELs, used in solid-state lighting and fiber optic
communications, respectively.

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The AXT Advantage

We are a leading developer and supplier of
high-performance compound semiconductor substrates. There are
three key causes of our success:

Our VGF technology is a competitive
advantage.We pioneered the commercial
use of VGF technology to manufacture GaAs substrates and we
believe that through the use of VGF we became a leading
worldwide supplier of GaAs substrates. Our VGF process produces
substrates with high mechanical strength and physical and
chemical uniformity, as well as low crystal defect densities.
The following changes in our customers technologies are
increasing the share of substrates sold with these features:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Greater use of epitaxy rather than ion
    implantation.Many of the newest
    generation of high-performance semiconductor devices for fiber
    optic and wireless communications applications, including
    heterojunction bipolar transistors, or HBTs, and pseudomorphic
    high electron mobility transistors, or PHEMTs, are popular
    because they offer lower power consumption and better device
    linearity than their predecessors. These devices are created
    using epitaxial processed substrates. Our VGF substrates are
    more suitable for these applications than are products
    manufactured using LEC and HB technologies, and competing
    materials such as silicon germanium, or SiGe.
|
| |  | Switch to six-inch diameter
    wafers.Many semiconductor device
    manufacturers switched their GaAs production lines to six-inch
    diameter substrates in order to reduce unit costs and increase
    capacity. We were among the first competitors able to deliver
    large volumes of six-inch diameter VGF substrates and retain a
    significant amount of manufacturing capacity for this product.                                                                                                                                                                                                                                                                                                             
|
| |  | Customer technology
    independence.Our semiconductor device
    manufacturing customers often compete among themselves. For
    example, several of our customers compete for technological
    leadership in the wireless handset market. These customers or
    end-users all manufacture their devices on GaAs substrates. We
    are, therefore, largely immune from the effects of such
    competition and benefit from an overall need for faster, more
    power efficient electronic and opto-electronic devices.                                                                                                                                                                                               

Some customers specify VGF
substrates.Our wafers are qualified
with many of the key suppliers of GaAs and InP semiconductor
devices. The qualification process, which is lengthy and must be
repeated for each customer, can be a barrier to entry for a new
material or supplier. Furthermore, certain of our customers now
effectively specify that they will only accept VGF-grown or
equivalent substrates for their manufacturing processes. The
lengthy qualification period benefits us when we are already
qualified with a customer, but acts as a barrier to entry for
those customers with which we are not qualified.

Our low-cost manufacturing is an
advantage.In 1998, we began moving
portions of our substrate manufacturing operations to China, to
benefit from a combination of lower costs for facilities, labor
and materials than we encounter in the United States. That move
continued and as of the end of 2003, most of our substrate
manufacturing activities occur in China. We have also made some
strategic investments in raw materials producers, including one
that produces gallium, that provide us with a secured and low
cost source of important materials and enables us to market
surplus production to others. We believe this provides us with a
cost advantage vis-à-vis our competitors, which do not
enjoy similar arrangements.

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Technology

Our core technologies include our proprietary VGF
technique used to produce high quality crystals that are
processed into compound substrates, and our gallium extraction
technology which allows us to extract raw gallium from aluminum
ore.

(VGF FURNACE DIAGRAM)

Our VGF technique is designed to control the
crystal-growth process with minimal temperature variation and is
the technique we use to produce our GaAs, InP and Ge substrates.
Unlike traditional techniques, our VGF technique places the hot
compound melt above the cool crystal, thereby reducing the
turbulence at the interface of the melt and the solid crystal,
compared with the LEC technique in which the melt and crystal
are inverted. The temperature gradient between the melt and the
crystal in the VGF technique is significantly lower than in
traditional techniques. These aspects of the VGF technique
enable us to grow crystals that have a relatively low defect
density and high uniformity. The crystal and the resulting
substrate are mechanically strong, resulting in lower breakage
rates during a customers manufacturing process. Since the
temperature gradient is controlled electronically rather than by
physical movement, the sensitive crystal is not disturbed as it
may be during some competitors VGF-like growth processes.
In addition, the melt and growing crystal are contained in a
closed chamber, which isolates the crystal from the outside
environment to reduce potential contamination. This substrate
isolation allows for more precise control of the
gallium-to-arsenic ratio, resulting in better consistency and
uniformity of the crystals.

Our VGF technique offers several benefits when
compared to traditional crystal growing technologies. The Liquid
Encapsulated Czochralski, or LEC, technique is the traditional
method for producing semi-insulating GaAs substrates for
electronic applications. During the LEC process, the crystal is
grown by dipping a seed crystal through molten boric oxide into
a melt and slowly pulling the seed up into the cool zone above
the boric oxide where the crystal hardens. Unlike the VGF
technique, the LEC technique is designed so that the hotter GaAs
melt is located beneath the cooler crystal, resulting in greater
turbulence in the melt, and at a temperature gradient that is
significantly higher than the VGF technique. The turbulence and
high temperature cause LEC-grown crystals to have a higher
dislocation density than VGF-grown crystals, resulting in a
higher rate of breakage during the device manufacturing process.
As an open process, the LEC technique also results in greater
propensity for contamination and difficulty controlling the
ratio of gallium to

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arsenic. It requires large, complex
electro-mechanical systems that are expensive and require highly
skilled personnel to operate. Strategy Analytics, a third-party
market research firm, estimated that approximately
60 percent of the GaAs substrates sold in 2002 by all
competitors to customers that manufacture electronic devices
were manufactured using VGF or similar techniques. They
projected that VGFs share would increase to approximately
70 percent by 2007.


Our VGF technique also offers advantages over the
Horizontal-Bridgeman, or HB, technique, for producing
semi-conducting GaAs substrates for opto-electronic
applications. The HB technique holds the GaAs melt in a
semi-cylindrical container, causing crystals grown using the HB
method to have a semi-circular, or D-shaped, cross-section.
Accordingly, more crystal material is discarded when the
D-shaped substrate is subsequently trimmed to a round shape. In
addition, crystals grown using the HB technique have a higher
defect density than VGF-grown crystals. The HB technique cannot
be used cost-effectively to produce substrates greater than
three inches in diameter. The HB technique houses the GaAs
melt in a quartz container during the growth process, which can
contaminate the GaAs melt with silicon impurities, making it
unsuitable for producing semi-insulating GaAs substrates.

The following table provides a comparison of
these three techniques: LEC remains about 40% of the
semi-insulating market and HB is still present in the
semi-conducting market.

|                                    |  |                                |  |                 |  |               
|----------------------------------- |  | ------------------------------ |  | --------------- |  | --------------
|                                    |  | VGF                            |  | HB              |  | LEC           
|                                    |  |                                |  |                 |  |               
|Substrate applications              |  | Electronic and opto-electronic |  | Opto-electronic |  | Electronic    
|Largest wafer size available        |  | 6                             |  | 3              |  | 6            
|Stress/defect levels                |  | Very Low                       |  | Low             |  | High          
|Crystal purity                      |  | Good                           |  | Poor            |  | Good          
|Applicability to multiple materials |  | GaAs, InP, Ge                  |  | GaAs            |  | GaAs, InP, GaP
|Equipment and labor cost            |  | Very Low                       |  | Low             |  | High          
|Amount of waste material            |  | Very Low                       |  | High            |  | Low           
|Equipment flexibility               |  | Versatile                      |  | Limited         |  | Limited       
|Equipment downtime                  |  | Minimal                        |  | Moderate        |  | High          
|Number of competitors               |  | Several                        |  | Declining       |  | Declining     

Products

We design, develop, manufacture and distribute
high-performance semiconductor substrates. The table below sets
forth our products and selected applications:

|           |  |                                         |  |                   
|---------- |  | --------------------------------------- |  | ------------------
|           |  |                                        
|Product    |  | Applications                           
|           |  |                                        
|           |  |                                         |  |                   
|Substrates |  | Electronic                              |  | Opto-electronic   
|GaAs       |  |  Cellular phones                       |  |  LEDs            
|           |  |  Direct broadcast television           |  |  Lasers          
|           |  |  High-performance transistors          |  |  Optical couplers
|           |  |  Satellite communications              |  |                   
|          
|InP        |  |  Fiber optic communications            |  |  Lasers          
|           |  |  Satellite communications              |  |                   
|           |  |  High-performance transistors          |  |                   
|           |  |  Automotive collision avoidance radars |  |                   
|          
|Ge         |  |  Satellite solar cells                 |  |                   

Substrates.We
currently sell compound substrates manufactured from GaAs and
InP, as well as single-element substrates manufactured from Ge.
We supply GaAs substrates in two-, three-, four-, five- and

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six-inch diameters. We manufacture InP substrates
in two-, three- and four-inch diameters and Ge substrates in
four-inch diameters.


Materials.We sell
99.99% pure gallium. We began selling Ga in 2001, primarily
through our majority owned subsidiary, Beijing Ji Ya
Semiconductor Material Company, Ltd. We sell primarily to
re-processors who improve the purity of the gallium. In 2003
sales of gallium were approximately $3.3 million.

Customers

We sell our compound semiconductor substrates and
materials worldwide. Our customers include:

|                            |  |                     |  |                          
|--------------------------- |  | ------------------- |  | -------------------------
|Advanced Epitaxy Technology |  | Kingmax             |  | Sumika                   
|Agilent Technologies        |  | Kopin               |  | Triquent Semiconductor   
|Coherent Tutcore            |  | Motorola            |  | Uni Light Technology     
|EMCORE                      |  | Osram               |  | Visual Photonics Epitaxy 
|Honeywell                   |  | Opto-Power          |  | United Epitaxy Company   
|IQE, Inc.                   |  | Procomp Informatics |  | Xiamen Shanan Electronics
|Isotech                     |  | Recapture Metals    |  |                          

Historically, we have sold a significant portion
of our products in any particular period to a limited number of
customers. No customer represented greater than 10% of product
revenues for the years ended December 31, 2003, 2002 and
2001. The companys top five customers represented 28.9% of
product revenue for the year ended December 31, 2003, 31.4%
of product revenue for the year ended December 31, 2002,
and 31.1% of product revenue for the year ended
December 31, 2001. We expect that sales to certain
customers will continue to comprise a significant portion of our
revenue in the future.

Manufacturing, Raw Materials and
Supplies

We believe that our results are partially due to
our manufacturing efficiency and high product yields and we
continually emphasize quality and process control throughout our
manufacturing operations. We perform our substrate manufacturing
operations at our facilities in Beijing, China and Fremont,
California. As part of our plan to reduce substrate
manufacturing costs, we shifted the vast majority of our
manufacturing processes to our facilities in China, where costs
are generally lower, by the end of 2003. We currently perform
research and development and limited manufacturing in our
Fremont, California facilities. We believe that our capital
investment and subsequent operating costs are lower for our
manufacturing facilities in China relative to the U.S. Many
of our manufacturing operations are fully automated and computer
monitored or controlled, enhancing reliability and yield. We use
proprietary equipment in our substrate manufacturing operations
to protect our intellectual property and control the timing and
pace of capacity additions. All of our manufacturing facilities
are ISO 9001 or 9002 certified.

Although we purchase supply parts, components and
raw materials from several domestic and international suppliers,
we depend on a single or limited number of suppliers for certain
critical materials used in the production of our substrates,
such as quartz tubing, polishing solutions, and paralytic boron
nitride. We generally purchase these materials through standard
purchase orders and not pursuant to long-term supply contracts.
Although we seek to maintain sufficient inventory levels of
certain materials to guard against interruptions in supply and
to meet our near term needs, and have to date been able to
obtain sufficient supplies of materials in a timely manner,
there may be shortages of certain key materials, such as
gallium. Accordingly, to help ensure continued supply of
materials, we formed joint ventures with and made investments in
some suppliers of key raw materials required to manufacture our
products, including gallium. We believe that these joint
ventures and investments will be advantageous in procuring
materials to support our growth. In addition, excess capacity is
marketed to others.

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Sales and Marketing

We advertise in trade publications, distribute
promotional materials, conduct marketing and sales programs, and
participate in industry trade shows and conferences in order to
raise market awareness of our products. We sell our substrate
products through our direct sales force in the U.S. and Japan
and through independent sales representatives in France, Japan,
South Korea, Taiwan and the United Kingdom. Our direct sales
force consists of sales engineers who are knowledgeable in the
manufacture and use of compound and single-element substrates.
Our sales engineers work with customers during all stages of the
substrate manufacturing process, from developing the precise
composition of the substrate through manufacturing and
processing the substrate to the customers exact
specifications. We believe that maintaining a close relationship
with customers and providing them with ongoing technical support
improves customer satisfaction and will provide us with a
competitive advantage in selling other substrates to our
customers. The substrate division launched a program in late
2000 with selected customers in which we guaranteed that certain
volumes of six-inch GaAs and other substrates would be delivered
on specific dates and the customer made a prepayment for part of
the value of its order. Several major customers participate in
this program. At December 31, 2003, the unearned
pre-payments we retained under this program equaled
$1.0 million. We do not expect to continue this program
after the pre-payments currently in hand are utilized by
customers.

International Sales.International sales are an important part of our business. In
the year ended December 31, 2003, sales to customers
outside of the United States accounted for 65.9% of our revenue,
as compared with 43.9% in 2002 and with 47.5% in 2001. The
primary markets for sales of our products outside of the United
States include countries in Asia and Western Europe. Our ability
to sustain and increase our international sales involves
significant risks, including volatile political, social and
economic instabilities abroad, possible fluctuations in currency
exchange rates, and changes in tariffs, import restrictions or
other trade barriers.

Research and Development

To maintain and improve our competitive position,
we focus our research and development efforts on designing new
proprietary processes and products, improving the performance of
existing products and reducing manufacturing costs. We have
assembled a multi-disciplinary team of highly skilled
scientists, engineers and technicians to meet our research and
development objectives.

Our current substrate research and development
activities focus on continued development and enhancement of
GaAs, InP and Ge substrates, including improved yield, enhanced
surface characteristics and uniformity, greater substrate
strength and increased crystal length. During 2003 we
experienced surface quality problems with our GaAs substrates
for some customers.

Research and development expenses were
$1.3 million in 2003, compared with $2.3 million in
2002, and $3.9 million in 2001. We believe that our current
rate of expenditure can enable us to achieve our research and
development goals.

Competition

The semiconductor substrate industry is
characterized by rapid technological change and price erosion,
as well as intense foreign and domestic competition. We believe
we currently have a leading position in the existing markets for
compound semiconductor substrates primarily as a result of our
expertise in VGF technology. However, we believe we face actual
and potential competition from a number of established domestic
and international companies who have advantages not available to
us.

We believe that the primary competitive factors
in the markets in which our substrate products compete are:



| |   |             
| | - | ------------
| |  | quality;    
|
| |  | price;      
|
| |  | performance;

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| |   |                                     
| | - | ------------------------------------
| |  | meeting customer specifications; and
|
| |  | customer support and satisfaction.  

Our ability to compete in target markets also
depends on factors such as:



| |   |                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------
| |  | the timing and success of the development and
    introduction of new products and product features by us and our
    competitors;
|
| |  | the availability of adequate sources of raw
    materials; and                                                                    
|
| |  | protection of our products by effective use of
    intellectual property laws and general economic conditions.                    

Our primary competition in the market for
compound semiconductor substrates includes Freiberger, Japan
Energy and Sumitomo Electric. In addition, we also face
competition from compound semiconductor device manufacturers
that produce substrates for their own internal use, including
Hitachi, and from companies such as IBM that are actively
developing alternative compound semiconductor materials.

Protection of our Intellectual
Property

Our success and the competitive position of our
VGF technique depend on our ability to maintain trade secrets
and other intellectual property protections. We rely on a
combination of patents, trademark and trade secret laws,
non-disclosure agreements and other intellectual property
protection methods to protect our proprietary technology. 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 depends as much on
the skills of our development personnel as upon the legal
protections afforded our existing technologies. To protect our
trade secrets, we take certain measures to ensure their secrecy,
such as executing non-disclosure agreements with our employees,
customers and suppliers. However, reliance on trade secrets is
only an effective business practice insofar as trade secrets
remain undisclosed and a proprietary product or process is not
reverse engineered or independently developed.

To date, we have been issued
4 U.S. patents and have 4 U.S. patent
applications pending, which relate to our VGF products and
processes. We have 9 patent applications pending (in
PCT/national stage process) in Europe, Canada, China, Japan and
South Korea which are based on our U.S. patents that relate
to our VGF processes. We have 1 issued foreign patent.

Environmental Regulations

We are subject to federal, state and local
environmental laws and regulations. These laws, rules and
regulations govern the use, storage, discharge and disposal of
hazardous chemicals during manufacturing, research and
development and sales demonstrations. If we fail to comply with
applicable regulations, we could be subject to substantial
liability for clean-up efforts, personal injury and fines or
suspension or cessation of our operations. We cooperated with
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. In May 2000,
Cal-OSHA levied a fine against us in the amount of $313,655 for
alleged health and safety violations. In March 2001, we settled
this claim in the amount of $200,415, and have put in place
engineering, administrative and personnel protective equipment
programs to address these issues. On May 1, 2001, the
Santa Clara Center for Occupational Safety and Health
(SCCOSH) filed a complaint for injunctive relief and civil
penalties against us alleging violations of California Business
Professions Code 17200 et seq., and Health and Safety Code
section 25249 et seq. as a result of our use of arsenic and
inorganic arsenic compounds in our workplace. We reached a
settlement with SCCOSH during 2002.

Employees

As of December 31, 2003, we had
972 employees, of whom 818 were principally engaged in
manufacturing, 141 in sales and administration, and 13 in
research and development. Of these employees, 119

8



---



##### Table of Contents



are located in the U.S., 852 in China and 1
in Japan. As a result of shifting more of our substrate
manufacturing to China, we implemented headcount reductions in
our Fremont, California facilities, and expect further
reductions as our shift of manufacturing activities to China is
completed. Our employees are not represented by a union and we
have never experienced a work stoppage. Although morale has been
affected by our workforce reductions, we consider our relations
with our employees to be good.







|        |           
|------- | ----------
|Item 2. | Properties

Our principal properties as of March 15,
2004 are as follows:

|                  |  |        |        |               |  |                               |  |                                                                     
|----------------- |  | ------ | ------ | ------------- |  | ----------------------------- |  | --------------------------------------------------------------------
|                  |  | Square |        |               |  |                              
|Location          |  | Feet   |        | Principal Use |  | Ownership                    
|                  |  |        |        |               |  |                              
|Fremont, CA       |  |        | 80,000 |               |  | Production                    |  | Owned                                                               
|Fremont, CA       |  |        | 14,441 |               |  | Administration                |  | Operating lease, expires May 2005                                   
|Fremont, CA       |  |        | 9,280  |               |  | Warehouse                     |  | Operating lease, expires June 2005                                  
|Fremont, CA       |  |        | 24,100 |               |  | Warehouse                     |  | Operating lease, expires July 2006                                  
|Fremont, CA       |  |        | 55,000 |               |  | Production and Administration |  | Operating lease, expires March 2013                                 
|Monterey Park, CA |  |        | 22,000 |               |  | Vacant                        |  | Owned; available for sale                                           
|El Monte, CA      |  |        | 5,600  |               |  | Production                    |  | Operating lease, expires December 2006                              
|Beijing, China    |  |        | 31,000 |               |  | Production and Administration |  | Owned                                                               
|Beijing, China    |  |        | 31,000 |               |  | Production                    |  | Owned                                                               
|Beijing, China    |  |        | 32,000 |               |  | Production                    |  | Owned                                                               
|Beijing, China    |  |        | 16,000 |               |  | Housing                       |  | Owned                                                               
|Beijing, China    |  |        | 34,000 |               |  | Production                    |  | Owned                                                               
|Beijing, China    |  |        | 48,000 |               |  | Production                    |  | Owned                                                               
|Beijing, China    |  |        | 22,000 |               |  | Production and Administration |  | Owned                                                               
|Beijing, China    |  |        | 53,000 |               |  | Production                    |  | Owned; under construction                                           
|Xianshee, China   |  |        | 56,500 |               |  | Production                    |  | Owned by Beijing Ji Ya Semiconductor Materials,
    Co., Ltd.       
|Xianshee, China   |  |        | 7,500  |               |  | Administration                |  | Owned by Beijing Ji Ya Semiconductor Materials,
    Co., Ltd.       
|Xianshee, China   |  |        | 1,000  |               |  | Administration                |  | Owned by Beijing Ji Ya Semiconductor Materials,
    Co., Ltd.       
|Nanjing, China    |  |        | 22,000 |               |  | Production                    |  | Owned by Nanjing Jin Mei Gallium Co., Ltd.                          
|Nanjing, China    |  |        | 5,700  |               |  | R&D and Administration        |  | Owned by Nanjing Jin Mei Gallium Co., Ltd.                          
|Nanjing, China    |  |        | 3,900  |               |  | Production                    |  | Owned by Nanjing Jin Mei Gallium Co., Ltd.                          
|Beijing, China    |  |        | 7,600  |               |  | Production and Administration |  | Owned by Beijing Bo Yu Semiconductor Vessel
    Craftwork Technology

We consider each facility to be in good operating
condition and adequate for its present use, and believe that
each facility has sufficient plant capacity to meet its current
and anticipated operating requirements.






|        |                  
|------- | -----------------
|Item 3. | 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.

9



---



##### Table of Contents



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

On June 11, 2003, Cree, Inc. filed a
complaint in the United States Court for Northern District of
California against us alleging patent infringement. The
complaint sought damages and injunction against infringement. On
July 23, 2003, we filed a counter complaint in the United
States Court for Northern District of California, denying any
patent infringement and alleging that Crees actions were
intentionally designed to interfere with our prospective
business relationships. We reached an agreement with Cree
resolving the disputes between us and signed a settlement
agreement on March 5, 2004. The resolution of the disputes
did not have a material adverse impact on the Companys
consolidated financial position or results of operations.






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

None




PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Stockholder Matters

Our common stock has been trading publicly on the
Nasdaq National Market under the symbol AXTI since
May 20, 1998, the date we consummated our initial public
offering. The following table sets forth, for the periods
indicated, the range of quarterly high and low closing sales
prices for our common stock on the Nasdaq National Market.

|            |                                        |      |   |        |  |  |   |       | 
|----------- | -------------------------------------- | ---- | - | ------ |  |  | - | ----- | 
|            |                                        | High |   | Low   
|            |                                        |      |   |       
|Fiscal 2003 |                                        |      |   |        |  |  |   |      
|            | First Quarter ended March 31, 2003     |      | $ | 1.950  |  |  | $ | 0.670 | 
|            | Second Quarter ended June 30, 2003     |      | $ | 1.650  |  |  | $ | 0.680 | 
|            | Third Quarter ended September 30, 2003 |      | $ | 3.120  |  |  | $ | 1.200 | 
|            | Fourth Quarter ended December 31, 2003 |      | $ | 3.420  |  |  | $ | 1.890 | 
|           
|Fiscal 2002 |                                        |      |   |        |  |  |   |      
|            | First Quarter ended March 31, 2002     |      | $ | 16.890 |  |  | $ | 8.850 | 
|            | Second Quarter ended June 30, 2002     |      | $ | 11.600 |  |  | $ | 7.000 | 
|            | Third Quarter ended September 30, 2002 |      | $ | 8.390  |  |  | $ | 2.080 | 
|            | Fourth Quarter ended December 31, 2002 |      | $ | 2.820  |  |  | $ | 0.970 | 

As of December 31, 2003, there were 121
holders of record of our common stock. Because many shares of
AXTs common stock are held by brokers and other
institutions on behalf of stockholders, we are unable to
estimate the total number of stockholders.

We have never paid or declared any cash dividends
on our common stock and do not anticipate paying cash dividends
in the foreseeable future. Dividends accrue on our outstanding
Series A preferred stock at the rate of $0.20 per
annum per share of Series A preferred stock.






|        |                                         
|------- | ----------------------------------------
|Item 6. | Selected Consolidated Financial
    Data

The following selected consolidated financial
data are derived from and should be read in conjunction with our
consolidated financial statements and related notes set forth in
Item 8 below, and in our previously filed reports on
Form 10-K. See also Item 7 Managements
Discussion and Analysis of Financial Condition

10



---



##### Table of Contents



and Results of Operations for further
information relating to items reflecting our results of
operations and financial condition.


|                                                                               |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |        |        | 
|------------------------------------------------------------------------------ | ---------------------------------------- | ------------------------------------- | ------- | ------ | ------ | ---- | ------- | ------- | ------ | ---- | ------- | ------- | ------ | - | ------- | ------- | ------ | - | ------ | ------ | ------ | 
|                                                                               |                                          |                                      
|                                                                               |                                          | Years Ended December 31,             
|                                                                               |                                          |                                      
|                                                                               |                                          | 2003                                  |         | 2002   |        | 2001 |         | 2000    |        | 1999
|                                                                               |                                          |                                       |         |        |        |      |         |         |        |     
|                                                                               |                                          |                                      
|                                                                               |                                          | (In thousands, except per share data)
|Income Statement Data:                                                         |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|Revenue                                                                        |                                          | $                                     | 34,713  |        |        | $    | 44,865  |         |        | $    | 108,800 |         |        | $ | 113,374 |         |        | $ | 56,732 |       
|Cost of revenue                                                                |                                          |                                       | 32,478  |        |        |      | 53,758  |         |        |      | 67,494  |         |        |   | 61,361  |         |        |   | 33,446 |       
|                                                                               |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|Gross profit (loss)                                                            |                                          |                                       | 2,235   |        |        |      | (8,893  | )       |        |      | 41,306  |         |        |   | 52,013  |         |        |   | 23,286 |       
|Operating expenses:                                                            |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|                                                                               | Selling, general, and administrative     |                                       |         | 10,475 |        |      |         | 13,860  |        |      |         | 17,208  |        |   |         | 13,619  |        |   |        | 6,194  |       
|                                                                               | Research and development                 |                                       |         | 1,337  |        |      |         | 2,339   |        |      |         | 3,876   |        |   |         | 4,307   |        |   |        | 2,007  |       
|                                                                               | Restructuring costs                      |                                       |         |       |        |      |         | 14,632  |        |      |         |        |        |   |         |        |        |   |        |       |       
|                                                                               | Acquisition costs                        |                                       |         |       |        |      |         |        |        |      |         |        |        |   |         |        |        |   |        | 2,810  |       
|                                                                               |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|                                                                               |                                          | Total operating expenses              |         |        | 11,812 |      |         |         | 30,831 |      |         |         | 21,084 |   |         |         | 17,926 |   |        |        | 11,011 | 
|                                                                               |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|Income (loss) from operations                                                  |                                          |                                       | (9,577  | )      |        |      | (39,724 | )       |        |      | 20,222  |         |        |   | 34,087  |         |        |   | 12,275 |       
|Interest expense                                                               |                                          |                                       | 466     |        |        |      | 437     |         |        |      | 831     |         |        |   | 2,357   |         |        |   | 1,431  |       
|Other (income) and expense, net                                                |                                          |                                       | 1,050   |        |        |      | 12,703  |         |        |      | 13,379  |         |        |   | (28,463 | )       |        |   | (1,308 | )     
|                                                                               |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|Income (loss) from continuing operations before
    provision for income taxes |                                          |                                       | (11,093 | )      |        |      | (52,864 | )       |        |      | 6,012   |         |        |   | 60,193  |         |        |   | 12,152 |       
|Provision for income taxes                                                     |                                          |                                       |        |        |        |      | 2,119   |         |        |      | 2,164   |         |        |   | 22,874  |         |        |   | 5,685  |       
|                                                                               |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|Income (loss) from continuing operations                                       |                                          |                                       | (11,093 | )      |        |      | (54,983 | )       |        |      | 3,848   |         |        |   | 37,319  |         |        |   | 6,467  |       
|Discontinued operations:                                                       |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|                                                                               | Loss from discontinued operations        |                                       |         | (6,163 | )      |      |         | (34,625 | )      |      |         | (13,818 | )      |   |         | (22,264 | )      |   |        | (7,092 | )     
|                                                                               | Loss on disposal                         |                                       |         | (9,475 | )      |      |         |        |        |      |         |        |        |   |         | (1,341  | )      |   |        |       |       
|                                                                               | Benefit for income taxes                 |                                       |         |       |        |      |         | (8,427  | )      |      |         | (4,974  | )      |   |         | (7,896  | )      |   |        | (1,305 | )     
|                                                                               |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|Loss from discontinued operations                                              |                                          |                                       | (15,638 | )      |        |      | (26,198 | )       |        |      | (8,844  | )       |        |   | (15,709 | )       |        |   | (5,787 | )     
|Extraordinary item, net of tax benefits                                        |                                          |                                       |        |        |        |      |        |         |        |      |        |         |        |   |        |         |        |   | (508   | )     
|                                                                               |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|Net income (loss)                                                              |                                          | $                                     | (26,731 | )      |        | $    | (81,181 | )       |        | $    | (4,996  | )       |        | $ | 21,610  |         |        | $ | 172    |       
|                                                                               |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|Basic income (loss) per share:                                                 |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|                                                                               | Income (loss) from continuing operations |                                       | $       | (0.49  | )      |      | $       | (2.46   | )      |      | $       | 0.17    |        |   | $       | 1.90    |        |   | $      | 0.35   |       
|                                                                               | Loss from discontinued operations        |                                       |         | (0.69  | )      |      |         | (1.17   | )      |      |         | (0.40   | )      |   |         | (0.80   | )      |   |        | (0.31  | )     
|                                                                               | Extraordinary item                       |                                       |         |       |        |      |         |        |        |      |         |        |        |   |         |        |        |   |        | (0.03  | )     
|                                                                               | Net income (loss)                        |                                       |         | (1.18  | )      |      |         | (3.63   | )      |      |         | (0.23   | )      |   |         | 1.10    |        |   |        | 0.01   |       
|Diluted income (loss) per share:                                               |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|                                                                               | Income (loss) from continuing operations |                                       | $       | (0.49  | )      |      | $       | (2.46   | )      |      | $       | 0.17    |        |   | $       | 1.77    |        |   | $      | 0.33   |       
|                                                                               | Loss from discontinued operations        |                                       |         | (0.69  | )      |      |         | (1.17   | )      |      |         | (0.39   | )      |   |         | (0.75   | )      |   |        | (0.29  | )     
|                                                                               | Extraordinary item                       |                                       |         |       |        |      |         |        |        |      |         |        |        |   |         |        |        |   |        | (0.03  | )     
|                                                                               | Net income (loss)                        |                                       |         | (1.18  | )      |      |         | (3.63   | )      |      |         | (0.23   | )      |   |         | 1.03    |        |   |        | 0.01   |       
|Shares used in per share calculations:                                         |                                          |                                       |         |        |        |      |         |         |        |      |         |         |        |   |         |         |        |   |        |       
|                                                                               | Basic                                    |                                       |         | 22,781 |        |      |         | 22,433  |        |      |         | 22,278  |        |   |         | 19,677  |        |   |        | 18,655 |       
|                                                                               | Diluted                                  |                                       |         | 22,781 |        |      |         | 22,433  |        |      |         | 22,879  |        |   |         | 21,059  |        |   |        | 19,771 |       

11



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##### Table of Contents



|                                                |  |                |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |         | 
|----------------------------------------------- |  | -------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                                |  |               
|                                                |  | December 31,  
|                                                |  |               
|                                                |  | 2003           |         | 2002 |  | 2001 |         | 2000 |  | 1999
|                                                |  |                |         |      |  |      |         |      |  |     
|                                                |  |               
|                                                |  | (In thousands)
|Balance Sheet Data:                             |  |                |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |         | 
|Cash and cash equivalents                       |  | $              | 24,339  |      |  | $    | 13,797  |      |  | $    | 37,538  |  |  | $ | 68,585  |  |  | $ | 6,062   | 
|Short-term investments                          |  |                | 14,669  |      |  |      | 8,205   |      |  |      | 25,673  |  |  |   | 30,852  |  |  |   |        | 
|Working capital                                 |  |                | 57,335  |      |  |      | 65,375  |      |  |      | 125,295 |  |  |   | 140,387 |  |  |   | 40,462  | 
|Restricted deposits                             |  |                | 9,302   |      |  |      | 11,150  |      |  |      |        |  |  |   |        |  |  |   |        | 
|Long-term investments                           |  |                |        |      |  |      | 3,657   |      |  |      | 6,552   |  |  |   |        |  |  |   |        | 
|Total assets                                    |  |                | 107,023 |      |  |      | 145,667 |      |  |      | 243,359 |  |  |   | 250,220 |  |  |   | 115,762 | 
|Long-term capital lease, net of current portion |  |                |        |      |  |      | 4,847   |      |  |      | 10,002  |  |  |   | 7,278   |  |  |   | 6,853   | 
|Long-term debt, net of current portion          |  |                | 8,842   |      |  |      | 13,289  |      |  |      | 14,342  |  |  |   | 15,123  |  |  |   | 15,254  | 
|Stockholders equity                            |  |                | 82,298  |      |  |      | 105,657 |      |  |      | 186,322 |  |  |   | 185,347 |  |  |   | 62,459  | 

All periods have been restated to reflect the
accounting for discontinued operations. As a result, the
discontinued opto-electronics and consumer products divisions
have been eliminated from continuing operations in the income
statements.

12



---



##### Table of Contents






Item 7.     Managements
Discussion and Analysis of Financial Condition and Results of
Operations

The following discussion and analysis of our
financial condition and results of operations should be read in
conjunction with Selected Consolidated Financial
Data and our consolidated financial statements and related
notes included elsewhere in this Form 10-K. In addition to
historical information, the discussion in this Form 10-K
contains forward-looking statements that involve risks and
uncertainties that could cause our actual results to differ
materially from those projected. The statements contained in the
Report on Form 10-K that are not purely historical are
forward looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of
the Exchange Act, including, without limitation, statements
regarding our expectations, beliefs, intentions or strategies
regarding the future. All forward-looking statements included in
this Report on Form 10-K are based on information available
to us on the date hereof, and we assume no obligation to update
any such forward-looking statements. These statements involve
known and unknown risks, uncertainties and other factors, which
may cause our actual results to differ materially from those
implied by the forward-looking statements. In some cases, you
can identify forward-looking statements by terminology such as
may, will, should,
expects, plans, anticipates,
believes, estimates,
predicts, potential, or
continues or the negative of these terms or other
comparable terminology. Factors that might cause or contribute
to such differences include, but are not limited to, those set
forth under Risks Related to Our Business and
elsewhere in this Form 10-K.

Overview

We were founded in 1986 to commercialize and
enhance our proprietary vertical gradient freeze
(VGF) technique for producing high-performance compound
semiconductor substrates. Upon the discontinuance of our
opto-electronics division, and the sale of substantially all of
the assets of this business in 2003, we now have one operating
segment: our substrate division. We made our first substrate
sales in 1990 and our substrate division currently sells gallium
arsenide (GaAs) and indium phosphide (InP) substrates to
manufacturers of semiconductor devices for use in applications
such as fiber optic and wireless telecommunications, light
emitting diodes (LEDs) and lasers. We also sell raw materials
including gallium and germanium through our participation in
majority- and minority-owned joint ventures. We have the
capability to manufacture germanium substrates for use in
satellite solar cells but withdrew from this business during
2000 so that we could more profitably use our then constrained
capacity. We are now trying to re-qualify our germanium
substrates with the few existing satellite solar cell system
manufacturers.

Our total revenue from continuing operations was
$34.7 million for 2003, $44.9 million for 2002 and
$108.8 million for 2001. In 2003 we incurred a loss from
operations of $9.6 million compared to a loss of
$39.7 million for 2002 and income of $20.2 million for
2001.

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

On September 27, 2003 we completed a sale of
substantially all of the assets of our opto-electronics business
to Lumei Optoelectronics, Corp. and Dalian Luming Science and
Technology Group, Co., Ltd. for the Chinese Renminbi (RMB)
equivalent of $9.6 million. Sale proceeds of
$1.0 million will be held in escrow for up to one year and
will not be recorded until all claims, if any, are settled. If
unclaimed, up to $250,000 of the sale proceeds will be held in
escrow for a second year and will not be recorded until all
claims, if any, are settled. We retain a building located in
Monterey Park, CA, that we expect to sell in 2004. This asset is
classified as Held for Sale on our consolidated balance sheet at
December 31, 2003.

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Our continuing business, primarily sales of our
substrate products, is dependant on the semiconductor industry,
which is highly cyclical and has historically experienced
downturns both as a result of economic changes and of
overcapacity. We experienced a growth period that lasted from
our initiation of sales in 1990 through the first half of 2001.
In the second half of 2001, we experienced a $44.9 million,
or 58.5% decrease in revenue compared to the first half as a
result of the rapid decline in the mobile and fiber optic
telecommunications markets. Together with other industry
participants, we experienced lower revenues, slower bookings,
push outs and cancellation of orders. As such, we recorded
losses in the third and fourth quarters of 2001.

During the first half of 2002 our revenues grew
due to improvements in the wireless market. In the second half
of 2002 our revenue fell, however, because the substrate
industry was still facing excess capacity that caused prices to
decline, and because we experienced a loss of market share after
two competitors developed technologies similar to ours. In
addition, certain customers selected competitors products
in order to diversify their supply sources and due to the belief
that the competitors substrates offered better surface
qualities. Full year 2002 revenue declined $63.9 million,
or 58.8% compared to 2001. We recorded losses in each quarter of
2002 and incurred impairment charges against fixed assets and
inventory due to the decline in demand and prices. In reaction
to the economic downturn, we initiated an aggressive effort to
reduce substrate manufacturing costs. This included moving much
of our substrate manufacturing operations to China, reducing
capacity in our Fremont, CA facility and developing and
investing in key low-cost raw material sources.

In 2003, we believe that the wireless
communications and HBLED markets grew, but our revenue did not
increase until the fourth quarter of 2003 due to continued
reductions in prices and the time required to improve our
substrate surface quality and regain some lost customers.
Revenue for 2003 fell by $10.2 million, or 22.6% compared
with 2002. We recorded losses in each quarter of 2003. During
the year we continued to shift more of our manufacturing
operations to China and reduced our costs incurred in the United
States.

We cannot predict the level of future industry
demand or of our ability to regain lost market share, but they
have impacted our ability to sell our products and operate
profitably. If demand for our products remains depressed for an
extended period, our business will be harmed as a result. Our
business performance will be most influenced by market demand
for compound semi-conductor substrates, our ability to offer
products that equal or exceed the quality provided by
competitors, product pricing, our ability to shift more of our
manufacturing production to China, and our ability to create and
defend our intellectual property while not infringing on the
intellectual property of others.

Critical Accounting Policies and
Estimates

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

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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 December 31,
2003 our accounts receivable balance was $6.3 million net
of an allowance for doubtful accounts of $4.3 million.



| |          
| | ---------
| | Inventory

Inventories are stated at the lower of cost or
market. Cost is determined using the standard cost method.
Finished goods and work-in-process inventories include material,
labor and manufacturing overhead costs. We routinely evaluate
the levels of our inventory in light of current market
conditions in order to identify excess and obsolete inventory
and we provide a valuation allowance for certain inventories
based upon the age and quality of the product. Competitive
delivery times are frequently less than the time required for us
to manufacture a product, requiring us to build some
work-in-process inventories in anticipation of orders. If orders
are not obtained for the product built, the products will
ultimately be deemed obsolete and we will establish a reserve
for their value. We also review our inventory to ensure costs
can be realized upon ultimate sale to our customers. If we
determine that the value of any items in ending inventory
exceeds the sales value less any related selling costs, a
reserve is established for the difference.



| |                                    
| | -----------------------------------
| | Impairment of Long-Lived
    Assets

We evaluate the recoverability of property,
equipment, and intangible assets in accordance with Statement of
Financial Accounting Standards No. 144, or
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. When events and
circumstances indicate that long-lived assets may be impaired,
we compare the carrying value of the long-lived assets to the
projection of future undiscounted cash flows attributable to
such assets and in the event that the carrying value exceeds the
future undiscounted cash flows, we record an impairment charge
against income equal to the excess of the carrying value over
the assets fair value.



| |            
| | -----------
| | Investments

We determine the appropriate classification of
investments at the time of purchase. Available-for-sale
investments are carried at their fair value based on quoted
market prices as of the balance sheet date. The amortized cost
of securities is adjusted for amortization of premiums and
accretion of discounts to maturity. Such amortization is
included in other (income) and expense, net.
Realized gains or losses are determined on the specific
identification method and are reflected in other (income)
and expense, net. Net unrealized gains or losses are
recorded directly in stockholders equity. Those unrealized
losses that are deemed to be other than temporary are reflected
in interest and other income, net. We also maintain
minority investments in private companies which are accounted
for under the cost basis. These investments are reviewed for
other

15



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than temporary declines in value on a quarterly
basis. Reasons for other than temporary declines in value
include whether the related company would have insufficient cash
flow to operate for the next twelve months, significant changes
in the operating performance and changes in market conditions.




| |             
| | ------------
| | Income Taxes

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

Voluntary Stock Option Exchange
Program

On May 27, 2003, we announced a voluntary
stock option exchange program for our employees. Under the
program, our option holders, excluding our executive officers
and independent directors, had the opportunity to cancel
outstanding options with an exercise price in excess of
$2.10 per share in exchange for new options to be granted
at a future date that was at least six months and one day after
the cancellation date. The number of shares of common stock
subject to the new options was equal to 75% of the number
subject to the exchanged options. Under the exchange program,
options to purchase an aggregate of 738,027 shares of our
common stock, representing approximately 48% of the options that
were eligible to be tendered in the Offer were tendered and
cancelled. New options will vest at the same rate as the
exchanged options and have an exercise price equal to the fair
market value of our common stock at the new grant date, which
was $3.11 per share. On December 31, 2003, we granted
options to purchase an aggregate of 522,754 shares of our
common stock in exchange for such tendered options.

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##### Table of Contents



Results of Operations

The following table sets forth certain operating
data as a percentage of total revenues for the periods indicated.

|                                                                               |                                      |                          |       |       |      |      |        |       |      |   |       |       |      |  
|------------------------------------------------------------------------------ | ------------------------------------ | ------------------------ | ----- | ----- | ---- | ---- | ------ | ----- | ---- | - | ----- | ----- | ---- | -
|                                                                               |                                      |                         
|                                                                               |                                      | Years Ended December 31,
|                                                                               |                                      |                         
|                                                                               |                                      | 2003                     |       | 2002  |      | 2001
|                                                                               |                                      |                          |       |       |      |     
|Revenue                                                                        |                                      |                          | 100.0 | %     |      |      | 100.0  | %     |      |   | 100.0 | %    
|Cost of revenue                                                                |                                      |                          | 93.6  | %     |      |      | 119.8  | %     |      |   | 62.0  | %    
|                                                                               |                                      |                          |       |       |      |      |        |       |      |   |       |      
|Gross profit (loss)                                                            |                                      |                          | 6.4   | %     |      |      | (19.8  | )%    |      |   | 38.0  | %    
|Operating expenses:                                                            |                                      |                          |       |       |      |      |        |       |      |   |       |      
|                                                                               | Selling, general, and administrative |                          |       | 30.2  | %    |      |        | 30.9  | %    |   |       | 15.8  | %   
|                                                                               | Research and development             |                          |       | 3.9   | %    |      |        | 5.2   | %    |   |       | 3.6   | %   
|                                                                               | Restructuring costs                  |                          |       | 0.0   | %    |      |        | 32.6  | %    |   |       | 0.0   | %   
|                                                                               |                                      |                          |       |       |      |      |        |       |      |   |       |      
|                                                                               |                                      | Total operating expenses |       |       | 34.1 | %    |        |       | 68.7 | % |       |       | 19.4 | %
|                                                                               |                                      |                          |       |       |      |      |        |       |      |   |       |      
|Income (loss) from operations                                                  |                                      |                          | (27.7 | )%    |      |      | (88.5  | )%    |      |   | 18.6  | %    
|Interest expense                                                               |                                      |                          | 1.3   | %     |      |      | 1.0    | %     |      |   | 0.8   | %    
|Other (income) and expense, net                                                |                                      |                          | 3.0   | %     |      |      | 28.3   | %     |      |   | 12.3  | %    
|                                                                               |                                      |                          |       |       |      |      |        |       |      |   |       |      
|Income (loss) from continuing operations before
    provision for income taxes |                                      |                          | (32.0 | )%    |      |      | (117.8 | )%    |      |   | 5.5   | %    
|Provision for income taxes                                                     |                                      |                          | 0.0   | %     |      |      | 4.7    | %     |      |   | 2.0   | %    
|                                                                               |                                      |                          |       |       |      |      |        |       |      |   |       |      
|Income (loss) from continuing operations                                       |                                      |                          | (32.0 | )%    |      |      | (122.5 | )%    |      |   | 3.5   | %    
|Discontinued operations:                                                       |                                      |                          |       |       |      |      |        |       |      |   |       |      
|                                                                               | Loss from discontinued operations    |                          |       | (17.8 | )%   |      |        | (77.1 | )%   |   |       | (12.7 | )%  
|                                                                               | Loss on disposal                     |                          |       | (27.3 | )%   |      |        | 0.0   | %    |   |       | 0.0   | %   
|                                                                               | Benefit for income taxes             |                          |       | 0.0   | %    |      |        | 18.8  | %    |   |       | 4.6   | %   
|                                                                               |                                      |                          |       |       |      |      |        |       |      |   |       |      
|Loss from discontinued operations                                              |                                      |                          | (45.1 | )%    |      |      | (58.3  | )%    |      |   | (8.1  | )%   
|                                                                               |                                      |                          |       |       |      |      |        |       |      |   |       |      
|Net Loss                                                                       |                                      |                          | (77.1 | )%    |      |      | (180.8 | )%    |      |   | (4.6  | )%   
|                                                                               |                                      |                          |       |       |      |      |        |       |      |   |       |      

Year Ended December 31, 2003 Compared to
Year Ended December 31, 2002

Revenue from continuing
operations.Revenue from continuing
operations decreased $10.2 million, or 22.6%, to
$34.7 million in 2003 compared to $44.9 million in
2002. Total GaAs substrate revenue decreased $4.6 million,
or 13.9%, to $28.3 million in 2003 compared to
$32.9 million in 2002. Sales of 5 inch and 6 inch
diameter GaAs substrates, which are used exclusively to
manufacture electronic devices, decreased $3.4 million, or
38.9%, to $5.4 million in 2003 compared to
$8.8 million in 2002. InP substrate revenue decreased
$4.4 million, or 68.0%, to $2.1 million in 2003
compared to $6.5 million in 2002. InP substrates are used
almost exclusively for telecommunications applications. The
decrease in GaAs and InP substrate revenue is due to decreased
volume and lower average sales prices as a result of the
slowdown in our target markets including telecommunications,
high speed electronic devices, and short wavelength lasers, and
the introduction of VGF-like substrates from our competitors
that caused some customers to purchase substrates from our
competitors rather than from us.

International revenue increased to 65.9% of total
revenue from continuing operations in 2003 compared to 43.9% in
2002. The increase was primarily due to a greater share of our
GaAs substrates being used in opto-electronics applications and
the majority of our customers for these applications being in
Asia.

Gross margin.Gross
margin increased to 6.4% of revenue in 2003 compared to negative
19.8% in 2002. The increase was primarily due to reduced costs
associated with moving most of our production to China. In
addition, we incurred a charge of $9.7 million in 2002
related to the write-down of certain inventory that we concluded
was obsolete.

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Selling, general and administrative
expenses.Selling, general and
administrative expenses decreased $3.4 million, or 24.4%,
to $10.5 million in 2003 compared to $13.9 million in
2002. As a percentage of total revenue, selling, general and
administrative expenses were 30.2% in 2003 compared to 30.9% in
2002. The decrease in selling, general and administrative
expenses is the result of our efforts to adjust costs in line
with our current business and of our ability to shift some of
these activities to China where our costs are lower.

Research and development
expenses.Research and development
expenses decreased $1.0 million or 42.8%, to
$1.3 million in 2003 compared to $2.3 million in 2002.
As a percentage of total revenue, research and development
expenses were 3.9% in 2003 compared to 5.2% in 2002. Although we
reduced research and development expenses in 2003 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 2003 were focused primarily on
improving the yield and surface quality of our GaAs substrates.

Interest expense.Interest expense increased $29,000, or 6.6%, to $466,000 in 2003
compared to $437,000 in 2002. By the end of 2003, we had repaid
$10.1 million in equipment lease and loan debt which will
reduce future interest payments.

Other income and expense,
net.Other expense was
$1.1 million in 2003 compared to $12.7 million in
2002. The amount in 2003 includes charges of $2.1 million
related to the write-down of investments we hold in two
privately held U.S. companies. The amount in 2002 includes
non-cash charges of $10.8 million related to the write-down
to market value of our investment in Finisar Corporation common
stock and $3.1 million to write-down a building held for
sale to net realizable value.

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. During 2003, we continued
to record a full valuation allowance against our net deferred
tax assets and as a result, our effective tax rate decreased to
0.0% for 2003.

Loss from discontinued
operations.Loss from our discontinued
opto-electronics division for the year ended December 31,
2003 was $15.6 million, which included a loss on disposal
of $9.5 million and the operating loss from our
discontinued opto-electronics division of $6.1 million.

Year Ended December 31, 2002 Compared to
Year Ended December 31, 2001

Revenue from continuing
operations.Revenue from continuing
operations decreased $63.9 million, or 58.8%, to
$44.9 million in 2002 compared to $108.8 million in
2001. Total GaAs substrate revenue decreased $42.5 million,
or 56.4%, to $32.9 million in 2002 compared to
$75.4 million in 2001. Sales of 5 and 6
diameter GaAs substrates decreased $12.8 million, or 59.2%,
to $8.8 million in 2002 compared to $21.6 million in
2001. InP substrate revenue decreased $21.7 million, or
77.0%, to $6.5 million in 2002 compared to
$28.2 million in 2001. The decrease in GaAs and InP
substrate revenue was 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.

International revenue decreased to 43.9% of total
revenue in 2002 compared to 47.5% of total revenue in 2001.

Gross margin.Gross
margin decreased to negative 19.8% of revenue in 2002 compared
to positive 38.0% in 2001. The decrease was primarily due to
lower unit sales and average sales prices of GaAs and InP
substrates spread over a relatively fixed manufacturing overhead
base and a $9.7 million charge to write-down excess
inventory. As a result, we initiated manufacturing cost
reductions in order to align our costs with lower expected sales
volumes and prices. We shifted much of our substrate
manufacturing to China and reduced capacity in our Fremont,
California facility.

Selling, general and administrative
expenses.Selling, general and
administrative expenses decreased $3.3 million, or 19.5%,
to $13.8 million in 2002 compared to $17.2 million in
2001. As a percentage of total

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revenue, selling, general and administrative
expenses were 30.9% in 2002 compared to 15.8% in 2001. In order
to align our cost structure with the rapid decline in revenues,
we initiated and aggressively pursued cost reductions in this
area, which led to the decrease in 2002.


Research and development
expenses.Research and development
expenses decreased $1.5 million or 39.7%, to
$2.3 million in 2002 compared to $3.9 million in 2001.
As a percentage of total revenue, research and development
expenses were 5.2% in 2002 compared to 3.6% in 2001. Research
and development efforts during 2002 were focused primarily on
improving the yield and surface quality of our GaAs substrates.

Interest expense.Interest expense decreased $394,000, or 47.4%, to $437,000 in
2002 compared to $831,000 in 2001. The decrease was primarily
due to the repayment of certain long-term real estate notes and
capital equipment leases.

Other income and
expense.Other expense was
$12.7 million in 2002 compared to $13.4 million in
2001. The amount in 2002 includes non-cash charges of
$10.8 million related to the write-down to market value of
our investment in Finisar Corporation common stock and
$3.1 million to write-down a building held for sale to net
realizable value. The 2001 balance includes a non-cash charge of
$15.6 million to write-down to market value our investment
in Finisar common stock.

Provision for income
taxes.Due to our continuing operating
losses during 2002 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 7.2% in 2002. Our
effective tax rate in 2001 was 36%.

Loss from discontinued
operations.Loss from our discontinued
opto-electronics division for the year ended December 31,
2002 was $26.2 million net of income tax benefit of
$8.4 million.

Liquidity and Capital Resources

We consider cash and cash equivalents, and
short-term investments as liquid and available for use.
Short-term investments are comprised of government bonds and
high-grade commercial debt instruments. Also included in
short-term investments is our common stock investment in Finisar
Corporation.

Cash and cash equivalents, short-term investments
and long-term investments, excluding $3.7 million and
$1.1 million for our investment in Finisar common stock at
December 31, 2003 and 2002 respectively, increased
$8.9 million to $44.6 million at December 31,
2003 compared to $35.7 million at December 31, 2002.

Cash and cash equivalents increased
$10.5 million to $24.3 million at December 31,
2003 compared to $13.8 million at December 31, 2002.

Net cash provided by operating activities of
$6.3 million for the year ended December 31, 2003 was
comprised primarily of our net loss adjusted for non-cash items
of $18.0 million, consisting primarily of the loss on
disposal of our opto-electronics division of $9.5 million,
depreciation of $5.8 million, and by a $15.0 million
net change in assets and liabilities. The net change in assets
and liabilities resulted primarily from a decrease in inventory,
prepaid expenses and income tax receivable, offset by decreases
in accounts payable and accrued liabilities.

Accounts receivable decreased $898,000, or 12.5%,
to $6.3 million at December 31, 2003 compared to
$7.2 million at December 31, 2002. The change reflects
lower sales volume, collections of $32.5 million and a
decrease in our allowance for doubtful accounts of
$2.4 million due to the collection of previously
written-down receivables. It also included a $666,000 write-down
of accounts receivable from our discontinued opto-electronics
division, which is included in loss on disposal in
our consolidated statement of operations for the year ended
December 31, 2003.

Inventories decreased $13.5 million, or
35.9% to $24.1 million at December 31, 2003 compared
to $37.6 million at December 31, 2002. The decrease in
inventory included a $2 million write-down of inventory
from our discontinued opto-electronics division, which is
included in loss on disposal in our consolidated

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statement of operations for the year ended
December 31, 2003. The Company adopted a strategy of using
inventory to conserve cash. During 2004 we do not expect to
maintain the same rate of net inventory decrease as we
experienced in 2003.


Net cash provided by investing activities of
$13.7 million for the year ended December 31, 2003
includes proceeds from the sale of property and equipment, and
high grade investment securities totaling $27.7 million,
offset by purchases of property and equipment of
$2.2 million primarily used to transfer production capacity
to China for the substrate division, and purchases of high grade
investment securities with maturities of less than two years
totaling $5.9 million. It also includes an increase in
restricted cash of $5.8 million to collateralize a letter
of credit with a bank that supports our long-term debt and
workers compensation insurance policy.

We do not have any plans to initiate any major
new capital spending projects through 2004. We are currently
completing certain projects at our China facilities and are
continuously constructing minor improvements to our existing
production facilities in China and California. We expect to
invest approximately $5.0 million in capital projects in
2004. We believe that our existing and planned facilities and
equipment are sufficient to fulfill current and expected future
orders.

Net cash used in financing activities of
$9.6 million consisted of proceeds of $480,000 from the
exercise of options by our employees, offset by payments of
$10.1 million to reduce long-term borrowings and capital
leases.

Our main Fremont, California manufacturing
facility is financed by long-term borrowings, which were
refinanced by taxable variable rate revenue bonds in 1998. These
bonds mature in 2023 and bear interest at a variable rate that
was 1.35% at December 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
December 31, 2003, $8.5 million was outstanding under
these bonds.

At December 31, 2003 the credit facility
maintained by us with a bank included a letter of credit
supporting repayment of our industrial bonds with an outstanding
amount of $8.5 million. The Company has pledged and placed
cash and certain investment securities with an affiliate of the
bank as additional collateral for this facility. We have also
pledged cash for a credit facility for our workers compensation
insurance. As a result, $9.3 million of our cash and
long-term investments are restricted.

We currently hold a note payable secured by
certain equipment in China totaling $3.3 million at
December 31, 2003 (see Note 4 to our consolidated
financial statements). The balance on this note will be due in
December 2004.

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

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Outstanding contractual obligations as of
December 31, 2003 are summarized below (in thousands):

|           |  |      |        |           |  |       |       |  |  |   |        | 
|---------- |  | ---- | ------ | --------- |  | ----- | ----- |  |  | - | ------ | 
|           |  |      |        | Operating |  |      
|           |  | Debt |        | Leases    |  | Total
|           |  |      |        |           |  |      
|2004       |  | $    | 3,694  |           |  | $     | 1,231 |  |  | $ | 4,925  | 
|2005       |  |      | 514    |           |  |       | 1,115 |  |  |   | 1,629  | 
|2006       |  |      | 459    |           |  |       | 836   |  |  |   | 1,295  | 
|2007       |  |      | 462    |           |  |       | 616   |  |  |   | 1,078  | 
|2008       |  |      | 466    |           |  |       | 617   |  |  |   | 1,083  | 
|Thereafter |  |      | 6,941  |           |  |       | 3,236 |  |  |   | 10,177 | 
|           |  |      |        |           |  |       |       |  |  |   |        | 
|           |  | $    | 12,536 |           |  | $     | 7,651 |  |  | $ | 20,187 | 
|           |  |      |        |           |  |       |       |  |  |   |        | 

We lease certain office space, manufacturing
facilities and property under long-term operating leases
expiring at various dates through March 2013. Total rent expense
under these operating leases was approximately $1.2 million
for the year ended December 31, 2003, $947,000 in 2002 and
$779,000 in 2001.

Risks Related to Our Business



| |                                                                                                                                  
| | ---------------------------------------------------------------------------------------------------------------------------------
| | The semiconductor industry is cyclical and
    has experienced a downturn which has adversely impacted our
    operating results.

Our continuing business depends in significant
part upon manufacturers of electronic and opto-electronic
semiconductor devices, as well as the current and anticipated
market demand for such devices and products using such devices.
As a supplier to the semiconductor industry, we are subject to
the business cycles that characterize the industry. The timing,
length and volatility of these cycles are difficult to predict.
The semiconductor industry has historically been cyclical
because of sudden changes in demand for semiconductors and
capacity requirements, including capacity utilizing the latest
technology. The rate of changes in demand, including end demand,
is high, and the effect of these changes upon us occurs quickly,
exacerbating the volatility of these cycles. These changes have
affected the timing and amounts of customers capital
equipment purchases and investments in new technology. These
industry cycles create pressure on our net sales, gross margin
and net income.

The industry has previously experienced periods
of oversupply that result in significantly reduced demand for
semiconductor devices and components, including our products,
both as a result of general economic changes and overcapacity.
When these periods occur, our operating results and financial
condition are adversely affected, and create pressure on our
revenue, gross margins and net income. Inventory buildups in
telecommunications products and slower than expected sales of
computer equipment resulted in overcapacity and led to reduced
sales by our customers, and therefore reduced purchases of our
products. During periods of weak demand such as those
experienced over the past years, customers typically reduce
purchases, delay delivery of products and/or cancel orders of
component parts such as our products. Increased price
competition has resulted, causing pressure on our net sales,
gross margin and net income. We experienced cancellations, price
reductions, delays and push outs of orders, which have resulted
in reduced revenues. If the economic downturn were to continue,
or occur again in the future, further order cancellations,
reductions in order size or delays in orders will materially
adversely affect our business and results of operations. Actions
to reduce our costs, such as those we have recently taken, may
be insufficient to align our structure with prevailing business
conditions. We may be required to undertake additional
cost-cutting measures, and may be unable to invest in marketing,
research and development and engineering at the levels we
believe are necessary to maintain our competitive position. Our
failure to make these investments could seriously harm our
business.

During periods of increasing demand for
semiconductor devices, we must have sufficient manufacturing
capacity and inventory to meet customer demand, and must be able
to attract, hire, train and retain qualified employees to meet
demand. It appears that the semiconductor industry is in the
early stages of an upturn and increasing demand. However, we
cannot predict the sustainability of a recovery, if any, and the
industrys rate of growth in this recovery, if it occurs.
If we are unable to effectively manage our resources and
production

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capacity during an industry upturn, there could
be a material adverse effect on our business, financial
condition and results of operations.




| |                                                                                                                                                                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If the economy recovers and we are again in
    a period of high demand for our products, we may be unable to
    expand our manufacturing capacity quickly enough to meet
    increased demand, we may make decisions to expand capacity that
    are not profitable, and we may be unable to lower our costs or
    increase revenue.

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

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



| |   |                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | unforeseen environmental or engineering problems;                                                                                                           
|
| |  | unavailability or late delivery of production
    equipment;                                                                                                
|
| |  | delays in completing new facilities;                                                                                                                        
|
| |  | delays in bringing production equipment on-line;                                                                                                            
|
| |  | work stoppages or delays;                                                                                                                                   
|
| |  | inability to recruit and train qualified
    staff; and                                                                                                     
|
| |  | unanticipated cost increases and restrictions
    imposed by requirements of local, state or federal regulatory
    agencies in the United States and China.

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



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

We have not over the past year been able to
sustain growth, and may not be able to return to historic growth
levels in the current economic environment. Our net loss in 2002
was the largest in our history and our losses continued during
2003. We believe we will endure losses for at least part of
2004. We have and may continue to experience significant
fluctuations in our revenue and earnings. Our quarterly and
annual revenue and operating results have varied significantly
in the past and may vary significantly in the future due to a
number of factors, including:



| |   |                                                                                             
| | - | --------------------------------------------------------------------------------------------
| |  | 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;                                                       

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

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

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



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

We must manage our inventory of component parts,
work-in-process, and finished goods effectively to meet changing
customer requirements, while keeping inventory costs down and
improving gross margins. Some of our products and supplies have
in the past and may in the future become obsolete while in
inventory due to changing customer specifications, or become
excess inventory due to decreased demand for our products and an
inability to sell the inventory within a foreseeable period.
Furthermore, if current costs of production increase or sales
prices drop below the standard prices at which we value
inventory, we may need to take a charge for a reduction in
inventory values. We have in the past had to take inventory
valuation and impairment charges. If we are not successfully
able to manage our inventory, we may need to write off
unsaleable, obsolete or excess inventory, which could adversely
affect our results of operations. On October 1, 2003, we
implemented a new inventory control system that may experience
unexpected difficulties.



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

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



| |                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------
| | Much of our cash resources are denominated
    in Chinese currency and are subject to exchange control
    restrictions.

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

23



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| |                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | A reoccurrence of Severe Acute Respiratory
    Syndrome (SARS) or the outbreak of a different contagious
    disease may adversely impact our manufacturing operations and
    some of our key suppliers and customers.

The majority of our substrate manufacturing
activities are conducted in China. In addition, we source key
raw materials, including gallium, from our joint ventures and
other suppliers in China. The 2003 SARS outbreak was most
notable in China and a small number of cases have been reported
to date in 2004. One employee at our LED production facility in
China contracted SARS in late April 2003 prompting us to close
the facility for ten days. There was no significant impact to
our ability to fill customer orders. If there were to be another
outbreak of SARS or a different contagious disease and if our
employees contracted the disease, we may be required to
temporarily close our manufacturing operations. Similarly, if
one of our key suppliers is required to close for an extended
period, we may not have enough raw material inventory to
continue manufacturing operations. In addition, while we possess
management skills among our China staff that enable us to
maintain our manufacturing operations with minimal on-site
supervision from our US-based staff, our business could also be
harmed if travel to or from Asia and the United States is
restricted or inadvisable, as it was during parts of 2003. None
of our substrate competitors is as dependent on manufacturing
facilities in China as we are. If our manufacturing operations
were closed for a significant period, we could lose revenue and
market share during that period which would depress our
financial performance and could be difficult to recapture.
Finally, if one of our key customers is required to close for an
extended period, we may not be able to ship product to them, our
revenue would decline and our financial performance would suffer.



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

Our operating results can vary significantly
based upon the impact of changes in global economic conditions
on our customers. More specifically, the macro-economic
environment that we faced in 2003 was more uncertain than in
some prior periods, lasted longer than expected and has
materially and adversely affected us and our operating results
and may continue to do so. The revenue growth and profitability
of our business depends on the overall demand for our
substrates, and we are particularly dependant on the market
conditions for the wireless, solid-state illumination, fiber
optics and telecommunications industries. Because our sales are
primarily to major corporate customers whose businesses
fluctuate with general economic and business conditions, a
softening of demand for products that use our substrates, caused
by a weakening economy may result in further or prolonged
decreased revenues. Customers may find themselves facing excess
inventory from earlier purchases, and may defer or reconsider
purchasing products due to the downturn in their business and in
the general economy.



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

Our success depends on our ability to offer new
products and product features that incorporate leading
technology and respond to technological advances. In addition,
our new products must meet customer needs and compete
effectively on quality, price and performance. The life cycles
of our products are difficult to predict because the markets for
our products are characterized by rapid technological change,
changing customer needs and evolving industry standards. If our
competitors introduce products employing new technologies or
performance characteristics, our existing products could become
obsolete and unmarketable. During the past year, we have seen
our competitors selling more substrates manufactured using a
crystal growth technology similar to ours, which has eroded our
technological differentiation. If we fail to offer new products,
we may not generate sufficient revenue to offset our development
costs and other expenses or meet our customers
requirements. Other companies, including Triquent, are actively
developing substrate materials that could be used to manufacture
devices that could provide the same high-performance, low-power
capabilities as GaAs- and InP-based devices at competitive
prices. If these substrate materials or VGF derived products are
successfully developed and semiconductor device manufacturers
adopt them, demand for our GaAs substrates could decline and our
revenue could suffer.

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



| |                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------
| | Our operating results depend in large part
    on further customer acceptance of our existing substrate
    products manufactured in China.

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

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



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

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



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

Our competitors could develop new or enhanced
products that are more effective than our products are.

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



| |                                                                    
| | -------------------------------------------------------------------
| | Defects in our products could diminish
    demand for our products.

Our products are complex and may contain defects.
We have experienced quality control problems with some of our
products over the past two years, which caused customers to
return products to us, reduce orders for our products, or both.
If we continue to experience quality control problems, or
experience these or other problems in new products, customers
may cancel or reduce orders or purchase products from our
competitors

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


If new products developed by us contain defects
when released, our customers may be dissatisfied and we may
suffer negative publicity or customer claims against us, lose
sales or experience delays in market acceptance of our new
products.



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

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



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

If our yields decrease, our revenue could decline
because many of our manufacturing costs are fixed, or would
increase. We have experienced product shipment delays and
difficulties in achieving acceptable yields on both new and
older products, and delays and poor yields have adversely
affected our operating results. We may experience similar
problems in the future and we cannot predict when they may occur
or their severity. In particular, many of our manufacturing
processes are new and are still being refined, which can result
in lower yields.



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

Our revenue growth depends in part on the
expansion of our international sales and operations.
International sales represented 65.9% of our total revenue for
the year ended December 31, 2003 and 43.9% for the year
ended December 31, 2002. We expect that sales to customers
outside the U.S. will continue to represent a significant
portion of our revenue, particularly sales to customers in Asia.

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

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



| |   |                                                                                
| | - | -------------------------------------------------------------------------------
| |  | changes in tariffs, import or export restrictions
    and other trade barriers;
|
| |  | unexpected changes in regulatory requirements;                                 

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| |   |                                                                  
| | - | -----------------------------------------------------------------
| |  | longer periods to collect accounts receivable;                   
|
| |  | changes in export license requirements;                          
|
| |  | political and economic instability;                              
|
| |  | unexpected changes in diplomatic and trade
    relationships; and
|
| |  | foreign exchange rate fluctuations.                              

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



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

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



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

If demand for the end user applications for which
our products are used decreases, or our customers are unable to
develop, market and sell their products, demand for our products
will decrease.



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

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



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

We depend on a limited number of suppliers for
certain raw materials, components and equipment used in
manufacturing our products, including key materials such as
quartz tubing, polishing solutions, and paralytic boron nitride.
We generally purchase these materials through standard purchase
orders and not pursuant to long-term supply contracts and no
supplier guarantees supply of raw materials or equipment to us.
If we lose any of our key suppliers, our manufacturing efforts
could be significantly hampered and we could be prevented from
timely producing and delivering products to our customers. We
have experienced delays

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obtaining critical raw materials and spare parts,
including gallium, due to shortages of these materials. We may
experience delays due to shortages of materials and may be
unable to obtain an adequate supply of materials. These
shortages and delays could result in higher materials costs and
cause us to delay or reduce production of our products. If we
have to delay or reduce production, we could fail to meet
customer delivery schedules and our revenue and operating
results could suffer.


If we fail to comply with environmental and
safety regulations, we may be subject to significant fines or
cessation of our operations; in addition, we could be subject to
suits for personal injuries caused by exposure to hazardous
materials.

We are subject to federal, state and local
environmental and safety laws and regulations in all of our
operating locations. These laws, rules and regulations govern
the use, storage, discharge and disposal of hazardous chemicals
during manufacturing, research and development, and sales
demonstrations. If we fail to comply with applicable
regulations, we could be subject to substantial liability for
clean-up efforts, personal injury and fines or suspension or
cessation of our operations. In March 2001, we settled a claim
made by the California Occupational Safety and Health
Administration, or Cal-OSHA, in an investigation primarily
regarding impermissible levels of potentially hazardous
materials in certain areas of our manufacturing facility in
Fremont, California for $200,415. 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. Existing or future changes in
laws or regulations may require us to incur significant
expenditures or liabilities, or may restrict our operations. In
addition, our employees could be exposed to chemicals or other
hazardous materials at our facilities and we may be subject to
lawsuits seeking damages for wrongful death or personal injuries
allegedly caused by exposure to chemicals or hazardous materials
at our facilities.

If litigation is brought against us, litigation
is inherently uncertain and while we would expect to defend
ourself vigorously, it is possible that our business, financial
condition, results of operations or cash flows, could be
affected in any particular period by such litigation if brought
against us.



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

A small number of substrate customers have
historically accounted for a substantial portion of our total
revenue. Five customers accounted for 28.9% of our total revenue
for the year ended December 31, 2003 and 31.4% for the year
ended December 31, 2002. One customer accounted for 6.8% of
our revenue for the year ended December 31, 2003. We expect
that a significant portion of our future revenue will continue
to be derived from a limited number of substrate customers. Our
customers are not obligated to purchase a specified quantity of
our products or to provide us with binding forecasts of product
purchases. In addition, our customers may reduce, delay or
cancel orders at any time without any significant penalty, and
during the past year, we have experienced slower bookings,
significant push outs and cancellation of orders. In addition,
due to the difficult economic environment, several of our
previously large customers have stopped operations entirely. If
we lose a major customer or if a customer cancels, reduces or
delays orders, our revenue would decline. In addition, customers
that have accounted for significant revenue in the past may not
continue to generate revenue for us in any future period. Any
delay in scheduled shipments of our products could cause net
sales to fall below our expectations and the expectations of
market analysts or investors, causing our stock price to decline.



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

Customers typically place orders with us for our
substrate products three months to a year or more after our
initial contact with them. The sale of our products may be
subject to delays due to our customers lengthy internal
budgeting, approval and evaluation processes. During this time,
we may incur substantial expenses and expend sales, marketing
and management efforts while the customers evaluate our
products. These expenditures may not result in sales of our
products. If we do not achieve anticipated sales in a period as

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expected, we may experience an unplanned
shortfall in our revenue. As a result, we may not be able to
cover expenses, causing our operating results to vary. In
addition, if a customer decides not to incorporate our products
into its initial design, we may not have another opportunity to
sell products to this customer for many months or even years. In
the current competitive and economic climate, the average sales
cycle for our products has lengthened even further and is
expected to continue to make it difficult to accurately forecast
our future sales. We anticipate that sales of any future
substrate products will also have lengthy sales cycles and will,
therefore, be subject to risks substantially similar to those
inherent in the lengthy sales cycle of our current substrate
products.




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

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

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

It is possible that pending or future United
States or foreign patent applications made by us will not be
approved, that our issued patents will not protect our
intellectual property, or that third parties will challenge the
ownership rights or the validity of our patents. In addition,
the laws of some foreign countries may not protect our
proprietary rights to as great an extent as do the laws of the
United States and it may be more difficult to monitor the use of
our intellectual property. Our competitors may be able to
legitimately ascertain non-patented proprietary technology
embedded in our systems. If this occurs, we may not be able to
prevent the development of technology substantially similar to
ours.

We may have to resort to costly litigation to
enforce our intellectual property rights, to protect our trade
secrets or know-how or to determine their scope, validity or
enforceability. Enforcing or defending our proprietary
technology is expensive, could cause us to divert resources and
may not prove successful. Our protective measures may prove
inadequate to protect our proprietary rights, and if we fail to
enforce or protect our rights, we could lose valuable assets.



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

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

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| |                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------
| | As our business matures, we may need to
    upgrade our systems, or incur additional costs related to
    regulatory compliance.

In the past, periods of rapid growth and
expansion has strained our management and other resources. The
expansion of our manufacturing capacity and the shift of
manufacturing operations to China placed and continue to place a
significant strain on our operations and management resources.
We recently upgraded our inventory control systems and may
implement additional systems relating to consolidation of our
financial results. If we fail to manage these changes
effectively, our operations may be disrupted.

To manage our business effectively, we may need
to implement additional and improved management information
systems, further develop our operating, administrative,
financial and accounting systems and controls, add experienced
senior level managers, and maintain close coordination among our
executive, engineering, accounting, marketing, sales and
operations organizations.

If necessary, we will spend substantial sums to
support our future growth and shift to China and to comply with
the reporting and attestation requirements of the Sarbanes-Oxley
Act of 2002. We may incur additional unexpected costs. Our
systems, procedures or controls may not be adequate to support
our operations, and we may be unable to expand quickly enough to
exploit potential market opportunities.



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

We anticipate that our existing cash resources
will fund any anticipated operating losses, purchases of capital
equipment and provide adequate working capital for the next
twelve months. However, our liquidity is affected by many
factors including, among others, the extent to which we pursue
additional capital expenditures, the level of our production,
and other factors related to the uncertainties of the industry
and global economies. If we fail to manage our contractions
successfully we may draw down our cash reserves, which would
adversely affect our operating results and financial condition,
reduce our value and may impinge our ability to raise debt and
equity funding in the future, at a time when we may be required
to raise additional cash. Accordingly, there can be no assurance
that events in the future will not require us to seek additional
capital, or, if so required, that such capital will be available
on terms acceptable to us, if at all. As part of our effort to
reduce costs, we may lose key staff, production resources, and
technology that we will need to grow when end markets recover.
These events could reduce our ability to grow profitably as
markets recover.



| |                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 demand for our products, we implemented a corporate
restructuring beginning in 2001 and reduced our workforce,
shifted production activities to China, reduced capital
expenditures, and discontinued our opto-electronics business. In
addition, our stock price is volatile, which can affect the
value of stock options issued to our employees. Our
restructuring may yield unanticipated consequences, such as
attrition beyond our planned reduction in workforce and loss of
employee morale and decreased performance. 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.

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

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



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

For example, we incurred substantial costs in
connection with our acquisition of Lyte Optronics in May 1999,
including the assumption of approximately $10.0 million of
debt, which was subsequently repaid, resulting in a decline of
cash available. We also incurred consistent operating losses for
the business following the acquisition, and have discontinued
all operations and sold the related assets acquired in our
acquisition of Lyte Optronics during 2003.

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



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

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



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

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

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

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

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

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



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

The United States continues to be on alert for
terrorist activity. The potential near- and long-term impact
terrorist activities may have in regards to our suppliers,
customers and markets for our products and the U.S. economy
are uncertain. There may be embargos of ports or products, or
destruction of shipments or our facilities, or attacks that
affect our personnel. There may be other potential adverse
effects on our operating results due to a significant event that
we cannot foresee.



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

Our stock price has fluctuated significantly
since we began trading on the Nasdaq National Market. For the
year ended December 31, 2003, the high and low closing
sales prices of our common stock were $3.42 and $0.67,
respectively. A number of factors could cause the price of our
common stock to continue to fluctuate substantially, including:



| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | actual or anticipated fluctuations in our
    quarterly or annual operating results;                                            
|
| |  | changes in expectations about our future
    financial performance or changes in financial estimates of
    securities analysts;
|
| |  | announcements of technological innovations by us
    or our competitors;                                                        
|
| |  | new product introduction by us or our competitors;                                                                              
|
| |  | large customer orders or order
    cancellations; and                                                                           
|
| |  | the operating and stock price performance of
    comparable companies.                                                          

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



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

Our board of directors has the authority to issue
up to 2,000,000 shares of preferred stock and to determine
the price, rights, preferences and privileges of those shares
without any further vote or action by the stockholders. The
rights of the holders of common stock will be subject to, and
may be adversely affected by, the rights of the holders of any
preferred stock that may be issued in the future. The issuance
of shares of preferred stock, while potentially providing
desirable flexibility in connection with possible acquisitions
and for

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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.

In addition, provisions in our amended and
restated certificate of incorporation and bylaws may have the
effect of delaying or preventing a merger, acquisition or change
of control of us, or changes in our management, including:



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

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



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



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

In order to comply with the newly adopted
Sarbanes-Oxley Act of 2002, as well as proposed changes to
listing standards by Nasdaq, and proposed accounting changes by
the Securities and Exchange Commission, we may be required to
increase our internal controls, hire additional personnel and
additional outside legal, accounting and advisory services, all
of which will cause our general and administrative costs to
increase. Insurers may increase premiums as a result of the high
claims rates they incurred over the past year, and our premiums
for our various insurance policies, including our
directors and officers insurance policies, increased
during 2003. Proposed changes in the accounting rules, including
legislative and other proposals to account for employee stock
options as a compensation expense among others, could materially
increase the expense that we report under generally accepted
accounting principles and adversely affect our operating results.



| |                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We need to continue to improve or implement
    our systems, procedures and controls and may not receive
    favorable attestation of our internal control systems by our
    independent auditors.

The new requirements adopted by the Securities
and Exchange Commission in response to the passage of the
Sarbanes-Oxley Act of 2002 will require annual review and
evaluation of our internal control systems, and attestation of
these systems by our independent accountants. We are currently
reviewing our internal control procedures and considering
further documentation of such procedures that may be necessary.
However, the

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guidelines for the evaluation and attestation of
internal control systems have not yet been finalized.
Furthermore, once the guidelines are finalized, the evaluation
and attestation processes will be new and untested. Therefore,
we can give no assurances that our systems will satisfy the new
requirements of the Securities and Exchange Commission or that
we will receive a favorable review and attestation by our
independent auditors.







|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    About Market Risk



| |                      
| | ---------------------
| | Foreign Currency Risk

We use short-term forward exchange contracts for
hedging purposes to reduce the effects of adverse foreign
exchange rate movements. We have purchased foreign exchange
contracts to hedge against certain trade accounts receivable
denominated in Japanese yen. The change in the fair value of the
forward contracts is recognized as part of the related foreign
currency transactions as they occur. As of December 31,
2003, we had no outstanding commitments with respect to foreign
exchange contracts.



| |                   
| | ------------------
| | Interest Rate Risk

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

|                          |  |              |        |          |  |           |      |                  |  |                  |      |   |  |   |      |   |  |   |      |  
|------------------------- |  | ------------ | ------ | -------- |  | --------- | ---- | ---------------- |  | ---------------- | ---- | - |  | - | ---- | - |  | - | ---- | -
|                          |  |              |        |          |  | Current   |      | Proforma 10%     |  | Proforma 10%    
|                          |  | Balance      |        | Current  |  | Interest  |      | Interest Rate    |  | Interest Rate   
|                          |  | December 31, |        | Interest |  | Income/   |      | Decline          |  | Increase        
|Instrument                |  | 2003         |        | Rate     |  | (Expense) |      | Income/(Expense) |  | Income/(Expense)
|                          |  |              |        |          |  |           |      |                  |  |                 
|Cash and cash equivalents |  | $            | 24,339 |          |  |           | 1.80 | %                |  | $                | 438  |   |  | $ | 394  |   |  | $ | 482  |  
|Bonds (see Note 5)        |  |              | 8,450  |          |  |           | 1.35 | %                |  |                  | (114 | ) |  |   | (103 | ) |  |   | (125 | )
|                          |  |              |        |          |  |           |      |                  |  |                  |      |   |  |   |      |   |  |   |      |  
|                          |  |              |        |          |  |           |      |                  |  | $                | 324  |   |  | $ | 291  |   |  | $ | 357  |  
|                          |  |              |        |          |  |           |      |                  |  |                  |      |   |  |   |      |   |  |   |      |  



| |            
| | -----------
| | Equity Risk

We also maintain minority investments in private
and publicly traded companies. These investments are reviewed
for other than temporary declines in value on a quarterly basis.
Reasons for other than temporary declines in value include
whether the related company would have insufficient cash flow to
operate for the next twelve months, significant changes in the
operating performance and changes in market conditions. In 2003,
we recorded $2.0 million in charges to other expense to
write down our investment in two private US companies. As of
December 31, 2003, the minority investments we continue to
hold totaled $4.3 million.






|        |                                                             
|------- | ------------------------------------------------------------
|Item 8. | Consolidated Financial Statements and
    Supplementary Data



| |                                             
| | --------------------------------------------
| | Selected Quarterly Results of
    Operations

The following table sets forth unaudited
quarterly results in dollars and percentages for the eight
quarters ended December 31, 2003. We believe that all
necessary adjustments, consisting only of normal recurring

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adjustments, have been included in the amounts
stated below to present fairly such quarterly information. The
operating results for any quarter are not necessarily indicative
of results for any subsequent period.


|                                                                      |                                     |                          |        |           |       |          |        |          |       |          |         |           |       |          |        |          |       |   |         |        |       |   |         |         |       |   |         |         |        |   |        |        |       | 
|--------------------------------------------------------------------- | ----------------------------------- | ------------------------ | ------ | --------- | ----- | -------- | ------ | -------- | ----- | -------- | ------- | --------- | ----- | -------- | ------ | -------- | ----- | - | ------- | ------ | ----- | - | ------- | ------- | ----- | - | ------- | ------- | ------ | - | ------ | ------ | ----- | 
|                                                                      |                                     |                         
|                                                                      |                                     | Quarters ended          
|                                                                      |                                     |                         
|                                                                      |                                     | Dec. 31,                 |        | Sept. 30, |       | June 30, |        | Mar. 31, |       | Dec. 31, |         | Sept. 30, |       | June 30, |        | Mar. 31,
|                                                                      |                                     | 2003                     |        | 2003      |       | 2003     |        | 2003     |       | 2002     |         | 2002      |       | 2002     |        | 2002    
|                                                                      |                                     |                          |        |           |       |          |        |          |       |          |         |           |       |          |        |         
|Revenue                                                               |                                     | $                        | 9,129  |           |       | $        | 8,529  |          |       | $        | 8,519   |           |       | $        | 8,536  |          |       | $ | 8,503   |        |       | $ | 11,726  |         |       | $ | 12,897  |         |        | $ | 11,739 |       
|Cost of revenue                                                       |                                     |                          | 8,342  |           |       |          | 8,029  |          |       |          | 7,844   |           |       |          | 8,263  |          |       |   | 18,253  |        |       |   | 12,885  |         |       |   | 11,087  |         |        |   | 11,533 |       
|                                                                      |                                     |                          |        |           |       |          |        |          |       |          |         |           |       |          |        |          |       |   |         |        |       |   |         |         |       |   |         |         |        |   |        |       
|Gross profit (loss)                                                   |                                     |                          | 787    |           |       |          | 500    |          |       |          | 675     |           |       |          | 273    |          |       |   | (9,750  | )      |       |   | (1,159  | )       |       |   | 1,810   |         |        |   | 206    |       
|Operating expenses:                                                   |                                     |                          |        |           |       |          |        |          |       |          |         |           |       |          |        |          |       |   |         |        |       |   |         |         |       |   |         |         |        |   |        |       
|                                                                      | Selling, general and administrative |                          |        | 2,502     |       |          |        | 2,654    |       |          |         | 2,819     |       |          |        | 2,500    |       |   |         | 2,752  |       |   |         | 3,495   |       |   |         | 3,441   |        |   |        | 4,172  |      
|                                                                      | Research and development            |                          |        | 289       |       |          |        | 301      |       |          |         | 368       |       |          |        | 379      |       |   |         | 597    |       |   |         | 486     |       |   |         | 513     |        |   |        | 743    |      
|                                                                      | Restructuring costs                 |                          |        |          |       |          |        |         |       |          |         |          |       |          |        |         |       |   |         |       |       |   |         | 542     |       |   |         | 14,090  |        |   |        |       |      
|                                                                      |                                     |                          |        |           |       |          |        |          |       |          |         |           |       |          |        |          |       |   |         |        |       |   |         |         |       |   |         |         |        |   |        |       
|                                                                      |                                     | Total operating expenses |        |           | 2,791 |          |        |          | 2,955 |          |         |           | 3,187 |          |        |          | 2,879 |   |         |        | 3,349 |   |         |         | 4,523 |   |         |         | 18,044 |   |        |        | 4,915 | 
|                                                                      |                                     |                          |        |           |       |          |        |          |       |          |         |           |       |          |        |          |       |   |         |        |       |   |         |         |       |   |         |         |        |   |        |       
|Loss from operations                                                  |                                     |                          | (2,004 | )         |       |          | (2,455 | )        |       |          | (2,512  | )         |       |          | (2,606 | )        |       |   | (13,099 | )      |       |   | (5,682  | )       |       |   | (16,234 | )       |        |   | (4,709 | )     
|Interest expense                                                      |                                     |                          | 96     |           |       |          | 145    |          |       |          | 108     |           |       |          | 117    |          |       |   | 75      |        |       |   | 105     |         |       |   | 122     |         |        |   | 135    |       
|Other (income) and expense, net                                       |                                     |                          | 15     |           |       |          | (3     | )        |       |          | 1,269   |           |       |          | (231   | )        |       |   | 4,520   |        |       |   | (308    | )       |       |   | 9,208   |         |        |   | (717   | )     
|                                                                      |                                     |                          |        |           |       |          |        |          |       |          |         |           |       |          |        |          |       |   |         |        |       |   |         |         |       |   |         |         |        |   |        |       
|Loss from continuing operations before provision
    for income taxes |                                     |                          | (2,115 | )         |       |          | (2,597 | )        |       |          | (3,889  | )         |       |          | (2,492 | )        |       |   | (17,694 | )      |       |   | (5,479  | )       |       |   | (25,564 | )       |        |   | (4,127 | )     
|Provision (benefit) for income taxes                                  |                                     |                          |       |           |       |          |       |          |       |          |        |           |       |          |       |          |       |   | (2,314  | )      |       |   | 10,673  |         |       |   | (4,590  | )       |        |   | (1,650 | )     
|                                                                      |                                     |                          |        |           |       |          |        |          |       |          |         |           |       |          |        |          |       |   |         |        |       |   |         |         |       |   |         |         |        |   |        |       
|Loss from continuing operations                                       |                                     |                          | (2,115 | )         |       |          | (2,597 | )        |       |          | (3,889  | )         |       |          | (2,492 | )        |       |   | (15,380 | )      |       |   | (16,152 | )       |       |   | (20,974 | )       |        |   | (2,477 | )     
|Discontinued operations:                                              |                                     |                          |        |           |       |          |        |          |       |          |         |           |       |          |        |          |       |   |         |        |       |   |         |         |       |   |         |         |        |   |        |       
|                                                                      | Loss from discontinued operations   |                          |        |          |       |          |        | (1,591   | )     |          |         | (2,747    | )     |          |        | (1,825   | )     |   |         | (2,476 | )     |   |         | (19,533 | )     |   |         | (10,813 | )      |   |        | (1,803 | )    
|                                                                      | Loss on disposal                    |                          |        |          |       |          |        | 1,625    |       |          |         | (11,100   | )     |          |        |         |       |   |         |       |       |   |         |        |       |   |         |        |        |   |        |       |      
|                                                                      | Benefit for income taxes            |                          |        |          |       |          |        |         |       |          |         |          |       |          |        |         |       |   |         | (324   | )     |   |         | (7,012  | )     |   |         | (369    | )      |   |        | (722   | )    
|                                                                      |                                     |                          |        |           |       |          |        |          |       |          |         |           |       |          |        |          |       |   |         |        |       |   |         |         |       |   |         |         |        |   |        |       
|Loss from discontinued operations                                     |                                     |                          |       |           |       |          | 34     |          |       |          | (13,847 | )         |       |          | (1,825 | )        |       |   | (2,152  | )      |       |   | (12,521 | )       |       |   | (10,444 | )       |        |   | (1,081 | )     
|                                                                      |                                     |                          |        |           |       |          |        |          |       |          |         |           |       |          |        |          |       |   |         |        |       |   |         |         |       |   |         |         |        |   |        |       
|Net loss                                                              |                                     |                          | (2,115 | )         |       |          | (2,563 | )        |       |          | (17,736 | )         |       |          | (4,317 | )        |       |   | (17,532 | )      |       |   | (28,673 | )       |       |   | (31,418 | )       |        |   | (3,558 | )     
|                                                                      |                                     |                          |        |           |       |          |        |          |       |          |         |           |       |          |        |          |       |   |         |        |       |   |         |         |       |   |         |         |        |   |        |       

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|                                                                      |                                     |                          |       |           |      |          |       |          |      |          |        |           |      |          |       |          |      |   |        |       |      |   |        |        |      |   |        |       |       |   |       |       |      |  
|--------------------------------------------------------------------- | ----------------------------------- | ------------------------ | ----- | --------- | ---- | -------- | ----- | -------- | ---- | -------- | ------ | --------- | ---- | -------- | ----- | -------- | ---- | - | ------ | ----- | ---- | - | ------ | ------ | ---- | - | ------ | ----- | ----- | - | ----- | ----- | ---- | -
|                                                                      |                                     |                         
|                                                                      |                                     | Quarters ended          
|                                                                      |                                     |                         
|                                                                      |                                     | Dec. 31,                 |       | Sept. 30, |      | June 30, |       | Mar. 31, |      | Dec. 31, |        | Sept. 30, |      | June 30, |       | Mar. 31,
|                                                                      |                                     | 2003                     |       | 2003      |      | 2003     |       | 2003     |      | 2002     |        | 2002      |      | 2002     |       | 2002    
|                                                                      |                                     |                          |       |           |      |          |       |          |      |          |        |           |      |          |       |         
|Revenue                                                               |                                     |                          | 100.0 | %         |      |          | 100.0 | %        |      |          | 100.0  | %         |      |          | 100.0 | %        |      |   | 100.0  | %     |      |   | 100.0  | %      |      |   | 100.0  | %     |       |   | 100.0 | %    
|Cost of revenue                                                       |                                     |                          | 91.4  | %         |      |          | 94.1  | %        |      |          | 92.1   | %         |      |          | 96.8  | %        |      |   | 214.7  | %     |      |   | 109.9  | %      |      |   | 86.0   | %     |       |   | 98.2  | %    
|                                                                      |                                     |                          |       |           |      |          |       |          |      |          |        |           |      |          |       |          |      |   |        |       |      |   |        |        |      |   |        |       |       |   |       |      
|Gross profit (loss)                                                   |                                     |                          | 8.6   | %         |      |          | 5.9   | %        |      |          | 7.9    | %         |      |          | 3.2   | %        |      |   | (114.7 | )%    |      |   | (9.9   | )%     |      |   | 14.0   | %     |       |   | 1.8   | %    
|Operating expenses:                                                   |                                     |                          |       |           |      |          |       |          |      |          |        |           |      |          |       |          |      |   |        |       |      |   |        |        |      |   |        |       |       |   |       |      
|                                                                      | Selling, general and administrative |                          |       | 27.4      | %    |          |       | 31.1     | %    |          |        | 33.1      | %    |          |       | 29.3     | %    |   |        | 32.4  | %    |   |        | 29.8   | %    |   |        | 26.7  | %     |   |       | 35.5  | %   
|                                                                      | Research and development            |                          |       | 3.2       | %    |          |       | 3.5      | %    |          |        | 4.3       | %    |          |       | 4.4      | %    |   |        | 7.0   | %    |   |        | 4.1    | %    |   |        | 4.0   | %     |   |       | 6.3   | %   
|                                                                      | Restructuring costs                 |                          |       | 0.0       | %    |          |       | 0.0      | %    |          |        | 0.0       | %    |          |       | 0.0      | %    |   |        | 0.0   | %    |   |        | 4.6    | %    |   |        | 109.3 | %     |   |       | 0.0   | %   
|                                                                      |                                     |                          |       |           |      |          |       |          |      |          |        |           |      |          |       |          |      |   |        |       |      |   |        |        |      |   |        |       |       |   |       |      
|                                                                      |                                     | Total operating expenses |       |           | 30.6 | %        |       |          | 34.6 | %        |        |           | 37.4 | %        |       |          | 33.7 | % |        |       | 39.4 | % |        |        | 38.6 | % |        |       | 139.9 | % |       |       | 41.9 | %
|                                                                      |                                     |                          |       |           |      |          |       |          |      |          |        |           |      |          |       |          |      |   |        |       |      |   |        |        |      |   |        |       |       |   |       |      
|Loss from operations                                                  |                                     |                          | (22.0 | )%        |      |          | (28.7 | )%       |      |          | (29.5  | )%        |      |          | (30.5 | )%       |      |   | (154.1 | )%    |      |   | (48.5  | )%     |      |   | (125.9 | )%    |       |   | (40.1 | )%   
|Interest expense                                                      |                                     |                          | 1.1   | %         |      |          | 1.7   | %        |      |          | 1.3    | %         |      |          | 1.4   | %        |      |   | 0.9    | %     |      |   | 0.9    | %      |      |   | 0.9    | %     |       |   | 1.2   | %    
|Other (income) and expense, net                                       |                                     |                          | 0.2   | %         |      |          | 0.0   | %        |      |          | 14.9   | %         |      |          | (2.7  | )%       |      |   | 53.2   | %     |      |   | (2.6   | )%     |      |   | 71.4   | %     |       |   | (6.1  | )%   
|                                                                      |                                     |                          |       |           |      |          |       |          |      |          |        |           |      |          |       |          |      |   |        |       |      |   |        |        |      |   |        |       |       |   |       |      
|Loss from continuing operations before provision
    for income taxes |                                     |                          | (23.3 | )%        |      |          | (30.4 | )%       |      |          | (45.7  | )%        |      |          | (29.2 | )%       |      |   | (208.1 | )%    |      |   | (46.7  | )%     |      |   | (198.2 | )%    |       |   | (35.2 | )%   
|Provision (benefit) for income taxes                                  |                                     |                          | 0.0   | %         |      |          | 0.0   | %        |      |          | 0.0    | %         |      |          | 0.0   | %        |      |   | (27.2  | )%    |      |   | 91.0   | %      |      |   | (35.6  | )%    |       |   | (14.1 | )%   
|                                                                      |                                     |                          |       |           |      |          |       |          |      |          |        |           |      |          |       |          |      |   |        |       |      |   |        |        |      |   |        |       |       |   |       |      
|Loss from continuing operations                                       |                                     |                          | (23.3 | )%        |      |          | (30.4 | )%       |      |          | (45.7  | )%        |      |          | (29.2 | )%       |      |   | (180.9 | )%    |      |   | (137.7 | )%     |      |   | (162.6 | )%    |       |   | (21.1 | )%   
|Discontinued operations:                                              |                                     |                          |       |           |      |          |       |          |      |          |        |           |      |          |       |          |      |   |        |       |      |   |        |        |      |   |        |       |       |   |       |      
|                                                                      | Loss from discontinued operations   |                          |       | 0.0       | %    |          |       | (18.7    | )%   |          |        | (32.2     | )%   |          |       | (21.4    | )%   |   |        | (29.1 | )%   |   |        | (166.6 | )%   |   |        | (83.8 | )%    |   |       | (15.4 | )%  
|                                                                      | Loss on disposal                    |                          |       | 0.0       | %    |          |       | 19.1     | %    |          |        | (130.3    | )%   |          |       | 0.0      | %    |   |        | 0.0   | %    |   |        | 0.0    | %    |   |        | 0.0   | %     |   |       | 0.0   | %   
|                                                                      | Benefit for income taxes            |                          |       | 0.0       | %    |          |       | 0.0      | %    |          |        | 0.0       | %    |          |       | 0.0      | %    |   |        | (3.8  | )%   |   |        | (59.8  | )%   |   |        | (2.9  | )%    |   |       | (6.2  | )%  
|                                                                      |                                     |                          |       |           |      |          |       |          |      |          |        |           |      |          |       |          |      |   |        |       |      |   |        |        |      |   |        |       |       |   |       |      
|Loss from discontinued operations                                     |                                     |                          | 0.0   | %         |      |          | 0.4   | %        |      |          | (162.5 | )%        |      |          | (21.4 | )%       |      |   | (25.3  | )%    |      |   | (106.8 | )%     |      |   | (81.0  | )%    |       |   | (9.2  | )%   
|                                                                      |                                     |                          |       |           |      |          |       |          |      |          |        |           |      |          |       |          |      |   |        |       |      |   |        |        |      |   |        |       |       |   |       |      
|Net loss                                                              |                                     |                          | (23.3 | )%        |      |          | (30.0 | )%       |      |          | (208.2 | )%        |      |          | (50.6 | )%       |      |   | (206.2 | )%    |      |   | (244.5 | )%     |      |   | (243.6 | )%    |       |   | (30.3 | )%   
|                                                                      |                                     |                          |       |           |      |          |       |          |      |          |        |           |      |          |       |          |      |   |        |       |      |   |        |        |      |   |        |       |       |   |       |      

Other Consolidated Financial Statements and
Supplementary Data required by this item are set forth at the
pages indicated at Item 14(a).






|        |                                                                                              
|------- | ---------------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
    Accountants on Accounting and Financial
    Disclosures

None.




Item 9A. Controls and
Procedures

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

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

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##### Table of Contents






PART III

The SEC allows us to include information required
in this report by referring to other documents or reports we
have already or will soon be filing. This is called
Incorporation by Reference. We intend to file our
definitive proxy statement pursuant to Regulation 14A not
later than 120 days after the end of the fiscal year
covered by this report, and certain information therein is
incorporated in this report by reference.






|         |                                                        
|-------- | -------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant.

The information required by this Item is
incorporated herein by reference to information set forth in our
definitive proxy statement to be filed in connection with our
annual meeting of stockholders to be held on May 18, 2004,
under the section entitled Proposal No. 1-Election of
Directors.

Information concerning our executive officers is
incorporated herein by reference to information set forth in our
definitive proxy statement to be filed in connection with our
annual meeting of stockholders to be held on May 18, 2004,
under the section entitled Executive Compensation and
Other Matters.

The information required by this Item with
respect to compliance with Section 16(a) of the Securities
Exchange Act of 1934 is incorporated herein by reference to
information set forth in the definitive Proxy statement to be
filed in connection with our annual meeting of stockholders to
be held on May 18, 2004, under the heading
Section 16(a) Beneficial Ownership Reporting
Compliance.

We have revised our Insider Trading Policy to
allow our directors, officers and other employees covered under
the policy to establish, under limited circumstances
contemplated by Rule 10b5-1 under the Securities Exchange
Act of 1934, written programs that permit automatic trading of
our stock or trading of our stock by an independent person (such
as an investment bank) who is not aware of material inside
information at the time of the trade. On February 28, 2003
Morris S. Young, our Chief Executive Officer, activated a
trading plan under Rule 10b5-1. Some other of our directors
or officers may establish such programs in future periods.

We adopted a code of Business Conduct and Ethics
that applies to our principal executive officer, principal
financial officer, and other employees. A copy of this Code of
Business Conduct and Ethics is filed as an exhibit to this
Form 10-K.






|         |                        
|-------- | -----------------------
|Item 11. | Executive Compensation.

The information required by this Item is
incorporated herein by reference to information set forth in our
definitive Proxy statement to be filed in connection with our
annual meeting of stockholders to be held on May 18, 2004,
under the section entitled Executive Compensation and
Other Matters.






|         |                                                                                                                  
|-------- | -----------------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management, and Equity Compensation Plan
    Information.

The information required by this Item is
incorporated herein by reference to information set forth in our
definitive Proxy statement to be filed in connection with our
annual meeting of stockholders to be held on May 18, 2004,
under the section entitled Security Ownership of Certain
Beneficial Owners and Management and Equity
Compensation Plan Information.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    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.

We entered into an operating lease in July 2001
for warehouse space in Fremont, CA with 4160 Business Center,
LLC, a real estate holding company, in which Davis Zhang, the
president of our substrate division, is the sole shareholder.
Lease payments to 4160 Business Center, LLC were approximately
$121,000 for the

37



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##### Table of Contents



three months ended March 31, 2003. In April
of 2003, Mr. Zhang sold this warehouse to a party unrelated
to the Company. We 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 14. | Principal Accountant Fees and
    Services

The information required by this Item is
incorporated herein by reference to information set forth in our
definitive Proxy statement to be filed in connection with our
annual meeting of stockholders to be held on May 18, 2004,
under the section entitled Principal Accountant Fees and
Services.

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##### Table of Contents






PART IV






|         |                                                                     
|-------- | --------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules,
    and Reports on Form 8-K



| |     |                                                              
| | --- | -------------------------------------------------------------
| | (a) | The following documents are filed as part of this
    report:



| |     |                      
| | --- | ---------------------
| | (1) | Financial Statements:

INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

|                                                    |  |  |       | 
|--------------------------------------------------- |  |  | ----- | 
|Report of Independent Auditors                      |  |  | 40    | 
|Consolidated Balance Sheets                         |  |  | 41    | 
|Consolidated Statements of Operations               |  |  | 42    | 
|Consolidated Statements of Stockholders
    Equity |  |  | 43    | 
|Consolidated Statements of Cash Flows               |  |  | 44    | 
|Notes to Consolidated Financial Statements          |  |  | 45-63 | 



| |     |                              
| | --- | -----------------------------
| | (2) | Financial Statement Schedules

All schedules have been omitted because the
required information is not present or not present in amounts
sufficient to require submission of the schedules or because the
information required is included in the Consolidated Financial
Statements or Notes thereto.



| |             
| | ------------
| | (3) Exhibits

See Index to Exhibits on page 65 hereof. The
exhibits listed in the accompanying Index to Exhibits are filed
as part of, or incorporated by reference into, this report on
Form 10-K.

(b) Reports on Form 8-K

We filed or furnished the following quarterly
reports on Form 8-K during the quarter ended
December 31, 2003:



| |                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------
| | (1) We furnished the report on Form 8-K
    on October 22, 2003 reporting our financial results for the
    quarter ended September 30, 2003.

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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders of
AXT, Inc.:

In our opinion, the accompanying consolidated
balance sheets and the related consolidated statements of
operations, of stockholders equity and cash flows present
fairly, in all material respects, the financial position of
AXT, Inc. and its subsidiaries at December 31, 2003
and 2002, and the results of their operations and their cash
flows for each of the three years in the period ended
December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America. These
financial statements are the responsibility of the
Companys management; our responsibility is to express an
opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.

/S/ PRICEWATERHOUSECOOPERS LLP

San Jose, California

March 5, 2004


40



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##### Table of Contents



AXT, INC.

CONSOLIDATED BALANCE SHEETS

|                                                |                                                                                                                  |                                            |        |         |         |  |        |         |         | 
|----------------------------------------------- | ---------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------- | ------- |  | ------ | ------- | ------- | 
|                                                |                                                                                                                  |                                           
|                                                |                                                                                                                  | December 31,                              
|                                                |                                                                                                                  |                                           
|                                                |                                                                                                                  | 2003                                       |        | 2002   
|                                                |                                                                                                                  |                                            |        |        
|                                                |                                                                                                                  |                                           
|                                                |                                                                                                                  | (In thousands, except                     
|                                                |                                                                                                                  | per share data)                           
|ASSETS                                         
|Current assets                                  |                                                                                                                  |                                            |        |         |         |  |        |        
|                                                | Cash and cash equivalents                                                                                        |                                            | $      | 24,339  |         |  | $      | 13,797  |        
|                                                | Short-term investments                                                                                           |                                            |        | 14,669  |         |  |        | 8,205   |        
|                                                | Accounts receivable, net                                                                                         |                                            |        | 6,297   |         |  |        | 7,195   |        
|                                                | Inventories                                                                                                      |                                            |        | 24,083  |         |  |        | 37,598  |        
|                                                | Prepaid expenses and other current assets                                                                        |                                            |        | 1,575   |         |  |        | 4,002   |        
|                                                | Income tax receivable                                                                                            |                                            |        |        |         |  |        | 8,783   |        
|                                                | Assets held for sale                                                                                             |                                            |        | 1,000   |         |  |        | 5,957   |        
|                                                |                                                                                                                  |                                            |        |         |         |  |        |        
|                                                |                                                                                                                  | Total current assets                       |        |         | 71,963  |  |        |         | 85,537  | 
|Property, plant and equipment                   |                                                                                                                  |                                            | 21,795 |         |         |  | 39,982 |        
|Restricted deposits                             |                                                                                                                  |                                            | 9,302  |         |         |  | 11,150 |        
|Long-term investments                           |                                                                                                                  |                                            |       |         |         |  | 3,657  |        
|Other assets                                    |                                                                                                                  |                                            | 3,963  |         |         |  | 5,341  |        
|                                                |                                                                                                                  |                                            |        |         |         |  |        |        
|                                                |                                                                                                                  | Total assets                               |        | $       | 107,023 |  |        | $       | 145,667 | 
|                                                |                                                                                                                  |                                            |        |         |         |  |        |        
|                                               
|LIABILITIES AND STOCKHOLDERS
    EQUITY       
|Current liabilities                             |                                                                                                                  |                                            |        |         |         |  |        |        
|                                                | Accounts payable                                                                                                 |                                            | $      | 2,638   |         |  | $      | 4,228   |        
|                                                | Accrued liabilities                                                                                              |                                            |        | 8,296   |         |  |        | 11,407  |        
|                                                | Current portion of long-term debt                                                                                |                                            |        | 3,694   |         |  |        | 965     |        
|                                                | Current portion of capital lease obligation                                                                      |                                            |        |        |         |  |        | 3,562   |        
|                                                |                                                                                                                  |                                            |        |         |         |  |        |        
|                                                |                                                                                                                  | Total current liabilities                  |        |         | 14,628  |  |        |         | 20,162  | 
|Long-term debt, net of current portion          |                                                                                                                  |                                            | 8,842  |         |         |  | 13,289 |        
|Long-term capital lease, net of current portion |                                                                                                                  |                                            |       |         |         |  | 4,847  |        
|Other long-term liabilities                     |                                                                                                                  |                                            | 1,255  |         |         |  | 1,712  |        
|                                                |                                                                                                                  |                                            |        |         |         |  |        |        
|                                                |                                                                                                                  | Total liabilities                          |        |         | 24,725  |  |        |         | 40,010  | 
|                                                |                                                                                                                  |                                            |        |         |         |  |        |        
|Commitments and Contingencies
    (Note 14)     |                                                                                                                  |                                            |        |         |         |  |        |        
|Stockholders equity:                           |                                                                                                                  |                                            |        |         |         |  |        |        
|                                                | Preferred stock, $.001 par value;
    2,000 shares authorized;
    883 shares issued and outstanding             |                                            |        | 3,532   |         |  |        | 3,532   |        
|                                                | Common stock, $.001 par value;
    70,000 shares authorized;
    22,957 and 22,495 shares issued and outstanding |                                            |        | 155,178 |         |  |        | 154,485 |        
|                                                | Accumulated deficit                                                                                              |                                            |        | (78,928 | )       |  |        | (52,197 | )      
|                                                | Other comprehensive income (loss)                                                                                |                                            |        | 2,516   |         |  |        | (163    | )      
|                                                |                                                                                                                  |                                            |        |         |         |  |        |        
|                                                |                                                                                                                  | Total stockholders equity                 |        |         | 82,298  |  |        |         | 105,657 | 
|                                                |                                                                                                                  |                                            |        |         |         |  |        |        
|                                                |                                                                                                                  | Total liabilities and stockholders equity |        | $       | 107,023 |  |        | $       | 145,667 | 
|                                                |                                                                                                                  |                                            |        |         |         |  |        |        

The accompanying notes are an integral part of
these consolidated financial statements.

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AXT, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                                             |                                          |                                       |         |        |        |      |         |         |        |   |         |         |        | 
|---------------------------------------------------------------------------- | ---------------------------------------- | ------------------------------------- | ------- | ------ | ------ | ---- | ------- | ------- | ------ | - | ------- | ------- | ------ | 
|                                                                             |                                          |                                      
|                                                                             |                                          | Years Ended December 31,             
|                                                                             |                                          |                                      
|                                                                             |                                          | 2003                                  |         | 2002   |        | 2001
|                                                                             |                                          |                                       |         |        |        |     
|                                                                             |                                          |                                      
|                                                                             |                                          | (In thousands, except per share data)
|Revenue                                                                      |                                          | $                                     | 34,713  |        |        | $    | 44,865  |         |        | $ | 108,800 |        
|Cost of revenue                                                              |                                          |                                       | 32,478  |        |        |      | 53,758  |         |        |   | 67,494  |        
|                                                                             |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|Gross profit (loss)                                                          |                                          |                                       | 2,235   |        |        |      | (8,893  | )       |        |   | 41,306  |        
|Operating expenses:                                                          |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|                                                                             | Selling, general and administrative      |                                       |         | 10,475 |        |      |         | 13,860  |        |   |         | 17,208  |       
|                                                                             | Research and development                 |                                       |         | 1,337  |        |      |         | 2,339   |        |   |         | 3,876   |       
|                                                                             | Restructuring costs                      |                                       |         |       |        |      |         | 14,632  |        |   |         |        |       
|                                                                             |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|                                                                             |                                          | Total operating expenses              |         |        | 11,812 |      |         |         | 30,831 |   |         |         | 21,084 | 
|                                                                             |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|Income (loss) from operations                                                |                                          |                                       | (9,577  | )      |        |      | (39,724 | )       |        |   | 20,222  |        
|Interest expense                                                             |                                          |                                       | 466     |        |        |      | 437     |         |        |   | 831     |        
|Other (income) and expense, net                                              |                                          |                                       | 1,050   |        |        |      | 12,703  |         |        |   | 13,379  |        
|                                                                             |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|Income (loss) from continuing operations before
    benefit for income taxes |                                          |                                       | (11,093 | )      |        |      | (52,864 | )       |        |   | 6,012   |        
|Provision for income taxes                                                   |                                          |                                       |        |        |        |      | 2,119   |         |        |   | 2,164   |        
|                                                                             |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|Income (loss) from continuing operations                                     |                                          |                                       | (11,093 | )      |        |      | (54,983 | )       |        |   | 3,848   |        
|Discontinued operations:                                                     |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|                                                                             | Loss from discontinued operations        |                                       |         | (6,163 | )      |      |         | (34,625 | )      |   |         | (13,818 | )     
|                                                                             | Loss on disposal                         |                                       |         | (9,475 | )      |      |         |        |        |   |         |        |       
|                                                                             | Benefit for income taxes                 |                                       |         |       |        |      |         | (8,427  | )      |   |         | (4,974  | )     
|                                                                             |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|Loss from discontinued operations                                            |                                          |                                       | (15,638 | )      |        |      | (26,198 | )       |        |   | (8,844  | )      
|                                                                             |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|Net loss                                                                     |                                          | $                                     | (26,731 | )      |        | $    | (81,181 | )       |        | $ | (4,996  | )      
|                                                                             |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|Basic income (loss) per share:                                               |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|                                                                             | Income (loss) from continuing operations |                                       | $       | (0.49  | )      |      | $       | (2.46   | )      |   | $       | 0.17    |       
|                                                                             | Loss from discontinued operations        |                                       |         | (0.69  | )      |      |         | (1.17   | )      |   |         | (0.40   | )     
|                                                                             | Net loss                                 |                                       |         | (1.18  | )      |      |         | (3.63   | )      |   |         | (0.23   | )     
|Diluted income (loss) per share:                                             |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|                                                                             | Income (loss) from continuing operations |                                       | $       | (0.49  | )      |      | $       | (2.46   | )      |   | $       | 0.17    |       
|                                                                             | Loss from discontinued operations        |                                       |         | (0.69  | )      |      |         | (1.17   | )      |   |         | (0.39   | )     
|                                                                             | Net loss                                 |                                       |         | (1.18  | )      |      |         | (3.63   | )      |   |         | (0.23   | )     
|Shares used in per share calculations:                                       |                                          |                                       |         |        |        |      |         |         |        |   |         |        
|                                                                             | Basic                                    |                                       |         | 22,781 |        |      |         | 22,433  |        |   |         | 22,278  |       
|                                                                             | Diluted                                  |                                       |         | 22,781 |        |      |         | 22,433  |        |   |         | 22,879  |       

The accompanying notes are an integral part of
these consolidated financial statements.

42



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AXT, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

|                                               |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   |         |         |   |   |         |         |  
|---------------------------------------------- | ----------------------------------------------- | --------------- | --- | ------------ |  | -------- | ----- | -------- |  | ------------- | ------ | -------- |  | ------------- | ------- | ----- |  | ------------- | ---- | - |  | - | ------- | ------- | - | - | ----- | ------ | - | - | ------- | ------- | - | - | ------- | ------- | -
|                                               |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |              
|                                               |                                                 | Preferred Stock |     | Common Stock |  |          |       |          |  | Other         |        |          |  |              
|                                               |                                                 |                 |     |              |  | Deferred |       | Retained |  | Comprehensive |        |          |  | Comprehensive
|                                               |                                                 | Shares          |     | Amount       |  | Shares   |       | Amount   |  | Compensation  |        | Earnings |  | Income/(loss) |         | Total |  | Income/(loss)
|                                               |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |              
|                                               |                                                 |                
|                                               |                                                 | (In thousands) 
|Balance at December 31, 2000                   |                                                 |                 | 883 |              |  | $        | 3,532 |          |  |               | 21,952 |          |  | $             | 145,748 |       |  | $             | (107 | ) |  | $ | 33,980  |         |   | $ | 2,194 |        |   | $ | 185,347 |         |   | $ | 23,828  |        
|                                               |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   |         |         |   |   |         |        
|Common stock options exercised                 |                                                 |                 |     |              |  |          |       |          |  |               | 388    |          |  |               | 3,862   |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   | 3,862   |         |   |   |         |        
|Issuance of Employee Stock Purchase Plan stock |                                                 |                 |     |              |  |          |       |          |  |               | 43     |          |  |               | 900     |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   | 900     |         |   |   |         |        
|Income tax benefit from stock option exercises |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               | 3,125   |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   | 3,125   |         |   |   |         |        
|Amortization of deferred compensation          |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               | 107  |   |  |   |         |         |   |   |       |        |   |   | 107     |         |   |   |         |        
|Comprehensive loss                             |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   |         |         |   |   |         |        
|                                               | Net loss                                        |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         | (4,996  | ) |   |       |        |   |   |         | (4,996  | ) |   |         | (4,996  | )
|                                               | Unrealized gain (loss) on marketable securities |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       | (2,052 | ) |   |         | (2,052  | ) |   |         | (2,052  | )
|                                               | Currency translation adjustment                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       | 29     |   |   |         | 29      |   |   |         | 29      |  
|                                               |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   |         |         |   |   |         |        
|Balance at December 31, 2001                   |                                                 |                 | 883 |              |  | $        | 3,532 |          |  |               | 22,383 |          |  | $             | 153,635 |       |  | $             |     |   |  | $ | 28,984  |         |   | $ | 171   |        |   | $ | 186,322 |         |   | $ | (7,019  | )      
|                                               |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   |         |         |   |   |         |        
|Common stock options exercised                 |                                                 |                 |     |              |  |          |       |          |  |               | 88     |          |  |               | 684     |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   | 684     |         |   |   |         |        
|Issuance of Employee Stock Purchase Plan stock |                                                 |                 |     |              |  |          |       |          |  |               | 24     |          |  |               | 166     |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   | 166     |         |   |   |         |        
|Comprehensive loss                             |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   |         |         |   |   |         |        
|                                               | Net loss                                        |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         | (81,181 | ) |   |       |        |   |   |         | (81,181 | ) |   |         | (81,181 | )
|                                               | Unrealized gain (loss) on marketable securities |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       | (21    | ) |   |         | (21     | ) |   |         | (21     | )
|                                               | Currency translation adjustment                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       | (313   | ) |   |         | (313    | ) |   |         | (313    | )
|                                               |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   |         |         |   |   |         |        
|Balance at December 31, 2002                   |                                                 |                 | 883 |              |  | $        | 3,532 |          |  |               | 22,495 |          |  | $             | 154,485 |       |  | $             |     |   |  | $ | (52,197 | )       |   | $ | (163  | )      |   | $ | 105,657 |         |   | $ | (81,515 | )      
|                                               |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   |         |         |   |   |         |        
|Common stock options exercised                 |                                                 |                 |     |              |  |          |       |          |  |               | 33     |          |  |               | 73      |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   | 73      |         |   |   |         |        
|Issuance of Employee Stock Purchase Plan stock |                                                 |                 |     |              |  |          |       |          |  |               | 404    |          |  |               | 592     |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   | 592     |         |   |   |         |        
|Issuance of common stock to board members      |                                                 |                 |     |              |  |          |       |          |  |               | 25     |          |  |               | 28      |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   | 28      |         |   |   |         |        
|Comprehensive loss                             |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   |        |         |   |   |         |        
|                                               | Net loss                                        |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         | (26,731 | ) |   |       |        |   |   |         | (26,731 | ) |   |         | (26,731 | )
|                                               | Unrealized gain (loss) on marketable securities |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       | 2,482  |   |   |         | 2,482   |   |   |         | 2,482   |  
|                                               | Currency translation adjustment                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       | 197    |   |   |         | 197     |   |   |         | 197     |  
|                                               |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   |         |         |   |   |         |        
|Balance at December 31, 2003                   |                                                 |                 | 883 |              |  | $        | 3,532 |          |  |               | 22,957 |          |  | $             | 155,178 |       |  | $             |     |   |  | $ | (78,928 | )       |   | $ | 2,516 |        |   | $ | 82,298  |         |   | $ | (24,052 | )      
|                                               |                                                 |                 |     |              |  |          |       |          |  |               |        |          |  |               |         |       |  |               |      |   |  |   |         |         |   |   |       |        |   |   |         |         |   |   |         |        

The accompanying notes are an integral part of
these consolidated financial statements.

43



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##### Table of Contents



AXT, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                             |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |         |        |        |         |  
|------------------------------------------------------------ | ----------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------- | ------------------------------------------------------------ | ------------------------------------------------------- | ------ | ----- | ------- | ------- | ------ | ------ | ------- | ------- | ------ | ------ | ------- | -
|                                                             |                                                                                                       |                                                                      
|                                                             |                                                                                                       | Years Ended December 31,                                             
|                                                             |                                                                                                       |                                                                      
|                                                             |                                                                                                       | 2003                                                                  |                                                              | 2002                                                    |        | 2001 
|                                                             |                                                                                                       |                                                                       |                                                              |                                                         |        |      
|                                                             |                                                                                                       |                                                                      
|                                                             |                                                                                                       | (In thousands)                                                       
|Cash flows from operating
    activities:                    |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|                                                             | Net loss                                                                                              |                                                                       | $                                                            | (26,731                                                 | )      |       | $       | (81,181 | )      |        | $       | (4,996  | )     
|                                                             |                                                                                                       | Adjustments to reconcile net loss to cash
    provided by operations: |                                                              |                                                         |        |       |         |         |        |        |         |         |        |       
|                                                             |                                                                                                       |                                                                       | Depreciation                                                 |                                                         |        | 5,782 |         |         |        | 9,493  |         |         |        | 8,538  |        
|                                                             |                                                                                                       |                                                                       | Deferred income taxes                                        |                                                         |        |      |         |         |        | 2,533  |         |         |        | (5,041 | )      
|                                                             |                                                                                                       |                                                                       | Amortization                                                 |                                                         |        | 502   |         |         |        | 403    |         |         |        | 554    |        
|                                                             |                                                                                                       |                                                                       | Stock compensation                                           |                                                         |        | 28    |         |         |        |       |         |         |        | 107    |        
|                                                             |                                                                                                       |                                                                       | Stock option tax benefits                                    |                                                         |        |      |         |         |        |       |         |         |        | 3,125  |        
|                                                             |                                                                                                       |                                                                       | Impairment of PP&E                                           |                                                         |        |      |         |         |        | 39,086 |         |         |        |       |        
|                                                             |                                                                                                       |                                                                       | Impairment of investments                                    |                                                         |        | 2,128 |         |         |        | 10,577 |         |         |        | 15,636 |        
|                                                             |                                                                                                       |                                                                       | Loss (gain) on disposal of property, plant
    and equipment |                                                         |        | (11   | )       |         |        | 3,404  |         |         |        | 229    |        
|                                                             |                                                                                                       |                                                                       | Loss on disposal of a discontinued business                  |                                                         |        | 9,475 |         |         |        |       |         |         |        |       |        
|                                                             |                                                                                                       |                                                                       | Changes in assets and liabilities:                           |                                                         |        |       |         |         |        |        |         |         |        |        |        
|                                                             |                                                                                                       |                                                                       |                                                              | Accounts receivable, net                                |        |       | 232     |         |        |        | 8,489   |         |        |        | 11,939  |  
|                                                             |                                                                                                       |                                                                       |                                                              | Inventories                                             |        |       | 11,541  |         |        |        | 17,989  |         |        |        | (3,741  | )
|                                                             |                                                                                                       |                                                                       |                                                              | Prepaid expenses                                        |        |       | 2,217   |         |        |        | (320    | )       |        |        | 1,240   |  
|                                                             |                                                                                                       |                                                                       |                                                              | Other assets                                            |        |       | (137    | )       |        |        | (362    | )       |        |        | (454    | )
|                                                             |                                                                                                       |                                                                       |                                                              | Accounts payable                                        |        |       | (1,590  | )       |        |        | 1,285   |         |        |        | (7,013  | )
|                                                             |                                                                                                       |                                                                       |                                                              | Accrued liabilities                                     |        |       | (5,493  | )       |        |        | (5,019  | )       |        |        | (2,967  | )
|                                                             |                                                                                                       |                                                                       |                                                              | Income tax receivable                                   |        |       | 8,783   |         |        |        | (6,091  | )       |        |        |        |  
|                                                             |                                                                                                       |                                                                       |                                                              | Other long-term liabilities                             |        |       | (457    | )       |        |        | 439     |         |        |        | (12     | )
|                                                             |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|                                                             |                                                                                                       |                                                                       |                                                              | Net cash provided by operating activities               |        |       | 6,269   |         |        |        | 725     |         |        |        | 17,144  |  
|                                                             |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|Cash flows from investing
    activities:                    |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|                                                             | Purchases of property, plant and equipment                                                            |                                                                       |                                                              | (2,175                                                  | )      |       |         | (14,238 | )      |        |         | (25,834 | )     
|                                                             | Investment in marketable securities                                                                   |                                                                       |                                                              | (5,941                                                  | )      |       |         | (17,869 | )      |        |         | (21,591 | )     
|                                                             | Investment in other assets                                                                            |                                                                       |                                                              |                                                        |        |       |         |        |        |        |         | (1,307  | )     
|                                                             | Proceeds from sale of marketable securities                                                           |                                                                       |                                                              | 13,885                                                  |        |       |         | 17,070  |        |        |         | 1,034   |       
|                                                             | Proceeds from sale of property and equipment from
    discontinued opto-electronics business (Note 2) |                                                                       |                                                              | 8,600                                                   |        |       |         |         |        |        |         |         |       
|                                                             | Proceeds from sale of property located in
    Fremont, California (Note 3)                            |                                                                       |                                                              | 5,172                                                   |        |       |         |        |        |        |         |        |       
|                                                             | Increase in restricted cash                                                                           |                                                                       |                                                              | (5,818                                                  | )      |       |         | (1,000  | )      |        |         |        |       
|                                                             |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|                                                             |                                                                                                       |                                                                       |                                                              | Net cash provided by (used in) investing
    activities |        |       | 13,723  |         |        |        | (16,037 | )       |        |        | (47,698 | )
|                                                             |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|Cash flows from financing
    activities:                    |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|                                                             | Proceeds from (payments of):                                                                          |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |         |       
|                                                             |                                                                                                       | Issuance of common stock                                              |                                                              |                                                         | 480    |       |         |         | 850    |        |         |         | 4,762  |       
|                                                             |                                                                                                       | Capital lease payments                                                |                                                              |                                                         | (8,409 | )     |         |         | (5,965 | )      |         |         | (4,274 | )     
|                                                             |                                                                                                       | Capital lease borrowings                                              |                                                              |                                                         |       |       |         |         |       |        |         |         | 3,143  |       
|                                                             |                                                                                                       | Short-term bank borrowings                                            |                                                              |                                                         |       |       |         |         |       |        |         |         | (1,353 | )     
|                                                             |                                                                                                       | Long-term debt borrowings                                             |                                                              |                                                         |       |       |         |         | 3,935  |        |         |         |       |       
|                                                             |                                                                                                       | Long-term debt payments                                               |                                                              |                                                         | (1,718 | )     |         |         | (6,936 | )      |         |         | (2,800 | )     
|                                                             |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|                                                             |                                                                                                       |                                                                       |                                                              | Net cash used in financing activities                   |        |       | (9,647  | )       |        |        | (8,116  | )       |        |        | (522    | )
|                                                             |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|Effect of exchange rate changes                              |                                                                                                       |                                                                       | 197                                                          |                                                         |        |       | (313    | )       |        |        | 29      |        
|                                                             |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|Net increase (decrease) in cash and cash
    equivalents     |                                                                                                       |                                                                       | 10,542                                                       |                                                         |        |       | (23,741 | )       |        |        | (31,047 | )      
|Cash and cash equivalents at the beginning of the
    period |                                                                                                       |                                                                       | 13,797                                                       |                                                         |        |       | 37,538  |         |        |        | 68,585  |        
|                                                             |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|Cash and cash equivalents at the end of the period           |                                                                                                       | $                                                                     | 24,339                                                       |                                                         |        | $     | 13,797  |         |        | $      | 37,538  |        
|                                                             |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|Non cash activity:                                           |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|                                                             | Purchases of property, plant and equipment
    through financing                                      |                                                                       | $                                                            |                                                        |        |       | $       | 577     |        |        | $       | 2,170   |       
|Supplemental Disclosures:                                    |                                                                                                       |                                                                       |                                                              |                                                         |        |       |         |         |        |        |         |        
|                                                             | Interest paid                                                                                         |                                                                       | $                                                            | 790                                                     |        |       | $       | 1,326   |        |        | $       | 2,081   |       

The accompanying notes are an integral part of
these consolidated financial statements.

44



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##### Table of Contents



AXT, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



|        |                                                   
|------- | --------------------------------------------------
|Note 1. | The Company and Summary of Accounting
    Policies



| |            
| | -----------
| | The Company

AXT designs, develops, manufactures and
distributes high-performance compound semiconductor substrates.
AXTs substrate products are used primarily in wireless
communications, lighting display applications, and fiber optic
communications.

On June 24, 2003, the Companys Board
of Directors approved managements plan to exit the
Companys unprofitable Opto-electronics business.
Substantially all of the assets of this division were sold in
September 2003. The decision to dispose of the business was due
to continuing operating losses and negative cash flows from the
division and significant uncertainty regarding future
profitability.

The Company officially changed its name from
American Xtal Technology, Inc. to AXT, Inc. on
July 7, 2000.



| |                 
| | ----------------
| | Use of Estimates

The preparation of financial statements in
conformity with generally accepted accounting principles
requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could
differ materially from these estimates.



| |                            
| | ---------------------------
| | Principles of Consolidation

The consolidated financial statements include the
accounts of the Company and its majority-owned subsidiaries. All
significant intercompany accounts and transactions have been
eliminated. Investments in business entities in which AXT does
not have control, but has the ability to exercise significant
influence over operating and financial policies (generally
20-50% ownership), are accounted for by the equity method.



| |                             
| | ----------------------------
| | Foreign Currency Translation

The functional currencies of the Companys
Japanese and Chinese subsidiaries are the local currencies.
Transaction gains and losses resulting from transactions
denominated in currencies other than the U.S. dollar for
the Company or in the functional currencies for the subsidiaries
are included in other (income) expense for the periods presented.

The assets and liabilities of the subsidiaries
are translated at the rates of exchange on the balance sheet
date. Revenue and expense items are translated at the average
rate of exchange for the period. Gains and losses from foreign
currency translation are included in other comprehensive income
in stockholders equity.



| |                    
| | -------------------
| | Revenue Recognition

The Company recognizes revenue upon the shipment
of its products to the customer provided that the Company has
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 significant obligations. The Company
provides for future returns based on historical experience at
the time revenue is recognized. The Company does not provide for
warranty related exposure as such exposure has historically been
immaterial.

45



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##### Table of Contents



AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                        
| | ---------------------------------------
| | Fair Value of Financial
    Instruments

The reported amounts of certain of the
Companys financial instruments including cash and cash
equivalents, accounts receivable, short-term investments,
accounts payable and accrued liabilities approximate fair value
due to their short maturities. The reported amounts of
short-term and long-term debt approximate fair value due to the
market interest rates that these debts bear, and interest rates
currently available to the Company.



| |                             
| | ----------------------------
| | Concentration of Credit Risk

Financial instruments, which potentially subject
the Company to concentration of credit risk, consist primarily
of cash and cash equivalents and trade accounts receivable. The
Company performs ongoing credit evaluations of its
customers financial condition, and limits the amount of
credit extended when deemed necessary, but generally does not
require collateral. The Company invests primarily in money
market accounts and commercial paper instruments. Cash
equivalents are maintained with high quality institutions and
their composition and maturities are regularly monitored by
management.

No customer represented greater than 10% of
product revenues for the years ended December 31, 2003,
2002 and 2001. The companys top five customers represented
28.9% of product revenue for the year ended December 31,
2003, 31.4% of product revenue for the year ended
December 31, 2002, and 31.1% of product revenue for the
year ended December 31, 2001. We expect that sales to
certain customers will continue to comprise a significant
portion of our revenue in the future.

No customer accounted for 10% or more of the
trade accounts receivable balance as of December 31, 2003
and 2002.



| |                 
| | ----------------
| | Cash Equivalents

The Company considers all highly liquid debt
instruments purchased with an original maturity of three months
or less to be cash equivalents.



| |            
| | -----------
| | Investments

Management determines the appropriate
classification of investments at the time of purchase.
Available-for-sale investments are carried at their fair value
based on quoted market prices as of the balance sheet date. The
amortized cost of securities is adjusted for amortization of
premiums and accretion of discounts to maturity. Such
amortization is included in other (income) and expense,
net. Realized gains or losses are determined on the
specific identification method and are reflected in other
(income) and expense, net. Net unrealized gains or losses
are recorded directly in stockholders equity. Those
unrealized losses that are deemed to be other than temporary are
reflected in interest and other income, net. The
Company also maintains minority investments in private companies
which are accounted for under the costs basis. These investments
are reviewed for other than temporary declines in value on a
quarterly basis. Reasons for other than temporary declines in
value include whether the related company would have
insufficient cash flow to operate for the next twelve months,
significant changes in the operating performance and changes in
market conditions.



| |            
| | -----------
| | Inventories

Inventories are stated at the lower of cost
(approximated by standard cost) or market. Cost is determined
using the weighted average cost method. Finished goods and
work-in-process inventories include material, labor and
manufacturing overhead costs.

46



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##### Table of Contents



AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                              
| | -----------------------------
| | Property, Plant and Equipment

Property, plant and equipment are stated at cost
less accumulated depreciation computed using the straight-line
method over the estimated economic lives of the assets, which
vary from 3 to 27.5 years. Leasehold improvements are
amortized over the shorter of the estimated useful life or the
term of the lease. We generally depreciate computers and
software over 3 years, automobiles over 5 years,
office equipment, furniture and fixtures over 3 years,
leasehold improvements over 10 years, and buildings over
27.5 years. Depreciation expense was $5.8 million,
$9.5 million, and $8.5 million for the years ended
2003, 2002, and 2001 respectively.



| |                                    
| | -----------------------------------
| | Impairment of Long-Lived
    Assets

Management evaluates the recoverability of
property, equipment, and intangible assets in accordance with
Statement of Financial Accounting Standards No. 144, or
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. When events and
circumstance indicate that long-lived assets may be impaired,
management compares the carrying value of the long-lived assets
to the projection of future undiscounted cash flows attributable
to such assets and in the event that the carrying value exceeds
the future undiscounted cash flows, management records an
impairment charge against income equal to the excess of the
carrying value over the assets fair value.



| |                         
| | ------------------------
| | Stock-Based Compensation

The Company accounts for stock-based employee
compensation arrangements using the intrinsic value method as
prescribed in Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees and related
interpretations thereof. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the market
price of the Companys stock at the date of grant over the
stock option exercise price. In addition, the Company provides
additional disclosure provisions as required under Statement of
Financial Accounting Standard No. 123, Accounting for
Stock-Based Compensation and SFAS 148,
Accounting for Stock- Based Compensation 
Transition and Disclosurein Note 13.



| |                         
| | ------------------------
| | Research and Development

Research and development costs are expensed as
incurred.



| |             
| | ------------
| | 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.



| |                     
| | --------------------
| | Comprehensive Income

Comprehensive income is defined as the change in
equity of a company during a period from transactions and other
events and circumstances, excluding transactions resulting from
investment by owners and distribution to owners. The difference
between net income and comprehensive income for the Company
relates to foreign currency translation adjustments and
unrealized gains and losses on investment securities.
Comprehensive income for the years ended December 31, 2003,
2002 and 2001 is disclosed in the Consolidated Statements
of Stockholders Equity.

47



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##### Table of Contents



AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                                  
| | -------------------------------------------------
| | Basic and Diluted Net Income (Loss) Per
    Share

Basic income (loss) per share is computed by
dividing the income (loss) available to holders of common stock
for the period by the weighted average number of shares of
common stock outstanding during the period. The calculation of
diluted income (loss) per share excludes potential common stock
if the effect of such stock is antidilutive. Potential common
stock consists of common shares issuable upon the exercise of
stock options.



| |                  
| | -----------------
| | Reclassifications

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



| |                                     
| | ------------------------------------
| | Recent Accounting
    Pronouncements

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

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

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

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

In May 2003, the FASB issued
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity. SFAS No. 150 establishes standards for
an issuer to classify

48



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##### Table of Contents



AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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



|        |                        
|------- | -----------------------
|Note 2. | Discontinued Operations

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

On September 27, 2003 the Company completed
a sale of substantially all of the assets of its
opto-electronics business to Lumei Optoelectronics, Corp. and
Dalian Luming Science and Technology Group, Co., Ltd. for the
Chinese Renminbi equivalent of $9.6 million. Proceeds of
$1.0 million will be held in escrow for up to one year and
will not be recorded until all claims, if any, are settled. If
unclaimed, up to $250,000 of the sale proceeds will be held in
escrow for a second year and will not be recorded until all
claims, if any, are settled. The Company retains a building
located in Monterey Park, CA, that it expects to sell in 2004.
This asset is classified as Held for Sale on the consolidated
balance sheet at December 31, 2003.

The Company recorded a loss on disposal of
$9.5 million to write-down the book value of assets sold to
their estimated fair market value.

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

|                                                              |                                     |                          |         |       |       |      |         |        |        |   |         |       |       | 
|------------------------------------------------------------- | ----------------------------------- | ------------------------ | ------- | ----- | ----- | ---- | ------- | ------ | ------ | - | ------- | ----- | ----- | 
|                                                              |                                     |                         
|                                                              |                                     | Years Ended December 31,
|                                                              |                                     |                         
|                                                              |                                     | 2003                     |         | 2002  |       | 2001
|                                                              |                                     |                          |         |       |       |     
|Revenue                                                       |                                     | $                        | 7,245   |       |       | $    | 18,310  |        |        | $ | 10,730  |      
|Cost of revenue                                               |                                     |                          | 9,972   |       |       |      | 20,273  |        |        |   | 14,697  |      
|                                                              |                                     |                          |         |       |       |      |         |        |        |   |         |      
|Gross profit (loss)                                           |                                     |                          | (2,727  | )     |       |      | (1,963  | )      |        |   | (3,967  | )    
|Operating expenses:                                           |                                     |                          |         |       |       |      |         |        |        |   |         |      
|                                                              | Selling, general and administrative |                          |         | 2,297 |       |      |         | 4,788  |        |   |         | 4,279 |      
|                                                              | Research and development            |                          |         | 814   |       |      |         | 2,529  |        |   |         | 4,328 |      
|                                                              | Impairment costs                    |                          |         |      |       |      |         | 24,454 |        |   |         |      |      
|                                                              |                                     |                          |         |       |       |      |         |        |        |   |         |      
|                                                              |                                     | Total operating expenses |         |       | 3,111 |      |         |        | 31,771 |   |         |       | 8,607 | 
|                                                              |                                     |                          |         |       |       |      |         |        |        |   |         |      
|Loss from operations                                          |                                     |                          | (5,838  | )     |       |      | (33,734 | )      |        |   | (12,574 | )    
|Interest expense                                              |                                     |                          | 325     |       |       |      | 891     |        |        |   | 1,244   |      
|                                                              |                                     |                          |         |       |       |      |         |        |        |   |         |      
|Loss before benefit for income taxes and loss on
    disposal |                                     |                          | (6,163  | )     |       |      | (34,625 | )      |        |   | (13,818 | )    
|Income tax (benefit)                                          |                                     |                          |        |       |       |      | (8,427  | )      |        |   | (4,974  | )    
|Loss on disposal                                              |                                     |                          | (9,475  | )     |       |      |        |        |        |   |        |      
|                                                              |                                     |                          |         |       |       |      |         |        |        |   |         |      
|Net loss                                                      |                                     | $                        | (15,638 | )     |       | $    | (26,198 | )      |        | $ | (8,844  | )    
|                                                              |                                     |                          |         |       |       |      |         |        |        |   |         |      

49



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##### Table of Contents



AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

|                                 |                          |                      |       |       |       |   |        |       |        | 
|-------------------------------- | ------------------------ | -------------------- | ----- | ----- | ----- | - | ------ | ----- | ------ | 
|                                 |                          |                     
|                                 |                          | Years Ended         
|                                 |                          | December 31,        
|                                 |                          |                     
|                                 |                          | 2003                 |       | 2002 
|                                 |                          |                      |       |      
|Current assets:                  |                          |                      |       |       |       |   |        |      
|                                 | Cash                     |                      | $     | 539   |       |   | $      | 336   |       
|                                 | Accounts receivable, net |                      |       | 250   |       |   |        | 3,224 |       
|                                 | Inventories              |                      |       |      |       |   |        | 3,439 |       
|                                 | Assets held for sale     |                      |       | 1,000 |       |   |        |      |       
|                                 | Other current assets     |                      |       |      |       |   |        | 2,482 |       
|                                 |                          |                      |       |       |       |   |        |      
|                                 |                          | Total current assets |       |       | 1,789 |   |        |       | 9,481  | 
|Propert, plant and equipment     |                          |                      |      |       |       |   | 14,854 |      
|Other assets                     |                          |                      | 200   |       |       |   | 200    |      
|                                 |                          |                      |       |       |       |   |        |      
|                                 |                          | Total assets         |       | $     | 1,989 |   |        | $     | 24,535 | 
|                                 |                          |                      |       |       |       |   |        |      
|Current liabilities:             |                          |                      |       |       |       |   |        |      
|                                 | Accounts payable         |                      | $     | 43    |       |   | $      | 1,975 |       
|                                 | Accrued liabilites       |                      |       | 1,232 |       |   |        | 2,806 |       
|                                 |                          |                      |       |       |       |   |        |      
|                                 |                          | Total liabilities    |       |       | 1,275 |   |        |       | 4,781  | 
|Net assets                       |                          |                      | 714   |       |       |   | 19,754 |      
|                                 |                          |                      |       |       |       |   |        |      
|Total liabilities and net assets |                          | $                    | 1,989 |       |       | $ | 24,535 |      
|                                 |                          |                      |       |       |       |   |        |      

Assets held for sale consist of a building and
are carried at managements estimated fair value less costs
to sell, totaling $1.0 million at December 31, 2003.



|        |                     
|------- | --------------------
|Note 3. | Assets Held for Sale

Assets held for sale at December 31, 2003
consist of a property located in Monterey Park, California,
which is part of the Companys discontinued
opto-electronics division (see Note 2). Assets held for
sale at December 31, 2002 consist of a property located at
4281 Technology Drive, Fremont, California. In November of 2002,
the Company entered into a contract to sell this 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. The gain the Company incurred on
this transaction was less than $15,000. Under the terms of the
sale agreement, the Company has agreed to lease back the
property for a ten-year period. Accordingly, on March 11,
2003, the Company signed an operating lease for this property
through March 2013. Annual rent under this operating lease is
approximately $600,000.



|        |            
|------- | -----------
|Note 4. | Inventories

Inventories are stated at the lower of cost or
net realizable value. Cost is determined using the weighted
average cost method. Finished goods and work-in-process
inventories include material, labor and manufacturing overhead
costs. The Company routinely evaluates the levels of its
inventory in light of current market conditions in order to
identify excess and obsolete inventory and provides a valuation
allowance for certain inventories based upon the age and quality
of the product.

50



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##### Table of Contents



AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

|             |                 |              |        |        |  |   |        |        | 
|------------ | --------------- | ------------ | ------ | ------ |  | - | ------ | ------ | 
|             |                 |             
|             |                 | Years Ended 
|             |                 | December 31,
|             |                 |             
|             |                 | 2003         |        | 2002  
|             |                 |              |        |       
|Inventories: |                 |              |        |        |  |   |        |       
|             | Raw materials   |              | $      | 7,086  |  |   | $      | 12,559 | 
|             | Work in process |              |        | 16,027 |  |   |        | 22,950 | 
|             | Finished goods  |              |        | 970    |  |   |        | 2,089  | 
|             |                 |              |        |        |  |   |        |       
|             |                 | $            | 24,083 |        |  | $ | 37,598 |       
|             |                 |              |        |        |  |   |        |       



|        |     
|------- | ----
|Note 5. | Debt



| |                
| | ---------------
| | Credit Facility

At December 31, 2003 the credit facility
maintained by the Company with a bank included a letter of
credit supporting repayment of its industrial bonds with an
outstanding amount of $8.5 million. The Company has pledged
and placed cash and certain investment securities with the trust
department of the bank as additional collateral for this
facility. The Company has also pledged cash for a credit
facility for workers compensation insurance. As a result,
$9.3 million of cash and long-term investments are
restricted.

51



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##### Table of Contents



AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |               
| | --------------
| | Long-Term Debt

The components of long-term debt are summarized
below (in thousands):

|                                                                                                                                                                                                              |  |              |        |      |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------ | ---- |  | - | ------ | -
|                                                                                                                                                                                                              |  |             
|                                                                                                                                                                                                              |  | Year Ended  
|                                                                                                                                                                                                              |  | December 31,
|                                                                                                                                                                                                              |  |             
|                                                                                                                                                                                                              |  | 2003         |        | 2002
|                                                                                                                                                                                                              |  |              |        |     
|Various notes payable to banks, secured by
    certain equipment, bearing interest at fixed rates between 4.55%
    and 4.72%                                                                                 |  | $            |       |      |  | $ | 1,083  |  
|Debenture loan to Bay Area Employment Development
    Company, guaranteed by the U.S. Small Business
    Administration, bearing interest at a fixed rate of 7.27%,
    maturing October 2016                 |  |              | 788    |      |  |   | 823    |  
|Taxable revenue bonds, secured by a letter of
    credit from a bank, bearing interest at the H15 30 day bond
    yield for commercial paper which was 1.35% on December 31,
    2003, maturing December 2023 |  |              | 8,450  |      |  |   | 9,050  |  
|Notes payable to a bank, secured by certain
    equipment in China, bearing interest at a fixed rate of 5.49%,
    maturing December 2004                                                                     |  |              | 3,298  |      |  |   | 3,298  |  
|                                                                                                                                                                                                              |  |              |        |      |  |   |        |  
|                                                                                                                                                                                                              |  |              | 12,536 |      |  |   | 14,254 |  
|Less current portion                                                                                                                                                                                          |  |              | (3,694 | )    |  |   | (965   | )
|                                                                                                                                                                                                              |  |              |        |      |  |   |        |  
|                                                                                                                                                                                                              |  | $            | 8,842  |      |  | $ | 13,289 |  
|                                                                                                                                                                                                              |  |              |        |      |  |   |        |  
|Maturities of long-term debt at December 31,
    2003 were as follows:                                                                                                                                        |  |              |        |      |  |   |        |  
|2004                                                                                                                                                                                                          |  |              | 3,694  |      |  |   |        |  
|2005                                                                                                                                                                                                          |  |              | 514    |      |  |   |        |  
|2006                                                                                                                                                                                                          |  |              | 459    |      |  |   |        |  
|2007                                                                                                                                                                                                          |  |              | 462    |      |  |   |        |  
|2008                                                                                                                                                                                                          |  |              | 466    |      |  |   |        |  
|Thereafter                                                                                                                                                                                                    |  |              | 6,941  |      |  |   |        |  
|                                                                                                                                                                                                              |  |              |        |      |  |   |        |  
|                                                                                                                                                                                                              |  | $            | 12,536 |      |  |   |        |  
|                                                                                                                                                                                                              |  |              |        |      |  |   |        |  



|        |                                     
|------- | ------------------------------------
|Note 6. | Investments in Marketable Securities

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

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AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

quoted market prices, with net unrealized gains
and losses included in comprehensive income, net of tax. The
components of investments at December 31, 2003 are
summarized below (in thousands):

|                            |  |      |        |             |  |           |       |   |  |   |        | 
|--------------------------- |  | ---- | ------ | ----------- |  | --------- | ----- | - |  | - | ------ | 
|                            |  |      |        |             |  | Aggregate
|                            |  |      |        | Unrealized  |  | Fair     
|Available for Sale          |  | Cost |        | Gain/(Loss) |  | Value    
|                            |  |      |        |             |  |          
|Money market                |  | $    | 17,495 |             |  | $         |      |   |  | $ | 17,495 | 
|Corporate bonds             |  |      | 8,469  |             |  |           | 378   |   |  |   | 8,847  | 
|Government agency bonds     |  |      | 4,155  |             |  |           | (344  | ) |  |   | 3,811  | 
|Corporate equity securities |  |      | 1,115  |             |  |           | 2,560 |   |  |   | 3,675  | 
|                            |  |      |        |             |  |           |       |   |  |   |        | 
|                            |  | $    | 31,234 |             |  | $         | 2,594 |   |  | $ | 33,828 | 
|                            |  |      |        |             |  |           |       |   |  |   |        | 
|Recorded as:                |  |      |        |             |  |           |       |   |  |   |        | 
|Cash equivalents            |  | $    | 9,857  |             |  |           |       |   |  |   |        | 
|Short-term investments      |  |      | 14,669 |             |  |           |       |   |  |   |        | 
|Restricted deposits         |  |      | 9,302  |             |  |           |       |   |  |   |        | 
|                            |  |      |        |             |  |           |       |   |  |   |        | 
|                            |  | $    | 33,828 |             |  |           |       |   |  |   |        | 
|                            |  |      |        |             |  |           |       |   |  |   |        | 



|        |                     
|------- | --------------------
|Note 7. | Corporate Affiliates

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

|                                               |  |                    |       |            |  |           |       |            |  |  |              |  |  |  |    |  
|---------------------------------------------- |  | ------------------ | ----- | ---------- |  | --------- | ----- | ---------- |  |  | ------------ |  |  |  | -- | -
|                                               |  |                    |       |            |  |          
|                                               |  | Investment Balance |       |            |  |          
|                                               |  | at December 31,    |       |            |  |          
|                                               |  |                    |       | Accounting |  | Ownership
|Affiliate                                      |  | 2003               |       | 2002       |  | Method    |       | Percentage
|                                               |  |                    |       |            |  |           |       |           
|Xilingol Tongli Ge Co. Ltd.                    |  | $                  | 822   |            |  | $         | 773   |            |  |  | Equity       |  |  |  | 25 | %
|Emeishan Jia Mei High Pure Metals Co., Ltd.    |  |                    | 603   |            |  |           | 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 $769,000 at
December 31, 2003 and $861,000 at December 31, 2002.
Net income/(loss) recorded from the Companys corporate
affiliates was ($92,000) for the year ended December 31,
2003, $131,000 for 2002, and $701,000 for 2001.

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 December 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 8. | Impairment of Investments

The Company also maintains minority investments
in private companies which are accounted for under the cost
basis. These investments are reviewed for other than temporary
declines in value on a quarterly basis. Reasons for other than
temporary declines in value include whether the related company
would have insufficient cash flow to operate for the next twelve
months, significant changes in the operating performance and
changes in market conditions. In 2003, the Company recorded
$2.0 million in charges to other expense to

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AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

write down its investment in two private US
companies. As of December 31, 2003, the minority
investments the Company continues to hold totaled $602,000.



|        |                     
|------- | --------------------
|Note 9. | Balance Sheet Detail

The components of selected balance sheet accounts
are summarized below (in thousands):

|                                                                                                                       |  |              |        |      |  |   |        |  
|---------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------ | ---- |  | - | ------ | -
|                                                                                                                       |  |             
|                                                                                                                       |  | Years Ended 
|                                                                                                                       |  | December 31,
|                                                                                                                       |  |             
|                                                                                                                       |  | 2003         |        | 2002
|                                                                                                                       |  |              |        |     
|Accounts receivable:                                                                                                   |  |              |        |      |  |   |        |  
|Accounts receivable, gross                                                                                             |  | $            | 10,601 |      |  | $ | 13,871 |  
|Allowance for doubtful accounts                                                                                        |  |              | (4,304 | )    |  |   | (6,676 | )
|                                                                                                                       |  |              |        |      |  |   |        |  
|                                                                                                                       |  | $            | 6,297  |      |  | $ | 7,195  |  
|                                                                                                                       |  |              |        |      |  |   |        |  
|The reduction in allowance for doubtful accounts
    was due to the collection of previously written-down receivables.
|Property, plant and equipment:                                                                                         |  |              |        |      |  |   |        |  
|Land                                                                                                                   |  | $            | 1,120  |      |  | $ | 1,722  |  
|Building                                                                                                               |  |              | 17,180 |      |  |   | 15,849 |  
|Machinery and equipment                                                                                                |  |              | 8,275  |      |  |   | 13,142 |  
|Leasehold improvements                                                                                                 |  |              | 443    |      |  |   | 2,600  |  
|Construction in progress                                                                                               |  |              | 1,150  |      |  |   | 7,260  |  
|                                                                                                                       |  |              |        |      |  |   |        |  
|                                                                                                                       |  |              | 28,168 |      |  |   | 40,573 |  
|Less: accumulated depreciation and amortization                                                                        |  |              | (6,373 | )    |  |   | (591   | )
|                                                                                                                       |  |              |        |      |  |   |        |  
|                                                                                                                       |  | $            | 21,795 |      |  | $ | 39,982 |  
|                                                                                                                       |  |              |        |      |  |   |        |  
|Accrued liabilities:                                                                                                   |  |              |        |      |  |   |        |  
|Accrued compensation                                                                                                   |  | $            | 1,012  |      |  | $ | 1,304  |  
|Customer deposits                                                                                                      |  |              | 994    |      |  |   | 2,196  |  
|Accrued restructuring costs                                                                                            |  |              |       |      |  |   | 1,254  |  
|Income tax payable                                                                                                     |  |              | 3,063  |      |  |   | 3,063  |  
|Other                                                                                                                  |  |              | 3,227  |      |  |   | 3,590  |  
|                                                                                                                       |  |              |        |      |  |   |        |  
|                                                                                                                       |  | $            | 8,296  |      |  | $ | 11,407 |  
|                                                                                                                       |  |              |        |      |  |   |        |  

54



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##### Table of Contents



AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|         |             
|-------- | ------------
|Note 10. | Income Taxes

The components of the benefit for income taxes
for income (loss) are summarized below (in thousands):

|          |         |                                    |   |      |   |      |   |        |        |   |   |        |        |  
|--------- | ------- | ---------------------------------- | - | ---- | - | ---- | - | ------ | ------ | - | - | ------ | ------ | -
|          |         |                                   
|          |         | Years Ended December 31,          
|          |         |                                   
|          |         | 2003                               |   | 2002 |   | 2001
|          |         |                                    |   |      |   |     
|Current:  |         |                                    |   |      |   |      |   |        |        |   |   |       
|          | Federal |                                    | $ |     |   |      | $ | (8,841 | )      |   | $ | 1,917  |       
|          | State   |                                    |   |     |   |      |   |       |        |   |   |       |       
|          | Foreign |                                    |   |     |   |      |   |       |        |   |   | 314    |       
|          |         |                                    |   |      |   |      |   |        |        |   |   |       
|          |         | Total current                      |   |      |  |      |   |        | (8,841 | ) |   |        | 2,231  |  
|          |         |                                    |   |      |   |      |   |        |        |   |   |       
|Deferred: |         |                                    |   |      |   |      |   |        |        |   |   |       
|          | Federal |                                    |   |     |   |      |   | 1,301  |        |   |   | (3,481 | )     
|          | State   |                                    |   |     |   |      |   | 1,232  |        |   |   | (1,560 | )     
|          |         |                                    |   |      |   |      |   |        |        |   |   |       
|          |         | Total deferred                     |   |      |  |      |   |        | 2,533  |   |   |        | (5,041 | )
|          |         |                                    |   |      |   |      |   |        |        |   |   |       
|          |         | Total net benefit for income taxes |   | $    |  |      |   | $      | (6,308 | ) |   | $      | (2,810 | )
|          |         |                                    |   |      |   |      |   |        |        |   |   |       

A reconciliation of the effective income tax
rates and the U.S. statutory federal income tax rate is
summarized below:

|                                                |  |                          |        |      |  |      |       |    |  |  |       |   
|----------------------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ----- | -- |  |  | ----- | --
|                                                |  |                         
|                                                |  | Years Ended December 31,
|                                                |  |                         
|                                                |  | 2003                     |        | 2002 |  | 2001
|                                                |  |                          |        |      |  |     
|Statutory federal income tax rate               |  |                          | (35.00 | )%   |  |      | (35.0 | )% |  |  | (35.0 | )%
|State income taxes, net of federal tax benefits |  |                          | (1.71  | )%   |  |      | (2.7  | )% |  |  | (5.0  | )%
|Foreign sales corporation benefit               |  |                          | 0.00   | %    |  |      | 0.0   | %  |  |  | 0.0   | % 
|Unbenefited losses and credits                  |  |                          | 35.83  | %    |  |      | 29.9  | %  |  |  | 0.0   | % 
|Change in valuation allowance                   |  |                          | 0.00   | %    |  |      | 2.8   | %  |  |  | 0.0   | % 
|Other                                           |  |                          | 0.88   | %    |  |      | (2.2  | )% |  |  | 4.0   | % 
|                                                |  |                          |        |      |  |      |       |    |  |  |       |   
|Effective tax rate                              |  |                          | 0.00   | %    |  |      | (7.2  | )% |  |  | (36.0 | )%
|                                                |  |                          |        |      |  |      |       |    |  |  |       |   

55



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##### Table of Contents



AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Deferred tax assets and liabilities are
summarized below (in thousands):

|                          |                                                              |              |        |         |   |   |        |         |  
|------------------------- | ------------------------------------------------------------ | ------------ | ------ | ------- | - | - | ------ | ------- | -
|                          |                                                              |             
|                          |                                                              | Years Ended 
|                          |                                                              | December 31,
|                          |                                                              |             
|                          |                                                              | 2003         |        | 2002   
|                          |                                                              |              |        |        
|Deferred tax assets:      |                                                              |              |        |         |   |   |        |        
|                          | Accruals and reserves not yet deductible                     |              | $      | 7,624   |   |   | $      | 15,337  |  
|                          | Net operating loss                                           |              |        | 28,170  |   |   |        | 8,923   |  
|                          | Depreciation                                                 |              |        |        |   |   |        | 5,519   |  
|                          | Credits                                                      |              |        | 4,212   |   |   |        | 3,477   |  
|                          |                                                              |              |        |         |   |   |        |        
|                          |                                                              | $            | 40,006 |         |   | $ | 33,256 |        
|Deferred tax liabilities: |                                                              |              |        |         |   |   |        |        
|                          | Unrealized appreciation on Finisar marketable
    securities |              |        |        |   |   |        |        |  
|                          | State taxes                                                  |              |        | (526    | ) |   |        | (980    | )
|                          | Gain on receipt of Finisar marketable securities             |              |        |         |   |   |        |        |  
|                          | Unrepatriated Foreign Earnings                               |              |        | (1,239  | ) |   |        | (1,085  | )
|                          | Depreciation                                                 |              |        | (3,634  | ) |   |        |        |  
|                          |                                                              |              |        |         |   |   |        |        
|                          |                                                              | $            | (5,399 | )       |   | $ | (2,065 | )      
|                          |                                                              |              |        |         |   |   |        |        
|                          | Net deferred tax assets                                      |              | $      | 34,607  |   |   | $      | 31,191  |  
|                          | Valuation allowance                                          |              |        | (34,607 | ) |   |        | (31,191 | )
|                          | Net deferred tax assets                                      |              |        |        |   |   |        |        |  
|                          |                                                              |              |        |         |   |   |        |        

At December 31, 2003, the Company had
federal and state net operating loss carryforwards of
approximately $75.9 million and $31.4 million,
respectively, which will expire beginning in 2020 and 2005,
respectively. In addition, the Company had federal tax credit
carryforwards of approximately $1.6 million, which will
expire beginning in 2019. The Company also has state tax credit
carryforwards of approximately $2.7 million which will
expire beginning 2007.

The deferred tax assets valuation allowance at
December 31, 2003 is attributed to U.S. federal, and
state deferred tax assets, which result primarily from future
deductible accruals, reserves, net operating loss carryforwards,
and tax credit carryforwards. The Company believes that, based
on a number of factors, the available objective evidence creates
sufficient uncertainty regarding the realizability of the
deferred tax assets such that a full valuation allowance has
been recorded. These factors include the Companys history
of losses, and the lack of carryback capacity to realize
deferred tax assets.

In accordance with Section 382 of the
Internal Revenue Code, the amounts of and benefits from net
operating loss and tax credit carryforwards may be impaired or
limited in certain circumstances. Events which cause limitations
in the amount of net operating losses or credits that the
Company may utilize in any one year include, but are not limited
to, a cumulative ownership change of more than 50% as defined,
over a three year period.

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AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|         |                   
|-------- | ------------------
|Note 11. | Net loss per Share

A reconciliation of the numerators and
denominators of the basic and diluted net loss per share
calculations is as follows (in thousands, except per share data):

|                                                                                   |                                                                               |                          |        |         |   |      |        |         |   |  |        |        |     | 
|---------------------------------------------------------------------------------- | ----------------------------------------------------------------------------- | ------------------------ | ------ | ------- | - | ---- | ------ | ------- | - |  | ------ | ------ | --- | 
|                                                                                   |                                                                               |                         
|                                                                                   |                                                                               | Years Ended December 31,
|                                                                                   |                                                                               |                         
|                                                                                   |                                                                               | 2003                     |        | 2002    |   | 2001
|                                                                                   |                                                                               |                          |        |         |   |     
|Numerator:                                                                         |                                                                               |                          |        |         |   |      |        |         |   |  |        |       
|                                                                                   | Income (loss) from continuing operations                                      |                          | $      | (11,093 | ) |      | $      | (54,983 | ) |  | $      | 3,848  |    
|                                                                                   | Loss from discontinued operations                                             |                          |        | (15,638 | ) |      |        | (26,198 | ) |  |        | (8,844 | )  
|                                                                                   | Less: Preferred stock dividends                                               |                          |        | (177    | ) |      |        | (177    | ) |  |        | (177   | )  
|                                                                                   |                                                                               |                          |        |         |   |      |        |         |   |  |        |       
|                                                                                   | Net loss to common stockholders                                               |                          | $      | (26,908 | ) |      | $      | (81,358 | ) |  | $      | (5,173 | )  
|                                                                                   |                                                                               |                          |        |         |   |      |        |         |   |  |        |       
|Denominator:                                                                       |                                                                               |                          |        |         |   |      |        |         |   |  |        |       
|                                                                                   | Denominator for basic net loss per
    share  weighted average common shares |                          |        | 22,781  |   |      |        | 22,433  |   |  |        | 22,278 |    
|                                                                                   | Effect of dilutive securities:                                                |                          |        |         |   |      |        |         |   |  |        |        |    
|                                                                                   |                                                                               | Common stock options     |        |         |  |      |        |         |  |  |        |        | 601 | 
|                                                                                   |                                                                               |                          |        |         |   |      |        |         |   |  |        |       
|Denominator for dilutive net loss per share                                        |                                                                               |                          | 22,781 |         |   |      | 22,433 |         |   |  | 22,879 |       
|                                                                                   |                                                                               |                          |        |         |   |      |        |         |   |  |        |       
|Basic income (loss) per share:                                                     |                                                                               |                          |        |         |   |      |        |         |   |  |        |       
|                                                                                   | Income (loss) from continuing operations                                      |                          | $      | (0.49   | ) |      | $      | (2.46   | ) |  | $      | 0.17   |    
|                                                                                   | Loss from discontinued operations                                             |                          |        | (0.69   | ) |      |        | (1.17   | ) |  |        | (0.40  | )  
|                                                                                   | Net loss to common stockholders                                               |                          |        | (1.18   | ) |      |        | (3.63   | ) |  |        | (0.23  | )  
|Diluted income (loss) per share:                                                   |                                                                               |                          |        |         |   |      |        |         |   |  |        |       
|                                                                                   | Income (loss) from continuing operations                                      |                          | $      | (0.49   | ) |      | $      | (2.45   | ) |  | $      | 0.17   |    
|                                                                                   | Loss from discontinued operations                                             |                          |        | (0.69   | ) |      |        | (1.17   | ) |  |        | (0.39  | )  
|                                                                                   | Net loss to common stockholders                                               |                          |        | (1.18   | ) |      |        | (3.63   | ) |  |        | (0.23  | )  
|Options excluded from diluted net loss per share
    as the impact is antidilutive |                                                                               |                          | 2,326  |         |   |      | 2,867  |         |   |  | 2,107  |       
|                                                                                   |                                                                               |                          |        |         |   |      |        |         |   |  |        |       



|         |                     
|-------- | --------------------
|Note 12. | Stockholders Equity

In May 1998, the Company completed its initial
public offering, or IPO, and issued 2,875,000 shares of its
common stock at $10.00 per share, including the shares from
the exercise of the underwriters over-allotment option.
The Company received cash of approximately $25.8 million
net of underwriting discounts, commissions and IPO expenses.
Upon the closing of the IPO, all outstanding shares of the
Companys then convertible preferred stock were
automatically converted into shares of common stock.

On May 28, 1999, the Company completed its
acquisition of Lyte Optronics, Inc. Under the terms of the
acquisition, the Company issued approximately
2,023,000 shares of common stock and 883,000 shares of
non-voting and non-convertible preferred stock, in exchange for
all of the issued and outstanding shares of the capital stock of
Lyte. Dividends accrue on non-convertible preferred stock at the
rate of $0.20 per annum per share and are payable when
declared by the board of directors of the Company or in the case
of a change in control. The preferred stock has a $4 per
share liquidation preference over common stock.

On July 25, 2000 the Company completed a
private securities offering, raising approximately
$8.5 million in exchange for 234,115 shares of common
stock.

57



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##### Table of Contents



AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

On September 19, 2000, the Company sold,
pursuant to an underwritten public offering,
2,510,000 shares of its common stock at a price of
$34.25 per share, including the shares from the exercise of
the underwriters over-allotment option. The Company
received cash of approximately $80.8 million net of
underwriting discounts, commissions and expenses. Following the
public offering, proceeds were used to repay its line of credit
and for general corporate purposes.



|         |                       
|-------- | ----------------------
|Note 13. | Employee Benefit Plans

Stock Option
Plans

In March 1993, the Companys board of
directors approved the 1993 Stock Option Plan (1993
Plan), which provided for granting of incentive and
non-qualified stock options to employees and directors of the
Company. Under the 1993 Plan, 880,000 shares of common
stock were reserved for issuance as of December 31, 1998.
Options granted under the 1993 Plan were generally for periods
not to exceed ten years and were granted at the fair market
value of the stock at the date of grant as determined by the
board of directors. Options granted under the 1993 Plan
generally vested 25.0% upon grant and 25.0% each year
thereafter, with full vesting occurring on the third anniversary
of the grant date. This plan terminated on March 12, 2003.

In July 1997, the Companys board of
directors approved the 1997 Stock Option Plan (1997
Plan), which provides for granting of incentive and
non-qualified stock options to employees and directors of the
Company. Under the 1997 Plan, 5,901,501 shares of common
stock have been reserved for issuance as of December 31,
2003. Options granted under the 1997 Plan are generally for
periods not to exceed ten years (five years if the option is
granted to a 10.0% stockholder) and are granted at the fair
market value of the stock at the date of grant as determined by
the board of directors. Options granted under the 1997 Plan
generally vest 25.0% at the end of one year and 2.1% each month
thereafter, with full vesting after four years.

The following summarizes the Companys stock
option activity under the 1993 Plan and the 1997 Plan, and
related weighted average exercise price within each category for
each of the years ended December 31, 2001, 2002, and 2003:

|                             |           |           |           |            |   |                 |           |            |   |  |   |               |  |   |       |       | 
|---------------------------- | --------- | --------- | --------- | ---------- | - | --------------- | --------- | ---------- | - |  | - | ------------- |  | - | ----- | ----- | 
|                             |           | Available |           | Number of  |   |                 |           | Price per 
|                             |           | For Grant |           | Shares     |   | Price per Share |           | Share     
|                             |           |           |           |            |   |                 |           |           
|Balance at December 31, 2000 |           |           | 2,936,898 |            |   |                 | 2,495,229 |            |   |  |   |               |  | $ | 20.46 |      
|                             | Granted   |           |           | (1,693,070 | ) |                 |           | 1,693,070  |   |  | $ | 10.30 - 43.88 |  |   |       | 16.71 | 
|                             | Exercised |           |           |           |   |                 |           | (388,617   | ) |  |   | 5.00 - 39.00  |  |   |       | 9.94  | 
|                             | Cancelled |           |           | 485,272    |   |                 |           | (485,272   | ) |  |   | 5.00 - 44.25  |  |   |       | 22.14 | 
|                             |           |           |           |            |   |                 |           |            |   |  |   |               |  |   |       |      
|Balance at December 31, 2001 |           |           | 1,729,100 |            |   |                 | 3,314,410 |            |   |  |   |               |  | $ | 19.63 |      
|                             | Granted   |           |           | (1,137,450 | ) |                 |           | 1,137,450  |   |  | $ | 1.92 - 15.90  |  |   |       | 3.06  | 
|                             | Exercised |           |           |           |   |                 |           | (23,791    | ) |  |   | 5.00 - 9.125  |  |   |       | 6.94  | 
|                             | Cancelled |           |           | 863,204    |   |                 |           | (863,204   | ) |  |   | 5.00 - 42.50  |  |   |       | 20.10 | 
|                             |           |           |           |            |   |                 |           |            |   |  |   |               |  |   |       |      
|Balance at December 31, 2002 |           |           | 1,454,854 |            |   |                 | 3,564,865 |            |   |  |   |               |  | $ | 14.15 |      
|                             | Granted   |           |           | (1,116,964 | ) |                 |           | 1,116,964  |   |  | $ | 0.84 -  3.11  |  |   |       | 2.29  | 
|                             | Exercised |           |           |           |   |                 |           | (32,815    | ) |  |   | 2.19 -  2.19  |  |   |       | 2.19  | 
|                             | Cancelled |           |           | 2,060,178  |   |                 |           | (2,060,178 | ) |  |   | 1.38 - 43.88  |  |   |       | 15.64 | 
|                             |           |           |           |            |   |                 |           |            |   |  |   |               |  |   |       |      
|Balance at December 31, 2003 |           |           | 2,398,068 |            |   |                 | 2,588,836 |            |   |  |   |               |  | $ | 10.79 |      
|                             |           |           |           |            |   |                 |           |            |   |  |   |               |  |   |       |      

58



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AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Information about stock options outstanding at
December 31, 2003 is summarized below:

|                |  |                     |           |                     |  |             |       |          |  |  |           |  |  |   |       | 
|--------------- |  | ------------------- | --------- | ------------------- |  | ----------- | ----- | -------- |  |  | --------- |  |  | - | ----- | 
|                |  |                     |           |                    
|                |  | Options Outstanding |           | Options Exercisable
|                |  |                     |           |                    
|                |  |                     |           | Weighted            |  |            
|                |  |                     |           | Average             |  |             |       | Weighted
|                |  |                     |           | Remaining           |  |             |       | Average 
|Range of        |  | Number              |           | Contractual         |  | Number      |       | Exercise
|Exercise Prices |  | Outstanding         |           | Life                |  | Outstanding |       | Price   
|                |  |                     |           |                     |  |             |       |         
|$ 0.84 - 1.34   |  |                     | 8,500     |                     |  |             | 9.12  |          |  |  | 677       |  |  | $ | 0.84  | 
|1.38 - 1.38     |  |                     | 462,900   |                     |  |             | 9.55  |          |  |  |          |  |  |   |      | 
|1.40 - 2.10     |  |                     | 42,000    |                     |  |             | 9.48  |          |  |  | 3,937     |  |  |   | 1.61  | 
|2.19 - 2.19     |  |                     | 646,330   |                     |  |             | 8.89  |          |  |  | 177,043   |  |  |   | 2.19  | 
|2.74 - 3.01     |  |                     | 16,000    |                     |  |             | 9.94  |          |  |  |          |  |  |   |      | 
|3.11 - 3.11     |  |                     | 522,754   |                     |  |             | 10.00 |          |  |  | 289,064   |  |  |   | 3.11  | 
|5.00 - 12.12    |  |                     | 393,375   |                     |  |             | 5.90  |          |  |  | 270,501   |  |  |   | 7.84  | 
|12.90 - 22.69   |  |                     | 274,310   |                     |  |             | 7.00  |          |  |  | 160,643   |  |  |   | 17.06 | 
|24.00 - 39.80   |  |                     | 217,667   |                     |  |             | 6.37  |          |  |  | 153,501   |  |  |   | 26.40 | 
|$41.50 - 41.50  |  |                     | 5,000     |                     |  |             | 6.43  |          |  |  | 4,167     |  |  |   | 41.50 | 
|                |  |                     |           |                     |  |             |       |          |  |  |           |  |  |   |       | 
|                |  |                     | 2,588,836 |                     |  |             | 8.38  |          |  |  | 1,059,533 |  |  | $ | 9.80  | 
|                |  |                     |           |                     |  |             |       |          |  |  |           |  |  |   |       | 



| |                                              
| | ---------------------------------------------
| | Stock-Based Compensation Under APB
    No. 25

In connection with certain stock option grants
the Company recorded deferred compensation costs totaling
$203,000 for the year ended December 31, 1998. Compensation
cost is the difference between the exercise price and the deemed
fair value at the date of grant. Compensation cost is being
amortized over the vesting period relating to these options, of
which no amount was amortized for the years ended
December 31, 2003 and 2002, and $107,000 was amortized for
the year ended December 31, 2001.

Certain Pro
Forma Disclosures

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

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

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AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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:

|                         |  |                          |       |      |  |      |       |   |  |  |       |  
|------------------------ |  | ------------------------ | ----- | ---- |  | ---- | ----- | - |  |  | ----- | -
|                         |  |                         
|                         |  | Years Ended December 31,
|                         |  |                         
|                         |  | 2003                     |       | 2002 |  | 2001
|                         |  |                          |       |      |  |     
|Risk free interest rate  |  |                          | 2.9   | %    |  |      | 3.0   | % |  |  | 3.9   | %
|Expected life (in years) |  |                          | 5.0   |      |  |      | 5.0   |   |  |  | 5.0   |  
|Dividend yield           |  |                          | 0.0   | %    |  |      | 0.0   | % |  |  | 0.0   | %
|Volatility               |  |                          | 109.0 | %    |  |      | 101.0 | % |  |  | 104.0 | %

The weighted average grant-date fair value of
options granted during the year ended December 31, 2003 was
$1.19, $2.39 in 2002 and $12.97 in 2001.

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 earnings and net earnings per share
would have been as summarized below (in thousands except per
share data):

|                    |                          |                          |   |         |       |      |   |         |       |   |   |         |       |  
|------------------- | ------------------------ | ------------------------ | - | ------- | ----- | ---- | - | ------- | ----- | - | - | ------- | ----- | -
|                    |                          |                         
|                    |                          | Years Ended December 31,
|                    |                          |                         
|                    |                          | 2003                     |   | 2002    |       | 2001
|                    |                          |                          |   |         |       |     
|Net loss:           |                          |                          |   |         |       |      |   |         |       |   |   |        
|                    | As reported              |                          | $ | (26,731 | )     |      | $ | (81,181 | )     |   | $ | (4,996  | )    
|                    | Pro forma option expense |                          |   | 7,323   |       |      |   | 9,182   |       |   |   | 7,046   |      
|                    | Pro forma net loss       |                          | $ | (34,054 | )     |      | $ | (90,363 | )     |   | $ | (12,042 | )    
|Net loss per share: |                          |                          |   |         |       |      |   |         |       |   |   |        
|                    | As reported:             |                          |   |         |       |      |   |         |       |   |   |         |      
|                    |                          | Basic                    |   | $       | (1.18 | )    |   | $       | (3.63 | ) |   | $       | (0.23 | )
|                    |                          | Diluted                  |   |         | (1.18 | )    |   |         | (3.63 | ) |   |         | (0.23 | )
|                    | Pro forma net loss:      |                          |   |         |       |      |   |         |       |   |   |         |      
|                    |                          | Basic                    |   | $       | (1.49 | )    |   | $       | (4.04 | ) |   | $       | (0.54 | )
|                    |                          | Diluted                  |   |         | (1.49 | )    |   |         | (4.04 | ) |   |         | (0.54 | )

Because additional option grants are expected to
be made each year, the above pro forma disclosures are not
representative of pro forma effects on reported net income for
future years.

Employee
Stock Purchase Plan

In February 1998, the Companys board of
directors approved the 1998 Employee Stock Purchase Plan (the
1998 Purchase Plan). The Companys stockholders
approved the 1998 Purchase Plan in March 1998. At
December 31, 2003 a total of 900,000 shares of the
Companys common stock were reserved for issuance under the
1998 Purchase Plan. A total of 683,000 shares were
purchased as of December 31, 2003. The 1998 Purchase Plan
permits eligible employees to acquire shares of the
Companys common stock through payroll deductions. The
common stock purchase price is determined as 85.0% of the lower
of the market price of the common stock at the purchase date or
the date of offer to the employee.

Retirement
Savings Plan

The Company has a 401(k) Savings Plan (the
Savings Plan) which qualifies as a thrift plan under
Section 401(k) of the Internal Revenue Code. All full-time
U.S. employees are eligible to participate in the Savings
Plan after 90 days from the date of hire. Participants may
contribute up to 10.0% of their earnings to the Savings Plan
with a discretionary matching amount provided by the Company.
The Companys

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AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

contributions to the Savings Plan were $191,000
for the year ended December 31, 2003, $315,000 for 2002 and
$456,000 for 2001.



|         |                                            
|-------- | -------------------------------------------
|Note 14. | Voluntary Stock Option Exchange
    Program

On May 27, 2003, the Company announced a
voluntary stock option exchange program for our employees. Under
the program, option holders, excluding our executive officers
and independent directors, had the opportunity to cancel
outstanding options with an exercise price in excess of
$2.10 per share in exchange for new options to be granted
at a future date that was at least six months and one day after
the date of cancellation, which was June 30, 2003. The
number of shares of common stock subject to the new options was
equal to 75% of the number subject to the exchanged options.
Under the exchange program, options to purchase an aggregate of
738,027 shares of our common stock, representing
approximately 48% of the options that were eligible to be
tendered in the Offer as of May 27, 2003, were tendered and
cancelled. New options will vest at the same rate as the
exchanged options and have an exercise price equal to the fair
market value of our common stock at the new grant date, which
was $3.11 per share. On December 31, 2003, the Company
granted options to purchase an aggregate of 522,754 shares
of our common stock in exchange for such tendered options.



|         |                                               
|-------- | ----------------------------------------------
|Note 15. | Segment and Foreign Operations
    Information

The Company has one operating segment comprising
of the design, development, manufacture and distribution of
high-performance compound semiconductor substrates.

The Company sells its substrates 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):

|              |                                           |                          |   |        |  |      |   |        |  |  |   |         | 
|------------- | ----------------------------------------- | ------------------------ | - | ------ |  | ---- | - | ------ |  |  | - | ------- | 
|              |                                           |                         
|              |                                           | Years Ended December 31,
|              |                                           |                         
|              |                                           | 2003                     |   | 2002   |  | 2001
|              |                                           |                          |   |        |  |     
|Net revenues: |                                           |                          |   |        |  |      |   |        |  |  |   |        
|              | United States                             |                          | $ | 11,823 |  |      | $ | 25,185 |  |  | $ | 57,137  | 
|              | Europe                                    |                          |   | 5,638  |  |      |   | 5,508  |  |  |   | 21,341  | 
|              | Canada                                    |                          |   | 186    |  |      |   | 1,023  |  |  |   | 6,643   | 
|              | Taiwan                                    |                          |   | 7,055  |  |      |   | 4,246  |  |  |   | 10,441  | 
|              | Japan                                     |                          |   | 4,167  |  |      |   | 3,000  |  |  |   | 8,355   | 
|              | Asia Pacific (excluding Japan and Taiwan) |                          |   | 5,844  |  |      |   | 5,903  |  |  |   | 4,883   | 
|              |                                           |                          |   |        |  |      |   |        |  |  |   |        
|              | Consolidated                              |                          | $ | 34,713 |  |      | $ | 44,865 |  |  | $ | 108,800 | 
|              |                                           |                          |   |        |  |      |   |        |  |  |   |        

Property, plant and equipment by geographic
location is summarized below (in thousands):

|                                    |               |              |        |        |  |   |        |        | 
|----------------------------------- | ------------- | ------------ | ------ | ------ |  | - | ------ | ------ | 
|                                    |               |             
|                                    |               | Years Ended 
|                                    |               | December 31,
|                                    |               |             
|                                    |               | 2003         |        | 2002  
|                                    |               |              |        |       
|Property, plant and equipment, net: |               |              |        |        |  |   |        |       
|                                    | United States |              | $      | 7,583  |  |   | $      | 21,133 | 
|                                    | China         |              |        | 14,212 |  |   |        | 18,849 | 
|                                    |               |              |        |        |  |   |        |       
|                                    |               | $            | 21,795 |        |  | $ | 39,982 |       
|                                    |               |              |        |        |  |   |        |       

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AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|         |                           
|-------- | --------------------------
|Note 16. | Related Party Transactions

Since January 2002, there has not been, nor is
there currently proposed, any transaction or series of similar
transactions to which the Company was or is 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 the Companys voting securities or members of that
persons immediate family had or will have a direct or
indirect material interest other than the transactions described
below.

The Company entered into an operating lease in
July 2001 for warehouse space in Fremont, CA with 4160 Business
Center, LLC, a real estate holding company, in which Davis
Zhang, the president of our substrate division, is the sole
shareholder. Lease payments to 4160 Business Center, LLC were
approximately $121,000 for the three months ended March 31,
2003. In April of 2003, Mr. Zhang sold this warehouse to a
party unrelated to the Company. The Company began leasing this
warehouse from the new owner on the date of sale. Mr. Zhang
will continue to hold a $3.7 million note on the property
through April 2005.



|         |                              
|-------- | -----------------------------
|Note 17. | 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. We do not expect that any of
these matters, individually or in the aggregate, will have a
material adverse effect on our business, financial condition,
cash flows or results of operation.

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

On June 11, 2003, Cree, Inc. filed a
complaint in the United States Court for Northern District of
California against the Company alleging patent infringement. The
complaint sought damages and injunction against infringement. On
July 23, 2003, the Company filed a counter complaint in the
United States Court for Northern District of California, denying
any patent infringement and alleging that Crees actions
were intentionally designed to interfere with the Companys
prospective business relationships. The Company reached an
agreement with Cree resolving the disputes between us and signed
a settlement agreement on March 5, 2004. The resolution of
the disputes did not have a material adverse impact on the
Companys consolidated financial position or results of
operations.

The Company has entered into contracts to supply
several large customers with GaAs wafers. The contracts
guarantee the delivery of a certain number of wafers between
January 1, 2001 and December 31, 2004 with a current
contract value of $2.0 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
$994,000 are included in accrued liabilities at
December 31, 2003. As of December 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.

The Company leases certain office space,
manufacturing facilities and property under long-term operating
leases expiring at various dates through March 2013. Total rent
expense under these operating leases was approximately
$1.2 million for the year ended December 31, 2003,
$947,000 in 2002 and $779,000 in 2001.

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AXT, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The Company has an outstanding purchase order for
manufacturing equipment related to its discontinued
opto-electronics division totaling $1.4 million at
December 31, 2003. The Company is currently negotiating a
settlement with the supplier for this un-needed equipment.

Total minimum lease payments under the above
leases as of December 31, 2003, are summarized below (in
thousands):

|           |  |           |       | 
|---------- |  | --------- | ----- | 
|           |  | Operating
|           |  | Leases   
|           |  |          
|2004       |  | $         | 1,231 | 
|2005       |  |           | 1,115 | 
|2006       |  |           | 836   | 
|2007       |  |           | 616   | 
|2008       |  |           | 617   | 
|Thereafter |  |           | 3,236 | 
|           |  |           |       | 
|           |  | $         | 7,651 | 
|           |  |           |       | 

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##### Table of Contents



Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the
undersigned, thereto duly authorized.



| |          
| | ---------
| | AXT, INC.



| |     |                    
| | --- | -------------------
| | By: | /s/ MORRIS S. YOUNG

| |                                          
| | -----------------------------------------
| |                                          
| | Morris S. Young,                         
| | Chief Executive Officer and
    President

Date: March 29, 2004

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each
person whose signature appears below hereby constitutes and
appoints Morris S. Young and Donald L. Tatzin, and each of them,
his true and lawful attorney-in-fact and agent, with full power
of substitution, each with power to act alone, to sign and
execute on behalf of the undersigned any and all amendments to
this Report on Form 10-K, and to perform any acts necessary
in order to file the same, with all exhibits thereto and other
documents in connection therewith with the Securities and
Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every
act and thing requested and necessary to be done in connection
therewith, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that
said attorney-in-fact and agent, or their or his or her
substitutes, shall do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities and on the dates indicated.

|                                     |  |                                                                  |  |                |  | 
|------------------------------------ |  | ---------------------------------------------------------------- |  | -------------- |  | 
|                                     |  |                                                                  |  |               
|Signature                            |  | Title                                                            |  | Date          
|                                     |  |                                                                  |  |               
|                                    
|/s/ MORRIS S. YOUNGMorris S. Young   |  | President, Chief Executive Officer and Chairman
    of the Board |  | March 29, 2004
|                                    
|/s/ DONALD L. TATZINDonald L. Tatzin |  | Senior Vice President, Chief Financial Officer,
    Director     |  | March 29, 2004
|                                    
|/s/ DAVID C. CHANGDavid C. Chang     |  | Director                                                         |  | March 29, 2004
|                                    
|/s/ JESSE CHENJesse Chen             |  | Director                                                         |  | March 29, 2004
|                                    
|/s/ LEONARD LEBLANCLeonard LeBlanc   |  | Director                                                         |  | March 29, 2004

64



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AXT, Inc.

EXHIBITS


TO


FORM 10-K ANNUAL REPORT


For the Year Ended December 31,
2003

|        |    |             |  |                                                                                                                                                                                                                                                                                                                
|------- | -- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 3  | .1(3)       |  | Restated Certificate of Incorporation                                                                                                                                                                                                                                                                          
|        | 3  | .2(4)       |  | Certificate of Designation, Preferences and
    Rights of Series A Preferred Stock (which is incorporated
    herein by reference to Exhibit 2.1 to the registrants
    form 8-K dated May 28, 1999).                                                                                                         
|        | 3  | .3(5)       |  | Second Amended and Restated By Laws                                                                                                                                                                                                                                                                            
|        | 4  | .2(5)       |  | Rights Agreement dated April 24, 2001 by and
    between AXT, Inc. and ComputerShare Trust Company, Inc.                                                                                                                                                                                                       
|        | 10 | .1(1)       |  | Form of Indemnification Agreement for directors
    and officers.*                                                                                                                                                                                                                                             
|        | 10 | .2(1)       |  | 1993 Stock Option Plan and forms of agreements
    thereunder.*                                                                                                                                                                                                                                                
|        | 10 | .3(1)       |  | 1997 Stock Option Plan and forms of agreements
    thereunder.*                                                                                                                                                                                                                                                
|        | 10 | .4(1)       |  | 1997 Employee Stock Purchase Plan and forms of
    agreements thereunder.*                                                                                                                                                                                                                                     
|        | 10 | .5(1)       |  | 1998 Employee Stock Purchase Plan and forms of
    agreements thereunder.*                                                                                                                                                                                                                                     
|        | 10 | .7(2)       |  | Purchase and Sale Agreement by and between Limar
    Realty Corp. #23 and AXT, Inc. dated April 1998.                                                                                                                                                                                                          
|        | 10 | .10(3)      |  | Bond Purchase Contract between Dain Rauscher
    Incorporated and AXT, Inc. dated December 1, 1998.                                                                                                                                                                                                            
|        | 10 | .11(3)      |  | Remarketing Agreement between Dain Rauscher
    Incorporated and AXT, Inc. dated December 1, 1998.                                                                                                                                                                                                             
|        | 10 | .15(7)      |  | Reimbursement Agreement between Wells Fargo Bank
    National Association and AXT, Inc. dated April 7, 2003.                                                                                                                                                                                                   
|        | 10 | .16(8)      |  | Asset purchase agreements dated September 4,
    2003 by and between Dalian Luming Science and Technology Group,
    Ltd and AXT, Inc. and by and between Lumei Optoelectronics
    Corp., AXT, Inc., Lyte Optronics, Inc., Beijing
    Tongmei Xtal Technology and Xiamen Advanced Semiconductor Co.,
    Ltd.



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##### Table of Contents



|        |    |             |  |                                                                                                        
|------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 10 | .17         |  | Code of Business Conduct and Ethics dated
    February 2, 2004.                                        
|        | 21 | .1(1)       |  | List of Subsidiaries.                                                                                  
|        | 24 | .1          |  | Power of Attorney (see signature page).                                                                
|        | 31 | .1          |  | Certification by Chief Executive Officer Pursuant
    to Section 302 of the Sarbanes-Oxley Act of 2002.
|        | 31 | .2          |  | Certification by Chief Financial Officer Pursuant
    to Section 302 of the Sarbanes-Oxley Act of 2002.
|        | 32 | .1          |  | Certification by Chief Executive Officer Pursuant
    to Section 906 of the Sarbanes-Oxley Act of 2002.
|        | 32 | .2          |  | Certification by Chief Financial Officer Pursuant
    to Section 906 of the Sarbanes-Oxley Act of 2002.



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|    |                                                                                                                                                                               
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to the exhibit as of
    the same number as filed with the SEC in our Registration
    Statement on Form S-1 on March 17, 1998.                     
|(2) | Incorporated by reference to the exhibit as of
    the same number as filed with the SEC in our Registration
    Statement on Amendment No. 2 to Form S-1 on
    May 11, 1998.
|(3) | Incorporated by reference to the exhibit as of
    the same number as filed with the SEC in our Annual Report on
    Form 10-K for the year ended December 31, 1998           
|(4) | Incorporated by reference to the exhibit as of
    the same number as filed with the SEC in our Form 8-K on
    June 14, 1999                                                 
|(5) | Incorporated by reference to the exhibit as of
    the same number as filed with the SEC in our Form 8-K on
    May 30, 2001                                                  
|(6) | Incorporated by reference to the exhibit as of
    the same number as filed with the SEC in our Form 10Q on
    November 12, 2002                                             
|(7) | Incorporated by reference to the exhibit as of
    the same number as filed with the SEC in our Form 10Q on
    May 9, 2003                                                   
|(8) | Incorporated by reference to the exhibit as of
    the same number as filed with the SEC in our Form 10Q on
    November 13, 2003                                             

| |   |                                
| | - | -------------------------------
| | * | Indicates a management contract