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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC. 20549

(Mark One)

x		Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2002
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)

4281 Technology Drive, Fremont, California 94538
(Address of principal executive offices) (Zip code)
(510) 683-5900
(Registrant’s telephone number, including area code)

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

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

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AXT, INC.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

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

See accompanying notes to these unaudited condensed consolidated financial statements.

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

See accompanying notes to these unaudited condensed consolidated financial statements.

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

See accompanying notes to these unaudited condensed consolidated financial statements.

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AXT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

     The accompanying condensed consolidated balance sheets as of September 30, 2002 and December 31, 2001, the condensed consolidated income statements for the three and nine months ended September 30, 2002 and 2001, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2002 and 2001 have been prepared by AXT, Inc. (“AXT” or the “Company”) and are unaudited. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosure normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States have been condensed or omitted. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, considered necessary to present fairly the financial position, results of operations and cash flows of AXT and its subsidiaries for all periods presented.

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

     The results of operations are not necessarily indicative of the results to be expected in the future or for the full fiscal year. It is recommended that these condensed consolidated financial statements be read in conjunction with the Company’s consolidated financial statements and the notes thereto included in its 2001 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 26, 2002.

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

Note 2. Gain on Demeter Warrants

     In August 2000, the Company entered into a business transfer and acquisition agreement with Demeter Technologies, Inc., a Delaware corporation founded by Theodore S. Young, the former president of the Company’s fiber optic division and a former member of the Company’s board of directors, and Robert Shih, the former chief technology officer of the Company’s opto-electronics division. Under this agreement, the Company agreed to transfer certain non-core rights to Demeter relating to research and development activities in the field of fiber optics. The Company entered into non-competition agreements with Messrs. Shih and Young that prohibit them from certain activities, including the manufacture of certain VCSEL devices. The Company leased to Demeter a portion of its owned facility in El Monte, California, subleased a portion of its rented facility in El Monte, California, leased certain equipment, including an MOCVD machine, and sold certain inventory relating to fiber optics to Demeter. In exchange, Demeter granted to the Company a warrant to purchase up to 4.5 million shares of its Series A convertible preferred stock at a price of $0.5714 per share. Demeter was purchased by Finisar Corporation and as a result, AXT converted its Demeter warrant for approximately 1.1 million shares of Finisar Corporation common stock on November 21, 2000. On November 21, 2000, a gain of $27.3 million was recorded in other income as a result of the transaction. On December 10, 2001, the Company received approximately 86,000 additional shares of common stock of Finisar Corporation that had been held in escrow in accordance with the terms of the acquisition agreement between Demeter and Finisar. A gain of $1.1 million was recorded in other income as a result of receiving these additional shares. On December 31, 2001, the Company wrote its investment in Finisar Corporation down to current market value, in accordance with SFAS 115, resulting in a realized loss of $16.7 million recorded in other income and expense. On February 4, 2002, the Company received approximately 24,000 additional shares of common stock of Finisar Corporation that had been held in escrow in accordance with the terms of the acquisition agreement between Demeter and Finisar. A gain of $251,000 was recorded in other income as a result of receiving these additional shares. The investment in Finisar Corporation common stock is accounted for as available for sale and

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classified as a short-term investment. On June 30, 2002, the Company wrote its investment in Finisar Corporation down to current market value, in accordance with SFAS 115, resulting in a realized loss of $9.2 million recorded in other income and expense.

Note 3. Long-Lived Asset Impairment

     In the second quarter of 2002, the Company completed an impairment review of certain manufacturing assets used in the substrate and opto-electronics divisions. The review was undertaken due to the recent history of operating losses, declines in the demand for our products due to macro economic conditions and excess capacity resulting in part from the relocation of certain manufacturing operations in the Company’s substrate division to China.

     Upon completion of the review, the Company determined that the carrying value of the manufacturing assets was not expected to be recoverable and accordingly recorded an impairment charge in order to write-down the related assets to their estimated fair value. The Company determined the amount of the impairment charge by estimating the net present value of expected future cash flows to be generated by the assets. Based on this analysis, the Company recorded non-cash impairment charges of $14.1 million in the substrate segment and $9.9 million in the opto-electronics segment for the laser diode operating unit.

     In the third quarter of 2002, the Company completed an impairment review of certain manufacturing assets in the opto-electronics division. The review was undertaken due to the unexpected operating losses incurred in the third quarter, declines in product demand due to the Company’s inability to manufacture high volumes of its LED products to the Company’s customers’ requirements, and the need for the Company to reduce its current level of production to conserve cash.

     Upon completion of the review, the Company determined that the carrying value of the manufacturing assets was not expected to be recoverable and accordingly recorded an impairment charge in order to write-down the related assets to their estimated fair value. The Company determined the amount of the impairment charge by estimating the net present value of expected future cash flows to be generated by the assets. Based on this analysis, the Company recorded a non-cash impairment charge of $14.0 million.

Note 4. Goodwill Impairment

     The Company adopted the provisions of SFAS 142, “Goodwill and Other Intangible Assets,” effective January 1, 2002. Under the transition provisions of SFAS No. 142, there was no goodwill impairment at January 1, 2002 based upon the Company’s analysis at that time. However, during the quarter ended September 30, 2002, circumstances developed that indicated that the goodwill was likely impaired and the Company performed an impairment analysis as of September 30, 2002. This analysis resulted in a $1.1 million impairment of goodwill. The circumstances that led to the impairment included a net loss for the quarter and a significant drop in the Company’s market capitalization.

Note 5. Investments

     The Company classifies all of its investment securities as available-for-sale securities as prescribed by Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and does not hold any debt securities with the positive intent and ability to hold to maturity, or trading securities bought and held principally for the purpose of selling in the near term. All investments considered to be strategic in nature are carried at fair value, which is determined based on quoted market prices, with net unrealized gains and losses included in comprehensive income, net of tax. The components of investments at September 30, 2002 are summarized below (in thousands):

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Note 6. Inventories

     Inventories are stated at the lower of cost or net realizable value. Cost is determined using the weighted average cost method. Finished goods and work-in-process inventories include material, labor and manufacturing overhead costs. We routinely evaluate the levels of our inventory in light of current market conditions in order to identify excess and obsolete inventory and we provide a valuation allowance for certain inventories based upon the age and quality of the product. The components of inventory are summarized below (in thousands):

Note 7. Net Income (loss) Per Share

     Basic earnings per common share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include dilutive potential common shares calculated using the treasury stock method. Dilutive potential common shares consist of the shares issuable upon the exercise of stock options.

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

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Note 8. Comprehensive Income

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

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Note 9. Segment Information

     The Company has two reportable segments as of September 30, 2002: substrates and opto-electronics. The segments in which the Company operates are subject to rapid technological change and significant competition. Also, the number of suppliers of certain materials used by the Company and the number of customers are limited.

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

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

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Note 10. Corporate Affiliates

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

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

Note 11. Restructuring Costs

     On December 14, 2000, the Company’s Board of Directors approved management’s plan to exit its unprofitable 650 nm laser diode product line within its opto-electronics division. As a result, during the fourth quarter of 2000, the Company recorded a pre-tax restructuring charge of $8.2 million. The restructuring charge included $2.1 million for incremental costs and contractual obligations for such items as leasehold termination payments and other facility exit costs incurred as a direct result of this plan.

     The components of the restructuring charge are summarized below (in thousands):

     The fair value of assets determined to be impaired in accordance with the guidance for assets to be disposed set forth in SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,” was determined in accordance with management estimates, and exit costs incurred as a direct result of the restructuring plan were determined in accordance with EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.” The restructuring actions, as outlined by the plan, are substantially complete. The remaining costs are approximately $1.1 million and relate to clean up of a leased facility. The clean up is expected to be completed in 2002.

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Note 12. Commitments

     From time to time the Company is involved in litigation in the normal course of business. Management believes that the outcome of matters to date will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

     On May 1, 2001, the Santa Clara Center for Occupational Safety and Health filed a complaint for injunctive relief and civil penalties against the Company in the Superior Court of California, County of Alameda, Hayward Division, Case No. H218237-5. The complaint alleged violations of California Business and Professions Code section 17200 et seq., and violations under Proposition 65 and California Health and Safety Code section 25249 et seq. as a result of AXT’s use of arsenic and inorganic arsenic compounds in its workplace. On June 24, 2002, the Company participated in a private mediation, and as a result, reached a settlement of all claims, pursuant to which the Company agreed to pay the Santa Clara Center for Occupational Safety and Health an amount equal to $175,000. The parties have executed a settlement agreement, and the court approved the settlement on September 20, 2002, and dismissal of the case is pending.

     The Company has entered into contracts to supply several large customers with GaAs wafers. The contracts guarantee the delivery of a certain number of wafers between January 1, 2001 and December 31, 2002 with a current contract value of $8.2 million. The contract sales prices are subject to review quarterly and can be adjusted in the event that raw material prices change. In the event of non-delivery of the determined wafer quantities in any monthly delivery period, the Company could be subject to non-performance penalties of between 5% and 10% of the value of the delinquent monthly deliveries. Partial prepayments received for these supply contracts totaling $2.9 million are included in accrued liabilities at September 30, 2002. As of September 30, 2002 the Company has met all of its delivery obligations under these contracts and expects to do so for the remainder of the contract terms.

Note 13. Foreign Exchange Contracts and Transaction Losses

     The Company uses short-term forward exchange contracts for hedging purposes to reduce the effects of adverse foreign exchange rate movements. The Company has purchased foreign exchange contracts to hedge against certain trade accounts receivable denominated in Japanese yen. The change in the fair value of the forward contracts is recognized as part of the related foreign currency transactions as they occur. As of September 30, 2002, the Company’s outstanding commitments with respect to the foreign exchange contracts, which were commitments to sell Japanese yen, had a total contract value of approximately $3.7 million.

     The Company incurred a foreign transaction exchange loss of $46,121 and a gain of $107,443 for the three and nine months ended September 30, 2002 respectively and gains of $84,500 and $394,300 for the three and nine months ended September 30, 2001 respectively.

Note 14. Credit Facility

     At June 30, 2002, the credit facility maintained by the Company with a bank included a $5 million line of credit with no balance outstanding, term loans in the amount of $4.8 million and a letter of credit supporting repayment of the Company’s industrial revenue bonds with an outstanding amount of $9.4 million. The credit facility is collateralized by all corporate personal and real property owned by the Company. As of June 30, 2002, the Company was in default of the credit facility by failure to maintain certain financial covenants required under the terms of the facility. As a result, on September 30, 2002 we modified the credit agreement with our bank, which waived the covenant default, terminated the credit line, amended the financial covenants and added additional collateral to secure repayment of the bonds. At September 30, 2002 the credit facility included a letter of credit supporting our bonds with an outstanding amount of $9.2 million and foreign exchange and overdraft obligations in the amount of $1.1 million. The Company has pledged and placed certain investment securities with the trust department of the bank as additional collateral for this facility. As a result, $10.3 million of our long-term investments are restricted. At September 30, 2002 we are in compliance with the financial covenants as amended.

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Note 15. Income taxes

     The Company recorded an income tax provision expense of $3.7 million and a benefit of $3.7 million for the three and nine months ended September 30, 2002 respectively. Included in the provisions is a charge of $14.9 million and $24.5 million for the three and nine months ended September 30, 2002 respectively, to record a valuation allowance against cumulative tax benefits due to uncertainties regarding the ability to realize the deferred tax assets arising from the asset impairment charges recorded during the second and third quarters.

Note 16. Recent Accounting Pronouncements

     In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 141 and No. 142, or SFAS 141, “Business Combinations”, and SFAS 142, “Goodwill and Other Intangible Assets.” Under SFAS 141, all business combinations must be accounted for using the purchase method of accounting; use of the pooling-of-interests (pooling) method is prohibited. The provisions of the statement will apply to all business combinations initiated after June 30, 2001. SFAS 142 will apply to all acquired intangible assets whether acquired singly, as a part of a group, or in a business combination. The statement will supersede APB Opinion No. 17, “Intangible Assets”, and will carry forward provisions in APB Opinion No. 17 relating to internally developed intangible assets. Adoption of SFAS 142 will result in ceasing amortization of goodwill. All of the statement should be applied in fiscal years beginning after December 31, 2001 to all goodwill and other intangible assets recognized in an entity’s statement of financial position at that date, regardless of when those assets were initially recognized. During the quarter, as a result of our periodic review of the recoverability of goodwill in accordance with SFAS 142, we recorded an impairment charge of $1.1 million.

     In October 2001, the FASB issued Statement of Accounting Standards No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 144 supercedes SFAS 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.” SFAS 144 applies to all long-lived assets (including discontinued operations) and consequently amends Accounting Principles Board Opinion No. 30 (APB 30), “Reporting Results of Operations- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS 144 requires the long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of the entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS 144 is effective for the Company for all financial statements issued in fiscal 2002. During the nine months ended September 30 2002, the Company recorded non-cash impairment charges of $38.0 million to write down to estimated fair value, idle manufacturing assets to be held and used.

     In July 2002, the FASB issued Statement of Accounting Standards No. 146, “Accounting for Costs Associated with Exit and Disposal Activities.” This statement revises the accounting for exit and disposal activities under EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity,” by spreading out the reporting of expenses related to restructuring activities. Commitment to a plan to exit an activity or dispose of long-lived assets will no longer be sufficient to record a one-time charge for most anticipated costs. Instead, companies will record exit disposal costs when they are “incurred” and can be measured at fair value, and they will subsequently adjust the recorded liability for changes in estimated cash flows. The provisions of SFAS No. 146 are effective prospectively for exit or disposal activities initiated after December 31, 2002. Companies may not restate previously issued financial statements for the effect of the provisions of SFAS No. 146 and liabilities that a company previously recorded under EITF Issue 94-3 are grandfathered. We do not believe that the adoption of SFAS No. 146 will have a material impact on our consolidated financial statements.

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

     This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes a number of forward-looking statements made pursuant to the provisions of Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based upon management’s current views with respect to future events and financial performance, and are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated. Such risks and uncertainties include those set forth under “Risks Related to our Business” below. Forward-looking statements may be identified by the use of terms such as “anticipates,’’ “believes,’’ “estimates,” “expects,’’ “intends,’’ and similar expressions. Statements concerning our financial position, business strategy and plans or objectives for future operations are forward-looking statements. These forward-looking statements are not guarantees of future performance. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. This discussion should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001 and the condensed consolidated financial statements included elsewhere in this report.

Overview

     We were founded in 1986 to commercialize and enhance our proprietary vertical gradient freeze (VGF) technique for producing high-performance compound semiconductor substrates. We currently operate two divisions: our substrate division and our opto-electronics division. We made our first substrate sales in 1990 and our substrate division currently sells gallium arsenide (GaAs) and indium phosphide (InP) substrates to manufacturers of semiconductor devices for use in applications such as fiber optic and wireless telecommunications, light emitting diodes (LEDs) and lasers. We also sell germanium substrates for use in satellite solar cells. We acquired Lyte Optronics, Inc., on May 28, 1999, and currently operate part of Lyte’s historical business as our opto-electronics division. The opto-electronics division manufactures high-brightness LED’s (HBLEDs) for the illumination markets, including full-color displays, automobile lighting and traffic signals, and also manufactures vertical cavity surface emitting lasers (VCSELs) and laser diodes for fiber optic communications and storage area networks. We previously operated the consumer products division, discontinued in December 2000, which had focused on the design and manufacture of laser-pointing and alignment products for the consumer, commercial and industrial markets.

Critical Accounting Policies and Estimates

     We have prepared our consolidated financial statements in accordance with accounting principles generally accepted in the United States. As such, we have made estimates and judgments that affect the preparation of these statements based upon historical experience and on other assumptions that are believed to be reasonable under the circumstances. The discussion and analysis of our results of operations and financial condition are based upon these statements. Actual results may differ from these estimates under different assumptions or conditions. We have identified the policies below as critical to our business operations and understanding of our financial condition and results of operations.

     We recognize revenue upon shipment of products to our customers, provided that we have received a signed purchase order, the price is fixed, title has transferred, collection of resulting receivables is probable, product returns are reasonably estimable, there are no customer acceptance requirements and there are no remaining significant obligations. We assess the probability of collection based on a number of factors including past history with the customer and credit worthiness. We provide for future returns at the time revenue is recognized, based on historical experience, current economic trends and changes in customer demand. Except for sales in Japan and some sales in Taiwan, which in both cases are denominated in Japanese yen, we denominate and collect our international sales in U.S. dollars.

     We periodically review the collectability of our accounts receivable balances and provide an allowance for doubtful accounts receivable based upon the age of these accounts. We provide a 100% allowance for U.S. receivables in excess of 90 days and for foreign receivables in excess of 120 days. At September 30, 2002 our accounts receivable balance was $11.9 million net of an allowance for doubtful accounts of $8.2 million.

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     Inventories are stated at the lower of cost or net realizable value. Cost is determined using the weighted average cost method. Finished goods and work-in-process inventories include material, labor and manufacturing overhead costs. We routinely evaluate the levels of our inventory in light of current market conditions in order to identify excess and obsolete inventory and we provide a valuation allowance for certain inventories based upon the age and quality of the product. We also review our inventory to ensure costs can be realized upon ultimate sale to our customers. If we determine that the value of any items in ending inventory plus any related selling costs exceeds the sales value, a reserve is established for the difference.

     Our industry requires substantial investments in property and equipment in order to meet demand and changes in technology. In addition, we occasionally make investments in companies, which are developing promising relevant technologies. We review the carrying value of our long-lived assets and investments in order to identify any impairment. Long-lived assets are written down when the carrying value of these assets exceeds their related undiscounted future cash flows. Key assumptions in estimating future cash flows include estimates of sales volumes, changes in selling prices and cost of materials. It is possible that actual results will differ from these estimates and such differences may be material and require future adjustments to the carrying value of our long-lived assets. In the second and third quarters of 2002, we completed an impairment review of certain manufacturing assets used in the substrate and opto-electronics divisions. The review was undertaken due to the recent history of operating losses, declines in the demand for our products due to macro economic conditions, the Company’s inability to manufacture high volumes of its LED products to the Company’s customers’ requirements, and excess capacity resulting in part from the addition of certain manufacturing operations in our substrate division in China. Upon completion of the review, we determined that the carrying value of the manufacturing assets was not expected to be recoverable and accordingly recorded an impairment charge in order to write-down the related assets to their estimated fair value. We determined the amount of the impairment charge by estimating the net present value of expected future cash flows to be generated by the assets. Based on this analysis for the nine months ended September 30, 2002, we recorded non-cash impairment charges of $14.1 million in the substrate segment and $23.9 million in the opto-electronics segment.

     In connection with the preparation of our consolidated financial statements, we must estimate our income taxes by the jurisdiction in which we operate. This process requires us to estimate our actual current tax exposure and asses temporary differences resulting from differing treatment of items, such as deferred revenue and/or expense, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations.

     Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against our net deferred tax assets. We have recorded a valuation allowance of $24.5 million as of September 30, 2002, due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of certain net operating losses carried forward and tax credits, before they expire. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to establish an additional valuation allowance which could materially impact our financial position and results of operations.

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Results of Operations

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