Philip Yin – Chairman, Chief Executive Officer Wilson Cheung – Chief Financial Officer

Richard Shannon – Northland Securities Pierre Maccagno – Needham & Company Michael Burch – Kennedy Capital [Peter Trapp – DeVoss Fund] [Matt Reiner – Adirondack Funds]

With us today is Wilson Cheung, our Chief Financial Officer. Wilson will take you through a detailed financial overview of our second quarter results, and then I will give you my perspective on our markets and future opportunity.

Following the conclusion of my comments, Wilson will provide forward-looking guidance and then we'll open up the call to your questions.

Before we begin, I would like to remind you that during the course of this conference call including comments made in response to your questions, we will provide projections or make other forward-looking statements regarding among other things, the future financial performance of the company and our ability to maintain profitability, growth in our customer base and expansion of our industrial markets, increasing market share, progress in our product qualifications with customers, our ability to resolve technical issues resulting in increased shipments, growth in our gallium arsenide and substrate business and continuing demand for new and existing customers, as well as other market conditions and trends. We wish to caution you that such statements that deal with future events are based upon management's current expectations and are subject to risks and uncertainties that could cause actual events or results to differ materially.

In addition to the factors that may be discussed on this call, we refer you to the company's periodic reports filed with the Securities and Exchange Commission and available online by link from our web site for additional information on risk factors that could cause actual results to differ materially from our current expectations. This conference call will be available on our website at axt.com through July 30, 2009.

Also before we begin I want to note that shortly following the close of market today, we issued a press release reporting financial results for the second quarter. This press release can be accessed from the Investor Relations section of AXT's website at axt.com.

Turning to our financial results, revenue for the second quarter of 2008 was $19.9 million compared with $19.6 in the first quarter of 2008. Gallium arsenide and substrate revenue was $13.1 million for the second quarter of 2008 compared with $15.7 million in the first quarter of 2008.

Specifically, six inch diameter [wafer] sales were $5.5 million for the second quarter compared with $5.9 million in the first quarter of 2008. Phil will explain the short fall of the six inch later in the call.

Gallium arsenide and substrate revenue was $500,000 for the second quarter of 2008 compared with $478,000 in the first quarter of 2008. Gallium substrate revenue was $1.4 million same as the first quarter of 2008.

Finally, sales of raw materials was primarily 99.99% in pure gallium were $4.9 million in the second quarter of 2008 compared with $4 million in the first quarter of 2008 as we shipped more orders to customers to avoid transportation restrictions prior to the commencement of the Beijing Olympics. We expect sales of raw materials to return to about $3 million to $3.5 million in the third quarter.

In the second quarter of 2008 revenue from North America was 27%, Asia Pacific was 53% and Europe was 20% of total revenue. Two greater than 10% customers generated a combined 22.7% of our revenue during our second quarter while the top five customers generated 34% of our second quarter revenue.

Gross margin was 32.3% of revenue for the second quarter of 2008. This included a benefit from the sale of approximately $735,000 in fully reserved wafers which positively affected the quarterly gross margin by 3.7%.

By comparison, gross margin in the first quarter of 2008 was 31.7%. This included a benefit from the sales of approximately $620,000 in fully reserved wafers which positively affected first quarter gross margin by 3.2%.

Excluding stock compensation expenses, selling general and administrative expenses were $3.5 million for the second quarter of 2008 compared with $3.5 million in the first quarter of 2008. On July 3, 2008 we entered into a new lease agreement with the landlord to be effective December 1, 2008.

We expect the new lease will save us approximately $2.6 million over a seven year period. Also excluding stock compensation expenses, research and development costs were $540,000 for the second quarter of 2008 compared with $472,000 for the first quarter of 2008 as we continue with more products testing in R&D.

Total stock compensation expense was $151,000 in the second quarter of 2008 of which $10,000 was in cost of revenues, $112,000 in SG&A and $29,000 in R&D. Income from operations for the second quarter of 2008 was $2.3 million compared with $2 million in the prior quarter.

Net interest and other expenses for the second quarter of 2008 was $925,000 compared with net interest and other income of $552,000 for the first quarter of 2008. Our second quarter 2008 other expense of $925,000 included foreign exchange losses of $593,000 primarily due to A/R collections from Yen denominated Asian customers and from our China joint ventures who sell raw materials denominated in U.S.

dollars and the loss and sale of investment of $133,000. Our first quarter 2008 other income of $552,000 included a gain on sale of investments of $459,000.

Our tax provision for the second quarter of 2008 was $635,000 compared with $560,000 for the first quarter of 2008. The increase was due to a higher percentage of revenue in a net income contributions from our China joint ventures.

Due to the impact of the foreign exchange loss of $593,000 plus the loss and sale of investment which made up approximately $0.025 eps, our net income in the second quarter of 2008 was $737,000 or $0.02 per diluted share. By comparison, in the first quarter 2008, we reported net income of $2 million or $0.06 per diluted share which included approximately $0.15 to $0.02 eps from our gain on sale of investments.

Let's now look at our cash on the balance sheet. Cash and cash equivalents with maturities of less than three months short term investments and other investments in high grade debt securities with maturities of less than two years, including restricted deposits were $43.4 million at June 30, 2008 compared with $46 million at March 31, 2008.

As I mentioned last quarter we have notified the bond holders to pay down our debt, and accordingly on July 1, 2008 we paid down $6.4 million and released all of our restricted cash. Accounts receivables, net of reserves were $13.6 million at June 30, 2008 compared with $16.7 million at March 31, 2008.

Day sales outstanding was at 62 days for the second quarter compared with 77 days in the prior quarter. Net inventory was $38.9 million at June 30, 2008 compared with $29.1 million at March 31, 2008.

As we noted last quarter, we continue to build inventory of raw materials prior to the commencement of the summer Olympics to avoid transportation restrictions. Also, we increased our work in process inventory for higher production based on higher sales forecast for the remainder of 2008.

And finally, we increased our finished goods inventory as we shipped out more to customers on consignment. Our cash use in operations for the second quarter was approximately $100,000.

Depreciation and amortization in the second quarter was $507,000 and capital expenditures were $2.5 million. As of June 30, 2008 the company, including our consolidated joint ventures has 1,200 total employees of whom 965 worked in production.

This concludes our financial review. Let me now turn the call back to Phil.

Despite the near term set backs to our gallium arsenide revenue results in the second quarter, our business as a whole performed very well. We experienced strong growth in several key accounts and we've made significant progress in qualifications with tier one customers across all of our major product lines.

The ongoing diversification that we have achieved over the last two years allows us to weather three unexpected events, meeting our revenue goals and exceeding our operating target in the second quarter. Further, the market for our products has remained solid with the exception that some weakness in the low cost hand set application, and continue to provide opportunities for growth in Q3.

Let's begin by giving you a little more color on the events that affected our second quarter revenue. As Wilson mentioned earlier, we had three primary issues in the second quarter that collectively impacted our Gallium arsenide revenue posing an overall net decline of approximately $400,000 from the prior quarter.

The first event was a major U.S. customer closing its operations during the second quarter resulting in a loss of revenues from them for six inch Gallium arsenide substrates.

The second issue we faced was that a major non U.S. customer shut down its operations for two weeks for routine annual maintenance.

And finally, we also encountered a parametric with six inch substrates with the same customer due to a change in their application of our substrates during the second quarter. We are working closely with them to reach a solution and our sequence of six inch substrates have already begun to resume in the third quarter.

We expect our shipments to ramp over the balance of 2008. While the pause in our growth was disappointing, especially given our momentum in recent quarters, we believe that most of the revenue will come back over the next few quarters.

Further, the impact to our revenue from these issues belies excellent progress at several other accounts. We significantly increased our shipments to another U.S.

based company responding to very positive growth in their business. Further, while the hand set market showed pockets of weakness, we continue to benefit from solid growth in a number of key suppliers.

We believe that this is the result of certain market share shifts at the hand set level that have favored our customer base. Also, the hand set market sales mix currently seems to reflect a higher percentage of video and smart phones and successful new offerings from Apple, Samsung, LG, Rim, Nokia and others.

The increased feature sets and functionality of these devices drive Gallium arsenide content. We believe that sales of these types of phone will continue to increase as customers are inventing more robust and intelligent mobile computing devices for enterprising, great mobility and portable entertainment.

Further, we noted last quarter we believe that our growth is also coming from our own market share gains as we have continued to expand our production capability to support our customers' needs and made meaningful progress with high priority accounts that have done limited or no business with AXT in many years. In fact, based on some of our major customers' future forecast requirements, we're in the process of implementing a 27% expansion of our six inch semi insulating Gallium arsenide capacity to be completed in Q4 of this year.

We believe that this expansion will be increasingly beneficial as we continue to see major industry trends towards large diameter substrates. Strategy analytics is now estimating that the merchant demand for four inch material will decline by more that 20% by 2009.

The demand shift to six inch material will increase from 63% of the total market revenue in 2007 to 76% in 2012. This shift is very positive for AXT as we have the facilities necessary to accommodate this growth in demand and the capability to build our own crystal growth furnaces at a significant discount versus commercially available furnaces.

In total, we believe that a Gallium arsenide business is very solid and we will see resumed growth in the third quarter. Now let's turn to semi conductor Gallium arsenide.

We continue to see a massive proliferation of semi conducting based LED devices and an increasingly broad array of applications. In particular, shipments to general illumination, automotive, flat panel TV, and signage and display applications are expected to show strong growth over the next five years.

We continue to selectively pursue opportunities that allow us to penetrate these and other high volume applications while preserving a gross margin performance. We are pleased to report excellent progress in our qualification with two major LED manufacturers and look forward to completing the process in the second half of this year.

We are also pleased to report that we will begin moving to more automated processing our of small diameter substrates in Q3 to further enhance our quality and improve our manufacturing efficiency and cost control. Turning to Gallium substrates, we continue to see strong world wide interest in photovoltaic technology.

Europe continues to lead the rest of the world with the greatest number of installations in Spain. And in addition, government subsidies in the U.S., Asia and Australia are promoting the development of technology around the world.

Concentrated photovoltaic comfortably holds the record for conversion efficiency of solar energy, delivering near 40% as compared with less that 20% for silicon. In fact, Strategy Analytics recently reported that they expect the germanium based market to terrestrial photovoltaic materials to grow by approximately 133% through 2012 to reach approximately $3.5 billion.

Further, they expect the concentrated photovoltaic segment of that market to increase from the current 1% to reach about 10% by 2012. In terms of our own revenue from germanium substrates, following a very strong first quarter where our revenues doubled from the quarter before, our second quarter revenues were approximately flat at that higher level.

We are currently in line for production of two customers and we have a third customer in the final stages of qualification. We also have three other customers in qualifications and expect to see continued growth in our germanium substrate revenues throughout the year.

With a worldwide focus on alternative energy such as wind, biofuels, nuclear and other sources, solar energy with all its various technologies will maintain its robust growth well into the next decade. In fact, we are seeing many of our customers that have excess epi capacity not only requesting pricing for our germanium substrates but also forward pricing for an expected industry conversion to six inch diameter.

Turning to our raw materials, revenues in the area were a bit stronger than normal in Q2 as a result of accelerated shipments from our joint ventures due to the potential transportation restrictions on shipments leading up to and during the summer Olympics. As we reported last quarter, we had built some raw materials inventory of our own in order to protect ourselves from the likelihood that we may not be able to transport raw materials from our current joint ventures to manufacturing facilities during this time frame.

We believe that these precautions will be sufficient to assure smooth shipment schedules for our production throughout the quarter. In general, we see prices for raw materials and arsenic beginning to stabilize as expected as our joint ventures continue to sell to their capacity, creating positive gross margins upside for us.

Demands for [four ninths] Gallium arsenide continues to be so strong that our joint ventures are implementing approximately 50% capacity increase to bring it up to 30 metric tons of raw materials by the end of the year. In conclusion, although the macro economic environment remains somewhat uncertain, we believe that our growth is more related over the short and long period to the industry trends that are converging in our favor and the market share gain that we continue to make.

The U.S. market is an important end market for many of our customers' products and weakness here has prompted us to continue to be conservative in our planning and outlook.

But the Gallium arsenide market will continue to growth over time both as hand set and LED applications push the demand for high efficiency and low power devices. Further, the drive for alternative energy is in its infancy with a long growth ahead.

Therefore, we feel that we have significant competitive advantages to address a growing market and that opportunities will only strengthen as the economic backdrop improves.

We estimate that our revenue for the third quarter will increase to between $20.1 million and $20.5 million. Also, we estimate our net income per diluted share will be between $0.03 and $0.05.

This concludes our prepared comments. We're now happy to answer your questions.

My first question is about this major Asian customer you mentioned both in your script as well as your press release. The language in the press release was a little uncertain to me.

Are you actually returning to shipping the six inch wafers to them already in the third quarter? Is that something you expect to do at some point?

Let me be a little bit more specific. First of all, I just want to make sure that people understand that this is not an issue with our quality or consistency of our wafers.

The issue really arose when the customer really changed the application of our product that was used and there, it affected the epi process. So basically, our substrates are not performing that well on this new process and once we resolve this issue and move to new reactors which are where our product performs better, we expect the volumes to regain again.

I remember back in the third quarter last year where you talked about a spec mismatch. Was that similar to the situation you're describing just now?

No that was a different issue.

Is this customer for semi conductors or semi insulating?

Semi insulating.

The second question related to the foreign exchange losses. Do you consider this to be a one time issue, or is this something that's continuing?

I took a look at your last couple of Q's and noticed that you didn't have any foreign exchange contracts in place as of the end of the quarter so I'm kind of curious as to how you look at this.

We are actually looking into this matter right now and I can tell you that we do have foreign exchange gains and losses every quarter, but this quarter in particular is a little higher because on our A/R we actually have a higher percentage of the A/R that are Yen denominated where we actually need to market. In fact in Q1 of last quarter, we actually recognized the game when we do the math to market.

One of the things that we're looking at right now is we want to determine what is the overall cost versus benefit to do a hedge. We also have to look at the internal bandwidth, how much it will cost us and also the disclosure requirements on [VAS 143] whether we're going to do the hedge or not.

So we're doing all that. But there's another approach that we're looking into is that we'll go ahead and talk to customers to see how open that they are in setting the contract price in U.S.

dollars, but that remains to be seen.

Next question specifically in Gallium arsenide six inch wafers, you talked about a resumption of growth in the third quarter here. Can I get a sense of where you think that number could come out in the third quarter?

Is that something you can get to the level you saw in the first quarter or above that? I want to feel you out how you think about that number.

I think there'll be a combination. One is regaining the volume that we had in the previous quarter from one of these customers that we had the issue with, and new customers completing qualifications and wrapping up their schedule.

Let me also add by saying that if you look at our guidance for Q3, and as I mentioned on the script, we're expecting raw materials sales to be between $3 million to $3.5 million. So even with my overall revenue guidance to over $20 million, we're really talking about over $2 million in incremental revenues mostly coming from the six inch.

The last question for me specific to your guidance, your revenue guidance for the quarter, a little bit higher than last quarter, I'd love to get the sense of how you feel, how you're looking at the discrete categories like gross margins and OpEx to get down to that bottom number of $0.03 to $0.05 in GAAP. What do you think about those general numbers?

I can tell you that as far as the $20.1 to $20.5 million, we're really expecting the gross margin range only to be between let's say 20% to 30%. As you go down to the P&L, I think R&D and SG&A will probably stay at the same level.

Income taxes, that always varies quarter by quarter but in my modeling guidance, I only put between $500,000 to $600,000 for the quarter for the income tax provision. So that gives me between $0.03 to $0.05.

Could you talk a little bit more about the collective impact of the three events? What was the total impact, and also could you talk about each of them?

Could you say which was from more important to less important?

Specifically one is, and you probably know who it is, the entire plant closed down in the West Coast. That was a big hit.

That was all six inch. And the other two that I just mentioned, the total hit was about $1.6 million to $1.7 million.

And net net wise, we made most of it up. So really it's only [Bond & Kay] so we've made that up, but the total hit was about to $1.6 million to $1.7 million.

And we made that up with customers.

So this was totally unexpected.

Absolutely. Especially the shutdown, and then the applications, they used our materials for different applications which they didn't tell us.

And when they did tell us, through discussions we found out that was the case.

You could have had a very impressive...

We would have blown it out of the budget.

Could you give us what would be the pro forma EPS if you don't include the options expense?

The option expense actually wasn't that much. We're only talking about $151,000 so that's about half a cent.

But if you also take into account the non operational items like the foreign exchange losses of $593,000, if you also take out the loss of sale of securities that's worth $133,000. Both of those two, it's already close to $0.02, so that could be added back to our GAAP EPS number.

And you're expectation of EPS of $0.03 to $0.05 is pro forma?

No. That is a GAAP number.

If it were pro forma?

We don't really give pro forma numbers but I can tell you that as in the past, stock compensation expenses will always be around $200,000. We also put in fully reserved wafers at about $250,000 per quarter, so you can do the math and take those out when you calculate the pro forma EPF number.

Just a quick question for you on the inventory. I see you've built some ahead here.

Where would you expect that to trend over Q3 and Q4?

I can tell you that we have been stockpiling raw materials for the last few quarters in anticipation of the Olympics. So I would say from the raw materials perspective we should actually start to see that peaking in Q3.

In terms of finished goods, the ups or downs for that would really depend on whether we have any other tier one customers that may want to do consignment inventory arrangements with us. If we for example, get another customer, that we're actually talking to right now, do decide to do consignment inventory, that may not come down.

But I would expect the raw materials portion to come down.

So in terms of an absolute overall number, would you expect that to come down or come down in days?

Absolutely.

But keep in mind that some of our tier one customers, if their ramp or volumes increase the consignment is going to increase too in proportion.

In terms of the gross margin question on Q3, do you think that's more pertaining to mix in terms of trimming a little bit, or is that something where you could say, okay, we had some production and we accounted for in Q2, we're not going to have as much production in Q3. How should I think about that?

I think it's a combination of two things. One is product mix because as I said earlier, we expect the raw materials revenues to come down which we normally enjoy a high percentage of gross margins, but at the same time, Phil has been talking about the fact that we're buying some of these raw materials for example, germanium, and even Gallium, we're buying those at higher prices in the last few quarters.

So those raw materials that we bought, they actually came in at a higher cost so when we manufacture we'll be using those new costs coupling with the gross margins for the sales for Q3 and Q4.

I know we've talked about it before but with the costs going up is there a point where you can get any pricing power to pass any of that on, or are you just pretty much kind of squeezed?

I guess as a general outlook right now, I think six inch is basically stabilized and semi insulating, the small diameter meaning specifically two inch, especially two inch and three inch, semi conducting materials for the entire industry is [inaudible] is still getting price pressure on that. And the major reason for that is the LED manufacturers are trying to compete with the introduction of fluorescence lights so they've got to get their costs down.

We're basically solid state lighting, that's what's driving it.

I was listening to a call yesterday where they talked about the Gallium arsenide outlook being extremely strong and Gallium nitride as well. As I listened to your comments about your sales and qualifications etc, I'm assuming that you must be getting close to where you can somehow estimate or project that some of this extremely strong, that they were talking about yesterday, that you're going to get a piece of that.

Can you comment on that?

When you say strong, you're saying the entire Gallium arsenide market? What is the specific application?

Hand sets among others.

We are already in qualification as I mentioned in several of our customers that we haven't done business with in several years.

Is that close enough that you could say that third or fourth quarter you're going to get a piece of that?

That's next years potential. We are already now with some of them, and definitely in the third and fourth quarter some of these guys will ramp up and some of the guys will be coming on.

They're at various stages.

The other question I had, on the Forex losses, I'm assuming that's a mark to market so therefore that's a non cash issue?

It is mark to market, but it's a timing issue.

To the extent that you had to prepare statements as of June 30. I'm assuming that on July 1 and July 30, or whatever date it happens to be, that that number could be either larger or smaller.

Correct. I think by the time when we collect the A/R if the exchange rates changed again to our favor, then I will be collecting more.

So you're correct.

So my guess is with the dollar strengthening this amount of money that you had to report as a loss will actually start to decline.

Actually, then we would have to report back a gain.

The other question I have on the Forex is do you have in place some kind of method whereby if the Forex loss goes over X, it sets off a red light or something because that is a rather large swing to have gone from positive $250,000 to minus $500,000 in the course of one quarter.

We are definitely discussing that between management and the Board.

What happens is that even though it's non cash it creates obviously some significant volatility to your earnings and volatility is normally repaid in the market by a compressed multiple.

Your note is well taken.

With the cash sitting on the balance sheet, and I understand how important it is to be conservative in these difficult times, are you any further along with conversations of JV's or increased participation on JV's? How is that going along?

Can you comment, give us any comments on that?

The only comment I can give you is we're continuing to discuss.

I noticed that your gross margin is pro forma based with 36%. Am I right there, and if so it's a dramatic increase from 28.6% last quarter.

If I take out the impact on the fully reserved wafers I only have a 10 basis point difference. So if you read the press release, we basically said that the gross margin was 32.3% and the fully reserved wafers made up 3.7%, so you can just take 32.3 and minus 3.7 to come up with your pro forma number.

And then last quarter, was 31.7$ and you can minus the impact of 3.2% to get the pro forma number for last quarter. And I believe that if you do the math right, it's only about a 10 basis point difference.

Going back to inventory, can you give us a little more quantification to how much the increase of the raw materials built up versus the possible finished goods increase?

I can tell you that the majority of that increase in the last quarter, I would say between $5 million and $6 million was raw materials. We have a little increase on [inaudible] and maybe another $1 million or $2 million in finished goods which is mostly due to the consignment arrangements that we have with the customers.

Wilson, I noticed that accounts payable were up from $4 million to $14. Could you just give us some commentary?

That seems like a rather large increase percentage.

This is mostly due to timing because we placed the orders to purchase raw materials and so we have increased my inventory and also increased my A/P. So over time, we've got to pay the inventory with our cash on the accounts payable.

That's all it is then. It's just the materials.

Yes. The majority of that increase in the A/P was due to the raw materials purchases.

In your cash and cash equivalents and then in your short term investments is there anything in there that requires taking a little extra look at in the sense of maturities getting pushed out or liquidity issues or are you okay?

We are always looking at that on a monthly basis.

But there hasn't been any need for any concern is what I think I'm hearing you say.

Not at this point. I think we do have enough for working capital purposes.

If anything other than working capital, then we've got to rethink our strategy. But at this point, nothing concerns us.

Thank you everyone for participating in our conference call. And during the third quarter we'll be visiting investors in several cities around the country, and we look forward to seeing you there.

Talk to you next quarter.