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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 28, 2003

OR

[   ] 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 23103

APPLIED FILMS CORPORATION
(Exact name of registrant as specified in its charter)

9586 I-25 Frontage Road, Longmont CO 80504
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (303) 774-3200

Securities registered pursuant to Section 12(b) of the Act: None.

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

Common Stock, no par value (Title of Class)

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 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  X   No ____

Indicate by check mark 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 amendments to this Form 10-K. [ X ]

The aggregate market value of the common stock held by non-affiliates of the Registrant, based on a per share price of $20.33 as of December 27, 2002, was $217,280,046. As of August 27, 2003, there were outstanding 11,187,137 shares of the Company’s Common Stock (no par value).

Documents Incorporated by Reference: Portions of the Company’s Proxy Statement for the 2003 Annual Meeting of Shareholders are incorporated by reference into Part III of this Report.

PART I

ITEM 1: Business

The following discussion contains trend information and other forward-looking statements (including statements regarding future operating results, future capital expenditures, new product introductions, technological developments and industry trends) that involve a number of risks and uncertainties. Our actual results could differ materially from our historical results of operations and those discussed in the forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, those identified in “ITEM 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the section entitled “Risk Factors.” All period references are to our fiscal periods ended June 28, 2003, June 29, 2002, or June 30, 2001, unless otherwise indicated.

Applied Films Corporation’s (“Applied Films,” or the “Company,” or “We”) Internet address is www.appliedfilms.com. We make available free of charge on our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. In addition and at no extra cost, we will also provide, electronic or paper copies of our reports and other filings made with the Securities and Exchange Commission. All requests should be directed to Applied Films Corporation, Attention: Lawrence D. Firestone, 9586 I-25 Frontage Road, Suite 200, Longmont, Colorado 80504.

The information on our website is not and should not be considered part of this annual report on Form 10-K and is not incorporated by reference in this report.

ITEM 1(a): General Development of Business

Introduction

Applied Films Corporation is a leading provider of thin film deposition equipment to the flat panel display, the architectural, automotive and solar glass, and the consumer products packaging and electronics industries. Our deposition systems are used to deposit thin films that enhance the characteristics of a base substrate, such as glass, plastic, paper or foil. These thin films provide conductive, electronic, reflective, filter, barrier and other properties that are critical elements of our customers’ products. Our thin film deposition systems provide our customers with high yield and throughput, flexible modular configurations, and innovative coating and process technologies. Through our China Joint Venture we process and sell thin film coated glass to the flat panel display, or FPD, industry.

We leverage our thin film expertise, technology and market presence to address the evolving demand for more sophisticated, technologically advanced thin film deposition equipment. Our manufacturing operations in Germany together with our global sales and support offices enable us to provide thin film coating solutions to customers throughout the world. We have sold over 90 FPD deposition systems, 45 architectural and automotive glass thin film deposition systems, and 500 web coating systems. We have over 80 patents and patent applications related to thin film technologies.

Markets We Serve

Our thin film solutions enable our customers to offer the latest product innovations in the following markets:

Flat Panel Displays. FPDs are used in a wide variety of consumer and industrial products, including laptop and flat panel desktop computer monitors, liquid crystal display, or LCD televisions, plasma display televisions, cellular telephones, personal digital assistants, calculators, pagers, scientific instruments, portable video games, gasoline pumps, automotive instruments, point-of-sale terminals and a number of other electronic devices. Virtually all FPDs require optically transparent, electrically conductive thin films coated on substrates such as glass. Growth in the FPD market is driven by consumers’ desire for increased access to information in wireless and portable communication devices with display capabilities. Consumers also desire to replace heavy, bulky cathode ray tube, or CRT, monitors and televisions with thinner, lighter FPDs. The increasing affordability of FPDs significantly expands the potential market.

Architectural, Automotive and Solar Glass. Thin film coated glass is used in buildings for exterior window glass, automobiles for windshields and side windows and solar energy collecting applications. Applying certain thin films on glass significantly reduces heat transfer through the glass, improving the efficiency of heating and cooling systems in buildings and vehicles. In addition, thin films form conductive layers and are integral components of solar cells. Demand for architectural and automotive coated glass is driven by the need for energy conservation in commercial and residential construction and increasingly, in automotive applications. The demand for alternative energy sources also drives demand for solar cells as we seek to reduce the demand on municipal power grids worldwide.

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Consumer Products Packaging and Electronics. Web coating systems are used to deposit thin films on multi-layer flexible packaging for consumer food products and cigarettes. Web coating systems are also used to produce capacitors and other electronic components. Thin films are applied to a thin plastic or metal foil substrate to create a barrier, extending shelf life in consumer food products. Thin films provide the conductive and electronic elements critical to the manufacture of certain electronic products, such as capacitors and touch panel screens. The packaging market for web coaters is driven by demand for products packaged in bags and for decorative packaging. Demand for touch panel applications and capacitors is driving the electronics market for web coaters. We have developed thin films for the plastic bottling industry that improve the barrier characteristics of polyethylene terephthalate, or PET bottles, extending the shelf life of beverages by reducing the rate at which carbonation escapes or contaminants enter the bottle. The demand for PET bottles with more efficient barrier characteristics is driven by the bottlers’ desire to transition away from glass in favor of plastic.

Our Thin Film Technology Solutions

Over the past 27 years, we have developed leading thin film process and equipment technologies that we leverage to meet our customers’ needs for sophisticated, technologically advanced thin film deposition equipment. We have over 80 patents and patent applications related to thin film technologies, and we continue to invest in research and development. Historically, we manufactured our own equipment to produce thin film coated glass and have used that experience to transition our business to the design and manufacture of thin film deposition equipment.

Our broad range of thin film deposition equipment solves critical manufacturing issues for our customers with innovative coating and process technologies. We provide in-line or batch, high or low volume, high-yield deposition systems to coat thin films on large, rigid or flexible substrates. Our deposition solutions are highly specialized for our customers to enhance the electrical, optical and barrier qualities of the substrates used in their products.

The principal methods of deposition that we integrate in our systems are physical vapor deposition, or PVD, evaporation, and plasma enhanced chemical vapor deposition, or PECVD. PVD is a process technology in which molecules of coating material are bombarded with ions, or sputtered, from a target or source material. The material is then deposited on the substrate as a thin film. In the evaporation process, an electrical current is passed through the target material in a vacuum until it vaporizes and is then deposited onto the substrate as a thin film. PECVD is a process where plasma, a high energy field, is used to initiate a chemical reaction which then deposits a newly formed thin film onto the substrate. With each deposition method, the quality of the coatings, the cycle time of the process, the utilization of materials, and other factors are controlled by our technology solutions.

Our manufacturing operations in Germany, together with our global sales and support offices, enable us to provide thin film deposition solutions around the world. Our knowledge, understanding of customer thin film coating requirements, and ongoing research and development enable us to make continuous improvements that provide our customers with high value and increasingly advanced technological solutions. The depth of our experience and technologies enables our customers to continue to develop innovative products for their current and future markets.

Strategy

Our objective is to enhance our position as a leading supplier of thin film deposition equipment. Key elements of our strategy include:

Focus on High Margin Equipment Opportunities. We have successfully implemented our strategy of transitioning from supplying thin film coated glass to manufacturing thin film deposition equipment. This transition has substantially improved our gross profit margins, as higher-margin equipment sales now constitute greater than 95% of our revenues. We will continue to focus our research and development on process technologies designed to increase our value to the customer and further improve our margins.

Leverage Our Leadership in Our Core Markets. We are a market leader with the largest installed base of inline systems for the FPD, the architectural and automotive glass markets, and the consumer products packaging and electronics markets. We have sold over 90 inline FPD deposition systems, 45 architectural and automotive systems, and 500 web coating systems. We believe our reputation as a high quality supplier of thin film deposition equipment allows us to establish key customer relationships and to grow with these customers as they develop new products and to meet new market requirements. We intend to utilize our strong technological capabilities to capture additional market share in core markets.

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Target Emerging High Growth Market Opportunities. We have recently entered and are focusing our research and development efforts on three growth markets for solar cell, organic light emitting diodes, or OLEDs, and barrier coated PET bottles. We have installed development and pilot production tools for each of these markets, and are working with our strategic partners to develop our technologies in each of these areas.

Engage in Strategic Relationships. Our strategic relationships have influenced our technological direction, maximized our research and development investments, and enhanced the sales, marketing and distribution of our products. For example, we have been working with a strategic customer in the OLED market who has purchased one of our systems and is working with us as we develop the thin film and process technologies to shorten our development time for a high volume production solution for color OLED’s. We have also developed process technology with the cooperation of the major energy companies to advance our process technologies for the solar cell market. We continue to develop our barrier coating process technology for PET bottles in partnership with The Coca-Cola Company. We also entered into a joint venture in China (referred to as the China JV or the Joint Venture) with Nippon Sheet Glass Co., Ltd., or NSG, one of the world’s largest supplier of glass to the FPD market, through which we coat and distribute glass to the FPD industry. We will continue to pursue strategic relationships with industry leaders in each new market or market segment that we enter.

Continue to Serve Diverse Markets. We have applied our thin film technology to diverse markets ranging from consumer packaging for potato chip bags to plasma displays for televisions. We will continue to serve and invest in extensions of these diverse markets because we believe this reduces our exposure to the cyclical nature of any individual market.

ITEM 1(b): Financial Information About Industry Segments

We supply thin film coated glass primarily to LCD manufacturers and thin film deposition equipment to several markets, which are currently considered to be two separate industry segments. For further discussion see “ITEM 8: Financial Statements and Supplementary Data — Note 11: Segment Information”.

ITEM 1(c): Narrative Description of Business

Products

Our thin film coating systems are used in many different applications spanning four distinct markets. The following table illustrates our principal products:

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Thin Film Deposition Equipment

Flat Panel Displays

Our flat panel display in-line deposition equipment applies conductive, optical and barrier coatings for manufacturing high information content, color displays such as high resolution liquid crystal displays, or LCDs, and plasma display panels, or PDPs, used in computer monitors and high definition televisions.

NEW ARISTO. Our NEW ARISTO is an advanced thin film deposition system that accommodates the largest mother glass sizes including generation 6 and 7 and meets the low particulate requirements of the active matrix LCD, plasma display television and color super twisted nematic, or CSTN, coated glass markets. The system features high throughput, low cost of ownership and the capability for double-sided coatings.

VES 400. Our VES 400 system is an advanced production thin film deposition system for the OLED market. The VES 400 applies all of the thin films necessary for an OLED device including the metal layers and organic layers in a vacuum. The VES-400 is targeted at providing OLED manufacturers with the ability to produce OLED devices in production volumes. We believe this is the first vertical in-line deposition system developed for OLED.

Architectural, Automotive and Solar Glass

Our architectural and automotive thin film deposition systems apply Low-E coatings on large glass substrates used in building glass and automotive windshields. Our solar glass coating systems apply thin films that create the conductive layers on substrates used for energy collection in solar cells.

Terra-G.   Our Terra-G thin film deposition system is our most advanced coating system designed for the large architectural and automotive glass market. The Terra-G uses large planar magnetron or rotary cathodes and uniformly deposits multiple thin films across a large area at very high throughput rates. The Terra-G can be up to 130 meters long and can deposit complex layer stacks of different thin films on a single side of glass.

SOLARISTO.   Our SOLARISTO thin film deposition system, a derivative of the NEW ARISTO, is a vertical in-line system that handles medium-sized glass substrates. The SOLARISTO uses planar magnetron cathodes or a linear PECVD source and deposits multiple thin films on the substrate, which is moving vertically through the system.

ECOVERA.   Our ECOVERA thin film deposition system is a vertical coating system that applies the functional layers and transparent conductive oxide layers for amorphous silicon and microcrystalline solar cells.

ATON.   Our ATON thin film deposition system is a horizontal sputtering system that applies silicon nitride and other thin film layers for a polycrystalline water based solar cell.

A-650.   Our A-650 thin film deposition system is a horizontal coating system that applies the functional layers and other thin film layers for CIS or CIGS solar cells.

Consumer Products Packaging and Electronics

Our consumer packaging and electronics coating systems deposit thin films on flexible substrates used in various markets such as food packaging, decorative packaging or electronic applications such as electromagnetic interference shielding, capacitors, and touch panel applications. Thin films are applied to a thin plastic or metal foil substrate to create a barrier to promote freshness and extend shelf life in consumer products and are used as conductive coatings in the manufacture of certain electronic products, such as capacitors and touch panel screens.

TOPMET.   Our TOPMET web thin film deposition system provides a solution for coating metal materials on flexible substrates. The TOPMET uses thermal evaporation to deposit thin film layers of aluminum in a vacuum onto flexible substrates, usually film, paper or textiles in roll format.

MULTIMET.   Our MULTIMET web thin film deposition system uses evaporative deposition technology to deposit thin films on very thin foil at high speed in a vacuum for the capacitor market. The MULTIMET offers the ability to mask specific patterns on substrates.

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TOPBEAM.   Our TOPBEAM web thin film deposition system uses electron beam evaporation technology to produce transparent thin film barrier coatings used in the food packaging industry. The TOPBEAM web coating system uses high powered electron beam guns to evaporate metal or metal oxide.

MULTIWEB.   Our MULTIWEB thin film deposition system uses PVD processes to apply thin film conductive coatings primarily for touch panel applications.

BESTPET-LG 20. Our BESTPET-LG 20 system deposits silicon oxide on plastic bottles at a rate of 20,000 bottles per hour. The system deposits transparent thin film coatings on the outside of the bottle using evaporation technology.

Thin Film Coated Glass

TN, STN and CSTN Coated Glass. Our joint venture in China is a leading producer of twisted nematic or TN, super twisted nematic or STN and color super twisted nematic or CSTN coated glass that is used for low resolution black and white and color LCDs. Our customers incorporate these LCDs into consumer products that include cellular phones, personal digital assistants and electronic instruments. To produce TN, STN, and CSTN coated glass, our Joint Venture uses our proprietary in-line coating systems and batch systems to deposit thin films on high quality glass panels. Our Joint Venture then packages and ships the coated glass panels to their customers for incorporation into their products.

Sales, Marketing and Customers

We have sales offices in the United States, Germany, Hong Kong, Belgium, Taiwan, Korea, Japan and China, and utilize sales representatives worldwide to supplement the marketing activities of our sales force. The sales cycle for thin film deposition equipment is long, involving multiple visits to and by the customer. We usually sell our thin film deposition equipment on a progress payment basis. We generally sell our thin film coated glass on open account, most of which are backed by letter of credit, or insured. Our customer payment history has been excellent.

In fiscal 2003, our ten largest customers accounted for approximately 53% of our gross revenues. Revenue from Guardian Industries Corporation represented 13.3% of net revenue for fiscal 2003. Approximately 71% of our fiscal 2003 net revenues were derived from exports to our customers outside of our manufacturing center in Europe, primarily to Asia. The demand for FPD thin film coated glass is primarily in Asia, and our customers for thin film deposition equipment have historically been predominately located in Japan, Korea, China, Taiwan, Europe and the United States.

Customer Service

We provide technical assistance and spare parts to support our customers. Technical assistance is an important factor in our business as most of our thin film deposition equipment is used in critical phases of our customers’ manufacturing. Field engineers install the systems, perform preventive maintenance and repair services, and are available for assistance in solving customer problems. Our global presence permits us to provide these functions in proximity to our customers. We also maintain local spare part supply centers to facilitate quick support.

We provide maintenance during the product warranty period, usually one year following product acceptance, and thereafter perform maintenance pursuant to individual orders issued by the customer. Our customer service operations are also responsible for customer training programs, spare parts sales and technical publications. In appropriate circumstances, we will send technical personnel to customer locations to support the customers for extended periods of time to optimize the use of the equipment for the customer’s specific processes.

Manufacturing and Facilities

Our Longmont, Colorado, headquarters net of a sublease contains approximately 87,000 square feet and include general offices and research and development. This facility is leased from an independent third party.

Our Alzenau, Germany, manufacturing facility contains approximately 260,000 square feet and includes general offices, research and development facilities, and equipment manufacturing facilities. This facility is leased from an independent third party. We design and manufacture thin film deposition equipment and can concurrently build multiple thin film deposition systems at this facility.

Our China JV glass coating facilities are incorporated into the glass production facilities owned by NSG and contain approximately 60,000 square feet located in Suzhou China.

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In addition to our Longmont, Alzenau and China JV facilities, we use bonded warehouses in Japan, Taiwan and Hong Kong from which we supply coated glass and spare parts to customers on a just-in-time basis. We also have sales offices in the United States, Germany, Belgium, Hong Kong, Korea, Japan, Taiwan, and China.

We have multiple sources for the principal components of our deposition equipment manufacturing operations.

Competition

The key competitive factors in each of our markets include performance, process technology, after-sales support, service and price. We believe we are competitive with respect to each of these factors. In each of our markets, we compete primarily with one or two companies, which vary from small to large in terms of the amount of their net revenues and range of products.

Our primary competitors in each of our markets are as follows:

Flat Panel Display Deposition Equipment. For FPD thin film deposition equipment, we compete against Ulvac Technologies, Inc. of Japan, and Anelva Ltd. of Japan.

Architectural, Automotive and Solar Glass Deposition Equipment. In architectural and automotive glass deposition systems, we primarily compete against Von Ardenne, AG, a German thin film deposition equipment company. In solar glass deposition systems, we primarily compete against Ulvac Technologies and Von Ardenne.

Consumer Products Packaging and Electronics Deposition Equipment. Our most significant competitors for web coating systems are Valmet General, headquartered in the United Kingdom and Kontex AG of Germany. In the coated PET bottle market, we compete with Sidel, a French filling line equipment company, and a division of Tetra-Pak (Swiss) SA.

Thin Film Coated Glass. Our primary competitors for thin film coated glass are The Samsung Corning, Co., Ltd, Merck Display Technologies Ltd., Shenzhen Nanbo Display Technology Co. Ltd., and Shenzhen Laibao Vactech Co. Ltd.

Our markets are highly competitive. Many of our competitors have substantially greater financial, technical, marketing and sales resources than we have.

Research and Development

We have approximately 50 engineers and scientists involved in research and development. We will continue to emphasize improvements in current equipment technology, the development of new process technologies for thin film deposition, and the modification of thin film material properties. The foundations of our success are based on engineering solutions, extensive experience with vacuum technologies, and the depth of our commercial deposition experience. Our customer oriented solutions include cost effective thin film deposition, simplified process control, and innovative deposition equipment designs. We continue to build on these traditions in the development of process control and deposition design, which lower the cost of ownership to the customer.

• Thermal evaporation by direct heating for organics and inorganics;
  
  
• Electron beam evaporation for dielectrics;
  
  
• Direct current, radio frequency and radio frequency superimposed direct current magnetron for reactive and non-reactive sputtering;
  
  
• Alternating current magnetron (TWINMAG) for fully reactive sputtering;
  
  
• Hollow cathode source for highly reactive coatings;
  
  
• Direct current, radio frequency and microwave sources for PECVD;
  
  
• Cleaning with direct current glow discharge, radio frequency etch and ion assisted etch; and
  
  

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• Arc evaporation for high speed deposition of barrier layers.
  
  

Our research and development expenditures were $6.3 million in fiscal 2001, $9.2 million in fiscal 2002 and $12.2 million in fiscal 2003.

Intellectual Property

We use a combination of patent, copyright, trademark and trade secret protection as well as non-disclosure agreements and licensing arrangements to establish and protect our proprietary rights. Steps taken by us to protect our proprietary rights may not be adequate to prevent misappropriation of such rights or third parties from independently developing a functionally equivalent or superior technology. We have over 80 patents and patent applications.

We license certain intellectual property to Balzers Process Systems GmbH, an indirect subsidiary of Unaxis under an irrevocable, royalty-free, perpetual and worldwide license agreement. We also license certain intellectual property from Balzers Process Systems. The license is irrevocable, royalty-free, perpetual and worldwide.

Certain patents and other intellectual property related to PET bottle coating technology are licensed from The Coca-Cola Company.

Strategic Relationships with The Coca-Cola Company

In July 1997, we entered into a strategic relationship with The Coca-Cola Company to develop and produce thin film deposition equipment to apply barrier coatings to the outside of plastic bottles. We have designed and constructed prototype machines, and sold pilot lines to Coca-Cola. We continue to improve our barrier coating process technology and believe that our strategic relationship with The Coca-Cola Company presents us with a good foundation for technology development.

We then entered into a Commercialization Agreement with The Coca-Cola Company and KRONES AG effective September 2000, which specifies our rights and responsibilities with respect to this process and technology. We are responsible for manufacturing the thin film deposition equipment, including the integration of the bottle handling components supplied by KRONES AG. KRONES is responsible for selling and servicing the BESTPET deposition equipment. We and KRONES may sell to any third parties, provided that KRONES and The Coca-Cola Company receive royalty payments on third party sales. The Commercialization Agreement continues in effect until August 31, 2005. Even if the agreement is not renewed, we will retain a worldwide, non-exclusive license of the intellectual property related to thin film deposition on plastic bottles.

The LAC Acquisition

Effective December 31, 2000 we acquired the LAC business from Unaxis, which expanded our capabilities in the FPD market and enabled our entry into three new product markets: architectural, automotive and solar glass, consumer products packaging and electronics and plastic bottles.

Unaxis agreed that, until December 31, 2002, it would not compete with the LAC business we acquired. We also agreed to license certain intellectual property from Unaxis, and Unaxis agreed to license certain intellectual property from us. Since December 31, 2002, Unaxis has been free to compete with us in our markets with certain intellectual property related to our deposition technology.

China Joint Venture

In fiscal 1999, we entered into a joint venture with NSG, a major Japanese glass manufacturer, to supply the low and high resolution coated glass market from a production base in Suzhou, China. The China JV was formed as a limited liability company under the laws of the People’s Republic of China. We are 50%-50% joint venture partners with NSG, and the term of the China JV is 50 years. Profits, dividends, risks and losses are also shared by the partners in proportion to their equity contributions. Each party has contributed $3.2 million equity in cash, and the balance was derived from the conversion of retained earnings to paid in capital.

Our strategy for the China JV has involved the transfer of the majority of our thin film coated glass manufacturing capacity to China. We have transferred three thin film coating systems to the China JV facilities, bringing the number of high throughput coating systems to three. The China JV’s location in Asia allows them to produce coated glass in the China JV facility immediately adjacent to our primary source of raw glass, NSG, and in close proximity to the China JV’s Asian customer base. During fiscal 2003 we expanded into the color STN market by supplying thin film coated glass over color filter from our China JV. We will also continue to evaluate business opportunities that strengthen our position with the China JV’s customers.

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Employees

As of June 28, 2003, we employed a total of 506 people, with 28 people in the United States, 429 in Europe and 49 in Asia, including regular, contract and temporary employees. Our United States workforce is non-union, the majority of our German work force is represented by a works council that has employee representation. Most companies in Germany are required to be represented by works councils. We negotiate wages and benefits annually with our German workforce. Our workforce in Asia is primarily dedicated to sales and customer service. We consider our relationship with our employees to be good.

We operate under a participative management system, which we believe enhances productivity by emphasizing individual employee opportunity and participation both in operating decisions and in our profitability. We believe this emphasis assists with enhanced productivity, cost control, and product quality and has helped us attract and retain capable employees.

Environmental Regulations

Our operations create a small amount of hazardous waste. The amount of hazardous waste we produce may increase in the future depending on changes in our operations. The general issue of the disposal of hazardous waste has received increasing focus from federal, state and local governments and agencies both in the United States and Germany and has been subject to increasing regulation. Based on regulations currently in effect, compliance with these regulations will not have a material impact on our capital expenditures, earnings or competitive position.

Trademarks

ATX-700, NEW ARISTO, Terra-G, SOLARISTO, ECOVERA, ATON, MULTIWEB, TOPMET, TOPBEAM, MULTIMET, GMS Tester, VES 400, and TWINMAG are trademarks or registered trademarks of ours. Coca-Cola and BESTPET are registered trademark of The Coca-Cola Company. KRONES is a registered trademark of KRONES AG.

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ITEM 1 (d): Information About Foreign Operations

See “ITEM 1(c): Narrative Description of Business — Sales, Marketing, and Customers” and “China Joint Venture”.

ITEM 2: Properties

See "ITEM 1 (c): Narrative Description of Business -Manufacturing and Facilities"

ITEM 3: Legal Proceedings

From time to time, we may be subject to litigation and claims incident to our business. As of the date of this report, we are not involved in any legal proceedings which, if not settled in our favor, would, individually or collectively, have a material adverse impact on our financial condition.

ITEM 4: Submission of Matters to a Vote of Security Holders

No matters were submitted during the fourth quarter of fiscal 2003 to a vote of our Shareholders.

ADDITIONAL ITEM: EXECUTIVE OFFICERS OF THE REGISTRANT

Executive Officers and Directors

Our executive officers and directors are as follows:

_________________

⁽¹⁾     Member of the Audit, Compensation Committees, Nominating and Governance Committees.
⁽²⁾ Executive Officer

Thomas T. Edman has been employed by our company since June 1996 and has served as our President and Chief Executive Officer since May 1998. From June 1996 until May 1998, Mr. Edman served as Chief Operating Officer and Executive Vice President. Mr. Edman has served as a director of our company since July 1998. From 1993 until joining our company, he served as General Manager of the High Performance Materials Division of Marubeni Specialty Chemicals, Inc., a subsidiary of a major Japanese trading corporation. Mr. Edman also serves on the national board of directors of the American Electronics Association, a professional trade organization, and is chairman of its audit committee. Mr. Edman has a bachelors of arts degree in East Asian studies (Japan) from Yale and received a masters degree in business administration from The Wharton School at the University of Pennsylvania.

Graeme Hennessey has served as our Vice President — Sales and Marketing since April 1993 and is currently also President of Applied Films Asia Pacific. From 1980 until he joined our company, Mr. Hennessey was employed by Donnelly Corporation as a product line manager where he was responsible for sales and marketing as well as manufacturing. Mr. Hennessey has a bachelors of science degree in physics from Catholic University of America and a masters degree in physics from Fordham University.

Lawrence D. Firestone has served as our Chief Financial Officer, Treasurer and Secretary since July 1999. From March 1996 until March 1999, Mr. Firestone served as Vice President and Chief Operating Officer of Avalanche Industries, Inc., a custom cable and harness manufacturer. From 1993 to 1996, Mr. Firestone served as Director of Finance and Operations for the Woolson Spice and Coffee Company, a gourmet coffee roasting and distribution company, and from 1988 to 1993, as Vice President and Chief Financial Officer for TechniStar Corporation, a manufacturer of robotic automation equipment. From 1981 to 1988, Mr. Firestone served in various capacities and finally as Vice President and Chief Financial Officer at Colorado Manufacturing Technology, a contract manufacturer that specialized in printed circuit board and cable assembly. Mr. Firestone has a bachelors of science degree in business/accounting from Slippery Rock State College.

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Helmut Frankenberger served as our Executive Vice President — Sales & Marketing since the LAC acquisition on December 31, 2000 through August 31, 2003 when he resigned his position with Applied Films Corporation. Prior to the acquisition, Mr. Frankenberger served as President of Balzers Process Systems, located in Germany, since 2000, and the Vice President of Large Area Display Division since 1999. From 1997 through 1998, he served as the Division Manager of Display Products, and from 1996 through 1997, served as the Division Manager of Data Storage at Balzers Process Systems. From 1969 to 1987 Mr. Frankenberger served in various capacities related to sales, marketing and equipment service for Leybold Deutschland in Germany, Japan and the United States. Mr. Frankenberger obtained his bachelors degree in electronic and computer science from University Darmstadt in Germany.

Jim Scholhamer has served as our Senior Vice President since July 2003. From January 2001 to July 2003, Mr. Scholhamer was the Vice President — Operations and from August 1997 to January 2001 he was the Director of Operations for Thin Film Coatings. From 1992 until he joined the Company, Mr. Scholhamer held the titles of Manufacturing Manager and Process Engineer at Viratec Thin Films, Inc., located in Minnesota. From 1989 to 1992, Mr. Scholhamer served as Production Manager and Process Engineer at Ovonic Synthetic Materials, Inc., a division of Energy Conversion Devices, located in Michigan. Mr. Scholhamer has a bachelors of science degree in engineering from the University of Michigan.

Allen H. Alley has been a director of our company since September 2002. Mr. Alley co-founded Pixelworks and has served as the President, CEO, and chairman of the board of Pixelworks since its inception in 1997. From 1992 to 1997, Mr. Alley served as the Vice President Corporate Development, Engineering and Product Marketing at InFocus Systems, a leading electronic display company. While at InFocus, Mr. Alley was also the co-CEO of a joint venture with Motorola, Inc. called Motif. From 1986 until 1992, Mr. Alley served as General Partner with Battery Ventures, a venture capital investment firm. From 1983 to 1986, Mr. Alley was the Director of Mechanical Computer Aided Engineering of Computervision Corporation, a computer-aided design software developer. From 1979 to 1983, Mr. Alley was a Lead Mechanical Engineer at Boeing Commercial Airplane Division. From 1976 to 1979, Mr. Alley served as a Product Design Engineer for the Ford Motor Company. Additionally, Mr. Alley serves on the board of directors of the Oregon Museum of Science and Industry, is the Chairman of the Oregon Council of Knowledge and Economic Development, and in February 2002, he accepted an appointment by President George W. Bush to the US-Japan Private Sector Government Commission. Mr. Alley holds a bachelors of science degree in mechanical engineering from Purdue University.

John S. Chapin co-founded Applied Films Lab, Inc. in 1976 and served as Vice President — Research, Corporate Secretary from 1976 to November 2000. Mr. Chapin has also served as a director of our company since its inception. Mr. Chapin is the inventor of the planar magnetron and co-inventor of a reactive sputtering process control. Mr. Chapin has a bachelors of science degree in geophysics from the Colorado School of Mines and a masters degree in electrical engineering from the University of Colorado.

Chad D. Quist has been a director of our company since April 1997. Mr. Quist is the President of Optera, Inc., a wholly-owned subsidiary of Magna Donnelly Corporation. Mr. Quist has been employed by Magna Donnelly since 1995. Optera, Inc. is a leading supplier of glass components for the touch screen and display industry. From 1989 to 1995, Mr. Quist served as Vice President of Fisher-Rosemont, Inc., an industrial instrumentation company. Mr. Quist has a bachelors degree in engineering from Stanford University and a masters degree in business administration from the Kellogg Graduate School of Business at Northwestern University.

Richard P. Beck has served as our director since May 1998 and Chairman of the Board since October 2001. From March 1992 to May 2002, Mr. Beck served in various capacities for Advanced Energy Industries, Inc., a publicly held manufacturer of power conversion and integrated technology solutions, including Senior Vice President from November 2001 to May 2002, Senior Vice President and Chief Financial Officer from February 1998 to November 2001, and Vice President and Chief Financial Officer from March 1992 to February 1998, and he continues to serve as a Director of the company. From November 1987 to March 1992, Mr. Beck served as Executive Vice President and Chief Financial Officer of Cimage Corporation, a computer software company. Mr. Beck serves as a director of Photon Dynamics, Inc. and TTM Technologies, Inc., both publicly held companies, and he serves as chairman of their audit committees. Mr. Beck has a bachelors of science degree in accounting and a masters degree in business administration in finance from Babson College.

Vincent Sollitto, Jr. has been a director of our company since October 1999. Mr. Sollitto is the President and Chief Executive Officer and member of the board of Brillian Corporation. From July 1996 to February 2003, Mr. Sollitto was President and Chief Executive Officer and a member of the Board of Directors at Photon Dynamics, Inc. From August 1993 to 1996, Mr. Sollitto was the General Manager of Business Unit Operations for Fujitsu Microelectronics, Inc. From April 1991 to August 1993, he was the Executive Vice President of Technical Operations at Supercomputer Systems, Incorporated. Prior to 1991, Mr. Sollitto spent 21 years in various management positions at IBM, including Director of Technology and Process. Mr. Sollitto serves as a director on the boards of Irvine Sensors Corporation and Ultratech Inc.. Mr. Sollitto holds a bachelor of science degree in electrical engineering from Tufts College.

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Executive Officers

The Board of Directors elects executive officers on an annual basis. Executive officers serve at the pleasure of the board.

ADDITIONAL ITEM:  RISK FACTORS

You should carefully consider the following risk factors and other information contained or incorporated by reference in this report before deciding to invest in our common stock. Investing in our common stock involves a high degree of risk. The risks and uncertainties described below may not be the only ones we face. If any of the following risks actually occur, our business could be harmed and the trading price of our common stock could decline, and you may lose all or part of your investment. Please see “Forward-Looking Statements” on page 34 of this report.

Our quarterly revenues and operating results fluctuate due to a variety of factors, which may result in volatility or a decrease in the price of our common stock.

We have experienced and may continue to experience significant annual and quarter-to-quarter fluctuations in our operating results as a result of a variety of factors including:

• the cyclical nature of the capital equipment market;
  
  
• fluctuation in customer demand, which is influenced by general economic conditions in the industries and geographic markets we serve;
  
  
• our product and revenue mix;
  
  
• competition, including competitive pressures on prices of our products;
  
  
• the length and variability of the sales cycle for our products;
  
  
• manufacturing and operational issues;
  
  
• the timing of customer orders;
  
  
• issues related to new product development and introduction, including increased research, development and engineering costs and marketing expenses;
  
  
• we use the percentage of completion revenue accounting method;
  
  
• the timing of the recognition of revenues from capital equipment orders and the accuracy of the estimation of our costs;
  
  
• sales and marketing issues, including our concentration on a small number of customers; and
  
  
• fluctuations in foreign currency exchange rates.
  
  

These factors are difficult or impossible to forecast.

Our business could be adversely affected by the cyclical nature of market conditions in the industries we serve.

Our business depends on the purchasing requirements of manufacturers of flat panel displays, or FPDs, and our customers in the architectural, automotive and solar glass, the consumer products packaging and electronics and the polyethylene terephthalate, or PET, plastic bottle markets. Certain of these markets, in particular the FPD market, have been subject to dramatic cyclical variations in product supply and demand. The timing, length and severity of these cycles are difficult to predict. In some cases, these cycles have lasted more than a year. Manufacturers may contribute to these cycles by over- or under-investing in manufacturing capacity and equipment. We may not be able to respond effectively to these industry cycles.

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Downturns in the industry often occur in connection with, or in anticipation of, maturing product cycles and declines in general economic conditions. Industry downturns have been characterized by reduced demand for equipment, production over-capacity and accelerated decline in average selling prices. During a period of declining demand, we must be able to quickly and effectively reduce expenses, and this ability is limited by our need for continued investment in engineering and research and development and extensive ongoing customer service and support requirements. In addition, although we order materials and components in response to firm orders, the long lead time for production and delivery of some of our products creates a risk that we may incur expenditures or purchase inventories for products, which we cannot sell or for which orders may be cancelled.

In fiscal 2001 and fiscal 2002, we experienced a downturn in the FPD market, and there can be no assurance when or if demand for active matrix LCD’s or thin film transistors, or TFTs or plasma display panels will increase. Unfavorable economic conditions that relate to the consumer electronics or other industries in which we operate, or that result in reductions in capital expenditures by our customers, could have a material adverse effect on our business, operating results, financial condition and prospects.

Our industry is subject to rapid technological change, and we may not be able to forecast or respond to commercial and technological trends.

Our growth strategy and future success is dependent upon commercial acceptance of products incorporating technologies we have developed and are continuing to develop. The market for thin film coated glass and thin film deposition equipment is characterized by rapid change and frequent introductions of enhancements to existing products. Technological trends have had and will continue to have a significant impact on our business. Our results of operations and ability to remain competitive are largely based upon our ability to accurately anticipate customer and market requirements. Our success in developing, introducing and selling new and enhanced products depends upon a variety of factors, including:

• accurate technology and product selection;
  
  
• timely and efficient completion of product design and development;
  
  
• timely and efficient implementation of manufacturing and assembly processes;
  
  
• product performance in the field; and
  
  
• product support and service and effective sales and marketing.

We may not be able to accurately forecast or respond to commercial and technological trends in the industries in which we operate.

Technological changes, process improvements, or operating improvements that could adversely affect us include:

• development of new technologies by our competitors;
  
  
• changes in product requirements of our customers;
  
  
• changes in the way coatings are applied to glass, paper, metal foil or plastic bottles;
  
  
• development of new materials that improve the performance of the coated substrate; and
  
  
• improvements in the alternatives to our technologies.

We may not have sufficient funds to devote to research and development, or our research and development efforts may not be successful in developing products in the time, or with the characteristics, necessary to meet customer needs. If we do not adapt to such changes or improvements, our competitive position, operations and prospects would be materially adversely affected.

We have limited resources to allocate to research and development, and must allocate our resources among a variety of projects. Because of intense competition in our industry, the cost of failing to invest in strategic products is high. If we fail to adequately invest in research and development, we may be unable to compete effectively in the markets in which we operate.

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Our products generally have long sales cycles and implementation periods, which increase our costs in obtaining orders and extend the effects of economic downturns.

We derive a substantial portion of our net revenues from complex, customized products that are a major capital expenditure for our customers and typically require long lead times. Because of the significance of the product purchase decision, prior to placing an order, prospective customers generally commit resources to test and evaluate our products and often require a number of product presentations and demonstrations before reaching a sufficient level of confidence in the product’s performance and compatibility with the customer’s specific requirements. The sales cycle of our products is typically six to 15 months or more, requiring us to invest significant marketing and engineering resources in attempting to make sales and delaying the generation of revenue. Following periods of economic downturn during which the sales process may have been suspended, the long sales cycle will lengthen the period following economic recovery before we will begin to receive revenues. Long sales cycles also subject us to other risks, including customers’ budgetary constraints, internal acceptance reviews and cancellations. The time required for our customers to incorporate our products into their systems can also be lengthy and require significant on-site engineering support. Because our customers’ final payment obligations are not triggered until ultimate product acceptance, any delay in acceptance could postpone our receipt of the final 10-15% of the purchase price.

We face competition or potential competition from companies with greater resources than ours, and if we are unable to compete effectively with these companies, our market share may decline and our business could be harmed.

The market for thin film deposition equipment is highly competitive. We face substantial competition from established companies in many of the markets we serve. Some of our competitors have greater financial, engineering, manufacturing and marketing resources, broader product offerings and service capabilities and larger installed customer bases than we do. As a result, our competitors may be able to respond more quickly to new or emerging technologies or market developments by devoting greater resources to the development, promotion and sale of products, which could impair sales of our products. In addition, their greater capabilities in these areas may enable them to:

• better withstand periodic economic downturns;
  
  
• compete more effectively on the basis of price and technology;
  
  
• more quickly develop enhancements to and new generations of products; and
  
  
• more effectively retain existing customers and obtain new customers.

Many of our customers and potential customers that purchase deposition equipment are large companies that require global support and service for their thin film deposition equipment. Our larger competitors have more extensive infrastructures than we do, which could place us at a disadvantage when competing for the business of global manufacturers and other purchasers of thin film deposition equipment.

In addition, new companies may in the future enter the markets in which we compete, further increasing competition.

We believe that our ability to compete successfully depends on a number of factors, including:

• performance of our products;
  
  
• quality of our products;
  
  
• reliability of our products;
  
  
• cost of owning and using our products;
  
  
• our ability to ship products on the schedule required;
  
  
• quality of the technical service we provide;
  
  
• timeliness of the services we provide;

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• our success in developing new products and enhancements;
  
  
• existing market and economic conditions;
  
  
• foreign currency exchange conditions; and
  
  
• price of our products and our competitors’ products.

Many of these factors are outside our control. We may not be able to compete successfully in the future, and increased competition may result in price reductions, reduced profit margins, loss of market share, and inability to generate cash flows that are sufficient to maintain or expand our development of new products.

Due to our significant level of export revenues, we are subject to operational, financial and political risks such as unexpected changes in regulatory requirements, tariffs, political and economic instability, outbreaks of hostilities and adverse tax consequences.

Export revenues to customers outside of our manufacturing center in Europe represented approximately 79% of our net revenues in fiscal 2001, 60% of our net revenues in fiscal 2002 and 71% of our net revenues in fiscal 2003. The principal international markets into which we and our China JV sell our products are China (including Hong Kong), Korea, Japan and Taiwan. Banking and currency problems in Asia have had and may continue to have an adverse impact on our revenues and operations. Our operations in China will be subject to the economic and political uncertainties affecting that country. For example, the Chinese economy has experienced significant growth in the past decade, but such growth has been uneven across geographic and economic sectors. This growth may continue to be uneven and any slowdown may have a negative effect on our business. We believe international sales will continue to represent a significant portion of our sales, and that we will continue to be subject to the normal risks of conducting business internationally. Such risks include:

• foreign exchange risks;
  
  
• inflation or deflation in foreign economies;
  
  
• the burdens of complying with a wide variety of foreign laws;
  
  
• unexpected changes in regulatory requirements and the imposition of government controls;
  
  
• political and economic instabilities;
  
  
• export license requirements;
  
  
• protective trade activities, such as tariffs and other barriers;
  
  
• the risk of business interruption;
  
  
• difficulties in accounts receivable collections;
  
  
• inability to protect intellectual property rights;
  
  
• difficulties in staffing and managing foreign sales operations; and
  
  
• potentially adverse tax consequences.

We conduct business in foreign currencies, and fluctuation in the values of those currencies could result in foreign exchange losses and negatively affect our competitive position.

In fiscal 2003, approximately 3% of our net revenues were denominated in yen, 90% were denominated in Euros and 7% were denominated in U.S. dollars. Any strengthening or weakening of the yen, Euro or U.S. Dollar in relation to other currencies in which our customers or competitors do business, could adversely affect our competitiveness, as our products will become more expensive to customers outside Europe and less competitive with products produced by competitors outside Europe. A strengthening of the Euro or other competitive factors could put pressure on us to denominate a greater portion of our Japanese sales in yen, thereby increasing our exposure to fluctuations in the Euro-yen exchange rate. Our China JV transacts much of its business in Chinese Yuan Renminbi. While this currency has remained fairly constant in value, any devaluation of the Chinese Yuan Renminbi would adversely affect our business, operating results, financial conditions and prospects. Foreign sales also expose us to collection risks in the event it becomes more expensive for our foreign customers to convert their local currencies into dollars. Fluctuations in exchange rates could adversely affect our competitive position or result in foreign exchange losses, either of which could materially adversely affect our business, operating results, financial conditions and prospects.

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The assets, liabilities and operating expenses of our German operations are reported in Euros. Our financial statements, including our consolidated financial statements, are expressed in dollars. The translation exposures that result from the inclusion of financial statements that are expressed in functional currencies other than dollars are not hedged. These net translation exposures are taken into stockholders’ equity. As a result, our operating results are exposed to fluctuations of Euros against the dollar. As of June 28, 2003, the unrealized translation adjustment was $11.5 million, which was primarily attributable to the goodwill and other intangible assets from the LAC acquisition that are denominated in Euros and intercompany debt denominated in the functional currency of the country.

We derive a significant portion of our revenue from large sales to a small number of large customers, and if we are not able to retain these customers, or if they reschedule, reduce or cancel orders, our revenues would be reduced and our financial results would suffer.

Our ten largest customers accounted for 53% of our net revenues in fiscal 2003. Revenues from Guardian Industries represented 13.6% of net revenues for fiscal 2003. Revenues from our largest customers have varied significantly from year to year and will continue to fluctuate in the future. We may not be able to retain our key customers, or these customers may cancel purchase orders or reschedule or decrease their level of purchases from us. If a large order were delayed or cancelled, our revenues would significantly decline, and the loss of, or a significant reduction of purchases by, one or more of our significant customers would materially adversely affect our business, operating results, financial condition and prospects. In addition, any difficulty in collecting amounts due from one or more key customers could harm our financial results. There are a limited number of potential customers in each of our markets, and we expect that sales to a relatively small number of customers will continue to account for a high percentage of our revenues in those markets in the foreseeable future.

The failure of our strategic partners to devote adequate resources to marketing and distributing our products could limit our ability to grow or sustain our revenues and earnings.

The success of our strategy to develop emerging high growth market opportunities depends on the level of sales, marketing and distribution support we receive from our strategic partners. For example, we have little experience in the market for barrier coated plastic bottles. We have developed PET bottle deposition equipment for this market in partnership with The Coca-Cola Company and KRONES AG. We are relying on KRONES to provide the atmospheric top coater and the necessary sales, marketing and distribution support of our product once it is commercially viable to introduce our product the PET bottle market. The failure of Coca-Cola to devote adequate resources toward product development and KRONES to devote adequate resources to marketing and distributing our PET bottle deposition equipment could limit our ability to grow or sustain our revenues and earnings.

If we are unable to continue to introduce new products, our results will be adversely affected.

We believe our future growth depends significantly upon our ability to successfully introduce new products, such as our Solar, VES 400 and BESTPET, deposition systems. We are subject to the risks inherent in the development of new products, including risks associated with attracting and servicing a customer base, manufacturing products in a cost-effective and profitable manner, and training qualified engineering, manufacturing, service and marketing personnel. Product development is based on our expectations regarding future growth of target markets, but it is difficult to anticipate the direction of future growth and to design equipment to meet the needs of a changing market. Changes in technology could render our products less attractive. If the market for our new products fails to grow, or grows more slowly than anticipated, we may be unable to realize the expected return on our investment in product development, and our business, operating results, financial condition and prospects could be materially adversely affected. Among other markets, we are anticipating growth in the plastic bottle market. If commercialization of that technology develops more slowly than we expect, if the market demand fails to develop as anticipated, or if alternative technologies are more successful in meeting market needs, our future results will be negatively affected.

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We manufacture all of our products at two facilities, and any prolonged disruption in the operations of those facilities or a demand for products that exceeds the manufacturing capacity at such facilities, could have a material adverse effect on our revenues or equity earnings.

We produce all of our products in our manufacturing facilities located in Alzenau, Germany, and the facilities leased by the China JV in Suzhou, China. Any prolonged disruption in the operations of our manufacturing facilities, whether due to technical or labor difficulties, destruction of or damage as a result of a fire or any other reason, could seriously harm our ability to satisfy our customer order deadlines. In addition, if customer demand for equipment exceeds the manufacturing capacity of our facilities, the growth in our revenues or equity earnings from the Joint Venture could be negatively affected. If we cannot deliver our systems on time, our revenues could also be adversely affected.

If we deliver systems with defects or that fail to meet specifications, our credibility will be harmed and the market acceptance and sales of our systems will decrease.

Our systems are complex, are often customized and sometimes have contained defects or failed to meet contractual specifications. Most of our systems are uniquely designed for the particular customer, and are frequently new models with features that have not previously been tested. If we deliver systems with defects or fail to meet specifications, our credibility and the market acceptance and sales of our systems could be harmed. In addition, if our systems contain defects or fail to meet specifications, we may incur contractual penalties and be required to expend significant capital and other resources to alleviate such problems. Such problems could also damage our relationships with specific customers, impair market acceptance of our products and adversely affect our gross profit margins and operating results.

We depend on the continuing operations of our joint venture partner in China.

Our coated glass revenues, and equity earnings from Joint Venture depend solely on the China JV with Nippon Sheet Glass Co., Ltd., (“NSG”), in China. The results of the China JV depend on the continuing cooperation of NSG. The success of the China JV is subject to a number of risks, over many of which we have limited control. We rely on NSG to house the China JV within its glass fabrication facility and to supply glass to the China JV. We also rely on NSG’s management personnel to manage the day-to-day operations of the China JV, and the managing director of the China JV is employed by NSG as well as by the China JV. We do not have employment agreements with any management personnel at the China JV. The China JV’s future success will be dependent in part on our ability to continue to effectively participate in the China JV and manage our relationship with NSG. Our business, operating results, financial condition or growth could be materially adversely affected if NSG ceases to supply glass to the China JV, focuses its management and operational efforts on other activities or terminates the joint venture.

Our operations and assets in China are subject to significant political, economic, legal and other uncertainties in China. China currently does not have a comprehensive and highly developed system of laws, particularly with respect to foreign investment activities and foreign trade. Enforcement of existing and future laws and contracts is uncertain, and implementation and interpretation of laws may be inconsistent. We could also be adversely affected by a number of factors, including inadequate development or maintenance of infrastructure or a deterioration of the general political, economic or social environment in China.

The coated glass market is highly competitive and subject to pricing pressures, which could adversely affect our operating results.

The market to supply thin film coated glass to liquid crystal display, or LCD, manufacturers is highly competitive. Many of our competitors have substantially greater financial, technical, marketing and sales resources than we or our China Joint Venture have. Additional competitors may enter our markets, certain of which may offer lower prices. Prices for much of our low resolution thin film coated glass products supplied to the LCD market declined in past years. We and our Joint Venture have experienced further pricing pressures and decreased demand in fiscal 2003, and we may in the future experience pricing pressures as a result of a decline in industry demand, excess inventory levels, increases in industry capacity or the introduction of new technologies. Many of our customers are under continuous pressure to reduce prices and we expect to continue to experience downward pricing pressures on our thin film coated glass products. We and our Joint Venture are frequently required to commit to price reductions before we know that the cost reductions required to maintain profitability can be achieved. To offset declining sales prices, we and our Joint Venture must achieve manufacturing efficiencies and cost reductions and obtain orders for higher volume products. If we are unable to offset declining sales prices, our gross margins on coated glass will decline and equity earnings from the Joint Venture will decline.

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Our ability to compete could be jeopardized if we are unable to protect our intellectual property rights from challenges by third parties.

Our success and ability to compete depend in large part upon protecting our proprietary technology. We rely on a combination of patent, trade secret, copyright and trademark laws, non-disclosure and other contractual agreements and technical measures to protect our proprietary rights. These agreements and measures may not be sufficient to protect our technology from third-party infringements, or to protect us from the claims of others. While we have formally recorded our ownership of the patents we acquired in the LAC acquisition, we have not filed our registered patents and trademarks for patent or trademark protection in all of the jurisdictions in which such filings may be made. There can be no assurance that the steps taken by us to protect our proprietary rights will be adequate to prevent misappropriation of such rights or that third parties will not independently develop a functionally equivalent or superior technology. Patents issued to us may be challenged, invalidated or circumvented; our rights granted under those patents may not provide competitive advantages to us; and third parties may assert that our products infringe their patents, copyrights or trade secrets. Third parties could also independently develop functionally equivalent or superior technology and similar products or could duplicate our products. Monitoring unauthorized use of our products is difficult and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology. If competitors are able to use our technology, our ability to compete effectively could be harmed.

Claims or litigation regarding intellectual property rights could seriously harm our business or require us to incur significant costs.

In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. We could become subject to litigation in the future either to protect our intellectual property rights or as a result of allegations that we infringe others’ intellectual property rights.

From time to time, we have received claims of infringement from third parties. Any claims that our products infringe proprietary rights would force us to defend ourselves and possibly our customers or manufacturers against the alleged infringement. These claims and any resulting lawsuit, if successful, could subject us to significant liability for damages and invalidation of our proprietary rights. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management time and attention. Any potential intellectual property litigation could force us to do one or more of the following:

• lose our proprietary rights;
  
  
• stop manufacturing or selling our products that incorporate the challenged intellectual property;
  
  
• obtain from the owner of the infringed intellectual property right a license to sell or use the relevant technology, which license may not be available on reasonable terms or at all and may involve significant royalty payments;
  
  
• pay damages, including treble damages and attorney’s fees in some circumstances; or
  
  
• redesign those products that use such technology.

If we are forced to take any of the foregoing actions, our business could be severely harmed.

Our efforts to protect our intellectual property may be less effective in some foreign countries where intellectual property rights are not as well protected as in the United States.

In fiscal 2003, 71% of our revenue was derived from sales in foreign countries outside of our manufacturing center in Europe, including certain countries in Asia such as Taiwan, Korea, China and Japan. The laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of Europe and the United States, and many companies have encountered substantial problems in protecting their proprietary rights against infringement in such countries. For example, Taiwan is not a signatory of the Patent Cooperation Treaty, which is designed to specify rules and methods for defending intellectual property internationally. In many instances, the publication of a patent prior to the filing of a patent application in Taiwan would invalidate the ability of a company to obtain a patent in Taiwan. Similarly, in contrast to the United States where the contents of patents remain confidential during the patent prosecution process, the contents of a patent are published upon filing, which provides competitors an advance view of the contents of a patent application prior to the establishment of the patent rights. There is a risk that our means of protecting our proprietary rights may not be adequate in these countries. For example, our competitors in these countries may independently develop similar technology or duplicate our systems. If we fail to adequately protect our intellectual property in these countries, it would be easier for our competitors to sell competing products in those countries.

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Our assets may become impaired

We prepare our financial statements in conformity with U.S. GAAP. U.S. GAAP requires us to annually evaluate whether certain assets have been impaired. Goodwill is tested for impairment using a fair-value-based approach. In addition, GAAP also requires us to evaluate the carrying value of all long-lived intangible assets other than goodwill whenever events or circumstances indicate that the carrying value of assets may exceed their recoverable amounts. An impairment loss on long-lived intangible assets other than goodwill is recognized when the estimated future cash flows (undiscounted and without interest) expected to result from the use of an asset are less than the carrying amount of the asset. One or more impairment losses could adversely affect our financial condition and results of operations.

Recently the FASB issued new pronouncements under FASB 142 regarding goodwill and intangible assets and under FASB 144 long-lived assets. As a result of the acquisition of the large area coatings business and the adoption of FASB 142 in July of 2001, we have $89.0 million in goodwill and intangible assets on our balance sheet of which $61.3 million is goodwill, which we do not amortize. We undergo an impairment test each year and based on future market conditions these assets could become impaired and our financials would need to be adjusted to reflect that. This could negatively impact our financial performance.

Because of our 50% ownership in the Joint Venture, we record our portion of the earnings from the Joint Venture in the investments in Joint Venture section of the balance sheet. This item is a long-lived asset and under FASB 144 long-lived assets will undergo our impairment test each year, based on current market conditions. This asset could become impaired and our financial statements would need to be adjusted to reflect that. This could negatively impact our financial performance.

If we fail to comply with environmental regulations, our operations could be suspended.

We use hazardous chemicals in producing our products. As a result, we are subject to a variety of local, state and federal governmental regulations in Germany relating to the storage, discharge, handling, emission, generation, manufacture and disposal of toxic or other hazardous substances used to manufacture our products, compliance with which is expensive. Environmental claims against us or our failure to comply with any present of future regulations could result in:

• the assessment of damages or imposition of fines against us;
  
  
• the suspension of production of our products; or
  
  
• the cessation of our operations.

New regulations could require us to acquire costly equipment or to incur other significant expenses. Our failure to control the use or adequately restrict the discharge of hazardous substances could subject us to future liabilities, which could negatively impact our earnings and financial position.

The loss of key personnel could adversely affect our ability to manage our business.

Our future success will depend largely upon the continued services of our executive officers and certain other key employees. The loss of the services of one or more of the executive officers or other key employees could materially adversely affect our business. We do not have employment agreements with or key-man life insurance on any of our executive officers or other key employees. Our future success will depend in part upon our ability to attract and retain additional qualified managers, engineers and other employees. Our business, operating results, financial condition or growth could be materially adversely affected if we were unable to attract, hire, assimilate, and train these employees in a timely manner.

Our stock price may fluctuate significantly.

The market price of our common stock has been, and we expect will continue to be, subject to significant fluctuations. Factors affecting our market price include:

• the limited number of shares of common stock available for purchase or sale in the public markets;
  
  
• quarterly variations in our results of operations;

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• failure to meet earnings estimates;
  
  
• changes in earnings estimates or buy/sell recommendations by analysts;
  
  
• the operating and stock price performance of comparable companies;
  
  
• developments in the financial markets;
  
  
• the announcement of new products or product enhancements or business results by us or our competitors; and
  
  
• general market conditions or market conditions specific to the industries in which we operate.

Recent stock prices for many technology companies have fluctuated in ways unrelated or disproportionate to the operating performance of the companies. Those fluctuations and general economic, political and market conditions, such as recessions or international currency fluctuations, may adversely affect the market price of our common stock. The market price at any particular date may not remain the market price in the future.

Future sales of our common stock may cause our stock price to decline.

All of our outstanding shares of common stock, other than shares owned by affiliates, are freely tradable without restriction or further registration. Affiliates must comply with the volume and other requirements of Rule 144, except for the holding period requirements, in the sale of their shares. Sales of substantial amounts of common stock by our stockholders, including shares issued upon the exercise of outstanding options, or even the potential for such sales, may have a depressive effect on the market price of our common stock and could impair our ability to raise capital through the sale of our equity securities.

Some anti-takeover provisions may affect the price of our common stock.

Our articles of incorporation and bylaws contain various provisions, including notice provisions, provisions for staggered terms of office of the board of directors, fair price provisions, and provisions authorizing us to issue preferred stock, this situation may make it more difficult for a third-party to acquire, or may discourage acquisition bids for, our company. Such provisions could limit the price that certain investors would be willing to pay in the future for shares of our common stock.

We may issue additional shares and dilute your ownership percentage.

Some events over which you have no control could result in the issuance of additional shares of our common stock, which would dilute the ownership percentage of holders of our common stock. We may issue additional shares of common stock or preferred stock:

• to raise additional capital or finance acquisitions;
  
  
• upon the exercise or conversion of outstanding options, warrants and shares of convertible preferred stock; and/or
  
  
• in lieu of cash payment of dividends.

In addition, the rights of holders of common stock may be adversely affected by the rights of holders of any preferred stock that may be issued in the future that would be senior to the rights of the holders of the common stock.

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PART II

ITEM 5: Market for Registrant’s Common Stock and Related Security Holder Matters

Our common stock has been traded on the Nasdaq National Market under the symbol “AFCO” since November 21, 1997. The following table sets forth, for the quarters indicated, the high and low sale prices per share of our common stock as reported on the Nasdaq National Market.

On August 27, 2003, the last reported sale price of our common stock on the Nasdaq National Market was $30.951 per share and there were approximately 47 stockholders of record of the common stock. We estimate that there are approximately 2,481 beneficial owners of the common stock.

Information required by this item regarding equity compensation plans is addressed in Item 12 of Part III of this report.

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ITEM 6: Selected Consolidated Financial Data

This section presents our selected historical financial data. You should read carefully the financial statements included in this report, including the notes to the financial statements. The selected data in this section is not intended to replace the financial statements. The amounts below have been adjusted to show the operating results of the Longmont Coatings Division, which was sold on September 24, 2002, as discontinued operations.

We derived the consolidated balance sheet data for the years ended June 28, 2003 and June 29, 2002, and our consolidated statement of operations data for each of the three years in the period ended June 28, 2003, from the audited consolidated financial statements in this report. The financial statements for June 28, 2003, June 29, 2002 and June 30, 2001 were audited by Ernst & Young LLP, independent auditors. The financial statements for the fiscal years 1999 and 2000 were audited by Arthur Andersen LLP, independent auditors. The consolidated balance sheet data as of July 3, 1999, July 1, 2000, and June 30, 2001 and the consolidated statement of operations data for the years ended July 3, 1999 have been derived from audited consolidated financial statements that are not included in this report.

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	July 3, 1999	July 1, 2000	June 30, 2001	June 29, 2002	June 29, 2003
Consolidated Balance Sheet Data:
Working capital	$   11,812	$   63,785	$   22,417	$   81,128	$   88,684
Total assets	26,159	79,673	167,484	215,108	254,742
Long-term debt, net of current portion	7,180	-	6,483	-	-
Total stockholders' equity	14,658	73,197	89,192	154,570	177,198

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ITEM 7: Management’s Discussion and Analysis of Financial Condition and Results of Operation

Management’s Discussion and Analysis
of Financial Condition and Results of Operation

You should read this discussion together with the financial statements and other financial information included in this report. This report contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those indicated in the forward-looking statements. Please see “Cautionary Statement Regarding Forward-Looking Statements” elsewhere in this report.

Overview

We are a leading provider of thin film deposition equipment to the flat panel display, the architectural, automotive and solar glass, and the consumer products packaging and electronics industries. Our deposition systems deposit thin films that enhance the characteristics of a base substrate, such as glass, plastic, paper or foil. These thin films provide conductive, electronic, reflective, filter, barrier and other properties that are critical elements of our customers’ products. Our thin film deposition systems provide our customers with high yield and throughput, flexible modular configurations, and innovative coating and process technologies. We also sell thin film coated glass produced by our China Joint Venture to the flat panel display, or FPD, industry.

Our operations and financial position have been significantly affected by three corporate transactions that were implemented to advance our strategic transition from lower gross profit margin sales of coated glass to higher gross profit margin sales of thin film deposition equipment. In 1998, we entered into a 50%-50% joint venture (the “Joint Venture” or “China JV”), with Nippon Sheet Glass Co., Ltd. to supply the low and high resolution coated glass market from a production base in Suzhou, China. The China JV began operations in April of 1999. In December 2000, we completed the acquisition of the Large Area Coatings, or LAC, division of Unaxis Holding AG, or Unaxis, which reported revenues of approximately $94 million for the twelve months ended December 31, 2000. The LAC acquisition expanded our product offering for the FPD industry. The LAC acquisition also enabled our entry into three new product markets: architectural, automotive and solar glass, consumer products packaging and electronics and polyethylene terephthalate, or PET, plastic bottles.

Effective September 24, 2002, we sold certain assets related to our contract glass coating business to Information Products Longmont, Inc. (since renamed Optera), which is a subsidiary of Magna Donnelly Corporation. The assets we sold included thin film deposition equipment, inventory, office furniture and equipment, certain intellectual property rights, including know-how related to the glass coating operations and certain other assets located at Applied Films’ facility in Longmont, Colorado. The transaction did not affect our ownership position in the China JV or the sale of coated glass that we conduct from our Hong Kong office.

Our China JV was formed to lower our product cost, and to operate in a closer proximity to our raw glass supply and our Asian customer base. We buy coated glass manufactured by the China JV and resell it to our customers in Asia. While our sales of coated glass products appear as revenues on our consolidated financial statements, because of the 50%-50% ownership structure of the China JV, the revenues and expenses of the China JV itself are not consolidated and do not appear as revenues and expenses in our financial statements. The benefit of the lower cost structure of the China JV is captured in the net income of the China JV, 50% of which appears as “Equity earnings of Joint Venture” in our consolidated statements of operations.

The following table sets forth our net revenues (net of returns and allowances) by our industry segments for the last three fiscal years (in thousands):

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The following table sets forth our net revenues as a percentage of total revenues by our industry segments for the last three fiscal years:

Revenues for thin film deposition equipment are generally recognized on the percentage-of-completion method, measured by the percentage of the total costs incurred in relation to the estimated total costs to be incurred for each contract. Coated glass revenues and related costs are recognized when products are shipped to the customer and title transfers.

The sales cycle for thin film deposition equipment is long, involving multiple visits to and by the customer and a protracted technical sales effort. We operate with a backlog of new and in-process equipment orders. Deposition equipment backlog was $99.2 million at the end of fiscal 2001, $41.1 million at the end of fiscal 2002, and $100.6 million at the end of fiscal 2003. The increase in backlog was caused by strong order volume in fiscal 2003 for all of our products. Given the average manufacturing time of our products of nine months, this increase in backlog is comprised of revenue not yet recognized from deposition equipment contracts denominated in Euros, U.S. dollars and Japanese yen and, unless hedged, is subject to fluctuation depending on changes in the valuation of the foreign currencies against the dollar. Customers usually make a non-refundable deposit ranging from 20% to 35% of the total purchase price at the time the order is placed and make progress payments during the period of manufacture. We usually receive approximately 80%-85% of the purchase price in cash or letter of credit prior to shipment. We generally ship our thin film coated glass within 30 days of receipt of the order and therefore we do not customarily have a backlog of coated glass sales.

Revenues generated from exports to customers outside of our manufacturing center in Europe were 60% in fiscal 2002 compared to 71% of revenues for fiscal 2003.

Sales of products purchased from the China JV for resale to our customers are generally denominated in U.S. dollars and sales of products manufactured in Germany are generally denominated in Euros. The U.S. dollar equivalent of gross revenues in Japanese yen and Euros were approximately $7.1 million and $117.2 million, respectively, for fiscal 2002 and $5.0 million and $138.4 million, respectively for fiscal 2003. Currently, we engage in international currency hedging transactions to mitigate our foreign exchange exposure related to sales of certain equipment, and the effects of foreign exchange rate changes on foreign currency transactions have not been significant to date. As of June 28, 2003, the U.S. dollar equivalent of accounts receivable denominated in Japanese yen and Euros were approximately $1.1 million and $8.4 million, or approximately 9% and 71% respectively, of total accounts receivable. As of June 28, 2003, the U.S. dollar equivalent of accounts payable are denominated in Japanese yen and Euros were approximately $363,000 and $9.9 million, or approximately 1% and 55% respectively, of total accounts payable.

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Results of Operations

The following table sets forth information derived from the consolidated statements of operations expressed as a percentage of net revenues for the periods indicated.

The amounts below have been adjusted to show the operating results of the Longmont Coatings Division, which was sold on September 24, 2002, as discontinued operations.

Year Ended June 29, 2002 Compared to Year Ended June 28, 2003

Net Revenues. Net revenues increased 12.5% from $137.1 million in fiscal 2002 to $154.2 million in fiscal 2003. Our revenue concentration remained focused on the equipment segment of our business as our revenues generated by equipment sales remained constant at 96% of total net revenues in fiscal 2002 and fiscal 2003.

Net revenues from thin film deposition equipment increased 13.0% from $131.1 million in fiscal 2002 to $148.1 million in fiscal 2003. This increased reflects orders from Taiwanese display customers during fiscal 2003 compared with no order activity from Taiwan during fiscal 2002 and strong orders and increased revenues from our architectural glass customers during fiscal 2003 which led to an increase in equipment backlog from $41.1 million at the end of fiscal 2002 to $100.6 million at the end of fiscal 2003.

Thin film coated glass revenues increased from $6.1 million in fiscal 2002 to $6.2 million in fiscal 2003.

Gross Profit. Gross profit increased from $32.6 million in fiscal 2002 to $36.6 million in fiscal 2003. The increase in gross profits was due primarily to the revenue growth as gross margins were 23.7% in both fiscal 2002 and fiscal 2003.

Selling, General and Administrative. As a result of cost management, selling, general and administrative expenses increased 2.5% from $23.7 million in fiscal 2002 to $24.3 million in fiscal 2003. As a percentage of net revenues, selling, general and administrative expenses declined from 17.3% in fiscal 2002 to 15.8% in fiscal 2003.

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Research and Development. Research and development expenses increased 32.1% from $9.2 million in fiscal 2002 to $12.2 million in fiscal 2003. In fiscal 2003 growth in Research and Development for Display was driven by the development efforts targeted towards generation 6 and 7 glass sizes. Research and development expenses consist primarily of salaries, outside contractor expenses, lab expenses, and other expenses related to our ongoing product development and technology development for Display, OLED, Solar, PET bottle process development and other research and development activities. As a percentage of net revenues, research and development expenses were 6.7% in fiscal 2002 and 7.9% in fiscal 2003.

Amortization of Other Intangible Assets. In the fiscal year ended June 29, 2002, amortization of other intangible assets related to the LAC acquisition was $3.4 million. In the fiscal year ended June 28, 2003, amortization of other intangible assets was $3.8 million. The increase in amortization of other intangible assets was due to the currency fluctuation between the U.S. dollar and the Euro. The intangible assets are carried on the balance sheet of our German subsidiary and the strength of the Euro during fiscal 2003 increased this amortization amount as it is reported in US dollars.

Interest Income. Interest income was $701,000 in fiscal 2002 and $2.0 million in fiscal 2003. At the end of fiscal 2002 our average investment yield was 2.6% compared to 2.4% at the end of fiscal 2003. The increase in interest income was because the excess cash that was invested as a result of the equity offering that we closed in November 2001 which was invested for only part of the fiscal 2002 year as compared to a full year of investment in fiscal 2003.

Other Income. Other income decreased from $2.2 million in fiscal 2002 to $1.6 million in fiscal 2003. Other income includes items such as realized foreign currency transaction adjustments and royalties earned from the China JV. We receive a 2% royalty on all sales by the China JV, payable quarterly. In fiscal 2002, $762,000 was reported for the reversal of unused reserves for the completion of the building in Alzenau, Germany. Fiscal 2003 other income arose primarily from realized currency translation.

Equity earnings of Joint Venture. Our equity earnings of the China JV increased from $465,000 in fiscal 2002 to $2.2 million in fiscal 2003. The 379.8% increase in equity earnings is primarily due to the increase in the market for color STN coated glass for the cellular telephone handset market.

Income Tax Expense. We recorded a tax expense for fiscal 2002 of $91,000 compared to $491,000 for fiscal 2003. The income tax expense reflects the tax effect of the earnings of each operating subsidiary and their respective tax rates. The income tax expense for fiscal 2003 was increased by a valuation allowance against the deferred tax asset. There are several items which lower our effective tax rates in some of the countries in which we operate, such as the tax effect of the amortization of goodwill and other intangible assets in Germany, tax-free investment and interest income in the U.S., and equity earnings of the Joint Venture which are reported as tax free because the earnings will be reinvested in the Joint Venture as a permanent investment.

Discontinued Operations.  On September 24, 2002, we sold the Longmont Coatings Division to Information Products for $5.2 million in cash. We accounted for the sale as a discontinuance of business and our financial statements have been restated to reflect our business without the results of the Longmont Coatings business. The $85,000 loss reflected the operating results of that business for fiscal 2003 through September 24, 2002. The $429,000 gain was the after tax gain on the sale of assets related to discontinued operations.

Year Ended June 30, 2001 Compared to Year Ended June 29, 2002

Net Revenues. Net revenues increased 42.4% from $96.3 million in fiscal 2001 to $137.1 million in fiscal 2002 as a result of a full year reporting of combined company results following the LAC acquisition. Our revenue concentration continued to shift to the equipment segment of our business as our revenues generated by equipment sales increased from 88.4% of total net revenues in fiscal 2001 to 96.0% in fiscal 2002.

Net revenues from thin film deposition equipment increased from $85.2 million in fiscal 2001 to $131.1 million in fiscal 2002, due primarily to a full year reporting of combined company results following the LAC acquisition. However, equipment backlog declined from $99.2 million at the end of fiscal 2001 to $41.1 million at the end of fiscal 2002 primarily due to a weakness in bookings for new orders in the architectural and FPD portions of the equipment business during fiscal 2002.

Thin film coated glass revenues decreased 45% from $11.1 million in fiscal 2001 to $6.1 million in fiscal 2002. This reduction resulted from lower prices which reduced our gross margins, and reduced demand for coated glass used in low end LCD displays.

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Gross Profit. Gross profit increased from $21.6 million in fiscal 2001 to $32.6 million in fiscal 2002, largely driven by the increased revenues from the equipment segment of our business as we reported a full year of combined company operations following the LAC acquisition. Gross margins were 22.5% in fiscal 2001 and 23.7% in fiscal 2002. Equipment revenues generally have higher gross margins than coated glass revenues. Gross margins were negatively affected during the year by sales of certain coated glass inventory at a market price that had moved below cost. Additionally we experienced a cost overrun on a transport system for an architectural glass equipment customer.

Selling, General and Administrative. Selling, general and administrative expenses increased from $15.6 million in fiscal 2001 to $23.7 million in fiscal 2002. This increase represents a full year of combined company results following the LAC acquisition. As a percentage of net revenues, selling, general and administrative expenses were 16.3% in fiscal 2001 and 17.3% in fiscal 2002.

Research and Development. Research and development expenses increased 46.3% from $6.3 million in fiscal 2001 to $9.2 million in fiscal 2002. This increase represents a full year of operations of the combined company following the LAC acquisition. Research and development expenses consist primarily of salaries, outside contractor expenses, lab expenses, and other expenses related to our ongoing product development and technology development for OLED, Solar, PET bottle process development and other research and development activities. As a percentage of net revenues, research and development expenses were 6.5% in fiscal 2001 and 6.7% in fiscal 2002.

In-Process Research and Development. During the fiscal year ended June 30, 2001, we recognized an $11.5 million non-recurring charge to write-off in-process research and development (IPR&D) costs attributed to the LAC acquisition. Several projects were included, of which the principal projects were based on the following technologies: organic light emitting diodes (OLED) for flat panel displays, barrier improvement coating technology for plastic bottles, rotatable cathodes for depositing thin films, planar cathodes for depositing thin films and thin film coating technology for solar cells used to generate electrical power.

The following table discloses by product the percentage complete at the December 31, 2000 acquisition date, the estimated value at the acquisition date and the estimated completion date at the time of the acquisition (dollars in thousands):

The estimates used in valuing IPR&D were based upon assumptions we believed to be reasonable but which are inherently uncertain and unpredictable. Risks and uncertainties associated with completing development within a reasonable period of time include the completion of all planning, designing and testing activities that are necessary to create a product that provides the functions, features and technical performance requirements suited for the market and requested by our customers. Actual results may vary from potential results. If the IPR&D projects are not completed on a timely basis, we could lose the advantage of being first to market with new technologies and achieve market share and sales that are less than what we might have achieved if such products were completed on a timely basis.

We have delivered one system using the OLED technology, and that system achieved its final specification at the customer site. We intend to continue to improve the OLED technology and believe that the initial development will be concluded by the end of fiscal 2004. We expect to recognize revenues from sales of deposition equipment including OLED technology in calendar 2004 and 2005.

We have delivered several systems using the BESTPET barrier coating technology for plastic bottles which is the first of two coatings necessary to achieve the improved barrier results. We recently experienced a setback with the atmospheric barrier protection top coat, as our partner Krones AG was not able to deliver a commercially viable coating system for the top coat. We continue to develop the technology in our own labs in an effort to develop a process that will improve the characteristics of the barrier coatings. We have not established a revised estimate for the completion of this technology.

We have discontinued development of the specific rotatable cathode technology projects that were outstanding at the closing and decided instead to obtain this technology from a third party. We have also discontinued efforts to develop the specific planar cathode technology projects that were outstanding at the closing. We are instead pursuing other planar cathode technologies.

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We have delivered five systems using thin film coating technology for solar cells and continue to develop enhancements to that technology. With these developments, we continue to position ourselves as a market leader in developing high volume manufacturing solutions for the solar cell market.

We believe that these technologies will benefit our future financial performance, although the estimated future benefits cannot be quantified with certainty and are subject to certain assumptions. We do not believe that any of the delays we experienced in the development of the acquired IPR&D technologies have materially affected our financial performance.

Amortization of Goodwill and Other Intangible Assets. In fiscal year 2001, amortization of goodwill and other intangible assets related to the LAC acquisition included $3.4 million related to goodwill and $1.7 million related to intangible assets. Following the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” on July 1, 2001, goodwill and certain other intangible assets related to assembled workforce are no longer being amortized. In fiscal year 2002, amortization of other intangible assets was $3.4 million.

Interest Income. Interest income was $1.0 million in fiscal 2001 and $701,000 in fiscal 2002. Because we principally used available cash and bank borrowings to fund the LAC acquisition, interest income in the first half of fiscal 2001 changed to interest expense in the second half of fiscal 2001, as we incurred interest expense under our credit facility. The use of our bank line of credit continued until the second quarter of fiscal 2002 when we raised additional cash, through an offering of common stock, and we reduced our borrowings. In the third and fourth quarters of fiscal 2002, we invested the cash reserves and returned to interest income. At the end of fiscal 2001 our average investment yield was 4.7% compared to 2.6% at the end of fiscal 2002.

Other Income. Other income increased from $805,000 in fiscal 2001 to $2.2 million in fiscal 2002. Other income includes items such as realized foreign currency transaction adjustments and royalties earned from the China JV. We receive a 2% royalty on all sales by the China JV, payable quarterly. Much of the increase in fiscal 2002 was due to $762,000 for the reversal of excess reserves set aside for the completion of the required building reconditioning cost for the facility in Alzenau to house all manufacturing operations in a single location and $588,000 for the recognition of a non-refundable advance payment from a customer who went bankrupt which was previously recorded as a liability on our balance sheet.

Equity earnings of Joint Venture. Our equity earnings of the China JV decreased from $4.4 million in fiscal 2001 to $465,000 in fiscal 2002. The 90% decrease in equity earnings is primarily due to the weakness in the market for cellular phones as excess handset inventories have reduced the demand for coated glass.

Income Tax Benefit (expense). We recorded a tax expense during fiscal 2002 of ($91,000). The income tax expense for 2002 was reduced by approximately $1.9 million due to the establishment of a valuation allowance on net operating loss. The income tax benefit for fiscal 2001 of $5.9 million, reflects the tax effect of goodwill and other intangible assets in Germany, tax-free investment and interest income, and equity earnings of the Joint Venture which are reported as tax free will be reinvested in the Joint Venture.

Discontinued Operations.  On September 24, 2002, we sold the Longmont Coatings Division to Information Products for $5.2 million in cash. We accounted for the sale as a discontinuance of business and our financials have been restated to reflect our business without the results of the Longmont Coatings business. The $85,000 loss reflected the operating results of that business for fiscal 2003 through September 24, 2002. The $429,000 gain was the after tax gain on the sale of assets related to discontinued operations.

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Quarterly Results of Operations

The following table sets forth summary unaudited quarterly financial information for the eight fiscal quarters ended June 28, 2003. In the opinion of management, such information has been prepared on the same basis as the audited financial statements appearing elsewhere in this report and reflects all necessary adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of unaudited quarterly results when read in conjunction with the audited financial statements and notes thereto. The operating results for any quarter are not necessarily indicative of results for any future period and any trends reflected in such results may not continue in the future. Our results of operations may be subject to significant quarterly variations.

The amounts below have been adjusted to show the operating results of the Longmont Coatings Division, which was sold on September 24, 2002, as discontinued operations (in thousands).

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The following table sets forth the above unaudited information as a percentage of net revenues.

The amounts below have been adjusted to show the operating results of the Longmont Coatings Division, which was sold on September 24, 2002, as discontinued operations.

Our quarterly results of operations may be subject to significant fluctuations due to several factors, including the timing of orders, manufacturing and customer budget cycles and general economic conditions as they affect the industries which use our products. The volume of equipment sales is significantly dependent on our customers’ capital spending patterns.

During fiscal 2002 we experienced a slow down of new orders for equipment for our display coater products as well as our architectural glass coater products. With our book to bill ratio below 1:1 during each of the quarters of fiscal 2002 we experienced a drop in backlog from $99.2 million at the beginning of the fiscal year to $41.1 million at the end of the fiscal year 2002. The lack of new orders in these product areas reduced revenue from $39.3 million in the first quarter to $29.2 in the fourth quarter of fiscal 2002, a decline of 25%.

During fiscal 2003, we experienced a stronger flow of orders for our systems across all of our product lines, but specifically orders for our deposition equipment products for display in Taiwan and our architectural glass deposition equipment products restored a balance of revenue across our product areas and provided the momentum that resulted in growth in backlog to record levels of $100.6 million at the end of fiscal 2003 from $41.1 million at the end of fiscal 2002, and growth in revenues to a high of $51.2 million in the fourth quarter up 90% from the $26.9 million recognized in the first quarters of fiscal 2003.

Gross Margin experienced some downward fluctuations during fiscal 2003 in the second and third quarters as the revenues from a low gross margin coater that was booked to secure a strategic account were recognized, and the revenue mix shifted to the lower margin architectural glass coaters. Gross margins returned to above 25% in the fourth quarter as the revenue from a low margin coater was diminished and the revenue mix shifted to a balance from all of our products.

SG&A per quarter averaged $6.0 million for each of fiscal 2002 and 2003. The quarterly fluctuations resulted from restructuring costs as we reduced our workforce in Longmont, Colorado and from commission payments to third party sales representatives whom we use to aid in our sales coverage.

Our quarterly spending in R&D has been increasing as we have increased our investment in Display R&D. With the roll out of Generation 5 machines in Taiwan and the movement to Generation 6 and Generation 7 glass sizes we have for the first time three major new display platform sizes launching at the same time. At the same time we have continued our investments for our other emerging technologies in OLED, solar and plastic bottles.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States. During preparation of these financial statements, we are required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. On an on-going basis, we evaluate our estimates, including those related to product returns, bad debts, inventories, investments, fixed assets, intangible assets, income taxes, pension benefits and contingencies. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results form the basis of making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

We recognize revenues on a majority of contracts relating to the construction and sale of thin film deposition equipment using the percentage-of-completion method in accordance with the American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) No. 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts”. Pursuant to SOP 81-1, revenues are measured by the percentage of the total costs incurred and applied to date in relation to the estimated total costs to be incurred for each contract. Management considers costs incurred and applied to be the best available measure of progress on these contracts. Contract costs include all direct material and labor costs and those indirect costs related to contract performance. General and administrative costs are charged to expense as incurred. Changes in performance, contract conditions and estimated profitability, including those arising from contract penalty provisions and final contract settlements, may result in revisions to costs and income and are recognized in the period in which the revisions are determined.

The Company generally offers warranty coverage for equipment sales for a one year period after final installation is complete. The Company estimates the anticipated costs to be incurred during the warranty period and accrues a reserve as a percentage of revenue as revenue is recognized. These reserves are evaluated periodically based on actual experience and anticipated activity and are adjusted if necessary.

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We determine the adequacy of this allowance by regularly evaluating individual customer receivables and considering a customer’s financial condition, credit history, and current economic conditions. If the financial condition of our customers were to deteriorate, additional allowances may be required.

We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

We estimate our actual current tax exposure together with the temporary differences that have resulted from the differing treatment of items dictated by GAAP versus U.S. tax laws. These temporary differences result in deferred tax assets and liabilities. On an on-going basis, we then assess the likelihood that our deferred tax assets will be recovered from future taxable income. If we were to believe that the recovery were less likely, we would establish a valuation allowance against the deferred tax asset and charge the amount as an income tax expense in the period in which such a determination were made.

Liquidity and Capital Resources

We have funded our operations with cash generated from operations, proceeds from public offerings of our common stock and a private offering of preferred stock and bank borrowings. Cash used by operating activities was $1.7 million for fiscal 2002 compared to $2.5 million for fiscal 2003. As of June 28, 2003, we had cash and cash equivalents of approximately $22.9 million, marketable securities of $51.6 million and working capital of $88.7 million.

As of June 28, 2003, we had $5.0 million outstanding in a letter of credit as our portion of the security for the debt of the Joint Venture, compared with $7.0 million outstanding in a letter of credit on June 29, 2002 used for the same purpose. We are required under the terms of the China JV to provide credit support on a several basis for 50% of the China JV’s $10 million bank indebtedness.

Capital expenditures were $1.0 million for fiscal 2002 and $1.4 million for fiscal 2003. We anticipate capital expenditures of approximately $7.0 million in fiscal 2004. Our capital expenditures have consisted primarily of equipment purchases related to product development.

Cash used for investing activities was $50.6 million in fiscal 2002 and $9.5 million in fiscal 2003. During fiscal 2003, we purchased marketable securities of $8.0 million.

We believe that our working capital and operating needs will continue to be met by cash from operations, and proceeds from the offering, which closed in November 2001. Our capital requirements depend on a number of factors, including the amount and timing of orders we receive, the timing of payments received from customers, and capital requirements associated with new product introductions. If we require additional capital, we may consider various alternatives such as additional bank financing or the public or private sale of debt or equity securities. There can be no assurance that we will be able to raise such funds on satisfactory terms if and when such funds are needed.

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Contractual Obligations and Commercial Commitments

The Company has the following contractual obligations and commercial commitments as of June 28, 2003 (in thousands).

The operating leases primarily include leases for offices, factories and office equipment throughout our operations. Bank Guarantees represents cash pledged to provide the bank guaranty for 50% of the debt of the Joint Venture and other bank guarantees on cash deposits for contracts with certain customers in China. Our other commercial commitments consist of software licenses and third party service contracts. The bank guarantees are required by our customers primarily in China ensuring the progress payments made to the Company and are terminated when the contract terms are fulfilled.

Recent Financial Accounting Standards Board Statement

In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS 150 improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity and requires that those instruments be classified as liabilities (or assets in certain circumstances) in statements of financial position. SFAS 150 also requires disclosures about alternative ways of settling the instruments and the capital structure of entities all of whose shares are mandatorily redeemable. SFAS 150 is generally effective for all 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. The Company does not expect the adoption of SFAS 150 to have a material impact on its financial position or results of operations.

In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 149 is generally effective for derivative instruments, including derivative instruments embedded in certain contracts, entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The Company does not expect the adoption of SFAS 149 to have a material impact on its financial position or results of operations.

In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities." FIN 46 requires an investor with a majority of the variable interests in a variable interest entity to consolidate the entity and also requires

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majority and significant variable interest investors to provide certain disclosures. A variable interest entity is an entity in which the equity investors do not have a controlling interest or the equity investment at risk is insufficient to finance the entity's activities without receiving additional subordinated financial support from the other parties. The Company is currently reviewing its investment portfolio to determine whether any of its investee companies are variable interest entities. The Company does not expect to identify any variable interest entities that must be consolidated, but may be required to make additional disclosures.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition requirements of SFAS No. 148 are effective for the Company's fiscal year 2003. The Company currently does not plan to transition to a fair value method of accounting for stock-based employee compensation.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Generally, SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized as incurred, whereas EITF Issue No. 94-3 required such a liability to be recognized at the time that an entity committed to an exit play. The Company is currently evaluating the provisions of the new rule, which is effective for exit or disposal activities that are initiated after December 31, 2002.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statement No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This statement provides guidance on the classification of gains and losses from the extinguishment of debt and on the accounting for certain specified lease transactions. SFAS No. 145 is not expected to have a material impact on the Company.

In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations", which establishes accounting standards for recognition and measurement of a liability for an asset retirement obligation and the associated asset retirement cost. This Statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. SFAS No. 143 did not have a material effect on the Company's financial position.

ITEM 7A: Quantitative and Qualitative Disclosures about Market Risk

Market Risk Exposure

Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial market prices. Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We generally place our investments with high credit quality issuers and by policy are averse to principal loss and seek to protect and preserve our invested funds by limiting default risk, market risk and reinvestment risk.

As of June 28, 2003, our investment consisted primarily of equity securities, corporate, government and municipal bonds and money market mutual funds of $51.6 million, and earned approximately $2.2 million for the fiscal year, at an average interest rate of approximately 2.4%. The impact on interest income of a decrease of one percent in the average interest rate would have resulted in approximately $1.3 million less interest income for the fiscal year ended June 28, 2003.

Foreign Exchange Exposure

We are exposed to foreign exchange risk associated with accounts receivable and payable denominated in foreign currencies. At June 28, 2003, we had approximately $1.1 million of accounts receivable and approximately $360,000 of accounts payable denominated in Japanese yen. A one percent change in exchange rates would result in an approximate $7,000 net impact on pre-tax income based on the foreign currency denominated accounts receivable and accounts payable balances at June 28, 2003. At June 28, 2003, we had approximately $8.4 million of accounts receivable and approximately $9.9 million of accounts payable denominated in Euros. A one percent change in exchange rates would result in an approximate $15,000 net impact on pre-tax income based on the foreign currency denominated accounts receivable and accounts payable balances at June 28, 2003.

Sales of products manufactured in Germany are denominated in Euros, except for sales of equipment to certain Japanese customers, which are denominated in Japanese yen. Currently, we engage in international currency hedging transactions to mitigate our foreign exchange exposure related to sales of certain equipment, and the effects of foreign exchange rate changes on foreign currency transactions have not been significant to date.

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Notwithstanding the above, actual changes in interest rates and foreign exchange rates could adversely affect our operating results or financial condition. The potential impact depends upon the magnitude of the rate change. We are exposed to changes in interest rates and foreign currency exchange rates primarily in our cash balance, foreign currency transactions and the operating results of our foreign affiliates.

International manufacturing operations are primarily based in Germany and constitute a significant portion of our revenues and identifiable assets. Most of these identifiable assets are based in Euros. International operations result in a large volume of foreign currency commitment and transaction exposures and significant foreign currency net asset exposures.

Our cash position includes amounts denominated in foreign currencies primarily Euros. The repatriation of cash balances from certain of our affiliates could have adverse consequences to the statement of operations as well as tax consequences. However, those balances are generally available without legal restrictions to fund ordinary business operations.

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

The discussions in this Report on Form 10-K and the documents incorporated herein by reference which are not statements of historical fact (including statements in the future tense and those which include terms such as "believe," "will," "expect," and "anticipate") contain forward-looking statements that involve risks and uncertainties. The Company's actual future results could materially differ from those discussed. Factors that could cause or contribute to such differences include, but are not limited to, the effect of changing worldwide economic conditions, such as those in Asia, the risk of overall market conditions, product demand and market acceptance risk, risks associated with dependencies on suppliers, the impact of competitive products and pricing, technological and product development risks, and other factors including those discussed in ITEM 1 above in this Report and in the Management's Discussion and Analysis of Financial Condition and Results of Operations in ITEM 7, as well as those discussed elsewhere in this Report and the documents incorporated herein by reference.

ITEM 8: Financial Statements and Supplementary Data

Applied Films Corporation and Subsidiaries

Index To Consolidated Financial Statements

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Report of Independent Auditors

To the Stockholders of Applied Films Corporation:

We have audited the accompanying consolidated balance sheets of Applied Films Corporation and subsidiaries as of June 28, 2003 and June 29, 2002 and the related consolidated statements of operations, stockholders' equity and cash flows for the fiscal years ended June 28, 2003, June 29, 2002 and June 30, 2001. Our audits also included the financial statement schedule included in Item 15(a)2 for the fiscal years ended June 28, 2003, June 29, 2002 and June 30, 2001. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Applied Films Corporation and subsidiaries, as of June 28, 2003 and June 29, 2002 and the consolidated results of their operations, stockholders equity and cash flows for the fiscal years ended June 28, 2003, June 29, 2002 and June 20, 2001 in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

/s/ ERNST & YOUNG LLP                    

Denver, Colorado
July 24, 2003

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Applied Films Corporation and Subsidiaries
Consolidated Balance Sheets

        The accompanying notes are an integral part of these Consolidated Financial Statements.

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Applied Films Corporation and Subsidiaries
Consolidated Statements of Operations

        The accompanying notes are an integral part of these Consolidated Financial Statements.

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Applied Films Corporation and Subsidiaries
Consolidated Statements of Stockholders’ Equity

        The accompanying notes are an integral part of these Consolidated Financial Statements.

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Applied Films Corporation and Subsidiaries
Consolidated Statements of Cash Flows