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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended
December 27, 2003

[     ] 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 000-23103

APPLIED FILMS CORPORATION
(Exact Name of Registrant as Specified in its Charter)

9586 I-25 FRONTAGE ROAD, SUITE 200, LONGMONT, COLORADO 80504
(Address of principal executive offices)

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

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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes   X   No      

14,723,715 shares of Common Stock were outstanding as of January 29, 2004.

INDEX

Page 1 of 23

ITEM 1. – FINANCIAL STATEMENTS

APPLIED FILMS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands except share data)

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

Page 2 of 23

APPLIED FILMS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

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

Page 3 of 23

APPLIED FILMS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

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

Page 4 of 23

APPLIED FILMS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.   COMPANY ORGANIZATION AND OPERATIONS

Applied Films Corporation (“Applied Films,” the “Company,” “we,” or “our”) is a leading provider of thin film deposition equipment to the Flat Panel Display (“FPD”) industry; the architectural, automotive and solar glass industry; and the consumer packaging industry. Our high volume, large area deposition systems are used by our customers to deposit thin films that enhance the material properties of the base substrate. These thin films provide conductive, electronic, reflective, filter, barrier and other properties that become critical elements of the composition of its customers’ products.

Since inception in 1976, we have manufactured deposition equipment for use in our coated glass production process. In 1996, when high end flat panel technologies demanded that LCD manufacturers process their own glass substrates in their factories, we expanded our product offerings to include our proprietary deposition equipment. Since that time, we invested in the commercialization of thin film deposition equipment and coating processes for the high end of the LCD market.

On December 31, 2000, we acquired the Large Area Coatings division (“LAC”) of Unaxis. The LAC division is now operating as Applied Films GmbH and Co. KG, a wholly-owned subsidiary of the Company, with manufacturing in Alzenau, Germany and sales and service offices in Asia, Europe and the United States. Applied Films GmbH and Co. Kg designs, manufactures and sells large area deposition equipment in the display; architectural glass, automotive and solar glass; and consumer packaging and electronics industries.

In June of 1998, we formed a 50/50 Joint Venture (the “China JV”) in China with Nippon Sheet Glass Co. (“NSG”) to process, sell and export certain types of thin film coated glass (Note 4).

In September of 2003, we sold our Hong Kong coated glass business to NSG, our joint venture partner. The sale of this business allowed us to exit the coated glass market and focus on our deposition equipment business. In September 2002, we sold our Longmont coating operations to Optera, Inc.. The sale of this business allowed us to exit the manufacturing of coated glass for customers in the U.S. and Europe. The financial statements for the current and prior periods have been restated to reflect the effect of the sale of these businesses and the results have been included in “Income (loss) from discontinued operations, net of tax” in the accompanying consolidated statements of operations (Note 3).

NOTE 2.   SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The results of the China JV are accounted for using the equity method of accounting in the consolidated financial statements and the results appear in “Equity earnings of Joint Venture” (Note 4).

Certain reclassifications within the consolidated financial statements have been made to conform to the current year presentation.

Use of Estimates

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

Unaudited Financial Information

The accompanying interim financial information as of December 27, 2003 and for the six-month period ended December 27, 2003 and December 28, 2002 are unaudited. In the opinion of management, all adjustments (consisting of normal recurring adjustments) have been included that are necessary to provide a fair statement of the results of those interim periods presented. The results of operations for the quarter ended December 27, 2003 are not necessarily indicative of the results to be expected for the entire year.

Page 5 of 23

These unaudited interim consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. Such rules and regulations allow the omission of certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States, as long as the statements are not misleading. These interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s 2003 Annual Report on Form 10-K/A audited for the fiscal year ended June 28, 2003.

Fiscal Year

The Company has adopted a fiscal year ending on the Saturday nearest June 30, which will result in fiscal years composed of 52 or 53 weeks. Fiscal years 2004 and 2003 each include 52 weeks.

Cash and Cash Equivalents

The Company generally considers all highly liquid investments with an original maturity of less than 90 days to be cash equivalents.

Restricted Cash

The Company has pledged $10.1 million in cash, of which $2.5 million is to provide security for the bank guaranty for 50% of the debt of the China JV, and $6.9 million is to provide security for bank guarantees to certain customers in China, for their cash deposits on contracts. The Company expects the $2.5 million in cash securing the bank guaranty will be released in January 2004.

Marketable Securities

The Company classifies all of its short-term investments, that do not qualify as cash equivalents, as trading securities. Such short-term investments consist of equity securities, corporate, government and municipal bonds and money market mutual funds. Trading securities are bought and held principally for the purpose of selling them in the near term and are carried at current market values, which are based upon quoted market prices using the specific identification method. Realized and unrealized gains and losses on such securities are reflected as other income in the accompanying statements of operations.

As of December 27, 2003, the Company’s short term investments included in marketable securities consisted of $71.3 million in corporate bonds, $31.7 million in municipal debt securities, $20.3 million in government bonds, $17.8 million in equity securities and $6.6 million related to money market funds. The Company had no significant concentration of credit risk arising from investments.

As of June 28, 2003, the Company had $41.9 million in corporate bonds, $3.8 million in municipal debt securities, $3.0 million in government bonds, $2.6 million in equity securities and $300,000 related to money market mutual funds. The Company had no significant concentration of credit risk arising from investments and had no significant unrealized gains or losses at June 28, 2003.

Inventories

Inventories consist of materials that can be used in the construction of systems or spare parts and work in process for contracts accounted for under the completed contract method of accounting. Inventories are stated at the lower of cost (first-in, first-out) or market. Inventories at December 27, 2003 and June 28, 2003 consist of the following (in thousands):

Page 6 of 23

Property, Plant, and Equipment

Property, plant and equipment are stated at cost. Replacements, renewals and improvements are capitalized and costs for repairs and maintenance are expensed as incurred. Depreciation is computed using the straight-line method over the following estimated useful lives. Leasehold improvements are depreciated using the straight-line method over the lesser of the useful life of the asset or lease term.

Leased property meeting certain criteria is capitalized and the present value of the related lease payments is recorded as a liability. Amortization of capitalized leased assets is computed on the straight-line method over the term of the lease.

Goodwill and Intangible Assets

Goodwill and intangible assets are reported on the balance sheet of the Company's German subsidiary. Increases or decreases in the book value are due to currency fluctuation between the U.S. dollar and the Euro. The increase in accumulated amortization of intangible assets is due to the amortization expense in the current period and currency fluctuation between the U.S. dollar and the Euro. The composition of intangible assets follows:

The patents are amortized over seven years and the customer lists are amortized over five years. As a result of adopting SFAS No. 142, the Company no longer recognizes amortization expense on its goodwill. Annually, and more frequently if a triggering event occurs the Company is required to test the carrying value of goodwill for impairment.

Impairment of Long-Lived Assets

With the exception of goodwill, the Company evaluates the carrying value of all long-lived assets whenever events or circumstances indicate the carrying value of assets may exceed their recoverable amounts. An impairment loss 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. Measurement of an impairment loss is based on fair value of the asset computed using discounted cash flows if the asset is expected to be held and used. Measurement of an impairment loss for an asset held for sale would be based on fair market value less estimated costs to sell.

The Company’s investment in its China JV will undergo an impairment test at least annually to ensure that the fair value of the asset exceeds the carrying value of the asset on the Company’s balance sheet. The annual impairment test that was completed during fiscal 2003 determined that there was no impairment of the investment in the China JV.

The Company believes no circumstances exist indicating an impairment exists in any of its other long-lived assets.

Page 7 of 23

Accrued Expenses

The significant components of accrued expenses as of December 27, 2003 and June 28, 2003 are as follows (in thousands):

Accrued losses on contracts are a result of costs incurred on projects in excess of the contracted revenue. These costs are specific to certain projects. Accrued losses on contracts are provided for when the loss becomes probable and the amount of loss can be reasonably estimated. Loss provisions are based upon excess costs over the net revenue from the products contemplated by the specific order. Contract accounting requires management to make estimates of future costs over the performance period of the contract. These estimates are subject to change and result in adjustments to cost of goods sold, which are reflected in the margins on contracts in progress.

Spare Parts Revenue Recognition

Spare parts revenues and related costs are recognized when products are shipped to the customer. The Company’s spare parts are warranted to be free from material defects caused by workmanship and within its design or customer specifications and are inspected for workmanship and compliance to specification prior to shipment. Customers who experience defects in material may return product for credit or replacement. Applied Films maintains a reserve to cover sales returns for quality defects from its customers. The provision for estimated sales returns and allowances is recorded in the period of the sale and is typically in the range of 0.5% to 1.0% of sales.

Equipment Sales Revenue Recognition

The percentage of completion method of accounting is used for thin film coating equipment contracts valued at greater than $1 million and a construction time of greater than six months. 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”, 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 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 expensed 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. Our contracts under the percentage of completion method do not provide for the right of a customer to return the machine once the title has been transferred.

Revenues in excess of billings represent revenues recognized under the percentage of completion method prior to billing the customer for contractual cash payments. Billings in excess of revenue represent amounts billed pursuant to the contract terms, which occur prior to the Company’s recognition of revenues on the contract for financial reporting purposes.

Contracts in progress at December 27, 2003 and June 28, 2003 are as follows (in thousands):

The Company typically collects 80-85% of the cash due on the total project by the time the equipment is shipped from its manufacturing facility. The remaining 15-20% balance that is due following the ship date is billed in accordance with the contract terms and those subsequent billings are generally collected within 30 days after billing.

The Company generally offers warranty coverage for equipment sold 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.

Page 8 of 23

The Company uses the completed contract method of accounting for standard products that are typically valued at less than $1 million and have a machine construction time of less than six months. For projects accounted for using the completed contract method of accounting, the project costs are accumulated in work in process until the fabrication of the system is complete. Once fabrication of the system is complete, the customer evaluates the machine at the Company’s manufacturing facility according to any specific acceptance criteria outlined in the contract. Upon acceptance, the machine is shipped and installed at the customer’s facility and title is transferred to the customer. The Company recognizes the revenue, upon transfer of title. Our contracts under the completed contract method do not provide for the right of a customer to return the machine once the title has been transferred.

Losses on contracts in process are recognized in their entirety when the loss becomes probable and the amount of loss can be reasonably estimated. As of December 27, 2003 and June 28, 2003, the Company had accrued approximately $8.4 million and $7.4 million for loss contracts, respectively.

Research and Development Expenses

Research and development costs are expensed as incurred and consist primarily of salaries, supplies, lab expenses, and depreciation of equipment used in research and development activities. The Company incurred approximately $4.2 million and $2.6 million of research and development expenses for the three months ended December 27, 2003 and December 28, 2002, respectively, and approximately $8.3 million and $4.8 million of research and development expenses for the six months ended December 27, 2003 and December 28, 2002, respectively, net of reimbursements received from European governmental grants. The Company is reimbursed up to 50% of the costs incurred for specific research and development projects. The reimbursement terms are contained in an agreement between the Company and a governmental agency and is paid when the research is completed and accepted by the agency. The Company received reimbursements of $42,000 and $89,000 in the three month periods and $250,000 and $312,000 in the six month periods ended December 27, 2003 and December 28, 2002, respectively.

Foreign Currency Transactions

The Company generated 76% of its revenues in the six months ended December 27, 2003 from sales to foreign corporations located outside the Company’s manufacturing center in Europe, which are primarily in Asia. In addition, many of its raw materials are purchased from foreign corporations. The majority of the Company’s sales and purchases are denominated in Euros, with the remainder denominated in U.S. dollars or Japanese yen. For those transactions denominated in currencies other than the functional currency, the Company records the sale or purchase at the spot exchange rate in effect on the date of sale. Receivables from such sales or payables for such purchases are converted to the functional currency using the end of the period spot exchange rate. Realized gains and losses are charged or credited to income during the period.

Foreign Currency Translation

The financial results of the Company’s foreign subsidiaries are translated to U.S. dollars using the current-rate method. Assets and liabilities are translated at the period-end spot exchange rate, revenue and expenses at average exchange rates and equity transactions at historical exchange rates. Exchange differences arising on translation are recorded as a component of “Other cumulative comprehensive income (loss)".

Other Cumulative Comprehensive Income

SFAS No. 130, “Reporting Comprehensive Income,” establishes a standard for reporting and displaying comprehensive income and its components within the financial statements. Comprehensive income includes charges and credits to equity that are not the result of transactions with shareholders. Other cumulative comprehensive income for the Company represents foreign currency items associated with the translation of the Company’s investment in its foreign subsidiaries and the China JV and the unrealized gain on foreign currency hedge activities.

Page 9 of 23

Comprehensive Income (Loss)

A summary of the comprehensive income (loss) is as follows (in thousands):

Net Income (Loss) Per Common Share

The Company follows SFAS No. 128, “Earnings per Share” which establishes standards for computing and presenting basic and diluted earnings per share (“EPS”). Under this statement, basic earnings (loss) per share is computed by dividing the income or loss available to common stockholders by the weighted average number of shares of common stock outstanding. Diluted earnings per share is determined by dividing the income or loss available to common stockholders by the sum of (1) the weighted average number of common shares outstanding and (2) the dilutive effect of outstanding potentially dilutive securities, including convertible preferred stock, stock options and warrants determined utilizing the treasury stock method. Diluted loss per share is determined by dividing the loss available to common stockholders by the weighted average number of shares; no weight is given to the dilutive effect of stock options.

Statement of Financial Accounting Standards No. 123

SFAS No. 123, “Accounting for Stock-Based Compensation,” defines a fair value based method of accounting for employee stock options or similar equity instruments. However, SFAS No. 123 allows the continued measurement of compensation cost in the financial statements for such plans using the intrinsic value based method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), provided that pro forma disclosures are made of net income or loss, assuming the fair value based method of SFAS No. 123 had been applied. The Company has elected to account for its stock-based compensation plans for employees and directors under APB 25.

Accordingly, for purposes of the pro forma disclosures presented below, the Company has computed the fair values of all options granted during the periods using the Black-Scholes pricing model and the following weighted average assumptions:

To estimate expected lives of options for this valuation, it was assumed options will be exercised at varying schedules after becoming fully vested. All options are initially assumed to vest. Cumulative compensation cost recognized in pro forma net income or loss with respect to options that are forfeited prior to vesting is adjusted as a reduction of pro forma compensation expense in the period of forfeiture. Fair value computations are highly sensitive to the volatility factor assumed; the greater the volatility, the higher the computed fair value of the options granted.

The total fair value of options granted and the effect of the discount on employee stock purchase plan was computed to be approximately $1.8 million and $521,000 for the three month periods ended December 27, 2003 and December 28, 2002, respectively, and $2.5 million and $1.1 million for the six month periods ended December 27, 2003 and December 28, 2002, respectively. The fair value of all options amortized ratably over the vesting period of the options. Pro forma stock-based compensation, net of the effect of forfeitures, was $480,000 and $605,000 for the three month periods ended December 27, 2003 and December 28, 2003, respectively and $755,000 and $1.3 million for the six month periods ended December 27, 2003 and December 28, 2002, respectively.

Page 10 of 23

If the Company had accounted for its stock-based compensation plans in accordance with SFAS No. 123, including the effect of the Employee Stock Purchase Plan, the Company’s net income (loss) would have been reported as follows (in thousands, except share data):

Recent Accounting Standards

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 adoption of SFAS 150 did not to have a material impact on the Company’s 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 adoption of SFAS 149 did not have a material impact on the Company’s financial position or results of operations.

In January 2003, the FASB issued Interpretation 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 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. FIN 46 is effective for all entities created after December 31, 2003. For entities which were created prior to December 31, 2003, FIN 46 is primarily effective beginning in fiscal 2005. The Company has not created any variable interest entities since January 31, 2003. 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.

In December 2002, FASB issued SFAS 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 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 148 requires disclosure of the pro forma effect in interim financial statements. The transition requirements of SFAS 148 are effective for the Company’s 2003 fiscal year. The Company has no current plan to transition to a fair value method of accounting for stock-based employee compensation.

Related Parties

In addition to the Company’s China JV investment described in Note 4, the Company has engaged in certain related party transactions.  The Company purchased spare parts during the first six months of fiscal 2004 and fiscal 2003 of $396,000 and $133,000 respectively, and received sublease payments of $126,000 from Optera, Inc, of which a member of the Company’s board of directors is an officer.  In a separate transaction, the Company recorded $5.2 million from the sale of the Longmont Coatings Division to Optera, Inc. in September 2002 (see Note 3), and settled a warranty claim arising from the Longmont Coatings Division in September 2003, (Note 3).  Additionally, the Company had purchases of $5.5 million and $1.1 million, for the first six months of fiscal 2004 and fiscal 2003, respectively, from a company of which another member of the Company’s board of directors is a member of the board of directors and a former officer.

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NOTE 3.   SALE OF THE COATED GLASS BUSINESS - DISCONTINUED OPERATIONS

Effective September 26, 2003, the Company sold its coated glass business located in Hong Kong to NSG for approximately $1.4 million. The assets sold include the right to direct 50% of the China JV production, customer lists of the business, the coated glass inventory and any outstanding purchase orders of the coated glass business located in Hong Kong.

Proceeds from the sale of the business is $747,000 in cash and $600,000 in a promissory note. The note accrues interest at 5% per annum, is due on September 26, 2004, and does not have a prepayment penalty. The Company recorded a $783,000 gain, net of taxes of $415,000 through the second quarter.

The Company accounted for the sale of the Hong Kong coated glass business as a discontinuance of the business. As a result, certain financial information has been restated to give effect to the classification of the Hong Kong coated glass business as a discontinued operation. The net revenues of the discontinued operation was $1.4 million for the three month period ended December 28, 2002. The net revenues of discontinued operations was $933,000 and $3.2 million for the six month periods ended December 27, 2003 and December 28, 2002, respectively.

Page 12 of 23

The following quarterly statements of operations for fiscal year 2003 have been restated to give effect to the classification of the Hong Kong and Longmont coated glass businesses as discontinued operations (in thousands except per share amounts):

Effective September 24, 2002, the Company sold certain assets related to its contract glass coating business in Longmont, Colorado to Optera, Inc. The assets sold by the Company 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 the Company’s facility in Longmont, Colorado (the “Longmont Coatings Division”).

Pursuant to the Asset Purchase Agreement signed on September 24, 2002, Optera, Inc. paid Applied Films a cash purchase price of $5.2 million. Optera, Inc. received inventory and property, plant and equipment with a carrying value of $3.0 million and $1.3 million, respectively. The Company incurred $286,000 of separation costs and professional fees related to the transaction and recorded a $429,000 gain.

Page 13 of 23

The Company accounted for the sale of the Longmont Coatings Division as a discontinuance of the business. As a result, certain financial information of the Longmont Coatings Division has been restated to give effect to the classification of the Longmont Coatings Division as a discontinued operation.

Effective September 15, 2003, Applied Films and Optera, Inc. entered into a settlement agreement for $650,000 related to a warranty claim for coated glass that had been sold to Optera, Inc. prior to the sale of the Longmont Coatings division. The settlement was paid on September 24, 2003. The net after tax settlement of $422,000 has been recorded in results of operations of discontinued operations for the three-month period ended September 27, 2003.

NOTE 4.   INVESTMENT IN CHINA JV

In June 1998, the Company formed a 50/50 China JV with NSG in China to manufacture, process, sell and export certain types of thin film coated glass. Each party contributed $3.2 million in cash to the China JV as equity. During fiscal 2002, 2001 and 1999, the Company sold new and refurbished equipment to the China JV for use in the process of thin film coating of glass. The sales prices were approximately $1.2 million, $5.6 million and $5.1 million, respectively. Because the Company owns 50% of the China JV, the Company recorded 50% of the revenue and related cost of the sales and has deferred 50% of the gross profit of each sale, approximately $0, $1.3 million and $1.4 million, respectively, which will be recognized on a straight-line basis over ten years, consistent with the depreciation schedule at the China JV and the estimated depreciable life of the equipment. The amortization of the gross profit is included with “Equity earnings of joint venture” in the accompanying consolidated statements of operations.

The China JV began operations during the fourth quarter of fiscal 1999. The Company records 50% of income or loss from operations of the China JV after eliminating the impact of inter-entity transactions. The functional currency for the China JV is the local Chinese Yuan Renminbi. The Company’s investment in the China JV is translated into U.S. dollars using the period-end exchange rate. The earnings recorded by the Company from the China JV are translated at average rates prevailing during the period, which have remained fixed by the Chinese government for a number of years. The cumulative translation gain or loss, if any, would be recorded as “Other cumulative comprehensive income (loss)” in the Company’s consolidated financial statements.

As of December 27, 2003, the Company has provided a cash secured bank guarantee of $2.5 million to guarantee 50% of the debt of the China JV. At June 28, 2003 and December 27, 2003, the Company had approximately $44,000 and $113,000, respectively in accounts receivable from the China JV. The Company expects the $2.5 million in cash securing the bank guaranty will be released in January 2004.

Summarized statement of operations information for the China JV for the three months and six months ended December 31, 2003 and 2002, is presented below (in thousands):

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Summarized balance sheet information for the China JV as of December 31, 2003 and June 30, 2003, is presented below (in thousands):

NOTE 5.   LEASES

In connection with the sale of the Longmont Coatings Division, the Company and Optera, Inc. entered into a sublease pursuant to which Optera, Inc. is subleasing approximately 40,900 square feet at the Company’s Longmont, Colorado facility, which contains approximately 126,000 square feet. The term of the sublease began on September 24, 2002 and will terminate on March 31, 2005. Optera, Inc. has the option to renew the sublease for additional periods of one year each commencing at the expiration of the initial term and continuing until the expiration or termination of the Company’s lease for the Longmont, Colorado facility. The subtenant also holds a right of first refusal with respect to the assignment or subleasing of, certain additional space in the Longmont, Colorado facility. Basic rent under the sublease for the initial term is $252,000 annually.

The Company’s rent expense under operating leases, which includes buildings, office equipment and other, was $1.8 million and $1.6 million for the three months ended December 27, 2003 and December 28, 2002, respectively and $3.2 million for the six months ended December 27, 2003 and December 28, 2002. For the six months ended, December 27, 2003 rent expense is net of sublease income of $126,000.

NOTE 6. SALES BY GEOGRAPHIC REGION

The breakdown of net revenues by geographic region is as follows (in thousands):

The breakdown of net revenues by geographic region expressed as a percentage of net revenues is as follows:

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ITEM 2. – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes thereto included in this report and the consolidated financial statements and notes included in our Annual Report on Form 10-K/A for the fiscal year ended June 28, 2003. This report contains certain forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995) that involve substantial risks and uncertainties, including those described below, the effect of changing worldwide political and economic conditions, such as those in Asia, production levels, including those in Europe and Asia, the effect 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 risk factors. For a discussion of these and other risks and uncertainties, see our Annual Report on Form 10-K/A for the fiscal year ended June 28, 2003 and our Registration Statement on Form S-3, as amended (Registration No. 333-108718) and the section “Risk Factors” in that Registration Statement. When used herein, the terms “believe,” “anticipate,” “intend,” “goal,” “expect,” and similar expressions may identify forward-looking statements. Our actual results, performance or achievements may differ materially from those expressed or implied by such forward-looking statements.

Overview

We are a leading provider of thin film deposition equipment to diverse markets such as 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.

Our operations and financial position have been significantly affected by four 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. First, in 1998, we entered into our China JV, a 50%-50% joint venture with NSG, to supply the low and high-resolution coated glass market from a production base in Suzhou, China. Our China JV began operations in April of 1999. 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. Beginning in fiscal 1999 we moved the majority of our production of coated glass from Longmont to the China JV. Because of the 50%-50% ownership structure of our China JV, the revenues and expenses of our China JV are not consolidated and do not appear as revenues and expenses in our financial statements. The benefit of the lower cost structure of our China JV is captured in the net income of our China JV, 50% of which is included in “Equity earnings of joint venture” in our consolidated statements of operations.

Second, in December 2000, we completed the acquisition of the LAC business of Unaxis. The LAC acquisition expanded our product offering for the FPD industry. The LAC acquisition also enabled our entry into two new product markets architectural, automotive and solar glass, and consumer products packaging and electronics.

Finally, the sale of our coated glass business in two stages completed the exit of coated glass from our revenue stream. On September 24, 2002, we sold our Longmont coatings division, which included certain assets related to our contract glass coating business to Optera, Inc. 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 our facility in Longmont, Colorado. In September 2003, we sold our coated glass sales business located in Hong Kong to NSG. The assets sold included the right to direct 50% of the China JV’s product as well as the customer lists and all of the outstanding purchase and sales commitments. The financial statements for the prior periods have been restated to reflect the effect of the sale of those businesses and the results have been included as discontinued operations.

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.

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 certain amount of unrecognized revenue, which we refer to as backlog, on our signed contracts in progress using the percentage of completion and the completed contract method of accounting. Deposition equipment backlog was $88.7 million at December 27, 2003, and $75.9 million at December 28, 2002. 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.

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In the second quarter of fiscal 2004, 71% of our total net revenues were generated from exports to customers outside of our manufacturing center in Europe, compared to 70% of revenues from exports to customers outside of our manufacturing center in Europe for the second quarter of fiscal 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. The U.S. dollar equivalent of gross revenues in Euros were approximately $54.2 million, in the second quarter of fiscal 2004 and $27.8 million, for the second quarter of 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 December 27, 2003, the U.S. dollar equivalent of accounts receivable denominated in Euros were approximately $16.7 million or approximately 86%, of total accounts receivable. As of December 27, 2003 the U.S. dollar equivalent of accounts payable denominated in Euros were approximately $11.7 million, or approximately 93%, of total accounts payable.

Comparison of the Second Quarter Ended December 28, 2002 to the Second Quarter Ended December 27, 2003

Comparisons of revenue and expense items reported in our financial statements are affected by changes in the valuation of foreign currencies, relative to the dollar, primarily the Euro, which was 15.4% stronger relative to the dollar than the prior year quarter. Part of certain increases in revenue and expenses compared to the prior year quarter result from the increased value of the Euro relative to the dollar.

Net Revenues.  Net revenues increased 96.1% from $29.1 million in the second quarter of fiscal 2003 to $57.1 million for the second quarter of fiscal 2004 due to the increased volume of equipment manufactured across all our product lines, which was driven by higher backlog at the beginning of the period and strong bookings during the quarter. The revenue mix was concentrated in the architectural glass area. Backlog grew 16.9% from $75.9 million at the end of the second quarter of fiscal 2003 to $88.7 million at the end of the second quarter of fiscal 2004.

Gross Profit. Gross profit increased 126.5% from $6.3 million in the second quarter of fiscal 2003 to $14.2 million in the second quarter of fiscal 2004, largely driven by the increase in equipment revenues.  Gross margins were 21.5% in second quarter of fiscal 2003 and 24.8% in second quarter of fiscal 2004.  The increase was due to the revenue growth during the second quarter of fiscal 2004 as well as the effectiveness of several cost reduction programs initiated in Germany to reduce the cost of purchased parts and to increase labor efficiency. 

Research and Development. Research and development expenses increased 64.8% from $2.6 million in the second quarter of fiscal 2003 to $4.2 million in the second quarter of fiscal 2004 primarily due to increased spending on materials to manufacture prototype equipment to process larger glass substrates for flat panel displays. Research and development expenses consist primarily of salaries, outside contractor expenses, materials, lab expenses, and other expenses related to our ongoing product development for new products. As a percentage of net revenues, research and development expenses were 8.8% in the second quarter of fiscal 2003 and 7.4% in the second quarter of fiscal 2004.

Selling, General and Administrative. Selling, general and administrative expenses increased from $5.8 million in the second quarter of fiscal 2003 to $6.4 million for the second quarter of fiscal 2004 due to increases in personnel costs associated with Sarbanes-Oxley compliance, directors and officers insurance, and normal operating increases. As a percentage of net revenues, selling, general and administrative expenses were 19.9% in the second quarter of fiscal 2003 and 11.3% in the second quarter of fiscal 2004.

Amortization of Intangible Assets. The amortization of intangible assets was $901,000 and $1.1 million for the second quarter of fiscal 2003 and the second quarter of fiscal 2004, respectively. The increase in amortization of intangibles consists of a currency translation as the intangible assets are carried on our German subsidiary balance sheet and are subject to fluctuation in the Euro as compared to the U.S. Dollar.

Interest Income, Net. Interest income, net was $624,000 in the second quarter of fiscal 2003 and $671,000 in the second quarter of fiscal 2004. Although the rate of return was down 0.8%, interest income fluctuated because of the increase in available cash to invest, due to the public offering of stock that closed in October of 2003, raising $94.0 million in cash. We invest our cash reserves in corporate, government and municipal bonds, equity securities, money market funds and short-term time deposits. During the second quarter of fiscal 2003 and the second quarter of fiscal 2004, we earned an average annual rate of return of 2.5% and 1.7%, respectively on cash and cash equivalents, restricted cash and marketable securities.

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Other Income, Net. Other income, net increased from $240,000 in the second quarter of fiscal 2003 to $452,000 in the second quarter of fiscal 2004, primarily due to foreign exchange gains realized between the Euro and the dollar and royalty income. We receive a 1% royalty on all sales by the China JV, payable quarterly.

Equity in Earnings of Joint Venture.  Our equity in earnings of the China JV increased 23.0% from $864,000 in the second quarter of fiscal 2003 to $1.1 million in the second quarter of fiscal 2004. This increase in equity earnings is primarily due to strong demand during the quarter for color STN glass used in color displays for cellular phones and personal digital assistants.

Income Tax Benefit (Provision) Expense.  We recorded an income tax benefit of $711,000 in the second quarter of fiscal 2003 compared to an income tax expense of $1.2 million in the second quarter of fiscal 2004. The effective tax rate was 33.0% during the second quarter of fiscal 2003 and 32.0% during the second quarter of fiscal 2004. Our tax provision is adjusted based on our year to date tax calculation for each subsidiary tax jurisdiction. 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 our China JV which are reported as tax free because the earnings will be reinvested in our China JV as a permanent investment.

Discontinued Operations. On September 26, 2003, we sold our Hong Kong coated glass business to NSG for $1.35 million in cash and a note receivable. 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 our Hong Kong coated glass business. The $75,000 income from discontinued operations for the second quarter of fiscal 2003 reflected the operating results of the Hong Kong coated glass business, for that period. The $13,000 gain on from disposal of discontinued operations for the second quarter of fiscal 2004 reflects the reversal of accrued professional fees not deemed necessary.

Comparison of the Six Months Ended December 28, 2002 to the Six Months Ended December 27, 2003  

Comparisons of revenue and expense items reported in our financial statements are affected by changes in the valuation of foreign currencies, relative to the dollar, primarily the Euro, which was 14.0% stronger relative to the dollar than the prior year period. Part of certain increases in revenue and expenses compared to the prior year quarter result from the increased value of the Euro relative to the dollar.

Net Revenues. Net revenues increased 93.3% from $54.2 million in the first six months of fiscal 2003 to $104.8 million for the first six months of fiscal 2004 due to increased volume of equipment manufactured, which was driven by the strong backlog position at the beginning of the fiscal year.  Backlog grew 145% from $41.1 million at the beginning of the first six months of fiscal 2003 compared to $100.6 million at the beginning of the first six months of fiscal 2004, and at the end of the period grew from $75.9 million to $88.7 million.

Gross Profit. Gross profit increased 110.7% from $12.9 million in the first six months of fiscal 2003 to $27.2 million in the first six months of fiscal 2004, largely driven by the increased equipment revenues. Gross margins were 23.8% in first six months of fiscal 2003 and 25.9% in first six months of fiscal 2004, due to the revenue growth during the first half of fiscal 2004, as well as the effectiveness of several cost reduction programs initiated in Germany to reduce the cost of purchased parts and to increase labor efficiency.  

Research and Development. Research and development expenses increased 71.8% from $4.8 million in the first six months of fiscal 2003 to $8.3 million in the first six months of fiscal 2004. The increase over the same period in the prior year was primarily caused by increased material and personnel cost to manufacture prototype equipment to process larger glass substrates for flat panel displays. Research and development expenses consist primarily of salaries, outside contractor expenses, lab expenses, materials, and other expenses related to our ongoing product development for new products. As a percentage of net revenues, research and development expenses were 8.9% and 7.9% in the first six months of fiscal 2003 and fiscal 2004, respectively.

Selling, General and Administrative. Selling, general and administrative expenses increased from $11.8 million in the first six months of fiscal 2003 to $12.7 million in the first six months of fiscal 2004 due to increases in costs associated with Sarbanes-Oxley compliance, directors and officers insurance, and normal operating increases. As a percentage of net revenues, selling, general and administrative expenses were 21.7% in the first six months of fiscal 2003 and 12.1% in the first six months of fiscal 2004.

Amortization of Other Intangible Assets. The amortization of other intangible assets was $1.8 million and $2.1 million for the first six months of fiscal 2003 and fiscal 2004, respectively. The increase in amortization of intangibles consists of a currency translation as the intangible assets are carried on our German subsidiary balance sheet and are subject to fluctuation in the Euro as compared to the U.S. Dollar.

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Interest Income, Net. Interest income, net was $1.3 million in the first six months of fiscal 2003 and $900,000 in the first six months of fiscal 2004. The reduction in interest income was related to the reduction in the average annual rate of return. During the first six months of fiscal 2003 and fiscal 2004, we earned an average annual rate of return of 2.5% and 1.8%, respectively, on cash and cash equivalents, restricted cash and marketable securities. The interest income was generated from the investment of our cash reserves in corporate, government and municipal bonds, equity securities, money market funds, and short-term deposits.

Other Income, Net. Other income, net increased from $373,000 in the first six months of fiscal 2003 to $1.1 million in the first six months of fiscal 2004. Other income, net includes items such as realized foreign currency translation adjustments and royalties earned from the China JV. We receive a 1% royalty on all sales by the China JV, payable quarterly.

Equity in Earnings of Joint Venture. Our equity in earnings of the China JV increased 31.2% from $1.2 million in the first six months of fiscal 2003 to $1.6 million in the first six months of fiscal 2004. This increase in equity earnings is primarily due to an increase in demand for color STN glass used in color displays for cellular phones and personal digital assistants.

Income Tax Benefit (Provision). We recorded an income tax benefit of $1.2 million in the first six months of fiscal 2003 compared to an income tax expense of $2.1 million in the first six months of fiscal 2004. The effective tax rate was 31.0% during the first six months of fiscal 2003 and 34.0% during the first six months of fiscal 2004. Equity earnings of the Joint Venture will be reinvested in the Joint Venture and as such are not taxed in the United States and are not included in our tax calculations.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with U.S. Generally Accepted Accounting Principles. 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 project costs, cash collections, 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.

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. Our 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, administrative, selling and research and development 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.

We generally offer warranty coverage for equipment sold for a one-year period after final installation is complete. We estimate the anticipated costs to be incurred during the warranty period and accrue 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.

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In consolidation the financial results of our foreign subsidiaries are translated into U.S. dollars using the current rate method. Assets and liabilities are translated at the year-end spot exchange rate, revenues and expenses at average exchange rates and equity transactions at historical exchange rates. Exchange differences arising on translation are recorded as a component of other cumulative comprehensive income (loss).

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 U.S. 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 balances, cash generated from operations, proceeds from public offerings of our common stock and a private offering of preferred stock, and bank borrowings. Cash flow provided by operations for the first six months of fiscal 2003 was $208,000 compared to cash used in operations of $1.8 million for the first six months of fiscal 2004. The decrease is primarily due to fluctuations in restricted cash revenue in excess of billings and billings in excess of revenues, accounts payable, and inventory. As of December 27, 2003, we had cash and marketable securities of $187.5 million consisting of cash and cash equivalents of approximately $29.7 million, restricted cash of approximately $10.1 million, marketable securities of $147.7 million and working capital of $200.9 million.

We are required under the terms of our China JV to provide credit support for 50% or $2.5 million of the China JV’s $5.0 million line of credit of which $2.5 million was drawn as of December 27, 2003. As of December 27, 2003 and June 28, 2003, we pledged $2.5 million and $5.0 million, respectively, cash to provide credit support for our guarantee. The Company expects the $2.5 million in cash securing the bank guaranty will be released in January 2004.

Cash flow used in investing activities was $5.7 million and $97.9 million for the first six months of fiscal year 2003 and 2004, respectively. We purchased $5.1 million and $96.1 million of marketable securities in the first six months of fiscal years 2003 and 2004, respectively.

Capital expenditures were $553,000 in the first six months of fiscal 2003 and $1.7 million in the first six months of fiscal 2004. We anticipate capital expenditures of approximately $7.0 million in fiscal 2004 compared to $1.4 million in fiscal 2003. Our capital expenditures have consisted primarily of purchases of process equipment related to product development. The increase in capital expenditure in 2004 is related to the investment in larger size display equipment for our research and development team to continue to develop the process technology needed for the display market.

Cash generated from financing activities was $1.4 million and $98.0 million for the first six months of fiscal 2003 and 2004, respectively. The increase is due to the cash raised of $94.0 million from the public offering of stock for 3,450,000 shares of common stock at $28.75 per share, which closed in October of 2003.

We believe that our working capital and operating needs will continue to be met by cash on hand, cash from operations, and the net proceeds from public offering of common stock registered on form S-3 which closed in October 2003. 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

We had the following contractual obligations and commercial commitments as of December 27, 2003 (in thousands).

The operating leases primarily include leases for offices, factories and office equipment throughout our operations. The bank guarantees represent: 1) our guaranty of 50% of the China JV’s outstanding debt as of December 27, 2003 of $2.5 million, and is expected to be released in January 2004, 2) progress payments made to the Company, primarily from customers in China, deposited in a restricted account until the contract terms are fulfilled, and 3) the guaranties required by the German government for custom duties for items received into Germany. Our other commercial commitments consist of software licenses and third party service contracts.

ITEM 3. – 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 December 27, 2003, our investment consisted primarily of equity securities and corporate, government and municipal bonds of $147.8 million and restricted cash, and earned approximately $653,000 for the quarter then ended, at an average interest rate of approximately 1.7%. The impact on interest income of a decrease of one percent in the average interest rate would have resulted in approximately $276,000 interest income for the quarter ended December 27, 2003.

Foreign Exchange Exposure

We are exposed to foreign exchange risk associated with accounts receivable and payable denominated in foreign currencies. At December 27, 2003, we had approximately $16.7 million of accounts receivable and approximately $11.7 million of accounts payable denominated in Euros. A one percent change in exchange rates would result in an approximate $50,000 net impact on pre-tax income based on the Euro foreign currency denominated accounts receivable and accounts payable balances at December 27, 2003.

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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. Currency hedging transactions have not been significant to date.

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.

Our manufacturing operations are 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 with the exception of $2.5 million which is pledged against a bank guaranty for our 50% of the China JV debt and $6.9 million of guarantees related to progress payments primarily from our Chinese customers and custom duties, for items received in Germany. The Company expects the $2.5 million in cash securing the bank guaranty will be released in January 2004.

ITEM 4: Controls and Procedures

The Company maintains certain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to permit timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, the Company’s management recognizes that any controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving the desired control objectives, and management’s duties require it to make it best judgment in evaluating the cost-benefit relationship of potential controls and procedures.

The Company and its management, including the Chief Executive Officer and Chief Financial Officer, engage in a variety of perpetual procedures to evaluate the effectiveness of the design and implementation of the Company’s disclosure controls and procedures. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were reasonably effective in meeting the desired objectives as of December 27, 2003.

There has been no change in the Company’s internal controls over financial reporting during the fiscal quarter ended December 27, 2003, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION.

ITEM 4. – SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS

ITEM 6. – EXHIBITS AND REPORTS ON FORM 8-K.

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SIGNATURES

        Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on behalf of the undersigned thereunto duly authorized.

EXHIBIT INDEX

EXHIBIT 31.1

I, Thomas T. Edman, certify that:

Date: February 3, 2004

EXHIBIT 31.2

I, Lawrence D. Firestone, certify that:

Date: February 3, 2004