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SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (FEE REQUIRED).

For the fiscal year ended December 31, 2002.

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED).

For the transition period from        to       .

Commission file number: 000-26966

ADVANCED ENERGY INDUSTRIES, INC.

1625 Sharp Point Drive, Fort Collins, CO		80525
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (970) 221-4670

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

None

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

Common Stock, $0.001 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 (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

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Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No [   ].

The [approximate] aggregate market value of voting and non-voting stock held by non-affiliates of the registrant was $251.9 million (A) as of June 28, 2002.

(A)  Excludes 20,716,508 shares of common stock held by directors and officers, and any stockholders whose ownership exceeds 5% of the shares outstanding, at June 28, 2002. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, directly or indirectly, to direct or cause the direction of the management or policies of the registrant, or that such person is controlled by or under common control with the registrant.

32,177,067

(Number of shares of Common Stock outstanding as of March 17, 2003)

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement for the 2003 Annual Meeting of Stockholders to be held on May 7, 2003, to be filed subsequently, are incorporated by reference into Part III of this Form 10-K.

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ADVANCED ENERGY INDUSTRIES, INC.
FORM 10-K
TABLE OF CONTENTS

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PART I

ITEM 1. BUSINESS

Overview

     We design, manufacture and support a group of key components and subsystems for vacuum process systems. Our customers use our products in plasma-based thin-film processing equipment that is essential to the manufacture of semiconductors; compact disks, DVDs and other digital storage media; flat-panel computer and television screens; coatings for architectural glass and optics; and power converters for advanced technology computer workstations and servers.

     Our direct current (DC) and radio frequency (RF) power systems refine, modify and control the raw electrical power from a utility and convert it into power that is uniform and predictable. This allows manufacturing equipment to produce and deposit very thin films at an even thickness on a mass scale. Our acquisition of Dressler HF Technik GmbH (Dressler) in March 2002, has further enhanced our power systems.

     Through our acquisitions of Engineering Measurements Company (EMCO) in January 2001 and Aera Japan Limited (Aera) in January 2002, which provide gas flow products, and Noah Holdings, Inc. (Noah) in April 2000 and Sekidenko, Inc. in August 2000, which provide thermal control and measurement products, we are a company that can provide “best-of-breed” components and systems, bringing together technologies that provide our customers increased precision and productivity.

     We use ion source technology for products that produce a beam of ions for surface modification and other ion beam processes. We have developed a sophisticated pulsing power supply specifically for electroplating processes on semiconductor wafers.

     In collaboration with a major microprocessor manufacturer we have developed the IKOR™ product group of DC-DC converters specifically designed to power the new low voltage, high current microprocessors, application-specific integrated circuits (ASICs), logic and memory chips.

     We market and sell our products primarily to large, original equipment manufacturers (OEMs) of semiconductor, flat panel display, data storage and other industrial thin-film manufacturing equipment. We have sold our products worldwide to more than 100 OEMs and directly to more than 500 end users. Our principal customers include Applied Materials, Inc., Axcelis Technologies, Inc., Lam Research Corporation, Novellus Systems, Inc., ULVAC Technologies, Inc., The Unaxis Corporation and Tokyo Electron Limited. Sales to customers in the semiconductor capital equipment industry comprised 62% of our sales in 2002, 59% in 2001 and 70% in 2000. We sell our products primarily through direct sales personnel to customers in the United States, Europe and Asia, and through distributors in various regions outside the United States. International sales represented 40% of our sales in 2002, 36% in 2001 and 28% in 2000, although many of our products sold domestically are placed on systems shipped overseas by our customers.

Development of Company Business

     We incorporated in Colorado in 1981 and reincorporated in Delaware in 1995. In 1995 we effected the initial public offering of our Common Stock. Unless the context otherwise requires, as used in this Form 10-K, references to “Advanced Energy” refer to Advanced Energy Industries, Inc. and references to “we”, “us”, or “our” refer to Advanced Energy and its consolidated subsidiaries. Our executive offices are located at 1625 Sharp Point Drive, Fort Collins, Colorado 80525, and our telephone number is 970-

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221-4670. Our website address is www.advanced-energy.com. We make available free of charge on our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to these reports as soon as reasonably practicable after filing such reports with, or furnishing them to, the Securities and Exchange Commission (the SEC).

Products

     The following summarizes our portfolio of products:

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DIRECT CURRENT PRODUCTS

     The MDX Series. These products are most commonly used as DC power supplies for PVD sputtering where precise control, superior arc prevention and suppression and low stored energy characteristics are required. They are also used as bias supplies for RF sputtering, tool coating and some etching systems. The MDX series consists of six different product lines that provide a range of power levels from 500W to 120kW. Our second-generation product, the MDX II, was introduced to support higher power levels, to provide wider output range, and to meet strict European regulatory requirements. A model in the MDX series, the MDX-L, was designed for especially high reliability.

     The Pinnacle™ Platform. The Pinnacle platform, which we updated with Pinnacle™ –II is the most recent general-purpose platform in the DC product line. We developed the Pinnacle primarily for use in DC PVD sputtering processes, and it provides substantial improvements in arc prevention, arc suppression capability, reduced size, higher precision and expanded control capability. The low stored energy of Pinnacle, a basic feature of our DC power conversion equipment, is due to the patented basic circuit topology.

     The Pinnacle™ Plus Platform. This platform is a pulsed DC power system designed principally for use in reactive sputtering to produce insulating films. It is capable of producing up to 10kW of power in short pulses at frequencies up to 350kHz, for virtual elimination of arcing in difficult processes.

     The Pinnacle™ 3000. The Pinnacle 3000 power supply, which we introduced in 2002, offers a high feature set that enables precision optical coatings, hard disk thin-film deposition and other related PVD applications. The Pinnacle 3000 offers user-selectable and programmable parameters, up to 3kW of power from less than 50 to 1000V DC and delivers process consistency and control that reduces process variation and improves yields.

     Sparc-le® Accessories. Our Sparc-le line of DC accessories have been updated several times since its introduction, and are designed both to reduce the number of arcs that occur in plasma-based processes and to reduce the energy delivered if arcs do occur. The Sparc-le accessories are especially effective in applications involving the deposition of

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insulating materials where the reaction between the plasma and target is likely to produce more severe arc conditions. The Sparc-le accessories are most commonly used with the MDX product lines.

     Electrostatic Chuck Power Systems. We designed this system of power conversion units for a specific customer for use in wafer handling systems for the semiconductor fabrication market. The electrostatic chuck is a device that uses electric fields to hold or “chuck” a wafer in a vacuum environment without mechanical holding force. This permits more gentle handling of the wafer and simultaneous heating or cooling of the wafer during processing. When our power system applies voltage to the wafer, electric fields are created which hold the wafer in position. Exact control and careful ramping of the voltage permits the wafer to be picked and placed with precision. The system permits multiple power units to be held in a single chassis for ease of integration into the customer’s system.

     Astral™ Products. The Astral products, made in 20kW, 120kW and 200kW versions, offer a technology, called “current pulsed dual magnetron sputtering.” These units are used for development of coatings for CRT and flat panel displays, automotive applications and new types of glass coatings.

     Crystal™. The Crystal 180kW power conversion unit was developed for use in industrial PVD applications such as architectural glass coating, but is also useful in Plasma Enhanced Chemical Vapor Deposition. The latter may be used for deposition of oxygen- and water-vapor-barrier coatings on films used in food packaging. In PVD the unit is typically used as a powering source for a pair of magnetron sputtering sources in the “dual” configuration in a reactive sputtering system.

     The PE Series. The PE low frequency power products are air cooled and primarily intended for use in certain PVD, chemical vapor deposition (CVD) and industrial surface modification applications, including dual cathode sputtering and printed circuit board de-smearing. The PE series products range in frequency from 25kHz to 100kHz. The PE-II products are water cooled and produce 10kW at 40kHz.

     The ID Series. The ID power conversion and control systems were the first products we designed. These systems were specifically designed to power broad-beam ion sources. ID series products are composed of a coordinated set of multiple special purpose power supplies that are used for ion-beam deposition and sputtering, implantation, etching and milling.

     The E’Wave™. The E’Wave is designed for the semiconductor industry for electroplating copper onto a wafer. The power supply can produce up to four channels of multi-step, bipolar, square waveforms, which permit the copper to be alternatively plated and etched in precisely controlled ways, in order to fill very small cavities on the wafer surface. Each channel can produce 400W continuous and up to 2kW peak, for a total supply output of 1.6kW continuous and 8kW peak.

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RADIO FREQUENCY PRODUCTS

     RF POWER GENERATORS

     Low Frequency (LF) Generators. The LF-5 is a 500W unit and the LF-10 is a 1kW unit. Both of these units are variable-frequency, microprocessor-controlled systems. With a frequency range extending from 50kHz to 460kHz, these generators are a good complement to the PD and PE series.

     PDX Series. The PDX series of mid-frequency power conversion and control systems apply cost-effective, single conversion, switchmode techniques to higher frequencies. Depending upon power levels and application, they are available as air or water cooled generators and are used primarily in semiconductor etch and CVD applications. Unlike the LF series, which is frequency agile, the PDX platform products are supplied at discrete frequencies from 275kHz to 400kHz. Some versions provide pulsed operation.

     HFV Series. Three versions of the HFV generator produce 3, 5, or 8kW of power at a variable frequency centered at about 2MHz for powering inductively coupled plasma (ICP) systems through a fixed element matching network. This platform is water cooled and ultra compact, providing up to 8kW of power in a 5-1/4 inch rack mount enclosure 20-1/4 inches deep.

     The RFG Series. The RFG and RFXII are water cooled, full switchmode RF power conversion generators that make extensive use of custom hybrid technologies. Versions of the RFG, targeted at OEM installations, and the full-featured microprocessor controlled RFXII, are currently available at frequencies of 4MHz and 13.56MHz, and in power levels up to 5kW. They are extensively used in semiconductor processes, including CVD, RF sputtering, plasma etching/deposition and reactive ion etching.

     APEX Series. The APEX series of power control and conversion systems feature extremely high power densities and sophisticated microprocessor control. This product line addresses the latest semiconductor industry trends, associated with 300mm wafer processing, for higher power levels and tighter control. The APEX series is highly configurable for OEM applications and includes models from 1.5kW to 10kW as well as many custom versions, intended for direct tool mounting, which include selectable fixed matches and post-match network RF instrumentation. The instrumentation can be used for plasma, chamber and/or process diagnostics or closed-loop control in conjunction with some of our other integrated system control products.

     The RF Series. The RF series products generate power between 500W and 5kW, and are selectively available with frequencies from 2MHz to 40MHz. They use simple, reliable alternating current (AC) transformer front ends and employ linear RF sections, permitting variable frequency and high-speed pulse operation.

     The Atlas™ Series. The Atlas power products combine the advantages of a modernized version of the linear RF sections of the RF series with a switchmode AC

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front end. These products currently range in power up to 4kW and are targeted at applications requiring agile frequency control in the high frequency (HF) range or fixed frequency VHF operation up to 200MHz. These units complement the APEX series of fixed frequency, high efficiency HF range generators. Our customers can choose to have either the compact package of the fixed frequency APEX or, where required, the frequency agility or VHF capability of the Atlas products.

     RF MATCHING NETWORKS

     Analog Control Matching Networks. The AZX, AM and Mercury series impedance matching networks represent several generations of auto match networks. These match networks are designed as accessories to match the complex electrical impedance of the plasma to the 50-Ohm-output impedance of the generators, in order to permit maximum power transfer. These networks use servo-motor driven, ceramic envelope, variable vacuum capacitors and are designed for specific impedance ranges. Some models handle input powers up to 30kW. Different mechanical packages and various servo control schemes are employed in the different series, supporting a wide variety of applications.

     Fixed and No-Moving-Part Variable Match Networks. We pioneered the use of fixed element and/or electronically variable element matches for use in load power regulated and frequency-agile RF power delivery products. We introduced the RFG 2K2V and Multi-function Adapter with fixed-element matching networks for use in a chamber-mount dielectric CVD system. This system provides significant cost savings and performance enhancements. In 1998, we introduced Frequency Transformation Matching System, which is a solid-state variable matching network with no moving parts. Used with the Atlas series of generators in a frequency-agile, tuned poly-etch system, this delivery system provides a wide impedance matching range, yet requires no servo controls or moving parts. We use this product in conjunction with our frequency-agile Atlas generators. The extension of this technology continues and is reflected in the incorporation of selectable fixed matches within custom APEX generator packages.

     Microprocessor Controlled Matching Networks. The Navigator series is the most recent matching network platform we have introduced. This platform is highly modular and employs direct-coupled, microprocessor-controlled stepper motors to drive variable vacuum capacitors. This platform makes provisions for pre- and post-match RF parameter measurements. The microprocessor control enables sophisticated control algorithms to handle tough plasma matching applications that would be impossible with analog control schemes. The provision for post-match RF instrumentation (Navigator Z variations), within the controlled environment at the input to the chamber, has significant potential for improved processes through closed-loop control. Navigator series matching networks are being well received by OEMs for use in their next generation tools.

     RF INSTRUMENTATION

     Z-Scan™ Voltage-Current (V-I) Probe. This unit replaces the RFZ impedance probe. Z-Scan measures the RF properties of a plasma process and provides condensed

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information through its Z-Ware software. The sensing technology incorporated in the Z-Scan probe allows accurate, real-time measurement of power, voltage, current and impedance levels at both fundamental and harmonic frequencies, under actual powered process conditions. Such measurements not only help our customers design their process systems, but are also used as sensitive detectors of process conditions, including etch endpoint.

FLOW PRODUCTS

     Our acquisition of EMCO in 2001 expanded our product offerings to flow meters, providing applications to measure de-ionized, ultra-pure and waste water steams and gases, among other materials. Our acquisition of Aera in January 2002 expanded our offerings to thermal-based, pressure-based and liquid-based mass flow controllers for applications in semiconductor processes, fiber optics, CVD and chemical mechanical planarization (CMP).

TEMPERATURE CONTROL PRODUCTS

     Our acquisition of Noah in 2000 expanded our product offerings to temperature control products, including dynamic point-of-use thermoelectric chillers and static thermoelectric chillers with power levels from 500W to 4.25kW for etch, strip and track applications. Our acquisition of Sekidenko, Inc., also in 2000, expanded our offerings to non-contact optical fiber thermometry for rapid thermal processing (RTP), CVD and strip applications.

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IKOR™ PRODUCTS

IKOR™.  IKOR is a technology-driven supplier of low voltage, high current power delivery solutions for integrated circuits applications at original equipment manufacturers in the high-end computing, automated test equipment and DataCom markets.

     The newer generations of microprocessors require the support of higher current at lower voltages, and must be extremely agile (able to handle rapidly changing power outputs). IKOR products deliver high performance, high efficiency, and high power density including: sub-one volt high current supplies, isolated and non-isolated DC-DC converter modules, and AC-DC power solutions. The IKOR patented basic circuit topology permits smaller, cost-effective solutions, which are stable under high rates of change of current draw, without the use of expensive and unreliable electrolytic capacitors.

Markets and Customers

MARKETS

     Most of our sales have historically been to customers in the semiconductor capital equipment industry. Sales to customers in this industry represented 62% of our sales in 2002, 59% in 2001 and 70% in 2000. Our power conversion and control products, flow products, and ion and plasma sources are also used in the flat panel display, data storage and advanced product applications markets. Our other brand, IKOR™ products, are used in the advanced product applications market. Following is a discussion of the major markets for our products:

     SEMICONDUCTOR CAPITAL EQUIPMENT MANUFACTURING MARKET. We sell our products primarily to semiconductor capital equipment manufacturers for incorporation into equipment used to make integrated circuits. Our products are currently used in a variety of applications including dielectric and metal film deposition, etch, ion implantation, photo-resist strip and megasonic cleaning. The precise control over plasma-based processes enables the production of integrated circuits with reduced feature sizes and increased speed and performance. We anticipate that the semiconductor capital equipment industry will continue to be a substantial part of our business for the foreseeable future.

     DATA STORAGE MANUFACTURING EQUIPMENT MARKETS. We also sell products to manufacturers of data storage equipment and data storage devices for use in producing a variety of products, including CDs, CD-ROMs and DVDs and computer hard disks, including both media and thin-film heads. These products use a PVD process to produce optical and magnetic thin-film layers, as well as a protective wear layer. In this market, the trend towards higher recording densities is driving the demand for denser, thinner and more precise films. The use of equipment incorporating magnetic media to

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store analog and digital data continues to expand with the growth of the laptop, desktop and workstation computer markets and the consumer electronics audio and video markets.

     FLAT PANEL DISPLAY MANUFACTURING EQUIPMENT MARKET. We also sell our products to manufacturers of flat panel displays and flat panel projection devices, which have fabrication processes similar to those employed in manufacturing integrated circuits. Flat panel technology produces bright, sharp, large, color-rich images on flat screens for products ranging from hand-held computer games to laptop and desktop computer monitors to large-screen televisions. There are three major types of flat panel displays: liquid crystal displays, field emitter displays, and gas plasma displays. There are two types of flat panel projection devices: liquid crystal projection and digital micro-mirror displays. We sell our products to all five of these flat panel markets.

     ADVANCED PRODUCT APPLICATIONS MARKETS. We also sell our products to OEMs and producers of end products in a variety of industrial markets. Thin-film optical coatings are used in the manufacture of many industrial products including solar panels, architectural glass, eyeglasses, lenses, barcode readers and front surface mirrors. Thin films of diamond-like coatings and other materials are currently applied to products in plasma-based processes to strengthen and harden surfaces on such diverse products as tools, razor blades, automotive parts and hip joint replacements. Other thin-film processes that use our products also enable a variety of industrial packaging applications, such as decorative wrapping and food packaging. The advanced thin-film production processes allow precise control of various optical and physical properties, including color, transparency and electrical and thermal conductivity. The improved adhesion and high film quality resulting from plasma-based processing make it the preferred method of applying the thin films. Many of these thin-film industrial applications require power levels substantially greater than those used in our other markets.

APPLICATIONS

     We have sold our products for use in connection with the following processes and applications:

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CUSTOMERS

     Our products are sold worldwide to more than 100 OEMs and directly to more than 500 end users. Our ten largest customers accounted for 53% of our total sales in 2002 and in 2001, and 72% in 2000. We expect that sales of our products to these customers will continue to account for a high percentage of our sales in the foreseeable future. Representative customers include:

     Applied Materials, our largest customer, accounted for 27% of our sales in 2002, 24% in 2001 and 39% in 2000. No other customer exceeded 10%. See Note 13 to our financial statements.

     Our backlog increased from $16.3 million at December 31, 2001 to $21.8 million at December 31, 2002. Approximately $2.8 million of this increase was a result of our acquisitions of Aera and Dressler in 2002. We schedule production of our systems based on order backlog and customer commitments. Backlog includes only orders for which written authorizations have been accepted and revenue has not been recognized. Due to possible customer changes in delivery schedules and cancellations of orders, our backlog at any particular date is not necessarily indicative of actual sales for any succeeding period. Delays in delivery schedules and/or a reduction of backlog during any particular period could have a material adverse effect on our business and results of operations.

Marketing, Sales and Service

     We sell our products primarily through direct sales personnel to customers in the United States, Europe and Asia. Our sales personnel are located at our headquarters in Fort Collins, Colorado, and in sales offices in Concord, Massachusetts; San Jose, California; Tempe, Arizona; Vancouver, Washington; and Voorhees, New Jersey. To serve customers in Asia and Europe, we have offices in Tokyo and Hachioji, Japan; Bundang, South Korea; Taipei Hsien and Hsinchu, Taiwan; Shenzhen and Shanghai, China; Filderstadt, Kirchheim, Stolberg and Dresden, Germany; Bicester, England; and Edinburgh, Scotland. These offices have primary responsibility for sales in their respective markets. We also have distributors outside the United States.

     Sales outside the United States represented approximately 40% of our total sales during in 2002, 36% in 2001 and 28% in 2000. We expect sales outside the United States

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to continue to represent a significant portion of future sales. Although we have not experienced any significant difficulties involving international sales, such sales are subject to certain risks, including exposure to currency fluctuations, the imposition of governmental controls, political and economic instability, trade restrictions, changes in tariffs and taxes and longer payment cycles typically associated with international sales.

     We believe that customer service and technical support are important competitive factors and are essential to building and maintaining close, long-term relationships with our customers. We maintain customer service offices in Fort Collins, Colorado; Longmont, Colorado; San Jose, California; Vancouver, Washington; Voorhees, New Jersey; Tokyo and Hachioji, Japan; Bundang, South Korea; Taipei Hsien and Hsinchu, Taiwan; Shenzhen and Shanghai, China; Filderstadt, Kirchheim and Dresden, Germany; Bicester, England; and Edinburgh, Scotland, but plan to close our Longmont, Colorado and Voorhees, New Jersey customer service locations during 2003.

     We offer warranty coverage for our products after shipment against defects in design, materials and workmanship, for periods ranging from 12 to 36 months, with the majority of our products having terms ranging from 18 to 24 months.

Manufacturing

     We have manufacturing locations in Fort Collins and Longmont, Colorado; Voorhees, New Jersey; and Vancouver, Washington. In connection with the acquisitions of Aera and Dressler, we now have manufacturing facilities in Hachioji, Japan; Bundang, South Korea; and Kirchheim and Stolberg, Germany. We generally manufacture different products at each facility. During 2003, we plan to transition the manufacturing of our products in Longmont, Colorado and Voorhees, New Jersey to Fort Collins, Colorado and a new facility in Shenzhen, China. Our manufacturing activities consist of the assembly and testing of components and subassemblies, which are then integrated into our final products. Once final testing of all electrical and electro-mechanical subassemblies is completed, the final product is subjected to a series of reliability enhancing operations prior to shipment to customers. We purchase a wide range of electronic, mechanical and electrical components, some of which are designed to our specifications. We are increasingly outsourcing more of our subassembly work.

     We rely on sole and limited source suppliers for certain parts and subassemblies. This reliance creates a potential inability to obtain an adequate supply of required components,

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and reduces control over pricing and timing of delivery of components. An inability to obtain adequate supplies would require us to seek alternative sources of supply or might require us to redesign our products to accommodate different components or subassemblies. We could be prevented from the timely shipping of our products to our customers if we are forced to seek alternative sources of supply, manufacture such components or subassemblies internally, or redesign our products.

Intellectual Property

     We have a policy of seeking patents on inventions governing new products or technologies as part of our ongoing research, development, and manufacturing activities. We currently hold 63 United States patents and have over 50 patent applications pending in the United States, Europe and Japan. We do not have patent protection for our intellectual property in several countries in which we do business, and we have limited patent protection in certain other countries. The cost of applying for patents in foreign countries and translating the applications into foreign languages requires us to select carefully the inventions for which we apply for patent protection and the countries in which we seek such protection. Generally, our efforts to obtain international patents have been concentrated in the United Kingdom, Germany, France, Italy and Japan because there are other manufacturers and developers of power conversion and control systems in those countries, as well as customers for those systems.

     Litigation may from time to time be necessary to enforce patents issued to us, to protect trade secrets or know-how owned by us, to defend us against claimed infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. See “Cautionary Statements – Risk Factors – We are highly dependent on our intellectual property but may not be able to protect it adequately” and “—Intellectual property litigation is costly.”

Competition

     The markets we serve are highly competitive and characterized by ongoing technological development and changing customer requirements. Significant competitive factors in our markets include product performance, price, quality and reliability and level of customer service and support. We believe that we currently compete effectively with respect to these factors, although there can be no assurance that we will be able to compete effectively in the future.

     The markets in which we compete have seen an increase in global competition, especially from Japanese- and European-based equipment vendors. We have several

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foreign and domestic competitors for each of our product lines. Some of these competitors are larger and have greater resources than we have. Our ability to continue to compete successfully in these markets depends on our ability to make timely introductions of system enhancements and new products. Our primary competitors are MKS Instruments, Inc.; Huettinger Elektronik GmbH and Co. KG; Shindingen; Kyosan Electric Manufacturing Co. Ltd.; Comdel; STEC, Inc.; Celerity Group, Inc. (formerly Kinetics); Mykrolis Corp.; and Daihen Corp. We expect our competitors will continue to improve the design and performance of their products and to introduce new products with competitive performance characteristics. We believe we will be required to maintain a high level of investment in both research and development and sales and marketing in order to remain competitive.

Operating Segment

     We operate and manage our business of manufacturing, marketing and servicing components and subsystems for plasma-based manufacturing processes as one segment.

Research and Development

     The market for our subsystems for vacuum process systems and related accessories is characterized by ongoing technological changes. We believe that continued and timely development of new products and enhancements to existing products to support OEM requirements is necessary for us to maintain a competitive position in the markets we serve. Accordingly, we devote a significant portion of our personnel and financial resources to research and development projects and seek to maintain close relationships with our customers and other industry leaders in order to remain responsive to their product requirements. Research and development expenses were $49.0 million in 2002, $45.2 million in 2001 and $37.0 million in 2000, representing 20.5% of total sales in 2002, 23.3% in 2001 and 10.2% in 2000. We believe that continued research and development investment and ongoing development of new products are essential to the expansion of our markets, and expect to continue to make significant investments in research and development activities.

Number of Employees

     As of December 31, 2002, we had a total of 1,398 employees, 1,319 of whom were full-time continuous employees. There is no union representation of our employees, and we have never experienced a work stoppage. We utilize temporary employees as a means to provide additional staff while reviewing the performance of the temporary employee. We consider our employee relations to be good.

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Effects of Environmental Laws

     We are subject to federal, state and local environmental laws and regulations, as well as the environmental laws and regulations of the foreign federal and local jurisdictions in which we have manufacturing facilities. We believe we are in material compliance with all such laws and regulations.

Cautionary Statements – Risk Factors

     This Form 10-K includes “forward-looking statements” within the meanings of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements contained or incorporated by reference in this Form 10-K, other than statements of historical fact, are “forward-looking statements.” For example, statements relating to our beliefs, expectations, plans and projections are forward-looking statements, as are statements that specified actions or circumstances will continue or change. Forward-looking statements involve risks and uncertainties. In some cases, forward-looking statements can be identified by the inclusion of words such as “believe,” “expect,” “plan,” “anticipate,” “estimate” and similar words.

     Some of the forward-looking statements in this Form 10-K are expectations or projections relating to:

	•		customer inventory levels, needs and order levels;
	•		our future revenues;
	•		our future gross profit;
	•		market acceptance of our products;
	•		research and development expenses;
	•		selling, marketing, general and administrative expenses;
	•		capital resources sufficiency and availability;
	•		potential acquisitions;
	•		capital expenditures;
	•		restructuring activities and expenses; and
	•		general economic conditions in the U.S. and worldwide.

     Our actual results could differ materially from those projected or assumed in our forward-looking statements, because forward-looking statements by their nature are subject to risks and uncertainties. Factors that could contribute to these differences or prove our forward-looking statements, by hindsight, to be overly optimistic or unachievable, include the factors described in this section. Other factors, including factors which we do not now consider material, also might contribute to the differences between our forward-looking statements and our actual results. We assume no obligation to update any forward-looking statement or the reasons why our actual results might differ.

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Our quarterly operating results are subject to significant fluctuations, which could negatively impact the market prices of our securities.

     Our quarterly operating results have fluctuated significantly and we expect them to continue to experience significant fluctuations. Downward fluctuations in our quarterly results historically have resulted in decreases in the price of our common stock. Quarterly operating results are affected by a variety of factors, many of which are beyond our control. These factors include:

	•		changes or slowdowns in economic conditions in the semiconductor and semiconductor capital equipment industries and other industries in which our customers operate;
	•		the timing and nature of orders placed by our customers;
	•		changes in customers’ inventory management practices;
	•		customer cancellations of previously placed orders and shipment delays;
	•		pricing competition from our competitors;
	•		component shortages or allocations or other factors that change our levels of inventory or substantially increase our spending on inventory or result in manufacturing delays;
	•		the introduction of new products by us or our competitors;
	•		costs incurred by responding to specific feature requests by customers;
	•		declines in macroeconomic conditions;
	•		timing and challenges of integrating recent and potential future acquisitions and strategic alliances;
	•		potential litigation especially regarding intellectual property; and
	•		our exposure to currency exchange rate fluctuations between the several functional currencies in foreign locations in which we have operations.

     In addition, companies in the semiconductor capital equipment industry and other electronics companies experience pressure to reduce costs. Our customers exert pressure on us to reduce prices, enhance features, improve reliability, shorten delivery times and extend payment terms. These pressures could lead to significant changes in our operating results from quarter to quarter. These changes often occur quickly and make it difficult for us to predict our revenues or operating results. For example, our ability to predict future operating results is quite low given the continued uncertainty in virtually all forms of technology spending.

     We have incurred significant charges and costs related to inventory obsolescence and warranty. These costs may be driven by many factors, including new technologies introduced to the marketplace by our competitors and others, volatility in the demand for our products and our introduction of newer, more complex products, which required substantial rework and in some cases replacement in accordance with the terms of our warranties.

     In the past, we have incurred charges and costs related to events such as acquisitions, restructuring and storm damages. In addition, we have from time to time incurred

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charges and costs related to new technologies that are being developed by others. The occurrence of similar events in the future could adversely affect our operating results in the applicable quarter.

     Our operating results in one or more future quarters may fall below the expectations of analysts and investors. In those circumstances, the trading price of our common stock would likely decrease and, as a result, any trading price of our convertible notes may decrease as well.

The semiconductor and semiconductor capital equipment industries are highly volatile, and our operating results are affected to a large extent by events in those industries.

     The semiconductor industry historically has been highly volatile and has experienced periods of oversupply resulting in significantly reduced demand for semiconductor capital equipment. These reductions, in turn, have significantly reduced demand for our products. A rapid decrease in demand for our products can occur with limited advance notice because we supply subsystems to equipment manufacturers and make a substantial portion of our shipments on a just-in-time basis. This decrease in demand can adversely impact our business and financial results disproportionately because of its unanticipated nature.

     During downturns, some of our customers have drastically reduced their orders to us and have implemented substantial cost reduction programs. The semiconductor industry is currently involved in one of the most significant downturns in its history and there is no reason to believe that this situation will significantly improve in the near term. Sales to customers in the semiconductor capital equipment industry accounted for 62% of our total sales in 2002, 59% in 2001 and 70% in 2000. We expect that our business will continue to depend significantly on the volatile semiconductor and semiconductor capital equipment industries for the foreseeable future.

The market price of our common stock is highly volatile, which could lead to fluctuating prices for our convertible notes, losses for individual investors and costly securities class action litigation.

     The market for technology stocks, including our common stock, has experienced significant price and volume fluctuations. These fluctuations often have been unrelated or disproportionate to the operating performance of the companies. From our IPO in November 1995 through March 17, 2003, the closing prices of our common stock on the NASDAQ National Market have ranged from $3.50 to $73.25. The market for our common stock, and any market for our convertible notes, likely will continue to be subject to severe fluctuations. Many factors could cause the trading price of our common stock and notes to fluctuate substantially, including the following:

•

future announcements concerning our business, technology, customers or competitors;

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	•		variations in our operating results;
	•		introduction of new products or changes in product pricing policies by us, our competitors or our customers;
	•		changes in earnings estimates by securities analysts or announcements of operating results that are not aligned with the expectations of analysts and investors;
	•		reduced spending for consumer electronic items;
	•		the economic and competitive conditions in the industries in which our customers operate;
	•		changes or slowdowns in general economic conditions or conditions in the semiconductor and semiconductor capital equipment industries and other industries in which our customers operate;
	•		changes in the general geopolitical environment; and
	•		general stock market trends.

     In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation often has been brought against that company. Many technology companies have been subject to this type of litigation. We may also become involved in this type of litigation. Litigation is often expensive and diverts management’s attention and resources, which could significantly harm our business, financial condition and results of operations.

A significant portion of our sales is concentrated among a few customers.

     Our ten largest customers accounted for 53% of our total sales in 2002 and 2001, and 72% in 2000. Our largest customer, Applied Materials, accounted for 27% of our total sales in 2002, 24% in 2001 and 39% in 2000. The loss of any of our larger customers or a material reduction in any of their purchase orders would significantly harm our business, financial condition and results of operations.

The markets in which we operate are highly competitive.

     We face substantial competition, primarily from established companies, some of which have greater financial, marketing and technical resources than we do. Our primary competitors are MKS Instruments, Inc.; Huettinger Elektronik GmbH and Co. KG; Shindingen; Kyosan Electric Manufacturing Co. Ltd.; Comdel; STEC, Inc.; Celerity Group, Inc. (formerly Kinetics); Mykrolis Corp.; and Daihen Corp. We expect that our competitors will continue to develop new products in direct competition with ours, improve the design and performance of their products and introduce new products with enhanced performance characteristics.

     To remain competitive, we need to continue to improve and expand our products and product offerings. In addition, we need to maintain a high level of investment in research and development and expand our sales and marketing efforts, particularly outside of the United States. We may not be able to make the technological advances and investments necessary to remain competitive.

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     New products developed by competitors or more efficient production of their products could increase pressure on the pricing of our products. In addition, electronics companies, including companies in the semiconductor capital equipment industry, have been facing pressure to reduce costs. Either of these factors may require us to make significant price reductions to avoid losing orders. Further, our current and prospective customers consistently exert pressure on us to lower prices, shorten delivery times and improve the capability of our products. Failure to respond adequately to these pressures could result in a loss of customers and orders.

We recently acquired a number of companies and technologies, and may continue seeking acquisitions, but might not be able to integrate our acquisitions successfully or efficiently and may record significant charges related to these acquisitions.

     We have significantly expanded our product offerings through acquisitions and continue to seek acquisition opportunities actively. Prior to 1997, we did not make any significant acquisitions. In the three years from 1997 through 1999, we acquired five companies. In 2000 and 2001, we acquired three companies and entered into a strategic partnership arrangement with one other company. In January 2002, we acquired Aera, a privately owned Japanese corporation with approximately 220 employees in six locations worldwide. In March 2002, we acquired Dressler, a privately owned Stolberg, Germany-based provider of power supplies and networks.

     Integrating the companies and technologies that we have acquired has placed substantial demands on our management team. Further, the increased pace of our acquisitions has required us to try to integrate multiple acquisitions simultaneously. This has decreased the time and effort that management can give to integrating each acquisition, while continuing to manage our existing business.

     Some of our acquisitions have been in technology and geographic markets in which we have limited experience. We might not be able to compete successfully in these markets or operate the acquired businesses efficiently. While we may be able to reduce some costs through consolidation, such as the elimination of redundant locations and personnel, other unanticipated costs of operating acquired companies or integrating them into our operations may continue to emerge. Our business and results of operations could be adversely affected if integrating our acquisitions results in substantial charges, costs, delays or other operational or financial problems. Our acquisitions in 2002 and 2001 created significant goodwill and other intangible assets, resulting in increased amortization expense. We may also recognize significant goodwill and other intangible asset impairment charges depending upon the success of the operations of our acquisitions and Advanced Energy as a whole.

     Future acquisitions could place additional strain on our operations and management. Our ability to manage future acquisitions will depend on our success in:

	•		evaluating new markets and investments;
	•		monitoring operations of acquired companies;

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	•		controlling costs and unanticipated expenses of acquired companies;
	•		integrating acquired operations and personnel;
	•		retaining existing customers and strategic partners of acquired companies;
	•		leveraging our existing distribution channels;
	•		maintaining effective quality controls of acquired companies; and
	•		expanding our internal management, technical and accounting systems.

Future acquisitions may result in dilution to existing stockholders, adversely affect our financial results or the market price of our securities or limit our financial flexibility.

     In connection with future acquisitions we may issue equity securities, incur or assume debt, recognize substantial one-time expenses or create goodwill and other intangible assets that could result in future charges for impairment or in the case of other intangible assets, significant amortization expense. Parties to whom we issue equity securities in acquisitions may seek to liquidate their ownership following an acquisition, which may lead to increased pressure on the market price of our stock and convertible notes. The market price of our securities may also decline upon announcement of an acquisition, if investors do not view it favorably. Also, many acquisition opportunities are for foreign companies or for divisions of larger companies, for whom cash is generally a more attractive consideration than securities. The use of cash for these acquisitions may reduce our future financial flexibility.

We might not be successful in acquiring the companies or developing the technologies necessary to implement our business strategy.

     We continue to look for ways to expand our product offerings to new and existing customers and expand into new markets through acquisitions, internal development and refinement of technologies, and sales and marketing efforts. However, whether or not we are successful in implementing our goal of becoming a single-source provider of integrated solutions will depend on many factors, several of which are out of our control. For example, we may not be able to identify or acquire companies or develop internally products which complement our present product offerings. If we identify appropriate target companies or technologies, we may not be able to afford to acquire them or may be otherwise unsuccessful in doing so due to market conditions, competition, failure to agree on terms and other circumstances. Implementation of our growth, acquisition and product integration strategy may be delayed or altered as these factors affect management’s acquisition and development decisions.

Our newly acquired foreign operations, as well as our foreign sales and service offices, present difficulties that we have limited experience addressing.

     Our acquisitions of Aera and Dressler significantly increased our operations outside of the United States. In addition to our operations in Japan and Germany, we maintain sales and service offices in Germany, the United Kingdom, South Korea, Taiwan and China. In implementing our business strategy, we may acquire other companies or relocate some

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of our current domestic operations outside of the United States. In February 2003, we announced that we plan to move selected power supply and mass flow production lines to a new facility in China. We have limited experience in operating manufacturing facilities in China, and may face difficulties in the following areas among others:

	•		integrating our production processes;
	•		maintaining effective quality controls;
	•		meeting our customers’ demand schedules;
	•		integrating operations and administrative personnel;
	•		complying with local laws, regulations and trade barriers; and
	•		controlling costs and expenses

     Our foreign operations subject us to risks and uncertainties that we have limited experience addressing. For example, we face greater difficulty outside the United States:

	•		managing and staffing our offices;
	•		safeguarding our intellectual property;
	•		understanding and complying with local business customs and laws;
	•		maintaining consistent standards of internal accounting controls and compliance with accounting policies in our operations around the world; and
	•		competing for customers and supplies with companies based in the foreign country.

     In addition, our foreign operations are subject to risks in each country, including:

	•		currency controls and exchange rate fluctuations;
	•		governmental regulations and controls; and
	•		political and economic instability.

     Our ability to integrate the operations of Aera and Dressler, transition selected manufacturing processes to China, as well as our overall financial results might be adversely affected, if we are unable to address these difficulties and risks successfully.

We might not be able to compete successfully in international markets or meet the service and support needs of our international customers.

     Our customers increasingly require service and support on a worldwide basis as the markets in which we compete become increasingly globalized. Our success in competing in international markets is subject to our ability to manage various risks and difficulties, including:

	•		compliance with product safety requirements and standards that are different from those of the United States;
	•		barriers to entry;
	•		import and export requirements and controls;

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	•		trade restrictions;
	•		collecting past due accounts receivable from foreign customers; and
	•		changes in tariffs and taxes.

     Sales to customers outside the United States accounted for 40% of our total sales in 2002, 36% in 2001 and 28% in 2000. As a result of our acquisitions of Aera and Dressler, we expect international sales to represent a larger portion of our future sales. Providing support services for our products on a worldwide basis also is subject to various risks, including:

	•		our ability to hire qualified support personnel;
	•		maintenance of our standard level of support;
	•		difficulties managing overseas distributors and representatives; and
	•		differences in local customs and practices.

     Our ability to implement our business strategies and maintain market share will be compromised, if we are unable to manage these risks successfully.

Fluctuations in the currency exchange rate between the U.S. dollar and foreign currencies could adversely affect our operating results.

     A portion of our sales is subject to currency exchange risk as a result of our international operations. Approximately 40% of our revenues in 2002 were subject to this risk. As a result of our expanded international operations and sales, including those acquired through the acquisitions of Aera and Dressler, we expect a greater portion of our future revenues to be subject to this risk.

     We have experienced fluctuations in foreign currency exchange rates, particularly against the Japanese yen and the euro, which have negatively affected our operating results from time to time. We have in the past entered into various forward foreign exchange contracts to mitigate currency fluctuations in the yen and intend to continue to do so. We have not employed derivative techniques with respect to any other currencies. Our current or any future derivative techniques might not protect us adequately against substantial currency fluctuations and may increase our foreign currency exposure and the volatility of our results of operations.

Shortages of components necessary for our product assembly can delay our shipments.

     Manufacturing our products and control systems for the semiconductor capital equipment industry requires numerous electronic components. Dramatic growth in the electronics industry has significantly increased demand for these components. This demand has resulted in periodic shortages and allocations of needed components, and we expect to experience additional shortages and allocations from time to time. Shortages and allocations could cause shipping delays for our products, adversely affecting our

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results of operations. Shipping delays also could damage our relationships with current and prospective customers as well as our perception in the markets in which we operate.

Our dependence on sole and limited suppliers could affect our ability to manufacture products and systems.

     We rely on sole and limited source suppliers for some of our components and subassemblies that are critical to the manufacturing of our products. This reliance involves several risks, including the following:

	•		the potential inability to obtain an adequate supply of required components;
	•		the potential for a sole source provider to cease operations;
	•		our need to fund the operating losses of a sole source provider;
	•		reduced control over pricing and timing of delivery of components; and
	•		the potential inability of our suppliers to develop technologically advanced products to support our growth and development of new products.

     We believe that in time we could obtain and qualify alternative sources for most sole and limited source parts or could manufacture the parts ourselves. Seeking alternative sources or commencing internal manufacture of the parts could require us to redesign our products, resulting in increased costs and likely shipping delays. We may be unable to manufacture the parts internally or redesign our products, which could result in further costs and shipping delays. These increased costs would decrease our profit margins if we could not pass the costs to our customers. Further, shipping delays could damage our relationships with current and potential customers and have a material adverse effect on our business and results of operations.

Our current and future investments in start-up or early stage companies might not be economically beneficial or otherwise rewarding and might cause us to realize losses.

     We have invested in start-up and early stage companies that develop products and technologies that we believe may provide us with future benefits. These investments may not provide us with any benefit, and we may not achieve any economic return on any of these investments. Our investments in these companies are subject to all of the risks inherent in investing in companies that are not established. We could lose all or any part of our investments in these companies. Over the last twelve months the implied value of a number of companies has decreased dramatically and a number of technology companies have been forced to write off all or a portion of their investments in these companies. In 2002 and 2001, we recorded impairment charges related to an investment in an early stage company totaling $1.9 million and $6.8 million, respectively.

     As we make additional investments, we may be required to reflect all or a portion of such investments as a charge against earnings or record our share of the company’s income or losses. As of December 31, 2002, we have committed to advance $2.3 million to several privately held companies over the next two years.

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We are highly dependent on our intellectual property but may not be able to protect it adequately.

     Our success depends in part on our proprietary technology. We attempt to protect our intellectual property rights through patents and non-disclosure agreements. However, we might not be able to protect our technology, and competitors might be able to develop similar technology independently. In addition, the laws of some foreign countries might not afford our intellectual property the same protections as do the laws of the United States. Our intellectual property is not protected by patents in several countries in which we do business, and we have limited patent protection in some other countries. The costs of applying for patents in foreign countries and translating the applications into foreign languages requires us to select carefully the inventions for which we apply for patent protection and the countries in which we seek protection. Generally, we have concentrated our efforts to obtain international patents in the United Kingdom, Germany, France, Italy and Japan because there are other manufacturers and developers of similar products and control systems in those countries, as well as customers for those products. Our inability or failure to obtain adequate patent protection in a particular country could threaten our ability to compete effectively in that country.

     Our patents also might not be sufficiently broad to protect our technology, and any existing or future patents might be challenged, invalidated or circumvented. Additionally, our rights under our patents may not provide meaningful competitive advantages.

Intellectual property litigation is costly.

     We have recently faced significant intellectual property litigation, which resulted in us recording approximately $5.3 million in litigation damages and expenses in 2002. As a result of this judgment we have entered into a settlement agreement allowing us to sell the infringing product subsequent to the date of the jury award. Under the terms of the settlement agreement, we are required to pay royalties to MKS Instruments for each unit of the infringing products we sell. We charged approximately $530,000 to cost of sales in 2002 related to this agreement.

     Subject to the foregoing, we do not believe that any of our products are infringing any patents or proprietary rights of others, although infringements may exist or might occur in the future. Litigation may be necessary to enforce patents issued to us, to protect our trade secrets or know-how, to defend ourselves against claimed infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. This type of litigation often requires substantial management time and attention, as well as financial and other resources.

     An adverse determination in any current or future litigation could cause us to lose proprietary rights, subject us to significant liabilities to third parties, require us to seek licenses or alternative technologies from others or prevent us from manufacturing or

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selling our products and impact future revenue. Any of these events could threaten our business, financial condition and results of operations.

We must constantly develop and sell new products in order to keep up with rapid technological change.

     The markets for our products and the markets in which our customers compete are characterized by ongoing technological developments and changing customer requirements. We must continue to improve existing products and to develop new products that keep pace with technological advances and meet the needs of our customers in order to succeed. We might not be able to continue to improve our products or develop new products. The products we do develop might not be cost-effective or introduced in a timely manner. Developing and introducing new products may involve significant and uncertain costs. Our business, financial condition and results of operations, as well as our customer relationships, could be adversely affected if we fail to develop or introduce improved products and new products in a timely manner.

We must achieve design wins to retain our existing customers and to obtain new customers.

     The constantly changing nature of semiconductor fabrication technology causes equipment manufacturers to continually design new systems. We often must work with these manufacturers early in their design cycles to modify our equipment to meet the requirements of the new systems. Manufacturers typically choose one or two vendors to provide the power conversion equipment for use with the early system shipments. Selection as one of these vendors is called a design win. It is critical that we achieve these design wins in order to retain existing customers and to obtain new customers.

     We typically must customize our products for particular customers to use in their equipment to achieve design wins. This customization increases our research and development expenses and can strain our engineering and management resources. These investments do not always result in design wins.

     Once a manufacturer chooses a power conversion and control system for use in a particular product, it is likely to retain that system for the life of that product. Our sales and growth could experience material and prolonged adverse effects if we fail to achieve design wins. In addition, design wins do not always result in substantial sales or profits.

     We believe that equipment manufacturers often select their suppliers based on factors such as long-term relationships. Accordingly, we may have difficulty achieving design wins from equipment manufacturers who are not currently customers. In addition, we must compete for design wins for new systems and products of our existing customers, including those with whom we have had long-term relationships.

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Our efforts to be responsive to customers may lead to incurring costs that are not readily recoverable.

     We may incur manufacturing overhead and other costs, many of which are fixed, to meet anticipated customer demand. Accordingly, operating results could be adversely affected if orders or revenues in a particular period or for a particular system do not meet expectations.

     We often require long lead times for development of our products during which times we must expend substantial funds and management effort. We may incur significant development and other expenses as we develop our products without realizing corresponding revenue in the same period, or at all.

Our success depends upon our ability to attract and retain key personnel.

     Our success depends upon the continued efforts of our senior management team and our technical, marketing and sales personnel. These employees may voluntarily terminate their employment with us at any time. Our success also depends on our ability to attract and retain additional highly qualified management, technical, marketing and sales personnel. The process of hiring employees with the combination of skills and attributes required to carry out our strategy can be extremely competitive and time-consuming. We may not be able to successfully retain existing personnel or identify, hire and integrate new personnel. If we lose the services of key personnel for any reason, including retirement, or are unable to attract additional qualified personnel, our business, financial condition and results of operations could be materially and adversely affected.

We conduct manufacturing at only a few sites and our sites are not generally interchangeable.

     We conduct the majority of our manufacturing at our facilities in Fort Collins and Longmont, Colorado; Voorhees, New Jersey; Vancouver, Washington; Stolberg, Germany; and Hachioji, Japan. In 2003, we plan to transition the manufacturing of our products in Longmont, Colorado and Voorhees, New Jersey to Fort Collins, Colorado and a new facility in Shenzhen, China. We also have smaller sites in Bundang, South Korea; and Kirchheim, Germany. Each facility generally manufactures different products and, therefore, is not readily interchangeable. In July 1997, a severe rainstorm in Fort Collins caused substantial damage to our Fort Collins facilities and to some equipment and inventory. The damage caused us to stop manufacturing at that facility temporarily and prevented us from resuming full production there until mid-September 1997. Our insurance policies did not cover all of the costs that we incurred in connection with the rainstorm. Future natural or other uncontrollable occurrences at any of our primary manufacturing facilities that negatively impact our manufacturing processes may not be fully covered by insurance and could cause significant harm to our operations and results of operations.

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We must maintain minimum levels of customized inventory to support some customer delivery requirements.

     We must keep a relatively large number and variety of customized products in our inventory to meet customer delivery requirements. Our inventory may become obsolete as we develop new products, as our customers develop new systems, and due to products developed by competitors. Recent inventory obsolescence has had a material impact on our financial condition and results of operations. We recorded approximately $5.8 million of inventory obsolescence charges in 2002, $6.4 million in 2001 and $654,000 in 2000. We cannot provide any assurance that we will not recognize significant future inventory obsolescence charges.

Warranty costs on certain products may be excessive.

     In recent years we have experienced higher than expected levels of warranty costs on certain products. We have been required to repair, rework, and in some cases, replace, the products. Our warranty costs generally increase when we introduce newer, more complex products. We recorded warranty costs of approximately $13.2 million in 2002, $7.6 million in 2001 and $4.6 million in 2000. If such levels of warranty costs persist in the future, our financial condition and results of operations may be materially adversely affected.

We are subject to numerous governmental regulations.

     We are subject to federal, state, local and foreign regulations, including environmental regulations and regulations relating to the design and operation of our products and control systems. We must ensure that our products meet safety and emissions standards, many of which vary across the states and countries in which our products are used. For example, the European Union has published directives specifically relating to power supplies. We must comply with these directives in order to ship our products into countries that are members of the European Union. In the past, we have invested significant resources to redesign our products to comply with these directives. We believe we are in compliance with current applicable regulations, directives and standards and have obtained all necessary permits, approvals and authorizations to conduct our business. However, compliance with future regulations, directives and standards could require us to modify or redesign some products, make capital expenditures or incur substantial costs. If we do not comply with current or future regulations, directives and standards:

	•		we could be subject to fines;
	•		our production could be suspended; or
	•		we could be prohibited from offering particular products in specified markets.

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We lease a portion of our Fort Collins, Colorado facilities and a condominium from entities in which a major stockholder and insider has financial interests.

     We lease our executive offices and manufacturing facilities in Fort Collins, Colorado from Prospect Park East Partnership and from Sharp Point Properties, LLC. Douglas S. Schatz, our Chairman, President and Chief Executive Officer, holds a 26.7% interest in each of the leasing entities. Aggregate rental payments under these leases for 2002 totaled approximately $2.7 million. We also lease a condominium in Breckenridge, Colorado to provide rewards and incentives to our customers, suppliers and employees. We lease the condominium from AEI Properties, a partnership in which Mr. Schatz holds a 60% interest. Aggregate rental and other payments under the condominium lease for 2002 totaled approximately $67,000. As of December 31, 2002, Mr. Schatz owned approximately 34.3% of our common stock. It is possible that the interests of Mr. Schatz may not coincide with our interests with respect to these properties.

Our executive officers and directors own a significant percentage of our outstanding common stock, which could enable them to control our business and affairs.

     Our executive officers and directors owned approximately 39.4% of our common stock outstanding as of December 31, 2002. Douglas S. Schatz, our Chairman, President and Chief Executive Officer, owned approximately 34.3% of our common stock outstanding as of December 31, 2002. These stockholdings give our executive officers and directors collectively, and Mr. Schatz individually, significant voting power. Depending on the number of shares that abstain or otherwise are not voted on a particular matter, our executive officers collectively may be able to elect all of the members of our board of directors and to control our business affairs for the foreseeable future.

We recently have increased our leverage significantly.

     As a result of our acquisition of Aera in January 2002, we assumed approximately $34 million in bank loans and other debt. In August 2001, we issued $125 million of convertible notes. In October and November of 2002, we repurchased an aggregate of approximately $18.9 million principal amount of our convertible notes in the open market. As a result of these transactions, our principal and interest payment obligations increased and such debt increased from approximately $83.9 million at December 31, 2000 to approximately $212.2 million at December 31, 2002. Our bank loans assumed in the acquisition of Aera mature through May 2007 and our convertible notes are due in 2006. The degree to which we will be leveraged could adversely affect our ability to obtain financing for working capital, acquisitions or other purposes and could make us more vulnerable to industry downturns and competitive pressures. Our ability to meet our debt service obligations will be dependent upon our future performance, which will be subject to the financial, business and other factors affecting our operations, many of which are beyond our control. Our note holders and other creditors might require us to sell some of our assets, terminate some of our operations or take other actions, including

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completely liquidating the company, if we are unable to meet our debt service obligations.

Anti-takeover provisions limit the ability of a person or entity to acquire control of us and may adversely affect the value of our common stock and our convertible notes.

       Our certificate of incorporation and bylaws include provisions which:

	•		allow the board of directors to issue preferred stock with rights senior to those of the common stock without any vote or other action by the holders of the common stock;
	•		limit the right of our stockholders to call a special meeting of stockholders; and
	•		impose procedural and other requirements that could make it difficult for stockholders to effect particular corporate actions.

     In addition, we are subject to the anti-takeover provisions of the Delaware General Corporation Law. Any of these provisions could delay or prevent a person or entity from acquiring control of us. The effect of these provisions may be to limit the price that investors are willing to pay in the future for our securities. These provisions might also discourage potential acquisition proposals or could diminish the opportunities for our stockholders to participate in a tender offer, even if the acquisition proposal or tender offer is at a price above the then current market price for our common stock.

EXECUTIVE OFFICERS OF THE REGISTRANT

     Our executive officers, their positions and their ages as of February 28, 2003, are as follows:

     Douglas S. Schatz is a co-founder and has been our Chief Executive Officer and Chairman of the Board since our incorporation in 1981. From our incorporation to July 1999, Mr. Schatz also served as our President. In March 2001, Mr. Schatz was reappointed as President. From September 2002 until February 2003, Mr. Schatz served

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as our interim Chief Operating Officer. Since December 1995, Mr. Schatz has also served as a director of Advanced Power Technology, Inc., a publicly held company which provides high power, high voltage and high performance semiconductors and power modules.

     Dennis A. Faerber joined us in February 2003 as Executive Vice President and Chief Operating Officer. From July 2001 to February 2003, Mr. Faerber was Vice President and General Manager of U.S. Operations at Agilent Technologies’ Electronic Products and Solutions Group. Prior to Agilent, he held a variety of management positions in research and development, manufacturing, marketing and services throughout a twenty-four year career with Hewlett-Packard Corporation.

     Michael El-Hillow joined us in October 2001 as Senior Vice President of Finance and Administration and Chief Financial Officer, in February 2003 he was named Executive Vice President. From April 1997 to July 2001, Mr. El-Hillow was Senior Vice President and Chief Financial Officer of Helix Technology Corporation. He was Senior Vice President and Chief Financial Officer of Spike Broadband Systems, Inc. from July 2001 to October 2001. Prior to Helix he was Vice President, Finance, Treasurer and Chief Financial Officer at A.T. Cross Company and an audit partner at Ernst & Young.

     Richard A. Scholl joined us in 1988 as Vice President, Engineering. Mr. Scholl became our Chief Technology Officer in September 1995. Prior to joining us, Mr. Scholl was General Manager, Vacuum Products Division of Varian Associates, Inc., a manufacturer of high-technology systems and components.

     Charles S. Rhoades joined us in September 2002 as Senior Vice President and General Manager of Control Systems and Instrumentation. From March 2000 to September 2002, Mr. Rhoades was Vice President, Corporate Development at Portera Systems. Prior to Portera Systems he was Managing Director, Product Development at Lam Research.

     Brenda M. Scholl joined us in 1988 as Product Manager for DC products and held several positions in marketing thereafter, before becoming Vice President and General Manager, DC Products in May 2001. In October 2002, Mrs. Scholl was named Senior Vice President and General Manager of our Power Strategic Business Unit. Prior to joining us, she held positions in marketing and sales for Varian Associates and LFE Corporation.

     Scott B. Burton joined us in June 2002 as Senior Vice President of Worldwide Operations. From 1999 to June 2002, he was Chief Operating Officer and Vice President of Operations, Far East Operations at Seagate Technology. Prior to Seagate he was Director of Marketing and PLM at Conner Peripherals and Account Marketing Representative at International Business Machines.

     James Guilmart joined us in August 1999 as Director of Applied Business Unit, and was named Senior Vice President of Sales in October 2000. In October 2002, Mr.

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Guilmart was named Senior Vice President of Global Customer Operations. From October 1998 to August 1999, he was Senior Vice President, SAP Business Unit at Siemens Information and Communications Products, LLC. Prior to Siemens, he was Vice President, Business Implementation at Unisys Corporation.

     Monica Moloney joined us in January 1991 as Human Resources Manager. Ms. Moloney held progressive positions in human resources thereafter, before becoming Vice President of Human Resources in February 1999. From 1985 to 1991, Ms. Moloney held a variety of human resources positions at TRW Electronic Products, Inc.

     Thomas K. Werning joined us in March 2002 as Vice President of Finance and Corporate Controller. From January 2000 to November 2001, Mr. Werning was Senior Vice President, Chief Operating Officer at Cirilium Corporation. Prior to Cirilium, he was Vice President of Finance and Operations at Hypercom Network Systems, and the European Controller for Marion Merrell Dow.

     Joseph P. Kovach joined us in June 2002 as Vice President and Chief Information Officer. From November 2000 to May 2002, Mr. Kovach was Chief Operating Officer at Interlink Group. Prior to Interlink, he was Senior Vice President and Chief Information Officer at R.L. Polk & Co. Mr. Kovach has also held management positions at Electronic Data Systems in operations and information technology.

     Mario Guerrero joined us in December 2001 as Vice President of Strategic Planning. From 1991 to December 2001, Mr. Guerrero was an Independent Management Consultant. Prior to being an Independent Management Consultant he was a partner and consultant at The Canaan Group, Ltd.

     John Wagner joined us in October 2002 as President of IKOR™. From October 1996 to November 2001, he was Vice President, Product Development/Management at Visiontek. Prior to Visiontek, he was Group Manager, GSM Business at Motorola.

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ITEM 2. PROPERTIES

     Information concerning our principal properties is set forth below:

     We consider all of the above facilities suitable and adequate to meet our production and office space needs for the foreseeable future. We believe that suitable additional or alternative space will be available in the future on commercially reasonable terms as needed.

     In 2002, we closed one of our San Jose, California sales and service locations and co-located this facility with another sales and service center in San Jose. We also closed our manufacturing facility in Austin, Texas, which was acquired in our acquisition of Aera, as a result of the transfer of the manufacturing of these products to Hachioji, Japan.

     In 2003, we expect to close and sell our Longmont, Colorado facility and close a 92,000 square foot facility in Fort Collins, Colorado, the Matthews, North Carolina facility, the Milpitas, California facility and the Edinburgh, Scotland facility as these leases expire.

ITEM 3. LEGAL PROCEEDINGS

     From time to time, we are party to various legal proceedings relating to our business. We are not currently party to any material legal proceedings, except as described below:

     We were a defendant in an action filed by Sierra Applied Sciences, Inc., a Colorado corporation. The civil action was filed in the U.S. District Court for the District of Colorado on September 17, 2001. The action was a Complaint for Declaratory Judgment in which the plaintiffs sought a Declaratory Judgment from the court that our patent is invalid or that the plaintiffs’ products do not infringe on the patent. On March 24, 2003, this action was dismissed by the U.S. District Court for the District of Colorado.

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     In November 2001, an interference action was filed in the United States Patent and Trademark Office (PTO) by The Unaxis Corporation, wherein The Unaxis claims prior invention of one of our concepts, for which we filed a patent application in 1992 and which ultimately resulted in U.S. Patent No. 6,001,224 being issued to us. Should Unaxis prevail, the effective result would be transference of the patent rights over the concept to Unaxis. Unaxis could then choose to license those rights to us. We have reason to believe that we will prevail in the interference proceeding, and are vigorously defending ourselves before the Board of Interference in the United States PTO. This litigation involves our Sparc, Sparc-le®, Pinnacle™ and Astral™ product lines, which have represented less than 4% of our total revenues since January 1, 2000.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     Not applicable.

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PART II

ITEM 5. MARKET PRICE FOR REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

     Our common stock trades on the NASDAQ National Market under the symbol “AEIS.” At March 17, 2003, the number of common stockholders of record was 880, and the last sale price on that day was $8.98.

     Below is a table showing the range of high and low trades for the common stock as quoted (without retail markup or markdown and without commissions) on the NASDAQ National Market; quotations do not necessarily represent actual transactions:

     We have not declared or paid any cash dividends on our capital stock since we terminated our election to be treated as an S-corporation for tax purposes, effective January 1, 1994. We currently intend to retain all future earnings to finance our business and do not anticipate paying cash or other dividends on our common stock in the foreseeable future. Furthermore, our revolving credit facility prohibits the declaration or payment of any cash dividends on our common stock.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

     The information below is not necessarily indicative of results of future operations, and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K in order to fully understand factors that may affect the comparability of the information presented below.

     The selected consolidated statement of operations data for the year ended December 31, 2002, and the related consolidated balance sheet data as of and for the year ended December 31, 2002, were derived from consolidated financial statements audited by KPMG LLP, independent auditors, whose related audit report is included in this Form

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10-K. The selected consolidated statement of operations data for the years ended December 31, 2001 and 2000, and the related consolidated balance sheet data as of and for the year ended December 31, 2001, were derived from consolidated financial statements audited by Arthur Andersen LLP, independent public accountants, whose related audit report is included in this Form 10-K. The selected consolidated statement of operations data for the years ended December 31, 1999 and 1998, and the related consolidated balance sheet data as of December 31, 2000, 1999 and 1998, were derived from audited consolidated financial statements not included in this Form 10-K.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion contains, in addition to historical information, forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Statements that are other than historical information are forward-looking statements. For example, statements relating to our beliefs, expectations and plans are forward-looking statements, as are statements that certain actions, conditions or circumstances will continue. Forward-looking statements involve risks and uncertainties. As a result, our actual results may differ materially from the results discussed in the forward-looking statements. Factors that could cause or contribute to such differences or prove any forward-looking statements, by hindsight to be overly optimistic or unachievable, include, but are not limited to the following:

	•		changes or slowdowns in general economic conditions or conditions in the semiconductor and semiconductor capital equipment industries and other industries in which our customers operate;
	•		the timing and nature of orders placed by major customers, including their product acceptance criteria;
	•		changes in customers’ inventory management practices;
	•		customer cancellations of previously placed orders and shipment delays;
	•		pricing competition from our competitors;
	•		component shortages or allocations or other factors that change our levels of inventory or substantially increase our spending on inventory;
	•		the introduction of new products by us or our competitors;
	•		costs incurred and judgments resulting from patent or other litigation;
	•		costs incurred by responding to specific feature requests by customers;
	•		timing and challenges of integrating recent and potential future acquisitions and strategic alliances;
	•		our ability to attract and retain key personnel; and
	•		our exposure to currency exchange rate fluctuations between the several functional currencies in foreign locations in which we have operations.

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Overview

     We design, manufacture and support a group of key components and subsystems for vacuum process systems. Our primary products are complex power conversion and control systems. Our products also control the flow of gases into the process chambers and provide thermal control and sensing within the chamber. Our customers use our products in plasma-based thin-film processing equipment that is essential to the manufacture of semiconductors; compact disks, DVDs and other digital storage media; flat-panel computer and television screens; coatings for architectural glass and optics; and a power supply for advanced technology computer workstations. We also sell spare parts and repair services worldwide through our customer service and technical support organization.

     We provide solutions to a diversity of markets and geographic regions. However, we are focused on the semiconductor capital equipment industry, which accounted for approximately 62% of our sales in 2002, 59% in 2001 and 70% in 2000. In 2000, the semiconductor capital equipment industry was at its historical peak for sales. Conversely, the years 2001 and 2002 saw the steepest cutback in capital equipment purchases in industry history. These cyclical changes accounted for the 55% reduction in our sales to the semiconductor capital equipment industry between 2000 and 2001 and the further reduction of 6% in 2002 to this industry excluding the effect of our acquisitions in 2002 of Aera Japan Limited, or Aera, and Dressler HF Technik GmbH, or Dressler. We expect future sales to the semiconductor capital equipment industry to represent approximately 55% to 70% of our total revenue, depending upon the strength or weakness of the industry cycles. Additionally, two of the other major industry groups which use our products, data storage and flat panel display, are also highly cyclical and have experienced significant reductions in demand during the 2000 through 2002 period.

     We have incurred significant losses over the past two years primarily as a result of lower revenues. Our results in 2002 include revenues from two companies acquired during the year, Aera and Dressler. Had the acquisitions not occurred, 2002 and 2001 revenues would have been relatively flat. To date, we have been unable to achieve profitability at current revenue levels and do not have confidence of an industry recovery in the short-term. We have established a goal of reducing our operating breakeven point to an annual revenue level of approximately $220 million to $240 million by the end of 2003, but cannot provide any assurance that such goals or revenue level are achievable in 2003.

     Our losses during 2001 and 2002 were impacted by high product costs and other expenses, primarily research and development, sales and marketing, and general and administrative expenses. To address product costs we are in the process of shifting a significant portion of our manufacturing to China, rebalancing our supply chain to tier one Asian suppliers, and relocating certain domestic operations to our headquarters in Fort Collins, Colorado. We will also attempt to reduce research and development expenses without significantly impacting our future competitive position in the rapidly changing industry in which we operate.

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     Our operating results during 2002 and 2001 were also affected by high inventory reserves and warranty expenses. As the industry downturn became longer and deeper than expected, a significant portion of our inventory became slow moving or obsolete based on reduced sales forecasts and the discontinuance of slower moving, older products. Warranty costs have been unusually high because of the shipment of some of our newer, more complex products developed in 1999 and 2000, which required substantial rework, repair and in some cases, replacement in accordance with the terms of our warranties. We believe the current generation of these products have much higher reliability.

     We believe the semiconductor capital equipment industry is in the midst of significant consolidation. To help insure our continued growth and maintain our competitive advantage, by being able to supply an increased proportion of the key components and subsystems used in plasma-based manufacturing, we have done the following:

	•		In March 2002, we acquired Dressler HF Technik GmbH, which supplies radio frequency, or RF power solutions.
	•		In January 2002, we acquired Aera Japan Limited. Aera primarily supplies the semiconductor capital equipment industry with product lines that include digital mass flow controllers, pressure-based mass flow controllers, liquid mass flow controllers, ultrasonic liquid flow meters and liquid vapor delivery systems.
	•		In January 2001, we acquired Engineering Measurements Company, or EMCO, which manufactures electronic and electromechanical precision instruments for measuring and controlling the flow of liquids, steam and gases for the semiconductor and other industries.
	•		In August 2000, we acquired Sekidenko, Inc., which supplies optical fiber thermometers to measure temperature in the semiconductor process chamber.
	•		In April 2000, we acquired Noah Holdings, Inc., which manufactures solid-state temperature control systems to control process temperatures during semiconductor manufacturing.

     These product offerings complement our position as a global leader for complex power conversion and control systems and process instruments, allowing us to provide best-of-breed components and develop systems to increase the precision and productivity of our customers’ products. It is also possible that we will acquire other companies or form strategic alliances.

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Results of Operations

SALES

     Sales were $238.9 million in 2002, $193.6 million in 2001 and $359.8 million in 2000, representing an increase of 23% from 2001 to 2002, and a decrease of 46% from 2000 to 2001. Excluding the acquisitions of Aera and Dressler, our sales would have been relatively flat from 2001 to 2002. The decrease in the level of our sales in 2002 and 2001 from 2000 was primarily due to changes in demand for our products from semiconductor capital equipment manufacturers, including many of our largest customers, and data storage and flat panel display customers. The historical volatility in the semiconductor industry impacted overall investment activities, which led to semiconductor manufacturers purchasing less capital equipment while the other industries were more impacted by general economic conditions.

     While sales of semiconductor capital equipment have grown at a compounded annual growth rate in excess of 15% since 1960, the industry is highly cyclical and is impacted by changes in the macroeconomic environment, changes in semiconductor supply and demand, and rapid technological advances in both semiconductor devices and wafer fabrication processes. Rapid growth and expansion during 2000 was followed by the most sudden and pronounced slump in industry history, with year-to-year revenues falling approximately 40% throughout the industry from 2000 to 2001 and declining nominally from 2001 to 2002. Our sales over the last three years illustrate this cyclicality.

     The following tables summarize annual net sales, and percentages of net sales, by customer type for each of the three years in the period ended December 31, 2002. Sales for the year ended December 31, 2002 include combined sales from Aera and Dressler, subsequent to their acquisitions of approximately $47.0 million:

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     The following table summarizes annual percentage changes in net sales by customer type for us from 2001 to 2002, including the effects of our acquisitions of Aera and Dressler, and from 2000 to 2001:

(1)		(6)% excluding Aera and Dressler
(2)		Unchanged excluding Aera and Dressler

     The following tables summarize annual net sales, and percentages of net sales, by geographic region for each of the three years in the period ended December 31, 2002:

  GROSS MARGIN

     Our gross margin was 28.8% in 2002, 29.7% in 2001 and 49.0% in 2000. Our gross margin remained relatively consistent between 2002 and 2001. The major items affecting the reduction in our 2002 and 2001 margins from our 2000 margin were:

	•		During 2000, the semiconductor industry and Advanced Energy experienced unprecedented new order and revenue growth. However, in 2001 and 2002 we experienced the most severe downturn in the semiconductor industry’s history. As a result our sales declined significantly which impacted our absorption of fixed costs.
	•		The semiconductor industry is moving to 300mm wafers and smaller line widths. These technology changes require new products that we have developed or are developing. Typical of products early in their life cycle and at low production levels, these products have lower margins than our established products. Margins on these products should improve over the next 12 to 36 months.

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	•		Although we have reduced our fixed overhead through reductions in force of some of our manufacturing staff in 2001 and 2002, to coincide with our sales decline, we retained certain knowledgeable employees with specific skill sets, to be ready for unexpected industry ramp-ups.
	•		Our cost of sales has also been adversely affected by periodic writedowns of excess and obsolete inventory, particularly in the fourth quarter of 2002, when our management made a strategic decision to discontinue certain product offerings, which resulted in an increase in excess and obsolete inventory expense.
	•		In 2001 and 2002, we incurred warranty expense in excess of historical rates and our expectations related to certain products, which required substantial rework, repair, and in some cases, replacement. The development of these products in 1999 and 2000 was accelerated to meet pressing customer needs in the midst of historically high product demand. We believe the current generation of these products have much higher reliability.

     Given the rapid change in technology, we monitor and forecast expected inventory needs based on our constantly changing sales forecast. Inventory is written down or written off when it becomes obsolete, generally because of engineering changes to a product or discontinuance of a product line, or when it is deemed excess. These determinations involve the exercise of significant judgment, and as demonstrated in recent periods, demand for our products is volatile and changes in expectations regarding the level of future sales can result in substantial charges against earnings for obsolete and excess inventory. Charges for obsolete and excess inventory were $5.8 million in 2002, $6.4 million in 2001 and $654,000 in 2000, which affected gross margins by 2.4%, 3.3% and 0.2% in these years, respectively. The amount of inventory written down in 2002 is primarily attributable to a strategic management decision we made in the fourth quarter to discontinue certain product offerings, coupled with the 19% decline in sales from the third quarter of 2002 to the fourth quarter of 2002. The inventory writedown in 2001 is primarily attributable to the severe decrease in product sales, which caused a larger than normal amount of inventory to become excess based on our sales forecasts.

     We provide warranty coverage for our products ranging from 12 to 36 months, with the majority of our products ranging from 18 to 24 months, and estimate the anticipated costs of repairing our products under such warranties based on the historical costs of the repairs and expected product failure rates. The assumptions we use to estimate warranty accruals are reevaluated periodically in light of actual experience, and when appropriate, the accruals are adjusted. Our determination of the appropriate level of warranty accrual is subjective and based on estimates. Should product failure rates differ from our estimates, actual costs could vary significantly from our expectations. We recognized charges for warranty expense of $13.2 million in 2002, $7.6 million in 2001 and $4.6 million in 2000.

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     The following summarizes the activity in our warranty reserve during 2002:

     Historically, price competition has not had a material effect on margins. However, as a result of the prolonged downturn in the semiconductor industry, OEMs and semiconductor capital equipment manufacturers are striving to reduce their costs. Any cost reduction programs initiated by OEMs and semiconductor capital equipment manufacturers could have a significant impact on our future gross margins.

  RESEARCH AND DEVELOPMENT

     We believe continued investment in the research and development of new products and subsystems is critical to our ability to serve new and existing markets, develop new products and improve existing product designs. However, we cannot provide assurance that the products we develop will meet customer requirements when those products are introduced to the market. To be advantageously positioned for a turnaround in demand we continue to invest heavily in new product development even during industry downturns, which allows us to compete for ongoing design wins on our customers’ new production tools. Since our inception, all of our research and development costs have been expensed as incurred.

     Our research and development expenses were $49.0 million in 2002, $45.2 million in 2001 and $37.0 million in 2000. As a percentage of sales, research and development expenses decreased from 23.3% in 2001 to 20.5% in 2002, because of the higher sales base achieved through our acquisitions of Aera and Dressler. Research and development expenses, as a percentage of sales, increased from 10.2% in 2000 to 23.3% in 2001 because of the lower sales base. The 8.5% increase in research and development expenses from 2001 to 2002 was primarily due to the acquisitions of Aera and Dressler and expenditures to launch new RF and direct current, or DC products. Our 22.0% increase in research and development expenses from 2000 to 2001 was primarily caused by increases in payroll, materials and supplies and depreciation of equipment used for new product development as well as the acquisition of EMCO in 2001.

  SALES AND MARKETING EXPENSES

     As we continue to expand our product offerings and sales channels through acquisitions, our sales and marketing efforts have become increasingly complex. We continue to refine our sales and marketing functions as we acquire and integrate new companies. We have continued the effort to market directly to end users of our products, in addition to our traditional marketing to manufacturers of semiconductor capital equipment and other industries. Our sales and marketing expenses support domestic and

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international sales and marketing activities that include personnel, trade shows, advertising, and other selling and marketing activities.

     Sales and marketing expenses were $34.9 million in 2002, $23.8 million in 2001 and $24.1 million in 2000. The 46.9% increase in sales and marketing expenses from 2001 to 2002 was primarily caused by the acquisitions of Aera and Dressler, which contributed approximately $9.6 million to our sales and marketing expenses. As a percentage of sales, sales and marketing expenses increased from 12.3% in 2001 to 14.6% in 2002. Sales and marketing expenses increased from 6.7% in 2000 to 12.3% of sales in 2001 due to the lower sales base in 2001.

  GENERAL AND ADMINISTRATIVE EXPENSES

     Our general and administrative expenses support our worldwide corporate, legal, patent, tax, financial, administrative, information systems and human resources functions in addition to our general management. General and administrative expenses were $30.5 million in 2002, $21.5 million in 2001 and $24.6 million in 2000. The 42% increase in general and administrative expenses from 2001 to 2002 was primarily caused by our acquisitions of Aera and Dressler, which contributed approximately $8.8 million to our general and administrative expenses. The 12% decrease from 2000 to 2001 was primarily due to lower spending for payroll, primarily employee bonuses, which were eliminated in 2001 due to the decline in operating profitability. Due to the cost reduction measures we initiated in the third and fourth quarters of 2002, we expect our general and administrative expenses to decline in 2003. See restructuring charges below for a discussion of these cost reduction measures.

  GOODWILL AND OTHER INTANGIBLE ASSET IMPAIRMENTS

     Beginning in April 2000, we made periodic advances to and investments totaling approximately $8 million in Symphony Systems, Inc., a privately held, early-stage developer of equipment productivity management software. Some of our advances were secured by Symphony’s intellectual property. In 2000, we obtained an exclusive license, for which we paid $1.5 million, to use Symphony’s products in the semiconductor industry. Beginning in the third quarter of 2001, and continuing through the end of the year, Symphony’s financial situation began to deteriorate significantly, and we determined that due to Symphony’s need for immediate liquidity, its declining business prospects, including the indefinite postponement of a significant order for its products from a major semiconductor capital equipment manufacturer, and other factors, the value of our investment in and advances to Symphony had substantially declined. We therefore valued our investments in and advances to Symphony at December 31, 2001, at approximately $1 million, which reflected our assessment of the value of the Symphony technology license, which we believed had continuing value to us. The amount of the impairment related to Symphony was $6.8 million, all of which was recorded in 2001 as an operating expense.

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     Symphony effectively ceased operations in February 2002, and we hired Symphony’s key employees, and acquired Symphony’s remaining assets in a foreclosure and liquidation sale of such assets on April 2, 2002. We recorded the assets acquired at their estimated fair values, based on information available at the time. The excess purchase price over the estimated fair value of tangible assets acquired of approximately $2.5 million was allocated to amortizable intangibles, with a weighted-average estimated useful life of approximately 5 years.

     In the fourth quarter of 2002, the semiconductor industry declined substantially from its levels in the third quarter of 2002, which caused a decrease in our sales level of approximately 19%. As a result, we determined there would be a significant delay by the semiconductor capital equipment industry in adopting advanced connectivity technology, and due to these industry conditions as well as our future strategic priorities, these intangible assets were likely impaired. We evaluated the carrying amount of assets acquired from Symphony by comparing its estimated future cash flows to its carrying value. This analysis indicated that our investment was impaired and we recorded an intangible impairment charge of $1.9 million for 2002, which was the remaining book value of Symphony’s intangible assets.

     During the second quarter of 2001, we terminated the operations of our Tower Electronics, Inc. subsidiary and our Fourth State Technology, or FST, product line due to significant softening in the projected demand for these products. Revenue contributed by Tower and FST operations for 2001 and 2000 represented less than five percent of our total revenue in each of these years. As a result of these actions, estimated related future cash flows no longer supported the carrying amounts of related goodwill, and we recorded goodwill impairment charges of $5.4 million in 2001 related to Tower and FST.

  RESTRUCTURING, MERGER COSTS AND LITIGATION COSTS

     In April 2000, we acquired Noah in a pooling of interests under the previous rules of Accounting Principles Board, or APB, Opinion No. 16. The merger involved the exchange of 687,000 shares of Advanced Energy common stock for the privately held common stock of Noah. As part of the business combination, we recorded a charge of $2.3 million in the second quarter of 2000 for merger costs, which could not be capitalized and which in certain cases were nondeductible for income tax purposes.

     In July 2000, we announced the consolidation of our Tower facility in Fridley, Minnesota, into our existing facility in Voorhees, New Jersey. We recorded a restructuring charge of $1.0 million in the third quarter of 2000 related to the consolidation, which was completed during the fourth quarter of 2000.

     In August 2000, we acquired Sekidenko in a merger that was accounted for as a pooling of interests. This merger involved the exchange of 2.1 million shares of Advanced Energy common stock for the privately held common stock of Sekidenko. As part of the business combination, we recorded a charge of $2.3 million in the third quarter

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of 2000 for merger costs, which could not be capitalized and which in certain cases were nondeductible for income tax purposes.

     In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, which required that the purchase method of accounting be used for all business combinations initiated after June 30, 2001.

     In the first quarter of 2001, we received a $1.5 million settlement for recovery of legal expenses pertaining to a patent infringement suit in which we were the plaintiff.

     During the second quarter of 2001, in response to the downturn in the semiconductor capital equipment industry, we implemented two reductions in force totaling approximately 135 regular employees and 90 temporary employees and recorded a charge of $614,000 for restructuring and severance costs, including fringe benefits.

     During the fourth quarter of 2001, in response to the sustained downturn in the semiconductor capital equipment industry and global economy, we announced and implemented additional cost-reduction measures, and recorded a charge of $2.5 million. Such measures included a reduction in force of approximately 105 employees and the closure of two facilities.

     During the second quarter of 2002, we recorded a charge of $5.3 million pertaining to damages awarded by a jury in a patent infringement case in which we were the defendant, and legal expenses related to the judgment. The Applied Science and Technology, or ASTeX, division of MKS Instruments, Inc. was the plaintiff in the case, which was tried in a Delaware court. Sales of the product in question have accounted for less than 5% of total sales since the product’s introduction, and approximately 1.4% of our consolidated sales for the year ended December 31, 2002. We have entered into a settlement agreement with MKS allowing us to sell the infringing product to our customer subsequent to the date of the jury award. Under the settlement agreement, royalties payable to MKS from the sales of the related product were approximately $530,000 in 2002, and are recorded as a component of cost of sales.

     In the third quarter of 2002, we began a program to gradually reduce our quarterly operating breakeven level from revenue of approximately $80 million without impacting our long-term viability. Our objective is to have a variable operating model by the end of 2003 that will allow us to achieve approximate breakeven operating results at a quarterly revenue level of $55 million to $60 million. We recorded a restructuring charge of approximately $3.2 million to close two facilities and implement headcount reductions of approximately 100 employees, or approximately 7% of our workforce.

     In the fourth quarter of 2002, we recorded an additional restructuring charge of $5.8 million. This charge included a reduction in force of 123 employees, or approximately 8% of our workforce and the closure of all or a portion of five facilities in the United States.

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     As a result of our decisions in the fourth quarter to consolidate certain operations, we performed an analysis of the fair value of EMCO’s long-lived assets. This analysis included an appraisal of EMCO’s land and building, which indicated an impairment of approximately $560,000, which has been reflected as restructuring charges in the accompanying statement of operations.

     We may incur additional restructuring charges in 2003 of $3 to $5 million as we continue to take actions to reduce our operating costs.

  OTHER INCOME (EXPENSE)

     Other income (expense) consists primarily of interest income and expense, foreign exchange gains and losses and other miscellaneous gains, losses, income and expense items.

     Interest income was approximately $3.3 million in 2002, $6.6 million in 2001 and $10.7 million in 2000. Our interest income in 2002 was lower than in 2001 due to our use of cash and marketable securities to finance the acquisitions of Aera in January 2002 and Dressler in March 2002, and to repurchase a portion of our 5.25% and 5.00% convertible subordinated notes in the open market in the fourth quarter of 2002. Interest income in 2001 was lower than in 2000 due to our use of cash and marketable securities to repurchase a portion of our 5.25% convertible subordinated notes in the fourth quarter of 2000 and due to our purchase of EMCO in January 2001. Interest income also declined throughout 2002 and 2001 due to the Federal Reserve lowering interest rates throughout the period. The prime rate declined from 9.5% in January 2001 to 4.25% in December 2002 and our yield declined from a high of 8.7% to approximately 2% on a pre-tax basis.

     Interest expense consists principally of accruals of interest on our convertible subordinated notes; amortization of our deferred offering costs on these notes; and bank loans and capital leases assumed in the acquisition of Aera. Interest expense was approximately $12.5 million in 2002, $7.4 million in 2001 and $7.7 million in 2000. The increase in interest expense from 2001 to 2002 was primarily due to the issuance of our 5.00% convertible subordinated notes in August 2001 and the debt and capital leases assumed in the acquisition of Aera in January 2002. Interest expense was relatively unchanged from 2000 to 2001.

     Our foreign subsidiaries’ sales are primarily denominated in currencies other than the U.S. dollar. We recorded a net foreign currency gain of $5.3 million in 2002, and losses of $235,000 in 2001 and $196,000 in 2000.

     Our foreign currency gain in 2002 was primarily related to an intercompany loan of Japanese yen, which was settled subsequent to December 31, 2002, that we made to our wholly owned subsidiary Advanced Energy Japan K.K., or AE-Japan, which has a functional currency of yen, for the purpose of effecting the acquisition of Aera. The loan

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was transacted in the first quarter of 2002, for approximately 5.7 billion yen, approximately $44 million based upon an exchange rate of approximately 130:1. During the first half of the year, the U.S. dollar weakened significantly against the yen to approximately 119:1, resulting in a gain of $4.9 million. In July and September 2002, we entered into various foreign currency forward contracts with our primary banks to mitigate the effects of potential future currency fluctuations between the dollar and the yen until the associated intercompany obligations are settled.

     Miscellaneous expense items were $2.1 million in 2002 and $1.0 million in 2001. The increase in miscellaneous expense in 2002 from 2001 was primarily related to the impairment of certain marketable equity securities. During the fourth quarter of 2002, the fair value of these securities continued a substantial decline and we determined the decline was other than temporary as defined by the Financial Accounting Standards Board. As a result we recorded an impairment of approximately $1.5 million. As of February 11, 2003 the value of this investment has declined an additional $675,000. If the fair value of this investment does not return to its December 31, 2002 carrying value by the end of the first quarter of 2003, we will record an additional impairment in the first quarter of 2003. Our remaining carrying balance at December 31, 2002 was approximately $2.0 million. Miscellaneous income of $4.7 million in 2000 was primarily due to a $4.8 million gain on a sale of an investment.

  (BENEFIT) PROVISION FOR INCOME TAXES

     The income tax benefit of $22.3 million for 2002, which included a provision of $1.6 million for an extraordinary item, represented an effective tax rate of 35%. The income tax benefit of $17.4 million for 2001 represented an effective rate of 36%. The income tax provision of $36.8 million in 2000, which included $4.6 million of provision for an extraordinary item, represented an effective rate of 35%. Changes in our relative earnings and the earnings of our foreign subsidiaries affect our consolidated effective tax rate. We adjust our income taxes periodically based upon the anticipated tax status of all foreign and domestic entities, and have adopted income tax planning strategies to reduce our worldwide income tax expense.

     Realization of our net deferred tax asset is dependent upon our generating sufficient taxable income in the appropriate tax jurisdictions in future years to obtain benefit from the reversal of net deductible temporary differences and from tax credit carryforwards. When recording acquisitions, we have recorded valuation allowances due to the uncertainty related to the realization of certain deferred tax assets existing at December 31, 2002. The amount of deferred tax assets considered realizable is subject to adjustment in future periods if estimates of future taxable income are changed. We believe that it is more likely than not that we will realize the benefits of our deferred tax asset, net of valuation allowance, as of December 31, 2002. Reversals of valuation allowances recorded in purchase accounting will be reflected as a reduction of goodwill in the period of reversal.

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  EXTRAORDINARY GAIN

     In the fourth quarter of 2002, we repurchased approximately $15.4 million of our 5.25% convertible subordinated notes and $3.5 million of our 5.00% convertible subordinated notes in the open market at an aggregate cost of approximately $14.5 million. These purchases resulted in a pretax extraordinary gain of $4.2 million, or $2.6 million after tax. In the fourth quarter of 2000, we repurchased an aggregate of approximately $53.4 million principal amount of our 5.25% convertible subordinated notes in the open market, for a cost of approximately $40.8 million. These purchases resulted in a pretax extraordinary gain of $12.2 million, or $7.6 million after tax.

Summary Results of Operations

     The following table summarizes certain data as a percentage of sales extracted from our statement of operations:

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Quarterly Results of Operations

     The following tables present unaudited quarterly results in dollars and as a percentage of sales for each of the eight quarters in the period ended December 31, 2002. We believe that all necessary adjustments have been included in the amounts stated below to present fairly such quarterly information. The operating results for any quarter are not necessarily indicative of results for any subsequent period.