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

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended June 30, 2003.

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from                 to                .

Commission file number: 000-26966

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

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

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

As of August 6, 2003, there were 32,280,479 shares of the registrant’s Common Stock, par value $0.001 per share, outstanding.

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

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PART I FINANCIAL INFORMATION

ITEM 1. UNAUDITED FINANCIAL STATEMENTS

ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)

The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated balance sheets.

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ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)

The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated statements.

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ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

The accompanying notes to condensed consolidated financial statements
are an integral part of these condensed consolidated statements.

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ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)

(1)  BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     In the opinion of management, the accompanying unaudited condensed consolidated balance sheets, statements of operations and cash flows contain all adjustments necessary to present fairly the financial position of Advanced Energy Industries, Inc., a Delaware corporation, and its wholly owned subsidiaries (the “Company”) at June 30, 2003 and December 31, 2002, and the results of their operations for the three- and six-month periods ended June 30, 2003 and 2002, and cash flows for the six-month periods ended June 30, 2003 and 2002.

     The unaudited financial statements presented herein have been prepared in accordance with the instructions to Form 10-Q and do not include all the information and note disclosures required by accounting principles generally accepted in the United States. The financial statements should be read in conjunction with the audited financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, filed March 27, 2003.

     The preparation of the Company’s condensed consolidated financial statements requires the Company’s management to make certain estimates and assumptions that affect the amounts reported and disclosed in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

     CASH AND CASH EQUIVALENTS — The Company considers all amounts on deposit with financial institutions and highly liquid investments with an original maturity of 90 days or less to be cash and cash equivalents.

     MARKETABLE SECURITIES — The Company has investments in marketable equity securities and municipal bonds, which have original maturities of 90 days or more. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” these investments are classified as available-for-sale securities and reported at fair value with unrealized gains and losses included in other comprehensive income. Due to the short-term, highly liquid nature of the marketable securities held by the Company, the cost, including accrued interest of such investments, is typically the same as their fair value.

     The Company also has investments in marketable equity securities which have been included with deposits and other assets in the accompanying condensed consolidated balance sheets. In accordance with SFAS No. 115, these investments are classified as available-for-sale securities and reported at fair value with unrealized holding gains and losses included in other comprehensive income. During the first quarter of 2003, the fair value of one of these securities continued to decline. Under the provisions of SFAS No. 115 and related interpretations the Company recorded an other than temporary decline in value impairment of approximately $175,000 which is included in other expense in the accompanying condensed consolidated statements of operations. However, in the second quarter of 2003 the fair value of this investment increased approximately $700,000 to approximately $2.5 million. In accordance with SFAS No. 115, this increase in fair value has been reflected as an unrealized gain and is included in other comprehensive income in the Company’s statement of stockholders’ equity. If the fair value of this investment declines further, the Company may be required to record additional impairments equal to the difference between the carrying value and its fair value if the Company believes that such decline is an other than temporary impairment in accordance with SFAS No. 115.

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     INVENTORIES — Inventories include costs of materials, direct labor and manufacturing overhead. Inventories are valued at the lower of cost or market, computed on a first-in, first-out basis and are presented net of reserves for obsolete and excess inventory. 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 by management, and as demonstrated in recent periods, demand for the Company’s 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.

     PROPERTY AND EQUIPMENT — Property and equipment is stated at cost or estimated fair value upon acquisition. Additions, improvements, and major renewals are capitalized. Maintenance, repairs, and minor renewals are expensed as incurred.

     Depreciation is provided using the straight-line method over three to ten years for machinery, equipment, furniture and fixtures, with computers and communication equipment depreciated over a three-year life. Amortization of leasehold improvements and leased equipment is provided using the straight-line method over the lease term or the estimated useful life of the assets, whichever period is shorter.

     DEMONSTRATION AND CUSTOMER SERVICE EQUIPMENT — Demonstration and customer service equipment are manufactured products that are utilized for sales demonstration and evaluation purposes. The Company also utilizes this equipment in its customer service function as replacement and loaner equipment to existing customers. The Company depreciates this equipment based on its estimated useful life of three years.

     GOODWILL AND INTANGIBLES — Goodwill and certain other intangible assets with indefinite lives, if present, are not amortized. Instead, goodwill and other intangible assets are subject to periodic (at least annual) tests for impairment. The impairment testing is performed in two steps: (i) the Company assesses goodwill for a potential impairment loss by comparing the fair value of a reporting unit with its carrying value, and (ii) if an impairment is indicated by a reporting unit whose fair value is less than its carrying amount, the Company measures the amount of impairment loss by comparing the implied fair value of goodwill with the carrying amount of that goodwill.

     In the fourth quarter of 2002, the Company completed its evaluation of the goodwill and intangible assets recorded as a result of the acquisitions of Aera, which it acquired on January 18, 2002, Dressler, which it acquired on March 28, 2002, and the remaining 40.5% of LITMAS that the Company did not previously own on April 2, 2002. In the fourth quarter of 2002, the Company also performed its annual goodwill impairment test, and concluded that because the estimated fair value of the Company’s reporting units exceeded their carrying amounts, no impairment of goodwill was indicated. As the Company is required to perform the test for impairment at least annually, it is reasonably possible that a future test may indicate impairment, and the amount of impairment may be material to the Company.

     Goodwill and other intangibles consisted of the following as of December 31, 2002:

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     Goodwill and other intangibles consisted of the following as of June 30, 2003:

     Aggregate amortization expense related to other intangibles for the three-month periods ended June 30, 2003 and 2002 was approximately $1.2 million, and approximately $2.3 million and $1.9 million for the six-month periods ended June 30, 2003 and 2002, respectively. Estimated amortization expense related to the Company’s acquired intangibles fluctuates with changes in exchange rates between the U.S. dollar, the Japanese yen and the euro. Estimated amortization expense for each of the five years 2003 through 2007 is as follows:

     CONCENTRATIONS OF CREDIT RISK — Financial instruments, which potentially subject the Company to credit risk include cash, marketable securities, trade accounts receivable and others. The Company maintains cash and cash equivalents, investments, and certain other financial instruments with various major financial institutions. The Company performs periodic evaluations of the relative credit standings of these financial institutions and limits the amount of credit exposure with any one institution. The Company’s customers generally are concentrated in the semiconductor capital equipment industry. As a result the Company is generally exposed to credit risk associated with this industry. Sales by the Company’s foreign subsidiaries are primarily denominated in currencies other than the U.S. dollar. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information.

     WARRANTY POLICY — The Company offers warranty coverage for its products for periods ranging from 12 to 36 months after shipment, with the majority of its products ranging from 18 to 24 months. The Company estimates the anticipated costs of repairing products under warranty based on the historical cost of the repairs and expected failure rates. The assumptions used to estimate warranty accruals are reevaluated periodically in light of actual experience and, when appropriate, the accruals are adjusted. The Company’s determination of the appropriate level of warranty accrual is subjective and based on estimates. The industries in which the Company operates are subject to rapid technological change and, as a result, the Company periodically introduces newer, more complex products which tend to result in increased warranty costs. Estimated warranty costs are recorded at the time of sale of the related product, are adjusted as appropriate and are considered a cost of sales.

     FOREIGN CURRENCY TRANSLATION — The functional currency of the Company’s foreign subsidiaries is their local currency. Assets and liabilities of international subsidiaries are translated to U.S. dollars at period-end exchange rates, and income statement activity and cash flows are translated at average exchange rates during the period. Resulting translation adjustments are recorded as a separate component of stockholders’ equity.

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     Transactions denominated in currencies other than the local currency are recorded based on exchange rates at the time such transactions arise. Subsequent changes in exchange rates result in foreign currency transaction gains and losses which are reflected in income as unrealized (based on period end translation) or realized (upon settlement of the transactions). Unrealized transaction gains and losses applicable to permanent investments by the Company in its foreign subsidiaries are included as cumulative translation adjustments, and unrealized translation gains or losses applicable to non-permanent intercompany receivables from or payables to the Company and its foreign subsidiaries are included in income.

     The Company recognized gains on foreign currency transactions of approximately $87,000 and $9,000 for the three- and six-month periods ended June 30, 2003, respectively. In the second quarter of 2002, the Company recognized a net foreign currency gain of approximately $4.5 million, the majority of which was related to an intercompany loan of Japanese yen (which was settled in January 2003) that Advanced Energy U.S. made to its subsidiary Advanced Energy Japan K.K. (“AE-Japan”) (which has a functional currency of yen) for the purpose of effecting the acquisition of Aera. The loan was transacted in the first quarter of 2002, for approximately 5.7 billion yen (approximately $44 million based on an exchange rate of 130:1). During the first quarter of 2002, the exchange rate between the U.S. dollar and the Japanese yen remained relatively stable, and an immaterial loss was recorded related to this intercompany loan. During the second quarter of 2002, the U.S. dollar weakened significantly against the yen to approximately 119:1, resulting in a gain of approximately $4.6 million.

     REVENUE RECOGNITION — The Company generally recognizes revenue upon shipment of its products and spare parts, at which time title passes to the customer, as its shipping terms are FOB shipping point, the price is fixed and collectibility is reasonably assured. Generally, the Company does not generate revenue from the installation of its products. In certain limited instances, some customers have negotiated product acceptance provisions relative to specific orders. Under these circumstances the Company defers revenue recognition until the related acceptance provisions have been satisfied. Revenue deferrals are reported as customer deposits in the accompanying condensed consolidated balance sheets.

     In certain instances, the Company requires its customers to pay for a portion or all of their purchases prior to the Company building or shipping these products. Cash payments received prior to shipment are recorded as customer deposits in the accompanying balance sheets, and then recognized as revenue upon shipment of the products. The Company does not offer price protections to its customers or allow returns, unless covered by the Company’s normal policy for repair of defective products.

     The Company has an arrangement with one of its major customers, a semiconductor capital equipment manufacturer, in which completed products are shipped to the customer and held by them in their warehouse. The customer draws products from this inventory as needed, at which time title passes to the customer and the Company recognizes revenue. The customer is subject to the Company’s normal warranty policy for repair of defective products.

     In certain instances the Company delivers products to customers for evaluation purposes. In these arrangements, the customer retains the products for specified periods of time without commitment to purchase. On or before the expiration of the evaluation period, the customer either rejects the product and returns it to the Company, or accepts the product. Upon acceptance, title passes to the customer, the Company invoices the customer for the product, and revenue is recognized. Pending acceptance by the customer, such products are reported on the Company’s balance sheet at an estimated value based on the lower of cost or market, and are included in the amount for demonstration and customer service equipment, net of accumulated depreciation.

     INCOME TAXES — The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” SFAS No. 109 requires deferred tax assets and liabilities to be recognized for temporary differences between the tax basis and financial reporting basis of assets and liabilities, computed at current tax rates, as well as for the expected tax benefit of net operating loss and tax credit carryforwards. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. At June 30, 2003 the Company reassessed its

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valuation allowance and determined that no adjustment to the valuation allowance was required based on the Company’s conclusion that it is more likely than not that its deferred tax assets, net of related deferred tax liabilities and valuation allowance, will be realized through future taxable income. This assessment requires significant judgment, and is based on management’s expectation of future profitable operations and taxable income. Should circumstances change such that the Company’s conclusion changes, this valuation allowance could be increased to reserve all or a portion of the net deferred tax assets and the amount of the related charge could be material.

     When recording acquisitions, the Company has recorded valuation allowances due to the uncertainty related to the realization of certain deferred tax assets existing at the acquisition dates. The amount of deferred tax assets considered realizable is subject to adjustment in future periods if estimates of future taxable income are changed. The Company believes that it is more likely than not that it will realize the benefits of its deferred tax asset, net of valuation allowance. Any reversals of valuation allowances recorded in purchase accounting will be reflected as a reduction of goodwill in the period of reversal.

     RESTRUCTURING COSTS — Restructuring charges include the costs associated with actions taken by the Company in response to the continuing downturn in the semiconductor capital equipment industry and as a result of the ongoing execution of the Company’s strategy. These charges consist of costs that are incurred to exit an activity or cancel an existing contractual obligation, including closure of facilities and employee termination related charges.

     Effective January 1, 2003, the Company adopted SFAS No. 146, “Accounting for Exit or Disposal Activities.” This statement addresses significant issues regarding the recognition, measurement and reporting of costs that are associated with exit and disposal activities, including restructuring activities that were previously accounted for pursuant to the guidance set forth in Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.” SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 did not have a material effect on the Company’s financial position or results of operations, however expense recognition of certain restructuring activities in 2003 have been delayed due to its adoption.

     At the end of 2002, the Company announced major changes in its operations to occur through the end of 2003. These included a manufacturing location in China, consolidating worldwide sales forces, a move to Tier 1 suppliers, primarily in Asia and the intention to close or sell certain facilities.

     Associated with the above plan, the Company recognized charges in the second quarter of 2003 that consisted primarily of the involuntary termination of approximately 55 manufacturing and administrative personnel in the Company’s U.S. operations. Certain of the employees were terminated and paid prior to the end of the second quarter of 2003, which resulted in restructuring charges totaling approximately $768,000 for the three months ended June 30, 2003. In addition, certain employees will be required to render service beyond a minimum retention period (generally 60 days). In accordance with SFAS No. 146, the Company measured the termination benefits at the communication date, but approximately $350,000 will be recognized as expense in the third and fourth quarters of 2003 as these employees complete their service requirement.

     Also, the Company recorded charges totaling approximately $1.5 million in the first quarter of 2003 primarily associated with manufacturing and administrative personnel headcount reductions in the Company’s Japanese operations. In accordance with Japanese labor regulations the Company offered voluntary termination benefits to all of its Japanese employees. Approximately 36 employees accepted the voluntary termination benefits prior to March 31, 2003 with termination dates in the second quarter of 2003. All termination benefits were paid in the second quarter of 2003.

     At June 30, 2003, outstanding liabilities related to the 2003 and 2002 restructuring charges were approximately $3.9 million, and were reported as part of other accrued expenses on the accompanying condensed consolidated balance sheet. The Company also expects to incur additional charges of $1.5 million to $2.0 million during the remainder of 2003 related to these operational changes.

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     The Company recorded restructuring charges totaling $9.1 million in 2002, primarily associated with changes in operations designed to reduce redundancies and better align the Company’s Aera mass flow controller business within its operating framework. The Company’s restructuring plans and associated costs consisted of $6.0 million to close and consolidate certain manufacturing facilities, and $3.1 million for related headcount reductions of approximately 223 employees.

     Included in the $6.0 million facility charge are the closure of the Company’s Advanced Energy Voorhees (“AEV”) manufacturing facilities, due to the transfer of the manufacturing of AEV’s products to Fort Collins, Colorado, and the closure of a manufacturing facility in Fort Collins, expected to be completed by the third quarter of 2003; the closure of Engineering Measurments Company’s (“EMCO”) manufacturing facilities due to the transfer of the manufacturing of EMCO’s products to Fort Collins, Colorado and Shenzhen, China, expected to be completed by the third quarter of 2003; and the closure of LITMAS, which was completed in the first quarter of 2003. During the fourth quarter of 2002, the Company closed its San Jose, California sales and service location, and the Company’s Austin, Texas manufacturing facility for the Aera-brand mass flow controller products. The Company transferred the manufacturing of these products to Hachioji, Japan to be co-located with Aera Japan Limited. These costs consist primarily of payments required under operating lease contracts and costs for writing down related leasehold improvements.

     The employee termination costs of $3.1 million consisted of severance benefits. All terminations and termination benefits were communicated to the affected employees prior to the accrual of the related charges. The affected employees were all part of the Company’s U.S. operations and included full-time permanent and temporary employees, and consisted primarily of manufacturing and administrative personnel.

     At December 31, 2002, outstanding liabilities related to the 2002 restructuring charges were approximately $6.0 million, and were reported as part of other accrued expenses on the accompanying condensed consolidated balance sheet.

     The following table summarizes the components of the restructuring charges, the payments and non-cash charges, and the remaining accrual as of June 30, 2003:

     STOCK-BASED COMPENSATION — Prior to May 7, 2003 the Company had five stock-based compensation plans, which are more fully described in Note 16 to the Company’s Form 10-K for the year ended December 31, 2002. On May 7, 2003 the Company’s stockholders approved the 2003 Stock Option Plan (the “2003 Plan”), the 2003 Non-Employee Directors’ Stock Option Plan (the “2003 Directors’ Plan”) and an amendment to the Employee Stock Purchase Plan (“ESPP”).

     The 2003 Plan provides for the issuance of up to 3,250,000 shares of common stock. Shares may be issued under the 2003 Plan on exercise of incentive stock options or non-qualified stock options granted

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under the 2003 Plan or as restricted stock awards. Stock appreciation rights may also be granted under the 2003 Plan, and the shares represented by the stock appreciation rights will be deducted from shares issuable under the 2003 Plan. The exercise price of incentive stock options and non-qualified stock options cannot be less than the market value of the Company’s common stock on the date of grant. The Company has the discretion to determine the vesting period of options granted under the 2003 Plan, however option grants will generally vest over four years, contingent upon the optionee continuing to be an employee, director or consultant of the Company. As of June 30, 2003 no awards have been granted under the 2003 Plan. The Company’s 1995 Employee Stock Option Plan terminated upon shareholder approval of the 2003 Plan.

     The 2003 Directors’ Plan provides for the issuance of up to 150,000 shares of common stock on exercise of non-qualified stock options granted under the 2003 Directors’ Plan. The exercise price of options granted under the 2003 Directors’ Plan cannot be less than the market value of the Company’s common stock on the date of grant. Non-employee directors are automatically granted an option to purchase 15,000 shares on the first date elected or appointed as a member of the Company’s board, and 5,000 shares on any date re-elected as a member of the board. Options granted on the date first elected or appointed as a member of the Company’s board immediately vest as to one-third of the shares subject to the grant, then another one-third on each of the first two anniversaries of the date granted, provided the optionee continues to be a director. Options granted upon re-election are immediately exercisable. As of June 30, 2003 125,000 shares of common stock were available for grant under this plan. The Company’s Non-Employee Directors Stock Option Plan terminated upon shareholder approval of the 2003 Directors’ Plan.

     The Company’s ESPP was amended to increase the number of common shares reserved for issuance under the plan from 200,000 shares to 400,000 shares. At June 30, 2003, approximately 185,000 shares remained available for future issuance.

     The Company accounts for employee stock-based compensation using the intrinsic value method prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. With the exception of certain options granted in 1999 and 2000 by a shareholder of Sekidenko, prior to its acquisition by the Company (which was accounted for as a pooling of interests), all options granted under these plans have an exercise price equal to the market value of the underlying common stock on the date of grant. Therefore no stock-based compensation cost is reflected in the Company’s net loss.

     For the quarters ended June 30, 2003 and 2002, approximately $122,000 and $131,000, respectively, of stock-based compensation expense was included in the determination of net loss as reported related to Sekidenko option grants made prior to the Company’s acquisition of Sekidenko. For the six-month periods ended June 30, 2003 and 2002 Sekidenko related stock-based compensation expense was approximately $244,000 and $262,000, respectively.

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     Had compensation cost for the Company’s plans been determined consistent with the fair value-based method prescribed by SFAS No. 123, “Accounting for Stock-Based Compensation”, the Company’s net loss would have increased to the following adjusted amounts:

     Cumulative compensation cost recognized with respect to options that are forfeited prior to vesting is reflected as a reduction of compensation expense in the period of forfeiture. Compensation expense related to awards granted under the Company’s employee stock purchase plan is estimated until the period in which settlement occurs, as the number of shares of common stock awarded and purchase price are not known until settlement.

     For SFAS No. 123 purposes, the fair value of each option grant and purchase right granted under the ESPP are estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

     Based on the Black-Scholes option pricing model, the weighted-average estimated fair value of employee stock option grants was $6.02 and $30.33 for the three months ended June 30, 2003 and 2002, respectively and was $6.50 and $25.07 for the six months ended June 30, 2003 and 2002, respectively. The weighted-average estimated fair value of purchase rights granted under the ESPP was $4.70 and $11.87 for the three months ended June 30, 2003 and 2002, respectively, and was $4.69 and $9.56 for the six months ended June 30, 2003 and 2002, respectively.

     EARNINGS PER SHARE — Basic earnings per share (“EPS”) is computed by dividing (loss) income available to common stockholders by the weighted-average number of common shares outstanding during the period. The computation of diluted EPS is similar to the computation of basic EPS except that the numerator is increased to exclude certain charges which would not have been incurred, and the denominator is increased to include the number of additional common shares that would have been

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outstanding (using the if-converted and treasury stock methods), if securities containing potentially dilutive common shares (convertible notes payable, options and warrants) had been converted to such common shares, and if such assumed conversion is dilutive. Due to the Company’s net loss for the three- and six- month periods ended June 30, 2003 and 2002, basic and diluted EPS are the same, as the assumed conversion of all potentially dilutive securities would be anti-dilutive. Potential shares of common stock issuable under options and warrants for common stock at June 30, 2003 and 2002 were approximately 3.9 million and 2.6 million, respectively. Potential shares of common stock issuable upon conversion of the Company’s convertible subordinated notes payable were approximately 5.4 million and 5.8 million, respectively.

     COMPREHENSIVE LOSS — Comprehensive loss for the Company consists of net loss, foreign currency translation adjustments and net unrealized holding (losses) gains on available-for-sale marketable investment securities as presented below:

     SEGMENT REPORTING — The Company operates in one segment for the manufacture, marketing and servicing of key subsystems, primarily to the semiconductor capital equipment industry. In accordance with SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information,” the Company’s chief operating decision maker has been identified as the Office of the Chief Executive Officer, which reviews operating results to make decisions about allocating resources and assessing performance for the entire company. SFAS No. 131, which is based on a management approach to segment reporting, establishes requirements to report selected segment information quarterly and to report annually entity-wide disclosures about products and services, major customers, and the countries in which the entity holds material assets and reports revenue. All material operating units qualify for aggregation under SFAS No. 131 due to their similar customer base and similarities in: economic characteristics; nature of products and services; and procurement, manufacturing and distribution processes. To report revenue from external customers for each product and service or group of similar products and services would not be practicable. Since the Company operates in one segment, all financial information required by SFAS No. 131 can be found in the accompanying condensed consolidated financial statements.

     GAINS AND LOSSES FROM EXTINGUISHMENT OF DEBT — Effective January 1, 2003, the Company adopted SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” This statement rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” which required all gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of income taxes. As a result, the criteria in Accounting Principles Board Opinion No. 30 will now be used to classify those gains and losses. Any gain or loss on the extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB 30 for classification as an extraordinary item shall be reclassified. The Company adopted the provisions of SFAS No. 145 on January 1, 2003. The adoption of this Statement will require the Company to reclassify its pretax extraordinary gain of $4,223,000 recorded during the fourth quarter of 2002 to income from continuing operations in future financial statements.

     DERIVATIVE INSTRUMENTS — The Company accounts for its derivative instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities by requiring all derivatives to be recorded on the balance sheet as either an asset or liability and measured at their fair value. Changes in the derivative’s fair value will be recognized currently in earnings unless specific hedging accounting criteria are met. SFAS No. 133 also establishes uniform hedge accounting

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criteria for all derivatives. The Company did not seek specific hedge accounting treatment for its foreign currency forward contracts.

     The Company, including its subsidiaries, enters into foreign currency forward contracts with counterparties to mitigate foreign currency exposure from foreign currency denominated trade purchases and intercompany receivables and payables. These derivative instruments are not held for trading or speculative purposes. To the extent that changes occur in currency exchange rates, the Company is exposed to market risk on its open derivative instruments. This market risk exposure is generally offset by the gain or loss recognized upon the translation of its intercompany payables and receivables. Foreign currency forward contracts are entered into with major commercial U.S., Japanese and German banks that have high credit ratings, and the Company does not expect the counterparties to fail to meet their obligations under outstanding contracts. Foreign currency gains and losses under these arrangements are not deferred. The Company generally enters into foreign currency forward contracts with maturities ranging from one to eight months, with contracts outstanding at June 30, 2003 maturing through December 2003.

     The Company’s subsidiary AE-Japan enters into foreign currency forward contracts to buy U.S. dollars to mitigate currency exposure from its payable position arising from trade purchases and intercompany transactions with its parent. At June 30, 2003, AE-Japan held foreign currency forward contracts with notional amounts of $5.0 million and market settlement amounts of $4.9 million for an unrealized gain position of approximately $100,000 that has been included in foreign currency gain in the accompanying condensed consolidated statements of operations.

     During 2003, the Company’s subsidiary Advanced Energy Industries GmbH (“AE-Germany”) entered into foreign currency forward contracts to buy U.S. dollars to mitigate currency exposure from its payable position arising from trade purchases and intercompany transactions with its parent. At June 30, 2003, AE-Germany held foreign currency forward contracts with notional amounts of $700,000 and market settlements amounts of $755,000 for an unrealized loss position of approximately $55,000 that has been included in foreign currency gain in the accompanying condensed consolidated statements of operations.

     ESTIMATES AND ASSUMPTIONS — The preparation of the Company’s condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates are used when establishing allowances for doubtful accounts, determining useful lives for depreciation and amortization, assessing the need for impairment charges, establishing restructuring accruals and warranty reserves, allocating purchase price among the fair values of assets acquired and liabilities assumed, accounting for income taxes, accounting for stock-based compensation, and assessing excess and obsolete inventory and various others items. The Company evaluates these estimates and judgments on an ongoing basis and bases its estimates on historical experience, current conditions and various other assumptions that are believed to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities as well as identifying and assessing the accounting treatment with respect to commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions.

     NEW ACCOUNTING PRONOUNCEMENTS — In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. SFAS No. 150 establishes standards on the classification and measurement of financial instruments with characteristics of both liabilities and equity. SFAS No. 150 will become effective for financial instruments entered into or modified after May 31, 2003 and for all financial instruments at the beginning of the first interim period beginning after June 15, 2003. The Company is in the process of assessing the effect of implementing SFAS No. 150, and does not expect the implementation of this pronouncement to have a material effect on its financial condition or results of operations.

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     In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”. SFAS No. 149 amends SFAS No. 133 to provide clarification on the financial accounting and reporting of derivative instruments and hedging activities and requires contracts with similar characteristics to be accounted for on a comparable basis. The Company is in the process of assessing the effect of implementing SFAS No. 149, and does not expect the adoption of it, which will be effective for contracts entered into or modified after June 30, 2003, to have a material effect on its financial condition or results of operations.

     In January 2003 the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN No. 46”). This interpretation clarifies existing accounting principles related to the preparation of consolidated financial statements when the equity investors in an entity do not have the characteristics of a controlling financial interest or when the equity at risk is not sufficient for the entity to finance its activities without additional subordinated financial support from others parties. FIN No. 46 requires a company to evaluate all existing arrangements to identify situations where a company has a “variable interest” (commonly evidenced by a guarantee arrangement or other commitment to provide financial support) in a “variable interest entity” (commonly a thinly capitalized entity) and further determine when such variable interests require a company to consolidate the variable interest entities’ financial statements with its own. The Company is required to perform this assessment by September 30, 2003 and consolidate any variable interest entities for which it will absorb a majority of the entities’ expected losses or receive a majority of the expected residual gains. Management has not yet performed this assessment and is currently evaluating the impact on its financial statements of adopting this Standard.

     In November 2002 the EITF reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 addresses revenue recognition on arrangements encompassing multiple elements that are delivered at different points in time, defining criteria that must be met for elements to be considered to be a separate unit of accounting. If an element is determined to be a separate unit of accounting, the revenue for the element is recognized at the time of delivery. EITF Issue No. 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Management does not believe the adoption of EITF Issue No. 00-21 will have a material impact on its consolidated financial position or results of operations.

     In November 2002 the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN No. 45”). This interpretation requires a liability to be recognized at the time a company issues a guarantee for the fair value of obligations assumed under certain guarantee agreements. Additional disclosures about guarantee agreements are also required in interim and annual financial statements, including a roll forward of the company’s product warranty liabilities. The disclosure provisions of FIN No. 45 were effective for the Company as of December 31, 2002. The provisions for initial recognition and measurement of guarantee agreements are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002. The adoption of FIN No. 45 did not have a material impact on the Company’s financial position or results of operations.

     RECLASSIFICATIONS — Certain prior period amounts have been reclassified to conform to the current period presentation.

(2) ACQUISITIONS

     LITMAS — During 1998 the Company acquired a 29% ownership interest in LITMAS, a privately held, North Carolina-based early-stage company that designed and manufactured plasma gas abatement systems and high-density plasma sources. The purchase price consisted of $1 million in cash. On October 1, 1999, the Company acquired an additional 27.5% interest in LITMAS for an additional $560,000. The purchase price consisted of $385,000 in the Company’s common stock and $175,000 in cash. The acquisition was accounted for using the purchase method of accounting and resulted in $523,000 allocated to intangible assets as goodwill. The results of operations of LITMAS have been consolidated in the Company’s consolidated financial statements from the date the controlling interest of 56.5% was acquired. On October

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1, 2000, the Company acquired an additional 3.0% interest in LITMAS for an additional $250,000, bringing the Company’s ownership interest in LITMAS to 59.5%. On April 2, 2002, the Company completed its acquisition of the 40.5% of LITMAS that it did not previously own, by issuing approximately 120,000 shares of the Company’s common stock valued at approximately $4.2 million, and approximately $400,000 of cash. The acquisition of the remaining minority interest in LITMAS resulted in approximately $5 million of additional goodwill.

     DRESSLER — On March 28, 2002, the Company completed its acquisition of Dressler HF Technik GmbH (“Dressler”), a privately owned Stolberg, Germany-based provider of power supplies and matching networks, for a purchase price of approximately $15 million in cash and a $1.7 million escrow. The escrow fund was retained by the Company until January 2003, at which time the related escrow liability was settled. The purchase price was also subject to a $3.0 million earn-out provision if Dressler achieved certain key business objectives by March 30, 2003. These business objectives were not met prior to the expiration date.

     The Company believes that Dressler will expand the Company’s product offerings to customers in the semiconductor, data storage, and flat panel equipment markets due to its strong power product portfolio that includes a wide range of power levels and RF frequencies. In addition, with inroads already made into the laser and medical markets, Dressler will be used to explore new market opportunities for the Company. Dressler will also strengthen the Company’s presence in the European marketplace. Dressler has well- established relationships with many European customers, who look to Dressler for innovative technical capability, quality products, and highly responsive customer service. The Company also expects to achieve synergies in product technology, production efficiency, logistics and worldwide service.

     The acquisition was accounted for using the purchase method of accounting in accordance with SFAS No. 141, “Business Combinations,” and the operating results of Dressler are reflected in the accompanying condensed consolidated financial statements prospectively from the date of acquisition. The tangible assets acquired and liabilities assumed were recorded at estimated fair values as determined by the Company’s management. Goodwill and other intangible assets were recorded at estimated fair values based upon independent appraisals. In the fourth quarter of 2002, the Company finalized its purchase price allocation.

     The purchase price, as finalized, was allocated to the net assets of Dressler as summarized below: