UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

     (Mark One)

For the fiscal year ended December 31, 2003.

For the transition period from                     to                     .

Commission file number: 000-26966

ADVANCED ENERGY INDUSTRIES, INC.

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 þ Noo.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).Yes þ Noo.

The [approximate] aggregate market value of voting and non-voting stock held by non-affiliates of the registrant was $183.1 million (A) as of June 30, 2003.

(A) Excludes 19.4 million shares of common stock held by directors and officers, and any stockholders whose ownership exceeds 5% of the shares outstanding, at June 30, 2003. 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.

32,590,201

(Number of shares of Common Stock outstanding as of February 17, 2004)

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement for the 2004 Annual Meeting of Stockholders to be held on May 5, 2004, 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 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 970-221-4670. 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). Such forms are also available at www.sec.gov.

     We design, manufacture and support a group of key components and subsystems primarily for vacuum process systems. Our primary products are complex power conversion and control systems. Our products also control the flow of liquids 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, among other things:

	•		Semiconductor devices for electronics applications;
	•		Flat panel displays for hand-held devices, computer and television screens;
	•		Compact discs, DVDs and other digital storage media;
	•		Optical coatings for architectural glass, eyeglasses and solar panels; and
	•		Industrial laser and medical applications.

     We also sell spare parts and repair services worldwide through our customer service and technical support organization.

     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. 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 59% of our sales in 2003, 68% in 2002 and 64% in 2001. We sell our products primarily through direct sales personnel to customers in the United States, Europe and Asia, and through distributors in various regions both inside and outside the United States. International sales represented 53% of our sales in 2003, 40% in 2002, and 36% in 2001, although many of our products sold domestically are placed on systems shipped overseas by our customers.

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     In 2001, 2002 and much of 2003 the semiconductor capital equipment industry experienced the steepest cutback in capital equipment purchases in industry history. This downturn resulted in a significant decrease in demand for semiconductor capital equipment and related components. Inventory buildups coupled with slower than expected personal electronics sales and slow global economic growth caused semiconductor companies to re-evaluate their capital spending and initiate cost reduction measures. These factors resulted in lower sales and downward gross margin pressure for our products during the periods presented herein. In mid 2003, the semiconductor capital equipment industry entered the early stages of what appears to be a return to higher product demand. 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.

     Although we are beginning to see indications of increased demand for our products primarily from the semiconductor capital equipment and flat panel display manufacturing industries, we cannot provide any assurance that such revenue levels are sustainable through 2004. We incurred significant operating losses from the second quarter of 2001 through the third quarter of 2003, primarily as a result of lower revenues, and during 2003 due to our duplicative manufacturing facilities as a result of our new China-based manufacturing facility and transition to lower cost, higher quality suppliers primarily located in Asia, or Tier 1 Asian suppliers. We generated positive income from operations of approximately $300,000 during the fourth quarter of 2003. Over the past eleven quarters, we have been unable to achieve profitability at current revenue levels, but are cautiously optimistic regarding an industry recovery in the short-term. At the end of 2002, we established a goal of reducing our operating cash flow breakeven point, while maintaining the flexibility to increase our spending level if projected revenue and new product opportunities support a higher spending level. As a result, our total operating expenses declined from $130.7 million in 2002 to $111.1 million in 2003.

     To achieve our goal of reducing our operating cash flow breakeven point, we announced major changes in our operations to occur through the end of 2003. These included establishing 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. As of December 31, 2003, we were manufacturing approximately 11% of our production in our manufacturing facility in China and have transitioned approximately 27% of our raw materials purchases to Tier 1 Asian suppliers. We expect to continue our progress on both of these objectives during 2004 and exit the year manufacturing approximately 70% of our Power and Flow Control production in our China-based facility and completing the transition of approximately 50% of our material purchases to Tier 1 Asian suppliers.

Products

     Our major products fall into these categories: Power, Flow Control, Thermal Instrumentation and Temperature Control and Source Technology. Our products are designed to improve productivity and lower the cost of ownership for our customers.

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Power

     Our Power systems include direct current (DC), high power, low and mid frequency, and radio frequency (RF) power supplies, matching networks and RF instrumentation. Our Power systems refine, modify and control the raw electrical power from a utility and convert it into power that is uniform, predictable and repeatable. Our Power systems are primarily used by semiconductor manufacturers in the following applications: physical vapor deposition; chemical vapor deposition; reactive sputtering; electroplating; plasma vacuum processes and bias; oxide, poly and metal etch; and carbon dioxide laser excitation.

Flow Control

     Our Flow Control products include thermal mass flow controllers (MFCs), pressure-based MFCs, liquid MFCs, liquid vapor delivery systems, pressure control systems and ultrasonic control systems. Our Flow Control products control or monitor the flow of high-purity liquids, liquid vapor, and gases encompassing a wide range of input pressures. Our Flow Control products are primarily used in semiconductor applications, fiber optics, safe delivery system applications, chemical vapor deposition and silica industries.

Thermal Instrumentation and Temperature Control

     Our Thermal Instrumentation and Temperature Control products include thermal sensing systems, chillers and heat exchangers. Our Thermal Instrumentation and Temperature Control products provide thermal management and process control primarily to the semiconductor industry by maintaining wafer set points in plasma etch applications and providing dynamic real-time independent temperature control of the cathode, anode and chamber walls. Our Thermal Instrumentation and Temperature Control products are primarily used in physical vapor deposition, rapid thermal processing and other semiconductor applications requiring non-contact temperature measurement, chemical mechanical polishing, track and lithography.

Source Technology

     Our Source Technology products include plasma and ion beam sources which are used in the direct deposition of thin films of diamond-like carbon, ion-assisted deposition, ion beam etching, optical coating, pre-cleaning and chamber clean. Our plasma-source platform fully integrates a remote plasma source, a power supply and an active matching network.

Other Products

     We also offer DC-DC converters specifically designed to power low voltage, high current microprocessors, application-specific integrated circuits, logic and memory chips and servers.

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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 59% of our sales in 2003, 68% of our sales in 2002, and 64% in 2001. Our Power, Flow Control, Thermal Instrumentation and Temperature Control, Source Technology as well as other products are also used in the flat panel display, data storage and advanced product applications markets. 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 the major semiconductor processing steps such as:

	•		Chemical vapor deposition
	•		Physical vapor deposition
	•		Oxide etch
	•		Poly etch
	•		Metal etch
	•		Wafer handling
	•		Other semiconductor processes

     Our Power systems provide the energy to drive the chemical reaction for thin-film processes such as deposition and etch. Our Flow Control products control the fluid or gas being delivered to ensure high purity, our Thermal Instrumentation and Temperature Control products measure the temperature of the process chamber and either heat or cool the silicon wafer and our Source Technology products optimize CVD clean, deposition and etch processes while providing a low cost of ownership. 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.

     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 devices to laptop and desktop computer monitors to plasma and liquid crystal display-screen televisions. The transition to larger panel sizes and higher display resolution is driving the need for tighter process controls to reduce manufacturing costs and defects. 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.

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     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; computer hard discs, including both media and thin-film heads; and optical storage media. 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 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.

     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.

     Also included in the advanced product applications markets are our sales to OEMs of high-end computing, automated test equipment and DataCom products.

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 54% of our total sales in 2003 and 53% in 2002 and in 2001. We expect that sales of our products to these customers will continue to account for a large percentage of our sales in the foreseeable future.

Representative customers include:

     Applied Materials, our largest customer, accounted for 20% of our sales in 2003, 27% in 2002 and 24% in 2001. No other customer exceeded 10% during these periods.

     Our backlog increased from $21.8 million at December 31, 2002, to $53.7 million at December 31, 2003. We schedule production of our systems based on order backlog and customer commitments. Backlog includes only orders scheduled to ship in the following quarter 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 San Jose, California; Concord, Massachusetts; Voorhees, New Jersey; Austin and Dallas, Texas; and Vancouver, Washington. To serve customers in Asia and Europe, we have offices in Shenzhen and Shanghai, China; Bicester, England; Dresden, Filderstadt and Stolberg, Germany; Hachioji and Tokyo, Japan; Bundang, South Korea; and Hsinchu and Taipei Hsien, Taiwan. These offices have primary responsibility for sales in their respective markets. We also have distributors inside and outside the United States. We plan to close our Voorhees, New Jersey facility in the first half of 2004.

     Sales outside the United States represented approximately 53% of our total sales in 2003, 40% in 2002 and 36% in 2001. We expect sales outside the United States to

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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 foreign 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; San Jose, California; Austin and Dallas, Texas; Vancouver, Washington; Shanghai, China; Bicester, England; Dresden, Filderstadt and Stolberg, Germany; Hachioji and Tokyo, Japan; Bundang, South Korea; and Hsinchu and Taipei Hsien, Taiwan.

     We offer warranty coverage for our products after shipment against defects in design, materials and workmanship for periods ranging from 12 to 60 months, with the majority of our products having terms ranging from 18 to 24 months.

Manufacturing

     Our major manufacturing locations are in Fort Collins, Colorado; Shenzhen, China; Stolberg, Germany; and Hachioji, Japan. We also have manufacturing locations in Voorhees, New Jersey (to be closed in the first half of 2004); Vancouver, Washington; and Bundang, South Korea. With the exception of our Fort Collins, Colorado and Shenzhen, China facilities, we generally manufacture different products at each facility. During 2004, we plan to transition the manufacturing of our products in Voorhees, New Jersey to Fort Collins, Colorado, and to transition approximately 70% of our worldwide Power and Flow Control production to 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 our 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 and reduces control over pricing and delivery time 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. Further, due to our customers’ “copy exact” requirements, most supplier changes require vendor requalification, which can be extensive and time consuming.

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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 73 United States patents and have over 100 patent applications pending in the United States, Europe and Asia. 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 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 and are exposed to various risks related to legal proceedings and claims.”

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 Asian- and European-based equipment vendors. We have several 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 Celerity Group, Inc.; Comdel; Daihen Corp.; Huettinger Elektronik GmbH; Kyosan Electric Manufacturing Co. Ltd.; MKS Instruments, Inc.; Mykrolis Corp.; Shindingen; and STEC, Inc., a Horiba Group Company. 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.

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Operating Segment

     We operate and manage our business of manufacturing, marketing and servicing components and subsystems for plasma-based manufacturing processes as one segment. All material operating units qualify for aggregation under Statement of Financial Accounting Standards “SFAS” No. 131, because all of our products and systems have similar economic characteristics, procurement, production and distribution processes. To report revenues from external customers for each product and service or each group of similar products and services would be impracticable. Since we operate in one segment, all financial segment information required by SFAS No. 131 is found in the accompanying consolidated financial statements. Please refer to Footnote 12 Industry Segment, Foreign Operations and Major Customer, included in Part II, Item 8 of this Form 10-K for further discussion regarding our operations by geographic region.

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 $51.6 million in 2003, $49.0 million in 2002 and $45.2 million in 2001, representing 19.7% of total sales in 2003, 20.5% in 2002 and 23.3% in 2001. We believe that the continued investment in research and development 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, 2003, we had a total of 1,347 employees, 1,201 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. We consider our employee relations to be good.

Effect 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.

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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:

	•		Reducing our operating cash flow breakeven point;
	•		Customer inventory levels, requirements 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;
	•		Sufficiency and availability of capital resources;
	•		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.

     We have invested significant human and financial resources to establish a manufacturing facility in China and transition our supply base to Tier 1 Asian suppliers, but might not be able to achieve the intended benefits as quickly as anticipated, or at all.

     As part of our strategy to reduce our operating cash flow breakeven point we are relying on lower labor and component costs associated with our new China-based manufacturing facility and transition to Tier 1 Asian suppliers. By the end of 2004, we

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expect to have transitioned approximately 70% of our Power and Flow Control manufacturing production to China. This strategy involves significant risks, including:

	•		Our customers may not accept products manufactured at our Chinese facility;
	•		Certain major customers have strict “copy exact” requirements which may delay or prevent acceptance of lower-cost components from Tier 1 Asian suppliers;
	•		We may face health-related risks, such as outbreaks of diseases, in the Asian countries in which we have manufacturing, distribution or sales facilities and the adverse impact of any quarantine or closure of such facilities;
	•		We may not be able to attract and retain key personnel in our Chinese facility;
	•		We may incur significant costs to test and repair products manufactured in our China facility to mitigate the risk of shipping lower-quality products to our customers;
	•		The Chinese government may allow the yuan to float against the U.S. dollar, which could significantly increase our operating costs; and
	•		Disruption of our United States employee base.

     In addition to these risks, we may not be able to successfully comply with China’s governmental regulations. The regulatory environment in China is evolving, and officials in the Chinese government often exercise discretion in deciding how to interpret and apply applicable regulations. Consequently, actions by Chinese governmental regulators may limit or adversely affect our ability to conduct business in China.

     Our inability to manage these risks among others could significantly impact our goal to reduce our operating cash flow breakeven point, as well as result in significant costs, expenditures, asset impairments and potentially damage our relationships with existing and prospective customers.

     Intellectual property rights are difficult to enforce in China.

     Commercial law in China is relatively undeveloped compared to the commercial law in the United States. Limited protection of intellectual property is available under Chinese law. Consequently, manufacturing our products in China may subject us to an increased risk that unauthorized parties may attempt to copy or otherwise obtain or use our intellectual property. We cannot assure you that we will be able to effectively protect our intellectual property rights or have adequate legal recourse in the event that we encounter difficulties with infringements of our intellectual property under Chinese law.

     We have experienced sustained losses recently and might not be able to achieve profitability in the near future.

     Demand for our products from the semiconductor capital equipment industry has declined substantially from its peak in 2000 and we incurred significant operating losses each quarter from the second quarter of 2001 through the third quarter of 2003. While

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we were able to generate positive operating income in the fourth quarter of 2003, we still incurred a significant net loss for the year. Due to the highly cyclical nature of the semiconductor industry we cannot assure you when, or if, we will be able to return to sustained profitability. A failure on our part to increase our revenue and contain our expenditures will cause our liquidity to suffer and could cause the price of our securities to decrease.

     Our quarterly and annual operating results fluctuate significantly and are difficult to predict.

     Our quarterly and annual operating results have fluctuated significantly, and we expect them to continue to experience significant fluctuations. Fluctuations in our operating results historically have resulted in corresponding changes in the market prices of our securities. Our operating results are affected by a variety of factors, many of which are beyond our control and difficult to predict. These factors include:

	•		Changes 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;
	•		The seasonal variations in capital spending by our customers;
	•		Changes in customers’ inventory management practices;
	•		Customer cancellations of previously placed orders and shipment delays;
	•		Pricing competition from our competitors;
	•		Customer demands to reduce prices, enhance features, improve reliability, shorten delivery times and extend payment terms;
	•		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;
	•		Declines in macroeconomic conditions;
	•		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.

     The semiconductor and semiconductor capital equipment industries are highly volatile, which impacts our operating results.

     The semiconductor and semiconductor capital equipment industries have historically been cyclical because of sudden changes in demand for semiconductors and manufacturing capacity. The rate of changes in demand, including end demand, is accelerating, and the effect of these changes is occurring sooner, exacerbating the volatility of these cycles. These changes affect the timing and amount of our customers’ equipment purchases and investments in new technology, as well as our costs and operations.

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     During periods of declining demand for semiconductor equipment components, our customers typically reduce purchases, delay delivery of products and cancel orders. We might incur significant charges as we seek to align our cost structure with the reduction in sales. In addition, we might not be able to respond adequately or quickly enough to the declining demand. We may also be required to record significant reserves for excess and obsolete inventory as demand for our products changes. Our inability to reduce costs and the charges resulting from other actions taken in response to changes in demand for our products would adversely affect our operating results.

     During periods of growth in the semiconductor and semiconductor capital equipment industries, we might not be able to acquire or develop sufficient manufacturing capacity or inventory to meet our customers’ increasing demand for our products. In addition, we might be required to make substantial capital investments to increase capacity.

     During 2001, 2002 and much of 2003, the semiconductor capital equipment industry experienced the steepest cutback in capital equipment purchases in industry history. While we have experienced an increase in sales to semiconductor capital equipment manufacturers in the fourth quarter of 2003, we cannot be certain that there will be a sustained recovery for the semiconductor industry or that another severe and prolonged downturn will not occur in the near future. A decline in the level of orders as a result of any future downturn or slowdown in the semiconductor industry would 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 54% of our total sales in 2003 and 53% of our total sales in 2002 and 2001. Our largest customer, Applied Materials, accounted for 20% of our total sales in 2003, 27% in 2002 and 24% in 2001. The loss of any of our significant customers or a material reduction in any of their purchase orders would significantly harm our business, financial condition and results of operations.

     Our customers continuously exert pressure on us to reduce our prices and extend payment terms. Given the nature of our customer base and the highly competitive markets in which we compete, we may be required to issue price concessions to our customers to remain competitive. A ten percent reduction in our historical selling prices could lead to a seven percent or greater decline in gross margin. We may not be able to reduce our other operating expenses in an amount sufficient to offset potential margin declines.

     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 Celerity Group, Inc.; Comdel; Daihen Corp.; Huettinger Elektronik GmbH; Kyosan Electric Manufacturing Co. Ltd.; MKS Instruments, Inc.; Mykrolis Corp.; Shindingen; and STEC, Inc., a Horiba Group Company. We expect that our

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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 must improve and expand our products and product offerings. In addition, we may 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 might not be able to make the technological advances and investments necessary to remain competitive. Our inability to improve and expand our products and product offerings would have an adverse affect on our sales and results of operations.

     We are exposed to risks associated with previous acquisitions and potential future acquisitions.

     In January 2002, we completed the acquisition of Aera Japan Limited and in March 2002, we completed the acquisition of Dressler HF Technik GmbH. Integrating the entities that we acquired into our business will require a substantial amount of our resources and management time. Moreover, the integration process may result in unforeseen operating difficulties and may require significant financial, operational and managerial resources that would otherwise be available for the operation, development and expansion of our existing business. We cannot assure you that the integration of our acquired entities will be successful or that we will realize the potential financial, operating or other benefits that we expect from these acquisitions.

     We may in the future make additional acquisitions of, or significant investments in, businesses with complementary products, services and technologies. Acquisitions involve numerous risks, including but not limited to:

	•		Diversion of management’s attention from other operational matters;
	•		The inability to realize expected synergies resulting from the acquisition;
	•		Failure to commercialize purchased technology;
	•		Significant and unanticipated capital investments required to integrate acquired businesses and technologies;
	•		Retaining existing customers and strategic partners of acquired companies;
	•		Increased levels of intangible asset amortization expense;
	•		Potential material charges for impairment of acquired intangible assets; and
	•		Dilution of earnings.

     Mergers and acquisitions are inherently subject to multiple significant risks. If we are unable to effectively manage these risks, our business, financial condition and results of operations will be adversely affected.

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

     For the years ended December 31, 2003, 2002 and 2001, our sales to customers outside the United States were approximately 53%, 40% and 36% of our total sales. Our success in competing in international markets is subject to our ability to manage various risks and difficulties, including, but not limited to:

	•		Our ability to develop relationships with suppliers and other local businesses;
	•		Compliance with product safety requirements and standards that are different from those of the United States;
	•		Variations in enforcement of intellectual property and contract rights in different jurisdictions;
	•		Trade restrictions, political instability, disruptions in financial markets and deterioration of economic conditions;
	•		The ability to provide sufficient levels of technical support in different locations;
	•		Collecting past due accounts receivable from foreign customers; and
	•		Changes in tariffs, taxes and foreign currency exchange rates.

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

     Component shortages exacerbated by our dependence on sole and limited source suppliers could affect our ability to manufacture products and systems and could delay our shipments.

     Our business depends on our ability to manufacture products that meet the rapidly changing demands of our customers. Our ability to manufacture depends in part on the timely delivery of parts, components and subassemblies from suppliers. We rely on sole and limited source suppliers for some of our parts, 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 parts, components or subassemblies;
	•		The potential for a sole source provider to cease operations;
	•		Our potential need to fund the operating losses of a sole source provider;
	•		Reduced control over pricing and timing of delivery of parts, components and subassemblies; and
	•		The potential inability of our suppliers to develop technologically advanced products to support our growth and development of new products.

     If we are unable to successfully qualify additional suppliers and manage relationships with our existing and future suppliers, we will experience shortages of parts, components or subassemblies, increased material costs and shipping delays for our products, which

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will adversely affect our results of operations and relationships with current and prospective customers.

     We are highly dependent on our intellectual property and are exposed to various risks related to legal proceedings and claims.

     Our success depends significantly 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 other countries. If we are unable to successfully protect our intellectual property, our results of operations will be adversely affected.

     Intellectual property litigation is costly. In May 2002, we recognized approximately $5.3 million of litigation damages and related legal expenses pertaining to a judgment entered by a jury against us and in favor of MKS Instruments, Inc., in a patent-infringement suit in which we were the defendant. We have settled this lawsuit with MKS. Under the settlement agreement, royalties payable to MKS from sales of the related product were not material in any of the periods presented.

     In May 2003, MKS Instruments, Inc. filed a patent infringement suit against us in the United States District Court in Wilmington, Delaware, alleging that our Xstream™ With Active Matching Network™ products infringe five patents held by MKS. We intend to defend vigorously against the MKS complaint. However, an adverse determination in the MKS or any 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 selling our products and impact future revenue. Any of these events could adversely affect our business, financial condition and results of operations.

     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 must work with these manufacturers early in their design cycles to modify our equipment or design new equipment to meet the requirements of their new systems. Manufacturers typically choose one or two vendors to provide the components 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.

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     Once a manufacturer chooses a component for use in a particular product, it is likely to retain that component for the life of that product. Our sales and growth could experience material and prolonged adverse effects if we fail to achieve design wins. However, 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. If we are not successful in achieving design wins our sales and results of operations will be adversely impacted.

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

     Our success depends in large part upon our ability to attract, retain and motivate key employees, including our senior management team and our technical, marketing and sales personnel. We do not have employment agreements with any of our executive officers or other key employees. These employees may voluntarily terminate their employment with us at any time. In the past three years, we have experienced turnover in key management positions such as the chief financial officer and chief operating officer. 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 will be adversely affected. Additionally, we do not maintain key-person life insurance policies on our executive officers.

     Warranty costs on certain products may be in excess of historical experience.

     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 these products. Our warranty costs generally increase when we introduce newer, more complex products. We recorded warranty expense of approximately $8.1 million, $13.2 million and $7.6 million in 2003, 2002 and 2001, respectively. If such levels of warranty costs persist or increase in the future, our financial condition and results of operations will be 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 might incur significant costs as we seek to ensure that our products meet safety and emissions standards, many of which vary across the states and countries in which our products are used. In the past, we have invested significant resources to redesign our products to comply with these directives. We believe we are in

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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.

     Our inability to comply with current or future regulations, directives and standards will adversely affect our operating results.

     Our Chief Executive Officer owns a significant percentage of our outstanding common stock, which could enable him to control our business and affairs.

     Douglas S. Schatz, our Chief Executive Officer, owned approximately 33.1% of our common stock outstanding as of February 17, 2004. This stockholding gives Mr. Schatz significant voting power. Depending on the number of shares that abstain or otherwise are not voted on a particular matter, Mr. Schatz may be able to elect all of the members of our board of directors and to control our business affairs for the foreseeable future.

EXECUTIVE OFFICERS OF THE REGISTRANT

     Our executive officers, their positions and their ages as of February 17, 2004, 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. Since December 1995, Mr. Schatz has also served as a Director of Advanced Power Technology, Inc. Mr. Schatz is a member of the CEO Committee of the Mountain States Council of the American Electronics Association and serves on the Engineering Advisory Board of Colorado State University.

     Michael El-Hillow joined us in November 2001 as Senior Vice President of Finance and Administration and Chief Financial Officer, in February 2003 he was named

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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 LLP.

     D. Craig Jeffries joined us in March 2003 as Executive Vice President and Chief Marketing Officer. From 2002 to 2003 Mr. Jeffries served as the founder and President of Ensenyo Software. From March 2001 to November 2001, he was Chief Marketing Officer at Exostar, LLC. He served as Vice President of Marketing and E-Business at Allied Signal/Honeywell International from October 1998 to November 2000. Prior to Allied Signal/Honeywell International, Mr. Jeffries was Strategic Marketing Manager at Hewlett-Packard Company.

     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 September 1999 as Director of Applied Materials Account Team and was named Senior Vice President of Sales in October 2000. In October 2002, Mr. 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.

     Larry McCulloch joined us in May 2003 as Senior Vice President and Chief Quality Officer. In 2002, Mr. McCulloch was Business Escalations Manager for the Networked Storage Organization of Hewlett-Packard. Prior, he was General Manager in the Networked Storage Solutions Organization leading acquisition integration and strategic planning for storage. As General Manager he led the Workgroup Information Management Division and worked in research and development. Mr. McCulloch joined Hewlett-Packard in 1974.

     LuAnn Piccard joined us in October 2003 as Senior Vice President and General Manager of our Power Business Unit. From 2001 to 2003, Ms. Piccard was Vice President and General Manager for the Communication Test Equipment Business Unit at Agilent Technologies. Before that, she was Vice President and General Manager for the Wireless Network Solutions Business Unit and Vice President and General Manager for the Communications Solutions Services Division at Agilent. Prior to Agilent’s separation from Hewlett-Packard, she had a variety of senior leadership positions in engineering, marketing and alliance management. Ms. Piccard joined Hewlett-Packard in 1982.

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     Stephen 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.

     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.

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.

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     In 2003, we sold our 45,000 square-foot Longmont, Colorado facility, and closed the following facilities:

     In the first half of 2004, we expect to close our 78,000 square-foot facility in Voorhees, New Jersey, and our 3,000 square-foot facility in Beaverton, Oregon.

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:

     In April 2003, we filed a claim in the United States District Court for the District of Colorado seeking a declaratory ruling that our new plasma source products Xstream™ With Active Matching Network™ (“Xstream Products”) are not in violation of U.S. Patents held by MKS. This case was transferred by the Colorado court to the United States District Court for the District of Delaware for consolidation with a patent infringement suit filed in that court by MKS in May 2003, alleging that our Xstream Products infringe five patents held by MKS. We believe that the Delaware court, in its May 2002 judgment in prior litigation between us and MKS, clearly defined the limits of the MKS technology. We specifically designed our Xstream Products not to infringe MKS’s patents, with the advice of a team of independent experts. In February 2004, the Delaware court restated its rulings on the construction of claims in the MKS patents consistent with its holding in the prior litigation. We intend to defend vigorously against the MKS complaint. The current patent case has been set for trial in July 2004. Litigation costs to defend this case are expected to increase our operating expenses during 2004.

     On September 17, 2001, Sierra Applied Sciences, Inc. filed for declaratory judgment asking the U.S. District Court for the District of Colorado to rule that their products did not infringe our U.S. patent no. 5,718,813 and that the patent was invalid. On March 24, 2003, the Court granted our motion to dismiss the case for lack of subject matter jurisdiction. Sierra has appealed the ruling of dismissal, and the decision on Sierra’s appeal from the Court of Appeals for the Federal Circuit is pending. We believe that, were the ruling of dismissal to be reversed and Sierra’s claim reinstated and tried, the validity of our patent will be upheld and Sierra’s products would be adjudged to infringe.

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 February 17, 2004, the number of common stockholders of record was 854, and the last sale price on that day was $23.44.

     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.

Equity Compensation Plan Information

     The following table presents information as of December 31, 2003 with respect to our equity compensation plans:

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(1) Consists of the 2003 Stock Option Plan, the 2003 Non-Employee Directors’ Stock Option Plan, 1995 Employee Stock Option Plan, the Non-Employee Directors Stock Option Plan, and the Employee Stock Purchase Plan. The 1995 Employee Stock Option Plan and the Non-Employee Directors Stock Option Plan terminated on May 7, 2003, upon shareholder approval of the 2003 Stock Option Plans, however existing stock options outstanding under the 1995 Employee Stock Option Plan and the Non-Employee Directors Stock Option Plan remain outstanding according to their original terms.

(2) Does not include purchase rights accruing under the Employee Stock Purchase Plan for the offering beginning on December 1, 2003, the number of shares and exercise price of which will not be determinable until the expiration of such offering period.

     Please refer to Footnote 15 Stock Plans included in Part II, Item 8 of this Form 10-K for further discussion regarding the material features of these equity compensation plans.

Overview

     We design, manufacture and support a group of key components and subsystems primarily for vacuum process systems. Our primary products are complex power conversion and control systems. Our products also control the flow of fluids into the process chambers, provide thermal control and sensing within the chamber, deposit thin-films of diamond-like carbon and clean the chamber. Our customers use our products in plasma-based thin-film processing equipment that is essential to the manufacture of, among other things:

	•		Semiconductor devices for electronics applications;
	•		Flat-panel displays for hand-held devices, computer and television screens;
	•		Compact discs, DVDs and other digital storage media;
	•		Optical coatings for architectural glass, eyeglasses and solar panels; and
	•		Industrial laser and medical applications.

     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 59% of our sales in 2003, 68% of our sales in 2002 and 64% in 2001. 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 industry cycles. Our sales to customers outside the United States represented approximately 53%, 40% and 36% of our sales in 2003, 2002 and 2001, respectively. We expect our international sales to continue to grow as a percentage of our total sales as more customers build or have their products built in lower-cost regions outside of the United States.

     In 2001, 2002 and much of 2003 the semiconductor capital equipment industry experienced the steepest cutback in capital equipment purchases in industry history. As a result, demand for our products from the semiconductor capital equipment industry declined substantially from the peak in 2000, and we have incurred significant operating losses each quarter from the second quarter of 2001 through the third quarter of 2003. In mid 2003, the semiconductor capital equipment industry entered the early stages of what appears to be a return to higher product demand and in the fourth quarter of 2003, we generated positive operating income of approximately $300,000. We are focused on returning to sustained profitability and achieving operating cash flow breakeven. To achieve this goal, we are in the process of developing a more variable operating model to allow us to remain profitable during industry downturns and continue to be successful during periods of expansion. We are taking the following actions:

	•		Establishing a China-based manufacturing facility;
	•		Transitioning a portion of our supply base to Tier 1 Asian suppliers;
	•		Closing certain facilities and reducing our permanent headcount; and

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•

Engaging contract manufacturers to manufacture certain products and components which were previously manufactured by us.

     In April 2003, we opened our 88,000 square-foot China-based manufacturing facility in Shenzhen, China. At the end of 2003, approximately 11% of our worldwide production was manufactured in China. By the end of 2004, we expect to have transitioned approximately 70% of our Power and Flow Control manufacturing production to China. During the transition period we are running duplicate manufacturing facilities, which is placing pressure on our gross margin. We expect our gross margin to improve throughout 2004 if industry conditions continue to improve.

     We plan to transition approximately 50% of our raw material purchasing to Tier 1 Asian suppliers. As of December 31, 2003, approximately 27% of our purchasing has been successfully transitioned and we expect to transition the remaining 23% by December 31, 2004. Our biggest obstacle in our Tier 1 supplier initiative is complying with certain major customers’ stringent “copy exact” requirements. We are working closely with our largest original equipment manufacturers, or OEM’s, to ensure the transition proceeds on schedule. However, our transition goals may prove difficult to realize because of customer needs.

     During 2003, we closed manufacturing facilities in Longmont, Colorado; Matthews, North Carolina; and Austin, Texas. In the first half of 2004, we plan to close our manufacturing facility in Voorhees, New Jersey. We expect to incur between $500,000 and $700,000 in restructuring charges in 2004, however, this estimate is subject to change based upon changes in the demand for our products and potential changes to our operating model. We also closed various sales and services locations throughout the world in an effort to rationalize our manufacturing capacity and sales force with the current industry environment.

     In the second quarter of 2003, as part of our ongoing cost reduction measures, we engaged a contract manufacturer to manufacture printed circuit boards for our direct current, radio frequency and computer workstation products. In the third quarter of 2003, we sold our Longmont, Colorado manufacturing facility to a contract manufacturer who continues to use this facility to manufacture our industrial flow products.

Critical Accounting Policies and Estimates

     The following discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing our financial statements, we must make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions. We believe that the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

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     VALUATION OF INTANGIBLE ASSETS AND GOODWILL — We have approximately $88.9 million of intangible assets and goodwill as of December 31, 2003, including approximately $19.4 million related to amortizable intangibles and $69.5 million in goodwill. In addition to the original cost of these assets, their recorded value is impacted by a number of our policy elections, including estimated useful lives and impairment charges, as well as foreign currency fluctuations.

     Due to our cost reduction initiatives we have restructured our business. As a result we have eliminated certain duplicative facilities and consolidated the operational and administrative activities of our reporting units. Based on our similar production characteristics, shared manufacturing facilities and blended financial reporting environment, our management reviews our results of operations as a single reporting unit.

     We review our intangible assets and goodwill for impairment annually and whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Factors we consider important which could indicate impairment include under performance relative to historical or expected future operating results, changes in the manner of our use of the asset or the strategy for our overall business and negative industry or general economic trends.

     In the fourth quarter of 2003, we engaged a third party valuation firm to perform the annual impairment analysis of our non-amortizable intangible assets and goodwill, which indicated that no charge for impairment was currently required. This assessment required estimates of future revenue, operating results and cash flows, as well as estimates of critical valuation inputs such as discount rates, terminal values and similar data. These projections of future results are by their nature subjective, and while they represent management’s current best assessment of the future, they may be materially different than actual future results. We will continue to perform impairment analyses of our non-amortizable intangible assets and goodwill resulting from our acquisitions. As a result of future periodic, at least annual, impairment analyses we may record impairment charges that would have a material adverse impact on our operating results. Additionally, we may make strategic business decisions in future periods which impact the fair value of our intangible assets and goodwill, which could result in significant impairment charges.

     LONG-LIVED ASSETS INCLUDING INTANGIBLES SUBJECT TO AMORTIZATION — Depreciation and amortization of our long-lived assets is provided using the straight-line method over their estimated useful lives. Changes in circumstances such as the passage of new laws or changes in regulations, technological advances, changes to our business model or changes in our strategy could result in the actual useful lives differing from initial estimates. In those cases where we determine that the useful life of a long-lived asset should be revised, we will depreciate the net book value in excess of the estimated residual value over its revised remaining useful life. Factors such as changes in the planned use of equipment, customer attrition, contractual amendments or mandated regulatory requirements could result in shortened useful lives.

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     Long-lived assets and asset groups are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The estimated future cash flows are based upon, among other things, assumptions about expected future operating performance and estimated discount rates, and may differ from actual cash flows. Impairments will also be assessed when assets are determined to be held-for-sale, as opposed to held and used in operations.

     RESERVE FOR EXCESS AND OBSOLETE INVENTORY— Inventory is valued at the lower of cost or market. Given the rapid change in technology, and volatility of the industries in which we serve, 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 by management, 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 excess and obsolete inventory. For the years ended December 31, 2003, 2002 and 2001, we recorded charges of $3.0 million, $5.8 million and $6.4 million, respectively, for excess and obsolete inventory. As of December 31, 2003, we had inventory balances of approximately $65.7 million. A significant decrease in the demand for our products, technological change, or new product development could result in charges for excess and obsolete inventory that are material to our financial condition and results of operations.

     RESERVE FOR WARRANTY — We provide warranty coverage for our products, ranging from 12 to 60 months, with the majority of our products ranging from 18 to 24 months, and estimate the anticipated cost of repairing our products under such warranties based on the historical cost 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. The industries in which we operate are subject to rapid technological change. As a result, we periodically introduce newer, more complex products, which tend to result in increased warranty costs. We expect the industries in which we operate to continue to require the introduction of new technologies, which could cause our warranty costs to increase in the future. Should product failure rates differ from our estimates, actual costs could vary significantly from our expectations. We recorded warranty charges of $8.1 million, $13.2 million and $7.6 million in 2003, 2002 and 2001, respectively.

     COMMITMENTS AND CONTINGENCIES — We are involved in disputes and legal actions arising in the normal course of our business. While we currently believe that the amount of any ultimate potential loss would not be material to our financial position, the outcome of these actions is inherently difficult to predict. In the event of an adverse outcome, the ultimate potential loss could have a material adverse effect on our financial position or reported results of operations in a particular quarter. An unfavorable decision, particularly in patent litigation, could require material changes in production processes and products or result in our inability to ship products or components found to have violated third-party patent rights. We accrue loss contingencies in connection with our

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litigation when it is probable that a loss has occurred and the amount of the loss can be reasonably estimated.

     REVENUE RECOGNITION — We generally recognize revenue upon shipment of our products and spare parts, at which time title passes to the customer, as our shipping terms are FOB shipping point, the price is fixed and collectability is reasonably assured. Generally, we do not have obligations to our customers after our products are shipped other than pursuant to warranty obligations. In limited instances we provide installation of our products. In accordance with Emerging Issues Task Force Issue 00-21 “Accounting for Revenue Arrangements With Multiple Deliverables”, we allocate revenue based on the fair value of the delivered item, generally the product, and the undelivered item, installation, based on their respective fair values. Revenue related to the undelivered item is deferred until the services have been completed. In certain limited instances, some of our customers have negotiated product acceptance provisions relative to specific orders. Under these circumstances we defer revenue recognition until the related acceptance provisions have been satisfied. Revenue deferrals are reported as customer deposits and deferred revenue.

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

     We may also deliver 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 us, or accepts the product. Upon acceptance, title passes to the customer, we invoice the customer for the product, and revenue is recognized. Pending acceptance by the customer, such products are reported on our 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 amortization.

     STOCK-BASED COMPENSATION — In accordance with Statement of Financial Accounting Standards Nos. 123 and 148, we have elected to continue to account for our employee stock-based compensation plans using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, which do not require compensation expense to be recorded if the consideration to be received is at least equal to the fair value of the common stock to be received at the measurement date. We provide information as to what our earnings and earnings per share would have been had we used the fair value method prescribed by SFAS No. 123. In future periods the Financial Accounting Standards Board will likely require companies to expense the fair value of their stock-

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based compensation over the respective vesting period. Such new accounting guidance is expected to have a material effect upon our results of operations.

     DEFERRED INCOME TAXES — We account 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. During 2003, we recorded valuation allowances against certain of our United States and foreign net deferred tax assets in jurisdictions where we have incurred significant losses in 2001, 2002 and 2003. Given such experience, management could not conclude that it was more likely than not that these net deferred tax assets would be realized. While there are indications that the markets in which we operate may improve in 2004 and 2005, these indications have not yet resulted in substantial taxable income. Accordingly, our management, in accordance with SFAS No. 109, in evaluating the recoverability of these net deferred tax assets, was required to place greater weight on our historical results as compared to projections regarding future taxable income. If we generate future taxable income, or should we be able to conclude that sufficient taxable income is reasonably assured based on profitable operations, in the appropriate tax jurisdictions, against which these tax attributes may be applied, some portion or all of the valuation allowance will be reversed and a corresponding reduction in income tax expense will be reported in future periods. A portion of the valuation allowance relates to the benefit from stock-based compensation. Any reversal of valuation allowances from this item will be reflected as a component of stockholders’ equity.

     When recording acquisitions, we have 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. Any reversals of valuation allowances recorded in purchase accounting will be reflected as a reduction of goodwill in the period of reversal.

Recent Acquisitions

     On March 28, 2002, we completed the acquisition of Dressler HF Technik GmbH, or Dressler, a privately owned Stolberg, Germany-based provider of power supplies and matching networks. We acquired Dressler to expand our product offerings to customers in the semiconductor, data storage and flat panel equipment markets with Dressler’s power product portfolio that includes a wide range of power levels and radio frequencies. In addition, with inroads already made into the laser and medical markets, Dressler enables us to explore new market opportunities. Dressler also strengthens our presence in the European marketplace and has well-established relationships with many European customers, who look to Dressler for innovative technical capability, high quality products, and highly responsive customer service.

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     On January 18, 2002, we completed the acquisition of Aera Japan Limited, or Aera, a privately held Japanese corporation. Aera supplies the semiconductor capital equipment industry with product lines that include digital mass flow controllers, thermal-based mass flow controllers, pressure-based mass flow controllers, liquid mass flow controllers and liquid vapor delivery systems. Aera provides us with a key leadership position in the gas delivery market. In addition, Aera’s products expand our offering of critical subsystem solutions that enable the plasma-based manufacturing processes used in the manufacture of semiconductors.

     The results of operations of these acquired companies are included in our consolidated statements of operations as of and since the date of acquisition.

Results of Operations

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

     SALES

     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, 2003. Sales for the years ended December 31, 2003 and 2002 include combined sales from Aera and Dressler, subsequent to their acquisitions of approximately $51.5 million and $47.0 million, respectively:

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     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, 2003:

     Sales were $262.4 million in 2003, $238.9 million in 2002 and $193.6 million in 2001, representing an increase of 10% from 2002 to 2003 and 23% from 2001 to 2002. Excluding the acquisitions of Aera and Dressler, our sales would have increased approximately 10% from 2002 to 2003 and would have been relatively flat from 2001 to 2002.

     According to a leading industry research firm sales of semiconductor capital equipment have grown at a compounded annual growth rate in excess of 11% over the past 30 years. However, we believe 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 pronounced slump in industry history, with year-to-year revenues falling approximately 40% throughout the industry from 2000 to 2001 and declining nominally thereafter. Our sales over the last three years illustrate this cyclicality. Our sales to the semiconductor capital equipment industry declined by approximately 2% from 2001 to 2002, excluding the effect of the acquisitions of Aera and Dressler; and by approximately 5% from 2002 to 2003.

     Our sales to the data storage, flat panel display and advanced product applications markets, increased each year from 2001 through 2003. This growth is primarily attributed to market share gains, order trends and the general expansion of end customer products including large flat panel displays, liquid crystal displays, DVD applications and applications dependent upon industrial coatings.

     Looking forward to 2004, our revenue may increase due to the recovery of the semiconductor capital equipment industry. Our other markets are also expected to grow

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in 2004. However, our average selling prices are likely to decline across all of our markets due to cost reduction initiatives by our major customers.

     GROSS MARGIN

     Our gross margin was 33.5% in 2003, 28.8% in 2002 and 29.7% in 2001. Our gross margin improved from 2002 to 2003 primarily due to our cost reduction measures, including our ongoing efforts to transition a portion of our manufacturing capacity to China and our supply base to Tier 1 Asian suppliers, as well as improved absorption due to the higher sales base; however, the transition of a portion of our manufacturing capacity to China has required us to operate duplicative manufacturing facilities which during 2003 impacted our gross margin. While we expect the transition of a portion of our production to China and our move to Tier 1 Asian suppliers will improve our gross margins in future periods, factors that could cause our gross margins to be negatively impacted include, but are not limited to the following:

	•		Continued pricing pressure from our major customers;
	•		Costs associated with transitioning a portion of our production to our new China facility, including costs incurred to operate duplicate manufacturing facilities;
	•		Unanticipated costs to comply with our customers’ “copy exact” requirements, especially related to our China transition and move to Tier 1 Asian suppliers;
	•		Cost reduction programs initiated by semiconductor manufacturers and semiconductor capital equipment manufacturers that negatively impact our average selling price;
	•		Warranty costs in excess of historical rates and our expectations;
	•		Increased levels of excess and obsolete inventory, either due to market conditions, the introduction of new products by our competitors, or our decision to discontinue certain product lines; and
	•		Changes in foreign currency exchange rates that might affect our costs.

     We recognized charges for excess and obsolete inventory of approximately $3.0 million, $5.8 million and $6.4 million in 2003, 2002 and 2001, respectively. Our warranty charges in 2003, 2002 and 2001 were approximately $8.1 million, $13.2 million and $7.6 million. Taken together, these charges represented approximately 4.2%, 8.0% and 7.2% of sales during 2003, 2002 and 2001, respectively.

     The major items affecting our gross margin in these years follow:

•

2003, 2002 and 2001 represent the most severe downturn in the semiconductor industry’s history. As a result, our sales declined significantly, which impacted our absorption of fixed costs.

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	•		The semiconductor industry is moving to 300mm wafers and smaller line widths. Typical of products early in their life cycle and at low production levels, these products have lower margins than our established products.
	•		Our cost of sales was adversely affected by periodic write-downs 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.
	•		We incurred warranty expense in excess of both 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. During 2002 and 2003 a significant portion of our warranty reserves were used to address these products.

     The following summarizes the activity in our warranty reserve during 2003 and 2002:

     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. We believe that the continued investment in research and development 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. Since our inception, all of our research and development costs have been expensed as incurred.

     Our research and development expenses were $51.6 million in 2003, $49.0 million in 2002 and $45.2 million in 2001. As a percentage of sales, research and development expenses decreased from 23.3% in 2001 to 20.5% in 2002 and 19.7% in 2003, due to the higher sales base. The 5.3% increase in research and development expenses from 2002 to 2003 was primarily due to increases in payroll and depreciation of equipment used for new product development. 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 products. Combined research and development expenses for

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Aera and Dressler were approximately $2.7 million in 2002. We expect our 2004 research and development expenses, in dollar terms, to be in line with 2003.

     SALES AND MARKETING EXPENSES

     Due, in part, to our recent acquisitions, our sales and marketing efforts have become increasingly complex. We continue to rationalize our sales and marketing functions with current industry conditions, while at the same time striving to increase market share and net sales. We have continued the effort to market directly to end users of our products, in addition to our traditional marketing to manufacturers of plasma-based equipment. Our sales and marketing expenses support domestic and international sales and marketing activities that include personnel, trade shows, advertising, and other selling and marketing activities.

     Sales and marketing expenses were $31.0 million in 2003, $34.9 million in 2002 and $23.8 million in 2001. The 11.1% decrease in sales and marketing expenses from 2002 to 2003 was primarily due to the closing of certain sales and service locations. See Restructuring Charges below for further discussion on these site closures. As a percentage of sales, sales and marketing expenses decreased from 14.6% in 2002 to 11.8% in 2003 due to our cost reduction measures and the higher sales base. Sales and marketing expenses increased from 12.3% of sales in 2001 to 14.6% in 2002 primarily due to our acquisitions of Aera and Dressler in 2002. Combined sales and marketing expenses for these companies were approximately $9.6 million in 2002. We expect sales and marketing expenses to increase in 2004, due to our higher anticipated sales level.

     GENERAL AND ADMINISTRATIVE EXPENSES

     Our general and administrative expenses support our worldwide corporate, legal, patent, tax, financial, corporate governance, administrative, information systems and human resource functions in addition to our general management. General and administrative expenses were $22.9 million in 2003, $30.5 million in 2002 and $21.5 million in 2001. The 24.9% decrease in general and administrative expense from 2002 to 2003 was due to our ongoing cost reduction measures as discussed in Restructuring Charges. As a percentage of sales, general and administrative expenses decreased from 12.8% in 2002 to 8.7% in 2003 due to our cost reduction measures and the higher sales base. The 41.9% increase in general and administrative expenses from 2001 to 2002 was primarily due to the absorption of additional headcount as a result of our acquisitions of Aera and Dressler, which contributed approximately $8.8 million to our general and administrative expenses in 2002. As a percentage of sales, general and administrative expenses increased from 11.1% in 2001 to 12.8% in 2002. We expect our general and administrative expenses in 2004 to be in line with 2003.

     LITIGATION DAMAGES AND EXPENSES (RECOVERY)

     During 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.

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     During 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 five percent of our total sales each year since the product’s introduction. We have entered into a settlement agreement with MKS allowing us to sell the infringing product to one of our customers subsequent to the date of the jury award. Under the settlement agreement, royalties payable to MKS from sales of the infringing product were not material in 2003.

     During 2003, litigation with MKS recommenced involving claims that one of our new products infringed certain patents held by MKS. The current patent case has been set for trial in July 2004 and we anticipate significantly increased spending for legal and other trial related expenses in 2004.

     RESTRUCTURING CHARGES

     During 2001, in response to the downturn in the semiconductor capital equipment industry, we implemented several reductions in force totaling 240 regular employees and 90 temporary employees and closed our manufacturing facilities in Austin, Texas and San Jose, California. Total restructuring charges for 2001 were approximately $3.1 million.

     We recorded restructuring charges totaling $9.1 million in 2002, primarily associated with changes in operations designed to reduce redundancies and better align Aera’s mass flow controller business within its operating framework. Our 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.

     At the end of 2002, we announced major changes in our operations to occur through 2003. These included establishing 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, we recognized restructuring charges of approximately $4.3 million during 2003. These charges consisted of the recognition of expense for involuntary employee termination benefits for 109 employees in our United States operations and voluntary employee termination benefits, primarily in our Japanese operations for 36 employees, and asset impairments incurred as a result of closing our Longmont, CO manufacturing facilities.

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GOODWILL AND OTHER INTANGIBLE ASSET IMPAIRMENTS

     During 2003, we determined that one of our mass flow controller products would not conform to changing customer requirements, and as such would no longer be accepted by our customers. As a result, we performed an assessment of the carrying value of the related intangible asset. This assessment consisted of estimating the intangible asset’s fair value and comparing the estimated fair value to the carrying value of the asset. We estimated the intangible asset’s fair value by applying a hypothetical royalty rate to the projected revenue stream and using a cash flow model discounted at discount rates consistent with the risk of the related cash flows. Based on this analysis we determined that the fair value of the intangible asset was minimal and recorded an impairment of the carrying value of approximately $1.2 million. Sales of this product represented less than 1% of our total sales during 2001, 2002 and 2003.

     During 2000, we made periodic advances and investments totaling approximately $9.5 million to Symphony Systems, Inc. In 2001, 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, the value of our investment in and advances to Symphony had substantially declined. We 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.

     Symphony effectively ceased operations in February 2002. We hired Symphony’s key employees, and acquired Symphony’s remaining assets in a foreclosure and liquidation sale of such assets in April 2002. We recorded the assets acquired at their estimated fair values. 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, our sales to the semiconductor capital equipment industry declined substantially from the third quarter of 2002. As a result 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, which was the remaining book value of Symphony’s intangible assets.

     During 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 represented less than five percent of our total revenue. 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.

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     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 $1.7 million in 2003, $3.3 million in 2002 and $6.6 million in 2001. The decline in interest income from 2002 to 2003 was due to our lower level of investment in marketable securities and the overall lower rate of interest paid on our investments which resulted from the Federal Reserve lowering interest rates during the period. The prime rate declined by 0.75% from January 2002 to December 2003. Additionally, during 2003 we used approximately $37.1 million of cash and marketable securities to fund our operations.

     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 also declined throughout 2002 and 2001 due to the Federal Reserve lowering interest rates during the period. The prime rate declined from 9.5% in January 2001 to 4.25% in December 2002.

     Interest expense consists principally 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 $11.3 million in 2003, $12.5 million in 2002 and $7.4 million in 2001. Interest expense decreased from 2002 to 2003 due to the repurchase of approximately $15.4 million and $3.5 million of our 5.25% and 5.00% convertible subordinated notes in the fourth quarter of 2002 and due to the repayment of approximately $12.8 million of notes payable and capital lease obligations during 2003.

     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 debt and capital leases assumed in the acquisition of Aera in January 2002.

     Our foreign subsidiaries’ sales are primarily denominated in currencies other than the U.S. dollar. We recorded net foreign currency gains of $869,000 in 2003, $5.3 million in 2002 and a loss of $235,000 in 2001.

     Our foreign currency gain in 2002 was primarily related to an intercompany loan of Japanese yen, which was settled in January 2003, 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 was transacted in the first quarter of 2002, for approximately 5.7 billion yen, approximately $44 million based upon an exchange rate of 130:1. During the first half of that year, the U.S. dollar weakened significantly against the yen to approximately 119:1, resulting in a gain of $4.9

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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 were settled.

     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 gain of $4.2 million. In prior financial statements this gain was reflected as an extraordinary item. In April 2002 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” We adopted the provisions of SFAS No. 145 on January 1, 2003. The adoption of this Statement required us to reclassify our pretax extraordinary gain of $4.2 million recorded during 2002 to other (expense) income in these financial statements.

     Miscellaneous expense items were $644,000 in 2003, $2.1 million in 2002 and $1.0 million in 2001. Miscellaneous expense in 2003 and 2002 was primarily related to the impairment of a marketable equity security. During the fourth quarter of 2002, the fair value of this security 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 charge of approximately $1.5 million. In the first quarter of 2003, this security continued to decline in value, and we recorded an additional impairment charge of $175,000. Since the first quarter of 2003, the value of this security has appreciated from $1.8 million to $3.3 million at December 31, 2003. However the increase in the fair value of this security will not be reflected in income until the security is sold.

     (PROVISION) BENEFIT FOR INCOME TAXES

     We account 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. During 2003, we recorded valuation allowances against certain of our United States and foreign net deferred tax assets in jurisdictions where we have incurred significant losses in 2001, 2002 and 2003. Given such experience, management could not conclude that it was more likely than not that these net deferred tax assets would be realized. While there are indications that the markets in which we operate may improve in 2004 and 2005, we have not yet been able to generate significant taxable income in the jurisdictions in which we operate. Accordingly, our management, in accordance with SFAS No. 109, in evaluating the recoverability of these net deferred tax assets, was required to place greater

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weight on our historical results as compared to projections regarding future taxable income.

     Due to the valuation allowances we recorded in 2003, we expect our 2004 effective tax rate to be approximately 15% to 25%, subject to variations in the relative earnings or losses in the tax jurisdictions in which we have operations. If we generate future taxable income, or should we be able to conclude that sufficient taxable income is reasonably assured based on profitable operations, in the appropriate tax jurisdictions, against which these tax attributes may be applied, some portion or all of the valuation allowance will be reversed and a corresponding reduction in income tax expense will be reported in future periods. A portion of the valuation allowance relates to the benefit from stock-based compensation. Any reversal of valuation allowance from this item will be reflected as a component of stockholders’ equity.

     The income tax provision of $11.8 million for 2003 represented a negative effective tax rate of 36%. The income tax benefit of $22.3 million for 2002 represented an effective tax rate of 35%. The income tax benefit of $17.4 million for 2001 represented an effective rate of 36%.

     When recording acquisitions, we have 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. Reversals of valuation allowances recorded in purchase accounting will be reflected as a reduction of goodwill in the period of reversal.

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, 2003. We believe that all necessary adjustments have been included in the amounts stated below to present fairly such quarterly information. Due to the volatility of the industries in which our customers operate the operating results for any quarter are not necessarily indicative of results for any subsequent period.

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adversely affected margins, particularly in the fourth quarter of 2002; and in the third quarter of 2003, due to our continued losses, we recorded a significant valuation allowance against certain of our United States and foreign net deferred tax assets.

     In 2002, gross margins improved each quarter through the third quarter, primarily due to better absorption from our increasing sales base. In the fourth quarter of 2002, our gross margin declined substantially as the sudden decline of 19% in our sales base hampered our fixed cost absorption and caused us to adjust our excess and obsolete inventory reserves to reflect our revised sales outlook.

     During 2003, as we began the implementation of our China-based manufacturing facility and transition of a portion of our supply base to Tier 1 Asian suppliers, our gross margin was negatively affected due to the costs of running duplicative facilities and new supplier qualification efforts.

Off-Balance Sheet Arrangements

     The following table sets forth our significant off-balance sheet arrangements, long-term debt and capital lease obligations as of December 31, 2003.

     Please refer to Footnote 7 Notes Payable, Footnote 8 Convertible Subordinated Notes Payable, Footnote 11 Commitments And Contingencies and Footnote 13 Related Party Transactions included in Part II, Item 8 of this Form 10-K for further discussion regarding our significant off-balance sheet arrangements, long-term debt and capital lease obligations.

     Our inventory purchase obligations consist of minimum purchase commitments we entered into with various suppliers to ensure we have an adequate supply of critical components to meet the demand of our customers. We believe that these purchase commitments will be consumed in our on-going operations during 2004.

     We have also committed to advance up to $1.5 million to a privately held company in exchange for an exclusive intellectual property license. At December 31, 2003, approximately $500,000 has been advanced under this agreement and expensed as research and development costs. The amount and

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timing of this advance is dependent upon the privately held company achieving certain business development milestones.

Liquidity and Capital Resources

     At December 31, 2003, our principle sources of liquidity consisted of cash, cash equivalents and marketable securities of $135.2 million, and a credit facility consisting of a $25.0 million revolving line of credit, none of which was outstanding at December 31, 2003. Advances under the revolving line of credit would bear interest at the prime rate (4.00% at February 17, 2004) minus 1%. Any advances under this revolving line of credit will be due and payable in May 2004. We are subject to covenants on our line of credit that provide certain restrictions related to working capital, net worth, acquisitions and payment and declaration of dividends. We were in compliance with all such covenants at December 31, 2003.

     During 2003, our cash, cash equivalents and marketable securities decreased $37.1 million from $172.3 million at December 31, 2002. In 2006, when our convertible subordinated notes become due, it is possible we may need substantial funds to repay such debt, which totaled $187.7 million at December 31, 2003. Our 5.00% convertible subordinated notes with a principal balance of $121.5 million are due September 1, 2006, and our 5.25% convertible subordinated notes with a principal balance of $66.2 million are due November 15, 2006. Payment would be required if our common stock price remains below approximately $30 per share for the 5.00% convertible subordinated notes and approximately $50 per share for the 5.25% convertible subordinated notes. In such a situation, there can be no assurance that we will be able to refinance the debt.

     To address our liquidity requirements, we have set a goal to move to a more variable operating model where we will reduce our operating cash flow breakeven point. Additionally, we may raise capital through the public markets during 2004 by issuing common stock or convertible debt securities, or a combination of the two. Such proceeds will be used to realign our capital structure and provide liquidity for the next semiconductor capital equipment up-cycle. However, we cannot provide assurance that such sources of liquidity will be available to us on acceptable terms.

     We have historically financed our operations and capital requirements through a combination of cash provided by operations, the issuance of long-term debt and common stock, bank loans, capital lease obligations and operating leases. However, we have not generated positive cash flow from operations since 2001.

     Operating activities used cash of $13.0 million in 2003, reflecting our net loss of $44.2 million partially offset by non-cash items of $35.2 million and increased by net working capital changes of approximately $4.0 million. Non-cash items primarily consisted of the following:

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	•		Depreciation of property and equipment of $12.7 million. We expect depreciation expense to increase to a range of $15.0 million to $16.0 million in 2004. This increase is primarily due to capital expenditures incurred in 2003 to launch our China-based manufacturing facility and information technology systems expenditures in 2003 and 2004;
	•		Amortization of intangible assets and demonstration and customer service equipment of $7.5 million;
	•		Amortization of deferred debt issuance costs of $1.1 million;
	•		Provision for excess and obsolete inventory of $3.0 million;
	•		Provision for deferred income taxes of $6.4 million. In 2003, we recorded valuation allowances against certain of our United States and foreign deferred income tax assets. We may generate taxable income in 2004, enabling us to reverse a portion of our valuation allowance. This reversal would create a use of cash from operations as the benefit from deferred income taxes is a non-cash item;
	•		A loss on the disposal of property and equipment of $2.8 million. During 2003, we closed multiple facilities resulting in the disposal of certain property and equipment. We plan to close our Voorhees, New Jersey manufacturing facility in the first half of 2004. Such closure may result in additional capital equipment disposals, if the related equipment cannot be utilized elsewhere in our organization; and
	•		Intangible asset impairment of $1.2 million. In the third quarter of 2003, the fair value of one of our intangible assets did not support its carrying value and an impairment loss was recognized. Based on our forecasts, we do not expect to incur additional intangible asset impairments in 2004. However, our forecast is subject to numerous factors that are beyond our control, therefore we can provide no assurance regarding the future recoverability of our intangible assets.

     Net working capital changes used cash of $5.3 million and primarily consisted of the following:

	•		Collection of $16.5 million of net income tax receivables during 2003;
	•		An increase in accounts receivable of $14.6 million. We expect our accounts receivable to remain high during 2004 if industry conditions continue to improve;
	•		An $11.3 million increase in inventory. Due to the establishment of our China-based manufacturing facility and increased sales orders we have built our inventory level to mitigate the risk of not being able to meet increasing customer demand for our products;
	•		A $5.9 million increase in trade accounts payable, which was primarily incurred to finance our inventory purchases;
	•		A $5.0 million increase in customer deposits and other accrued expenses;
	•		A $2.8 million decrease in accrued warranty; and
	•		A $2.8 million decrease in accrued restructuring.

     Operating activities used cash of $15.3 million in 2002, reflecting our net loss of $41.4 million partially offset by non-cash items of $20.8 million and net working capital

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changes of approximately $5.3 million. Non-cash items primarily consisted of the following:

	•		A $4.2 million pretax gain on the retirement of a portion of our convertible notes, repurchased at a discount below face value;
	•		A $4.9 million gain on an intercompany foreign currency loan. We do not expect to realize significant gains from intercompany indebtedness in the future as a result of a change in our currency risk management policy;
	•		A $6.9 million benefit for deferred income taxes;
	•		Depreciation of property and equipment of $13.4 million;
	•		Amortization of intangible assets and demonstration and customer service equipment of $8.1 million;
	•		Provision for excess and obsolete inventory of $5.8 million;
	•		Provision for doubtful accounts of $1.9 million; and
	•		Impairments of $5.1 million consisting of intangible assets of $1.9 million, property and equipment of $1.6 million and marketable securities of $1.5 million.

     Net working capital changes provided cash of $5.3 million and primarily consisted of the following:

	•		A $5.1 million increase in accounts receivable;
	•		A $2.9 million increase in demonstration and customer service equipment;
	•		A $4.9 million increase in accrued warranty costs; and
	•		A $4.6 million increase in accrued restructuring charges.

     Operating activities generated cash of $7.9 million in 2001, reflecting our net loss of $31.4 million adjusted for non-cash items of $32.6 million and changes in working capital of $6.7 million. Non-cash items primarily consisted of the following:

	•		A $3.6 million benefit for deferred income taxes;
	•		Depreciation of property and equipment of $10.0 million;
	•		Amortization of intangible assets and demonstration equipment of $5.9 million;
	•		A provision for excess and obsolete inventory of $6.4 million; and
	•		Impairments of $12.3 million. Our impairments consisted of goodwill of $5.4 million and an investment of $6.8 million.

     Net working capital changes provided cash of $6.7 million and primarily consisted of:

	•		A $45.0 million decrease in accounts receivable;
	•		A $5.5 million increase in inventory;
	•		A $5.5 million decrease in accounts payable;
	•		A $5.1 million decrease in accrued payroll and employee benefits; and
	•		A $22.0 million increase in net income taxes receivable.

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     Our near-term future operating activities may continue to use cash. Periods of rapidly increasing sales may cause increased working capital requirements, thereby requiring the use of cash to fund our operations.

     Investing activities used cash of $8.6 million in 2003 and primarily consisted of the purchase of equipment for $20.5 million and the settlement of the escrow deposit liability related to our acquisition of Dressler in 2002 of $1.7 million, partially offset by proceeds from the sale of assets of $5.2 million and the net sale of marketable securities of $8.8 million. We expect to spend between $12.5 million and $14.0 million for the purchase of property and equipment in 2004. Our planned level of capital expenditures is subject to frequent revisions because our business experiences sudden changes as we move into industry upturns and downturns and expected sales levels change. In addition, changes in foreign currency exchange rates may significantly impact our capital expenditures and depreciation expense recognized in a particular period.

     Investing activities provided cash of $24.3 million in 2002 and consisted of cash generated by the net sale of marketable securities of $87.9 million; partially offset by cash used for the acquisition of Aera for $35.7 million net of $8.3 million of cash acquired; the acquisition of Dressler for $14.4 million net of $680,000 of cash acquired; the acquisition of the minority interest of Litmas for $400,000 in addition to our common stock valued at approximately $4.2 million; the purchase of property and equipment of $10.7 million and the purchase of other investments of $2.8 million. Although investing activities provided cash of $24.3 million in 2002, our total cash and marketable securities declined approximately $99.6 million during 2002. Our marketable securities are not considered cash equivalents, and a significant portion of these securities were sold during 2002, to finance the above transactions as well as to fund our operating activities.

     Investing activities used cash of $81.2 million in 2001, and consisted of the acquisition of EMCO for $29.9 million net of $459,000 of cash acquired, the net purchase of marketable securities of $31.6 million, the purchase of investments and advances of $7.2 million and the purchase of property and equipment of $12.4 million.

     Investing cash flows experience significant fluctuations from year to year as we buy and sell marketable securities, which we convert to cash to fund strategic investments and our operating cash flow, and as we transfer cash into marketable securities when we attain levels of cash that are greater than needed for current operations. However, we do not expect to generate significant levels of cash that are greater than needed for our current operations in the near term.

     Financing activities used cash of $8.6 million in 2003, and consisted of payments on our senior borrowings and capital lease obligations of $12.8 million, partially offset by proceeds from the exercise of employee stock options and sale of common stock through our employee stock purchase plan, or ESPP of $4.2 million.

     We expect our financing activities to continue to fluctuate in the future. If market

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conditions and our financial position are deemed appropriate, we may repurchase additional convertible notes in the open market. Our payments under capital lease obligations and notes payable may also increase in the future if we enter into additional capital lease obligations or change the level of our bank financing. Our estimated payments under capital lease obligations and bank debt during 2004 will be approximately $8.6 million. However, a significant portion of these obligations are held in countries other than the United States; therefore, future foreign currency fluctuations, especially between the dollar and the yen, could cause significant fluctuations in our estimated 2004 payment obligations.

     Financing activities used cash of $22.6 million in 2002, and consisted primarily of open market repurchases of our convertible notes of $14.5 million, the repayment of our senior borrowings and capital lease obligations of $10.2 million, partially offset by proceeds from the exercise of employee stock options and sale of common stock through our ESPP of $2.1 million.

     Financing activities provided cash of $124.1 million in 2001, and consisted primarily of proceeds from convertible debt of $121.25 million and proceeds from the exercise of employee stock options and sale of common stock through our ESPP of $4.0 million.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

     Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio and long-term debt obligations. We generally place our investments with high credit quality issuers and by policy are averse to principal loss and seek to protect and preserve our invested funds by limiting default risk, market risk and reinvestment risk. As of December 31, 2003, our investments in marketable securities consisted primarily of commercial paper, municipal and state bonds and notes and institutional money markets. These securities are highly liquid. Earnings on our marketable securities are typically invested into similar securities. In 2003, the rates we earned on our marketable securities approximated 1.8% on a before tax equivalent basis. Because the Federal Reserve repeatedly lowered interest rates throughout 2001, 2002 and 2003, the interest rates we earned on our investments likewise decreased substantially. This, in conjunction with using our available cash and cash reserves to fund our operations and for acquisitions, including the EMCO acquisition in January 2001, the Aera acquisition in January 2002, the Dressler acquisition in March 2002, and the repurchase of a portion of our convertible subordinated notes in the fourth quarter of 2002, has greatly reduced our recent and anticipated interest income. The impact on interest income of a 10% decrease in the average interest rate would have resulted in approximately $170,000 less interest income in 2003, $300,000 in 2002 and $700,000 in 2001.

     The interest rates on our subordinated debt are fixed, specifically, at 5.25% for the $66.2 million of our debt due November 2006, and at 5.00% for the $121.5 million of our

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debt that is due September 2006. Our offerings of subordinated debt in 1999 and 2001 increased our fixed interest expense upon each issuance, though interest expense was partially reduced by the repurchase of a portion of these offerings. Because these rates are fixed, we believe there is no risk of increased interest expense with regard to these instruments.

     The interest rates on our Aera Japan subsidiary’s credit lines are variable and currently range from 1.5% to 3.1%. We believe a 10% increase in the average interest rate on these instruments would not have a material effect on our financial position or results of operations.

Foreign Currency Exchange Rate Risk

     We transact business in various foreign countries. Our primary foreign currency cash flows are generated in countries in Asia and Europe. During 2003, the U.S. dollar weakened approximately 10% against the Japanese yen and 17% against the euro. It is highly uncertain how currency exchange rates will fluctuate in the future. We have entered into various foreign currency forward exchange contracts to mitigate against currency fluctuations in the Japanese yen, euro, Taiwanese dollar and Chinese yuan. The notional amount of our foreign currency contracts at December 31, 2003 was $10.2 million. The potential fair value loss for a hypothetical 10% adverse change in foreign currency exchange rates at December 31, 2003, would be approximately $1.0 million, which would be essentially offset by corresponding gains related to the underlying assets. We will continue to evaluate various methods to minimize the effects of currency fluctuations when we translate the financial statements of our foreign subsidiaries into U.S. dollars. At December 31, 2003 we held foreign currency forward exchange contracts, maturing through March 2004, to purchase U.S. dollars and sell various foreign currencies. The following table summarizes our outstanding contracts as of December 31, 2003:

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

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INDEPENDENT AUDITORS’ REPORT

The Board of Directors and Stockholders of Advanced Energy Industries, Inc.:

We have audited the accompanying consolidated balance sheets of Advanced Energy Industries, Inc. (a Delaware corporation) and subsidiaries as of December 31, 2003 and 2002 and the related consolidated statements of operations, stockholders’ equity and comprehensive loss, and cash flows for the years then ended. In connection with our audits of the 2003 and 2002, consolidated financial statements, we also have audited the 2003 and 2002 financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. The consolidated financial statements of Advanced Energy Industries, Inc. and subsidiaries for the year ended December 31, 2001 were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements, before the revision described in Note 1 to the financial statements, in their report dated February 28, 2002.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the 2003 and 2002 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Advanced Energy Industries, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related 2003 and 2002 financial statement schedules, when considered in relation to the basic 2003 and 2002 consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

As discussed in Notes 1 and 2 to the consolidated financial statements, Advanced Energy Industries, Inc. and subsidiaries adopted the provisions of Statements of Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002.

As discussed in Note 1 to the consolidated financial statements, Advanced Energy Industries, Inc. and subsidiaries adopted the provisions of Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, effective January 1, 2003.

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As discussed above, the consolidated statements of operations, stockholders’ equity and comprehensive loss, and cash flows of Advanced Energy Industries, Inc. and subsidiaries for the year ended December 31, 2001 were audited by other auditors who have ceased operations. As described in Note 1, the consolidated financial statements for the fiscal year ended December 31, 2001 have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, which was adopted by the Company as of January 1, 2002. In our opinion, the disclosures for 2001 in Note 1 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 financial statements of the Company other than with respect to such disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 2001 consolidated financial statements taken as a whole.

KPMG LLP

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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Advanced Energy Industries, Inc.:

We have audited the accompanying consolidated balance sheets of Advanced Energy Industries, Inc. (a Delaware corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements and the schedule referred to below are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Advanced Energy Industries, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.

Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to consolidated financial statements is presented for purposes of complying with the Securities and Exchange Commission’s rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.

The report of Arthur Andersen LLP (Andersen) is a copy of a report previously issued by Andersen on February 28, 2002. The report has not been reissued by Andersen nor has Andersen consented to its inclusion in this Annual Report on Form 10-K. The Andersen report refers to the consolidated balance sheets as of December 31, 2001 and 2000, and the consolidated statements of operations, stockholders’ equity and cash flows for the years ended December 31, 2000 and 1999 which are no longer included in the accompanying financial statements.

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ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(In thousands)