UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2007.

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

For the transition period from                      to                     .

ADVANCED ENERGY INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

Delaware		84-0846841
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
1625 Sharp Point Drive, Fort Collins, CO		80525
(Address of principal executive offices)		(Zip Code)

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

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   No o.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o      Accelerated filer þ     Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No þ.

As of November 6, 2007, there were 45,273,511 shares of the registrant’s Common Stock, par value $0.001 per share, outstanding.

 

 

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

PART I FINANCIAL INFORMATION

ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Condensed Consolidated Balance Sheets — September 30, 2007 and December 31, 2006

Condensed Consolidated Statements of Income — Three and nine months ended September 30, 2007 and 2006

Condensed Consolidated Statements of Cash Flows — Nine months ended September 30, 2007 and 2006

Notes to Condensed Consolidated Financial Statements

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 4. CONTROLS AND PROCEDURES

PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

ITEM 1A. RISK FACTORS

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

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

ITEM 5. OTHER INFORMATION

ITEM 6. EXHIBITS

SIGNATURE

Certification of CEO Pursuant to Section 302

Certification of CFO Pursuant to Section 302

Certification of CEO Pursuant to Section 906

Certification of CFO Pursuant to Section 906

PART I FINANCIAL INFORMATION

ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

		September 30,				December 31,
		2007				2006
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	76,878			$	58,240
Marketable securities			108,154				85,978
Trade accounts receivable, net			69,704				71,956
Inventories			57,388				52,778
Deferred income taxes			21,740				24,434
Assets held for sale			1,345				—
Other current assets			5,877				7,341
Total current assets			341,086				300,727
PROPERTY AND EQUIPMENT, NET			30,677				33,571
OTHER ASSETS:
Deposits and other			8,296				2,640
Goodwill			60,587				58,679
Other intangible assets, net			6,426				6,905
Customer service equipment, net			939				832
Deferred income tax assets, net			4,222				8,549
Total assets		$	452,233			$	411,903
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Trade accounts payable		$	15,578			$	16,310
Taxes payable			4,453				7,741
Accrued payroll and employee benefits			11,350				16,899
Accrued warranty expense			9,194				7,845
Accrued restructuring charges			142				—
Capital lease obligations, current portion			128				131
Other current liabilities			3,221				4,003
Total current liabilities			44,066				52,929
LONG-TERM LIABILITIES:
Capital leases, net of current portion			133				198
Deferred income tax liabilities, net			1,787				1,971
Other long-term liabilities			7,931				1,015
Total long-term liabilities			9,851				3,184
Total liabilities			53,917				56,113
Commitments and contingencies (Note 11)
STOCKHOLDERS’ EQUITY			398,316				355,790
Total liabilities and stockholders’ equity		$	452,233			$	411,903

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

ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

		Three Months Ended September 30,
		2007				2006
SALES		$	90,491			$	107,688
COST OF SALES			53,765				60,674
Gross profit			36,726				47,014
OPERATING EXPENSES:
Research and development			12,937				11,345
Selling, general and administrative			15,738				17,309
Restructuring and asset impairment charges			556				31
Total operating expenses			29,231				28,685
INCOME FROM OPERATIONS			7,495				18,329
OTHER INCOME			307				1,044
Income before income taxes			7,802				19,373
PROVISION FOR INCOME TAXES			1,947				2,381
NET INCOME		$	5,855			$	16,992
BASIC EARNINGS PER SHARE		$	0.13			$	0.38
DILUTED EARNINGS PER SHARE		$	0 .13			$	0.38
BASIC WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING			45,248				44,762
DILUTED WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING			45,761				45,166

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

ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

		Nine Months Ended September 30,
		2007				2006
SALES		$	300,863			$	306,209
COST OF SALES			170,873				175,885
Gross profit			129,990				130,324
OPERATING EXPENSES:
Research and development			37,883				32,608
Selling, general and administrative			46,896				46,885
Restructuring and asset impairment charges			3,505				91
Total operating expenses			88,284				79,584
INCOME FROM OPERATIONS			41,706				50,740
OTHER INCOME			3,367				3,755
Income before income taxes			45,073				54,495
PROVISION FOR INCOME TAXES			14,879				6,580
NET INCOME		$	30,194			$	47,915
NET INCOME PER BASIC SHARE		$	0.67			$	1.07
NET INCOME PER DILUTED SHARE		$	0.66			$	1.06
BASIC WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING			45,117				44,679
DILUTED WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING			45,696				45,168

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

ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)

		Nine Months Ended September 30,
		2007				2006
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	30,194			$	47,915
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization			9,188				11,960
Stock-based compensation			2,807				2,224
Provision for deferred income taxes			6,848				95
Restructuring and asset impairment charges			3,505				—
Loss on disposal of property and equipment			—				154
Gain on sale of marketable securities			(32	)			(1,670	)
Changes in operating assets and liabilities
Accounts receivable, net			5,324				(5,528	)
Inventories			(4,133	)			(1,443	)
Other current assets			(1,482	)			1,113
Trade accounts payable			(843	)			(2,552	)
Other current liabilities and accrued expenses			(5,274	)			5,430
Income taxes payable/receivable, net			(3,142	)			1,488
Non-current assets			(1,923	)			(214	)
Non-current liabilities			(772	)			(1,214	)
Net cash provided by operating activities			40,265				57,758
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of marketable securities			(110,585	)			(57,300	)
Proceeds from sale of marketable securities			88,523				1,992
Proceeds from sales of assets			—				539
Purchase of property and equipment			(5,716	)			(3,000	)
Net cash used in investing activities			(27,778	)			(57,769	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on senior borrowings and capital lease obligations			(77	)			(3,511	)
Proceeds from common stock transactions			4,126				2,761
Net cash provided (used in) by financing activities			4,049				(750	)
EFFECT OF CURRENCY TRANSLATION ON CASH			2,102				676
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			18,638				(85	)
CASH AND CASH EQUIVALENTS, beginning of period			58,240				52,874
CASH AND CASH EQUIVALENTS, end of period		$	76,878			$	52,789
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest		$	41			$	316
Cash paid for income taxes		$	11,643			$	4,907

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

ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)

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

     In the opinion of management, the accompanying unaudited condensed consolidated balance sheets, statements of income and cash flows contain all adjustments, consisting of normal, recurring adjustments necessary to present fairly the financial position of Advanced Energy Industries, Inc., a Delaware corporation, and its wholly owned subsidiaries (the “Company”) at September 30, 2007 and December 31, 2006, and the results of their operations for the three- and nine-month periods ended September 30, 2007 and 2006 and cash flows for the nine-month periods ended September 30, 2007 and 2006.

     The unaudited condensed consolidated financial statements presented herein have been prepared in accordance with the instructions to Form 10-Q and do not include all the information and note disclosures required by accounting principles generally accepted in the United States. The condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

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

               NEW ACCOUNTING PRONOUNCEMENTS — In May 2007, the FASB issued Staff Position (FSP) No. FIN 48-1, “Definition of Settlement in FASB Interpretation No. 48,” which amends FIN 48 and provides guidance concerning how an entity should determine whether a tax position is “effectively,” rather than the previously required “ultimately,” settled for the purpose of recognizing previously unrecognized tax benefits. In addition, FSP No. FIN 48-1 provides guidance on determining whether a tax position has been effectively settled. FSP No. FIN 48-1 became effective on January 1, 2007. Companies that have not applied FSP No. FIN 48-1 must retroactively apply the provisions to January 1, 2007. The Company has adopted FSP No. FIN 48-1 and no retroactive adjustments are necessary.

             In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (SFAS No. 157). SFAS No. 157 establishes a common definition for fair value to be applied to generally accepted accounting principles requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS No. 157 and does not expect the adoption to have an impact on its consolidated financial position and results of operations.

           In February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS No. 159). SFAS No. 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS No. 159 and does not expect the adoption to have an impact on its consolidated financial position and results of operations.

     REVENUE RECOGNITION — The Company’s standard shipping term is freight on board (“FOB”) shipping point, for which revenue is recognized upon shipment of its products, at which time title passes to the customer, the price is fixed and collectibility is reasonably assured. For certain customers, the Company has FOB destination terms, for which revenue is recognized upon receipt of the products by the customer, at which time title passes to the customer, the price is fixed and collectibility is reasonably assured. Revenues from contracts that contain customer acceptance provisions are deferred until customer acceptance occurs. Generally, the Company does not have obligations to its customers after its products are shipped under FOB shipping point terms, after its products are received by customers under FOB destination terms, and after the products are accepted by customers under contractual acceptance provisions, other than pursuant to warranty obligations. In limited instances, the Company provides installation of its products. In accordance with Emerging Issues Task Force Issue 00-21 “Accounting for Revenue Arrangements With Multiple Deliverables”, the Company allocates 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 instances, the Company requires its customers to pay for a portion or all of their purchases prior to the Company manufacturing or shipping these products. Cash payments received prior to shipment are recorded as customer deposits and deferred revenue in the condensed consolidated balance sheets, and then recognized as revenue as appropriate based upon delivery of the products. The Company does not offer price protection to its customers or allow returns, unless covered by its normal policy for repair of defective products.

     WARRANTY RESERVE POLICY — The Company generally warrants its products for periods typically ranging from 12 to 24 months after shipment. Estimated warranty costs are recorded at the time of sale of the related product, and are recorded within cost of sales in the condensed consolidated statements of income. The Company estimates the anticipated costs of repairing products under warranty based on warranties claim experience as well as the historical cost of the repairs and expected failure rates. The assumptions used to estimate warranty accruals are reevaluated periodically in light of actual experience and, when appropriate, the accruals are adjusted. The Company’s determination of the appropriate level of warranty accrual is subjective and based on estimates.

     The following table summarizes the activity in the Company’s warranty reserve during the 2007 and 2006 periods:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(In thousands)		2007				2006				2007				2006
Balance at beginning of period		$	7,435			$	6,443			$	7,845			$	6,313
Provisions			5,000				2,611				9,225				6,858
Usages			(3,241	)			(2,490	)			(7,876	)			(6,607	)
Balance at end of period		$	9,194			$	6,564			$	9,194			$	6,564

     EXCESS AND OBSOLETE INVENTORY— Inventory is written down or written off when it is deemed excess or becomes obsolete, which generally occurs due to engineering changes to a product or discontinuance of a product line. Judgment by management is necessary in estimating the net realizable value of inventory based primarily upon forecasts of product demand. Charges for excess and obsolete inventory are recorded within cost of sales or research and development in the condensed consolidated statement of income per Company policy.

     COMMITMENTS AND CONTINGENCIES — From time to time, the Company is involved in disputes and legal actions arising in the normal course of its business. The Company accrues loss contingencies in connection with its commitments and contingencies, including litigation, when it is probable that a loss has occurred or may occur and the amount of the loss can be reasonably estimated.

     GOODWILL AND OTHER INTANGIBLE ASSETS — Goodwill represents the excess of the cost over the fair market value of net tangible and identifiable intangible assets of acquired businesses.

     Goodwill is subject to periodic (at least annual) tests for impairment. Impairment testing is performed in two steps: (i) goodwill is assessed for potential impairment by comparing the fair value of the Company’s reporting unit with the carrying value, and (ii) if potential impairment is indicated because the reporting unit’s fair value is less than its carrying amount, the amount of impairment loss is measured by comparing the implied fair value of goodwill with the carrying amount of that goodwill.

     Finite-lived intangible assets are amortized using the straight-line method over their estimated useful lives and are reviewed for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable.

(2) STOCK-BASED COMPENSATION

     The Company recognizes stock-based compensation expense in accordance with the provisions of Statement of Financial Accounting Standards No. 123R “Share-Based Payment”. Stock-based compensation was $994,000 and $807,000 for the three months ended September 30, 2007 and 2006, respectively and $2.8 million and $2.2 million for the nine months ended September 30, 2007 and 2006, respectively.

Stock Options

     A summary of our stock option activity for the nine-month period ended September 30, 2007 is as follows:

						Weighted-
						Average
						Grant-date
(In thousands, except fair values)		Shares				Fair Value
Options outstanding at December 31, 2006			3,079			$	18.85
Options granted			481				22.32
Options exercised			(322	)			13.48
Options cancelled			(165	)			24.63
Options outstanding at September 30, 2007			3,073			$	19.65
Exercisable at September 30, 2007			2,096			$	20.59

          The total intrinsic value of options exercised during the three and nine months ended September 30, 2007 was $51,000 and $2.9 million, respectively, and was $236,000 and $1.5 million for the three and nine months ended September 30, 2006, respectively, determined as of the exercise date. As of September 30, 2007, there was $10.7 million of total unrecognized compensation cost related to stock options granted and outstanding, which is expected to be recognized through fiscal year 2011, with a weighted average remaining vesting period of 2.8 years. Cash received from stock option exercises was $89,000 and $4.1 million, net of $300,000 in tax withholdings, during the three and nine months ended September 30, 2007, respectively. The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Risk-free interest rates			4.8	%			4.7	%			4.7	%			4.7	%
Expected dividend yield rates			0.0	%			0.0	%			0.0	%			0.0	%
Expected lives		5.5 years				5.5 years				5.5 years				5.5 years
Expected volatility			60.5	%			65.3	%			60.5	%			65.5	%
Expected forfeiture rate			22	%			22	%			22	%			22	%

Restricted Stock

     A summary of the Company’s non-vested RSU activity for the nine-month period ended September 30, 2007 is as follows:

						Weighted
						Average
						Grant Date
(In thousands, except fair values)		Shares				Fair Value
Balance outstanding at December 31, 2006			383			$	11.42
RSUs granted			199				22.70
RSUs vested			(86	)			18.90
RSUs forfeited			(19	)			11.88
Balance outstanding at September 30, 2007			477			$	16.05

          The fair value of the Company’s RSUs is determined based upon the closing fair market value of the Company’s common stock on the grant date. As of September 30, 2007, there was

$5.8 million of total unrecognized compensation cost related to non-vested RSUs granted, which cost is expected to be recognized over a weighted average period of 1.6 years. During the quarter ended September 30, 2007, the total fair value of RSUs which vested was $232,000, based upon the closing fair market value of the Company’s common stock on the date the underlying common stock was released to the recipient.

Employee Stock Purchase Plan (the “ESPP”)

          As of September 30, 2007, there was $15,000 of total unrecognized compensation cost related to the ESPP that is expected to be recognized over a remaining period of one month.

(3) INCOME TAXES

          We adopted the provisions of Financial Accounting Standards Board Interpretation No. 48 “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No 109” (“FIN 48”) as of January 1, 2007.  Upon adoption, the Company increased the long-term liability associated with uncertain tax positions by $6 million and also increased the long-term receivable by $5 million consisting of offsetting tax benefits. The balance of $1 million is an adjustment to the opening balance of retained earnings on January 1, 2007.  If recognized, the $1 million would affect our effective tax rate. There have been no changes to these amounts during the quarter ended September 30, 2007.  

          The tax years 2003 through 2006 remain open to examination by the United States taxing jurisdictions to which we are subject.  The foreign taxing jurisdictions have open tax years from 2001 through 2006.  In accordance with our accounting policy, we recognize accrued interest and penalties related to unrecognized tax benefits as a component of tax expense. This policy did not change as a result of the adoption of FIN 48. We did not have any accrued interest or penalties at December 31, 2006.  We do not anticipate a material change to the amount of unrecognized tax positions within the next 12 months.

          While we believe we have adequately provided for all tax positions, amounts asserted by taxing authorities could materially differ from our accrued positions as a result of uncertain and complex application of tax regulations.  Additionally, the recognition and measurement of certain tax benefits includes estimates and judgment by management and inherently includes subjectivity.  Accordingly, additional provisions on federal and foreign tax-related matters could be recorded in the future as revised estimates are made or the underlying matters are settled or otherwise resolved.

(4) RESTRUCTURING

          On March 2, 2007, the Company announced that it will be closing its manufacturing, distribution, and research and development facility located in Stolberg, Germany. Related to this manufacturing transition, the Company recorded restructuring charges of $1.9 million in the first quarter of 2007, consisting primarily of the accrual of employee severance and severance benefit costs associated with the planned reduction of employees at this facility. The Company also recorded as an asset impairment charge of approximately $900,000 relating to the write-down of certain real and personal property located at this facility to estimated fair value in the first quarter of 2007.

          In the second quarter of 2007, the Company recorded restructuring charges of $158,000 consisting of legal and other consulting fees.

          In the third quarter of 2007, the Company recorded restructuring charges of $556,000 consisting of $122,000 in employee separation costs and $434,000 in other costs including legal and transportation costs. At September 30, 2007, the Company’s restructuring reserve was approximately $142,000 primarily relating to legal and administrative services.

The following table summarizes the components of the restructuring charges, the payments and other settlements, and the remaining accrual as of September 30, 2007:

		Employee Severance and								Total
		Termination				Other				Restructuring
		Costs				Costs				Charges
						(In thousands)
Accrual balance at December 31, 2006		$	—			$	—			$	—
First quarter 2007 restructuring accrual			1,788				151				1,939
First quarter 2007 settlements			—				—				—
Accrual balance at March 31, 2007			1,788				151				1,939
Second quarter 2007 restructuring accrual			—				158				158
Second quarter 2007 reversals			(31	)			—				(31	)
Second quarter 2007 settlements			(517	)			(80	)			(597	)
Accrual balance at June 30, 2007			1,240				229				1,469
Third quarter 2007 restructuring accrual			122				434				556
Third quarter 2007 settlements			(1,355	)			(528	)			(1,883	)
Accrual balance at September 30, 2007		$	7			$	135			$	142

The Stolberg facility closed in October 2007 and the remaining restructuring liabilities are expected to be paid over the next two months. Related to the restructuring, on October 2, 2007, the Company completed the sale of assets related to its LPPA product line for $2.2 million. Assets related to this sale are recorded in Assets Held for Sale in the Company’s Condensed Consolidated Balance Sheet as of September 30, 2007.

(5) MARKETABLE SECURITIES

     Marketable securities consisted of the following:

			September 30,				December 31,
			2007				2006
		(In thousands)
Commercial paper		$	11,908			$	29,910
Certificates of deposit			7,926				3,404
Municipal bonds and notes			81,685				51,193
Institutional money markets			6,635				1,471
Total marketable securities		$	108,154			$	85,978

     These marketable securities are classified as available-for-sale and are stated at period end market value. The average weighted maturity of the instruments is maintained at approximately 180 days.

(6) ACCOUNTS RECEIVABLE

     Accounts receivable consisted of the following:

		September 30,				December 31,
		2007				2006
		(In thousands)
Trade accounts receivable, gross		$	70,370			$	72,501
Allowance for doubtful accounts			(666	)			(545	)
Trade accounts receivable, net		$	69,704			$	71,956

(7) INVENTORIES

     Inventories consisted of the following:

		September 30,				December 31,
		2007				2006
		(In thousands)
Parts and raw materials		$	50,427			$	47,187
Work in process			3,578				3,190
Finished goods			11,462				10,995
Inventory reserves			(8,079	)			(8,594	)
Total inventories		$	57,388			$	52,778

     Inventories include costs of materials, direct labor and manufacturing overhead. Inventories are valued at the lower of cost or market, computed on a first-in, first-out basis and are presented net of reserves for excess and obsolete inventory as of September 30, 2007 and December 31, 2006, respectively.

(8) GOODWILL AND OTHER INTANGIBLE ASSETS

     Goodwill and amortizable intangible assets consisted of the following as of September 30, 2007:

						Cumulative
						Effect of												Weighted-
		Gross				Changes in								Net				Average
		Carrying				Exchange				Accumulated				Carrying				Useful Life
		Amount				Rates				Amortization				Amount				(Years)
						(In thousands, except weighted-average useful life)
Amortizable intangible assets:
Technology-based		$	7,015			$	1,533			$	(7,874	)		$	674				5
Trademarks and other			8,604				1,771				(4,623	)			5,752				17
Total amortizable intangible assets			15,619				3,304				(12,497	)			6,426				12
Goodwill			49,766				10,821				—				60,587
Total goodwill and amortizable intangible assets		$	65,385			$	14,125			$	(12,497	)		$	67,013

     Goodwill and amortizable intangible assets consisted of the following as of December 31, 2006:

						Cumulative
						Effect of												Weighted-
		Gross				Changes in								Net				Average
		Carrying				Exchange				Accumulated				Carrying				Useful Life
		Amount				Rates				Amortization				Amount				(Years)
						(In thousands, except weighted-average useful life)
Amortizable intangible assets:
Technology-based		$	7,015			$	1,477			$	(7,499	)		$	993				5
Trademarks and other			8,604				1,578				(4,270	)			5,912				17
Total amortizable intangible assets			15,619				3,055				(11,769	)			6,905				12
Goodwill			49,766				8,913				—				58,679
Total goodwill and amortizable intangible assets		$	65,385			$	11,968			$	(11,769	)		$	65,584

     Amortization expense related to intangible assets for the three months ended September 30, 2007 and 2006 was $201,000 and $453,000, respectively and $720,000 and $1.4 million for the nine months ended September 30, 2007 and 2006, respectively. Estimated amortization expense related to the Company’s acquired intangible assets fluctuates with changes in foreign currency exchange rates between the U.S. dollar, the Japanese yen and the euro. Estimated amortization expense related to amortizable intangibles for each of the five years 2007 through 2011 is as follows:

		Estimated
		Amortization
		Expense
		(In thousands)
2007		$	958
2008			833
2009			521
2010			418
2011			418

(9) STOCKHOLDERS’ EQUITY

     Stockholders’ equity consisted of the following:

		September 30,				December 31,
(In thousands, except par value)		2007				2006
Common stock, $0.001 par value, 70,000 shares authorized, 45,257 and 44,855 shares issued and outstanding, respectively		$	45			$	45
Additional paid-in capital			265,631				258,688
Retained earnings			117,546				88,344
Unrealized holding gains on available-for-sale securities, net of tax			165				323
Cumulative translation adjustments			14,929				8,390
Total stockholders’ equity		$	398,316			$	355,790

(10) COMPREHENSIVE INCOME

     Comprehensive income for the Company consists of net income, foreign currency translation adjustments and net unrealized holding gains on available-for-sale marketable securities as presented below (In thousands):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Net income, as reported		$	5,855			$	16,992			$	30,194			$	47,915
Adjustment to arrive at comprehensive income, net of taxes:
Unrealized holding (loss) gain on available-for-sale marketable   securities			(50	)			(34	)			(126	)			(20	)
Reclassification adjustment for amounts included in net income related to sales of securities			—				—				(32	)			(964	)
Cumulative translation adjustments			8,414				(357	)			6,539				4,059
Comprehensive income		$	14,219			$	16,601			$	36,575			$	50,990

(11) COMMITMENTS AND CONTINGENCIES

     From time to time, the Company is involved in disputes and legal actions arising in the normal course of its business. The Company accrues loss contingencies in connection with its litigation when it is probable that a loss will occur and the amount of the loss can be reasonably estimated.  

(12) EARNINGS PER SHARE

     Basic earnings per share (“EPS”) is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding during the period. The computation of diluted EPS is similar to the computation of basic EPS except that the numerator is increased to exclude certain charges which would not have been incurred, and the denominator is increased to include the number of additional common shares that would have been outstanding (using the if-converted and treasury stock methods), if securities containing potentially dilutive common shares (convertible notes payable, stock options and restricted stock units) had been converted to such common shares, and if such assumed conversion is dilutive. As of September 30, 2007 and 2006, 3.6 million options were outstanding. Not included in the computation of diluted earnings per share are 2.8 million and 2.2 million stock options for the three months ended September 30, 2007 and 2006, respectively, and 3.2 and 2.1 million stock options for the nine months ended September 30, 2007 and 2006, respectively, due to the anti-dilutive effect of these shares.

     The following is a reconciliation of the numerators and denominators used in the calculation of basic and diluted EPS for the three and nine months ended September 30, 2007 and 2006:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(In thousands, except per share data)		2007				2006				2007				2006
Earnings per common share — basic
Net income		$	5,855			$	16,992			$	30,194			$	47,915
Weighted average common shares outstanding			45,248				44,762				45,117				44,679
Earnings per common share — basic		$	0.13			$	0.38			$	0.67			$	1.07
Earnings per common share—assuming dilution
Net income		$	5,855			$	16,992			$	30,194			$	47,915
Weighted average common shares outstanding			45,248				44,762				45,117				44,679
Effect of dilutive securities:
Stock options and restricted stock units			513				404				579				489
Adjusted weighted average common shares outstanding			45,761				45,166				45,696				45,168
Earnings per common share—assuming dilution		$	0.13			$	0.38			$	0.66			$	1.06

(13) FOREIGN OPERATIONS AND MAJOR CUSTOMERS

     The Company has operations in the United States, Asia Pacific and Europe. The following is a summary of the Company’s operations by geographic region:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Sales (1):						(In thousands)
United States		$	48,453			$	60,336			$	166,629			$	177,011
Asia Pacific			33,129				34,768				101,975				100,097
Europe			8,909				12,584				32,259				29,101
		$	90,491			$	107,688			$	300,863			$	306,209

Income (loss) from operations:
United States		$	1,165			$	6,455			$	18,325			$	31,593
Asia Pacific			4,587				8,958				19,201				15,217
Europe			1,649				2,141				5,176				3,981
Intercompany elimination			94				775				(996	)			(51	)
		$	7,495			$	18,329			$	41,706			$	50,740

		September 30,				December 31,
		2007				2006
Identifiable assets:
United States		$	19,514			$	14,954
Asia Pacific			17,346				18,616
Europe			1,543				2,276
		$	38,403			$	35,846

     Intercompany sales between the Company’s geographic areas are recorded on the basis of intercompany prices established by the Company.

     Applied Materials, Inc. is the Company’s largest customer and accounted for 27% and 30% of the Company’s sales for the three months ended September 30, 2007 and 2006, respectively and 28%and 30% for the nine months ended September 30, 2007 and 2006, respectively. No other customer accounted for 10% or more of the Company’s sales during these periods.

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

Special Note on Forward-Looking Statements

     The following discussion contains, in addition to historical information, forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Statements that are other than historical information are forward-looking statements. For example, statements relating to our beliefs, expectations and plans are forward-looking statements, as are statements that certain actions, conditions or circumstances will continue. Forward-looking statements involve risks and uncertainties, which are difficult to predict and many of which are beyond our control. These risks and uncertainties are described below and in other filings we make with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended December 31, 2006. As a result, our actual results may differ materially from the results discussed in the forward-looking statements. We assume no obligation to update any forward-looking statements or the reasons why our actual results might differ.

  OVERVIEW

     We design, manufacture and support complex power conversion and control systems, and gas flow control and thermal measurement devices used in plasma-based, thin-film processing equipment. This equipment is essential to the manufacture of products including the following:

	•		Semiconductor devices for electronics applications;
	•		Flat panel displays for hand-held devices and computer and television screens;
	•		Compact discs, DVDs, magnetic hard drives and other digital storage media;
	•		Solar panels or photovoltaics;
	•		Optical coatings for eyeglasses;
	•		Barrier coatings for architectural glass;
	•		Industrial laser and medical applications; and
	•		Other markets where thin film deposition is a critical part of the manufacturing process.

     In addition to our products that address the thin film deposition market, we recently introduced a new product for the solar photovoltaic inverter market and currently have inverter products installed in grid-connected applications. 

     Our installed base enables a recurring revenue opportunity as we sell spare parts, repair services and field upgrades worldwide through our customer service and technical support organization.

     We provide solutions to a diverse range of markets and geographic regions with the semiconductor capital market being our largest market. Sales to customers in the semiconductor capital equipment industry comprised 67% and 69% of our sales in the three months ended September 30, 2007 and 2006, respectively and 68% and 69% of our sales in the nine months ended September 30, 2007 and 2006, respectively. Other markets we sell to include flat panel display, data storage, architectural glass, solar cell and other industrial thin-film manufacturing

equipment. Our customers in the semiconductor and other markets are large OEM’s and we derive additional revenue by providing maintenance services to their customers.

Results of Operations

  OVERVIEW

          The following table summarizes our results of operations for the three and nine months ended September 30, 2007 and 2006:

		Three Months Ended								Increase/				%				Nine Months Ended								Increase/				%
		September 30,								(Decrease)				Change				September 30,								(Decrease)				Change
		2007				2006												2007				2006
		(In thousands)																(In thousands)
SALES		$	90,491			$	107,688			$	(17,197	)			(16	)%		$	300,863			$	306,209			$	(5,346	)			(2	)%
COST OF SALES			53,765				60,674				(6,909	)			(11	)%			170,873				175,885				(5,012	)			(3	)%
Gross profit			36,726				47,014				(10,288	)			(22	)%			129,990				130,324				(334	)			—
OPERATING EXPENSES:
Research and development			12,937				11,345				1,592				14	%			37,883				32,608				5,275				16	%
Selling, general and administrative			15,738				17,309				(1,571	)			(9	)%			46,896				46,885				11				—
Restructuring and asset impairment charges			556				31				525			nm					3,505				91				3,414			nm
Total operating expenses			29,231				28,685				546				2	%			88,284				79,584				8,700				11	%
INCOME FROM OPERATIONS			7,495				18,329				(10,834	)			(59	)%			41,706				50,740				(9,034	)			(18	)%
OTHER INCOME			307				1,044				(737	)			(71	)%			3,367				3,755				(388	)			(10	)%
Income before income taxes			7,802				19,373				(11,571	)			(60	)%			45,073				54,495				(9,422	)			(17	)%
PROVISION FOR INCOME TAXES			1,947				2,381				(434	)			(18	)%			14,879				6,580				8,299				126	%
NET INCOME		$	5,855			$	16,992			$	(11,137	)			(66	)%		$	30,194			$	47,915			$	(17,721	)			(37	)%
NET INCOME PER BASIC SHARE		$	0.13			$	0.38			$	(0.25	)			(66	)%		$	0.67			$	1.07			$	(0.40	)			(37	)%
NET INCOME PER DILUTED SHARE		$	0.13			$	0.38			$	(0.25	)			(66	)%		$	0.66			$	1.06			$	(0.40	)			(38	)%

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
Operating Expenses — % of sales		2007				2006				2007				2006
Research and development			14.3	%			10.5	%			12.6	%			10.6	%
Selling, general and administrative			17.4	%			16.1	%			15.6	%			15.3	%
Restructuring and asset impairment charges			—				—				1.2	%			—
Total operating expenses			31.7	%			26.6	%			29.4	%			25.9	%

  SALES

     The following tables summarize our unaudited net sales and percentages of net sales by customer type for the three- and nine-month periods ended September 30, 2007 and 2006:

		Three Months Ended								Increase/				%				Nine Months Ended								Increase/				%
		September 30,								(Decrease)				Change				September 30,								(Decrease)				Change
		2007				2006												2007				2006
		(In thousands)																(In thousands)
Semiconductor capital equipment		$	60,802			$	73,947			$	(13,145	)			(18	)%		$	205,274			$	212,854			$	(7,580	)			(4	%)
Non-semiconductor capital equipment			29,689				33,741				(4,052	)			(12	)%			95,589				93,355				2,234				2	%
Total sales		$	90,491			$	107,688			$	(17,197	)			(16	)%		$	300,863			$	306,209			$	(5,346	)			(2	)%

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
% of sales		2007				2006				2007				2006
Semiconductor capital equipment			67	%			69	%			68	%			69	%
Non-semiconductor capital equipment			33	%			31	%			32	%			31	%
			100	%			100	%			100	%			100	%