UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2006.

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

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

Common Stock, $0.001 par value

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ.

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ.

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 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. 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 Exchange Act Rule 12b-2). Yes o No þ.

The approximate aggregate market value of voting and non-voting common stock held by non-affiliates of the registrant was $391.1 million as of June 30, 2006.

44,906,405

(Number of shares of Common Stock outstanding as of February 15, 2007)

DOCUMENTS INCORPORATED BY REFERENCE

		Incorporated By
Document		Reference In Part No.
Portions of Advanced Energy Industries, Inc. definitive proxy statement for its 2006 Annual Meeting of Stockholders to be held on May 2, 2007		III

 

 

ADVANCED ENERGY INDUSTRIES, INC.

		Page
PART I
ITEM 1. BUSINESS			3
ITEM 1A. RISK FACTORS			8
ITEM 1B. UNRESOLVED STAFF COMMENTS			12
ITEM 2. PROPERTIES			13
ITEM 3. LEGAL PROCEEDINGS			13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS			13
PART II			13
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES			13
ITEM 6. SELECTED FINANCIAL DATA			14
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			15
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			22
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA			24
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE			51
ITEM 9A. CONTROLS AND PROCEDURES			51
ITEM 9B. OTHER INFORMATION			52
PART III			52
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT			52
ITEM 11. EXECUTIVE COMPENSATION			52
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS			52
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS			52
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES			52
PART IV			52
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES			52
SIGNATURES			56
Subsidiaries
Consent of Grant Thornton LLP
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

          Unless the context otherwise requires, as used in this Form 10-K, references to “Advanced Energy”, “the Company”, “we”, “us” or “our” refer to Advanced Energy Industries, Inc. and its consolidated subsidiaries.

ITEM 1. BUSINESS

Overview

          We design, manufacture and support complex power conversion and control systems and gas flow control 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 television, computer monitors and hand-held devices;
	•		Compact discs, DVDs, magnetic hard drives and other digital storage media;
	•		Solar panels or photovoltaics;
	•		Thermal coatings for architectural glass;
	•		Optical coatings for eyeglasses;
	•		Industrial laser and medical applications; and
	•		Other markets where thin film deposition is a critical part of the manufacturing process.

          Our installed base enables us to also sell spare parts, repair services and field upgrades 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. Sales to customers in the semiconductor capital equipment industry comprised 69% of our sales in 2006 and 63% of our sales in 2005 and 2004.

          We incorporated in Colorado in 1981 and reincorporated in Delaware in 1995. Our executive offices are located at 1625 Sharp Point Drive, Fort Collins, Colorado 80525, and our telephone number is 970-221-4670.

     Products

     Our major products fall into four categories: Power Conversion, Flow Control Technologies, Thermal Instrumentation and Source Technology. Our products are designed to enable new process technologies, improve productivity and lower the cost of ownership for our customers.

POWER CONVERSION

     Our power conversion systems include direct current (“DC”), high power, low and mid frequency, and radio frequency (“RF”) power supplies, matching networks and RF instrumentation. Our power conversion systems refine, modify and control the raw electrical power from a utility and convert it into power that is customized, predictable and repeatable. Our power conversion systems are primarily used by semiconductor and similar thin-film manufacture including flat panel display, data storage and architectural glass manufacturers in the following applications: physical vapor deposition; chemical vapor deposition; reactive sputtering; electroplating; plasma vacuum processes; oxide, poly and conductor etch; and carbon dioxide laser excitation.

FLOW CONTROL TECHNOLOGIES

     Our flow control technology 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 technology products control or monitor the flow of high-purity liquids, liquid vapor, and gases encompassing a wide range of input pressures. Our flow control technology products are primarily used in semiconductor, flat panel display manufacturing and similar thin-film applications, fiber optics, safe delivery systems and silica industries.

THERMAL INSTRUMENTATION

     Our thermal instrumentation products, primarily used in the semiconductor industry, provide thermal management and control solutions for applications where time-temperature cycles affect productivity and yield. They are used in physical vapor deposition, chemical vapor deposition, rapid thermal processing and other semiconductor applications requiring non-contact temperature measurement.

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, industrial coating, pre-cleaning and chamber cleaning. Our plasma-source platforms are complete systems, including a remote plasma source, a power supply and an active matching network.

Markets, Applications and Customers

MARKETS

     The following is a discussion of the major markets for our products.

     SEMICONDUCTOR CAPITAL EQUIPMENT MANUFACTURING MARKET. Most of our sales have historically been to customers in the semiconductor capital equipment industry for incorporation into equipment used in the major semiconductor processing steps that make integrated circuits, as well as to other equipment manufacturers discussed below. Sales to customers in this industry represented 69% of our sales in 2006 and 63% of our sales in 2005 and 2004. Our power conversion systems provide the energy to enable the chemical reaction for thin-film processes such as deposition and etch. Our flow control technology products control the fluid or gas being delivered to ensure accuracy, repeatability and stability, our thermal instrumentation products measure the temperature of the process chamber and our source technology products optimize CVD clean, deposition and etch processes. The precise control over the energy delivered to 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 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 (“LCD”) 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.

     DATA STORAGE MANUFACTURING EQUIPMENT MARKETS. We sell products to manufacturers of data storage equipment and data storage devices for use in producing a variety of products, including CDs and DVDs (read-only, one-time recordable and rewriteable); computer hard discs, including both media and thin-film heads; and magneto-optical storage media. These products use a Physical Vapor Deposition, or 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 requires thinner and more precise films. The use of equipment incorporating magnetic media to store analog and digital data expands with the growth of the laptop, desktop and workstation computer markets and the consumer electronics audio, video, gaming and entertainment markets.

     SOLAR CELL MARKET. We sell our products to both OEMs and manufacturers of solar cells. The majority of the industry’s research and development efforts are focused on thin film solar, which is the manufacture of the solar cell on a non-silicon substrate such as glass, plastic or metal. The coatings form optically absorbing and electrically conducting layers, allowing sunlight to be converted to electrical power. Today, the majority of solar cell manufacturers use a bulk silicon wafer as the substrate, which requires both CVD and PVD thin film processes using our DC and RF power supply products in those tools to manufacture the solar cell. As new companies emerge and technologies progress, such as thin film solar, we believe capital will increase as this market continues to grow. Our power supply and flow products are critical solutions for our customers in the solar cell market.

     ARCHITECTURAL GLASS MARKET. We sell our products to OEMs and to producers of Low Emissivity (Low-E ) architectural glass. This glass is used in commercial and residential buildings to reflect heat through the use of thin films coated directly on the glass which significantly reduces heat transfer through the glass, improving the efficiency of the heating and cooling systems in the building. The thin film deposition process employs PVD tools which use our DC power products. This market is driven by the need for energy conservation and the end market demand for glass related to the residential and commercial construction industry.

     ADVANCED PRODUCT APPLICATIONS MARKETS. We sell our products to OEMs and producers of end products in a variety of industrial markets. 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 enable a variety of industrial packaging applications such as decorative wrapping and food packaging. The advanced thin-film production processes allow precise control of various optical and physical properties, including color, transparency and electrical and thermal conductivity. The improved adhesion and high-film quality resulting from plasma-based processing make it the preferred method of applying the thin films. Many of these thin-film industrial applications require power levels substantially greater than those used in our other markets.

APPLICATIONS

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

Semiconductor		Data Storage		Flat Panel Display		Advanced Product Applications
Chemical vapor deposition Etch		CDs, DVDs, CD/DVD — ROMs		Active matrix LCDs Digital micro-mirror		Advanced computer technology workstations and servers
(conductor and dielectric)		CDs/DVDs rewritable		Field emission displays		Automobile coatings
High-density plasma CVD		Hard disc carbon wear coatings		Large flat panel displays		Chemical, physical and materials research
Ion implantation		Hard disc magnetic media		LCD projection		Circuit board etch-back and de-smear
Magnet field controls		Thin-film heads		Liquid crystal displays		Consumer product coatings
Mass flow management		Magneto-optic disks		Medical applications		Diamond-like coatings
Megasonic cleaning				Plasma displays		Superconductors
Photo-resist stripping						Food package coatings
Physical vapor deposition						Eyeglasses
Plasma-enhanced CVD						Optical coatings
Chemical mechanical polishing						Front surface mirrors
Solid-state temperature controls						Large-area glass coatings
Wafer handling
Rapid thermal processing
Electro-chemical deposition

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 63%, 57% and 60% of our sales in 2006, 2005 and 2004, respectively. 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.

     Applied Materials, our largest customer, accounted for 30%, 23% and 28% of our sales in 2006, 2005 and 2004, respectively. With the exception of Applied Materials and Ulvac, Inc., our largest customer in the flat panel display industry, accounting for 11% of our sales in 2005, no other customer exceeded 10% of our sales during these annual periods.

Backlog

     Our backlog increased 12.5% from $49.8 million at December 31, 2005 to $56.0 million at December 31, 2006. 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 and does not include just in time contractual obligations. Due to possible customer changes in delivery schedules and cancellations of orders, our backlog at any particular date is not 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; Austin Texas; and Vancouver, Washington. To serve customers in Asia and Europe, we have offices in Shenzhen and Shanghai, China; Bicester, England; Filderstadt and Stolberg, Germany; Hachioji, Japan; Sungnam City, South Korea; and Hsinchu and Taipei, Taiwan. These offices have primary responsibility for sales in their respective markets. We also have sales representatives and distributors inside and outside the United States. We maintain customer service offices at many of the locations listed above, as well as other sites chosen considering our customer locations as 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.

     The following table represents our net sales by geographic region and percentage of net sales for the years ended 2006, 2005 and 2004:

		Years Ended December 31,
		2006				2005				2004				2006				2005				2004
		(In thousands)
United States		$	238,468			$	163,657			$	198,263				58	%			50	%			52	%
Europe			41,760				34,228				58,852				10	%			11	%			16	%
Asia			130,115				126,480				122,533				32	%			39	%			32	%
Rest of world			399				1,117				889				—				—				—
Total sales		$	410,742			$	325,482			$	380,537				100	%			100	%			100	%

Manufacturing

     Our manufacturing locations are in Shenzhen, China; Fort Collins, Colorado; Hachioji, Japan; Stolberg, Germany; and Vancouver, Washington. In 2005, we completed the realignment of our worldwide manufacturing infrastructure, with Shenzhen, China being the

central high-volume manufacturing site. The focus of our Fort Collins, Colorado and Hachioji, Japan locations is low volume, high end manufacturing, service and support, new product design and launch and advanced manufacturing.

     We generally manufacture different products at each facility. 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.

Intellectual Property

     We have a practice of seeking patents on inventions governing new products or technologies as part of our ongoing research, development and manufacturing activities. We currently hold 83 United States patents, 52 foreign-issued patents, and have over 80 patent applications pending in the United States, Europe and Asia. Generally, our efforts to obtain international patents have been concentrated in the industrialized countries of Europe and the Pacific Rim, 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 “Item 1A Risk Factors – We are highly dependent on our intellectual property.”

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 we cannot assure 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 us. Our ability to continue to compete successfully in these markets depends on our ability to make timely introductions of system enhancements and new products. We expect our competitors will continue to improve the design and performance of their products and to introduce new products with competitive performance characteristics.

Operating Segment

     We operate and manage our business of manufacturing, marketing and servicing components and products for plasma-based manufacturing processes as one segment. All financial segment information required by SFAS No. 131 is found in the accompanying consolidated financial statements. Please refer to Note 16 Foreign Operations and Major Customers, included in Part II, Item 8 of this Form 10-K for further discussion regarding our operations.

Research and Development

     The market for our products is characterized by ongoing technological changes. We believe that continued and timely development of new highly differentiated 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 $44.8 million, $39.7 million and $49.0 million in 2006, 2005 and 2004, respectively, representing 10.9%, 12.2% and 12.9% of our total sales in 2006, 2005 and 2004, respectively.

Number of Employees

     As of December 31, 2006, we had a total of 1,583 employees. There is no union representation of our employees, and we have never experienced an involuntary work stoppage. 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.

Website Access

     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 reports are also available at www.sec.gov.

Special Note Regarding Forward-Looking Statements

     This Form 10-K includes or incorporates by reference “forward-looking statements” within the meanings of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. 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, conditions 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:

	•		Our future revenues;
	•		Our future gross profit;
	•		Reducing our operating breakeven point;
	•		Incremental profit above our breakeven point;
	•		Market acceptance of our products;
	•		Customer inventory levels, requirements and order levels;
	•		Research and development expenses;
	•		Selling, general and administrative expenses;
	•		Sufficiency and availability of capital resources;
	•		Capital expenditures;
	•		Restructuring activities and expenses; and
	•		General global economic conditions.

     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 ”Item 1A – Risk Factors” within Part I of this Form 10-K. Other factors might also 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.

ITEM 1A. RISK FACTORS

The semiconductor, semiconductor capital equipment and flat panel display industries are highly cyclical, which impacts our operating results.

     Our business and operating results depend in significant part upon capital expenditures by manufacturers of semiconductors and flat panel displays, which in turn depend upon current and anticipated demand for their products. Historically, these industries have been highly cyclical, with recurring periods of over-supply that have had a negative impact on the demand for capital equipment used to manufacture their products.

     During periods of declining demand, our customers typically reduce purchases of, and cancel orders for, our products and delay delivery of their own products. We may incur significant charges as we seek to align our cost structure with any such reduction in sales to these customers. In addition, we may not be able to respond adequately or quickly to the declining demand by reducing our costs. 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 business, financial condition and operating results.

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

     Our operating results may be adversely affected by a variety of factors, many of which are beyond our control and difficult to predict. These factors include:

	•		Fluctuations in demand in the semiconductor, semiconductor capital equipment and flat panel display industries and other industries in which our customers operate;
	•		The timing and nature of orders placed by our customers;
	•		Seasonal variations in capital spending by our customers;
	•		Changes in our customers’ inventory management practices;
	•		Customer cancellation or postponement of previously placed orders;
	•		Pricing competition from our competitors;
	•		Customer requests for us to reduce prices, enhance features, improve reliability, shorten delivery times and extend payment terms;
	•		Component shortages or allocations or other factors that result in delays in manufacturing and sales or result in changes to our inventory levels or cause us to substantially increase our spending on inventory;
	•		The introduction of new products by us or our competitors;
	•		Changes in macroeconomic conditions;
	•		Litigation, especially regarding intellectual property; and
	•		Currency exchange rate fluctuations. At December 31, 2006, a 10% change in exchange rates would have approximately a 2% to 4% impact on reported revenues and expenses.

We have transferred the production of substantially all of our product lines to our manufacturing facility in Shenzhen, China, and may experience unforeseen difficulties and challenges with these operations.

     We have invested significant human and financial resources to establish our manufacturing facility in Shenzhen, China. These investments were made with the goal of reducing our labor costs by increasing our workforce in China and correspondingly decreasing our workforce in the United States. Because our operating history in Shenzhen is limited, we cannot predict with certainty the impact that this new facility will have on our operating results. We may incur unforeseen costs with respect to this facility and the related workforce including, unforeseen escalation of costs that could have an adverse impact on our operating results.

We might not realize all of the intended benefits of transitioning our supply base to Asian suppliers.

     We are continuing our transition to purchasing a substantial portion of components for our products from Asian suppliers to lower our materials costs and shipping expenses. These components might require us to incur higher than anticipated testing or repairing costs, which would have an adverse effect on our operating results. Customers, including major customers who have strict and extensive requirements, might not accept our products if they contain these lower-priced components. A delay or refusal by our customers to accept such products, as well as an inability of our suppliers to meet our purchasing requirements, might require us to continue to purchase higher-priced components from our existing suppliers or might cause us to lose sales to these customers, which would have an adverse effect on our operating results.

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

     Our ten largest customers accounted for 63%, 57% and 60% of our total sales in 2006, 2005 and 2004, respectively. Applied Materials, our largest customer, accounted for 30%, 23% and 28% of our sales in 2006, 2005 and 2004, respectively. With the exception of Applied Material and Ulvac, Inc., our largest customer in the flat panel display industry, accounting for 11% of our sales in 2005, no other customer exceeded 10% of our sales during these annual periods. The loss of any of our significant customers or a material reduction in any of their purchase orders could 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 reduce our prices or extend payment terms to remain competitive. We may not be able to reduce our expenses in an amount sufficient to offset potential margin declines.

Raw material, part, component and subassembly 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 our products timely depends in part on the timely delivery of raw materials, parts, components and subassemblies from suppliers. We rely on sole and limited source suppliers for some of our raw materials, parts, components and subassemblies that are critical to the manufacturing of our products. This reliance involves several potential risks, including the following:

	•		Inability to obtain an adequate supply of required parts, components or subassemblies;
	•		Supply shortages if a sole source provider ceases operations;
	•		Having to fund the operating losses of a sole source provider;
	•		Reduced control over pricing and timing of delivery of raw materials, parts, components or subassemblies;
	•		Need to qualify alternative suppliers which could be time consuming and lead to delays in delivery of products to our customers, as well as increased costs; and
	•		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 or if our suppliers cannot meet our performance or quality specifications, or timing requirements, we may experience shortages of raw materials, parts, components or subassemblies, increased material costs and shipping delays for our products, which would adversely affect our business, financial condition and operating results and relationships with our current and prospective customers.

We generally have no written long-term contracts with our customers requiring them to purchase any specified quantities from us.

     As is typical in our industry, our sales are primarily made on a purchase order basis, and we generally have no written long-term purchase commitments from our customers. As a result, we are limited in our ability to predict the level of future sales or commitments from our current customers, which may diminish our ability to effectively allocate labor, materials and equipment in the manufacturing process. In addition, we may accumulate inventory in anticipation of sales that do not materialize resulting in excess and obsolete inventory write-offs.

If we are unable to adjust our business strategy successfully for some of our product lines to reflect the increasing price sensitivity on the part of our customers, our business and financial condition could be harmed.

     Our business strategy for many of our product lines has been focused on product performance and technology innovation to provide enhanced efficiencies and productivity. As a result of recent economic conditions and changes in various markets that we serve, our customers have experienced significant cost pressures and, as a result, we have observed increased price sensitivity on the part of our customers. If competition for any of our product lines should come to focus solely on price rather than on product performance and technology innovation, we will need to adjust our business strategy and product offerings accordingly and, if we are unable to do so, our business, financial condition and operating results could be materially and adversely affected.

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. We expect our competitors will continue to develop new products in direct competition with ours, improve the design and performance of their products and introduce new products with enhanced performance characteristics.

     To remain competitive, we 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.

Our competitive position could be weakened if we are unable to convince end users to specify that our products be used in the equipment sold by our customers.

     Our competitive success often depends upon factors outside of our control. For example, in some cases, particularly with respect to mass flow controller products, semiconductor device and flat panel display manufacturers may direct equipment manufacturers to use a specified supplier’s product in their equipment at a particular facility. Accordingly, for such products, our success will depend in part on our ability to have end users specify that our products be used at their facilities. In addition, we may encounter difficulties in changing established relationships of competitors that already have a large installed base of products within such facilities. If device manufacturers do not specify the use of our products, our sales may be reduced which would negatively affect our business, financial condition and operating results.

Our products may suffer from defects or errors leading to damage or warranty claims

     Our products use complex system designs and components that may contain errors or defects, particularly when we incorporate new technology into our products or release new versions. While we have never recalled a product, if any of our products are defective, we might be required to redesign or recall those products or pay damages or warranty claims. Product defects could result in substantial product liability, We maintain product liability insurance, but cannot be certain that it is adequate or will remain available on acceptable terms.

We must achieve design wins to retain our existing customers and to obtain new customers, although design wins achieved do not necessarily result in substantial sales.

     The constantly changing nature of semiconductor fabrication and flat panel display 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.

     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 our 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. Our efforts to achieve design wins are time consuming and expensive, and may not be successful. If we are not successful in achieving design wins, our business, financial condition and operating results will be adversely impacted.

     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, as sales of our products are dependent upon our customers’ sales of their products.

We are subject to risks inherent in international operations.

     Sales to our customers outside the United States were approximately 42%, 50% and 48% of our sales in 2006, 2005 and 2004, respectively. Our success competing in international markets is subject to our ability to manage various risks and difficulties, including, but not limited to:

	•		Our ability to effectively manage our employees at remote locations who are operating in different business environments from the United States;
	•		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;
	•		Customs regulations and the import and export of goods;
	•		The ability to provide sufficient levels of technical support in different locations;
	•		Our ability to obtain business licenses as may be needed in international locations to support expanded operations;
	•		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, maintain market share and compete successfully in international markets will be compromised if we are unable to manage these and other international risks successfully.

Unfavorable currency exchange rate fluctuations may lead to lower operating margins, or may cause us to raise prices which could result in reduced sales.

     Currency exchange rate fluctuations could have an adverse effect on our sales and results of operations and we could experience losses with respect to our forward exchange contracts. Unfavorable currency fluctuations could require us to increase prices to foreign customers which could result in lower net sales by us to such customers. Alternatively, if we do not adjust the prices for our products in response to unfavorable currency fluctuations, our operating results could be adversely affected. In addition, most sales made by our foreign subsidiaries are denominated in the currency of the country in which these products are sold and the currency they receive in payment for such sales could be less valuable at the time of receipt as a result of exchange rate fluctuations. We enter into forward exchange contracts and local currency purchased options to reduce currency exposure arising from intercompany sales of inventory. However, we cannot be certain that our efforts will be adequate to protect us against significant currency fluctuations or that such efforts will not expose us to additional exchange rate risks which could adversely affect our operating results.

Changes in the value of the Chinese yuan could impact the cost of our operation in Shenzhen, China.

     The Chinese government is continually pressured by its trading partners to allow its currency to float in a manner similar to other major currencies. The recent revaluation of the yuan has not had a material impact on our operations. Any further change may impact our ability to control the cost of our products in the world market. Specifically, the decision by the Chinese government to allow the yuan to begin to float against the United States dollar could significantly increase the labor and other costs incurred in the operation of our Shenzhen facility and the cost of raw materials, parts, components and subassemblies that we source in China, thereby negatively affecting our financial condition and operating results.

We are highly dependent on our intellectual property.

     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, including China. 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 European Union and certain industrialized countries in Asia, including, Korea, Japan and Taiwan. If we are unable to protect our intellectual property successfully, our business, financial condition and operating results could be adversely affected.

     China commercial law 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 our products or otherwise obtain or use our intellectual property. We cannot give assurance that we will be able to protect our intellectual property rights effectively or have adequate legal recourse in the event that we encounter infringements of our intellectual property in China.

We have been, and in the future may again be, involved in patent litigation. Patent litigation is costly and could result in further restrictions on our ability to sell certain products or an inability to prevent others from using technology we have developed.

     Litigation may be necessary to enforce patents issued to us, to protect our trade secrets or know-how, to defend ourselves against claimed infringement of the rights of others or to determine the scope and validity of our proprietary rights or the proprietary rights of others. This type of litigation often requires substantial management time and attention, as well as financial and other resources.

Future patent litigation might:

	•		Cause us to incur substantial costs in the form of legal fees, fines and royalty payments;
	•		Result in restrictions on our ability to sell certain products;
	•		Result in an inability to prevent others from using technology we have developed; and
	•		Require us to redesign products or seek alternative technologies.

     Any of these events could have a significant adverse effect on our business, financial condition and results of operations.

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. 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 or shipments could be suspended; or
	•		We could be prohibited from offering particular products in specified markets.

     Any inability to comply with current or future regulations, directives and standards could adversely affect our business, financial condition or operating results.

The market price of our common stock has fluctuated and may continue to fluctuate for reasons over which we have no control.

     The stock market has from time to time experienced, and is likely to continue to experience, extreme price and volume fluctuations. Prices of securities of technology companies have been especially volatile and have often fluctuated for reasons that are unrelated to their operating performance. In the past, companies that have experienced volatility in the market price of their stock have been the subject of securities class action litigation. If we were the subject of securities class action litigation, it could result in substantial costs and a diversion of our management’s attention and resources.

Our Chairman of the Board owns a significant percentage of our outstanding common stock, which could enable him to control our business and affairs and future sales of our common stock by our Chairman of the Board may negatively affect the market price of our common stock.

     Douglas S. Schatz, our Chairman of the Board, beneficially owns approximately 21% of our outstanding common stock as of February 15, 2007. This stockholding gives Mr. Schatz significant voting power and influence. 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 in a manner with which our other stockholders may not agree. In addition, the sale of a substantial amount of the shares owned by him could negatively affect the market price of our common stock. Mr. Schatz has entered into a written trading plan pursuant to Rule 10b5-1 under the Securities Exchange Act of 1934, which provides for the sale of up to 720,000 shares of common stock if certain price targets and other conditions are met.

ITEM 1B. UNRESOLVED STAFF COMMENTS

     None.

ITEM 2. PROPERTIES

     Information concerning our principal properties at December 31, 2006 is set forth below.

Location		Type		Principal Use		Sq. Footage				Ownership
San Jose, CA		Office		Distribution,			20,000			Leased
Fort Collins, CO		Office, plant		Headquarters,			205,000			Leased
				Research and development,
				Manufacturing, Distribution
Austin, TX		Office		Distribution			8,000			Leased
Dallas, TX		Office		Distribution			2,000			Leased
Vancouver, WA		Office, plant		Research and development,			20,000			Leased
				Manufacturing, Distribution
Shanghai, China		Office		Distribution			8,000			Leased
Shenzhen, China		Office, plant		Manufacturing, Distribution			131,000			Leased
Bicester, England		Office		Distribution			1,000			Leased
Filderstadt, Germany		Office		Distribution			9,000			Leased
Stolberg, Germany		Office, plant		Research and development,			17,000			Leased
				Manufacturing, Distribution
Hachioji, Japan		Office, plant		Research and development,			46,000			Owned
				Manufacturing, Distribution
Sungnam City, South Korea		Office		Distribution			14,000			Owned
Hsinchu, Taiwan		Office		Distribution			9,000			Leased
Taipei, Taiwan		Office		Distribution			13,000			Leased

ITEM 3. LEGAL PROCEEDINGS

     None.

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

     None.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

     Our common stock trades on the Nasdaq National Market under the symbol “AEIS.” At February 15, 2007, the number of common stockholders of record was 663, and the closing sale price on that day was $20.26 per share.

     The table below shows the range of high and low closing sale prices 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:

		2006								2005
		High				Low				High				Low
First Quarter		$	16.13			$	12.06			$	9.96			$	6.88
Second Quarter		$	17.08			$	12.39			$	11.10			$	7.86
Third Quarter		$	17.12			$	11.63			$	12.61			$	7.76
Fourth Quarter		$	18.87			$	14.89			$	13.85			$	10.01

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

ITEM 6. SELECTED FINANCIAL DATA

     The selected consolidated statement of operations data and the related consolidated balance sheet data were derived from the audited consolidated financial statements. The information below is not necessarily indicative of results of future operations and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part II of this Form 10-K in order to more fully understand the factors that may affect the comparability of the information presented below.

		Years Ended December 31,
(In thousands, except per share data)		2006				2005				2004				2003				2002
Statement of Operations Data:
Sales		$	410,742			$	325,482			$	380,537			$	253,536			$	233,730
Gross profit			175,218				117,081				114,626				84,319				66,192
Total operating expenses			107,829				101,107				118,093				108,746				128,891
Income (loss) from operations			67,389				15,974				(3,467	)			(24,427	)			(62,699	)
Income (loss) from continuing operations			87,184				3,622				(14,670	)			(45,536	)			(42,113	)
Net income (loss)			88,322				12,817				(12,747	)			(44,241	)			(41,399	)
Income (loss) from continuing operations per share — diluted		$	1.93			$	0.10			$	(0.45	)		$	(1.41	)		$	(1.31	)
Net income (loss) per share — diluted		$	1.95			$	0.34			$	(0.39	)		$	(1.37	)		$	(1.29	)
Diluted weighted-average common shares outstanding			45,265				37,434				32,649				32,271				32,026

		As of December 31,
		2006				2005				2004				2003				2002
Balance Sheet Data:
Cash, cash equivalents and marketable securities		$	144,218			$	59,685			$	107,982			$	134,892			$	172,347
Working capital			247,798				143,633				206,915				205,835				247,942
Total assets			411,903				310,117				394,407				414,731				455,733
Total debt			329				4,190				196,123				202,468				213,580
Stockholders’ equity			355,790				257,430				144,978				151,834				183,339

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

     Certain statements set forth below under this caption constitute forward-looking statements. See “Business—Special Note Regarding Forward-Looking Statements” in Item 1 of this report for additional factors relating to such statements, and see “Risk Factors” in Item 1A of this report for a discussion of certain risk factors applicable to our business, financial condition and results of operations.

Business Overview and Presentation

     We design, manufacture and support complex power conversion and control systems and gas flow control 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.

     Our vast 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. However, we are focused on the semiconductor capital equipment industry and market and sell our products primarily to large, original equipment manufacturers (“OEMs”) in this industry. Sales to customers in the semiconductor capital equipment industry comprised 69% of our sales in 2006 and 63% of our sales in 2005 and 2004. Our customers in non-semiconductor industries are also large OEM’s that sell flat panel display, data storage, architectural glass, solar cell and other industrial thin-film manufacturing equipment.

     Our analysis presented below is organized to provide the information we believe will be instructive for understanding the relevant trends going forward. However, this discussion should be read in conjunction with our consolidated financial statements in Item 8 of this report, including the notes thereto.

Results of Operations

     The following table summarizes our results of operations for the years ended 2006, 2005 and 2004:

		Years Ended December 31,												Increase/(decrease)								Percentage change
														2006 v				2005 v				2006 v				2005 v
		2006				2005				2004				2005				2004				2005				2004
		(in thousands)												(in thousands)
Sales		$	410,742			$	325,482			$	380,537			$	85,260				($55,055	)			26	%			(14	)%
Gross profit			175,218				117,081				114,626				58,137				2,455				50	%			2	%
Operating expenses:
Research and development			44,848				39,720				49,004				5,128				(9,284	)			13	%			(19	)%
Selling, general and administrative			62,870				55,681				61,851				7,189				(6,170	)			13	%			(10	)%
Litigation settlement			—				3,000				—				(3,000	)			3,000			nm				nm
Restructuring charges			111				2,706				3,912				(2,595	)			(1,206	)			(96	)%			(31	)%
Impairment of intangible assets			—				—				3,326				—				(3,326	)		nm				nm
Total operating expenses			107,829				101,107				118,093				6,722				(16,986	)			7	%			(14	)%
Income (loss) from operations			67,389				15,974				(3,467	)			51,415				19,441			nm				nm
Other income (expense), net			4,677				(7,479	)			(7,256	)			12,156				(223	)		nm					(3	)%
Income (loss) from continuing operations before income taxes			72,066				8,495				(10,723	)			63,571				19,218			nm					179	%
Benefit (Provision) for income taxes			15,118				(4,873	)			(3,947	)			19,991				(926	)		nm					23	%
Income (loss) from continuing operations			87,184				3,622				(14,670	)			83,562				18,292			nm					(125	)%
Income from discontinued operations, net of tax			1,138				9,195				1,923				($8,057	)			7,272			nm				nm
Net income (loss)		$	88,322			$	12,817			$	(12,747	)		$	75,505				25,564			nm				nm

SALES

     The following tables summarize annual net sales, and percentages of net sales, by customer type for each of the years ended 2006, 2005 and 2004:

		Years Ended December 31,												Increase/(decrease)								Percentage change
														2006 v				2005 v				2006 v				2005 v
		2006				2005				2004				2005				2004				2005				2004
		(In thousands)
Semiconductor capital equipment		$	283,470			$	205,322				238,728			$	78,148			$	(33,406	)			38	%			(14	)%
Non-semiconductor equipment			127,272				120,160				141,809				7,112				(21,649	)			6	%			(15	)%
Total sales		$	410,742			$	325,482			$	380,537			$	85,260			$	(55,055	)			26	%			(14	)%

		Years Ended December 31,
		2006				2005				2004
Semiconductor capital equipment			69	%			63	%			63	%
Non-semiconductor equipment			31	%			37	%			37	%
			100	%			100	%			100	%

     The following tables summarize annual net sales, and percentages of net sales, by geographic region for each of the years ended 2006, 2005 and 2004. The following amounts do not contemplate where our customers may subsequently transfer our products.

		Years Ended December 31,
														2006 v				2005 v				2006 v				2005 v
		2006				2005				2004				2005				2004				2005				2004
		(In thousands)
United States		$	238,468			$	163,657			$	198,263			$	74,811			$	(34,606	)			46	%			(17	)%
Europe			41,760				34,228				58,852				7,532				(24,624	)			22	%			(42	)%
Asia			130,115				126,480				122,533				3,635				3,947				3	%			3	%
Rest of world			399				1,117				889				(718	)			228				(64	)%			26	%
Total sales		$	410,742			$	325,482			$	380,537			$	85,260			$	(55,055	)			26	%			(14	)%

		Years Ended December 31,
		2006				2005				2004
United States			58	%			50	%			52	%
Europe			10				11				16
Asia			32				39				32
Rest of world			—				—				—
			100	%			100	%			100	%

     The increase in total sales from 2005 to 2006 and the decrease from 2004 to 2005 principally reflects fluctuations in demand in the semiconductor capital equipment. The semiconductor capital equipment 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. Our sales to our largest semiconductor capital equipment customers represented the majority of the fluctuating sales volume.

     Applied Materials is our largest customer and accounted for 30%, 23% and 28% of our total sales 2006, 2005 and 2004, respectively. Our ten largest customers accounted for 63%, 57% and 60% of our total sales in 2006, 2005 and 2004, respectively. With the exception of Applied Materials and Ulvac, Inc., our largest customer in the flat panel display industry, accounting for 11% of our sales in 2005, no other customer exceeded 10% of our sales during these annual periods.

GROSS PROFIT

     Our gross margin was 42.7%, 36.0% and 30.1% in 2006, 2005 and 2004, respectively. The improvement in our gross margin was attributed to increased volume of production and advanced manufacturing processes in our China manufacturing facility, lower freight costs, increased utilization of local Asian suppliers, design-led cost reductions and the increase in sales. Additionally, our gross margin in 2005 was positively impacted by our discontinuance of the allocation of human resource and finance department costs to cost of sales. As part of our significant operational restructuring, we have reviewed all aspects of our management reporting and determined that the continued allocation of such costs was no longer appropriate. In 2005, these costs are recorded in selling, general and administrative expenses. Human resource and finance department costs included in our gross margin represented 1.6 percentage points in 2004.

OPERATING EXPENSES

The following table summarizes our operating expenses as a percentage of sales for the years ended 2006, 2005 and 2004:

		Years Ended December 31,												% of Sales
		2006				2005				2004				2006				2005				2004
						(in thousands)
Research and development		$	44,848			$	39,720			$	49,004				11	%			12	%			13	%
Selling, general and administrative			62,870				55,681				61,851				15	%			17	%			16	%
Litigation settlement			—				3,000				—				—				1	%			—
Restructuring charges			111				2,706				3,912				—				1	%			1	%
Impairment of intangible assets			—				—				3,326				—				—				1	%
Total operating expenses		$	107,829			$	101,107			$	118,093				26	%			31	%			31	%

  RESEARCH AND DEVELOPMENT

     The market for our products for thin film deposition systems and related accessories is characterized by ongoing technological changes. We believe that continued and timely development of new highly differentiated 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.

     The increase in our research and development expenses from 2005 to 2006 was primarily due to increased variable compensation and non-cash stock-based compensation expense of $1 million as a result of the adoption of SFAS No. 123(R) and additional research projects in response to customer requests and to support the development of new products and enhancement of existing products. The decrease in our research and development expenses from 2004 to 2005 was primarily due to less engineering support needed in connection with the transition of high-volume product manufacturing to China, prioritization of our research and development projects and increased scrutiny of our costs.

  SELLING, GENERAL AND ADMINISTRATIVE

     Our selling expenses support domestic and international sales and marketing activities that include personnel, trade shows, advertising, and other selling and marketing activities. 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.

     The increase in our selling, general and administrative (SG&A) expense from 2005 to 2006 was primarily due to increased variable compensation expense, increased commissions, non-cash stock-based compensation expense of $1.5 million as a result of the adoption of SFAS No 123(R) and severance and related expenses related to the reorganization of our operations in Germany. The decrease from 2004 to 2005 was due primarily to the benefit of our cost reduction measures and decreased commissions, partially offset by the increased allocation of certain costs from cost of sales to SG&A expenses discussed above.

     Patent litigation expenses in 2004 and 2005 have comprised a portion of our SG&A expenses. In addition to the litigation settlement paid to MKS Instruments, Inc. (“MKS”) as described below, we have recorded legal fees and expenses related to litigation with MKS and others of approximately 2% to 8% of our total SG&A expenses for each of the years ended December 31, 2005 and 2004. Patent litigation expenses in 2006 comprised less than 1% of our SG&A expenses.

     LITIGATION SETTLEMENT

     On October 3, 2005, we executed a settlement agreement with MKS Instruments, Inc. (“MKS”), resolving all pending claims worldwide relating to our Xstream™ With Active Matching Network™ reactive gas generator products. Pursuant to the settlement agreement, we paid MKS $3.0 million in cash. We also stipulated to a final judgment of infringement and an injunction prohibiting us from making, using, selling, offering to sell, or importing into the United States, or any country in which a counterpart patent exists, our Xstream products and all other toroidal plasma generator products, except as permitted under the settlement agreement. Sales of these products have accounted for less than 5% of our total sales each year since introduction of the products.

  RESTRUCTURING CHARGES

     At the end of 2002, we announced major changes in our operations planned to occur through 2003. These included establishing the manufacturing location in China; consolidating worldwide sales forces; a move to lower-cost Asian suppliers; and the intention to close or sell certain facilities. Associated with these changes, we recorded restructuring charges of $111,000, $2.7 million and $3.9 million in 2006, 2005 and 2004, respectively.

     Our restructuring charges throughout 2004 and 2005 were incurred primarily in conjunction with our transition of our high-volume manufacturing to Shenzhen, China, which was substantially complete as of September 30, 2005. In 2004, we recorded $3.9 million of restructuring charges, primarily attributable to employee severance and termination costs for 262 employees in the Fort Collins facility. Related to this operations restructuring, and the transition of certain product lines from certain of our locations in Europe and Japan, we recorded restructuring charges in 2005 of $2.7 million, consisting primarily of $1.9 million for employee severance and termination costs and $746,000 for impairments of facilities-related assets in the United States and Japan, as a result of consolidation of certain of our facilities. The employee severance and termination costs were associated with 216 employees in the United States, 11 employees in Europe and three employees in Japan. As of December 31, 2006, all employee severance and termination costs have been paid and there is no remaining facility closing liability associated with those actions.

  IMPAIRMENT OF INTANGIBLE ASSETS

     We perform our annual impairment test for goodwill in the fourth quarter. However, whenever events or circumstances indicate that the carrying value of our goodwill or other intangible assets may not be recoverable, we perform tests for impairment of these assets and record impairment charges, as necessary. Such events or circumstances include downturns or anticipated downturns in the industries in which we serve, changes in customer technology requirements, and other changes in circumstances affecting the underlying value of the recorded asset.

     During the fourth quarter of 2004, in conjunction with our financial forecasting for future periods, it was evident that projected cash flows from certain customers of the Dressler product line were substantially below amounts previously projected. The projected cash flows were considered in determining the fair value of certain contract-based and other amortizable intangible assets recorded at acquisition and also in subsequent periods to assess such assets for potential impairment. Due to the decline in projected cash flows, we performed assessments of the carrying values of the related amortizable intangible assets. These assessments 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 through the use of projected cash flows based upon projected revenue streams over the life of the asset, discounted at rates consistent with the risk of the related cash flows. Based on this analysis we determined that the fair values of certain intangible assets were below the respective carrying values, and recorded impairment charges of approximately $2.9 million, which has been reported as an impairment of intangible assets in the accompanying consolidated statement of operations.

     Also during the fourth quarter of 2004, in conjunction with our restructuring plan, employees who were the subject of certain contract-based amortizable intangibles left the Company or their responsibilities were significantly altered. As a result, we performed assessments of the carrying values of the related amortizable intangible assets. These assessments 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 through the use of a lost profits method of determining the fair value, arriving at projected cash flows which were then discounted at rates consistent with the risk of the related cash flows. Based on this analysis we determined that the fair values of certain intangible assets were below the respective carrying values, and recorded impairment charges of approximately $397,000, which has been reported as an impairment of intangible assets in the accompanying consolidated statement of operations.

  OTHER INCOME (EXPENSE)

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

     Income from investments and cash was approximately $3.7 million, $2.9 million and $1.7 million in 2006, 2005 and 2004, respectively. The increase in income from investments was primarily due to our higher level of cash, cash equivalents and marketable securities generated from operations and net proceeds from our public offering of 11.5 million shares. This was offset in 2005 by our use of those proceeds to redeem our convertible subordinated notes in September 2005.

     Interest expense consisted principally of interest on our convertible subordinated notes, on borrowings under capital lease facilities and senior debt, and amortization of our deferred debt issuance costs. Interest expense was approximately $413,000, $8.2 million and $11.0 million in 2006, 2005 and 2004, respectively. The decrease was due primarily to the redemption of our convertible subordinated notes in September 2005.

     Our foreign subsidiaries’ sales are primarily denominated in currencies other than the United States dollar. We recorded net foreign currency loss of $206,000 in 2006 and a net foreign currency gain of $243,000 and $1.0 million in 2005 and 2004, respectively.

     Debt extinguishment expense of $3.2 million in 2005 resulted from the redemption of our convertible subordinated notes with a total principal balance of $187.7 million. The expense of $3.2 million is comprised of $2.1 million for redemption premium and $1.1 million for the write-off of deferred debt issuance costs.

     Net other income (expense) consists principally of miscellaneous gains and losses, including gains and losses on the sale of investments and impairments of investments.

  PROVISION 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 the expected tax rates for the periods in which the assets or liabilities will be realized, as well as for the expected tax benefit of net operating loss and tax credit carryforwards. Since 2003, we have recorded valuation allowances against certain of our United States and foreign net deferred tax assets in jurisdictions where we have incurred significant losses. Given such experience, prior to December 31, 2006, management could not conclude that it was more likely than not that these net deferred tax assets would be realized. Based on our 2006 operating results, our management, in accordance with SFAS No. 109, evaluated the recoverability of its net deferred tax assets and concluded that it was more likely than not that the majority of net deferred tax assets would be realized and recorded a reduction in the valuation allowance of approximately $23.5 million at December 31, 2006. The reduction in the valuation allowance was $39.3 million for the entire year. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period in which those difference become deductible the timing and amount of which is uncertain. Approximately $5.3 million of net deferred tax assets at December 31, 2006 related to certain U.S. net operating losses that are subject to limitations under the US tax code. These assets continue to have a full valuation allowance as management could not conclude that it was more likely than not that these net deferred tax assets would be realized. Additionally, approximately $3.0 million of the December 31, 2006 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. Please refer to Note 13 Income Taxes included in Part II, Item 8 of this Form 10-K for further discussion regarding income taxes.

     We assess the recoverability of our net deferred tax assets on a quarterly basis. If we determine that it is more likely than not that we will realize a portion or all of our remaining net deferred tax assets, some portion or all of the valuation allowance will be reversed with a corresponding reduction in income tax expense in such period.

     The income tax benefit of $15.1 million in 2006 represents an effective tax rate on income from continuing operations of (21)%. This negative rate includes the impact of the reversal of the valuation allowance. The income tax provision of $4.9 million in 2005 represents an effective tax rate on income from continuing operations of 57% and the income tax provision of $3.9 million in 2004 represents an effective tax rate on income from continuing operations of negative 37%, due to taxable income earned in certain foreign jurisdictions. The Company’s income from discontinued operations earned in prior periods was earned in the United States. No provision for income taxes is attributed to these discontinued operations, due to the valuation allowances against certain deferred tax assets in the United States that existed in those periods, including those generated by net operating losses.

     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. At December 31, 2006, approximately $2.9 million of the valuation allowance related to deferred tax assets obtained through acquisition. Any reversals of valuation allowances recorded in purchase accounting will be reflected as a reduction of goodwill in the period of reversal. For the year ended December 31, 2006, $3.7 million of valuation allowances established in purchase accounting were reversed with a corresponding reduction in goodwill.

DISCONTINUED OPERATIONS

     Income from discontinued operations was $1.1 million, $9.2 million and $1.9 million in 2006, 2005 and 2004, respectively. In 2005, we sold the assets of our EMCO product line and our IKOR product line, as they were not critical to our core operations. We recognized a gain on the sale of the EMCO product line of $2.9 million and a gain on the sale of the IKOR product line of $5.0 million. Because the EMCO product line has not represented a significant portion of our operations, with revenues representing 1.6% of annual consolidated sales in 2004 and 1.8% through its sale on June 24, 2005, and represents an insignificant portion of our operating results for all periods presented, we have not reclassified the results of operations of the EMCO product line to income from discontinued operations. The results of operations of the IKOR product line have been reclassified to income from discontinued operations, which results include income of $1.3 million and $1.9 million in 2005 and 2004, respectively. No provision for income taxes is attributed to these operations due to the valuation allowances against certain deferred tax assets in the United States, as the income from our discontinued operations was earned in the United States. In the second quarter of 2006, $138,000 held in escrow relating to the EMCO product line was released and in the forth quarter of 2006, $1.0 million held in escrow relating to the IKOR product line was released as various contingencies were resolved. These amounts were recorded as gains on the sale of discontinued assets.

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, 2006. 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.

		Quarters Ended
		Mar. 31,				June 30,				Sept. 30,				Dec. 31,				Mar. 31,				June 30,				Sept. 30,				Dec. 31,
		2005				2005				2005				2005				2006				2006				2006				2006
Sales		$	82,176			$	84,163			$	78,756			$	80,387			$	93,950			$	104,571			$	107,688			$	104,533
Gross profit			27,322				30,646				28,922				30,191				38,550				44,760				47,014				44,894
Income from operations			2,533				5,026				2,177				6,238				13,180				19,231				18,329				16,649
(Loss) income from continuing operations			(83	)			2,877				(4,203	)			5,031				12,761				18,025				16,992				39,406
Income from discontinued operations			817				3,072				312				4,994				—				138				—				1,000
Net income (loss)		$	734			$	5,949			$	(3,891	)		$	10,025			$	12,761			$	18,163			$	16,992			$	40,406
Diluted earnings (loss) per share		$	0.02			$	0.18			$	(0.10	)		$	0.22			$	0.28			$	0.40			$	0.38			$	0.89

		Quarters Ended
		Mar. 31,				June 30,				Sept. 30,				Dec. 31,				Mar. 31,				June 30,				Sept. 30,				Dec. 31,
		2005				2005				2005				2005				2006				2006				2006				2006
Percentage of Sales:
Sales			100.0	%			100.0	%			100.0	%			100.0	%			100.0	%			100.0	%			100.0	%			100.0	%
Gross profit			33.2	%			36.4	%			36.7	%			37.6	%			41.0	%			42.8	%			43.7	%			42.9	%
Income from operations			3.1	%			6.0	%			2.8	%			7.8	%			14.0	%			18.4	%			17.0	%			15.9	%
(Loss) income from continuing operations			(0.1	)%			3.4	%			(5.3	)%			6.3	%			13.6	%			17.2	%			15.8	%			37.7	%
Income from discontinued operations			1.0	%			3.7	%			0.4	%			6.2	%			—				0.1	%			—				1	%
Net income (loss)			0.9	%			7.1	%			(4.9	)%			12.5	%			13.6	%			17.4	%			15.8	%			38.7	%

     Our loss from continuing operations in the third quarter of 2005 included pretax charges of $3.2 million for debt extinguishment expenses (see Note 11 within Part II, Item 8) and $3.0 million for a litigation settlement (see Note 15 within Part II, Item 8).

     Liquidity and Capital Resources

     At December 31, 2006, our principal sources of liquidity consisted of cash, cash equivalents and marketable securities of $144.2 million, and a credit facility consisting of a $25.0 million revolving line of credit, none of which was outstanding at December 31, 2006. Borrowings under the revolving line of credit agreement are limited based upon letters of credit outstanding under this agreement and the lenders borrowing base calculation, which considers among other factors, our accounts receivable and inventory balances. Advances under the revolving line of credit would bear interest at the prime rate (8.25% at February 9, 2007) minus 1%. Any advances under this revolving line of credit will be due and payable in July 2007. 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, 2006.

     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. During 2006, our cash, cash equivalents and marketable securities increased $84.5 million, or 142%, to $144.2 million from $59.7 million at December 31, 2005, primarily due to cash generated from our operations. During 2005, our cash, cash equivalents and marketable securities decreased $48.3 million from $108.0 million at December 31, 2004 to $59.7 million at December 31, 2005, primarily due to the redemption of our convertible subordinated notes for $189.8 million, offset by the $105.5 million of net proceeds from our public offering of 11.5 million shares of common stock and $36.1 million of net cash provided by operating activities.

     Operating activities provided cash of $88.3 million 2006 and $36.1 million in 2005. The increase in cash generated from operations is primarily attributed to our increased profitability in 2006. Operating activities used cash of $11.4 million in 2004 primarily due to working capital changes.

     Investing activities used cash of $83.1 million in 2006 and provided cash of $67.0 million in 2005. Due to the significant cash generated from operations, in 2006 we purchased $79.4 million of marketable securities, compared to purchases of $87.2 million and sales of $151.7 million of marketable securities used to redeem a portion of the convertible subordinated notes in 2005. Capital expenditures in 2006 were $6.1 million, compared to capital expenditures of $10.8 million in 2005. Cash provided by investing activities in 2005 also reflects $8.9 million received on the sale of our IKOR product line and $3.9 million on the sale of our EMCO product line. Investing activities provided cash of $12.3 million in 2004, which primarily consisted of $23.8 million from proceeds on the net sale of marketable securities, offset by $14.0 million for the purchase of property and equipment.

     With the significant capital expenditures related to our investment in our manufacturing operations as well as our information technology infrastructure, we expect to increase our capital expenditures in 2007 to approximately $8.0 million. Our planned level of capital expenditures is subject to frequent revisions as our business experiences sudden changes. In addition, changes in foreign currency exchange rates may significantly impact our capital expenditures in a particular period.

     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 current operations, and as we transfer cash into marketable securities when we attain levels of cash that are greater than needed for current operations.

     Financing activities used cash of $741,000 in 2006, due primarily to $4.0 million in payments on our senior borrowings and capital lease obligations offset by the proceeds from the exercise of stock options of $2.9 million. Financing activities used cash of $86.0 million in 2005, primarily due to the redemption of our convertible subordinated notes offset in part by our public offering of common stock. During the third quarter of 2005, we raised $105.5 million in net proceeds from a public offering of 11.5 million shares of common stock. With these proceeds we fully redeemed the 5.25% convertible subordinated notes due November 15, 2006. This redemption consisted of a $66.2 million principal payment, $883,000 for redemption premium, and $1.1 million for interest through the redemption dates. After the redemption of the 5.25% convertible subordinate notes, proceeds of approximately $37.3 million remained. These proceeds together with approximately $88.9 million of cash, cash equivalents and marketable securities were used to redeem the 5.0% convertible subordinated notes due September 1, 2006. This redemption consisted of a $121.5 million principal payment, $1.2 million for redemption premium, and $3.5 million for interest through the redemption dates. Financing activities used cash of $5.2 million in 2004, which primarily consisted of payments on our senior borrowings and capital lease obligations, partially offset by proceeds from the exercise of employee stock options and sale of common stock through our employee stock purchase plan and in 2004 proceeds of a senior borrowing used to purchase a building in South Korea.

     We expect our financing activities to continue to fluctuate in the future. Our payments under capital lease obligations and other borrowings may also increase in the future if we enter into additional capital lease obligations or change the level of our bank financing.

          OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS

     Our off-balance sheet liabilities primarily consist of lease payment obligations incurred under operating leases. The following table sets forth our future payments due under operating lease obligations as of December 31, 2006.

		Payments Due by Period (In thousands)
		2007				2008				2009				2010				2011				Thereafter				Total
Operating lease obligations		$	5,557			$	4,947			$	3,831			$	2,724			$	1,758			$	6,060			$	24,877

     Other commitments as of December 31, 2006 include $5.3 million in non-cancelable purchase order obligations related primarily to inventory purchases. We expect to receive and pay for these materials and services in 2007 in the normal course of business. Please refer to Note 15 Commitments And Contingencies included in Part II, Item 8 of this Form 10-K for further discussion regarding our long-term debt and capital lease obligations.

     We believe that our working capital, together with cash anticipated to be generated by operations will be sufficient to satisfy our anticipated liquidity requirements for the next twelve months.

Critical Accounting Policies and Estimates

     The above 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 consolidated 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 have evaluated the accounting policies used in the preparation of the consolidated financial statements and related notes under Part II, Item 8 of this Form 10-K and believe that our accounting policies are reasonable and appropriate. We believe that the following critical accounting policies, among others, are most critical as they relate to our more significant judgments and estimates used in the preparation of our consolidated financial statements.

     REVENUE RECOGNITION — Our standard shipping term is free 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, we have 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 certain customer acceptance provisions are deferred until customer acceptance occurs. Generally, we do not have obligations to our 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, 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 instances, we require our customers to pay for a portion or all of their purchases prior to building 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 the transfer of title of the products.

We do not offer price protections to its customers or allow returns, unless covered by its normal policy for repair of defective products.

     WARRANTY POLICY — We offer warranty coverage for our products for periods typically ranging from 12 to 24 months after shipment. We estimate the anticipated costs of repairing products under warranty based on the historical cost of the repairs, adjusted for inflation, and expected failure rates. Unanticipated product failures or exceptional product performance can result in changes to our future liability. The assumptions used to estimate warranty accruals are reevaluated quarterly, at a minimum, in light of actual experience and, when appropriate, the accruals are adjusted. Our determination of the appropriate level of warranty accrual is based on estimates. Estimated warranty costs are recorded at the time of sale of the related product, and are recorded within cost of sales in the consolidated statements of operations.

     EXCESS AND OBSOLETE INVENTORY— Inventory is written down or written off when it becomes obsolete, generally due to engineering changes to a product, discontinuance of a product line, or when it is deemed excess. Judgment by management is necessary in estimating the net realizable value of inventory. Charges for excess and obsolete inventory are recorded, as necessary, within cost of sales in the consolidated statement of operations. We analyze both forecasted and historical demand on a quarterly basis.

     STOCK-BASED COMPENSATION — On January 1, 2006, we adopted the provisions of SFAS No. 123(R) to account for our stock plans and employee stock purchase plan, which requires the recognition of the fair value of stock-based compensation in the statement of operations. The fair value of stock options and purchase rights pursuant the employee stock purchase plan is estimated using the Black-Scholes valuation model. This model requires the input of highly subjective assumptions, including expected life of the award and expected stock price volatility. The fair value of restricted stock units is determined based upon our closing stock price on the grant date. The fair value of stock-based awards is amortized over the requisite service period, typically the vesting period, of the award on a straight-line basis.

     COMMITMENTS AND CONTINGENCIES — From time to time we are involved in disputes and legal actions arising in the normal course of our business (see Item 3 within Part I and Note 14 within Part II, Item 8). While we currently believe that the amount of any ultimate 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 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 commitments and contingencies, including litigation, when it is probable that a loss has occurred and the amount of the loss can be reasonably estimated.

     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 the tax rates expected in the period that the assets or liabilities are realized, as well as for the expected tax benefit of net operating loss and tax credit carryforwards. We assess the recoverability of our net deferred tax assets on a quarterly basis. Our assessment includes a number of factors, including historical results and income projections for each jurisdiction. If the Company determines that it is more likely than not that it will realize a portion or all of its remaining net deferred tax assets, some portion or all of the valuation allowance will be reversed with a corresponding reduction in income tax expense in such period.

     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 and certain other intangible assets with indefinite lives are not amortized. Instead, goodwill and other indefinite-lived intangible assets are subject to periodic (at least annual) tests for impairment. For the periods presented, we did not have any indefinite-lived intangible assets, other than goodwill. Impairment testing is performed in two steps: (i) we assess goodwill for potential impairment by comparing the fair value of our 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, we measure the amount of impairment loss by comparing the implied fair value of goodwill with the carrying amount of that goodwill.

     Finite-lived intangible assets continue to be 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.

Recent Accounting Pronouncements

     RECENT ACCOUNTING PRONOUNCEMENTS — In July 2006, the Financial Accounting Standards Board (the “FASB”) issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109”, which clarifies the accounting for uncertainty in tax positions. FIN No. 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that it has taken or expects to take on a tax return. The provisions of FIN No. 48 are effective as of the beginning of our fiscal year beginning January 1, 2007, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. We are currently evaluating the impact of adopting FIN No. 48 and at this time have not determined what the impact will be.

     In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (SAB 108). Due to diversity in practice among registrants, SAB 108 expresses SEC staff views regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether financial statement restatement is necessary. SAB 108 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. The adoption of SAB 108 did not have an impact on our financial position, results of operations or cash flows.

     In September 2006, the FASB issued Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“FAS 158”). Among other items, FAS 158 requires recognition of the overfunded or underfunded status of an entity’s defined benefit postretirement plan as an asset or liability in the financial statements, requires the measurement of defined benefit postretirement plan assets and obligations as of the end of the employer’s fiscal year, and requires recognition of the funded status of defined benefit postretirement plans in other comprehensive income. FAS 158 is effective for fiscal years ending after December 15, 2006, and early application is encouraged. The adoption of FAS 158 did not have a material impact on our financial position, results of operations or cash flows.

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, 2006, our investments in marketable securities consisted primarily of commercial paper, municipal bonds and notes and institutional money markets. These securities are highly liquid. Earnings on our marketable securities are typically invested into similar securities. We

believe that a 10% decrease in average interest rates on these instruments would not have a material effect on our financial condition and 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. 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, Taiwanese dollar, South Korean won and Chinese yuan. The notional amount of our foreign currency contracts at December 31, 2006 was $8.7 million. The potential fair value loss for a hypothetical 10% adverse change in foreign currency exchange rates at December 31, 2006, would be approximately $1.2 million, which would be essentially offset by corresponding gains related to the underlying assets. At December 31, 2006 we held foreign currency forward exchange contracts, maturing through January 2007, primarily to purchase U.S. dollars and sell various foreign currencies. The following table summarizes our outstanding contracts as of December 31, 2006:

						Market
						Settlement
		Notional				Amounts				Unrealized
(in thousands)		Amounts				(In thousands)				Gain/(Loss)
Purchase contracts:
British pound contract		$	700			$	695			$	5
Chinese yuan contract			500				499				1
European Euro contract			1,000				994				6
South Korean won contract			100				98				2
Taiwanese dollar contract			4,000				4,001				(1	)
Sales contract:
Japanese yen contract			2,400				2,346				(54	)
										$	(41	)

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

		Page
Reports of Grant Thornton LLP, Independent Registered Public Accounting Firm			25
Consolidated Balance Sheets as of December 31, 2006 and 2005			27
Consolidated Statements of Operations for the Years Ended December 31, 2006, 2005 and 2004			29
Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the Years Ended December 31, 2006, 2005 and 2004			30
Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004			31
Notes to Consolidated Financial Statements			32
Schedule II – Valuation and Qualifying Accounts			51

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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 (together the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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 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, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 1 to the consolidated financial statements, the Company adopted the Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, on January 1, 2006.

Our audits were conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule II is presented for purposes of additional analysis and is not a required 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, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Advanced Energy Industries, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 15, 2007 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ GRANT THORNTON LLP

Denver, Colorado
February 15, 2007

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that Advanced Energy Industries, Inc. (a Delaware Corporation) and subsidiaries (together the “Company”) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Advanced Energy Industries, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that Advanced Energy Industries, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by COSO. Also in our opinion, Advanced Energy Industries, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by COSO.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Advanced Energy Industries, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2006 and our report dated February 15, 2007 expressed an unqualified opinion on those financial statements.

/s/ GRANT THORNTON LLP

Denver, Colorado
February 15, 2007

ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

		December 31,
		2006				2005
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	58,240			$	52,874
Marketable securities			85,978				6,811
Accounts receivable — trade, net			71,956				64,900
Inventories, net			52,778				56,199
Deferred income taxes			24,434				—
Other current assets			7,341				10,865
Total current assets			300,727				191,649
PROPERTY AND EQUIPMENT, net			33,571				39,294
OTHER ASSETS:
Deposits and other			2,640				3,808
Goodwill			58,679				61,316
Other intangible assets, net			6,905				8,527
Customer service equipment, net			832				2,407
Deferred income tax assets, net			8,549				3,116
Total assets		$	411,903			$	310,117

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

ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

		December 31,
		2006				2005
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Trade accounts payable		$	16,310			$	22,028
Taxes payable			7,741				5,538
Accrued payroll and employee benefits			16,899				8,313
Accrued warranty expense			7,845				6,313
Accrued restructuring charges			—				616
Other accrued expenses			3,252				2,226
Customer deposits and deferred revenue			751				971
Capital lease obligations, current portion			131				196
Senior borrowings, current portion			—				1,815
Total current liabilities			52,929				48,016
LONG-TERM LIABILITIES:
Capital leases, net of current portion			198				270
Senior borrowings, net of current portion			—				1,909
Deferred income tax liabilities, net			1,971				—
Other long-term liabilities			1,015				2,492
Total long-term liabilities			3,184				4,671
Total liabilities			56,113				52,687
COMMITMENTS AND CONTINGENCIES (Note 15)
STOCKHOLDERS’ EQUITY:
Preferred stock, $0.001 par value, 1,000 shares authorized, none issued and outstanding			—				—
Common stock, $0.001 par value, 70,000 shares authorized; 44,855 and 44,500 shares issued and outstanding at December 31, 2006 and 2005, respectively			45				45
Additional paid-in capital			258,688				253,675
Retained earnings			88,344				22
Deferred compensation			—				(1,290	)
Unrealized holding gains on available-for-sale securities, net			323				1,328
Cumulative translation adjustments			8,390				3,650
Total stockholders’ equity			355,790				257,430
Total liabilities and stockholders’ equity		$	411,903			$	310,117

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

ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

		2006				2005				2004
SALES		$	410,742			$	325,482			$	380,537
COST OF SALES			235,524				208,401				265,911
GROSS PROFIT			175,218				117,081				114,626
OPERATING EXPENSES:
Research and development			44,848				39,720				49,004
Selling, general and administrative			62,870				55,681				61,851
Litigation settlement			—				3,000				—
Restructuring charges			111				2,706				3,912
Impairment of intangible assets			—				—				3,326
Total operating expenses			107,829				101,107				118,093
INCOME (LOSS) FROM OPERATIONS			67,389				15,974				(3,467	)
OTHER INCOME (EXPENSE):
Interest income			3,659				2,866				1,737
Interest expense			(412	)			(8,171	)			(11,049	)
Foreign currency (loss) gain			(206	)			243				1,023
Debt extinguishment expense			—				(3,180	)			—
Other income, net			1,636				763				1,033
Total other income (expense), net			4,677				(7,479	)			(7,256	)
Income (loss) from continuing operations before income taxes			72,066				8,495				(10,723	)
BENEFIT (PROVISION) FOR INCOME TAXES			15,118				(4,873	)			(3,947	)
INCOME (LOSS) FROM CONTINUING OPERATIONS			87,184				3,622				(14,670	)
Gain on sale of discontinued assets			1,138				7,855				—
Results of discontinued operations			—				1,340				1,923
INCOME FROM DISCONTINUED OPERATIONS			1,138				9,195				1,923
NET INCOME (LOSS)		$	88,322			$	12,817			$	(12,747	)
BASIC EARNINGS (LOSS) PER SHARE
Income (loss) from continuing operations		$	1.95			$	0.10			$	(0.45	)
Income from discontinued operations		$	0.03			$	0.25			$	0.06
NET INCOME (LOSS) PER SHARE		$	1.98			$	0.35			$	(0.39	)
DILUTED EARNINGS (LOSS) PER SHARE
Income (loss) from continuing operations		$	1.93			$	0.10			$	(0.45	)
Income from discontinued operations		$	0.03			$	0.25			$	0.06
NET INCOME (LOSS) PER SHARE		$	1.95			$	0.34			$	(0.39	)
BASIC WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING			44,721				37,084				32,649
DILUTED WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING			45,265				37,434				32,649

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

ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME