- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED). For the fiscal year ended December 31, 1997. [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED). For the transition period from __________ to __________. Commission file number: 0-26966 ADVANCED ENERGY INDUSTRIES, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) DELAWARE 84-0846841 (State or other jurisdiction of incorporation (I.R.S. Employer or organization) 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: NONE Securities registered pursuant to section 12(g) of the Act: COMMON STOCK, $0.001 PAR VALUE (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ No __. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's 1
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 [X]. As of January 31, 1998, there were 22,500,007 shares of the Registrant's Common Stock outstanding and the aggregate market value of such stock held by non-affiliates of the Registrant was $101,827,588 (based on the closing price on the Nasdaq Stock Market). DOCUMENTS INCORPORATED BY REFERENCE Portions of the annual shareholders report for the year ended December 31, 1997, are incorporated by reference into Parts I and II of this Form 10-K. Portions of the Company's definitive proxy statement for the annual shareholders meeting to be held May 6, 1998, are incorporated by reference into Part III of this Form 10-K. 2
ADVANCED ENERGY INDUSTRIES, INC. FORM 10-K TABLE OF CONTENTS PART I ITEM 1. BUSINESS 4 EXECUTIVE OFFICERS OF THE REGISTRANT 23 ITEM 2. PROPERTIES 25 ITEM 3. LEGAL PROCEEDINGS 25 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 25 PART II ITEM 5. MARKET PRICE FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS 26 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA 27 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 28 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 40 ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES 59 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 59 ITEM 11. EXECUTIVE COMPENSATION 59 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 59 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 59 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 60 3
PART I ITEM 1. BUSINESS GENERAL Advanced Energy is a leading supplier of power conversion and control systems most of which are incorporated in plasma-based thin film production equipment. The Company's systems are key elements of semiconductor, data storage, flat panel display, and a range of other industrial manufacturing equipment that utilizes gaseous plasmas to deposit or etch thin film layers on materials or substrates such as silicon, glass and metals. As a result of a recent acquisition, the Company now provides power supplies for non-plasma-based processes. The effectiveness of plasma-based production processes depends in large part on the characteristics of the electrical power used to ignite and maintain the plasma. The Company's power conversion and control systems refine, modify and control the raw power from a utility and produce the power required to obtain predictable and repeatable film characteristics. The Company's systems are used in an array of thin film processes such as physical vapor deposition, etch, chemical vapor deposition, plasma-enhanced chemical vapor deposition and ion implantation, as well as a broad range of thin film applications such as the production of semiconductors, magnetic hard disks, CD-ROMs, audio and video discs, thin film heads, liquid crystal displays and optical, glass and automobile coatings. The Company's customers for thin film applications include Applied Materials, Lam Research, Balzers/Leybold, Materials Research, Multi-Arc, and Ulvac. In recent years, significant technological advances in thin film processes have enabled the manipulation of materials on the atomic and molecular level. Manufacturers can now both deposit and etch layers of materials that are less than one-hundredth of a micron in thickness. By using modern thin film production processes, manufacturers are better able to control and alter the electrical, magnetic, optical and mechanical characteristics of materials. Thin film processes have been employed most extensively in the semiconductor industry, where multiple thin film layers of insulating or conductive material are deposited on a wafer or substrate. These processes are now used in a growing range of diverse industries. Thin film production was initially accomplished using either liquid chemical or thermal processes. Plasma-based process technology was developed to address the limitations of wet chemistry and thermal technologies in certain applications requiring thinner, more precise film, and to enable new applications. The Company is seeking, as part of its long-term strategy, opportunities that will allow it to diversify and generate business in growth sectors that are not related to the thin film applications that the Company has historically served. The first step in achieving that objective was the acquisition of Tower Electronics in August 1997. Tower designs and manufactures products for non-thin film applications including power supplies for use in modems, non-impact printers, night vision goggles and laser devices. The acquisition of Tower expands the Company's technology and customer base. Representative customers 4
of Tower include U.S. Robotics, Videojet International and ITT. The Company has achieved its market leadership position by providing systems which convert externally supplied power, operate over a wide range of power levels, control utility instabilities such as brownouts and surges created by raw utility power sources, and control intense localized electrical discharges known as arcs and control system instabilities which arise from the use of exotic gases and inherently unstable electrode arrangements. Most of the Company's products employ sophisticated switchmode technology that affords plasma-based systems the ability to minimize arc energy, which can slow down the throughput of a plasma process and may even destroy the substrate or the power conversion and control system. The Company believes the combination of its in-depth knowledge of plasma physics, its unique approach to product customization and its reusable engineering product design methodology have enabled it to develop the widest range of power conversion and control systems in the industry. Since inception, the Company, excluding Tower, has sold over 100,000 power conversion and control systems. Approximately 64% of the Company's sales in 1996 and 58% in 1997 were to the semiconductor equipment industry. Advanced Energy sells its systems primarily through direct sales personnel to customers in the United States, Japan and Europe. The Company also sells through distributors in Singapore, China, Japan, France, Italy, Israel, South Korea and Taiwan. International sales represented 24% and 25% of the Company's sales in 1996 and 1997, respectively. DEVELOPMENT OF COMPANY BUSINESS Advanced Energy was incorporated in Colorado in 1981 and reincorporated in Delaware in September 1995. In November 1995, the company effected the initial public offering of its common stock, $0.001 par value ("Common Stock"), pursuant to a registration statement on Form S-1 under the Securities Act of 1933, as amended (the "Securities Act"). In October 1997, the Company effected a second public offering of its Common Stock pursuant to a registration statement on Form S-3 under the Securities Act. As used in this Form 10-K, references to "Advanced Energy" refer to Advanced Energy Industries, Inc. and references to the "Company" refer to Advanced Energy and its consolidated subsidiaries. The Company's principal executive offices are located at 1625 Sharp Point Drive, Fort Collins, Colorado 80525, and its telephone number is (970) 221-4670. PRODUCTS The Company's switchmode power conversion and control technology products have enabled its customers to develop new plasma processing applications. In 1982, the Company introduced its first low-frequency switchmode power conversion and control system specifically designed for use in plasma processes. In 1983, the Company 5
introduced its first direct current (DC) system designed for use in PVD sputtering applications. This DC-based system is a compact, cost-effective power solution, which greatly reduced stored energy, a major limitation in PVD systems. In the early 1990's the Company introduced the first fully switchmode radio frequency (RF) power conversion and control systems for use in semiconductor etch applications. This product achieved significant design wins because of its smaller size and precise control. The Company introduced a family of accessories for the DC product line in 1993; these pulsed DC products provide major improvements in arc prevention and suppression. The Company is currently extending the power range of its systems to much higher power levels to enable it to supply products for emerging industrial applications. The Company's products currently range in price from $2,880 to $80,000, with an average price of approximately $10,000. As a result of an acquisition in August 1997, the Company expanded its product line to include low-power DC power supplies for use in telecommunications and other industrial applications. These power supplies range in power from 50 watts to 600 watts and have an average selling price of about $500. The following chart sets forth the Company's principal product lines and related basic information: 6
<TABLE> - -------------------------------------------------------------------------------- PRODUCT POWER/CURRENT MAJOR PROCESS PLATFORM DESCRIPTION LEVEL APPLICATIONS - -------------------------------------------------------------------------------- <S> <C> <C> <C> <C> MDX Power control 500W-80kW PVD and - Metal conversion sputtering system - Reactive sputtering ----------------------------------------------------------------- DIRECT MDX-II Power control 15kW-120kW PVD and - Metal conversion sputtering system - Reactive CURRENT sputtering ----------------------------------------------------------------- Pinnacle Power control 6kW-120kW PVD -TM- and - Metal PRODUCTS conversion sputtering system - Reactive sputtering ----------------------------------------------------------------- Sparc-le Arc management 1kW-60kW For use with MDX -Registered accessory systems -- Trademark- permits precise control of reactive sputtering of insulating films ----------------------------------------------------------------- E-Chuck Electrostatic < 100W General wafer chuck power handling in system semiconductor PVD, CVD, and etch applications - -------------------------------------------------------------------------------- HIGH-POWER Astral-TM- Pulsed DC power 20kW PVD - 20 system - Metal sputtering - Reactive sputtering ----------------------------------------------------------------- PRODUCTS Astral-TM- Pulsed DC power 120kW PVD - 120 system - Metal sputtering - Reactive sputtering ----------------------------------------------------------------- Crystal-TM- Multizone 120kW Semiconductor induction epitaxy heating power system - -------------------------------------------------------------------------------- PE Low-frequency 1.25kW-30kW CVD LOW- AND MID- power control PVD and - Reactive conversion sputtering system Surface FREQUENCY modification ----------------------------------------------------------------- PD Mid-frequency 1.25kW-8kW CVD PRODUCTS power control PVD and - Reactive conversion sputtering system Surface modification - -------------------------------------------------------------------------------- HFV/HFG Power control 3kW-8kW PVD and conversion Etch system ----------------------------------------------------------------- RADIO RFX Power control 600W General R&D and conversion system ----------------------------------------------------------------- FREQUENCY RFG Power control 600W-5.5kW Etch and conversion CVD system ----------------------------------------------------------------- PRODUCTS RFXII Power control 600W-5.5kW Etch and conversion CVD system ----------------------------------------------------------------- AZX Tuner 100W-5kW Impedance matching network - -------------------------------------------------------------------------------- OTHER RFZ Probe 50W-5kW Impedance measurement tool ----------------------------------------------------------------- PRODUCTS ID Ion-beam 500W-5kW Ion-beam conversion and deposition control system Ion implantation Ion-beam etching/ milling - -------------------------------------------------------------------------------- </TABLE> DIRECT CURRENT PRODUCTS THE MDX SERIES. The Company's MDX series of products was introduced in 1983. These products are most commonly used as DC power supplies for PVD sputtering where precise control, superior arc prevention and suppression and low stored energy characteristics are required. They are also used as bias supplies for RF sputtering, tool coating and some etching systems. The MDX series consists of six different product lines that provide a range of power levels from 500W to 120kW. The Company's second generation product, the MDX II, was introduced in 1991 to support higher power levels, 7
to provide wider output range, and to meet strict European regulatory requirements. A model in the MDX series, the MDX-L, was designed for especially high reliability and was introduced in 1992. THE PINNACLE SERIES-TM-. The Pinnacle series, introduced in 1995, is the most recent platform in the DC product line. Pinnacle was developed primarily for use in DC PVD sputtering processes and provides substantial improvements in arc prevention, arc suppression capability, reduced size, higher precision and expanded control capability. The low stored energy of Pinnacle, a basic feature of AE power conversion equipment, is the lowest ever achieved in a switchmode power supply, and is due to the patented basic circuit topology. SPARC-LE-Registered Trademark- ACCESSORIES. The Company's Sparc-le line of DC accessories, introduced in 1993, is designed both to reduce the number of arcs that occur in plasma-based processes and to reduce the energy delivered if arcs do occur. The Sparc-le accessories are especially effective in applications involving the deposition of insulative materials where the reaction between the plasma and target is likely to produce more severe arc conditions. The Sparc-le accessories are most commonly used with the MDX product lines. The Sparc-le arc prevention and suppression technology has been incorporated directly into the Pinnacle systems. ELECTROSTATIC CHUCK POWER SYSTEMS. This system of power conversion units was designed for a specific customer to be used in wafer handling systems for the semiconductor fabrication market. The electrostatic chuck is a device which uses electric fields to hold (or "chuck") a wafer in a vacuum environment without mechanical holding force. This permits more gentle handling of the wafer and its simultaneous heating or cooling during processing. The electric fields used to hold the wafer are created by applying to the wafer a voltage produced by the Advanced Energy power system. Exact control and careful ramping of the voltage permits the wafer to be picked and placed with precision. The system permits multiple power units to be held in a single chassis for ease of integration into the customer's system. HIGH-POWER PRODUCTS These products are designed for use in heavy industrial processes such as architectural glass and other large area coating applications. The Astral-TM-products, made in both 20kW and 120kW versions, offer a new technology, called "current pulsed dual magnetron sputtering," heretofore unavailable. The first of these units are in experimental use in development of coatings for CRT displays, automotive applications, and new types of glass coatings. The Crystal-TM- 120kW power conversion unit was developed for multizone induction heating in heating systems for semiconductor processing equipment in which layers are formed on heated semiconductor wafers by chemical vapor deposition, producing 8
epitaxial growth (the growth of a single crystal film as determined by the underlying wafer). One of the problems in forming such layers on a semiconductor wafer is ensuring that the temperature of the semiconductor wafer is kept uniform across the wafer during the deposition process, i.e., during heat-up, processing and cool-down. Since the deposition rate of a layer of material upon the wafer is dependent on the temperature of the wafer, any temperature variations between the center and edge of a wafer will undesirably result in the deposition of a layer of non-uniform thickness on the wafer. The multizone capability of the Crystal 120kW power conversion unit permits the furnace system to divide the wafer heater into up to six zones, and control power to each zone independently. LOW- AND MID-FREQUENCY PRODUCTS THE PE AND PD SERIES. The PE low-frequency power systems were introduced in 1982. The PE series systems are air cooled and primarily intended for use in certain PVD, CVD and industrial surface modification applications, including dual cathode sputtering and printed circuit board de-smearing. The PE series systems range in frequency from 25kHz to 100kHz. The low-frequency PE systems and the PD series of mid-frequency power conversion and control systems, introduced in 1990, represented significant technological advancements by applying switchmode techniques to higher frequencies. The water-cooled PD systems are used primarily in semiconductor etch and CVD applications. The PD series range in frequency from 275kHz to 400kHz. Both the PE and PD series systems have single-stage power generation, and include systems that incorporate pulsed power technology. RADIO FREQUENCY PRODUCTS THE HFV AND HFG POWER GENERATORS. The HFV unit produces 3, 5, or 8kW of power at a variable frequency of about 2MHz for powering of inductively coupled plasma (ICP) systems. It is water cooled and ultra compact, providing up to 8kW of power in a 5-1/4 inch rack mount enclosure 20-1/4 inches deep, thereby representing the highest power density in the industry. The HFG unit is similar but produces 8kW at a fixed frequency of 4MHz. THE RF SERIES. The RFX system is a 13.56MHz, 600W, air-cooled platform introduced in 1985. This low-power system is used primarily in research and development applications. The RFG and RFXII, introduced in 1991 and 1992, respectively, are water-cooled power conversion and control systems utilizing a new hybrid switchmode technology. The RFG and RFXII systems operate at frequencies ranging from 4MHz to 13.56MHz. These systems were the first entirely switchmode RF designs. These RF systems are most commonly used in semiconductor processes, including RF sputtering, plasma etching/deposition, and reactive ion etching applications. The Company also produces the RFXII in a compact version which incorporates new Fixed Match-TM- impedance matching technology. This technology eliminates certain previously required motors, gear trains, variable capacitors and inductors and 9
servomechanism circuitry, which results in cost savings and improvements in reliability. THE AZX SERIES. The AZX series tuners are RF matching networks designed as accessories to match the complex electrical characteristics of a plasma to the requirements of the Company's RF series of power conversion and control systems. AZX tuners, introduced in 1989, are also sold separately for incorporation into other vendors' power conversion and control systems. The AZX tuners typically operate at a 13.56MHz frequency range. The need for these tuner products is reduced with the advent of the Fixed Match technology designed as part of the RFXII product line. OTHER PRODUCTS THE RFZ IMPEDANCE PROBE. The RF impedance probe, introduced in 1993, is used for measuring the RF properties of a plasma. The sensing technology incorporated in the RF impedance probe allows accurate, real-time measurement of power, voltage, current and impedance levels under actual powered process conditions. THE ID SERIES. The ID power conversion and control systems, introduced in 1981, were the first products designed by the Company. These systems were specifically designed to power broad-beam ion sources. ID series systems are composed of a coordinated set of multiple special purpose power supplies that are used for ion-beam deposition and sputtering, implantation and etching and milling. MARKETS AND CUSTOMERS MARKETS Approximately 64% of the Company's sales in 1996 and 58% in 1997 were to the semiconductor equipment industry. Increasingly, the Company's power conversion and control systems are also being used in other markets, including flat panel display, data storage and various industrial applications. The following is a discussion of the major markets for the Company's systems: SEMICONDUCTOR MANUFACTURING EQUIPMENT MARKET. The Company's products are sold primarily to semiconductor equipment manufacturers for incorporation into equipment used to make integrated circuits. The Company's products are currently employed in a variety of applications including deposition, etch, ion implantation and megasonic cleaning. The precision control over plasma processes that use the Company's power conversion and control systems enables the production of integrated circuits with reduced feature sizes and increased speed and performance. The Company anticipates that the semiconductor equipment industry will continue to be a substantial part of its business for the foreseeable future. 10
FLAT PANEL DISPLAY MANUFACTURING EQUIPMENT MARKET. The Company also sells its systems to manufacturers of flat panel displays (FPDs) and flat panel projection devices (FPPs) which have fabrication processes similar to those employed in manufacturing integrated circuits. FPDs produce bright, sharp, large, color-rich images on flat, lightweight screens such as portable computer monitors. Currently there are three major types of FPDs: liquid crystal displays, field emitter displays and gas plasma displays. Two types of FPP, another emerging display technology, are currently in production: liquid crystal projection and digital micro-mirror displays. The Company sells its products to all three of the active FPD markets, as well as to each of the FPP markets. DATA STORAGE MANUFACTURING EQUIPMENT MARKETS. The Company's products are sold to data storage equipment manufacturers and to data storage device manufacturers for use in producing a variety of products, including compact discs, computer hard disks (both media and thin film heads), CD-ROMs and digital video discs (DVD). These products use a PVD sputtering process to produce optical and magnetic thin film layers, as well as a protective wear layer. In this market the trend towards higher recording densities is driving the demand for increasingly dense, thinner and more precise films. The use of equipment incorporating magnetic media to store analog and digital data continues to expand with the growth of the laptop, desktop, and workstation computer markets. THIN FILM INDUSTRIAL MARKETS. The Company sells its products to both OEMs and producers of end products in a variety of industrial markets. Thin film optical coatings are used in the manufacture of many industrial products including solar panels, architectural glass, eyeglasses, lens coatings, bar-code readers and front surface mirrors. Thin films of diamond coatings and other materials are now being applied to products in plasma-based processes to strengthen and harden surfaces on such diverse products as tools, automotive parts and hip joint replacements. A variety of industrial packaging applications, such as decorative wrapping and food packaging, are also enabled by thin film processes utilizing the Company's products. 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 processing makes 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 the Company's other markets. OTHER INDUSTRIAL MARKETS. Tower Electronics sells low-wattage power supplies to OEMs in the telecommunications, non-impact printing and laser markets. As an example, Tower provides U.S. Robotics, a subsidiary of 3Com, with three models of power supplies that are used in modems for Internet service providers. They also provide products to the largest manufacturer of non-impact printers used for printing date codes and lot information on beverage cans. 11
APPLICATIONS The Company's products have been sold for use in connection with the following processes and applications: <TABLE> SEMICONDUCTOR DATA STORAGE FLAT PANEL DISPLAY INDUSTRIAL/RESEARCH ------------- ------------ ------------------ ------------------- <S> <C> <C> <C> Physical vapor Thin film heads Liquid crystal Optical coatings deposition displays Etching CD-ROMs Active matrix LCDs Automobile coatings Ion implantation Audio discs Digital micro- Food package mirror coatings Chemical vapor Recordable CDs Plasma displays Glass coatings deposition (metal and dielectric) Plasma-enhanced Hard disk Large flat panel Consumer products CVD magnetic media displays coatings Magnet field Hard disk carbon Field emission Circuit board etch- controls wear coatings displays back and de-smear Photo-resist Magneto-optic CDs LCD projection Photovoltaics stripping Megasonic cleaning Digital video Medical applications discs (DVD) Etch (post- Superconductors treatment) Diamond coatings Chemical, physical and materials research Telecommunications Non-impact printing </TABLE> CUSTOMERS The Company has sold its systems worldwide to more than 100 OEMs and directly to more than 500 end-user customers. Since inception, the Company has sold more than 100,000 power conversion and control systems. The Company's largest customers are involved principally in the semiconductor equipment market. The Company also has significant customers in the data storage equipment, flat panel display equipment and industrial markets. Sales to Applied Materials and Lam Research in 1995, 1996 and 1997 accounted in the aggregate for approximately 41%, 47% and 44% of total sales, respectively. The Company expects that sales of its products to Applied Materials and Lam Research will continue to account for a high percentage of its sales in the foreseeable future. Representative customers of the Company include: Applied Materials Lam Research Balzers/Leybold Materials Research division of Tokyo Electron CVC Products Motorola First Light Technology Novellus Fujitsu Optical Coating Laboratory Hewlett-Packard Sony IBM Sputtered Films Intevac Texas Instruments Komag Ulvac U.S. Robotics Verteq Videojet International MARKETING, SALES AND SERVICE The Company sells its systems primarily through direct sales personnel to customers 12
in the United States, Japan and Europe. The Company's sales personnel are located at the Company's headquarters in Fort Collins, Colorado, and in regional sales offices in Milpitas, California; Concord, Massachusetts; and Austin, Texas. To serve customers in Asia and Europe, the Company has offices in Tokyo, Japan; Filderstadt, Germany; Bicester, United Kingdom; and Seoul, South Korea; which have primary responsibility for sales in their respective markets. The Company also sells to customers in Japan through Landmark Technology Corporation and has distributors and sales representatives in Singapore, China, France, Italy, Israel, South Korea and Taiwan. The Company's Tower Electronics subsidiary, located in Fridley, Minnesota, sells through manufacturer's representatives. Sales outside the United States represented approximately 29%, 24% and 25% of the Company's total sales during 1995, 1996 and 1997, respectively. The Company expects sales outside the United States to continue to represent a significant portion of future sales. Although the Company has not experienced any significant difficulties in connection with its international sales, such sales are subject to certain risks, including exposure to currency fluctuations, the imposition of governmental controls, political and economic instability, trade restrictions, changes in tariffs and taxes, and longer payment cycles typically associated with international sales. The future performance of the Company will depend, in part, upon its ability to compete successfully in Japan, one of the largest markets for semiconductor fabrication equipment and flat panel display equipment, and a major market for data storage and other industrial equipment utilizing the Company's systems. The Japanese market has historically been difficult for non-Japanese companies to penetrate. Although the Company and a number of its significant non-Japanese customers have begun to establish operations in Japan, there can be no assurance that the Company or its customers will be able to maintain or improve their competitive positions in Japan. The Company believes that customer service and technical support are important competitive factors and are essential to building and maintaining close, long-term relationships with its customers. The Company maintains customer service offices in Fort Collins, Colorado; Milpitas, California; Tokyo, Japan; Filderstadt, Germany; Seoul, South Korea; and Tower Electronics in Fridley, Minnesota. The Company offers warranty coverage for its systems for periods ranging from 12 to 24 months after shipment against defects in design, materials and workmanship. MANUFACTURING The Company's manufacturing facilities are located in Fort Collins, Colorado and Fridley, Minnesota. The Company's manufacturing activities consist of the assembly and testing of components and subassemblies which are then integrated into 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 13
to customers. The Company purchases a wide range of electronic, mechanical and electrical components, some of which are designed to the Company's specifications. The Company does outsource some of its subassembly work. The Company relies on sole and limited source suppliers for certain parts and subassemblies. This reliance creates a potential inability to obtain an adequate supply of required components, and reduced control over pricing and time of delivery of components. An inability to obtain adequate supplies would require the Company to seek alternative sources of supply or might require the Company to redesign its systems to accommodate different components or subassemblies. This could prevent the Company from shipping its systems to its customers on a timely basis. However, if the Company were forced to seek alternative sources of supply, manufacture such components or subassemblies internally, or redesign its systems, this could prevent the Company from shipping its systems to its customers on a timely basis. INTELLECTUAL PROPERTY The Company has a policy of seeking patents on inventions governing new products or technologies as part of its ongoing research, development, and manufacturing activities. The Company currently holds twelve United States patents and two foreign patents covering various aspects of its products, and has other applications pending in the U.S., Europe and Japan. The Company believes the duration of its patents generally exceeds the life cycles of the technologies disclosed and claimed therein. No assurance can be given that the Company's patents will be sufficiently broad to protect the Company's technology, nor that any existing or future patents will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide meaningful competitive advantages to the Company. Any of such events could have a material adverse effect on the Company's business, financial condition and results of operations. Although the Company is not aware of any infringement by its products of any patents or proprietary rights of others, there can be no assurance that such infringements do not exist or will not occur in the future. Litigation may be necessary in the future to enforce patents issued to the Company, to protect trade secrets or know-how owned by the Company, to defend the Company against claimed infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. Any such litigation could result in substantial cost and diversion of effort by the Company, which could have a material adverse effect on the Company's business, financial condition and results of operations. Moreover, adverse determinations in such litigation could result in the Company's loss of proprietary rights, subject the Company to significant liabilities to third parties, require the Company to seek licenses from third parties or prevent the Company from manufacturing or selling its products, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. 14
COMPETITION The markets the Company serves are highly competitive and characterized by rapidly evolving technology. Significant competitive factors in the Company's markets include product performance, price, quality and reliability and level of customer service and support. The Company believes that it currently competes effectively with respect to these factors, although there can be no assurance that the Company will be able to compete effectively in the future. The markets in which the Company competes have seen an increase in global competition, especially from Japanese- and European-based equipment vendors. The Company has several foreign and domestic competitors for each of the DC, low-frequency and mid-frequency alternating current (AC), and radio frequency AC lines of products. Some of these competitors are larger and have greater resources than the Company. The Company's ability to continue to compete successfully in these markets will depend upon its ability to introduce product enhancements and new products on a timely basis. The Company's primary competitors are ENI, a subsidiary of Astec (BSR) PLC, Huttinger, Shindingen, Kyosan, RF Power Products, Comdel and Daihen. The Company's competitors in each product area are expected to continue to improve the design and performance of their systems and to introduce new systems with competitive performance characteristics. To remain competitive, the Company believes it will be required to maintain a high level of investment in research and development and sales and marketing. No assurance can be given that the Company will continue to be competitive in the future. INDUSTRY SEGMENTS The Company operates entirely within one industry sector. RESEARCH AND DEVELOPMENT The market for power conversion and control systems and related accessories is characterized by rapid technological changes. The Company believes that continued and timely development of new products and enhancements to existing products to support OEM requirements is necessary for the Company to maintain a competitive position in the markets the Company serves. Accordingly, the Company devotes a significant portion of its personnel and financial resources to research and development projects and seeks to maintain close relationships with its customers and other industry leaders to remain responsive to their product requirements. Research and development expenses were approximately $10.5 million, $13.8 million and $14.8 million in fiscal 1995, 1996 and 1997, respectively. These amounts represented 15
11.1%, 13.9% and 10.4% of total sales for those periods. From 1995 to 1997, the Company introduced more than forty-five new products. The Company believes that continued research and development investment and ongoing development of new products is essential to the expansion of its markets and does not expect any significant decline in spending as a percentage of sales. NUMBER OF EMPLOYEES At December 31, 1997, the Company had a total of 1,059 employees, of whom 853 are full-time continuous employees. None of the Company's employees is represented by a union, and the Company has never experienced a work stoppage. The Company utilizes temporary employees as a means to provide additional staff while reviewing the performance of the temporary employee. The Company considers its employee relations to be good. EFFECTS OF ENVIRONMENTAL LAWS The Company is subject to federal, state and local environmental laws and regulations. The Company is in compliance with all such laws and regulations. CAUTIONARY STATEMENTS - RISK FACTORS In the interest of providing the Company's shareholders and potential investors with certain Company information, including management's assessment of the Company's future potential, certain statements set forth herein contain or are based on projections of revenue, income, earnings per share and other financial items or relate to management's future plans and objectives or to the Company's future economic performance. Such statements are "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended. Although any forward-looking statements contained herein or otherwise expressed by or on behalf of the Company are to the knowledge and in the judgment of the officers and directors of the Company, expected to prove true and to come to pass, management is not able to predict the future with absolute certainty. Accordingly, shareholders and potential investors are hereby cautioned that certain events or circumstances could cause actual results to differ materially from those projected or predicted herein. In addition, the forward-looking statements herein are based on management's knowledge and judgment as of the date hereof, and the Company does not intend to update any forward-looking statements to reflect events occurring or circumstances existing hereafter. In particular, the Company believes that the following factors could impact forward- 16
looking statements made herein or in future written or oral releases and by hindsight, prove such statements to be overly optimistic and unachievable. QUARTERLY OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS The Company has experienced and expects to continue to experience significant fluctuations in its quarterly operating results. As a supplier of subsystems to equipment manufacturers, the Company's sales often are subject to its customers' production schedules. A substantial and increasing proportion of the Company's shipments are made on a just-in-time basis in which the shipment of systems occurs within a few days or hours after an order is received. Due to the short time between receipt of orders and shipments, the Company operates with a low level of backlog. Moreover, this backlog at any point in time is not sufficient to meet the Company's revenue expectations for a particular quarter and orders generally are subject to cancellation or delay at the customer's option without penalty. As a result of these factors, it is difficult for the Company to predict accurately the timing and level of revenues for a particular quarter. The Company's quarterly revenues are also affected by a variety of other factors, including specific economic conditions in the industries in which the Company's customers operate, particularly the semiconductor industry; the timing of the receipt of orders from major customers; customer cancellations or shipment delays; pricing competition; component shortages resulting in manufacturing delays; changes in customers' inventory management practices; exchange rate fluctuations and the introduction of new products by the Company or its competitors. In addition, electronics companies, including companies in the semiconductor capital equipment industry, are subject to ongoing pressure to reduce costs. This has in the past caused and is continuing to cause the Company's current and prospective customers to exert pricing pressure and make other demands on the Company, which may include faster delivery times and longer payment terms, which could lead to significant changes in revenue and operating margins from quarter to quarter. The Company's gross profit and operating income in a particular quarter are affected by a number of factors, including product mix, price changes, outsourcing costs, manufacturing efficiencies and costs incurred to respond to specific feature requests by customers. Generally, the Company's gross profit and operating income have fluctuated significantly as a result of these factors in the past, and such fluctuations may continue. In particular, as the Company expands manufacturing capacity, manufacturing overhead and other costs may be incurred prior to full utilization of the additional facilities. As a result, the Company may incur significant development and other expenses without realizing corresponding revenue in the same quarter. In addition, many of the Company's expenses, which are based in part on expectations of future revenue, are fixed. Accordingly, if revenue levels in a particular quarter do not meet expectations, operating results will be disproportionately adversely affected. The Company has recently gone through a period of increasing production and capacity to meet anticipated demand for its products, which has involved substantial expenditures and commitments by the Company. If the Company does not generate the revenue it anticipated when it began these production and capacity increases, its operating results will be adversely affected. This dynamic negatively impacted the Company 17
throughout 1996 and the first half of 1997. In late 1995, the Company was in a growth mode and when the semiconductor capital equipment market went through the major downturn of 1996, the Company's operating results were severely impacted, which in turn had a material adverse effect on the market price of the Company's Common Stock. Further fluctuations in operating results on a quarterly basis could have a material adverse effect on the market price of the Common Stock. THE SEMICONDUCTOR AND SEMICONDUCTOR EQUIPMENT INDUSTRIES ARE HIGHLY VOLATILE Approximately 61%, 64% and 58% of the Company's sales in 1995, 1996, and 1997, respectively, were made to customers in the semiconductor equipment industry. The Company expects that its business will continue to depend in significant part on the semiconductor and semiconductor equipment industries for the foreseeable future. The Company's business depends in large part upon capital expenditures by manufacturers of semiconductor devices, which in turn depend upon the current and anticipated market demand for semiconductor devices and products utilizing such devices. The semiconductor industry historically has been highly volatile and has experienced periods of oversupply, resulting in significantly reduced demand for semiconductor fabrication equipment. In 1996, the semiconductor industry experienced a significant downturn, which caused a number of the Company's customers, including Applied Materials and Lam Research, to drastically reduce and, in some cases cancel, their orders from the Company. Applied Materials and Lam Research together accounted for approximately 47% and 44% of the Company's revenues during 1996 and 1997, respectively. SIGNIFICANT SALES ARE CONCENTRATED AMONG A FEW CUSTOMERS The Company's sales generally are concentrated among a small number of customers. Sales to the Company's ten largest customers accounted for approximately 73% and 75% of the Company's sales in 1996 and 1997, respectively. The loss of any of its major customers, particularly Applied Materials or Lam Research, or a reduction in orders from any of such customers, including reductions caused by changes in a customer's competitive position or economic conditions in the industries in which the Company's customers compete, could have a material adverse effect on the Company's business, financial condition and results of operations. None of the Company's customers has entered into a long-term agreement requiring it to purchase the Company's systems. Similarly, Tower's sales historically have been concentrated among a small number of customers. Tower's sales to U.S. Robotics (recently acquired by 3Com Corporation) and its contract manufacturer accounted for approximately 73% of Tower's total sales in 1997. The success of the Company's acquisition of Tower will depend in large part on retention of Tower's major customers, including U.S. Robotics and its contract manufacturer, and the level of orders received from such customers. RISKS ASSOCIATED WITH MANUFACTURING FACILITY All of the Company's manufacturing is conducted at its facility in Fort Collins, Colorado 18
except for the manufacturing conducted by its subsidiary Tower Electronics in Fridley, Minnesota. In July 1997, the Company sustained substantial damage to its facilities and certain equipment and inventory due to excess surface water caused by a severe rainstorm in Fort Collins. The Company was forced to cease manufacturing temporarily and did not resume full production until mid-September 1997. The Company's insurance policies will not cover all of the costs incurred by the Company in connection with the rainstorm. Because substantially all of the Company's manufacturing is conducted in one location, there can be no assurance that future natural or other occurrences, out of the Company's control, will not have a material adverse effect on the Company's operations. Cessation of manufacturing or the Company's inability to operate the Fort Collins facility at full capacity for any extended period could have a material adverse effect on the Company's business, financial condition and results of operations. RISKS ASSOCIATED WITH RECENT AND POTENTIAL FUTURE ACQUISITIONS The Company intends to expand its product offerings and customer base in part by acquiring other businesses, products and technologies that are complementary to those of the Company. In 1997, the Company acquired Tower and, in a separate transaction, acquired all of the assets of MIK Physics, Inc. ("MIK"). The assets acquired from MIK consisted predominantly of inventory, and the purchase price paid by the Company was immaterial. Tower designs and manufactures custom, high performance switchmode power supplies for use principally in the telecommunications, medical and non-impact printing industries, and MIK has developed technology to design and manufacture high power systems for certain industrial uses. The Company continues to operate Tower's business out of Tower's existing facilities in Fridley, Minnesota, and, accordingly, is required to manage two geographically separated manufacturing locations. Failure to integrate Tower, or any future acquisitions, without substantial costs, delays or other operational or financial problems could have a material adverse effect on the Company's business, financial condition and results of operations. Further, future acquisitions by the Company may result in dilutive issuances of equity securities, the incurrence of debt, large one-time expenses and the creation of goodwill or other intangible assets that could result in significant amortization expense. In addition, there can be no assurance that the Company will be able to identify, negotiate and consummate acquisitions that it considers advantageous to its business plans. MANAGEMENT OF GROWTH The Company has been experiencing a period of rapid growth and expansion. Such growth and expansion has placed, and is expected to continue to place, significant demands on the Company's resources. The management of such growth will require the Company to continue to improve and expand its management, operational and financial systems, procedures and controls, including accounting and other internal management systems, quality control, delivery and service capabilities. To accommodate its recent growth, the Company started to implement in 1997 a new comprehensive, integrated information management system that will incorporate substantially all of the Company's internal 19
financial and business systems, procedures and controls. The implementation is progressing well but the system is still prone to problems which can introduce severe disruptions in the Company's daily operations. The Company has postponed implementation of the new system at its international locations, due primarily to a shortage of trained personnel and other resources. In addition, the Company intends to continue to operate Tower's business out of Tower's existing facilities in Fridley, Minnesota and has retained all of Tower's employees. The failure to manage growth effectively, including delays or difficulties implementing new systems, procedures and controls or integrating acquisitions in a timely manner and without disruption of the Company's operations, could have a material adverse effect on the Company's business, financial condition and results of operations. SUPPLY CONSTRAINTS AND DEPENDENCE ON SOLE AND LIMITED SOURCE SUPPLIERS Manufacture of the Company's power conversion and control systems requires numerous electronic components. Growth in the electronics industry has significantly increased demand for such components. This demand can result in periodic shortages and allocations, which the Company has experienced from time to time. The Company expects that shortages and allocations of electronic components and subassemblies will continue in the foreseeable future and could result in shipment delays. Such delays could damage the Company's relationships with current and prospective customers, which in turn could have a material adverse effect on the Company's business, financial condition and results of operations. In this regard, the Company experienced a temporary delay in replacing certain key components that had been lost or damaged in the July 1997 rainstorm in Fort Collins. The Company relies on sole and limited source suppliers for certain parts and subassemblies. Such reliance involves several risks, including a potential inability to obtain an adequate supply of required components, reduced control over pricing and timing of delivery of components and suppliers' potential inability to develop technologically advanced products to support the Company's growth and development of new systems. The Company believes that alternative sources could be obtained and qualified, if necessary, for most sole and limited source parts. DEPENDENCE ON DESIGN WINS; BARRIERS TO OBTAINING NEW CUSTOMERS; HIGH LEVEL OF CUSTOMIZED SYSTEMS Equipment manufacturers begin new system design projects periodically due to the constantly changing nature of semiconductor fabrication technology. It is important for the Company to work with these manufacturers early in their design cycle because it is common for modifications to the Company's equipment to be required to meet the requirements of the new system. As the design cycle nears completion, one or two vendors are chosen by the equipment manufacturer to provide the power conversion equipment to be used with the early system shipments. Being selected as one of these vendors is called a "design win." The Company believes that achieving these "design wins" is critical to 20
retaining existing customers and to obtaining new customers. In order to achieve design wins, the Company typically must customize its systems for use in particular equipment and for particular customers. Such customization increases the Company's research and development expenses and can strain its engineering and management resources. In addition, there can be no assurance that such investment will result in design wins for the Company. Because a substantial proportion of the Company's business involves the just-in-time shipment of systems, the Company must keep a relatively large number and variety of customized systems in inventory. As the Company develops new systems and as its customers develop new products, systems in inventory may become obsolete. There can be no assurance that such inventory obsolescence will not have a material adverse effect on the Company's business, financial condition and results of operations. RAPID TECHNOLOGICAL CHANGE AND DEPENDENCE ON NEW SYSTEM INTRODUCTIONS The market for power conversion and control systems is characterized by ongoing technological developments and changing customer requirements. The markets in which the Company's customers compete are also characterized by continually evolving technology. The Company's success depends upon its ability to continue to improve existing systems and to develop and introduce new systems that keep pace with technological advances and adapt to support its customers' changing needs. There can be no assurance that the Company will continue to be able to improve its existing systems or develop new systems that will adequately address the changing needs of its customers and the marketplace. Development and introduction of new systems may involve significant costs that are difficult to forecast. Failure of the Company to develop or introduce improved systems and new systems in a timely manner could have a material adverse effect on the Company's business, financial condition and results of operations, as well as on its customer relationships. COMPETITION The Company faces substantial competition, primarily from established companies, some of which have greater financial, marketing and technical resources than the Company. The trend toward consolidation in the semiconductor equipment industry has made it increasingly important to have the resources necessary to compete effectively across a broad range of product offerings, to fund customer service and support on a worldwide basis and to invest in research and development. The Company expects its competitors to continue to develop new products aimed at applications currently served by the Company, to continue to improve the design and performance of their systems, and to introduce new systems with competitive performance characteristics. To remain competitive, the Company believes it will be required to maintain a high level of investment in research and development and sales and marketing. In addition, new products developed by competitors could make pricing more competitive, which may necessitate significant price reductions by the Company or result in lost orders. In addition, electronics companies, including companies in the semiconductor capital equipment industry, have been characterized by ongoing pressure to reduce costs. 21
RISKS ASSOCIATED WITH INTERNATIONAL SALES The markets in which the Company competes are becoming increasingly globalized. As a result, the Company's customers increasingly require service and support on a worldwide basis. The Company has invested substantial financial and management resources to develop an international infrastructure to meet the needs of its customers worldwide. The Company maintains sales and service offices outside the United States in Tokyo, Japan; Filderstadt, Germany; Bicester, United Kingdom; and Seoul, South Korea. There can be no assurance that the Company's investments will enable it to compete successfully in the international market or to meet the service and support needs of such customers. Approximately 29%, 24% and 25% of the Company's sales in 1995, 1996 and 1997, respectively, were attributable to customers outside the United States. The Company expects sales outside the United States to continue to represent a significant portion of future sales. Sales to customers outside the United States are subject to various risks, including exposure to currency fluctuations, the imposition of governmental controls, political and economic instability, trade restrictions, changes in tariffs and taxes, and longer payment cycles typically associated with international sales. The Company has entered into various forward foreign exchange contracts to mitigate the effect of depreciation of the Japanese yen; however, there can be no assurance that this or other hedging techniques can successfully protect the Company against substantial currency fluctuations. The Company has not employed hedging techniques with respect to any other currencies. THE ASIAN FINANCIAL CRISIS In the third quarter of 1997 the economic conditions in several Asian countries began to deteriorate and those conditions were exacerbated in the fourth quarter. The Company realized approximately 10% of its 1997 revenue from sales to customers in Asia, including Japan. Many of the Company's key customers had a much greater concentration of their revenue in Asia. Until such time as the uncertainty is resolved the Company, directly and through its customers, could suffer material reductions in revenue. INTELLECTUAL PROPERTY RIGHTS The Company's success depends in large part on the technical innovation of its products. While the Company attempts to protect its intellectual property rights through patents and non-disclosure agreements, it believes that its success will depend to a greater degree upon innovation, technological expertise and its ability to adapt its products to new technology. There can be no assurance that the Company will be able to protect its technology or that competitors will not be able to develop similar technology independently. Although the Company is not aware of any infringement by its products of any patents or proprietary rights of others, there can be no assurance that such infringements do not exist or will not occur in the future. Litigation may be necessary in the future to enforce patents issued to the Company, to protect trade secrets or know-how owned by the Company, to 22
defend the Company against claimed infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. Adverse determinations in such litigation could result in the Company's loss of proprietary rights, subject the Company to significant liabilities to third parties, require the Company to seek licenses from third parties or prevent the Company from manufacturing or selling its products, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. VOLATILITY OF MARKET PRICE OF COMMON STOCK The stock market generally, and the market for technology stocks in particular, have experienced significant price and volume fluctuations, which have often been unrelated or disproportionate to the operating performance of such companies. From the initial public offering of the Common Stock in November 1995 through December 31, 1997, the closing price of the Common Stock on the Nasdaq National Market has ranged from $3.50 to $38.125. There can be no assurance that the market for the Common Stock will not be subject to similar fluctuations. Many factors, including future announcements concerning the Company or its competitors, variations in operating results, announcements of technological innovations, the introduction of new products or changes in product pricing policies by the Company or its competitors, changes in earnings estimates by securities analysts and general stock market trends, could cause the market price of the Common Stock to fluctuate substantially. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company and their ages as of February 28, 1998 are as follows: <TABLE> NAME AGE POSITION ---- --- -------- <S> <C> <C> Douglas S. Schatz 52 President, Chief Executive Officer and Chairman of the Board G. Brent Backman 57 Vice President, Special Projects, Assistant Secretary and Director Eric A. Balzer 49 Vice President, Operations Richard P. Beck 64 Vice President, Chief Financial Officer and Director Hollis L. Caswell, Ph.D. 66 Chief Operating Officer and Director James F. Gentilcore 45 Vice President, Sales and Marketing Timothy A. Kerr 37 Vice President, Engineering Susan C. Schell 48 Vice President, Quality and Human Resources Richard A. Scholl 58 Vice President and Chief Technology Officer </TABLE> - ----------- DOUGLAS S. SCHATZ is a co-founder of the Company and has been its President and Chief Executive Officer and a director since its incorporation in 1981. Mr. Schatz also co-founded Energy Research Associates, Inc. and served as its Vice President of Engineering from 1977 through 1980. Prior to co-founding Energy Research Associates, Mr. Schatz held various engineering and management positions at Applied Materials. 23
G. BRENT BACKMAN is a co-founder of the Company and has been a Vice President and a director of the Company since its incorporation in 1981. Mr. Backman became Vice President, Special Projects in 1994. Prior to co-founding the Company, Mr. Backman was a Business Manager at Ion Tech, Inc. and a Laboratory Administrator at Hughes Aircraft Company. ERIC A. BALZER joined the Company in 1990 as Vice President, Operations. Prior to joining the Company, Mr. Balzer was Materials and Manufacturing Manager for the Systems Technology Division of IBM Corporation. RICHARD P. BECK joined the Company in 1992 as Vice President and Chief Financial Officer. He became a director of the Company in 1995. From 1987 to 1992, Mr. Beck served as Executive Vice President and Chief Financial Officer of Cimage Corporation, a computer software company. Mr. Beck is also a director of Target Financial, Inc., a privately-held computer rental company. HOLLIS L. CASWELL, PH.D. joined the Board of Directors of the Company in February 1997 and joined the Company as Chief Operating Officer in May 1997. Dr. Caswell was Chairman of the Board and Chief Executive Officer of HYPRES, Inc., a manufacturer of superconducting electronics, from 1990 to 1994. From 1984 to 1990, Dr. Caswell served as Senior Vice President of Unisys Corporation and President of such company's Computer Systems Group. He is a director of Thomas Group, Inc., a publicly traded consulting company. JAMES F. GENTILCORE joined the Company in 1996 as Vice President, Sales and Marketing. Prior to joining the Company, Mr. Gentilcore was Vice President, Marketing at MKS Instruments, Inc. TIMOTHY A. KERR joined the Company in 1987 as an engineer. In 1995, he became Director of Engineering and in August 1996, Vice President, Engineering. Prior to joining the Company, Mr. Kerr was a member of the technical staff at Hughes Aircraft Company. SUSAN C. SCHELL joined the Company in 1984 as Human Resources Manager and became Vice President, Quality and Human Resources in 1991. Prior to joining the Company, Ms. Schell was a Management Advisory Services Consultant with Cady and Company, P.C. RICHARD A. SCHOLL joined the Company in 1988 as Vice President, Engineering. Mr. Scholl became Chief Technology Officer of the Company in 1995. Prior to joining the Company, Mr. Scholl was General Manager, Vacuum Products Division at Varian Associates, Inc. 24
ITEM 2. PROPERTIES The Company's headquarters and manufacturing facility are located in Fort Collins, Colorado, in approximately 190,000 square feet of leased space. The Company also maintains sales and service offices in Milpitas, California; Tokyo, Japan; Filderstadt, Germany; and Seoul, South Korea; and sales offices in Concord, Massachusetts; Austin, Texas; and Bicester, United Kingdom. In August 1997, the Company acquired 100% of the common stock of Tower Electronics, Inc. The headquarters, sales and service offices and manufacturing facilities of Tower are in Fridley, Minnesota. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any legal proceedings in the ordinary course of its business to the best of its knowledge. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 25
PART II ITEM 5. MARKET PRICE FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Prior to November 17, 1995, there had been no public market for the Company's Common Stock. The Common Stock was approved for quotation on the Nasdaq Stock Market under the symbol AEIS, beginning November 17, 1995. At January 31, 1998, the number of common stockholders of record was 421. The range of high and low bid quotations for the Company's Common Stock as quoted (without retail markup or markdown and without commissions) on the Nasdaq Stock Market since its initial public offering is provided below. They do not necessarily represent actual transactions: <TABLE> High Bid Low Bid -------- ------- <S> <C> <C> 1995 Fiscal Year ---------------- Fourth Quarter (from November 17) 11 8-1/4 1996 Fiscal Year ---------------- First Quarter 10 6-1/2 Second Quarter 9-1/8 5-3/4 Third Quarter 7-3/4 4-1/2 Fourth Quarter 7-1/4 2-7/8 1997 Fiscal Year ---------------- First Quarter 8-3/8 5-1/4 Second Quarter 15-3/8 7-1/8 Third Quarter 33-3/8 14-1/2 Fourth Quarter 38-1/8 12-1/4 </TABLE> The Company has not declared or paid any cash dividends on its capital stock since it terminated its election to be treated as an S corporation for tax purposes, effective January 1, 1994. The Company currently intends to retain all future earnings to finance its business. Accordingly, the Company does not anticipate paying cash or other dividends on its Common Stock in the foreseeable future. Furthermore, the Company's revolving credit facility prohibits the declaration or payment of any cash dividends on the Common Stock. 26
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data is qualified by reference to, and should be read in conjunction with, the Company's 1997 Consolidated Financial Statements and notes thereto and the discussion thereof included elsewhere in this Form 10-K. The selected consolidated statements of operations for the years ended December 31, 1995, 1996 and 1997 and the related consolidated balance sheet data as of and for the years ended December 31, 1996 and 1997 derived from consolidated financial statements have been audited by Arthur Andersen LLP, independent accountants, whose report with respect thereto is included elsewhere in this Form 10-K. The selected consolidated statements of operations data for the years ended December 31, 1993 and 1994, and the related consolidated balance sheet data as of December 31, 1993, 1994 and 1995 have been derived from audited consolidated financial statements of the Company not included in this Form 10-K. <TABLE> YEARS ENDED DECEMBER 31, ------------------------ 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (IN THOUSANDS, EXCEPT SHARE DATA) <S> <C> <C> <C> <C> <C> STATEMENT OF OPERATIONS DATA: Sales $141,923 $98,852 $94,708 $51,857 $31,577 Gross profit 54,385 36,814 45,394 25,814 15,248 Total operating expenses 37,380 28,603 23,916 15,811 11,547 Income from operations 17,005 8,211 21,478 10,003 3,701 Net income $ 10,362 $ 5,144 $13,281 $ 5,963 $ 3,417 -------- ------- ------- ------- ------- -------- ------- ------- ------- ------- Diluted earnings per share $ 0.47 $ 0.24 $ 0.69 $ 0.32 Pro forma net income(1) $ 2,054 ------- ------- </TABLE> <TABLE> DECEMBER 31, ------------ 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (IN THOUSANDS) <S> <C> <C> <C> <C> <C> BALANCE SHEET DATA: Working capital $ 66,708 $35,179 $33,749 $ 7,773 $ 3,587 Total assets 112,243 56,031 55,319 23,149 13,389 Total debt 3,320 2,051 2,484 9,946 8,459 Stockholders' equity 87,348 46,496 41,087 7,218 1,011 </TABLE> - ------------ (1) In 1993, the Company was treated as an S corporation for tax purposes. The Company terminated its election to be treated as an S corporation effective as of January 1, 1994. Pro forma information assumes federal, state and foreign income tax rates aggregating 40.0%. See Note 10 of Notes to Consolidated Financial Statements. 27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion contains, in addition to historical information, forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements involve risks and uncertainties. As a result, the Company's actual results may differ materially from the results discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below. In particular, the Company believes that the following factors could impact forward-looking statements made herein or in future written or oral releases and by hindsight, prove such statements to be overly optimistic and unachievable: volatility of the semiconductor and semiconductor equipment industries, customer concentration, dependence on design wins, rapid technological change and dependence on new system introduction, competition, and management of growth. OVERVIEW The Company designs, manufactures, markets and supports power conversion and control systems used in industrial processes. The Company's systems are key elements in products that utilize gaseous plasmas to deposit or etch thin film layers on materials or substrates such as silicon, glass and metals. The Company commenced operations in 1981 and has been profitable each year since its inception. The Company markets and sells its systems primarily to original equipment manufacturers (OEMs) of semiconductor, flat panel display, data storage and other industrial thin film manufacturing equipment, and OEMs of the telecommunications, medical and non-impact printing industries. A substantial and increasing proportion of the Company's sales are made on a "just-in-time" basis in which the shipment of systems occurs within a few days or hours after an order is received. The Company recognizes revenues, which are derived from the sales of power conversion and control systems, upon shipment of its systems. The semiconductor equipment industry accounted for approximately 64% of the Company's sales in 1996 and 58% in 1997. The Company has benefited from strong growth in the semiconductor equipment industry in recent years until the industry growth stopped in mid-1996, but recovered in the second half of 1997. The largest customer of the Company is also the largest semiconductor equipment manufacturer. Sales to the data storage market increased significantly in 1997 when compared to 1996, but sales to industrial markets were flat during this same period. The Company experienced a decline in sales to the flat panel display market in 1996, primarily in Japan, but recovered in 1997 to a level higher than 1995. In connection with the acquisition of Tower Electronics, Inc. ("Tower") the Company now has products manufactured for use in the 28
telecommunications, laser and non-impact printing industries. The future success of the Company depends primarily on continued growth of the semiconductor equipment industry, data storage industry, and flat panel display industry. To date, the Company has been successful in achieving a number of "design wins" which have resulted in the Company obtaining new customers and solidifying relationships with its existing customers. The Company believes that its ability to continue to achieve design wins with existing and new customers will be critical to its future success. In response to the high rate of growth in 1995 and anticipated growth during 1996, the Company made substantial investments in infrastructure such as information technology, facilities, and in worldwide sales and support in 1996, which caused operating expenses to increase. This, combined with the slower growth in the semiconductor equipment industry, resulted in reduced operating margins in 1996. Margins improved in 1997 when the semiconductor equipment industry rebounded and returned to growth more in line with historical experience. Several events occurred during 1997 that affected and may continue to influence the Company's operations into 1998. The Company sustained damage to its manufacturing facilities and certain equipment during a severe rainstorm on July 29, 1997, which reduced production capacity during the following several months. On August 15, 1997, the Company purchased all of the outstanding stock of Tower Electronics, Inc. ("Tower"), a privately-held Minnesota-based manufacturer of custom, low-power power supplies used principally in the telecommunications, medical and non-impact printing markets. In October 1997, the Company completed an underwritten public offering of 1,000,000 shares of common stock at a price of $31 per share, for aggregate net proceeds of approximately $28.7 million. In October 1997, the Company completed formation of its 100%-owned sales and service subsidiary in South Korea. YEAR 2000 Computer programs that rely on two-digit date codes to perform computations and decision-making functions may cause computer systems to malfunction due to an inability of such programs to interpret the date code "00" as the year 2000. Advanced Energy has conducted an initial assessment of its internal exposure to the Year 2000 problem and believes that its recently installed enterprise-wide software system is Year 2000 compliant. Such belief is based significantly on discussions with and representations by the vendor of such software. The Company intends to conduct its own evaluations and testing of such software system and is currently involved in a project to ensure that its ancillary software and hardware are Year 2000 compliant. The Company expects to complete these projects during the second and third quarters of 1998. The Company does not expect the costs associated with such projects to have a material effect on the Company's financial results. Advanced Energy also may be vulnerable to other companies' Year 2000 issues. The Company's current estimates of the impact of the Year 2000 problem on its operations 29
and financial results do not include costs and time that may be incurred as a result of any vendors' or customers' failures to become Year 2000 compliant on a timely basis. The Company has initiated formal communications with all of its significant vendors and customers with respect to such persons' Year 2000 compliance programs and status. However, there can be no assurance that such other companies will achieve Year 2000 compliance or that any conversions by such companies to become Year 2000 compliant will be compatible with the Company's computer systems. The inability of the Company or any of its principal vendors or customers to become Year 2000 compliant in a timely manner could have a material adverse effect on the Company's financial condition or results of operations. The foregoing beliefs and expectations are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, and are based in large part on certain statements and representations made by persons outside the Company, any of which statements or representations ultimately could prove to be inaccurate. RESULTS OF OPERATIONS The following table sets forth certain statement of operations data of the Company expressed as a percentage of sales: <TABLE> YEARS ENDED DECEMBER 31, --------------------------- 1997 1996 1995 ------ ------ ------ <S> <C> <C> <C> Sales 100.0% 100.0% 100.0% Cost of sales 61.7 62.8 52.1 ------ ------ ------ Gross margin 38.3 37.2 47.9 ------ ------ ------ Operating expenses: Research and development 10.4 13.9 11.1 Sales and marketing 6.7 8.7 6.5 General and administrative 5.1 6.3 7.6 Storm damage, net of insurance reimbursement 1.9 0.0 0.0 Purchased in-process research and development 2.2 0.0 0.0 ------ ------ ------ Total operating expenses 26.3 28.9 25.2 ------ ------ ------ Income from operations 12.0 8.3 22.7 Other income (expense) 0.0 0.1 (0.4) ------ ------ ------ Net income before income taxes 12.0 8.4 22.3 Provision for income taxes 4.7 3.2 8.3 ------ ------ ------ Net income 7.3% 5.2% 14.0% ------ ------ ------ ------ ------ ------ </TABLE> SALES Sales were $94.7 million, $98.9 million and $141.9 million in 1995, 1996 and 1997, respectively, representing an increase of 4% from 1995 to 1996 and 44% from 1996 to 1997. The Company's sales growth during all periods presented has resulted from the increased unit sales of the Company's systems. A significant part of this growth during 1996 is attributable to increased sales to domestic customers and to customers in Europe, 30
offset by a 46% decrease in Japan sales when compared to 1995, which were primarily to the flat panel display market. In 1995 the Company sold subsystems in Japan to replace subsystems originally provided by competitors. That retrofit program was completed in 1995. A substantial portion of the Company's sales growth since 1995 is attributable to higher system sales to the Company's two largest customers, both of whom are primarily semiconductor equipment OEMs. Sales to this industry increased 35% from 1996 to 1997, while sales to data storage equipment OEMs increased 53% during the same period. Sales to international customers, primarily in Japan, Asia and Europe, were approximately $27.3 million, $24.0 million, and $36.0 million in 1995, 1996 and 1997, respectively. These amounts represented 29%, 24% and 25% of sales for those periods. During these periods, sales in Japan were primarily to flat panel display and data storage equipment manufacturers and sales in Europe were primarily to data storage equipment manufacturers. GROSS MARGIN The Company's gross margins were 47.9%, 37.2% and 38.3% for 1995, 1996 and 1997, respectively. Major factors causing the decrease in gross margin from 1995 to 1996 were generally higher material costs and other costs associated with continued outsourcing efforts in the first half of 1996, and underabsorption of manufacturing overhead due to lower sales in the second half of 1996. Sales for the first six months of 1996 were $57.0 million versus sales of $43.0 million in the comparable period in 1995, an increase of 33%, while sales in the last six months of 1996 were $41.9 million versus sales of $51.7 million for the comparable period in 1995, a decrease of 19%. Additionally, gross margin was negatively impacted throughout 1996 by a shift in product mix toward products on which material costs increased as a percentage of sales and by increased customer service costs. The increase in gross margin from 1996 to 1997 was primarily due to lower infrastructure costs associated with cost of goods sold and decreased material costs as a percentage of sales. Other cost improvements, as a percentage of sales, were achieved to a lesser extent in labor and customer support costs largely because of the higher 1997 base resulting from the recovery in the semiconductor equipment industry in the second quarter of 1997. These improvements were partially offset by a less favorable absorption of manufacturing overhead costs. The underabsorption of manufacturing overhead may continue to negatively impact gross margin should future sales levels decline. During the periods presented, the average selling price per unit has remained relatively constant. Historically, price competition has not had a material effect on margins. However, competitive pressures may produce a decline in average selling prices for certain products. Any material decline in average selling prices not offset by reduced costs could result in a material decline in the Company's gross margins. The Company provides warranty coverage for its systems ranging from 12 to 24 31
months. The Company estimates the anticipated costs of repairing its systems under such warranties based on the historical average costs of the repairs. To date, the Company has not experienced significant warranty costs in excess of its recorded reserves. RESEARCH AND DEVELOPMENT The Company's research and development costs are associated with researching new technologies, developing new products and improving existing product designs. Research and development expenses were $10.5 million, $13.8 million and $14.8 million for 1995, 1996 and 1997, respectively, representing an increase of 31% from 1995 to 1996 and 7% from 1996 to 1997. As a percentage of sales, research and development expenses increased from 11.1% in 1995 to 13.9% in 1996, but decreased to 10.4% in 1997 as a result of the higher sales base. The increase in expenses from 1995 to 1997 is primarily associated with increases in payroll and outside service costs incurred for new product development. In connection with the acquisition of Tower on August 15, 1997, the Company recorded a one-time charge of $3.1 million in 1997 for the portion of the purchase price attributable to in-process research and development, not included in the $14.8 million reported for research and development expense. The Company believes that continued research and development investment is essential to ongoing development of new products. Since inception, all research and development costs have been internally funded and expensed when incurred. SALES AND MARKETING Sales and marketing expenses support domestic and international sales and marketing activities which include personnel, trade shows, advertising, and other marketing activities. Sales and marketing expenses were $6.2 million, $8.6 million and $9.6 million for 1995, 1996 and 1997, respectively. This represented a 39% increase from 1995 to 1996 and an 11% increase from 1996 to 1997. The increases are attributable to higher payroll, promotional materials, depreciation and travel costs associated with expansion to support the increase in sales volume. As a percentage of sales, these expenses increased from 6.5% in 1995 to 8.7% in 1996, but decreased to 6.7% in 1997 as a result of the higher sales base. The Company continues to reorganize its sales and marketing team to better address the specific needs of its customers. Sales and marketing expenses are expected to continue to increase in future periods. GENERAL AND ADMINISTRATIVE General and administrative expenses support the worldwide financial, administrative, information systems and human resources functions of the Company. General and 32
administrative expenses were $7.2 million, $6.3 million and $7.3 million for 1995, 1996 and 1997, respectively. The decrease in general and administrative expenses from 1995 to 1996 was due primarily to a reduction in accrued bonuses and other employee benefits made in 1996 as part of the Company's cost reduction efforts, which were one-time reductions. Of the increase from 1996 to 1997 of $1.0 million, $0.7 million was due to the inclusion of Tower, of which $0.4 million was for amortization of goodwill resulting from the purchase. As a percentage of sales, general and administrative expenses were 7.6%, 6.3% and 5.1% for 1995, 1996 and 1997, respectively. The overall decrease as a percentage of sales from 1995 to 1997 is attributable to the Company's effort to maintain a level of general and administrative costs that do not increase at the same rate as sales. The Company continues to implement its new information management system software throughout the Company, including the replacement of existing systems in its foreign locations. The Company expects that charges related to training and implementation of the new software will continue through 1998, particularly for the foreign locations. ONE-TIME CHARGES The Company took one-time net charges totaling $5.8 million in 1997. A net charge of $2.7 million was taken for storm damage to the Company's headquarters and main manufacturing facilities that resulted from heavy rains in the Fort Collins area on July 29, 1997. The final extent of insurance coverage, if any, is unresolved, although the Company has received and recorded $0.3 million of proceeds to date. Any additional recoveries from the Company's insurance will likewise be recorded when received. As discussed above in "Research and Development," the acquisition of Tower resulted in a charge of $3.1 million for purchased in-process research and development, which is non-deductible for income tax purposes. OTHER INCOME (EXPENSE) Other income consists primarily of interest income and expense, foreign exchange gains and losses and other miscellaneous income and expense items. Interest income was approximately $0.1 million, $0.5 million and $0.5 million for the years 1995, 1996 and 1997, respectively. The higher amounts in 1996 and 1997 were due primarily to earnings on investments made from the proceeds of the initial public offering in November 1995 and the underwritten public offering in October 1997. Interest expense consists principally of borrowings under the Company's bank credit and capital lease facilities and was approximately $0.6 million, $0.2 million and $0.3 million for the years 1995, 1996 and 1997, respectively. The decrease of interest expense from 1995 to 1996 was primarily a result of repayments of equipment loans and less borrowing due to the availability of working capital provided from the proceeds of the Company's initial public offering in November 1995. The increase of interest expense 33
from 1996 to 1997 was primarily due to a short-term loan used to finance the acquisition of Tower, which was repaid with the proceeds from the underwritten public offering in October 1997. Approximately 91% of the Company's foreign subsidiaries' sales are denominated in currencies other than the U.S. dollar. An increase in the value of the German deutsche mark of 7% and a decrease in the value of the Japanese yen of 4% resulted in essentially no foreign exchange gain or loss in 1995. During 1996 the Company recorded a net foreign exchange loss of $0.4 million primarily as a result of a 12% decrease in the value of the yen. During the second half of 1996 the Company began to enter into various forward foreign exchange contracts to mitigate the effect in depreciation in the yen. During 1997, the Company recorded a net foreign currency gain of $0.1 million. The Company continues to evaluate various policies to minimize the effect of foreign currency fluctuations. PROVISION FOR INCOME TAXES The income tax provision of $7.8 million in 1995 represented a 37.0% effective tax rate. The income tax provision of $3.2 million for 1996 represented an effective rate of 38.1%. The increase in the Company's tax rate from 1995 to 1996 is primarily attributed to a higher effective state tax rate resulting from a larger proportion of the Company's sales being shipped to higher tax rate jurisdictions, particularly California. The income tax provision of $6.7 million for 1997 represented an effective rate of 39.2%. The increase in the Company's tax rate from 1996 to 1997 is primarily attributed to certain one-time charges in 1997 which were not deductible, including the $3.1 million one-time charge for purchased in-process research and development associated with the acquisition of Tower. Changes in the relative earnings of the Company and its foreign subsidiaries affect the Company's consolidated effective tax rate. To the extent that a larger percentage of taxable earnings are derived from the Company's foreign subsidiaries whose tax rates are higher than domestic tax rates, the Company could experience a higher consolidated effective tax rate than the historical rates the Company experienced before 1997. The Company adjusts its income taxes periodically based upon the anticipated tax status of all foreign and domestic entities. QUARTERLY RESULTS OF OPERATIONS The following table presents unaudited quarterly results in dollars and as a percentage of sales for the eight quarters ended December 31, 1997. The Company believes that all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly such quarterly information. The operating results for any quarter are not necessarily indicative of results for any subsequent period. 34
<TABLE> QUARTERS ENDED --------------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, 1996 1996 1996 1996 1997 1997 1997 1997 -------- -------- --------- -------- -------- -------- --------- -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> (IN THOUSANDS, EXCEPT PER SHARE DATA) Sales $27,166 $29,831 $21,639 $20,216 $20,667 $32,690 $42,571 $45,995 Cost of sales 17,035 17,204 15,047 12,752 13,158 20,139 25,538 28,703 ------- ------- ------- ------- ------- ------- ------- ------- Gross profit 10,131 12,627 6,592 7,464 7,509 12,551 17,033 17,292 ------- ------- ------- ------- ------- ------- ------- ------- Operating expenses: Research and development 3,498 3,645 3,349 3,268 2,821 3,513 4,072 4,345 Sales and marketing 2,083 2,248 2,201 2,058 1,799 2,336 2,329 3,101 General and administrative 1,725 2,330 933 1,265 1,248 1,702 1,943 2,391 Storm damage -- -- -- -- -- -- 3,000 (300) Purchased in-process research and development -- -- -- -- -- -- 3,080 -- ------- ------- ------- ------- ------- ------- ------- ------- Total operating expenses 7,306 8,223 6,483 6,591 5,868 7,551 14,424 9,537 ------- ------- ------- ------- ------- ------- ------- ------- Income from operations 2,825 4,404 109 873 1,641 5,000 2,609 7,755 Other (expense) income (170) (66) 97 232 (387) 286 54 73 ------- ------- ------- ------- ------- ------- ------- ------- Net income before income taxes 2,655 4,338 206 1,105 1,254 5,286 2,663 7,828 Provision for income taxes 982 1,676 83 419 489 1,996 2,146 2,038 ------- ------- ------- ------- ------- ------- ------- ------- Net income $ 1,673 $ 2,662 $ 123 $ 686 $ 765 $ 3,290 $ 517 $ 5,790 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Diluted earnings per share $ 0.08 $ 0.12 $ 0.01 $ 0.03 $ 0.04 $ 0.15 $ 0.02 $ 0.25 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Weighted-average number of shares and share equivalents 21,794 21,653 21,622 21,728 21,735 21,877 22,372 23,112 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- <CAPTION> QUARTERS ENDED --------------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, 1996 1996 1996 1996 1997 1997 1997 1997 -------- -------- --------- -------- -------- -------- --------- -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> PERCENTAGE OF SALES: Sales 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Cost of sales 62.7 57.7 69.5 63.1 63.7 61.6 60.0 62.4 ----- ----- ----- ----- ----- ----- ----- ----- Gross margin 37.3 42.3 30.5 36.9 36.3 38.4 40.0 37.6 ----- ----- ----- ----- ----- ----- ----- ----- Operating expenses: Research and development 12.9 12.2 15.5 16.2 13.7 10.8 9.6 9.4 Sales and marketing 7.7 7.5 10.2 10.2 8.7 7.1 5.5 6.7 General and administrative 6.3 7.8 4.3 6.2 6.0 5.2 4.6 5.2 Storm damage -- -- -- -- -- -- 7.0 (0.6) Purchased in-process research and development -- -- -- -- -- -- 7.2 -- ----- ----- ----- ----- ----- ----- ----- ----- Total operating expenses 26.9 27.5 30.0 32.6 28.4 23.1 33.9 20.7 ----- ----- ----- ----- ----- ----- ----- ----- Income from operations 10.4 14.8 0.5 4.3 7.9 15.3 6.1 16.9 Other (expense) income (0.6) (0.3) 0.5 1.2 (1.8) 0.9 0.2 0.1 ----- ----- ----- ----- ----- ----- ----- ----- Net income before income taxes 9.8 14.5 1.0 5.5 6.1 16.2 6.3 17.0 Provision for income taxes 3.6 5.6 0.4 2.1 2.4 6.1 5.1 4.4 ----- ----- ----- ----- ----- ----- ----- ----- Net income 6.2% 8.9% 0.6% 3.4% 3.7% 10.1% 1.2% 12.6% ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- </TABLE> The Company has experienced and expects to continue to experience significant fluctuations in its quarterly operating results. The Company's expense levels are based, in part, on expectations of future revenues. If revenue levels in a particular quarter do not meet expectations, operating results may be adversely affected. A variety of factors have an influence on the level of the Company's revenues in a particular quarter. These factors include general economic conditions, specific economic conditions in the industries the Company serves, the timing of the receipt of orders from major customers, customer cancellations or delay of shipments, specific feature requests by customers, production delays or manufacturing inefficiencies, exchange rate fluctuations, management decisions to commence or discontinue product lines, the Company's ability to design, introduce and manufacture new products on a cost effective and timely basis, the introduction of new products by the Company or its competitors, the timing of research and development expenditures, and expenses related to acquisitions, strategic alliances, and the further 35
development of marketing and service capabilities. A substantial portion of the Company's shipments are made on a "just-in-time" basis in which shipment of systems occurs within a few days or hours after an order is received. The Company's backlog is not meaningful because of the importance of "just-in-time" shipments. The Company is dependent on obtaining orders for shipment in a particular quarter to achieve its revenue objectives for that quarter. Accordingly, it is difficult for the Company to predict accurately the timing and level of sales in a particular quarter. Due to its "just-in-time" program, the Company anticipates quarterly fluctuations in sales will continue to occur. The Company's quarterly operating results in 1996 and 1997 reflect the changing demand for the Company's products during this period, principally from manufacturers of semiconductor equipment and data storage equipment, and the Company's ability to quickly adjust its manufacturing capacity to meet this demand. Demand from the semiconductor equipment companies was significantly lower from the third quarter of 1996 until the second quarter of 1997. In the second quarter of 1997, the semiconductor equipment market began a major recovery which continued throughout 1997, and sales to the data storage equipment market also experienced significant growth. Sales during the fourth quarter of 1997 increased 8% from the third quarter of 1997 primarily as a result of the inclusion of revenues from Tower. This increase was offset by a significant drop in sales in Japan from the third quarter of 1997 to the fourth quarter of 1997. The Company's gross margin fluctuated significantly on a quarterly basis in 1996 and 1997, primarily reflecting utilization of manufacturing capacity. Average selling prices remained relatively constant throughout the periods presented. The increase in gross margin from 37.3% in the first quarter of 1996 to 42.3% in the second quarter of 1996 resulted from a number of factors which resulted in decreased component costs. The reduction in gross margin to 30.5% in the third quarter of 1996 was primarily the result of underabsorbed fixed manufacturing costs from reduced revenue, as revenues in the third quarter of 1996 were $8.2 million lower than in the second quarter of 1996. Additionally, gross margin was negatively impacted by a shift in product mix toward products on which material costs as a percentage of sales were higher than the previous quarter. Increased customer service costs, as a percentage of sales, also contributed to the lower gross margin. The improvement in gross margin to 36.9% in the fourth quarter of 1996 was attributable primarily to a favorable product mix, decreased direct material costs and decreased customer service costs. The improvement in gross margin to 38.4% in the second quarter of 1997 and 40.0% in the third quarter of 1997 was primarily the result of a more favorable absorption of manufacturing overhead resulting from a 58% increase in sales from the first quarter of 1997 to the second quarter of 1997. Beginning August 15, 1997, the Company's operating results included Tower. The Company returned to full production in the fourth quarter of 1997, during which time gross margin declined to 37.6%. This decrease was primarily attributed to higher customer service costs and higher cost of goods sold as a percentage of sales for Tower. 36
The Company's operating expenses increased on a quarterly basis through the first half of 1996. Since the fourth quarter of 1995, operating expenses have included additional legal and administrative expenses as a result of being a publicly held company. Additionally, the Company has expensed costs incurred for consultants used in the implementation of a new information management system software. The Company expects expenses related to the implementation of the software to continue through 1998 as additional phases are implemented, including integration of the information systems of the Company's international subsidiaries. Quarterly decreases of operating expenses in the second half of 1996 and the first quarter of 1997 reflected a companywide restructuring and the implementation of cost containment measures started in the third quarter of 1996 to react to the significant decrease in demand, primarily from semiconductor equipment companies. The increases in operating expenses during the remaining quarters of 1997 reflected costs in support of higher sales resulting from the recovery in the semiconductor equipment industry and increases in sales to the data storage industry in the second and third quarters of 1997. Operating expenses of $14.4 million in the third quarter of 1997 would have been $8.3 million if not for the one-time charges of $6.1 million. As a percentage of sales, operating expenses have declined during periods of rapid sales growth, when sales increased at a rate faster than the Company's ability to add personnel and facilities to support the growth, and increased during periods of flat or decreased sales, when the Company's infrastructure is retained to support anticipated future growth or from non-recurring charges associated with downsizing. Other income (expense) consists primarily of interest income and expense and foreign currency gain and loss. The net foreign exchange loss of $0.4 million in 1996 was recognized during the first and fourth quarters of 1996, with essentially no gain or loss in the second and third quarter. During 1997, the Company recorded a net foreign exchange gain of $0.1 million. The Company continues to utilize forward foreign exchange contracts in Japan to mitigate the effects of foreign currency fluctuations. The Company's provision for income taxes remained relatively stable in 1996, ranging from 37.0% to 40.3%, but fluctuated significantly in 1997. An effective income tax rate of 80.6% in the third quarter of 1997 was due primarily to the one-time non-deductible charge of $3.1 million for the purchased in-process research and development associated with the acquisition of Tower. An effective income tax rate of 26.0% in the fourth quarter of 1997 was due primarily to a revised estimate resulting in a favorable adjustment to previously-accrued income taxes in Japan. The first and second quarters of 1997 had effective income tax rates of 39.0% and 37.8%, respectively, closer to historical rates. LIQUIDITY AND CAPITAL RESOURCES Since its inception, the Company has financed its operations, acquired equipment and met its working capital requirements through borrowings under its revolving line of credit, long-term loans secured by property and equipment and cash flow from 37
operations, and, from November 1995, proceeds from underwritten public offerings. Cash provided by operations totaled $3.3 million in 1996. In 1996, net income, depreciation, amortization and decreases in inventory were partially offset by increases in accounts receivable and decreases in accounts payable. Cash provided by operations totaled $8.1 million in 1997, of which major factors were net income, depreciation, amortization, purchased in-process research and development, and increases in accounts payable, offset by increases in accounts receivable and inventories. The Company expects future receivable and inventory balances to fluctuate with net sales. The Company provides "just-in-time" deliveries to certain of its customers and may be required to maintain higher levels of inventory to satisfy its customers' delivery requirements. Investing activities in 1996 used cash of $5.1 million and consisted of equipment acquisitions. Investing activities in 1997 used cash of $38.2 million and consisted of the acquisition of Tower for $13.0 million, the purchase of marketable securities of $20.0 million and the purchase of property and equipment of $5.2 million. Financing activities used cash of $0.3 million in 1996, and consisted primarily of net proceeds of notes payable to finance equipment of $1.6 million, offset by repayments of notes payable and capital lease obligations. In October 1997, the Company completed an underwritten public offering of 1,000,000 shares of common stock at a price of $31 per share, for aggregate net proceeds of approximately $28.7 million. The Company used $12.0 million of the net proceeds to repay a $12.0 million term loan used to finance the acquisition of Tower, and incurred a prepayment penalty of approximately $90,000. The remaining proceeds were added to the Company's working capital to finance future business needs. In 1997, financing activities provided cash of $30.5 million and consisted primarily of the net proceeds of $28.7 million from the underwritten public offering. Long-term loans secured by property and equipment were $1.5 million in 1996 and were paid off in 1997. The Company plans to spend approximately $6.0 million through 1998 for the acquisition of equipment, leasehold improvements and furnishings. As of December 31, 1997, the Company had working capital of $66.7 million. The Company's principal sources of liquidity consisted of $11.5 million of cash and cash equivalents, $20.2 million of marketable securities, and a credit facility consisting of a $30.0 million revolving line of credit which replaced the Company's prior line of credit, with options to convert up to $10.0 million to a three-year term loan. Advances under the new revolving line of credit bear interest at either the prime rate (8.5% at January 31, 1998) minus 1.25% or the LIBOR 360-day rate (5.65625% at January 31, 1998) plus 150 basis points, at the Company's option. All advances under the revolving line of credit will be due and payable in December 2000; however, there were no advances outstanding as of December 31, 1997. 38
The Company believes that its cash and cash equivalents, cash flow from operations and available borrowings, will be sufficient to meet the Company's working capital needs through at least the end of 1998. After that time, the Company may require additional equity or debt financing to address its working capital, capital equipment, or expansion needs. In addition, any significant acquisitions by the Company may require additional equity or debt financings to fund the purchase price, if paid in cash. There can be no assurance that additional funding will be available when required or that it will be available on terms acceptable to the Company. 39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE ---- Report of Arthur Andersen LLP, Independent Public Accountants 41 Consolidated Balance Sheets as of December 31, 1997 and 1996 42 Consolidated Statements of Income for the Years Ended December 31, 1997, 1996 and 1995 44 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1997, 1996 and 1995 45 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 46 Notes to Consolidated Financial Statements 47 Schedule II -- Valuation and Qualifying Accounts 58 40
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Advanced Energy Industries, Inc.: We have audited the accompanying consolidated balance sheets of Advanced Energy Industries, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These consolidated financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index of the consolidated financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in our 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. Denver, Colorado ARTHUR ANDERSEN LLP February 6, 1998. 41
ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) <TABLE> DECEMBER 31, ----------------------- 1997 1996 -------- ------- <S> <C> <C> ASSETS CURRENT ASSETS: Cash and cash equivalents $ 11,470 $11,231 Marketable securities - trading 20,174 -- Accounts receivable -- Trade (less allowances for doubtful accounts of approximately $428 and $242 at December 31, 1997 and 1996, respectively) 26,150 15,287 Related parties 893 541 Other 1,343 288 Inventories 26,243 13,976 Other current assets 2,472 1,013 Deferred income tax assets, net 2,836 1,223 -------- ------- Total current assets 91,581 43,559 -------- ------- PROPERTY AND EQUIPMENT, at cost, net of accumulated depreciation of $7,017 and $5,779 at December 31, 1997 and 1996, respectively 11,331 9,500 -------- ------- OTHER ASSETS: Deposits and other 500 1,139 Goodwill, net of accumulated amortization of $378 at December 31, 1997 7,112 -- Demonstration and customer service equipment, net of accumulated depreciation of $1,673 and $1,276 at December 31, 1997 and 1996, respectively 1,719 1,833 -------- ------- 9,331 2,972 -------- ------- Total assets $112,243 $56,031 -------- ------- -------- ------- </TABLE> The accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets. 42
ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) <TABLE> DECEMBER 31, ----------------------- 1997 1996 -------- ------- <S> <C> <C> LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable trade $ 12,045 $ 2,253 Accrued payroll and employee benefits 5,243 2,396 Other accrued expenses 1,327 1,156 Customer deposits 226 166 Accrued income taxes payable 2,734 1,485 Capital lease obligations, current portion 147 315 Notes payable, current portion 3,151 609 -------- ------- Total current liabilities 24,873 8,380 -------- ------- LONG-TERM LIABILITIES: Capital lease obligations, net of current portion 22 169 Notes payable, net of current portion -- 958 Deferred income taxes -- 28 -------- ------- 22 1,155 -------- ------- Total liabilities 24,895 9,535 -------- ------- COMMITMENTS AND CONTINGENCIES (Note 12) STOCKHOLDERS' EQUITY (Note 1): Preferred stock, $0.001 par value, 1,000 shares authorized, none issued and outstanding -- -- Common stock, $0.001 par value, 30,000 shares authorized; 22,493 and 21,268 shares issued and outstanding, respectively 22 21 Additional paid-in capital 52,625 23,075 Retained earnings 35,427 25,065 Stockholders' notes receivable -- (1,083) Deferred compensation (34) (82) Cumulative translation adjustment (692) (500) -------- ------- Total stockholders' equity 87,348 46,496 -------- ------- Total liabilities and stockholders' equity $112,243 $56,031 -------- ------- -------- ------- </TABLE> The accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets. 43
ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <TABLE> YEARS ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ---- ---- ---- <S> <C> <C> <C> SALES $141,923 $98,852 $94,708 COST OF SALES 87,538 62,038 49,314 -------- ------- ------- Gross profit 54,385 36,814 45,394 -------- ------- ------- OPERATING EXPENSES: Research and development 14,751 13,760 10,522 Sales and marketing 9,565 8,590 6,201 General and administrative 7,284 6,253 7,193 Storm damage, net of $300 insurance reimbursement 2,700 -- -- Purchased in-process research and development 3,080 -- -- -------- ------- ------- Total operating expenses 37,380 28,603 23,916 -------- ------- ------- INCOME FROM OPERATIONS 17,005 8,211 21,478 -------- ------- ------- OTHER INCOME (EXPENSE): Interest income 543 455 71 Interest expense (329) (168) (612) Foreign currency gain (loss) 97 (351) (7) Other (expense) income, net (285) 157 155 -------- ------- ------- Total other income (expense) 26 93 (393) -------- ------- ------- Net income before income taxes 17,031 8,304 21,085 PROVISION FOR INCOME TAXES 6,669 3,160 7,804 -------- ------- ------- NET INCOME $ 10,362 $ 5,144 $13,281 -------- ------- ------- -------- ------- ------- BASIC EARNINGS PER SHARE $ 0.48 $ 0.24 $ 0.73 -------- ------- ------- -------- ------- ------- DILUTED EARNINGS PER SHARE $ 0.47 $ 0.24 $ 0.69 -------- ------- ------- -------- ------- ------- BASIC WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING 21,544 21,242 18,216 -------- ------- ------- -------- ------- ------- DILUTED WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING 22,274 21,666 19,310 -------- ------- ------- -------- ------- ------- </TABLE> The accompanying notes to consolidated financial statements are an integral part of these consolidated statements. 44
ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS) FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 <TABLE> COMMON STOCK ADDITIONAL STOCKHOLDERS' CUMULATIVE TOTAL -------------- PAID-IN RETAINED NOTES DEFERRED TRANSLATION STOCKHOLDERS' SHARES AMOUNT CAPITAL EARNINGS RECEIVABLE COMPENSATION ADJUSTMENT EQUITY ------ ------ ------- -------- ---------- ------------ ---------- ------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> BALANCES, December 31, 1994 17,293 $17 $ 367 $ 6,640 $ -- $ -- $ 194 $ 7,218 Equity adjustment from foreign currency translation -- -- -- -- -- -- (761) (761) Exercise of stock options for cash 140 1 124 -- -- -- -- 125 Exercise of stock options in exchange for stockholders' notes receivable 1,236 1 1,082 -- (1,083) -- -- -- Deferred compensation on stock options issued -- -- 142 -- -- (142) -- -- Amortization of deferred compensation -- -- -- -- -- 12 -- 12 Sale of common stock through public offering, net of approximately $2,790 of expenses 2,400 2 21,210 -- -- -- -- 21,212 Net income -- -- -- 13,281 -- -- -- 13,281 ------ --- ------- ------- ------- ----- ----- ------- BALANCES, December 31, 1995 21,069 21 22,925 19,921 (1,083) (130) (567) 41,087 Equity adjustment from foreign currency translation -- -- -- -- -- -- 67 67 Exercise of stock options for cash 199 -- 150 -- -- -- -- 150 Amortization of deferred compensation -- -- -- -- -- 48 -- 48 Net income -- -- -- 5,144 -- -- -- 5,144 ------ --- ------- ------- ------- ----- ----- ------- BALANCES, December 31, 1996 21,268 21 23,075 25,065 (1,083) (82) (500) 46,496 Equity adjustment from foreign currency translation -- -- -- -- -- -- (192) (192) Exercise of stock options for cash 127 -- 255 -- -- -- -- 255 Exercise of stock options in exchange for stockholders' notes receivable 90 -- 470 -- (470) -- -- -- Proceeds from stockholders' notes receivable -- -- -- -- 1,553 -- -- 1,553 Sale of common stock through employee stock purchase plan 8 -- 102 -- -- -- -- 102 Amortization of deferred compensation -- -- -- -- -- 48 -- 48 Sale of common stock through public offering, net of approximately $2,276 of expenses 1,000 1 28,723 -- -- -- -- 28,724 Net income -- -- -- 10,362 -- -- -- 10,362 ------ --- ------- ------- ------- ----- ----- ------- BALANCES, December 31, 1997 22,493 $22 $52,625 $35,427 $ -- $ (34) $(692) $87,348 ------ --- ------- ------- ------- ----- ----- ------- ------ --- ------- ------- ------- ----- ----- ------- </TABLE> The accompanying notes to consolidated financial statements are an integral part of these consolidated statements. 45
ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) <TABLE> YEARS ENDED DECEMBER 31, ----------------------------- 1997 1996 1995 ------- ------- ------- <S> <C> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $10,362 $ 5,144 $13,281 Adjustments to reconcile net income to net cash provided by operating activities - Depreciation and amortization 3,710 2,609 1,543 Provision for deferred income taxes (1,584) (286) (252) Amortization of deferred compensation 48 48 12 Purchased in-process research and development 3,080 -- -- Loss on disposal of property and equipment 1,046 41 66 Earnings from marketable securities, net (174) -- -- Changes in operating assets and liabilities - Accounts receivable-trade, net (9,213) (1,747) (5,477) Related parties and other receivables (502) 803 (889) Inventories (9,576) 2,128 (8,907) Other current assets (1,420) (350) (371) Deposits and other 639 (324) (225) Demonstration and customer service equipment (636) (644) (937) Accounts payable, trade 8,500 (4,412) 3,568 Accrued payroll and employee benefits 2,569 (367) 725 Customer deposits and other accrued expenses 231 460 149 Income taxes payable 1,011 149 1,388 ------- ------- ------- Net cash provided by operating activities 8,091 3,252 3,674 ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of marketable securities (20,000) -- -- Acquisition of Tower Electronics, Inc., net of cash acquired (12,995) -- -- Purchase of property and equipment, net (5,179) (5,137) (3,824) ------- ------- ------- Net cash used in investing activities (38,174) (5,137) (3,824) ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from notes payable 13,763 1,606 31,179 Repayment of notes payable and capital lease obligations (13,883) (2,039) (34,103) Repayment of subordinated notes to stockholders -- -- (4,538) Sale of common stock, net of expenses 28,724 -- 21,212 Sale of common stock through employee stock purchase plan 102 -- -- Proceeds from exercise of stock options and warrants 255 150 125 Proceeds from stockholders' notes receivable 1,553 -- -- ------- ------- ------- Net cash provided by (used in) financing activities 30,514 (283) 13,875 ------- ------- ------- EFFECT OF CURRENCY TRANSLATION ON CASH FLOW (192) 67 (761) ------- ------- ------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 239 (2,101) 12,964 CASH AND CASH EQUIVALENTS, beginning of period 11,231 13,332 368 ------- ------- ------- CASH AND CASH EQUIVALENTS, end of period $11,470 $11,231 $13,332 ------- ------- ------- ------- ------- ------- SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Note payable assumed in Tower acquisition $ 1,389 $ -- $ -- ------- ------- ------- ------- ------- ------- Deferred compensation on stock options issued $ -- $ -- $ 142 ------- ------- ------- ------- ------- ------- Exercise of stock options in exchange for stockholders' notes receivable $ 470 $ -- $ 1,083 ------- ------- ------- ------- ------- ------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest $ 329 $ 168 $ 604 ------- ------- ------- ------- ------- ------- Cash paid for income taxes $ 7,242 $ 3,940 $ 6,668 ------- ------- ------- ------- ------- ------- </TABLE> The accompanying notes to consolidated financial statements are an integral part of these consolidated statements. 46
ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) COMPANY OPERATIONS Advanced Energy Industries, Inc. (the "Company") was incorporated in Colorado in 1981 and reincorporated in Delaware in 1995. The Company is primarily engaged in the development and production of power conversion and control systems which are used by manufacturers of semiconductors and in industrial thin film manufacturing processes. The Company owns 100% of each of the following subsidiaries: Advanced Energy Japan, K.K. ("AE-Japan"), Advanced Energy, GmbH ("AE-Germany"), Advanced Energy U.K. Limited ("AE-UK") and Advanced Energy Korea, Limited ("AE-Korea"). The Company also owns 100% of Tower Electronics, Inc. ("Tower"), a Minnesota-based designer and manufacturer of custom, high performance switchmode power supplies used principally in the telecommunications, medical and non-impact printing industries. In September 1995, the Company reincorporated in Delaware with an authorized capitalization of 30,000,000 shares of common stock, $0.001 par value. Also in September 1995, the Company approved a three for one share common stock split. All share and per share data have been retroactively adjusted in the accompanying consolidated financial statements for the effect of the stock split. Additionally, the Company also authorized 1,000,000 shares of $0.001 par value preferred stock. The Company continues to be subject to certain risks similar to other companies in its industry. These risks include the volatility of the semiconductor industry, customer concentration within the industry, technological changes, dependence on the Japanese market, foreign currency risk and competition. A significant change in any of these risk factors could have a material impact on the Company's business. (2) SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION -- The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. CASH AND CASH EQUIVALENTS -- For cash flow purposes, the Company considers all cash and highly liquid investments with an original maturity of 90 days or less to be cash and cash equivalents. INVENTORIES -- Inventories include costs of materials, direct labor and manufacturing overhead. Inventories are valued at the lower of market or cost, computed on a first-in, first-out basis. MARKETABLE SECURITIES - TRADING -- Effective July 1, 1994, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." SFAS No. 115 addresses the accounting and reporting for investments in equity and debt securities. The Company has investments in marketable equity securities and municipal bonds which have original maturities of 90 days or more. The investments are classified as trading securities and reported at fair value with unrealized gains and losses included in earnings. DEMONSTRATION AND CUSTOMER SERVICE EQUIPMENT -- Demonstration and customer service equipment are manufactured products utilized for sales demonstration and evaluation purposes. The Company also utilizes this equipment in its customer service function as replacement and loaner equipment to existing customers. All equipment is held for sale. 47
The Company depreciates the equipment based on an estimated 3-year useful life in the sales and customer service functions. PROPERTY AND EQUIPMENT -- Property and equipment is stated at cost. Additions, improvements, and major renewals are capitalized. Maintenance, repairs, and minor renewals are expensed as incurred. Depreciation is provided using straight-line and accelerated methods over three to ten years for machinery and equipment. Amortization of leasehold improvements and leased equipment is provided using the straight-line method over the life of the lease term or the life of the assets, whichever is shorter. CONCENTRATIONS OF CREDIT RISK -- The Company's revenues generally are concentrated among a small number of customers, the majority of which are in the semiconductor equipment industry. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information. WARRANTY POLICY -- The Company estimates the anticipated costs of repairing products under warranty based on the historical average cost of the repairs. The Company offers warranty coverage for its systems for periods ranging from 12 to 24 months after shipment. CUMULATIVE TRANSLATION ADJUSTMENT -- The functional currency for the Company's foreign operations is the applicable local currency. The Company records a cumulative translation adjustment from translation of the financial statements of AE-Japan, AE-Germany and AE-UK. This equity account includes the results of translating all balance sheet assets and liabilities at current exchange rates as of the balance sheet date, and the statements of income at the average exchange rates during the respective year. The Company recognizes gain or loss on foreign currency transactions which are not considered to be of a long-term investment nature. The Company recognized a gain (loss) on foreign currency transactions of $97,000, $(351,000) and $(7,000) for the years ended December 31, 1997, 1996 and 1995, respectively. REVENUE RECOGNITION -- The Company recognizes revenue when products are shipped. INCOME TAXES -- The Company accounts for income taxes by recognizing deferred tax assets and liabilities for temporary differences between the tax basis and financial reporting basis of assets and liabilities, computed at current tax rates. EARNINGS PER SHARE -- In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share," which requires companies to present basic earnings per share ("EPS") and diluted EPS, instead of the primary and fully-diluted EPS that were previously required. The new standard is effective for the Company in fiscal 1997 and all prior periods have been retroactively adjusted. Basic EPS is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding during the period. The computation of diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. ESTIMATES AND ASSUMPTIONS -- The preparation of the Company's consolidated financial statements in conformity with generally accepted accounting principles requires the Company's management to make estimates and assumptions that affect the amounts reported and disclosed in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. 48
ASSET IMPAIRMENTS -- The Company reviews its long-lived assets and certain identifiable intangibles held and used by the Company for impairment whenever events or changes in circumstances indicate their carrying amount may not be recoverable. In so doing, the Company estimates the future net cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future net cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized to reduce the asset to its estimated fair value. Otherwise, an impairment loss is not recognized. Long-lived assets and certain identifiable intangibles to be disposed of, if any, are reported at the lower of carrying amount or fair value less cost to sell. (3) ACQUISITION Effective August 15, 1997, the Company acquired all of the outstanding stock of Tower, a Minnesota-based designer and manufacturer of custom, high-performance switchmode power supplies used principally in the telecommunications, medical and non-impact printing industries. The purchase price consisted of $14.5 million in cash and a $1.5 million non-interest bearing promissory note to the seller (the "Note"), payable in August 1998. Total consideration, including the effect of imputing interest on the Note, equaled $15,889,000. The acquisition was accounted for using the purchase method of accounting and resulted in a one-time charge of $3,080,000 for in-process research and development acquired as a result of the transaction. Acquisition costs totaled approximately $209,000. The purchase price was allocated to the net assets of Tower as summarized below: <TABLE> (In thousands) <S> <C> Cash and cash equivalents $ 1,714 Accounts receivable 2,555 Inventories 2,691 Deferred tax asset 57 Fixed assets 280 Goodwill 7,490 Purchased in-process research and development 3,080 Other assets 39 Accounts payable (1,292) Accrued liabilities (516) -------- $16,098 -------- -------- </TABLE> The results of operations of Tower are included within the accompanying consolidated financial statements from the date of acquisition. The following table sets forth the condensed unaudited pro forma operating results of the Company for the twelve months ended December 31, 1997 and 1996. The condensed pro forma operating results assume that the Tower acquisition had occurred on January 1, 1996 and was funded with debt outstanding until the secondary offering occurred in October 1997. Additionally, the pro forma operating results do not include charges for the $3,080,000 purchased in-process research and development as it is non-recurring. The condensed pro forma results are not necessarily indicative of the results of operations had the acquisition consummated on January 1, 1996, and may not necessarily be indicative of future performance. <TABLE> TWELVE MONTHS ENDED DECEMBER 31, (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) 1997 1996 -------------------------------- ----------- ----------- <S> <C> <C> Sales $154,568 $112,253 Net income $ 14,476 $ 4,842 Basic earnings per share $ 0.67 $ 0.23 Diluted earnings per share $ 0.65 $ 0.22 Basic weighted-average common shares outstanding 21,544 21,242 Diluted weighted-average common shares outstanding 22,274 21,666 </TABLE> 49
(4) PUBLIC OFFERINGS In November 1995, the Company closed on the initial public offering of its common stock. In connection with the offering, 2,400,000 shares of common shares were sold at a price of $10 per share, providing gross proceeds of $24,000,000, less $2,790,000 in offering costs. In October 1997, the Company closed on a secondary offering of its common stock. In connection with this offering, 1,000,000 shares of common shares were sold at a price of $31 per share, providing gross proceeds of $31,000,000, less $2,276,000 in offering costs. (5) MARKETABLE SECURITIES - TRADING Marketable securities - trading consisted of the following: <TABLE> DECEMBER 31, ---------------------- 1997 1996 ------- ------ (IN THOUSANDS) <S> <C> <C> Equities $18,345 $ -- Municipal bonds and notes 1,700 -- Mutual funds 129 -- ------- ----- $20,174 $ -- ------- ----- ------- ----- </TABLE> These marketable securities are reported at fair value and have original costs of $20,000,000. (6) ACCOUNTS RECEIVABLE - TRADE Accounts receivable - trade consisted of the following: <TABLE> DECEMBER 31, ---------------------- 1997 1996 ------- ------ (IN THOUSANDS) <S> <C> <C> Domestic $16,724 $ 9,944 Foreign 9,854 5,585 Allowance for doubtful accounts (428) (242) ------- ------- $26,150 $15,287 ------- ------- ------- ------- </TABLE> (7) INVENTORIES Inventories consisted of the following: <TABLE> DECEMBER 31, ---------------------- 1997 1996 ------- ------ (IN THOUSANDS) <S> <C> <C> Parts and raw materials $18,549 $11,149 Work in process 2,542 1,122 Finished goods 5,152 1,705 ------- ------- $26,243 $13,976 ------- ------- ------- ------- </TABLE> 50
(8) PROPERTY AND EQUIPMENT Property and equipment consisted of the following: <TABLE> DECEMBER 31, ---------------------- 1997 1996 ------- ------ (IN THOUSANDS) <S> <C> <C> Machinery and equipment $ 8,912 $ 5,708 Computers and communication equipment 4,638 4,793 Furniture and fixtures 1,996 1,996 Vehicles 100 140 Leasehold improvements 2,702 2,642 ------- ------- 18,348 15,279 Less -- accumulated depreciation (7,017) (5,779) ------- ------- $11,331 $ 9,500 ------- ------- ------- ------- </TABLE> Included in the cost of property and equipment above is equipment obtained through capital leases. The net book value of capital lease equipment included in property and equipment above was as follows at December 31, 1997 and 1996: <TABLE> DECEMBER 31, ---------------------- 1997 1996 ------- ------ (IN THOUSANDS) <S> <C> <C> Machinery and equipment $ 79 $243 Computers and communication equipment -- 62 Furniture and fixtures 1 14 ---- ---- $ 80 $319 ---- ---- ---- ---- </TABLE> Depreciation of assets acquired under capitalized leases is included in depreciation expense. (9) NOTES PAYABLE <TABLE> DECEMBER 31, ---------------------- 1997 1996 ------- ------ (IN THOUSANDS) <S> <C> <C> Revolving line of credit of $30,000,000, expiring December 7, 2000, interest at bank's prime rate minus 1.25% or the LIBOR 360-day rate plus 150 basis points. Option to convert up to $10,000,000 to a three-year term loan; advances up to $5,000,000 each for Optional Currency Rate Advances and Foreign Exchange Contracts. Loan covenants provide certain financial restrictions related to working capital, leverage, net worth and profitability $ -- $ -- Bank overdraft loan, maturing February and March 1998 at interest rates ranging from 1.05% to 1.65% annually 1,762 -- Promissory note related to indemnification clause of Tower acquisition, maturing August 1998 with an imputed interest rate of 8% 1,389 -- Term loan of $1,500,000 with a bank at prime plus 0.25% -- 1,458 Other -- 109 -------- -------- 3,151 1,567 Less -- current portion (3,151) (609) -------- -------- $ -- $ 958 -------- -------- -------- -------- </TABLE> (10) INCOME TAXES For the years ended December 31, 1997, 1996 and 1995, the provision for income taxes consists of an amount for taxes currently payable and a provision for tax effects deferred to future periods. In 1997, the Company increased its statutory U.S. tax rate from 34% to 35%. 51
The provision (benefit) for income taxes for the years ended December 31, 1997, 1996 and 1995, is as follows: <TABLE> DECEMBER 31, ------------------------------------- 1997 1996 1995 ------- ------ ------ (IN THOUSANDS) <S> <C> <C> <C> Federal $ 5,470 $2,744 $5,827 State and local 1,128 568 918 Foreign taxes 71 (152) 1,059 ------- ------ ------ $ 6,669 $3,160 $7,804 ------- ------ ------ ------- ------ ------ Current 8,253 $3,446 $8,056 Deferred (1,584) (286) (252) ------- ------ ------ $ 6,669 $3,160 $7,804 ------- ------ ------ ------- ------ ------ </TABLE> The following reconciles the Company's effective tax rate to the federal statutory rate for the years ended December 31, 1997, 1996 and 1995: <TABLE> DECEMBER 31, --------------------------------- 1997 1996 1995 ------ ------ ------ (IN THOUSANDS) <S> <C> <C> <C> Income tax expense per federal statutory rate $5,961 $2,823 $7,397 State income taxes, net of federal deduction 733 375 596 Foreign sales corporation (209) (108) (208) Nondeductible goodwill amortization 132 -- -- Nondeductible purchased in-process research and development 1,078 -- -- Other permanent items, net (22) 77 49 Effect of foreign taxes (255) (168) 316 Tax credits (272) (182) (260) Other (477) 343 (86) ------ ------ ------ $6,669 $3,160 $7,804 ------ ------ ------ ------ ------ ------ </TABLE> The Company's deferred income taxes are summarized as follows: <TABLE> DECEMBER 31, 1997 CHANGE DECEMBER 31, 1996 ----------------- ------ ----------------- (IN THOUSANDS) <S> <C> <C> <C> Deferred tax assets: Employee bonuses $ 203 $ 203 $ -- Warranty reserve 312 137 175 Bad debt reserve 135 60 75 Vacation accrual 295 (31) 326 Obsolete and excess inventory 1,049 475 574 Foreign operating loss carryforward 643 643 -- Other 199 69 73 ------ ------ ------ 2,836 1,556 1,223 ------ ------ ------ Deferred tax liabilities: Accumulated depreciation -- 28 (28) ------ ------ ------ Net deferred income tax assets $2,836 $1,584 $1,195 ------ ------ ------ ------ ------ ------ </TABLE> The domestic versus foreign component of the Company's net income before income taxes at December 31, 1997, 1996 and 1995, was as follows: <TABLE> DECEMBER 31, ------------------------------------- 1997 1996 1995 ------- ------ ------- (IN THOUSANDS) <S> <C> <C> <C> Domestic $16,102 $8,255 $18,969 Foreign 929 49 2,116 ------- ------ ------- $17,031 $8,304 $21,085 ------- ------ ------- ------- ------ ------- </TABLE> 52
(11) RETIREMENT PLAN The Company has a 401(k) Profit Sharing Plan which covers all full-time employees who have completed six months of full-time continuous service and are age eighteen or older. Participants may defer up to 20% of their gross pay up to a maximum limit determined by law ($9,500 during 1997). Participants are immediately vested in their contributions. The Company may make discretionary contributions based on corporate financial results for the fiscal year. Effective January 1, 1998, the Company increased its matching contribution for participants in the 401(k) Plan up to a 50% matching on contributions by employees up to 6% of the employee's compensation. The Company's total contributions to the plan were approximately $580,000, $45,000 and $537,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Vesting in the profit sharing contribution account (company contribution) is based on years of service, with a participant fully vested after five years of credited service. (12) COMMITMENTS AND CONTINGENCIES CAPITAL LEASES The Company finances a portion of its property and equipment (Note 8) under capital lease obligations at interest rates ranging from 7.63% to 8.66%. The future minimum lease payments under capitalized lease obligations as of December 31, 1997, are as follows: <TABLE> (IN THOUSANDS) <S> <C> 1998 $ 154 1999 23 ----- Total minimum lease payments 177 Less -- amount representing interest (8) Less -- current portion (147) ----- $ 22 ----- ----- </TABLE> OPERATING LEASES The Company has various operating leases for automobiles, equipment, and office and production space (Note 14). Lease expense under operating leases was approximately $2,251,000, $1,788,000 and $1,184,000 for the years ended December 31, 1997, 1996 and 1995, respectively. The future minimum rental payments required under noncancelable operating leases as of December 31, 1997, are as follows: <TABLE> (IN THOUSANDS) <S> <C> 1998 $ 2,597 1999 2,488 2000 2,201 2001 1,929 2002 1,553 Thereafter 9,199 ------- $19,967 ------- ------- </TABLE> GUARANTEE In October 1997, the Company extended a guarantee for a $2,500,000 bank term loan for an additional year, entered into by an entity that serves as a supplier to the Company. An officer of the Company serves as a director of such entity. The Company has received warrants to purchase shares of the supplier for providing this guarantee. 53
(13) FOREIGN OPERATIONS The Company operates in a single industry segment with operations in the U.S., Japan and Europe. The following is a summary of the Company's foreign operations: <TABLE> YEARS ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 -------- -------- -------- (IN THOUSANDS) <S> <C> <C> <C> Sales: Originating in Japan to unaffiliated customers $ 11,431 $ 6,467 $ 11,997 Originating in Europe to unaffiliated customers 7,487 8,023 6,237 Originating in U.S. and sold to unaffiliated foreign customers 17,095 9,506 9,018 Originating in U.S. and sold to domestic customers 105,910 74,856 67,456 Transfers between geographic areas 14,523 10,496 11,524 Intercompany eliminations (14,523) (10,496) (11,524) -------- -------- -------- $141,923 $ 98,852 $ 94,708 -------- -------- -------- -------- -------- -------- Income (loss) from operations: Japan $ (73) $ (920) $ 1,094 Europe 1,488 1,056 953 U.S. 15,893 8,383 19,448 South Korea -- -- -- Intercompany eliminations (303) (308) (17) -------- -------- -------- $ 17,005 $ 8,211 $ 21,478 -------- -------- -------- -------- -------- -------- Identifiable assets: Japan $ 10,709 $ 6,445 $ 6,342 Europe 4,676 3,788 2,502 U.S. 126,111 54,736 54,415 South Korea 250 -- -- Intercompany eliminations (29,503) (8,938) (7,940) -------- -------- -------- $112,243 $ 56,031 $ 55,319 -------- -------- -------- -------- -------- -------- </TABLE> Intercompany sales among the Company's geographic areas are recorded on the basis of intercompany prices established by the Company. (14) RELATED PARTY TRANSACTIONS The Company leases office and production spaces from a limited liability partnership consisting of certain officers of the Company and other individuals. The leases relating to these spaces expire in 2009 and 2011 with monthly payments of approximately $39,000 and $46,000, respectively. The Company also leases other office and production space from another limited liability partnership consisting of certain officers of the Company and other individuals. The lease relating to this space expires in 2002 with a monthly payment of approximately $23,000. Approximately $1,320,000, $1,364,000, and $800,000 was charged to rent expense attributable to these leases for the years ended December 31, 1997, 1996 and 1995, respectively. The Company leases, for business purposes, a condominium owned by a partnership of certain stockholders. The Company paid the partnership $36,000 for each of the years ended December 31, 1997, 1996 and 1995, relating to this lease. Included in AE-Japan's accounts receivable at December 31, 1997, 1996 and 1995, is approximately $835,000, $394,000 and $953,000, respectively, due from an entity that is controlled by the president of AE-Japan. This entity also accounted for approximately 2%, 3%, and 3% of consolidated sales during 1997, 1996 and 1995, respectively. During 1997 and 1995, certain stockholders of the Company exercised options to purchase shares of the Company's common stock for an aggregate exercise price of $470,000 and $1,083,000, respectively. In exchange for the stock the Company received notes receivable in the amount of the exercise price. These notes receivable and accrued interest were paid in full during 1997. 54
(15) MAJOR CUSTOMERS The Company's sales to major customers (purchases in excess of 10% of total sales) are to entities which are primarily manufacturers of semiconductor equipment and, for the years ended December 31, 1997, 1996 and 1995 are as follows: <TABLE> DECEMBER 31, ------------------------- 1997 1996 1995 ---- ---- ---- <S> <C> <C> <C> Customer A 34% 27% 24% Customer B 10% 20% 17% ---- ---- ---- 44% 47% 41% ---- ---- ---- ---- ---- ---- </TABLE> (16) FORWARD CONTRACT AE-Japan enters into foreign currency forward contracts to buy U.S. dollars to hedge its payable position arising from trade purchases and intercompany transactions with its parent. Foreign currency forward contracts reduce the Company's exposure to the risk that the eventual net cash outflows resulting from the purchase of products denominated in yen will be adversely affected by changes in exchange rates. Foreign currency gains and losses under the above arrangements are not deferred. Foreign currency forward contracts are entered into with a major commercial Japanese bank that has a high credit rating and the Company does not expect the counterparty to fail to meet its obligations under outstanding contracts. The Company generally enters into foreign currency forward contracts with maturities ranging from 7 to 10 months, with contracts outstanding at December 31, 1997, maturing through September 1998. At December 31, 1997, the Company held foreign forward exchange contracts with notional amounts of $8,000,000 and fair value amounts of $7,280,000 or an unrealized gain position of $720,000. (17) STOCK PLANS EMPLOYEE STOCK OPTION PLAN -- During 1993, the Company adopted an Employee Stock Option Plan (the "Employee Option Plan") which was amended and restated in January and September 1995. The Employee Option Plan allows issuance of incentive stock options, non-qualified options, and stock purchase rights. The exercise price of incentive stock options shall not be less than 100% of the stock's fair market value on the date of grant. The exercise price of non-qualified stock options shall not be less than 50% of the stock's fair market value on the date of grant. Options issued in 1997, 1996 and 1995 were issued at 100% of fair market value, as determined by the Company, with typical vesting of one-third at the end of one year, and quarterly thereafter until fully vested after three years. Under the Employee Option Plan, the Company has the discretion to accelerate the vesting period. The options are exercisable for ten years from the date of grant. The Company has reserved 3,500,000 shares of common stock for the issuance of stock under the Employee Option Plan which terminates in June 2003. In connection with the grant of certain stock options on June 30, 1995, the Company recorded $142,000 of deferred compensation for the difference between the deemed fair value for accounting purposes and the option price as determined by the Company at the date of grant. This amount is presented as a reduction of stockholders' equity and will be amortized over the 3-year vesting period of the related stock options. EMPLOYEE STOCK PURCHASE PLAN -- In September 1995, stockholders approved an Employee Stock Purchase Plan (the "Stock Purchase Plan") covering an aggregate of 200,000 shares of common stock. Employees are eligible to participate in the Stock Purchase Plan if employed by the Company for at least 20 hours per week during at least five months per calendar year. Participating employees may have up to 15% (subject to a 5% limitation set by the Company's board of directors for fiscal 1996) of their earnings or a maximum of $1,250 per six month period withheld pursuant to the Stock Purchase Plan. Common stock purchased under the Stock Purchase Plan will be equal to 85% of the lower of the fair market value on the commencement date of each offering period or the relevant purchase date. During 1997 and 1996, 55
employees purchased an aggregate of 19,878 and 11,572 shares under the Stock Purchase Plan and the Company recognized approximately $27,000 and $11,000 in compensation expense, respectively. OUTSIDE DIRECTOR STOCK OPTION PLAN -- In September 1995, the Company adopted the 1995 Non-Employee Directors Stock Option Plan (the "Directors Plan") covering 50,000 shares of common stock. The Directors Plan provides for automatic grants of non-qualified stock options to directors of the Company who are not employees of the Company ("Outside Directors"). Pursuant to the Directors Plan, upon becoming a director of the Company, each Outside Director will be granted an option to purchase 7,500 shares of common stock. Such options will be immediately exercisable as to 2,500 shares of common stock, and will vest as to 2,500 shares of common stock on each of the second and third anniversaries of the grant date. On each anniversary of the date on which a person became an Outside Director, an option for an additional 2,500 shares is granted. Such additional options vest on the third anniversary of the date of grant. Options will expire ten years after the grant date, and the exercise price of the options will be equal to the fair market value of the common stock on the grant date. The Directors Plan terminates September 2005. The following summarizes the activity relating to options and warrants for the years ended December 31, 1997, 1996 and 1995: <TABLE> 1997 1996 1995 ---------------------- --------------------- --------------------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price --------- --------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> <C> Stock options: INCENTIVE STOCK OPTIONS -- Options outstanding at beginning of period 841 $ 3.02 729 $ 2.62 1,904 $ 0.95 Granted 686 11.42 751 5.10 212 6.40 Exercised (215) 3.32 (199) 8.51 (1,371) 3.53 Terminated (33) 4.24 (440) 6.92 (16) 1.69 ------ ----- ------ Options outstanding at end of period 1,279 6.77 841 3.02 729 2.62 ------ ----- ------ ------ ----- ------ Options exercisable at end of period 383 3.45 326 1.51 391 0.88 ------ ----- ------ ------ ----- ------ Weighted-average fair value of options granted during the period $ 7.86 $3.14 $ 1.84 ------ ----- ------ ------ ----- ------ Price range of outstanding options $0.83 - $31.63 $0.83 - $11.05 $0.83 - $11.05 -------------- -------------- -------------- -------------- -------------- -------------- Price range of options terminated $3.40 - $ 9.00 $0.83 - $11.05 $0.83 - $ 3.11 -------------- -------------- -------------- -------------- -------------- -------------- OUTSIDE DIRECTORS STOCK OPTIONS-- Options outstanding at beginning of period 20 $ 9.82 15 $11.05 -- $ -- Granted 17 16.64 5 6.13 15 11.05 Exercised (2) 7.13 -- -- -- -- Terminated (10) 9.82 -- -- -- -- ------ ----- ------ Options outstanding at end of period 25 14.86 20 9.82 15 11.05 ------ ----- ------ ------ ----- ------ Options exercisable at end of period 8 14.62 5 11.05 5 11.05 ------ ----- ------ ------ ----- ------ Weighted-average fair value of options granted during the period $11.43 $4.68 $ 3.19 ------ ----- ------ ------ ----- ------ Price range of outstanding options $8.63 - $31.63 $6.13 - $11.05 $11.05 -------------- -------------- ------ -------------- -------------- ------ Price range of options terminated $6.13 - $11.05 $ -- $ -- -------------- -------------- ------ -------------- -------------- ------ WARRANTS-- Warrants outstanding at beginning of period -- -- 7 $ 3.48 Granted -- -- -- -- Exercised -- -- (6) 2.27 Terminated -- -- (1) 3.99 ------- ------- ------ Warrants outstanding at end of period -- -- -- -- Price range of stock issuable under warrants $ -- $ -- $ -- ------- ------- ------ ------- ------- ------ Price range of warrants terminated $ -- $ -- $1.41 - $2.53 ------- ------- -------------- ------- ------- -------------- </TABLE> Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), defines a fair value based method of accounting for employee stock options or similar 56
equity instruments. However, SFAS No. 123 allows the continued measurement of compensation cost for such plans using the intrinsic value method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), provided that pro forma disclosures are made of net income or loss and net income or loss per share, assuming the fair value method of SFAS No. 123 had been applied. The Company has elected to account for stock-based compensation plans under APB No. 25, under which no compensation expense is recognized when stock is issued at market value. For SFAS No. 123 purposes, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: <TABLE> 1997 1996 1995 ------- ------- ------- <S> <C> <C> <C> Risk-free interest rates 6.17% 6.57% 6.16% Expected dividend yield rates 0.00% 0.00% 0.00% Expected lives 4 years 4 years 4 years Expected volatility 92.16% 110.16% 22.57% </TABLE> The total fair value of options granted was computed to be approximately $5,594,000, $1,317,000 and $420,000 for the years ended December 31, 1997, 1996 and 1995, respectively. These amounts are amortized ratably over the vesting period of the options. Cumulative compensation cost recognized in pro forma net income or loss with respect to options that are forfeited prior to vesting is adjusted as a reduction of pro forma compensation expense in the period of forfeiture. Pro forma stock-based compensation, net of the effect of forfeitures and tax, was approximately $415,000, $47,000 and $19,000 for 1997, 1996 and 1995, respectively. Had compensation cost for these plans been determined consistent with SFAS No. 123, the Company's net income would have been reduced to the following pro forma amounts: <TABLE> 1997 1996 1995 ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) <S> <C> <C> <C> Net Income: As reported $10,362 $5,144 $13,281 Pro forma 9,947 5,097 13,262 Diluted Earnings Per Share: As reported $ 0.47 $ 0.24 $ 0.69 Pro forma 0.45 0.24 0.69 </TABLE> Because the SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. The following table summarizes information about the stock options outstanding at December 31, 1997: <TABLE> Options Outstanding Options Exercisable ---------------------- ----------------------- Weighted- Average Weighted- Weighted- Range of Remaining Average Average Year Exercise Number Contractual Exercise Number Exercise Granted Prices Outstanding Life Price Exercisable Price - ---------- --------------- ----------- ----------- -------- ----------- --------- <S> <C> <C> <C> <C> <C> <C> 1993-1994 $0.83 to $2.53 169,000 5.9 years $ 0.92 169,000 $ 0.92 1995 $2.57 to $11.05 71,000 7.5 years $ 4.69 53,000 $ 4.48 1996 $3.88 to $8.75 389,000 8.8 years $ 4.10 136,000 $ 4.13 1997 $7.12 to $31.63 675,000 9.5 years $11.57 33,000 $12.04 --------- --------- ------ ------- ------ 1,304,000 8.7 years $ 7.58 391,000 $ 3.45 --------- --------- ------ ------- ------ --------- --------- ------ ------- ------ </TABLE> 57
ADVANCED ENERGY INDUSTRIES, INC. AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS <TABLE> BALANCE AT BEGINNING OF ADDITIONS CHARGED BALANCE AT PERIOD TO EXPENSE DEDUCTIONS END OF PERIOD ------------ ----------------- ---------- ------------- (IN THOUSANDS) <S> <C> <C> <C> <C> Year ended December 31, 1995: Inventory obsolescence reserve $ 724 $ 185 $ 120 $ 789 Allowance for doubtful accounts 134 76 -- 210 ------ ------ ------ ------ $ 858 $ 261 $ 120 $ 999 ------ ------ ------ ------ ------ ------ ------ ------ Year ended December 31, 1996: Inventory obsolescence reserve $ 789 $2,702 $1,966 $1,525 Allowance for doubtful accounts 210 35 3 242 ------ ------ ------ ------ $ 999 $2,737 $1,969 $1,767 ------ ------ ------ ------ ------ ------ ------ ------ Year ended December 31, 1997: Inventory obsolescence reserve $1,525 $4,310 $3,117 $2,718 Allowance for doubtful accounts 242 188 2 428 ------ ------ ------ ------ $1,767 $4,498 $3,119 $3,146 ------ ------ ------ ------ ------ ------ ------ ------ </TABLE> 58
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT In accordance with General Instruction G(3), the information required by this item (with the exception of certain information pertaining to executive officers, which is included in Part I hereof) has been omitted and is incorporated by reference to the Registrant's definitive Proxy Statement (the "Proxy Statement") relating to its 1998 Annual Meeting of Stockholders. ITEM 11. EXECUTIVE COMPENSATION The Proxy Statement will be filed not later than 120 days after the end of the fiscal year with the Securities and Exchange Commission. The information set forth therein under "Executive Compensation and Other Information" is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required is set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required is set forth under the caption "Certain Transactions" in the Proxy Statement and is incorporated herein by reference. 59
PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K <TABLE> <S> <C> <C> (a) (i) Financial Statements: Report of Independent Public Accountants 41 Consolidated Financial Statements: Balance Sheets at December 31, 1997 and 1996 42 Statements of Income for each of the three years in the period ended December 31, 1997 44 Statements of Stockholders' Equity for each of the three years in the period ended December 31, 1997 45 Statements of Cash Flows for each of the three years in the period ended December 31, 1997 46 Notes to Consolidated Financial Statements 47 (ii) Financial Statement Schedules for each of the three years in the period ended December 31, 1997 Schedule II--Valuation and Qualifying Accounts 58 (iii) Exhibits: 2.1 Share Purchase Agreement, dated August 11, 1997, among Roger C. Hertel, Tower Electronics, Inc. and the Company(1) 3.1 The Company's Restated Certificate of Incorporation(2) 3.2 The Company's By-laws(2) 4.1 Form of Specimen Certificate for the Company's Common Stock(2) 4.2 The Company hereby agrees to furnish to the SEC, upon request, a copy of the instruments which define the rights of holders of long-term debt of the Company. None of such instruments not included as exhibits herein represents long-term debt in excess of 10% of the consolidated total assets of the Company. 10.1 Master Purchase Order and Sales Agreement, dated January 1, 1990, between Applied Materials Inc. and the Company(2)+ 10.2 Purchase Order and Sales Agreement, dated July 1, 1993, amended September 16, 1995 between Lam Research Corporation and the Company(2)+ 10.3 Purchase Agreement, dated November 1, 1995, between Eaton Corporation and the Company(3)+ 10.4 Amended and Restated Loan and Security Agreement, dated as of November 17, 1995, between Silicon Valley Bank and the Company(2) 10.5 Loan and Security Agreement, dated August 15, 1997, among Silicon Valley Bank, Bank of Hawaii and the Company(4) 10.6 Loan Agreement dated December 8, 1997, by and among Silicon Valley Bank, as Servicing Agent and a Bank, and Bank of Hawaii, as a Bank, and the Company, as borrower 10.7 Equipment Line of Credit, dated July 11, 1994, between Silicon Valley Bank and the Company(2) 10.8 Master Lease Purchase Agreement, dated January 20, 1989, as amended, between MetLife Capital Corporation and the Company(2) 60
10.9 Lease Purchase Agreement, dated June 11, 1992, between MetLife Capital Corporation and the Company(2) 10.10 Master Equipment Lease, dated July 15, 1993, as amended, between KeyCorp Leasing Ltd. and Company(2) 10.11 Lease, dated June 12, 1984, amended June 11, 1992, between Prospect Park East Partnership and the Company for property in Fort Collins, Colorado(2) 10.12 Lease, dated March 14, 1994, as amended, between Sharp Point Properties, L.L.C., and the Company for property in Fort Collins, Colorado(2) 10.13 Lease, dated May 19, 1995, between Sharp Point Properties, L.L.C. and the Company for a building in Fort Collins, Colorado(2) 10.14 Form of Indemnification Agreement(2) 10.15 1995 Stock Option Plan, as amended and restated* 10.16 Employee Stock Purchase Plan(2)* 10.17 1995 Non-Employee Directors' Stock Option Plan(2)* 21.1 Subsidiaries of the Company(4) 23.1 Consent of Arthur Andersen LLP, Independent Accountants 24.1 Power of Attorney (included on the signature pages to this Annual Report on Form 10-K) 27.1 Financial Data Schedule </TABLE> (b) No reports on Form 8-K were required to be filed by the Company during the fourth quarter of the year ended December 31, 1997. - --------------- (1) Incorporated by reference to the Company's Current Report on Form 8-K (File No. 0-26966), dated August 15, 1997, filed August 19, 1997, as amended. (2) Incorporated by reference to the Company's Registration Statement on Form S-1 (File No. 33-97188), filed September 20, 1995, as amended. (3) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1996 (File No. 0-26966), filed March 21, 1997, as amended. (4) Incorporated by reference to the Company's Registration Statement on Form S-3 (File No. 333-34039), filed August 21, 1997, as amended. * Compensation Plan + Confidential treatment has been granted for portions of this agreement. 61
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ADVANCED ENERGY INDUSTRIES, INC. ------------------------------------- (Registrant) /s/ Douglas S. Schatz ---------------------- Douglas S. Schatz President Each person whose signature appears below hereby appoints Douglas S. Schatz and Richard P. Beck, and each of them severally, acting alone and without the other, his true and lawful attorney-in-fact with authority to execute in the name of each such person, and to file with the Securities and Exchange Commission, together with any exhibits thereto and other documents therewith, any and all amendments to this Annual Report on Form 10-K necessary or advisable to enable the registrant to comply with the Securities Exchange Act of 1934, as amended, and any rules, regulations and requirements of the Securities and Exchange Commission in respect thereof, which amendments may make such other changes in the Annual Report on Form 10-K as the aforesaid attorney-in-fact deems appropriate. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signatures Title Date - ---------- ----- ---- /s/ Douglas S. Schatz Chairman of the Board, March 11, 1998 - ----------------------- President and Chief Executive Officer Douglas S. Schatz (Principal Executive Officer) /s/ Richard P. Beck Vice President, Chief Financial March 11, 1998 - ----------------------- Officer, Assistant Secretary and Richard P. Beck Director (Principal Financial Officer and Principal Accounting Officer) /s/ G. Brent Backman Vice President, Special Projects March 11, 1998 - ----------------------- Assistant Secretary and Director G. Brent Backman /s/ Hollis L. Caswell Chief Operating Officer March 11, 1998 - ----------------------- and Director Hollis L. Caswell /s/ Elwood Spedden Director March 11, 1998 - ----------------------- Elwood Spedden /s/ Arthur A. Noeth Director March 11, 1998 - ----------------------- Arthur A. Noeth 62
EXHIBIT INDEX 2.1 Share Purchase Agreement, dated August 11, 1997, among Roger C. Hertel, Tower Electronics, Inc. and the Company(1) 3.1 The Company's Restated Certificate of Incorporation(2) 3.2 The Company's By-laws(2) 4.1 Form of Specimen Certificate for the Company's Common Stock(2) 4.2 The Company hereby agrees to furnish to the SEC, upon request, a copy of the instruments which define the rights of holders of long-term debt of the Company. None of such instruments not included as exhibits herein represents long-term debt in excess of 10% of the consolidated total assets of the Company. 10.1 Master Purchase Order and Sales Agreement, dated January 1, 1990, between Applied Materials Inc. and the Company(2)+ 10.2 Purchase Order and Sales Agreement, dated July 1, 1993, amended September 16, 1995 between Lam Research Corporation and the Company(2)+ 10.3 Purchase Agreement, dated November 1, 1995, between Eaton Corporation and the Company(3)+ 10.4 Amended and Restated Loan and Security Agreement, dated as of November 17, 1995, between Silicon Valley Bank and the Company(2) 10.5 Loan and Security Agreement, dated August 15, 1997, among Silicon Valley Bank, Bank of Hawaii and the Company(4) 10.6 Loan Agreement dated December 8, 1997, by and among Silicon Valley Bank, as Servicing Agent and a Bank, and Bank of Hawaii, as a Bank, and the Company, as borrower 10.7 Equipment Line of Credit, dated July 11, 1994, between Silicon Valley Bank and the Company(2) 10.8 Master Lease Purchase Agreement, dated January 20, 1989, as amended, between MetLife Capital Corporation and the Company(2) 10.9 Lease Purchase Agreement, dated June 11, 1992, between MetLife Capital Corporation and the Company(2) 10.10 Master Equipment Lease, dated July 15, 1993, as amended, between KeyCorp Leasing Ltd. and Company(2) 10.11 Lease, dated June 12, 1984, amended June 11, 1992, between Prospect Park East Partnership and the Company for property in Fort Collins, Colorado(2) 10.12 Lease, dated March 14, 1994, as amended, between Sharp Point Properties, L.L.C., and the Company for property in Fort Collins, Colorado(2) 10.13 Lease, dated May 19, 1995, between Sharp Point Properties, L.L.C. and the Company for a building in Fort Collins, Colorado(2) 10.14 Form of Indemnification Agreement(2) 10.15 1995 Stock Option Plan, as amended and restated* 10.16 Employee Stock Purchase Plan(2)* 63
10.17 1995 Non-Employee Directors' Stock Option Plan(2)* 21.1 Subsidiaries of the Company(4) 23.1 Consent of Arthur Andersen LLP, Independent Accountants 24.1 Power of Attorney (included on the signature pages to this Annual Report on Form 10-K) 27.1 Financial Data Schedule - --------------- (1) Incorporated by reference to the Company's Current Report on Form 8-K (File No. 0-26966), dated August 15, 1997, filed August 19, 1997, as amended. (2) Incorporated by reference to the Company's Registration Statement on Form S-1 (File No. 33-97188), filed September 20, 1995, as amended. (3) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1996 (File No. 0-26966), filed March 21, 1997, as amended. (4) Incorporated by reference to the Company's Registration Statement on Form S-3 (File No. 333-34039), filed August 21, 1997, as amended. * Compensation Plan + Confidential treatment has been granted for portions of this agreement. 64