| ADVANCED ENERGY INDUSTRIES INC ITEM 1A RISK FACTORS The semiconductor, semiconductor capital equipment and flat panel display industries are highly cyclical, which impacts our operating results |
| Our business and operating results depend in significant part upon capital expenditures by manufacturers of semiconductors and flat panel displays, which in turn depend upon current and anticipated demand for their products |
| Historically, these industries have been highly cyclical, with recurring periods of over-supply that have had a negative impact on the demand for capital equipment used to manufacture their products |
| During periods of declining demand, our customers typically reduce purchases of, and cancel orders for, our products and delay delivery of their own products |
| We may incur significant charges as we seek to align our cost structure with any such reduction in sales to these customers |
| In addition, we may not be able to respond adequately or quickly to the declining demand by reducing our costs |
| We may also be required to record significant reserves for excess and obsolete inventory as demand for our products changes |
| Our inability to reduce costs and the charges resulting from other actions taken in response to changes in demand for our products would adversely affect our business, financial condition and operating results |
| Our quarterly and annual operating results fluctuate significantly and are difficult to predict |
| Our operating results may be adversely affected by a variety of factors, many of which are beyond our control and difficult to predict |
| These factors include: • Fluctuations in demand in the semiconductor, semiconductor capital equipment and flat panel display industries and other industries in which our customers operate; • The timing and nature of orders placed by our customers; • Seasonal variations in capital spending by our customers; • Changes in our customers’ inventory management practices; • Customer cancellation or postponement of previously placed orders; • Pricing competition from our competitors; • Customer requests for us to reduce prices, enhance features, improve reliability, shorten delivery times and extend payment terms; • Component shortages or allocations or other factors that result in delays in manufacturing and sales or result in changes to our inventory levels or cause us to substantially increase our spending on inventory; • The introduction of new products by us or our competitors; • Changes in macroeconomic conditions; • Litigation, especially regarding intellectual property; and • Currency exchange rate fluctuations |
| Currently, a 10prca adverse change in exchange rates would have approximately a 4prca to 5prca adverse impact on reported revenues and expenses |
| We have recently transferred the production of substantially all of our product lines to our manufacturing facility in Shenzhen, China, and may experience unforeseen difficulties and challenges with these new operations |
| We have invested significant human and financial resources to establish our manufacturing facility in Shenzhen, China |
| These investments were made with the goal of reducing our labor costs by increasing our workforce in China and correspondingly decreasing our workforce in the United States |
| Because our operating history in Shenzhen is limited, we cannot predict with certainty the impact that this new facility will have on our operating results |
| We may incur unforeseen costs with respect to this facility and the related workforce |
| We might not realize all of the intended benefits of transitioning our supply base to Asian suppliers |
| We are continuing our transition to purchasing a substantial portion of components for our products from Asian suppliers to lower our materials costs and shipping expenses |
| These components might require us to incur higher than anticipated testing or repairing costs, which would have an adverse effect on our operating results |
| Customers, including major customers who have strict and extensive requirements, might not accept our products if they contain these lower-priced components |
| A delay or refusal by our customers to accept such products might require us to continue to purchase higher-priced components from our existing suppliers or might cause us to lose sales to these customers, which would have an adverse effect on our operating results |
| 9 _________________________________________________________________ [43]Table of Contents Raw material, part, component and subassembly shortages, exacerbated by our dependence on sole and limited source suppliers, could affect our ability to manufacture products and systems and could delay our shipments |
| Our business depends on our ability to manufacture products that meet the rapidly changing demands of our customers |
| Our ability to manufacture our products timely depends in part on the timely delivery of raw materials, parts, components and subassemblies from suppliers |
| We rely on sole and limited source suppliers for some of our raw materials, parts, components and subassemblies that are critical to the manufacturing of our products |
| This reliance involves several potential risks, including the following: • Inability to obtain an adequate supply of required parts, components or subassemblies; • Supply shortages if a sole source provider ceases operations; • Having to fund the operating losses of a sole source provider; • Reduced control over pricing and timing of delivery of raw materials, parts, components or subassemblies; • Need to qualify alternative suppliers which could be time consuming and lead to delays in delivery of products to our customers, as well as increased costs; and • Inability of our suppliers to develop technologically advanced products to support our growth and development of new products |
| If we are unable to successfully qualify additional suppliers and manage relationships with our existing and future suppliers or if our suppliers cannot meet our performance or quality specifications, or timing requirements, we may experience shortages of raw materials, parts, components or subassemblies, increased material costs and shipping delays for our products, which would adversely affect our business, financial condition and operating results and relationships with our current and prospective customers |
| A significant portion of our sales is concentrated among a few customers |
| Our ten largest customers accounted for 57prca of our total sales in 2005, 60prca in 2004 and 54prca in 2003 |
| Applied Materials, our largest customer, accounted for 23prca of our sales in 2005, 28prca in 2004 and 21prca in 2003 |
| Ulvac, Inc, our largest customer in the flat panel display industry, accounted for 11prca of our sales in 2005, and less than 10prca in 2004 and 2003 |
| The loss of any of our significant customers or a material reduction in any of their purchase orders could significantly harm our business, financial condition and results of operations |
| Our customers continuously exert pressure on us to reduce our prices and extend payment terms |
| Given the nature of our customer base and the highly competitive markets in which we compete, we may be required to reduce our prices or extend payment terms to remain competitive |
| We may not be able to reduce our expenses in an amount sufficient to offset potential margin declines |
| We generally have no written long-term contracts with our customers requiring them to purchase any specified quantities from us |
| As is typical in our industry, our sales are primarily made on a purchase order basis, and we generally have no written long-term purchase commitments from our customers |
| As a result, we are limited in our ability to predict the level of future sales or commitments from our current customers, which may diminish our ability to effectively allocate labor, materials and equipment in the manufacturing process |
| In addition, we may accumulate inventory in anticipation of sales that do not materialize resulting in excess and obsolete inventory write-offs |
| If we are unable to adjust our business strategy successfully for some of our product lines to reflect the increasing price sensitivity on the part of our customers, our business and financial condition could be harmed |
| Our business strategy for many of our product lines has been focused on product performance and technology innovation to provide enhanced efficiencies and productivity |
| As a result of recent economic conditions and changes in various markets that we serve, our customers have experienced significant cost pressures and, as a result, we have observed increased price sensitivity on the part of our customers |
| If competition for any of our product lines should come to focus solely on price rather than on product performance and technology innovation, we will need to adjust our business strategy and product offerings accordingly and, if we are unable to do so, our business, financial condition and operating results could be materially and adversely affected |
| The markets in which we operate are highly competitive |
| We face substantial competition, primarily from established companies, some of which have greater financial, marketing and technical resources than we do |
| We expect our competitors will continue to develop new products in direct competition with ours, improve the design and performance of their products and introduce new products with enhanced performance characteristics |
| To remain competitive, we must improve and expand our products and product offerings |
| In addition, we may need to maintain a high level of investment in research and development and expand our sales and marketing efforts, particularly outside of the United States |
| We might not be able to make the technological advances and investments necessary to remain competitive |
| Our inability to improve and expand our products and product offerings would have an adverse affect on our sales and results of operations |
| 10 _________________________________________________________________ [44]Table of Contents Our competitive position could be weakened if we are unable to convince end users to specify that our products be used in the equipment sold by our customers |
| For example, in some cases, particularly with respect to mass flow controller products, semiconductor device and flat panel display manufacturers may direct equipment manufacturers to use a specified supplier’s product in their equipment at a particular facility |
| Accordingly, for such products, our success will depend in part on our ability to have end users specify that our products be used at their facilities |
| In addition, we may encounter difficulties in changing established relationships of competitors that already have a large installed base of products within such facilities |
| If device manufacturers do not specify the use of our products, our sales may be reduced which would negatively affect our business, financial condition and operating results |
| We must achieve design wins to retain our existing customers and to obtain new customers, although design wins achieved do not necessarily result in substantial sales |
| The constantly changing nature of semiconductor fabrication and flat panel display technology causes equipment manufacturers to continually design new systems |
| We must work with these manufacturers early in their design cycles to modify our equipment or design new equipment to meet the requirements of their new systems |
| Manufacturers typically choose one or two vendors to provide the components for use with the early system shipments |
| Selection as one of these vendors is called a design win |
| It is critical that we achieve these design wins in order to retain existing customers and to obtain new customers |
| We believe that equipment manufacturers often select their suppliers based on factors such as long-term relationships |
| Accordingly, we may have difficulty achieving design wins from equipment manufacturers who are not currently our customers |
| In addition, we must compete for design wins for new systems and products of our existing customers, including those with whom we have had long-term relationships |
| If we are not successful in achieving design wins, our business, financial condition and operating results will be adversely impacted |
| Once a manufacturer chooses a component for use in a particular product, it is likely to retain that component for the life of that product |
| Our sales and growth could experience material and prolonged adverse effects if we fail to achieve design wins |
| However, design wins do not always result in substantial sales, as sales of our products are dependent upon our customers’ sales of their products |
| Our ability to borrow under our revolving line of credit may be restricted if we do not maintain compliance with certain financial covenants |
| Restrictions in our ability to borrow under our revolving line of credit could limit our flexibility in reacting to periods of increasing demand and amplify our vulnerability to general adverse economic and industry conditions |
| Although we currently have no outstanding borrowings under our dlra40 million revolving line of credit, we may in the future need to borrow under this line of credit |
| Advances under the line of credit would bear interest at the prime rate (7dtta5prca at March 22, 2006) minus 1prca and would be due and payable in July 2006 |
| Our borrowings under the line of credit agreement are limited based upon letters of credit outstanding under this agreement and the lenders borrowing base calculation, which considers among other factors, our accounts receivable and inventory balances |
| As a condition of borrowing and maintaining an outstanding balance under the line of credit, we are subject to covenants that provide certain restrictions related to working capital, net worth, acquisitions and payment and declaration of dividends |
| We were in compliance with all such covenants at December 31, 2005 |
| Our ability to comply with these covenants may be affected by changes in our business condition or results of our operations, or other events beyond our control or difficult to predict |
| The breach of any of these covenants would result in a default under the line of credit |
| There can be no assurance that a breach of any of the covenants will not occur in the future, nor can there be any assurance that our lender will waive any such breach |
| A breach of any of the covenants would permit our lender to restrict our borrowings and accelerate the maturity of any outstanding balances under the line of credit agreement and to take ownership of the assets securing them, which could adversely affect our business, financial condition and results of operations |
| We might not be able to compete successfully in international markets or meet the service and support needs of our international customers |
| Our sales to customers outside the United States were approximately 50prca in 2005, 48prca in 2004 and 53prca in 2003 |
| Our success in competing in international markets is subject to our ability to manage various risks and difficulties, including, but not limited to: • Our ability to effectively manage our employees at remote locations who are operating in different business environments from the United States; • Our ability to develop relationships with suppliers and other local businesses; • Compliance with product safety requirements and standards that are different from those of the United States; • Variations in enforcement of intellectual property and contract rights in different jurisdictions; 11 _________________________________________________________________ [45]Table of Contents • Trade restrictions, political instability, disruptions in financial markets and deterioration of economic conditions; • The ability to provide sufficient levels of technical support in different locations; • Collecting past due accounts receivable from foreign customers; and • Changes in tariffs, taxes and foreign currency exchange rates |
| Our ability to implement our business strategies, maintain market share and compete successfully in international markets will be compromised if we are unable to manage these and other international risks successfully |
| Unfavorable currency exchange rate fluctuations may lead to lower operating margins, or may cause us to raise prices which could result in reduced sales |
| Currency exchange rate fluctuations could have an adverse effect on our sales and results of operations and we could experience losses with respect to our forward exchange contracts |
| Unfavorable currency fluctuations could require us to increase prices to foreign customers which could result in lower net sales by us to such customers |
| Alternatively, if we do not adjust the prices for our products in response to unfavorable currency fluctuations, our operating results could be adversely affected |
| In addition, most sales made by our foreign subsidiaries are denominated in the currency of the country in which these products are sold and the currency they receive in payment for such sales could be less valuable at the time of receipt as a result of exchange rate fluctuations |
| We enter into forward exchange contracts and local currency purchased options to reduce currency exposure arising from intercompany sales of inventory |
| However, we cannot be certain that our efforts will be adequate to protect us against significant currency fluctuations or that such efforts will not expose us to additional exchange rate risks which could adversely affect our operating results |
| Changes in the value of the Chinese yuan could impact the cost of our operation in Shenzhen, China |
| The Chinese government is continually pressured by its trading partners to allow its currency to float in a manner similar to other major currencies |
| The recent revaluation of the yuan has not had a material impact on our operations |
| Any further change may impact our ability to control the cost of our products in the world market |
| Specifically, the decision by the Chinese government to allow the yuan to begin to float against the United States dollar could significantly increase the labor and other costs incurred in the operation of our Shenzhen facility and the cost of raw materials, parts, components and subassemblies that we source in China, thereby negatively affecting our financial condition and operating results |
| We are highly dependent on our intellectual property |
| Our success depends significantly on our proprietary technology |
| We attempt to protect our intellectual property rights through patents and non-disclosure agreements; however, we might not be able to protect our technology, and competitors might be able to develop similar technology independently |
| In addition, the laws of some foreign countries might not afford our intellectual property the same protections as do the laws of the United States |
| Our intellectual property is not protected by patents in several countries in which we do business, and we have limited patent protection in other countries, including China |
| The cost of applying for patents in foreign countries and translating the applications into foreign languages requires us to select carefully the inventions for which we apply for patent protection and the countries in which we seek such protection |
| Generally, our efforts to obtain international patents have been concentrated in the European Union and certain industrialized countries in Asia, including, Korea, Japan and Taiwan |
| If we are unable to protect our intellectual property successfully, our business, financial condition and operating results could be adversely affected |
| Intellectual property rights are difficult to enforce in China |
| Commercial law in China is relatively undeveloped compared to the commercial law in the United States |
| Limited protection of intellectual property is available under Chinese law |
| Consequently, manufacturing our products in China may subject us to an increased risk that unauthorized parties may attempt to copy our products or otherwise obtain or use our intellectual property |
| We cannot give assurance that we will be able to protect our intellectual property rights effectively or have adequate legal recourse in the event that we encounter infringements of our intellectual property in China |
| We have been, and in the future may again be, involved in patent litigation |
| Patent litigation is costly and could result in further restrictions on our ability to sell certain products or an inability to prevent others from using technology we have developed |
| Litigation may be necessary to enforce patents issued to us, to protect our trade secrets or know-how, to defend ourselves against claimed infringement of the rights of others or to determine the scope and validity of our proprietary rights or the proprietary rights of others |
| This type of litigation often requires substantial management time and attention, as well as financial and other resources |
| Future patent litigation might: • Cause us to incur substantial costs in the form of legal fees, fines and royalty payments; • Result in restrictions on our ability to sell certain products; • Result in an inability to prevent others from using technology we have developed; and • Require us to redesign products or seek alternative technologies |
| Any of these events could have a significant adverse effect on our business, financial condition and results of operations |
| 12 _________________________________________________________________ [46]Table of Contents We are subject to numerous governmental regulations |
| We are subject to federal, state, local and foreign regulations, including environmental regulations and regulations relating to the design and operation of our products and control systems |
| We might incur significant costs as we seek to ensure that our products meet safety and emissions standards, many of which vary across the states and countries in which our products are used |
| In the past, we have invested significant resources to redesign our products to comply with these directives |
| Compliance with future regulations, directives and standards could require us to modify or redesign some products, make capital expenditures or incur substantial costs |
| If we do not comply with current or future regulations, directives and standards: • We could be subject to fines; • Our production or shipments could be suspended; or • We could be prohibited from offering particular products in specified markets |
| Any inability to comply with current or future regulations, directives and standards could adversely affect our business, financial condition or operating results |
| The market price of our common stock has fluctuated and may continue to fluctuate for reasons over which we have no control |
| The stock market has from time to time experienced, and is likely to continue to experience, extreme price and volume fluctuations |
| Prices of securities of technology companies have been especially volatile and have often fluctuated for reasons that are unrelated to their operating performance |
| In the past, companies that have experienced volatility in the market price of their stock have been the objects of securities class action litigation |
| If we were the object of securities class action litigation, it could result in substantial costs and a diversion of our management’s attention and resources |
| Future sales of our common stock by our Chairman of the Board may negatively affect the market price of our common stock |
| Douglas S Schatz, our Chairman of the Board, beneficially owns approximately 21prca of our outstanding common stock as of March 22, 2006 |
| The sale of a substantial amount of the shares owned by him could negatively affect the market price of our common stock |
| Schatz has entered into a written trading plan pursuant to Rule 10b5-1 under the Securities Exchange Act of 1934, which provides for the sale of up to 720cmam000 shares of common stock if certain price targets and other conditions are met |
| Our Chairman of the Board owns a significant percentage of our outstanding common stock, which could enable him to control our business and affairs |
| This stockholding gives Mr |
| Schatz significant voting power and influence |
| Depending on the number of shares that abstain or otherwise are not voted on a particular matter, Mr |
| Schatz may be able to elect all of the members of our board of directors and to control our business affairs for the foreseeable future in a manner with which our other stockholders may not agree |