ITEM 2. 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. For example, statements relating to the Company's beliefs, expectations and plans are forward-looking statements, as are statements that certain actions, conditions or circumstances will continue. Forward-looking statements involve risks and uncertainties. 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 or prove any forward-looking statements, by hindsight, to be overly optimistic or unachievable, include, but are not limited to the following: the significant fluctuations in the Company's quarterly operating results, the volatility of the semiconductor and semiconductor capital equipment industries, timing and success of integration of recent and potential future acquisitions, supply constraints and technological changes. For a discussion of these and other factors that may impact the Company's realization of its forward-looking statements, see the Company's Annual Report on Form 10-K for the year ended December 31, 1998,

Part I "Cautionary Statements - Risk Factors."

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998

SALES

Sales for the first quarter of 1999 were $32.7 million, a decrease of 25% from first quarter of 1998 sales of $43.9 million. The decrease in sales between such periods resulted from decreased unit sales of the Company's systems. The decrease was attributable mostly to semiconductor capital equipment customers in the United States, including the Company's largest customer in that industry. The first quarter of 1999 continued to reflect the impact of the severe downturn in the semiconductor capital equipment market that began near the end of 1997 and was reflected in a decreasing sales trend throughout 1998. Sales in the first quarter of 1999 were significantly higher than sales in the third and fourth quarters of 1998, and represented a significant recovery in the semiconductor capital equipment market which is anticipated to continue throughout 1999. Many of the customers to whom the Company's OEM customers sell are located in Asia and Japan, and were negatively impacted by the Asian financial crisis.

Sales to the data storage equipment market decreased moderately on a worldwide basis, though sales to the Company's largest customer in that industry, located in Europe, decreased significantly. Sales to the flat panel display industry, predominately in Japan, were half the level of the comparable period last year. Sales to industrial markets were

down significantly, partially due to decreased sales by Tower Electronics, Inc., a wholly owned subsidiary. The Company sells primarily to the semiconductor capital equipment, data storage and industrial markets in the United States, to the flat panel display and data storage markets in Japan, and to the data storage and industrial markets in Europe. The Company also sells spare parts and repair services worldwide through its global support organization.

Sales for the first quarter of 1999 were up 45% from fourth quarter of 1998 sales of $22.6 million. This increase was due to higher demand from semiconductor capital equipment manufacturers in the United States, increased sales to the entertainment segment of the data storage market, and increased sales to flat panel customers in Japan, partially offset by decreased sales to industrial customers in the United States.

The following tables summarize net sales and percentages of net sales by customer type for the Company for the three-month periods ended March 31, 1999 and March 31, 1998, respectively:

                                                                       THREE MONTHS ENDED MARCH 31,
                                                                       ----------------------------
                                                                          1999              1998
                                                                       ---------        -----------
                                                                              (IN THOUSANDS)
Semiconductor capital equipment..................................        $18,266        $23,903
Data storage.....................................................          4,603          4,926
Flat panel display...............................................          1,217          2,412
Industrial.......................................................          7,041         10,862
Customer service technical support...............................          1,601          1,766
                                                                         -------        -------
                                                                         $32,728        $43,869
                                                                         -------        -------
                                                                         -------        -------

                                                                       THREE MONTHS ENDED MARCH 31,
                                                                       ----------------------------
                                                                          1999              1998
                                                                       ---------        -----------
Semiconductor capital equipment..................................          55.8%           54.5%
Data storage.....................................................          14.1            11.2
Flat panel display...............................................           3.7             5.5
Industrial.......................................................          21.5            24.8
Customer service technical support...............................           4.9             4.0
                                                                          ------          ------
                                                                          100.0%          100.0%
                                                                          ------          ------
                                                                          ------          ------

The following tables summarize net sales and percentages of net sales by geographic region for the Company for the three-month periods ended March 31, 1999 and March 31, 1998, respectively:

                                                                       THREE MONTHS ENDED MARCH 31,
                                                                       ----------------------------
                                                                          1999              1998
                                                                       ---------        -----------
                                                                              (IN THOUSANDS)
United States and Canada.........................................        $22,949        $33,658
Europe...........................................................          5,672          6,416
Asia Pacific.....................................................          3,789          3,645
Rest of world....................................................            318            150
                                                                         -------        -------
                                                                         $32,728        $43,869
                                                                         -------        -------
                                                                         -------        -------

                                                                       THREE MONTHS ENDED MARCH 31,
                                                                       ----------------------------
                                                                          1999              1998
                                                                       ---------        -----------
United States and Canada.........................................          70.1%           76.7%
Europe...........................................................          17.3            14.7
Asia Pacific.....................................................          11.6             8.3
Rest of world....................................................           1.0             0.3
                                                                          ------          ------
                                                                          100.0%          100.0%
                                                                          ------          ------
                                                                          ------          ------

GROSS MARGIN

The Company's gross margin for the first quarter of 1999 was 40.0%, up from 31.0% in the first quarter 1998 and up from 29.3% in the fourth quarter of 1998. The improvements in gross margin from both the first quarter of 1998 and the fourth quarter of 1998 to the first quarter of 1999 were primarily a result of the Company's efforts to reduce material costs and, to a lesser extent, a more favorable absorption of manufacturing overhead.

RESEARCH AND DEVELOPMENT

The Company's research and development expenses are incurred researching new technologies, developing new products and improving existing product designs. Research and development expenses for the first quarter of 1999 were $5.9 million, essentially unchanged from $5.8 million in the comparable period in 1998. As a percentage of sales, research and development expenses increased to 17.9% in the first quarter of 1999 from 13.3% in the first quarter of 1998, reflecting the lower sales base in 1999.

The Company believes continued research and development investment for development of new products is critical to the Company's ability to serve new and existing markets. Since inception, most research and development costs have been internally funded and all have been expensed as 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 for the first quarter of 1999 were $3.3 million, down from $3.6 million in the first quarter of 1998, representing a decrease of 7%. The decrease was attributable to lower depreciation and reduced spending for purchased services. As a percentage of sales, sales and marketing expenses increased to 10.1% in the first quarter of 1999 from 8.1% in the first quarter of 1998, reflecting the lower sales base in 1999.

GENERAL AND ADMINISTRATIVE

General and administrative expenses support the worldwide financial, administrative, information systems and human resources functions of the Company. General and administrative expenses for the first quarter of 1999 were $2.9 million, unchanged from the first quarter of 1998. As a percentage of sales, general and administrative expenses increased to 8.7% in the first quarter of 1999 from 6.5% in the first quarter of 1998, reflecting the lower sales base in 1999.

The Company continues to implement its management system software, including the replacement of existing systems in its domestic and foreign locations. The Company expects that charges related to training and implementation of the software will continue through 2000.

OTHER (EXPENSE) INCOME

Other (expense) income consists primarily of interest income and expense, foreign exchange gains and losses, and other non-operating expenses. Other expense for the first quarter of 1999 was $39,000, attributable primarily to $252,000 of net interest income offset by $200,000 for a writedown of a stock investment. In the comparable period in 1998, other income was $98,000.

The Company has experienced fluctuations in foreign currency exchange rates, particularly against the Japanese yen. As a hedge against currency fluctuations in the yen, the Company entered into various forward foreign exchange contracts to mitigate the effect of potential depreciation in that currency from 1997 to the present. The Company will continue to evaluate various methods to minimize the effects of currency fluctuations.

PROVISION FOR INCOME TAXES

The income tax provision of $498,000 for the first quarter of 1999 represented an estimated effective rate of 48.3%, compared to an effective income tax rate of 38.2% for the first quarter of 1998. The higher effective consolidated tax rate for the first quarter of 1999 was attributed to the effect of higher nondeductible goodwill expense and a shift in mix of the Company's taxable income toward a greater share from countries with higher effective tax rates. The Company adjusts its provision for income taxes periodically, based upon the anticipated tax status of all of its foreign and domestic entities.

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, cash flow from operations and proceeds from underwritten public offerings.

Operating activities used cash of $1.5 million in the first three months of 1999, primarily a result of increases in accounts receivable and inventories, partially offset by net income, depreciation, amortization, increases in accounts payable and increased accruals for payroll, employee benefits and income taxes. In the comparable period in 1998, operating activities provided cash of $2.6 million, primarily as a result of net income, depreciation, amortization, and decreases in accounts receivable and inventories, offset by decreases in accounts payable and decreased accruals for payroll, employee

benefits, income taxes and other accruals. 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 used cash of $0.2 million in the first three months of 1999, and included the purchase of property and equipment for $1.2 million offset by the sale of marketable securities of $1.0 million. In the comparable period in 1998, investing activities used cash of $0.9 million and included the purchase of property and equipment for $2.9 million and the purchase of preferred stock of LITMAS for $0.5 million, offset by the sale of marketable securities of $2.5 million.

Financing activities in the first three months of 1999 provided cash of $1.5 million and consisted primarily of proceeds from the sale of common stock of $1.2 million. Financing activities in the comparable period in 1998 used cash of $1.4 million and consisted primarily of repayment of notes payable and capital lease obligations of $2.8 million, partially offset by proceeds from notes payable of $1.4 million.

The Company plans to spend approximately $3.5 million through the remainder of 1999 for the acquisition of manufacturing and test equipment and furnishings.

As of March 31, 1999, the Company had working capital of $64.3 million. The Company's principal sources of liquidity consisted of $11.8 million of cash and cash equivalents, $15.0 million of marketable securities, and a credit facility consisting of a $30.0 million revolving line of credit, with options to convert up to $10.0 million to a three-year term loan. Advances under the revolving line of credit bear interest at either the prime rate (7.75% at April 30, 1999) minus 1.25% or the LIBOR 360-day rate (5.23% at April 30, 1999) 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 March 31, 1999.

The Company believes that its cash and cash equivalents, marketable securities, cash flow from operations and available borrowings, will be sufficient to meet the Company's working capital needs through the end of 1999. 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.

YEAR 2000 PROGRAM

The Year 2000 problem is the result of computer programs that rely on two-digit date codes, instead of four-digit date codes, to indicate the year. Such computer programs, which are unable to interpret the date code "00" as the year 2000, may not be able to perform computations and decision-making functions and could cause computer systems to malfunction.

The Company has developed a multi-phase program for Year 2000 information systems compliance that consists of the following:

- ASSESSMENT of the corporate systems and operations of the Company that could be affected by the Year 2000 problem;

- REMEDIATION of non-compliant systems and components; and

- TESTING of systems and components following remediation.

The Company has focused its Year 2000 review on three areas:

- information technology (IT) system applications;

- non-IT systems, including engineering and manufacturing applications; and

- relationships with third parties.

The Company has completed assessment of its IT and non-IT systems at all of its facilities, except for Tower's manufacturing facility in Fridley, Minnesota. Assessment of the IT and non-IT systems at Tower's facility is underway and is expected to be complete during June 1999. The Company believes that its enterprise-wide software system, which is installed at the Fort Collins facility and certain other facilities, is Year 2000 compliant. Such belief is based significantly on discussions with and representations by the vendor of such software. The Company has been, and will continue to be, in contact with such vendor in order to obtain any additional revisions or upgrades issued by the vendor to ensure that such enterprise-wide software remains Year 2000 compliant. The Company also has conducted its own tests on the enterprise-wide software to verify the vendor's representations. The Company has not determined whether to install its enterprise-wide software system at the Fridley facility prior to the year 2000.

Following completion of the assessment phase, the Year 2000 team identified those non-compliant systems that it considers to be "mission critical." Remediation and testing of the mission critical IT systems, except at the Fridley facility, have been completed. Remediation and testing of mission critical non-IT systems are underway and are expected to be completed during the third quarter of 1999, except at the Fridley facility. Remediation and testing of non-compliant systems that are not mission critical are expected to be completed during the third quarter of 1999. Once the Year 2000 team has

completed assessment of the IT and non-IT systems at the Fridley facility, it will identify the non-compliant systems that are mission critical. Until such time, the Company cannot determine the date by when remediation and testing will be completed at the Fridley facility. Based on the assessment results to date, the Company expects to complete remediation and testing of mission critical IT systems at the Fridley facility during the third quarter of 1999.

The Company is examining its relationship with third parties whose Year 2000 compliance could have a material effect on the Company. The Company considers third party suppliers and customers to pose the greatest Year 2000 risk to the Company, because the failure of such persons to become Year 2000 compliant in a timely manner, if at all, could result in the Company's inability to obtain components in a timely manner, reductions in the quality of components obtained, reductions, delays or cancellations of customer orders or delay in payments by customers for products shipped. In addition, conversions by third parties to become Year 2000 compliant might not be compatible with the Company's systems. Any or all of these events could have a material adverse effect on the Company's business, financial condition and results of operations.

The Company has circulated questionnaires to and has actively solicited feedback from its significant vendors and customers with respect to such persons' Year 2000 compliance programs and status, except that the Company has not yet contacted all of Advanced Energy Voorhees' significant vendors; the Company expects such contact to be made and feedback to be received by June 1999. Based on the results of such efforts, the Company believes that its principal customers and all of its sole source suppliers are either Year 2000 compliant or are implementing plans to become Year 2000 compliant in a timely manner. Certain suppliers have advised the Company that they are implementing Year 2000 programs, but have not indicated by when they expect to be Year 2000 compliant or have indicated that they don't expect to be Year 2000 compliant until the fourth quarter of 1999. The Company continues to pursue additional information about such suppliers' Year 2000 readiness in order to assess the risks involved in relying on such suppliers.

In what the Company believes to be the most reasonably likely worst case Year 2000 scenario, the Company would be unable to obtain electronic components from its suppliers because of such third parties' failure to become Year 2000 compliant, and the Company would be unable to manufacture such components internally or to redesign its systems to accommodate different components because of the failure of the Company's engineering and manufacturing systems to be Year 2000 compliant. The Company is in the process of reviewing the capabilities of its current and other component suppliers to ensure that the components most critical to production of the Company's systems are not sole-sourced. See the Company's Annual Report on Form 10-K for the year ended December 31, 1998, Part I "Cautionary Statements
- Risk Factors--Supply Constraints and Dependence on Sole and Limited Source Suppliers."

Although the Company is continuing to assess Year 2000 costs, it does not expect the costs associated with such projects to have a material effect on the Company's financial results. The Company expects to spend less than five percent of its total annual IT budget on Year 2000 costs. The Company has not identified any IT projects that have been deferred due to its Year 2000 efforts. The Company's current estimates of the impact of the Year 2000 problem on its operations 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 believes that its systems are Year 2000 ready, except that certain products acquired from Fourth State Technology have not been fully assessed. The Company intends to complete assessment of the Fourth State Technology products during June 1999.

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.