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

SPECIAL NOTE ON FORWARD LOOKING STATEMENTS

The following discussion may contain, 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 or occur. 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" and the other documents and information filed by the Company with the Securities and Exchange Commission.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998

Sales

The Company sells power conversion and control systems 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 third quarter of 1999 were $51.1 million, an increase of 95% from third quarter of 1998 sales of $26.3 million. The increase was attributable primarily to semiconductor capital equipment customers in the United States, including the Company's largest customer in that market, and to a lesser extent to increased sales to flat panel display manufacturers in Japan and entertainment data storage manufacturers in Europe.

From the third quarter of 1998 to the third quarter of 1999, sales to the data storage equipment market increased moderately. Within that industry, sales to the entertainment customer group increased significantly, offsetting a decrease in sales to the computer

customer group. Sales to the flat panel display market, predominantly in Japan, were significantly higher than the comparable period last year, while sales to industrial markets were relatively flat.

Sales for the third quarter of 1999 were up 23% from second quarter of 1999 sales of $41.5 million. This increase was due primarily to higher sales to semiconductor capital equipment manufacturers in the United States, while the other markets the Company serves also showed increases.

The following tables summarize net sales and percentages of net sales by customer type for the Company for the three-month periods ended September 30, 1999 and 1998:

                                            THREE MONTHS ENDED SEPTEMBER 30,
                                            --------------------------------
                                                1999                1998
                                            -----------        -------------
                                                     (IN THOUSANDS)
Semiconductor capital equipment               $32,383              $10,760
Data storage                                    5,878                4,982
Flat panel display                              2,759                  980
Industrial                                      7,241                7,354
Customer service technical support              2,881                2,216
                                              -------              -------
                                              $51,142              $26,292
                                              =======              =======

                                       THREE MONTHS ENDED SEPTEMBER 30,
                                       --------------------------------
                                          1999                  1998
                                       ---------             ----------
Semiconductor capital equipment           63.3%                  40.9%
Data storage                              11.5                   19.0
Flat panel display                         5.4                    3.7
Industrial                                14.2                   28.0
Customer service technical support         5.6                    8.4
                                        ------                 ------
                                         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 September 30, 1999 and 1998:

                            THREE MONTHS ENDED SEPTEMBER 30,
                            --------------------------------
                                1999                1998
                            -----------          -----------
                                      (IN THOUSANDS)
United States and Canada        $37,135              $17,486
Europe                            8,094                7,004
Asia Pacific                      5,835                1,664
Rest of world                        78                  138
                                -------              -------
                                $51,142              $26,292
                                =======              =======

                            THREE MONTHS ENDED SEPTEMBER 30,
                            --------------------------------
                              1999                    1998
                            ---------               --------
United States and Canada         72.6%                  66.5%
Europe                           15.8                   26.6
Asia Pacific                     11.4                    6.4
Rest of world                     0.2                    0.5
                                -----                  -----
                                100.0%                 100.0%
                                =====                  =====

Gross Margin

The Company's gross margin for the third quarter of 1999 was 44.1%, up from 30.3% in the third quarter of 1998. The improvement in gross margin from the third quarter of 1998 to the third quarter of 1999 was due to improved material costs and more favorable absorption of manufacturing overhead from the higher sales base. The Company's gross margin for the third quarter of 1999 was unchanged from 44.1% in the second quarter of 1999.

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 third quarter of 1999 were $6.9 million, up from $5.7 million in the comparable period in 1998, representing an increase of 21%. The increase was attributable to higher spending for payroll, materials and supplies and purchased services. As a percentage of sales, research and development expenses decreased to 13.6% in the third quarter of 1999 from 21.8% in the third quarter of 1998, reflecting the higher 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 the Company's inception, research and development costs generally 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 third quarter of 1999 were $4.2 million, up from $3.3 million in the third quarter of 1998, representing an increase of 29%. The increase was attributable to higher spending for payroll, materials and supplies and travel. As a percentage of sales, sales and marketing expenses decreased to 8.2% in the third quarter of 1999 from 12.4% in the third quarter of 1998, reflecting the higher 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 third quarter of 1999 were $3.7 million, up from $2.4 million in the third quarter of 1998, representing an increase of 58%. The increase was attributable to higher payroll, purchased services and travel expenses. As a percentage of sales, general and administrative expenses decreased to 7.3% in the third quarter of 1999 from 8.9% in the third quarter of 1998, reflecting the higher sales base in 1999.

One-time Charges

In August 1998, the Company announced a restructuring plan to respond to the downturn in the semiconductor capital equipment market. The plan included a reduction of workforce of 128 people, the closure of one facility in the Company's Fort Collins, Colorado campus, and the abandonment of plans to construct a new manufacturing facility in Fort Collins. Other reductions in workforce at the Voorhees facility were effected during 1998. The Company took a one-time charge of $1.0 million for the restructuring in the third quarter of 1998. There were no one-time charges in the third quarter of 1999.

Other Income (Expense)

Other income (expense) consists primarily of interest income and expense, foreign exchange gains and losses, and other non-operating expenses. Other income for the third quarter of 1999 was $1.1 million, attributable primarily to $1.0 million of foreign currency gain. In the comparable period in 1998, other expense was $214,000.

The Company has experienced fluctuations in foreign currency exchange rates, particularly against the Japanese yen. Beginning in 1997, the Company entered into various forward foreign exchange contracts as a hedge against currency fluctuations in the yen. The Company will continue to evaluate various methods to minimize the effects of currency fluctuations.

Provision for Income Taxes

The Company had an income tax provision of $3.3 million for the third quarter of 1999, compared to an income tax benefit of $1.1 million for the third quarter of 1998. The estimated effective tax rate for the third quarter of 1999 was 37.4%, compared to an effective income tax benefit rate of 23.8% for the third quarter of 1998. The higher effective consolidated tax rate for the third quarter of 1999 was attributed to losses recorded at the Company's Advanced Energy Voorhees, Inc. and Advanced Energy Japan K.K. subsidiaries in the third quarter of 1998 for which minimal tax benefit was recorded, and a greater share of the Company's taxable income derived from countries with higher effective tax rates. The Company adjusts its provision rates for income taxes periodically, based upon the anticipated tax status of all of its foreign and domestic entities.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998

Sales

Sales for the first nine months of 1999 were $125.4 million, an increase of 23% from sales of $102.1 million in the first nine months of 1998. The increase was attributable to an increase in sales to semiconductor capital equipment customers, which was partially offset by decreases in sales to customers in industrial markets.

The following tables summarize net sales and percentages of net sales by customer type for the Company for the nine-month periods ended September 30, 1999 and 1998:

                                         NINE MONTHS ENDED SEPTEMBER 30,
                                         -------------------------------
                                           1999                   1998
                                         --------               --------
                                                  (IN THOUSANDS)
Semiconductor capital equipment          $ 76,237               $ 51,580
Data storage                               14,918                 14,142
Flat panel display                          6,318                  4,749
Industrial                                 20,986                 26,235
Customer service technical support          6,926                  5,436
                                         --------               --------
                                         $125,385               $102,142
                                         ========               ========

                                         NINE MONTHS ENDED SEPTEMBER 30,
                                         -------------------------------
                                           1999                   1998
                                         --------               --------
Semiconductor capital equipment            60.8%                    50.5%
Data storage                               11.9                     13.9
Flat panel display                          5.0                      4.6
Industrial                                 16.8                     25.7
Customer service technical support          5.5                      5.3
                                          -----                    -----
                                          100.0%                   100.0%
                                          =====                    =====

The following tables summarize net sales and percentages of net sales by geographic region for the Company for the nine-month periods ended September 30, 1999 and 1998:

                                         NINE MONTHS ENDED SEPTEMBER 30,
                                         -------------------------------
                                           1999                   1998
                                         --------               --------
                                                  (IN THOUSANDS)
United States and Canada                 $ 90,588               $ 74,567
Europe                                     20,065                 19,839
Asia Pacific                               14,292                  7,378
Rest of world                                 440                    358
                                         --------               --------
                                         $125,385               $102,142
                                         ========               ========

                                         NINE MONTHS ENDED SEPTEMBER 30,
                                         -------------------------------
                                           1999                   1998
                                         --------               --------
United States and Canada                     72.2%                  73.0%
Europe                                       16.0                   19.4
Asia Pacific                                 11.4                    7.2
Rest of world                                 0.4                    0.4
                                            -----                  -----
                                            100.0%                 100.0%
                                            =====                  =====

Gross Margin

The Company's gross margin for the first nine months of 1999 was 43.0%, up from 29.5% in the comparable period in 1998. The improvement in gross margin was primarily a result of the Company's efforts to reduce material costs and a more favorable absorption of manufacturing overhead costs from the higher sales base.

Research and Development

Research and development expenses for the first nine months of 1999 were $19.5 million, up from $18.0 million in the comparable period in 1998, representing an increase of 9%. This increase was attributable to higher spending for materials and supplies, payroll and travel. As a percentage of sales, research and development expenses

decreased to 15.6% in the first nine months of 1999 from 17.6% in the comparable period of 1998.

Sales and Marketing

Sales and marketing expenses for the first nine months of 1999 were $11.5 million, up from $10.3 million in the comparable period in 1998, representing an increase of 11%. This increase was attributable to higher spending for payroll, materials and supplies and travel. As a percentage of sales, sales and marketing expenses decreased to 9.1% in the first nine months of 1999 from 10.1% in the comparable period of 1998.

General and Administrative

General and administrative expenses for the first nine months of 1999 were $9.7 million, up from $8.0 million in the comparable period in 1998, representing an increase of 21%. This increase was attributable to higher payroll, travel, and the effect of goodwill amortization of the acquisition of assets of FST, which were acquired in September 1998. As a percentage of sales, general and administrative expenses decreased slightly to 7.7% in the first nine months of 1999 from 7.8% in the comparable period of 1998.

One-time Charges

The Company took a one-time charge of $1.0 million for the restructuring in the first nine months of 1998. These charges related to a reduction in workforce of 128 people and the closure of one facility in the Company's Fort Collins, Colorado campus, and the abandonment of plans to construct a new manufacturing facility in Fort Collins.

Other Income

Other income for the first nine months of 1999 was $1.1 million, attributable primarily to $0.9 million of foreign currency gain. In the comparable period in 1998, other income was $13,000.

Provision for Income Taxes

The income tax provision was $5.6 million for the first nine months of 1999, compared to an income tax benefit of $1.4 million for the first nine months of 1998. The estimated effective tax rate was 38.6% for the first nine months of 1999 compared to an effective income tax benefit rate of 19.9% for the first nine months of 1998. The higher effective consolidated tax rate for the first nine months of 1999 was attributed to losses recorded at the Company's Advanced Energy Voorhees, Inc. and Advanced Energy Japan K.K. subsidiaries during the first nine months of 1998 for which minimal tax benefit was recorded and a greater share of the Company's taxable income derived from countries with higher effective tax 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, cash flow from operations and proceeds from equity offerings.

Operating activities provided cash of $1.3 million in the first nine months of 1999, primarily as a result of net income, depreciation and amortization, increases in accounts payable and increased accruals for payroll, employee benefits and income taxes, offset by increases in accounts receivable and inventories. In the comparable period in 1998, operating activities provided cash of $9.4 million, primarily as a result of depreciation and amortization and decreases in accounts receivable and inventories, offset by the net loss, decreases in accounts payable and decreased accruals for payroll, employee benefits and income taxes. As previously mentioned, sales in the third quarter of 1999 increased 95% over the same quarter in 1998, resulting in a much higher level of accounts receivable as of September 30, 1999, which had the effect of substantially reducing operating cash flow during the nine-month period ended September 30, 1999. 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, under certain contracts or agreements, to maintain minimum levels of inventory to satisfy its customers' delivery requirements. Any increase of such inventory levels will require the use of cash to finance the inventory.

Investing activities used cash of $5.3 million in the first nine months of 1999, and included the purchase of property and equipment for $4.2 million and $1.1 million of net purchases of marketable securities. Investing activities used cash of $6.6 million in the first nine months of 1998, and included the purchase of property and equipment for $4.6 million, the acquisition of assets of Fourth State Technology, Inc. for $2.5 million and the purchase of a stock investment in a start-up company for $1.0 million, offset by net sales of $1.5 million of marketable securities.

Financing activities in the first nine months of 1999 provided cash of $3.2 million and consisted primarily of proceeds from the exercise of employee stock options and sale of common stock through the Company's employee stock purchase plan ("ESPP") of $3.0 million and net increases in notes payable and capital lease obligations of $279,000. Financing activities in the comparable period in 1998 used cash of $4.0 million and consisted primarily of the net payment of notes payable and capital lease obligations of $4.4 million, partially offset by proceeds from the exercise of employee stock options and sale of common stock through the Company's ESPP of $0.4 million.

The Company plans to spend approximately $6.0 million through the remainder of 1999 and first nine months of 2000 for the acquisition of manufacturing and test equipment and furnishings. Further, the Company continues to implement its management systems software, including the replacement of existing systems in its

domestic and foreign locations. The Company expects to continue to implement its management system software through the year 2000.

As of September 30, 1999, the Company had working capital of $74.1 million. The Company's sources of available funds as of September 30, 1999 consisted of $11.3 million of cash and cash equivalents, $17.3 million of marketable securities, and a credit facility consisting of a $30.0 million revolving line of credit, of which none was outstanding as of September 30, 1999. Advances under the revolving line of credit bear interest at either the prime rate (8.25% at October 31, 1999) minus 1.25% or the LIBOR 360-day rate (6.2500% at October 31, 1999) plus 150 basis points, at the Company's option. All advances under the revolving line of credit will be due and payable on December 7, 2000. Indebtedness of up to $10 million may be converted into a 3-year term loan prior to that date.

The Company believes that its cash and cash equivalents, marketable securities, cash flow from operations and available borrowings, including the recent public offerings of common stock and convertible subordinated notes, will be sufficient to meet the Company's working capital needs for the next twelve months. From time to time, the Company may raise capital through additional equity or debt financing in order to take advantage of favorable market conditions or to fund material capital equipment purchases or desired expansion. The Company has considered, and will continue to consider, possible acquisitions of businesses or entities which the Company believes could create synergies or opportunities for the Company. On October 1, 1999, the Company acquired a controlling interest in Litmas Corporation, in which it previously owned a minority interest. No agreement or understanding with respect to any other future acquisition has been reached. If the Company were to undertake one or more acquisitions, the Company may require additional funds, which may be provided by the sale of equity or debt securities. 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. These 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 after December 31, 1999 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:

o Assessment of the Company's corporate systems and operations that could be affected by the Year 2000 problem;

o Remediation of non-compliant systems and components; and

o Testing of systems and components following remediation.

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

o information technology (IT) system applications;

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

o relationships with third parties.

The Company completed assessment of its IT and non-IT systems at all of its facilities. 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. This 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 the vendor 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.

Following completion of the assessment phase, the Year 2000 team identified those non-compliant systems that it considers "mission critical." Remediation and testing of the mission critical IT systems have been completed. During the third quarter of 1999, the Company completed remediation and testing of:

o mission critical IT systems at the Fridley facility;

o mission critical non-IT systems at all of its facilities; and

o non-compliant systems that are not mission critical.

The Company is examining its relationships with third parties whose Year 2000 compliance could have a material effect on its operations. The Company considers third party suppliers and customers to pose its greatest Year 2000 risk because the failure of these 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 delays 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 suppliers and customers with respect to their Year 2000 compliance programs and status. Based on the results of these efforts, the Company believes that its principal customers and all of its key suppliers are either Year 2000 compliant or are implementing plans to become Year 2000 compliant in a timely manner. The Company continues to pursue additional information about its suppliers' and customers' Year 2000 readiness in order to assess the risks involved in relying on them.

In what the Company believes to be its most reasonably likely worst case Year 2000 scenario, the Company would be unable to obtain electronic components from its suppliers because of their failure to become Year 2000 compliant. The Company may be unable to manufacture components internally or redesign its systems to accommodate different components. The Company continues to review its options for contingency plans to limit the potential impact of any Year 2000 failures. In particular, the Company is reviewing the capabilities of its current and potential 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, to date the Company has not incurred material costs related to its Year 2000 program, and the Company does not expect the costs associated with its Year 2000 projects to have a material effect on its 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 or time that may be incurred as a result of any suppliers' or customers' failures to become Year 2000 compliant on a timely basis. In addition, we cannot predict whether any litigation will be brought against the Company as a result of any supplier's or customer's failure to become Year 2000 compliant on a timely basis or claiming that the Company's products are not Year 2000 compliant or otherwise. The Company believes that its products are Year 2000 ready.

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, as described under the caption "Special Note on Forward-Looking Statements" above. Our forward-looking statements regarding our Year 2000 program and expectations 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.