# UNITED STATESSECURITIES AND
EXCHANGE COMMISSION Washington, D.C. 20549

_________________

# FORM 10-K

[X] ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE
ACT OF 1934

For the fiscal year
ended June 26, 2004

OR

[   ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition
period from _______ to ________

Commission file number
23103

APPLIED FILMS
CORPORATION(Exact Name of
Registrant as Specified in Its Charter)

|COLORADO                             
(State of Other Jurisdiction of Incorporation
or Organization) | 84-1311581
(I.R.S. Employer Identification No.)
|---------------------------------------------------------------------------------------------------- | -----------------------------------------------

9586 I-25 Frontage
Road, Suite 200, Longmont, CO 80504(Address of Principal
Executive Offices) (Zip Code)

Registrants
Telephone Number, Including Area Code: (303) 774-3200

Securities registered
pursuant to Section 12(b) of the Act: None.

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

Common Stock, no 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 is not contained herein, and
will not be contained, to the best of Registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. [ X ]

Indicate by check mark whether the
registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
Yes X No ____

The aggregate market value of the
common stock held by non-affiliates of the Registrant, based on a per-share price of
$32.80 as of December 26, 2003, was $476,396,679. As of
September 2, 2004, there were outstanding 14,838,859 shares of the Companys
Common Stock (no par value).

Documents Incorporated by Reference:
Portions of the Companys Proxy Statement for the 2004 Annual Meeting of Shareholders
are incorporated by reference into Part III of this Report.

---



# PART I

# ITEM 1: Business

The following discussion contains
trend information and other forward looking statements (including statements regarding
future operating results, future capital expenditures, new product introductions,
technological developments and industry trends) that involve a number of risks and
uncertainties. Our actual results could differ materially from our historical results of
operations and those discussed in the forward looking statements. Factors that could cause
actual results to differ materially include, but are not limited to, those identified in
ITEM 7: Managements Discussion and Analysis of Financial Condition and Results
of Operation and the section entitled Risk Factors. All period
references are to our fiscal periods ended June 26, 2004, June 28, 2003, or
June 29, 2002, unless otherwise indicated.

Applied Films Corporations
Internet address is www.appliedfilms.com (this is an inactive textual reference
site only). We make available free of charge on our website our annual reports on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange
Act of 1934, as soon as reasonably practicable after we electronically file such material
with, or furnish it to, the Securities and Exchange Commission. In addition and at no
extra cost, we will also provide electronic or paper copies of our reports and other
filings made with the Securities and Exchange Commission. All requests should be directed
to Applied Films Corporation, Attention: Lawrence D. Firestone, 9586 I-25 Frontage Road,
Suite 200, Longmont, Colorado 80504.

The information on our website is not
and should not be considered part of this annual report on Form 10-K and is not
incorporated by reference in this report.

# ITEM 1(a): General
Development of Business

# Introduction

Applied Films Corporation (Applied
Films, the Company, we, or our) is a leading
provider of thin film deposition equipment to diverse markets such as the flat panel
display (FPD), the architectural and solar glass, and the consumer products
packaging and electronics industries. Our deposition systems are used to deposit thin
films that enhance the characteristics of a base substrate, such as glass, plastic, paper
or foil. These thin films provide conductive, electronic, reflective, filter, barrier and
other properties that are critical elements of our customers products. Our thin film
deposition systems provide our customers with high yield and throughput, flexible modular
configurations, and innovative coating and process technologies.

# Our Markets

Our thin film deposition equipment
solutions enable our customers to offer the latest product innovations in the following
diverse markets:

Flat Panel
Displays.Flat panel displays, or FPDs, are used in a wide variety of
consumer and industrial products, including laptop and flat panel desktop computer
monitors, liquid crystal display, or LCD, televisions, plasma display televisions,
cellular telephones, personal digital assistants, calculators, pagers, scientific
instruments, portable video games, gasoline pumps, automotive instruments, point-of-sale
terminals and a number of other electronic devices. Virtually all FPDs require optically
transparent, electrically conductive thin films coated on substrates such as glass. Growth
in the FPD market is driven by consumers desire for increased access to information
in wireless and portable communication devices with display capabilities. Consumers also
desire to replace heavy, bulky cathode ray tube, or CRT, monitors and televisions with
thinner, lighter FPDs. The increasing affordability of FPDs significantly expands the
potential market.

Architectural and Solar
Glass.Thin film coated glass is used in buildings for exterior window
glass and solar energy collecting applications. Applying certain thin
films on glass significantly reduces heat transfer through the glass, improving the
efficiency of heating and cooling systems in buildings. In addition, thin
films form conductive layers and are integral components of solar cells. Demand for
architectural glass is driven by the need for energy conservation in commercial and
residential construction. The demand for alternative energy sources, such as solar cells,
is driven by the need to reduce the load on municipal power grids worldwide.

Consumer Products Packaging and
Electronics.Thin film deposition systems (web coaters or
roll coaters) in the consumer products packaging and electronics, or web,
market are used to deposit thin films on multi-layer flexible packaging for consumer food
products and cigarettes and to produce capacitors and other electronic components. Thin
films are applied to a thin plastic or metal foil substrate to create a barrier, extending
shelf life in consumer food products. Thin films also provide the conductive and
electronic elements critical to the manufacture of certain electronic products, such as
capacitors and touch panel screens. The packaging market for web coaters is driven by
demand for products packaged in bags and for decorative packaging. Demand for touch panel
applications and capacitors is driving the electronics market for web coaters.

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We have sold over 110 FPD thin film
deposition systems, 50 architectural glass and solar thin film deposition
systems and 500 web thin film deposition systems. We have developed leading thin film
process and equipment technologies to meet our customers needs for sophisticated,
technologically advanced thin film deposition equipment. We have over 134 patents and
patent applications related to thin film technologies, and we continue to invest in
research and development. Our manufacturing operations in Germany and Taiwan, together
with our international sales and support offices enable us to provide thin film deposition
equipment solutions to customers throughout the world, including our core markets in Asia,
Europe and North America.

# Our Thin Film Technology
Solutions

We solve critical manufacturing issues
for our customers with our broad range of thin film deposition equipment, innovative thin
film coating and process technologies, and after-market support. Our thin film deposition
solutions are highly specialized for our customers to enhance the electrical, optical and
barrier qualities of the substrates used in their products. We believe that the reliable,
high yield, high throughput, flexible and modular configurations of our thin film
deposition equipment and our innovative coating and process technologies offer several
advantages to our customers over the equipment and technologies of our competitors.

# Our Strategy

Our objective is to enhance our
position as a leading supplier of thin film deposition equipment. Key elements of our
strategy include:

Build on our Leadership in our
Core Markets.We are a market leader with what we believe to be the largest
installed base of thin film deposition equipment for the color filter
side of the FPD process, the
architectural market, and the consumer products packaging and
electronics markets. We believe our reputation as a high quality supplier of thin film
deposition equipment allows us to establish key customer relationships and to grow with
these customers as they develop new products to meet market requirements. We intend to
use our strong technological capabilities and long-standing customer relationships to
continue to supply our existing customers with competitive solutions and capture
additional market share in core markets.

Expand our Presence in our
Existing Markets.  We have developed new technologies for existing markets
that we serve. We have recently introduced our TRITON system using Physical Vapor
Deposition or (PVD) to deposit thin films for the transistor or array side of the FPD
which significantly expands our total available market for display coaters. We have developed the SmartWeb
system which is a flexible clean room compatible coater that deposits thin films on
flexible substrates in applications such as solar cell, flexible printed circuit board and
flexible display applications thus expanding the total available market for web coaters.
We believe our reputation as a high quality supplier of thin film deposition equipment
allows us to partner with our customers to ensure our new and next generation technologies
address the market requirements and to provide an alternative to competitive product
offerings for the markets we serve.

Target Emerging High Growth Market
Opportunities.  We have recently entered and are focusing our research and
development efforts on several high growth markets, including solar cell and organic light
emitting diodes (OLED). We have installed development and pilot production thin film
deposition equipment for each of these markets, and are working with our strategic
partners to develop our technologies in each of these areas.

Continue to Serve Diverse
Markets.We have applied our thin film technology to diverse markets
ranging from flat panel displays for televisions and computer monitors to consumer
packaging for potato chip bags. We will continue to invest in the technologies that
address the needs of diverse markets because we believe this reduces our exposure to the
cyclical nature of any individual market. For example, when the FPD market experienced a
downturn in fiscal years 2001 and 2002, we continued to sell thin film deposition
equipment to our other markets.

Engage in Strategic
Relationships.Our strategic relationships have influenced our
technological direction, optimized our research and development investments, and enhanced
the sales, marketing and distribution of our products. We will continue to pursue
strategic relationships with industry leaders in each new market or market segment that we
enter.

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Reduce Costs to Improve
Margins.In order to reduce our cost of goods sold and improve our gross
and operating margins, we will continue to review all aspects of producing our thin film
deposition equipment, including operating costs, transportation costs, component costs and
product design.

Pursue Selective
Acquisitions.We regularly seek and evaluate acquisition
opportunities that would enhance or complement our existing operations or otherwise offer
growth opportunities consistent with our strategy and core competencies. For example, our
acquisition and integration of the LAC business successfully completed our strategy of
transforming our business from coating glass to manufacturing thin film deposition
equipment, and our Helix acquisition expanded our manufacturing capacity to include Asia.

# ITEM 1(b): Financial
Information about Industry Segments

Historically, we supplied thin film
coated glass primarily to LCD manufacturers and thin film deposition equipment to several
markets. However, following the sale of the Hong Kong glass operations our only business
segment is the manufacture and sale of deposition equipment. For further discussion see
ITEM 8: Financial Statements and Supplementary Data  Note 3: Sale of Hong Kong
Coatings Division  Discontinued Operations.

# ITEM 1(c): Narrative
Description of Business

# Products

Our thin film coating systems are
used in many different applications spanning three distinct markets. The following table
illustrates our principal products:

|End Markets and Products                     | Deposition Method | Examples of End Market Application | General Price Range (1)
|-------------------------------------------- | ----------------- | ---------------------------------- | -----------------------
|                                             |                   |                                    |                        
|                                             |                   |                                    |                        
|Flat Panel Displays:                        
|NEW ARISTO                                   |                   |                                    | PVD                    
|TRITON                                       |                   |                                    | PVD                    
|VES 400 (Development)                        |                   |                                    | Evaporative            
|Architectural and Solar Glass:               |                   |                                   
|TERRA-G                                      |                   |                                    | PVD                    
|SOLARISTO                                    |                   |                                    | PECVD                  
|ECOVERA (Development)                        |                   |                                    | PECVD                  
|ATON (Development)                           |                   |                                    | PVD                    
|A-650                                        |                   |                                    | PVD                    
|Consumer Products Packaging and Electronics: |                   |                                   
|TOPMET                                       |                   |                                    | Evaporative            
|MULTIMET                                     |                   |                                    | Evaporative            
|SMARTWEB                                     |                   |                                    | PVD / Evaporative      
|TOPBEAM                                      |                   |                                    | Evaporative            
|MULTIWEB                                     |                   |                                    | PVD                    

1)  The price
for a particular system may be greater or less than the general price range, depending on
the specific configuration and specifications.

# Thin Film Deposition
Equipment

Flat Panel Displays

Our flat panel display in-line
deposition equipment applies conductive, optical and barrier coatings for high resolution
LCDs, and plasma display panels, or PDPs, used in computer monitors and high definition
televisions.

TRITON.Is a newly
introduced advanced high throughput vertical deposition platform designed to accommodate
larger than generation 6 substrate sizes.  Specifically designed and built for the TFT array process, TRITON
incorporates advanced designs that target demands of current and future TFT-LCD markets.

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NEW ARISTO.Our NEW
ARISTO is an advanced thin film deposition system that accommodates the largest mother
glass sizes, including generation 6 and 7, and meets the requirements of the color filter
side of the active matrix LCD, plasma display television and color super twisted nematic, or
CSTN, FPD markets. The system features high throughput, low cost of ownership and the
capability for double-sided coatings.

VES 400.Our VES
400 system is an advanced production thin film deposition system for the OLED market. The
VES 400 applies all of the thin films necessary for an OLED device including the metal
layers and organic layers in a vacuum. The VES 400 is targeted at providing OLED
manufacturers with the ability to produce OLED devices in production volumes. We believe
this is the first vertical in-line deposition system developed for OLED.

Architectural and Solar
Glass.Our architectural thin film deposition systems apply
Low-Emissivity or Low-E coatings on large glass substrates used in building glass. Our
solar glass coating systems apply thin films that create the conductive layers on
substrates used for energy collection in solar cells.

Terra-G.Our
Terra-G thin film deposition system is our most advanced coating system designed for the
large architectural glass market. The Terra-G uses large planar magnetron or rotary
cathodes and uniformly deposits multiple thin films across a large area at very high
throughput rates. The Terra-G can be up to 150 meters long and can deposit up to 20
different thin films on a single side of glass during the process.

SOLARISTO.Our
SOLARISTO thin film deposition system, a derivative of the NEW ARISTO, is a vertical
in-line system that handles medium-sized glass substrates. The SOLARISTO uses planar
magnetron cathodes or a linear PECVD source and deposits multiple thin films on the
substrate, while it moves vertically through the system.

ECOVERA.Our
ECOVERA thin film deposition system is a vertical coating system that applies the
functional layers and transparent conductive oxide layers for amorphous silicon and
microcrystalline solar cells.

ATON.Our ATON thin
film deposition system is a horizontal sputtering system that applies silicon nitride and
other thin film layers for a polycrystalline wafer based solar cells.

A-650.Our A-650
thin film deposition system is a horizontal coating system that applies the functional
layers and other thin film layers for copper indium diselenide (CIS) or copper indium
gallium diselenide (CIGS) solar cells.

Consumer Products Packaging and
Electronics.Our consumer packaging and electronics coating systems deposit
thin films on flexible substrates used in various markets such as food packaging,
decorative packaging or electronic applications such as electromagnetic interference
shielding, capacitors, and touch panel applications. Thin films are applied to a thin
plastic or metal foil substrate to create a barrier to promote freshness and extend shelf
life in consumer products and are used as conductive coatings in the manufacture of
certain electronic products, such as capacitors and touch panel screens.

TOPMET.Our TOPMET
web thin film deposition system provides a solution for coating metal materials on
flexible substrates. The TOPMET uses thermal evaporation to deposit thin film layers of
aluminum in a vacuum onto flexible substrates, usually film, paper or textiles in roll
format.

MULTIMET.Our
MULTIMET web thin film deposition system uses evaporative deposition technology to deposit
thin films on very thin foil at high speed in a vacuum for the capacitor market. The
MULTIMET offers the ability to mask specific patterns on substrates.

SMARTWEB.This new
web system is designed as a modular, clean room compatible sputter roll coater for small
width (400 to 800 mm)  R&D and production applications. The specific advantages of the
SmartWeb are high modularity and flexibility, low height, small footprint, linear
arrangement of chambers, no moving parts above the coating drum and special designed load
locks. The SmartWeb system offers a very high cost/performance ratio for medium throughput
applications.

TOPBEAM.Our
TOPBEAM web thin film deposition system uses electron beam evaporation technology to
produce transparent thin film barrier coatings used in the food packaging industry. The
TOPBEAM web coating system uses high powered electron beam guns to evaporate metal or
metal oxide.

MULTIWEB.Our
MULTIWEB thin film deposition system uses PVD processes to apply thin film conductive
coatings primarily for touch panel and solar control coating applications.

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Thin Film Coated Glass (China JV).
TN, STN and CSTN Coated Glass.Our China JV is a leading producer of
twisted nematic, or TN, super twisted nematic, or STN and color super twisted nematic, or
CSTN coated glass that is used for low resolution black and white and color LCDs. Their
customers incorporate these LCDs into consumer products that include cellular phones,
personal digital assistants and electronic instruments. To produce TN, STN, and CSTN
coated glass, our China JV uses our proprietary in-line coating systems and batch systems
to deposit thin films on high quality glass panels.

# Sales, Marketing and
Customers

Our customer base is global and we
have sales offices in the United States, Germany, Hong Kong, Belgium, Taiwan, Korea, Japan
and China, and utilize sales representatives worldwide to supplement the marketing
activities of our sales force. The sales cycle for thin film deposition equipment is long,
involving multiple visits to and by the customer. We usually sell our thin film deposition
equipment on a progress payment basis. We generally sell our spare parts on open account.
Our customer payment history has been excellent.

In fiscal 2004, our ten largest
customers accounted for approximately 65% of our net revenues. Revenues from our two
largest customers in fiscal 2004, LG International and AFG Industries Inc., represented
13% and 12%, respectively, of our net revenues. Approximately 81% of our fiscal 2004 net
revenues, 70% of our fiscal 2003 net revenues and 58% of our fiscal 2002 net revenues were
derived from exports to customers outside of our manufacturing center in Europe,
primarily to Asia.

# Customer Service

We provide technical assistance and
spare parts to support our customers. Technical assistance is an important factor in our
business as most of our thin film deposition equipment is used in critical phases of our
customers manufacturing process. Field engineers install the systems, perform preventive
maintenance and repair services, and are available for assistance in solving customer
problems. Our global presence permits us to provide these functions in proximity to our
customers. We also maintain local spare part supply centers to facilitate quick support.

We provide maintenance during the
product warranty period, usually one year following product acceptance, and thereafter
perform maintenance pursuant to individual orders issued by the customer. Our customer
service operations are also responsible for customer training programs, spare parts sales
and technical publications. In appropriate circumstances, we will send technical personnel
to customer locations to support the customers for extended periods of time to optimize
the use of the equipment for the customers specific processes.

# Manufacturing and
Facilities

Our Longmont, Colorado, headquarters
contains approximately 87,000 square feet and includes general offices and research and
development. This facility is leased from an independent third party. We conduct research
and development at this facility.

Our Alzenau, Germany, manufacturing
facility contains approximately 268,000 square feet and includes general offices, research
and development facilities, and equipment manufacturing facilities. This facility is
leased from an independent third party. We design and manufacture thin film deposition
equipment and can concurrently build multiple thin film deposition systems at this
facility.

Our Tainan, Taiwan, manufacturing
facility contains approximately 41,000 square feet and includes general offices, research
and development facilities, and equipment manufacturing facilities. This facility is
leased from an independent third party. We manufacture thin film deposition equipment and
can concurrently build multiple thin film deposition systems at this facility.

Our China JV glass coating facilities
are incorporated into the glass production facilities owned by Nippon Sheet Glass Co.,
Ltd. (NSG) and contain approximately 91,000 square feet located in Suzhou, China. Our
China JV manufactures thin film coated glass at these facilities.

In addition to our Longmont, Alzenau,
Tainan and China JV facilities, we have leased warehouse space from which we supply spare
parts to customers on a just-in-time basis in Japan, Taiwan and Hong Kong. We also have
leased sales  offices in  Belgium, Hong Kong, Korea, Japan,
Taiwan, and China.

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# Competition

The key competitive factors in each
of our markets include performance, hardware technology, process technology, after-sales
support, service, price and payment terms. We believe we are competitive with respect to
each of these factors. In each of our markets, we compete primarily with one or two
companies, which vary from small to large in terms of the amount of their net revenues and
range of products.

Our primary competitors in each of
our markets are as follows:

Flat Panel Display Deposition
Equipment.For the FPD market, we compete against Ulvac
Technologies, Inc. of Japan in the color filter market for FPDs, and Ulvac
Technologies, Inc., Unaxis Corporation of Switzerland, and Anelva Ltd. of Japan in the TFT
array market for FPDs.

Architectural and
Solar Glass Deposition Equipment.In the architectural glass market,
 we primarily compete against Von Ardenne, AG, a German thin film
deposition equipment company. In the solar glass market, we primarily compete
against Ulvac Technologies Inc. and Von Ardenne.

Consumer Products Packaging and
Electronics Deposition Equipment.Our most significant competitors in the
packaging and electronics markets are Valmet General, a division of Metso Ltd. headquartered in the United Kingdom and Leybold
Optics, AG of Germany.

Our markets are highly competitive.
Many of our competitors have substantially greater financial, technical, marketing and
sales resources than we have.

# Research and Development

We have approximately 150 engineers
and scientists in our company of which 58 are involved in research and development and 20
hold PhD degrees. We will continue to emphasize improvements in current equipment
technology, the development of new process technologies for thin film deposition, and the
modification of thin film material properties. Our success is based on
superior engineering solutions, extensive experience with vacuum technologies, and the depth of our
commercial deposition experience and the high quality performance of our systems. Our
customer oriented solutions include cost effective thin film deposition, simplified
process control, and innovative deposition equipment designs. We continue to build on
these traditions in the development of process control and deposition design, which lower
the cost of ownership to the customer.

Our
research and development expertise encompasses a wide range of deposition technologies,
including:

| |  | Thermal
evaporation by direct heating for organics and inorganics;
| | - | ------------------------------------------------------------------

| |  | Electron
beam evaporation for dielectrics;
| | - | ------------------------------------------

| |  | Direct
current,  radio frequency and radio frequency  superimposed  direct current  magnetron
for reactive               and non-reactive sputtering;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Alternating
current magnetron (TWINMAGTM)for fully reactive sputtering;
| | - | -----------------------------------------------------------------------

| |  | Hollow
cathode source for highly reactive coatings;
| | - | ---------------------------------------------------

| |  | Direct
current, radio frequency and microwave sources for PECVD;
| | - | ----------------------------------------------------------------

| |  | Cleaning
with direct current glow discharge, radio frequency etch and ion assisted etch; and
| | - | --------------------------------------------------------------------------------------------

| |  | Arc
evaporation for high speed deposition of barrier layers.
| | - | ------------------------------------------------------------

Our research and development
expenditures were $9.2 million in fiscal 2002 and $12.2 million in fiscal 2003,
and $16.8 million in fiscal 2004.

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# Intellectual Property

We use a combination of patent,
copyright, trademark and trade secret protection as well as non-disclosure agreements and
licensing arrangements to establish and protect our proprietary rights. Steps taken by us
to protect our proprietary rights may not be adequate to prevent misappropriation of such
rights or third parties from independently developing a functionally equivalent or
superior technology. Worldwide, we have over 134 patents and patent applications.

We license certain intellectual
property to Balzers Process Systems GmbH, an indirect subsidiary of Unaxis under an
irrevocable, royalty-free, perpetual and worldwide license agreement. We also license
certain intellectual property from Balzers Process Systems GmbH. The license is
irrevocable, royalty-free, perpetual and worldwide.

# Strategic Relationship
with The Coca-Cola Company

In July 1997, we entered into a
strategic relationship with The Coca-Cola Company to develop and produce thin film
deposition equipment to apply barrier coatings to the outside of plastic bottles. We then
entered into a Commercialization Agreement with The Coca-Cola Company and Krones AG
effective September 2000. In June 2004, we negotiated the termination of the
Commercialization Agreement and we are no longer pursuing the technology or the market for
barrier properties on plastic bottles. We retain certain intellectual property rights
following the termination of the Commercialization Agreement.

# The Helix Acquisition

Effective June 2, 2004, we acquired
the in-line systems division of Helix Technology, Inc. in Taiwan (Helix) which established
an Asian manufacturing base for us. Prior to the completion of this acquisition, all of
our manufacturing capacity was in Germany. The Helix acquisition adds manufacturing
capacity along with 32 people in Tainan, Taiwan, bringing us closer to our Asian customer
base. Revenues to customers in Asia were 62% of our total revenues for fiscal 2004.

# The LAC Acquisition

Effective December 31, 2000, we
acquired the LAC business from Unaxis, which expanded our capabilities in the FPD market
and enabled our entry into other markets that we currently serve. We also agreed to
license certain intellectual property from Unaxis, and Unaxis agreed to license certain
intellectual property from us. Since December 31, 2002, Unaxis has been free to
compete with us in our markets with certain intellectual property related to our
deposition technology.

# China Joint Venture

In fiscal 1999, we entered into a
joint venture with NSG, a major Japanese glass manufacturer, to supply the low and high
resolution coated glass market from a production base in Suzhou, China. Our China JV was
formed as a limited liability company under the laws of the Peoples Republic of
China. We are 50%-50% joint venture partners with NSG, and the term of our China JV is 50
years. Profits, dividends, risks and losses are also shared by the partners in proportion
to their equity contributions. Each party has contributed $3.2 million equity in cash.

Our strategy for our China JV has
involved the transfer of the majority of our thin film coated glass manufacturing capacity
to China. Our China JV facility produces coated glass immediately adjacent to its primary
source of raw glass, NSG, and in close proximity to our China JVs Asian customer
base. During fiscal 2003, our China JV expanded into the color STN market by supplying
thin film coating for color filter glass. We also continue to evaluate business
opportunities that could strengthen our position with our China JVs customers.

# Employees

As of June 26, 2004, we
employed a total of 589 people. Our United States and Asian workforce is non-union, and,
like most companies in Germany our German workforce is represented by a workers
council. We negotiate wages and benefits annually with
our German workforce. We consider our relationship with our employees to be good.

We operate under a participative
management system that we believe enhances productivity by emphasizing individual
employee opportunity and participation both in operating decisions and in our
profitability. We believe this emphasis assists with enhanced productivity, cost control,
and product quality and has helped us attract and retain capable employees.

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# Environmental Regulations

Our operations create a small amount
of hazardous waste. The amount of hazardous waste we produce may increase in the future
depending on changes in our operations. The general issue of the disposal of hazardous
waste has received increasing focus from federal, state and local governments and agencies
both in the United States and Germany and has been subject to increasing regulation. Based
on regulations currently in effect, we believe compliance with these regulations will not
have a material impact on our capital expenditures, earnings or competitive position.

# Trademarks

ARGUS3, ARISTO, ATON, A-Series,
ATX-700, BTX, DuoMag, EcoVeRa, ESCOSYS, HoloVap, MULTIMET, MULTIWEB, NEW ARISTO, OPTOPLEX,
PatVap, SmartWeb, SOLARISTO, Terra-G, TOPBEAM, TOPMET, ToraMag, TreatMag, TriMag, TRITON,
Twin-AR-Mag, TwinMag and VES400 are trademarks or registered trademarks of ours.

# ITEM 1 (d): Information
About Foreign Operations

See ITEM 1(c): Narrative Description
of Business  Sales, Marketing, and Customers and China Joint
Venture.

# ITEM 2: Properties

See ITEM 1(c): Narrative
Description of Business  Manufacturing and Facilities

# ITEM 3: Legal Proceedings

From time to time, we may be subject
to litigation and claims incident to our business. As of the date of this report, we are
not involved in any legal proceedings which, if not settled in our favor, would,
individually or collectively, have a material adverse impact on our financial condition or
results of operations.

# ITEM 4: Submission of
Matters to a Vote of Security Holders

No matters were submitted during the
fourth quarter of fiscal 2004 to a vote of our shareholders.

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# ADDITIONAL ITEM:
EXECUTIVE OFFICERS OF THE REGISTRANT

# Executive Officers and
Directors

Our executive officers and directors
are as follows:

|Name                                                                                                                                                                                                                                 | Age                           | Position                                                                                                                                                                                                                                                                                                                                                                                                                 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Thomas T.  Edman      
Lawrence D.  Firestone
J.H.  Bae             
Joachim Nell          
James P.  Scholhamer  
Allen H.  Alley       
Richard P.  Beck      
John S.  Chapin       
Gerald J.  Laber      
Vincent Sollitto, Jr. | 42
46
46
46
38
50
71
63
60
56 | Director, President and Chief Executive (2)
Chief Financial Officer, Treasurer, Senior Vice
President and Secretary (2)
Vice President Asia Pacific (2)
Executive Vice President of Worldwide Sales and
Marketing (2)
Senior Vice President - Operations, R&D and
Design (2)
Director (1) (5)           
Director, Chairman of the Board (1) (3)
Director                   
Director (6)               
Director (1) (4)

(1) Member
of the Audit, Compensation and Nominating and Governance Committees.(2) Executive
Officer(3) Chairman of Audit Committee(4) Chairman of
Compensation Committee(5) Chairman of Nominating and Governance Committee
(6) Member of the Audit Committee

Thomas T. Edmanhas been
employed by our company since June 1996 and has served as our President and Chief
Executive Officer since May 1998. From June 1996 until May 1998, Mr. Edman served as Chief
Operating Officer and Executive Vice President. Mr. Edman has served as a director of our
company since July 1998. From 1993 until joining our company, he served as General Manager
of the High Performance Materials Division of Marubeni Specialty Chemicals, Inc., a
subsidiary of a major Japanese trading corporation. Mr. Edman also serves on the national board
of directors of the American Electronics Association, a professional trade organization,
and is chairman of its audit committee. He also serves on the Governing Board of the USDC
(United States Display Consortium). Mr. Edman has a Bachelor of Arts degree in East Asian
studies (Japan) from Yale University and a Masters degree in business administration
from The Wharton School at the University of Pennsylvania.

Lawrence D. Firestonehas
served as our Chief Financial Officer, Treasurer and Secretary since July 1999 and as our
Senior Vice President as of July 2003. From 1996 until 1999, Mr. Firestone
served as Vice President and Chief Operating Officer of Avalanche Industries, Inc., a
contract manufacturer of custom cables and harnesses. From 1993 to 1996, Mr. Firestone served as Director
of Finance and Operations for the Woolson Spice and Coffee Company, a gourmet coffee
roasting and distribution company, and from 1988 to 1993, as Vice President and Chief
Financial Officer for TechniStar Corporation, a manufacturer of robotic automation
equipment. From 1981 to 1988, Mr. Firestone served in various capacities and finally as
Vice President and Chief Financial Officer at Colorado Manufacturing Technology, a
contract manufacturer that specialized in printed circuit board and cable assembly.
Additionally, Mr. Firestone serves on the board of directors of HyperSpace Communications, Inc,
and he serves as chairman of their audit and governance committees.  Mr.
Firestone has a Bachelor of Science degree in business administration with a concentration in
accounting from Slippery Rock State
College.

J.H.
          Baehas served as our Vice President of Asia Pacific since January 1, 2004
          and President of Applied Films Korea, Ltd since July 2003. Mr. Bae joined
          Applied Films in July 1, 2003 from IPS Ltd., a Korean manufacturer of vacuum
          deposition equipment for the semiconductor and flat panel display markets where
          he was the CEO & Executive Director. Mr. Bae was employed by IPS Ltd. from
          May 1996, through February 2003. Prior to his experience at IPS, he was
          the Executive Director of Varian Korea Ltd, a manufacturer of vacuum deposition
          equipment & ion implanters for the semiconductor industry, and before Varian
          Korea, Mr. Bae was employed by Samsung Electronics and other companies in
          various capacities first as an Equipment Engineer in 1975 and finally as the
          Sales & Service Director of JaeLim Engineering Ltd.

Joachim Nellhas served as our
Executive Vice President of Worldwide Sales and Marketing since January 1, 2004. Mr. Nell
joined Applied Films from Jusung Engineering Company, a Korean manufacturer of vacuum
deposition equipment for the flat panel display and semiconductor markets where he was the
President of its subsidiary Jusung Europe GmbH and the Corporate Vice President,
International Markets & Corporate Strategies. Mr. Nell was employed by Jusung
Engineering Company from January 2000 through December 2003. Prior to his experience at
Jusung, he was the Managing Director of STEAG Electronic Systems a capital equipment
supplier to the Semiconductor industry, and before STEAG, Mr. Nell was employed by IBM in
various capacities first as an engineer in 1985 and finally as the Marketing & Sales
Director of the Electro-Ceramics division. Mr. Nell graduated from the University of
Karlsruhe with a degree in electrical engineering (Dipl.-Ing.)

Page 9 of 63

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James P. Scholhamerhas served
as our Senior Vice President of Worldwide Operations, R&D and Design since July 2003.
From January 2001 to July 2003, Mr. Scholhamer was the Vice President  Operations
and from August 1997 to January 2001 he was the Director of Operations for Thin Film
Coatings. From 1992 until he joined the company, Mr. Scholhamer held the titles of
Manufacturing Manager and Process Engineer at Viratec Thin Films, Inc. From 1989 to 1992,
Mr. Scholhamer served as Production Manager and Process
Engineer at Ovonic Synthetic Materials, Inc., a division of Energy Conversion Devices.
 Mr. Scholhamer has a Bachelor of Science degree in engineering from
The University of Michigan.

Allen H. Alleyhas been a
director of our company since September 2002. Mr. Alley co-founded Pixelworks and has
served as the President, CEO, and Chairman of the Board of Pixelworks (NASDAQ:PXLW) since its inception
in 1997. From 1992 to 1997, Mr. Alley served as the Vice President Corporate Development,
Engineering and Product Marketing at InFocus Systems, a leading electronic display
company. While at InFocus, Mr. Alley was also the co-CEO of a joint venture with Motorola,
Inc. called Motif. From 1986 until 1992, Mr. Alley served as General Partner with Battery
Ventures, a venture capital investment firm. From 1983 to 1986, Mr. Alley was the Director
of Mechanical Computer Aided Engineering of Computervision Corporation, a computer-aided
design software developer. From 1979 to 1983, Mr. Alley was a Lead Mechanical Engineer at
Boeing Commercial Airplane Division. From 1976 to 1979, Mr. Alley served as a Product
Design Engineer for the Ford Motor Company. Additionally, Mr. Alley serves on the board of
directors of the Oregon Museum of Science and Industry, is the Chairman of the Oregon
Council of Knowledge and Economic Development, and in February 2002, he accepted an
appointment by President George W. Bush to the U.S.-Japan Private Sector Government
Commission. Mr. Alley holds a Bachelor of Science degree in mechanical engineering from
Purdue University.

Richard P. Beckhas served as
our Chairman of the Board since October 2001 and
as a director since May 1998.
From March 1992 to May 2002, Mr. Beck served in various capacities for Advanced Energy
Industries, Inc (NASDAQ:AEIS), a manufacturer of power conversion and integrated
technology solutions, including Senior Vice President from November 2001 to May 2002,
Senior Vice President and Chief Financial Officer from February 1998 to November 2001, and
Vice President and Chief Financial Officer from March 1992 to February 1998, and he
continues to serve as a director of the company. From November 1987 to March 1992, Mr.
Beck served as Executive Vice President and Chief Financial Officer of Cimage Corporation,
a computer software company. Mr. Beck serves as a director of Photon Dynamics, Inc. (NASDAQ:PHTN), and
TTM Technologies, Inc (NASDAQ:TTMI), and he serves as chairman of their
audit committees. Mr. Beck has a Bachelor of Science degree in accounting and a
Masters degree in business administration in finance from Babson College.

John S. Chapinco-founded
Applied Films Lab, Inc. in 1976 and served as Vice President of Research until his retirement in
November 2000 he also served as Corporate
Secretary from 1976 to November 2000. Mr. Chapin has also served as a director of our
company since its inception. Mr. Chapin is the inventor of the planar magnetron and
co-inventor of a reactive sputtering process control. Mr. Chapin has a Bachelor of Science
degree in geophysics from the Colorado School of Mines and a Masters degree in
electrical engineering from the University of Colorado.

Gerald J. Laberhas been a
director of our company since July 2004. Mr. Laber spent 33 years with Arthur Andersen,
LLP, from June 1965 through August 2000, including over 20 years as an audit partner with extensive
experience in auditing public companies and dealing with financial statement disclosure
and accounting matters. Mr. Laber currently serves on several boards of directors
including: Spectralink Corporation (NASDAW:SLNK); Healthetech, Inc
(NASDAQ:HETC); Centennial Specialty Foods (NASDAQ:SmallCap Market: CHLE); QualMark
Corporation (OTBB:QMRK); and Scotts LiquidGold, Inc. (OTC:SLGD), and he serves
as the chairman of their audit committees.  Mr. Laber is a member of the American Institute
of Certified Public Accountants and the Colorado Society of Certified Public Accountants.
Mr. Laber has a Bachelor of Science degree in Business Administration with a major in accounting from the
University of South Dakota.

Page 10 of 63

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Vincent Sollitto, Jr.has
been a director of our company since October 1999. Since June 2003, Mr. Sollitto has
been the President and Chief Executive Officer and member of the board of Brillian
Corporation. From July 1996 to February 2003, Mr. Sollitto was President and Chief
Executive Officer and a member of the Board of Directors of Photon Dynamics, Inc. From
August 1993 to 1996, Mr. Sollitto was the General Manager of Business Unit Operations for
Fujitsu Microelectronics, Inc. From April 1991 to August 1993, he was the Executive Vice
President of Technical Operations at Supercomputer Systems, Incorporated. Prior to 1991,
Mr. Sollitto spent 21 years in various management positions at IBM, including Director of
Technology and Process. Mr. Sollitto serves as a director on the board of Ultratech Inc.
(NASDAQ:UTEK), and Brillian Corporation (NASDAQ:BRLC).
Mr. Sollitto holds a Bachelor of Science degree in electrical engineering from Tufts
College.

# Executive Officers

The Board of Directors elects
executive officers on an annual basis. Executive officers serve at the pleasure of the
board.

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# ADDITIONAL ITEM: RISK
FACTORS

You should carefully consider the
following risk factors and other information contained or incorporated by reference in
this report before deciding to invest in our common stock. Investing in our common stock
involves a high degree of risk. The risks and uncertainties described below may not be the
only ones we face. If any of the following risks actually occurs, our business could be
harmed and the market price of our common stock could decline, and you may lose all or
part of your investment. Please see Forward Looking Statements on page 35 of
this report.

# Risks Related to our
Business

Our quarterly revenues and
operating results fluctuate due to a variety of factors, which may result in volatility or
a decrease in the price of our common stock.

We have experienced and may continue
to experience significant annual and quarter-to-quarter fluctuations in our revenues and
operating results as a result of a variety of factors including:

| |  | the
cyclical nature of the capital equipment market;
| | - | ----------------------------------------------------

| |  | fluctuation
in customer demand,  which is influenced by general economic  conditions in the
industries and          geographic markets we serve;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our
product and revenue mix;
| | - | ----------------------------

| |  | competition,
including competitive pressures on prices of our products;
| | - | -----------------------------------------------------------------------

| |  | the
length and variability of the sales cycle for our products;
| | - | ---------------------------------------------------------------

| |  | manufacturing
and operational issues;
| | - | -------------------------------------

| |  | the
timing of customer orders;
| | - | ------------------------------

| |  | issues
related to new product  development and introduction,  including  increased  research,
 development          and engineering costs and marketing expenses;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our
use of the percentage of completion revenue accounting method;
| | - | ------------------------------------------------------------------

| |  | the
 timing of the  recognition  of  revenues  from  capital  equipment  orders  and the
 accuracy  of the          estimation of our costs;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------

| |  | sales
and marketing issues, including the concentration of our customer base; and
| | - | ---------------------------------------------------------------------------------

| |  | fluctuations
in foreign currency exchange rates.
| | - | ------------------------------------------------

These
factors are difficult or impossible to forecast.

Our business could be adversely
affected by the cyclical nature of market conditions in the industries we serve.

Our business depends on the
purchasing requirements of our customers in the FPD, architectural and solar
glass, and the consumer products packaging and electronics markets.
Certain of these markets, in particular the FPD market, have been subject to dramatic
cyclical variations in product supply and demand. The timing, length and severity of these
cycles are difficult to predict. In some cases, these cycles have lasted more than a year.
Manufacturers may contribute to these cycles by over- or under-investing in manufacturing
capacity and equipment. We may not be able to respond effectively to these industry
cycles.

Downturns in the industry often occur
in connection with, or in anticipation of, maturing product cycles and declines in general
economic conditions. Industry downturns have been characterized by reduced demand for
equipment, production over-capacity and accelerated decline in average selling prices.
During a period of declining demand, we must be able to quickly and effectively reduce
expenses, and this ability is limited by our need for continued investment in engineering
and research and development and extensive ongoing customer service and support
requirements. In addition, although we order materials and components in response to firm
orders, the long lead time for production and delivery of some of our products creates a
risk that we may incur expenditures or purchase inventories for products which we cannot
sell or for which orders may be cancelled.

Page 12 of 63

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The FPD market experiences downturns,
and there can be no assurance as to future demand for active matrix LCDs, thin film
transistors, or TFTs, or plasma display panels. Unfavorable economic conditions that
relate to the consumer electronics or other industries in which we operate, or that result
in reductions in capital expenditures by our customers, could have a material adverse
effect on our business, operating results, financial condition and prospects.

Our industry is subject to rapid
technological change, and we may not be able to forecast or respond to commercial and
technological trends.

Our growth strategy and future
success is dependent upon commercial acceptance of products that incorporate technologies
we have developed and are continuing to develop. The market for
thin film deposition equipment is characterized by rapid change and frequent introductions
of enhancements to existing products. Technological trends have had and will continue to
have a significant impact on our business. Our results of operations and ability to remain
competitive are largely based upon our ability to accurately anticipate customer and
market requirements. Our success in developing, introducing and selling new and enhanced
products depends upon a variety of factors, including:

| |  | accurate
technology and product selection;
| | - | ------------------------------------------

| |  | timely
and efficient completion of product design and development;
| | - | ------------------------------------------------------------------

| |  | timely
and efficient implementation of manufacturing and assembly processes;
| | - | ----------------------------------------------------------------------------

| |  | product
performance in the field; and
| | - | -------------------------------------

| |  | product
support and service and effective sales and marketing.
| | - | --------------------------------------------------------------

We may not be able to accurately
forecast or respond to commercial and technological trends in the industries in which we
operate.

Technological changes, process
improvements, or operating improvements that could adversely affect us include:

| |  | development
of new technologies by our competitors;
| | - | ---------------------------------------------------

| |  | changes
in product requirements of our customers;
| | - | -------------------------------------------------

| |  | changes
in the way coatings are applied to glass, paper or metal foil;
| | - | ----------------------------------------------------------------------

| |  | development
of new materials that improve the performance of the coated substrate; and
| | - | --------------------------------------------------------------------------------------

| |  | improvements
in the alternatives to our technologies.
| | - | -----------------------------------------------------

If we fail to adequately invest in
research and development or allocate sufficient resources, we may be unable to compete
effectively in the markets in which we operate.

As a result of the intense
competition in our industry, the failure to invest sufficiently in strategic product
development could adversely affect us. We have limited resources to allocate to research
and development and must allocate our resources among a variety of projects. We may not
have sufficient funds to devote to research and development, or our research and
development efforts may not be successful in developing products in the time, or with the
characteristics, necessary to meet customer needs. If we do not adapt to such changes or
improvements, our competitive position, operations and prospects would be materially
adversely affected.

Our products generally have long
sales cycles and implementation periods, which increase our costs in obtaining orders and
extend the effects of economic downturns.

We derive a substantial portion of
our net revenues from complex, customized products that are a major capital expenditure
for our customers and typically require long lead times. Because of the significance of
the product purchase decision, prior to placing an order, prospective customers generally
commit resources to test and evaluate our products and often require a number of product
presentations and demonstrations before reaching a sufficient level of confidence in the
products performance and compatibility with the customers specific
requirements. The sales cycle of our products is protracted, requiring us to invest
significant marketing and engineering resources in attempting to make sales and delaying
the generation of revenue. Following periods of economic downturn during which the sales
process may have been suspended, the long sales cycle will lengthen the period following
economic recovery before we will begin to receive revenues. Long sales cycles also subject
us to other risks, including customers budgetary constraints, internal acceptance
reviews and cancellations. The time required for our customers to incorporate our products
into their systems can also be lengthy and require significant on-site engineering
support. Because our customers final payment obligations are not triggered until
ultimate product acceptance, any delay in acceptance could postpone our receipt of the
final 10-20% of the purchase price.

Page 13 of 63

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We face competition or potential
competition from companies with greater resources than ours, and if we are unable to
compete effectively with these companies, our market share may decline and our business
could be harmed.

The market for thin film deposition
equipment is highly competitive. We face substantial competition from established
companies in many of the markets we serve. Some of our competitors have greater financial,
engineering, manufacturing and marketing resources, broader product offerings and service
capabilities and a larger customer base than we do. As a result, our competitors may be
able to respond more quickly to new or emerging technologies or market developments by
devoting greater resources to the development, promotion and sale of products, which could
impair sales of our products. In addition, their greater capabilities in these areas may
enable them to:

| |  | better
withstand periodic economic downturns;
| | - | ---------------------------------------------

| |  | compete
more effectively on the basis of price and technology;
| | - | --------------------------------------------------------------

| |  | more
quickly develop enhancements to and new generations of products; and
| | - | -------------------------------------------------------------------------

| |  | more
effectively retain existing customers and obtain new customers.
| | - | --------------------------------------------------------------------

Many of our customers and potential
customers that purchase thin film deposition equipment are large companies that require
global support and service for their thin film deposition equipment. Our larger
competitors have more extensive infrastructures than we do, which could place us at a
disadvantage when competing for the business of global manufacturers and other purchasers
of thin film deposition equipment.

Some of our competitors
may be willing to reduce their profit margins or even sell at a loss to win
market share, which could result in fewer sales for us and reduced profit
margins on the equipment we sell.

Some of our competitors offer a
broader range of integrated products in a particular market. If we are unable to develop a
more extensive line of products, customers could elect to purchase products from a
supplier that offers a more extensive range of products, making it more difficult for us
to sell products which are just one part of an integrated process.

In addition, new companies may in the
future enter the markets in which we compete, further increasing competition.

We believe that our ability to
compete successfully depends on a number of factors, including:

| |  | performance,
quality and reliability of our products;
| | - | -----------------------------------------------------

| |  | cost
of owning and using our products;
| | - | --------------------------------------

| |  | our
ability to ship products on the schedule required;
| | - | ------------------------------------------------------

| |  | quality
of the technical service we provide;
| | - | --------------------------------------------

| |  | timeliness
of the services we provide;
| | - | --------------------------------------

| |  | our
success in developing new products and enhancements;
| | - | --------------------------------------------------------

| |  | existing
market and economic conditions;
| | - | ----------------------------------------

| |  | foreign
currency exchange conditions; and
| | - | -----------------------------------------

| |  | price
of our products and our competitors' products.
| | - | ----------------------------------------------------

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Many of these factors are outside our
control. We may not be able to compete successfully in the future, and increased
competition may result in price reductions, reduced profit margins, loss of market share,
and inability to generate cash flows that are sufficient to maintain or expand our
development of new products.

Effective December 31, 2000 we
acquired the LAC business from Unaxis Holding AG, or Unaxis. We also agreed to license
certain intellectual property from Unaxis, and Unaxis agreed to license certain
intellectual property from us. Since December 31, 2002, Unaxis has been free to
compete with us in our markets with certain intellectual property related to our
deposition technology. Competition by Unaxis may impair sales of our products.

Due to our significant level of
export revenues, we are subject to operational, financial and political risks such as
unexpected changes in regulatory requirements, tariffs, political and economic
instability, outbreaks of hostilities and adverse tax consequences.

Export revenues to customers outside
of our manufacturing center in Europe represented approximately 58% of our net revenues in
fiscal 2002, 70% of our net revenues in fiscal 2003 and 81% of our net revenues in fiscal
2004. The principal international markets into which we and our China JV sell our products
include China (including Hong Kong), Korea, Japan and Taiwan. Banking and currency problems in
Asia have had and may continue to have an adverse impact on our revenues and operations.
Our operations in China will be subject to the economic and political uncertainties
affecting that country. For example, the Chinese economy has experienced significant
growth in the past decade, but such growth has been uneven across geographic and economic
sectors. This growth may continue to be uneven and any slowdown may have a negative effect
on our business. We believe international sales will continue to represent a significant
portion of our sales, and that we will continue to be subject to the normal risks of
conducting business internationally. Such risks include:

| |  | foreign
exchange risks;
| | - | -----------------------

| |  | inflation
or deflation in foreign economies;
| | - | --------------------------------------------

| |  | the
burdens of complying with a wide variety of foreign laws, including export license
requirements;
| | - | ----------------------------------------------------------------------------------------------------

| |  | unexpected
changes in regulatory requirements and the imposition of government controls;
| | - | ----------------------------------------------------------------------------------------

| |  | political
and economic instabilities;
| | - | -------------------------------------

| |  | protective
trade activities, such as tariffs and other barriers;
| | - | ----------------------------------------------------------------

| |  | the
risk of business interruption caused by labor unrest, war or illness;
| | - | -------------------------------------------------------------------------

| |  | difficulties
in accounts receivable collections;
| | - | ------------------------------------------------

| |  | inability
to protect intellectual property rights;
| | - | --------------------------------------------------

| |  | the
quarantine or closure of any of our facilities, or those of our customers, due to an
outbreak of          Severe Acute Respiratory Syndrome or SARs;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | difficulties
in staffing and managing foreign sales operations; and
| | - | -------------------------------------------------------------------

| |  | potentially
adverse tax consequences.
| | - | -------------------------------------

We conduct business in foreign
currencies, and fluctuation in the values of those currencies could result in foreign
exchange losses and negatively affect our competitive position.

In fiscal 2004, approximately 95% of
our net revenues were denominated in Euros and approximately 1% were denominated in
U.S. dollars. Any strengthening or weakening of the Euro or U.S. dollar in
relation to other currencies in which our customers or competitors do business, could
adversely affect our competitiveness, as our products will become more expensive to
customers outside Europe and less competitive with products produced by competitors
outside Europe. Our China JV transacts much of its business in Chinese Yuan Renminbi.
While this currency has remained fairly constant in value, any devaluation of the Chinese
Yuan Renminbi would adversely affect our business, operating results, financial conditions
and prospects. Foreign sales also expose us to collection risks in the event it becomes
more expensive for our foreign customers to convert their local currencies into
Euro. Fluctuations in exchange rates could adversely affect our competitive
position or result in foreign exchange losses, either of which could materially adversely
affect our business, operating results, financial conditions and prospects.

Page 15 of 63

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Our consolidated financial statements
are expressed in U.S. dollars. However, the assets, liabilities and results of
operations of our German operations are reported in Euros. The translation exposures that
result from the inclusion of financial statements that are expressed in functional
currencies other than U.S. dollars are reported in the other cumulative
comprehensive income (loss) line in stockholders equity. As of June 26,
2004, the unrealized translation adjustment in other cumulative comprehensive income
(loss) was $12.6 million, which was primarily attributable to the goodwill and
other intangible assets from the LAC acquisition that are denominated in Euros and
intercompany debt denominated in the functional currency of the country in which our
subsidiary that received the loan is organized.

We derive a significant portion of
our revenue from large sales to a small number of large customers, and if we are not able
to retain these customers, or if they reschedule, reduce or cancel orders, our revenues
would be reduced and our financial results would suffer.

Our ten largest customers accounted
for approximately 65% of our net revenues in fiscal 2004. Revenues from our two largest
customers in fiscal 2004, LG International and AFG Industries, Inc. represented 13% and
12%, respectively, of our net revenues. Revenues from our largest customers have varied
significantly from year to year and we expect that this condition will continue in the
future. We may not be able to retain our key customers, or these customers may cancel
purchase orders or reschedule or decrease their level of purchases from us. If a large
order were delayed or cancelled, our revenues would significantly decline, and the loss
of, or a significant reduction of purchases by, one or more of our significant customers
would materially adversely affect our business, operating results, financial condition and
prospects. In addition, any difficulty in collecting amounts due from one or more key
customers could harm our financial results. There are a limited number of potential
customers in each of our markets, and we expect that sales to a relatively small number of
customers will continue to account for a high percentage of our revenues in those markets
in the foreseeable future.

The failure of our strategic
partners to devote adequate resources to developing new and improved technologies or
marketing and distributing our products could limit our ability to grow or sustain our
revenues and earnings.

The success of our strategy to
develop emerging high growth market opportunities depends on the level of product
development support we receive from our strategic partners.
For example, we have been working with a strategic partner in the OLED market who has
purchased one of our systems and is working with us as we develop the thin film and
process technologies to shorten our development time for a high volume production solution
for color OLEDs. If our partner were to halt or otherwise modify their development plans
this could have a materially adverse effect on our product development time table.

If we are unable to continue to
introduce new products, our results will be adversely affected.

We believe our future growth depends
significantly upon our ability to successfully introduce new products, such as our TRITON,
SmartWeb, SOLARISTO, ECOVERA, ATON, A-650, and our VES 400 deposition
systems. We are subject to the risks inherent in the development of new products,
including risks associated with attracting and servicing a customer base, manufacturing
products in a cost-effective and profitable manner, and training qualified engineering,
manufacturing, service and marketing personnel. Some of our competitors have experience
manufacturing and selling products that compete with products we introduce, and have
existing customers for these products. Product development is based on our expectations
regarding future growth of target markets, but it is difficult to anticipate the direction
of future growth and to design equipment to meet the needs of a changing market. Changes
in technology could render our products less attractive. If the market for our new
products fails to grow, or grows more slowly than anticipated, we may be unable to realize
the expected return on our investment in product development, and our business, operating
results, financial condition and prospects could be materially adversely affected.

We manufacture all of our equipment products
at two facilities, and our China JV operates at one facility, and any prolonged disruption in the operations of those facilities or
a demand for products that exceeds the manufacturing capacity at such facilities, could
have a material adverse effect on our revenues or equity earnings.

We produce all of our thin film
deposition equipment in our manufacturing facilities located in Alzenau, Germany and
Tainan, Taiwan. Our China JV produces all of its coated glass in its facilities
leased in Suzhou, China. Any prolonged disruption in the operations of our manufacturing
facilities, whether due to technical or labor difficulties, destruction or damage as a
result of a fire or any other reason, could seriously harm our ability to satisfy our
customer order deadlines. If we cannot deliver our systems on time, our revenues could
also be adversely affected.

Page 16 of 63

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If we deliver systems with defects
or that fail to meet specifications, our credibility will be harmed and the market
acceptance and sales of our systems will decrease.

Our systems are complex, are often
customized and sometimes have contained defects or fail to meet contractual
specifications. Most of our systems are uniquely designed for a particular customer, and
occasionally incorporate new features which  have not previously been tested.
If we deliver systems with defects or fail to meet specifications, our credibility and the
market acceptance and sales of our systems could be harmed. In addition, if our systems
contain defects or fail to meet specifications, we may incur contractual penalties and be
required to expend significant capital and other resources to alleviate such problems.
Such problems could also damage our relationships with specific customers, impair market
acceptance of our products and adversely affect our gross profit margins and operating
results.

We depend on the continuing
cooperation of our joint venture partner in China.

Our equity earnings from our China JV
depend solely on our joint venture with Nippon Sheet Glass Co., Ltd., or NSG, in China.
The results of our China JV depend on the continuing cooperation of NSG. The success of
our China JV is subject to a number of risks, over many of which we have limited control.
We rely on NSG to house our China JV within its glass fabrication facility and to supply
glass to our China JV. We also rely on NSGs management personnel to manage the
day-to-day operations of our China JV, and the managing director of our China JV is
employed by NSG as well as by our China JV. We do not have employment agreements with any
management personnel at our China JV. Our China JVs future success will depend
in part on our ability to continue to effectively participate in our China JV and manage
our relationship with NSG. Our business, operating results, financial condition or growth
could be materially adversely affected if NSG ceases to supply glass to our China JV,
focuses its management and operational efforts on other activities or terminates the joint
venture.

Our operations and assets in China
are subject to significant political, economic, legal and other uncertainties in China.
China currently does not have a comprehensive and highly developed system of laws,
particularly with respect to foreign investment activities and foreign trade. Enforcement
of existing and future laws and contracts is uncertain, and implementation and
interpretation of laws may be inconsistent. We could also be adversely affected by a
number of factors, including inadequate development or maintenance of infrastructure or a
deterioration of the general political, economic or social environment in China.

The coated glass market is highly
competitive and subject to pricing pressures, which could adversely affect our China JV's operating
results.

The market to supply thin film coated
glass to LCD manufacturers is highly competitive. Many of our China JV competitors have
substantially greater financial, technical, marketing and sales resources than our China
JV. Additional competitors may enter our markets, certain of which may offer lower prices.
Prices for much of our low resolution thin film coated glass products supplied to the LCD
market declined in past years. Our China JV may in the future experience pricing
pressures as a result of a decline in industry demand, excess inventory levels, increases
in industry capacity or the introduction of new technologies. Many of our China JV customers are
under continuous pressure to reduce prices, and we expect to continue to experience
downward pricing pressures on their thin film coated glass products. Our China JV is
frequently required to commit to price reductions before they know that the cost reductions
required to maintain profitability can be achieved. To offset declining sales prices, our
China JV must achieve manufacturing efficiencies and cost reductions and obtain orders for
higher volume products. If they are unable to offset declining sales prices, equity earnings
from our China JV will decline.

Our ability to compete could be
jeopardized if we are unable to protect our intellectual property rights from
infringements or challenges by third parties.

Our success and ability to compete
depends in large part upon protecting our proprietary technology. We rely on a combination
of patent, trade secret, copyright and trademark laws, non-disclosure and other
contractual agreements and technical measures to protect our proprietary rights. These
laws, agreements and measures may not be sufficient to protect our technology from
third-party infringements or to protect us from the claims of others. We have not filed
our registered patents and trademarks for patent or trademark protection in all of the
jurisdictions in which such filings may be made. There can be no assurance that the steps
taken by us to protect our proprietary rights will be adequate to prevent misappropriation
of such rights or that third parties will not independently develop a functionally
equivalent or superior technology. Patents issued to us may be challenged, invalidated or
circumvented; our rights granted under those patents may not provide competitive
advantages to us; and third parties may assert that our products infringe their patents,
copyrights or trade secrets. Third parties could also independently develop functionally
equivalent or superior technology and similar products or duplicate our products.
Monitoring unauthorized use of our products is difficult, and we cannot be certain that
the steps we have taken will prevent unauthorized use of our technology. If competitors
are able to use our technology, our ability to compete effectively could be harmed.

Page 17 of 63

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Claims or litigation regarding
intellectual property rights could seriously harm our business or require us to incur
significant costs.

In recent years, there has been
significant litigation in the United States involving patents and other intellectual
property rights. We could become subject to litigation in the future either to protect our
intellectual property rights or as a result of allegations that we infringe others
intellectual property rights.

From time to time, we have received
claims of infringement from third parties. Any claims that our products infringe
proprietary rights would force us to defend ourselves and possibly our customers or
manufacturers against the alleged infringement. These claims and any resulting lawsuit, if
successful, could subject us to significant liability for damages and invalidation of our
proprietary rights and could also result in an injunction barring us from making or
selling any infringing product. These lawsuits, regardless of their outcome, would likely
be time-consuming and expensive to resolve and would divert managements time and
attention. Any potential intellectual property litigation could force us to do one or more
of the following:

| |  | lose
our proprietary rights;
| | - | ----------------------------

| |  | stop
manufacturing or selling our products that incorporate the challenged intellectual
property;
| | - | -------------------------------------------------------------------------------------------------

| |  | obtain
from the owner of the infringed intellectual property right a license to sell or use the
relevant technology, which license may not be available on reasonable terms or at all and
may involve significant royalty payments;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | pay
damages, including treble damages and attorney's fees in some circumstances; or
| | - | -----------------------------------------------------------------------------------

| |  | redesign
those products that use such technology.
| | - | -------------------------------------------------

If we are forced to take any of the
foregoing actions, our business could be severely harmed.

Our efforts to protect our
intellectual property may be less effective in some foreign countries where intellectual
property rights are not as well protected as in Europe and the United States.

In fiscal 2004, 81% of our revenue
was derived from sales in foreign countries outside of our manufacturing center in Europe,
including certain countries in Asia such as Taiwan, Korea, China and Japan. The laws of
some foreign countries do not protect our proprietary rights to as great an extent as do
the laws of Europe and the United States, and many companies have encountered substantial
problems in protecting their proprietary rights against infringement in such countries.
For example, Taiwan is not a signatory of the Patent Cooperation Treaty, which is designed
to specify rules and methods for protecting intellectual property internationally. In many
instances, the publication of a patent prior to the filing of a patent application in
Taiwan would invalidate the ability of a company to obtain a patent in Taiwan. Similarly,
in contrast to the United States where the contents of patents remain confidential for at
least 18 months after first filing, in Taiwan, the contents of a patent are published
upon filing, which provides competitors an advance view of the contents of a patent
application prior to the establishment of the patent rights. There is a risk that our
means of protecting our proprietary rights may not be adequate in these countries. For
example, our competitors in these countries may independently develop similar technology
or duplicate our systems. If we fail to adequately protect our intellectual property in
these countries, it would be easier for our competitors to develop competing technology
and sell competing products.

We have significant goodwill and
other intangible assets. Consequently, potential impairment of goodwill and other
intangibles may significantly impact our profitability.

We prepare our financial statements
in conformity with U.S. generally accepted accounting principles, or U.S. GAAP.
U.S. GAAP requires us to annually evaluate whether certain assets have been impaired.
Annually, and more frequently if a triggering event occurs, the Company is required to
test the carrying value of goodwill for impairment using a fair-value-based approach. In
addition, U.S. GAAP also requires us to evaluate the carrying value of all long-lived
intangible assets other than goodwill whenever events or circumstances indicate that the
carrying value of assets may exceed their recoverable amounts. An impairment loss on
long-lived intangible assets other than goodwill is recognized when the undiscounted
estimated future cash flows expected to result from the use of an asset are less than the
carrying amount of the asset. One or more impairment losses could adversely affect our
financial condition and results of operations.

Page 18 of 63

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In accordance with the Financial Accounting
Standards Board, or FASB, pronouncements under FASB 142 regarding goodwill and
intangible assets and under FASB 144 long-lived assets, we
have $79.9 million in goodwill and other intangible assets on our balance sheet of
which $64.1 million is goodwill, which we do not amortize related to the LAC and Helix
acquisitions.  We undergo an impairment
test each year. As a result of the significance of this goodwill amount, our results of operations and
financial position in future periods could be negatively impacted should one or more
impairments of goodwill occur.

We record our portion of the earnings
from our China JV in the Investment in Joint Venture line item of the balance sheet. This
item is a long-lived asset, and we evaluate it annually or more frequently as conditions
demand to evaluate for impairment. This asset could become impaired and our financial
statements would need to be adjusted to reflect this impairment. This could negatively impact our
financial results.

Potential changes in accounting
standards or new pronouncements might cause us to revise our financial disclosure in the future, which might
change the way analysts measure our business or financial performance.

Recently discovered accounting
irregularities in various industries have forced regulators and legislators to take a
renewed look at accounting practices, financial disclosures, companies relationships
with their independent auditors, stock option expensing and retirement plan practices. Because it is still unclear
what laws or regulations will develop, we cannot predict the ultimate impact of any future
changes in accounting regulations or practices in general with respect to public companies
or in our operations specifically.

If we fail to comply with
environmental regulations, our operations could be suspended.

We use hazardous chemicals in
producing our products. As a result, we are subject to a variety of local, state and
federal governmental regulations in Germany relating to the storage, discharge, handling,
emission, generation, manufacture and disposal of toxic or other hazardous substances used
to manufacture our products, compliance with which is expensive. Environmental claims
against us or our failure to comply with any present of future regulations could result
in:

| |  | the
assessment of damages or imposition of fines against us;
| | - | ------------------------------------------------------------

| |  | the
suspension of production of our products; or
| | - | ------------------------------------------------

| |  | the
cessation of our operations.
| | - | --------------------------------

New environmental regulations could
require us to acquire costly equipment or to incur other significant expenses to comply
with such regulations. Our failure to control the use or adequately restrict the discharge
of hazardous substances could subject us to future liabilities, which could negatively
impact our earnings and financial position.

We are dependent on third parties
to supply all raw materials and components used in our products. Any interruption or
failure by these suppliers to meet their obligations could have a material adverse effect
on our business, profitability and cash flows.

We rely on third-party suppliers to
provide all raw materials and components for our products. Any interruption or failure by
these suppliers, distributors and collaboration partners to meet their obligations in a
timely manner, as well as any increases in the cost of their components or lapses in
quality, could have a material adverse effect on our business, financial condition,
profitability and cash flows.

The success of any future
acquisitions are subject to uncertainty and any completed acquisitions may reduce our
earnings, be difficult to integrate, not perform as expected or require us to obtain
additional financing.

We evaluate selective possible
acquisitions that we believe to be consistent with our strategy and core competencies.
Such acquisitions may be carried out through the purchase of assets, joint ventures,
licenses or by acquiring other companies. However, we cannot assure you that we will be
able to complete acquisitions on satisfactory terms, if at all. In particular, we may not
be able to identify suitable acquisition candidates, and we may have to compete for
acquisition candidates. Our competitors may have greater resources than us and therefore
be better able to complete acquisitions or may cause the ultimate price we pay for
acquisitions to increase. If we fail to achieve our acquisition goals, our growth may be
limited.

Page 19 of 63

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Acquisitions may expose us to
additional risks and may have a material adverse effect on our profitability and cash
flows. Any acquisitions we make may:

| |  | fail
to accomplish our strategic objectives;
| | - | --------------------------------------------

| |  | not
be successfully combined with our operations; and
| | - | -----------------------------------------------------

| |  | not
perform as expected.
| | - | ------------------------

In addition, acquisitions could
initially decrease our income per share and add significant intangible assets and related
amortization charges. Our acquisition strategy may require us to obtain additional debt or
equity financing, resulting in leverage, or increased debt obligations as compared to
equity, and dilution of ownership. We may not be able to finance acquisitions on terms
satisfactory to us.

The loss of key personnel could
adversely affect our ability to manage our business.

Our future success will depend
largely upon the continued services of our executive officers and certain other key
employees. The loss of the services of one or more of the executive officers or other key
employees could materially adversely affect our business. We do not have key-man life
insurance on any of our executive officers or other key employees. Our future success will
depend in part upon our ability to attract and retain additional qualified managers,
engineers and other employees. Our business, operating results, financial condition or
growth could be materially adversely affected if we were unable to attract, hire,
assimilate, and train these employees in a timely manner.

# Risks Related to our
Common Stock

# Our stock price may
fluctuate significantly.

The market price of our common stock
has been, and we expect will continue to be, subject to significant fluctuations. Factors
affecting our market price include:

| |  | the
limited number of shares of common stock available for purchase or sale in the public
markets;
| | - | --------------------------------------------------------------------------------------------------

| |  | quarterly
variations in our results of operations;
| | - | --------------------------------------------------

| |  | failure
to meet earnings estimates;
| | - | -----------------------------------

| |  | changes
in earnings estimates or buy/sell recommendations by analysts;
| | - | ----------------------------------------------------------------------

| |  | the
operating and stock price performance of comparable companies;
| | - | ------------------------------------------------------------------

| |  | developments
in the financial markets;
| | - | --------------------------------------

| |  | the
  announcement  of  new  products  or  product   enhancements  or  business   results  by
 us  or  our          competitors; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------

| |  | general
market conditions or market conditions specific to the industries in which we operate.
| | - | ----------------------------------------------------------------------------------------------

Recent stock prices for many
technology companies have fluctuated in ways unrelated or disproportionate to the
operating performance of the companies. Those fluctuations and general economic, political
and market conditions, such as recessions or international currency fluctuations, may
adversely affect the market price of our common stock.

Future sales of our common stock
may cause our stock price to decline.

All of our outstanding shares of
common stock, other than shares owned by affiliates and Helix Technology, Inc., are freely
tradeable without restriction or further registration. Affiliates and Helix Technology,
Inc. must comply with the volume and other requirements of Rule 144, except for the
holding period requirements, in the sale of their shares. Sales of substantial amounts of
common stock by our stockholders, including shares issued upon the exercise of outstanding
options and warrants, or even the potential for such sales, may have a depressive effect
on the market price of our common stock and could impair our ability to raise capital
through the sale of our equity securities.

Page 20 of 63

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Some anti-takeover provisions may
affect the price of our common stock.

Our articles of incorporation and
bylaws contain various provisions, including notice provisions, provisions for staggered
terms of office of the board of directors, fair price provisions, and provisions
authorizing us to issue preferred stock. These provisions may make it more difficult for a
third-party to acquire, or may discourage acquisition bids for, our company. Such
provisions could limit the price that certain investors would be willing to pay in the
future for shares of our common stock.

We may issue additional shares and
dilute your ownership percentage.

Some events over which you have no
control could result in the issuance of additional shares of our common stock, which would
dilute the ownership percentage of holders of our common stock. We may issue additional
shares of common stock or preferred stock:

| |  | to
raise additional capital or finance acquisitions;
| | - | ----------------------------------------------------

| |  | upon
the exercise or conversion  of  outstanding  options,  warrants and shares of
 convertible  preferred          stock; and/or
| | - | ---------------------------------------------------------------------------------------------------------------------------------

| |  | in
lieu of cash payment of dividends.
| | - | -------------------------------------

In addition, the rights of holders of
common stock may be adversely affected by the rights of holders of any preferred stock
that may be issued in the future that would be senior to the rights of the holders of the
common stock.

# PART II

# ITEM 5: Market for
Registrants Common Stock Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our common stock has been traded on
the NASDAQ National Market under the symbol AFCO since November 21, 1997. The
following table sets forth, for the quarters indicated, the high and low sale prices per
share of our common stock as reported on the NASDAQ National Market.

|                                          | High | Low
|----------------------------------------- | ---- | ---
|Fiscal 2002:                              |      |    
|First Quarter                             |      |    
|Second Quarter                            |      |    
|Third Quarter                             |      |    
|Fourth Quarter                            |      |    
|Fiscal 2003:                              |      |    
|First Quarter                             |      |    
|Second Quarter                            |      |    
|Third Quarter                             |      |    
|Fourth Quarter                            |      |    
|Fiscal 2004:                              |      |    
|First Quarter                             |      |    
|Second Quarter                            |      |    
|Third Quarter                             |      |    
|Fourth Quarter                            |      |    
|Fiscal 2005:                              |      |    
|First Quarter (through September 2, 2004) |      |    

On September 2, 2004, the last reported
sale price of our common stock on the NASDAQ National Market was $19.78 per share, and
there were approximately 40 stockholders of record of the common stock. We estimate that
there are approximately 6,654 beneficial owners of the common stock.

On June 1, 2004, we issued 80,826
unregistered shares of our common stock to Helix Technology, Inc. as part of the purchase
price for the In-line Systems division of Helix Technology, Inc., Taiwan.  We relied on
Section 4(2) of the Securities Act of 1933, as amended, for transactions by an
issuer not involving any public offering.

Information required by this item
regarding equity compensation plans is addressed in Item 12 of Part III of this report.

Page 21 of 63

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# ITEM 6: Selected
Consolidated Financial Data

The following selected consolidated
financial data should be read in conjunction with the consolidated financial statements
and related notes, and Managements Discussion and Analysis of Financial
Condition and Results of Operations included elsewhere in this annual report on Form
10-K. The consolidated statement of operations data for the years ended June 26, 2004,
June 28, 2003, and June 29, 2002, and the consolidated balance sheet data as of June 26,
2004 and June 28, 2003, have been derived from audited consolidated financial statements
included elsewhere in this annual report on Form 10-K. The consolidated statement of
operations data for the years ended June 30, 2001 and July 1, 2000, and the consolidated
balance sheet data as of June 29, 2002, June 30, 2001, and July 1, 2000, have been derived
from audited consolidated financial statements not included in this annual report on Form
10-K. The historical results presented below are not necessarily indicative of future
results.

The amounts below have been adjusted
to show the operating results of our Longmont coatings division, which was sold on
September 24, 2002, and the Hong Kong Coated Glass division which was sold on September
26, 2003, as discontinued operations.

|                                                                | Fiscal Year Ended                   
|--------------------------------------------------------------- | ------------------------------------
|                                                                |                                     
|                                                                |                                     
|                                                                |                                     
|Consolidated Statement of Operations Data:                      | (in thousands except per share data)
|Net revenues                                                    |                                     
|Cost of goods sold                                              |                                     
|                                                                |                                     
|Gross profit                                                    |                                     
|Operating expenses:                                             |                                     
|Research and development                                        |                                     
|Selling, general and administrative                             |                                     
|In-process research and development                             |                                     
|Amortization of goodwill and other intangible assets            |                                     
|                                                                |                                     
|Income (loss) from operations                                   |                                     
|Other income (expense), net                                     |                                     
|Interest income (expense), net                                  |                                     
|Other income, net                                               |                                     
|Equity earnings of Joint Venture                                |                                     
|                                                                |                                     
|Income (loss) from continuing operations before income taxes    |                                     
|Income tax benefit (expense)                                    |                                     
|                                                                |                                     
|Income (loss) from continuing operations                        |                                     
|Discontinued operations:                                        |                                     
|Income (loss) from discontinued operations, net of tax          |                                     
|Gain on disposal of discontinued operations, net of tax         |                                     
|                                                                |                                     
|Discontinued operations, net of tax                             |                                     
|Cumulative effect of change in accounting principle, net of tax |                                     
|Net income (loss)                                               |                                     
|Preferred stock dividends                                       |                                     
|                                                                |                                     
|Net income (loss) applicable to common stockholders             |                                     
|                                                                |                                     
|Income (loss) per share:                                        |                                     
|Basic:                                                          |                                     
|Income (loss) from continuing operations                        |                                     
|Income (loss) from discontinued operations                      |                                     
|Cumulative effect of change in accounting principle, net of tax |                                     
|                                                                |                                     
|Basic income (loss) per share                                   |                                     
|                                                                |                                     
|Diluted:                                                        |                                     
|Income (loss) from continuing operations                        |                                     
|Income (loss) from discontinued operations                      |                                     
|Cumulative effect of change in accounting principle, net of tax |                                     
|                                                                |                                     
|Diluted income (loss) per share                                 |                                     
|                                                                |                                     
|Weighted average common shares outstanding:                     |                                     
|Basic                                                           |                                     
|Diluted                                                         |                                     

Page 22 of 63

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|                                                   | Fiscal Year Ended
|-------------------------------------------------- | -----------------
|                                                   |                  
|                                                   |                  
|                                                   |                  
|                                                   | (in thousands)   
|Consolidated Balance Sheet Data:                   |                  
|Cash, cash equivalents and marketable securities . |                  
|Restricted cash(1)                                 |                  
|Working capital                                    |                  
|Total assets                                       |                  
|Long-term debt, net of current portion             |                  
|Total stockholders' equity                         |                  

|1) | Restricted cash represents cash that is pledged to provide bank guarantys
          on cash deposits for contracts with certain customers.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------

Page 23 of 63

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# ITEM 7:  Management's
Discussion and Analysis of Financial Condition and Results of Operation

# Overview

We are a leading provider of thin
film deposition equipment to diverse markets such as the flat panel display, the
architectural and solar glass, and the consumer products packaging and
electronics industries. Our deposition systems are used to deposit thin films that enhance
the characteristics of a base substrate, such as glass, plastic, paper or foil. These thin
films provide conductive, electronic, reflective, filter, barrier and other properties
that are critical elements of our customers products. Our thin film deposition
systems provide our customers with high yield and throughput, flexible modular
configurations, and innovative coating and process technologies.

We have exited the contract coated
glass business over the last six years. Beginning in fiscal 1999, we moved the majority of
our production of coated glass from Longmont to our China JV. Because of the 50%-50%
ownership structure of our China JV, the revenues and expenses of our China JV are not
consolidated and do not appear as revenues and expenses in our financial statements. Our
50% portion of the China JV net income is reported as Equity earnings of joint
venture in our consolidated statements of operations. In September 2002, we
sold our Longmont coatings division, which included certain assets related to our contract
glass coating business, to Optera, Inc. In September 2003, we sold our coated glass sales
business located in Hong Kong to NSG. The financial statements for the prior periods have
been restated to reflect the effect of the sale of those businesses and the results have
been included as discontinued operations.

Over the last four years we have
enhanced our position as a market leading manufacturer of thin film deposition equipment.
In December 2000, we completed the acquisition of the LAC business of Unaxis which
improved our position in FPD and enabled our entry into additional markets.

In June 2004, we completed the
acquisition of the In-Line Systems division of Helix Technology, Inc. in Taiwan. The
acquisition provided us with an additional 32 people who are familiar with our products,
as well as a facility that will serve as our Asian manufacturing base, where we expect to
manufacture some of our display systems beginning late in fiscal 2005. We believe
manufacturing in Taiwan will allow us to reduce our manufacturing and shipping costs and
reduce the transit time for systems sold to our customers in Asia. The addition of
technical personnel in Asia will also enhance our customer service.

Revenues for our thin film deposition
equipment are generally recognized using the percentage-of-completion method of
accounting, measured by the percentage of the total costs incurred in relation to the
estimated total costs to be incurred for each contract. We operate with a certain amount
of unrecognized revenue, which we refer to as backlog, on our contracts in progress.
Customers usually make progress payments during the term of the contract. We usually
receive approximately 80% to 85% of the purchase price in cash or letter of credit prior
to shipment. Our average manufacturing lead-time is between nine and twelve months.

Backlog was $41.1 million at the end
of fiscal 2002, $100.6 million at the end of fiscal 2003 and $73.6 million at the end
of fiscal 2004.

Export revenues generated from
customers outside of Europe were 70% in fiscal 2003 compared to 81% for fiscal 2004. Since
the Helix acquisition closed in June 2004, no revenues were generated from our facility in
Taiwan. Sales of our systems and backlog are denominated in Euros and, unless hedged, are
subject to fluctuation changes in the valuation of the foreign currencies against the
dollar. Should we engage in a sales contract other than denominated in Euros, we will usually enter into
currency hedging transactions to mitigate our foreign exchange exposure for the duration
of the contract. The effects of foreign exchange rate changes on non-Euro denominated
contracts have not been significant to date.

Net revenues in Euros reported in equivalent
U.S. dollars were approximately $138.4 million for fiscal 2003 and
$216.7 million for fiscal 2004. As of June 26, 2004, the U.S. dollar
equivalent of accounts receivable denominated in Euros was approximately
$14.0 million, or approximately 79%, of total accounts receivable. As of
June 26, 2004, the U.S. dollar equivalent of accounts payable denominated in
Euros was approximately $22.2 million, or approximately 95%, of total accounts
payable.

Page 24 of 63

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# Results of Operations

The following table sets forth
information derived from the respective consolidated statements of operations expressed as
a percentage of net revenues for the periods indicated.

The amounts below have been adjusted
to show the operating results of our coated glass divisions in Longmont and Hong Kong that
were sold as discontinued operations.

|                                                               | Fiscal year ended
|-------------------------------------------------------------- | -----------------
|                                                               |                  
|                                                               |                  
|                                                               |                  
|Consolidated Statement of Operations Data:                     |                  
|Net revenues                                                   |                  
|Cost of goods sold                                             |                  
|                                                               |                  
|Gross profit                                                   |                  
|Operating expenses:                                            |                  
|Research and development                                       |                  
|Selling, general and administrative                            |                  
|In-process research and development                            |                  
|Amortization of goodwill and other intangible assets           |                  
|                                                               |                  
|Operating income (loss)                                        |                  
|Interest income, net                                           |                  
|Other income, net                                              |                  
|Equity earnings of joint venture                               |                  
|                                                               |                  
|Income (loss) from continuing operations before income taxes . |                  
|Income tax expense                                             |                  
|                                                               |                  
|Income (loss) from continuing operations                       |                  
|Discontinued operations:                                       |                  
|Gain (loss) from discontinued operations, net of tax           |                  
|Gain on disposal of discontinued operations, net of tax        |                  
|                                                               |                  
|Discontinued operations, net of tax                            |                  
|Net income (loss)                                              |                  
|Preferred stock dividends                                      |                  
|                                                               |                  
|Net income (loss) applicable to common shareholders            |                  
|                                                               |                  

# Year Ended June 28, 2003
Compared to Year Ended June 26, 2004

The following table presents certain
key highlights and the percentage change from the results of operations for the fiscal
years ended June 28, 2003 and June 26, 2004.

|                                               | Fiscal year ended
|---------------------------------------------- | -----------------
|                                               |                  
|                                               |                  
|                                               |                  
|                                               |                  
|Net revenues                                   |                  
|Gross profit                                   |                  
|Research and development                       |                  
|Selling, general and administrative expenses . |                  
|Amortization of other intangible assets        |                  
|In-process research and development            |                  
|Interest income, net                           |                  
|Other income, net                              |                  
|Equity earnings of joint venture               |                  
|Income tax expense                             |                  
|Backlog                                        |                  

Net Revenues.The 54.2%
increase in net revenues reflects revenue from record levels of FPD related order activity
including equipment orders for Generation 4, 5, 6 and 7 substrate sizes during fiscal 2004
compared with strong equipment order activity for Generation 4 and 5 substrate sizes from FPD
customers during fiscal 2003. We began fiscal year 2004 with a strong backlog of our
architectural glass deposition equipment. Our backlog of $73.6 million
at the end of fiscal 2004 was down compared to our $100.6 million in backlog at the
end of fiscal 2003 primarily due to fewer orders in the fourth quarter of fiscal 2004 for
our display equipment.

Page 25 of 63

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Gross Profit.The 69.1%
increase in gross profits in fiscal 2004 compared to fiscal 2003 was due primarily to the
growth in revenues and the ability for better fixed cost absorption. Gross margins
increased from 24.2% in fiscal 2003 to 26.5% in fiscal 2004 driven by our product mix and
by the implementation of our cost reduction strategies throughout all of our products.

In Process Research and
Development.During the fiscal year ended June 26, 2004, we recorded a $2.2
million non-recurring charge to write-off in-process research and development (IPR&D)
costs attributed to the acquisition of the In-Line Systems division of Helix Technology,
Inc., Taiwan (the In-line Division). Several projects were included, of which
the principal projects were based on the following technologies: transparent conductive
coating on glass substrate for touch panel displays, a display machine for application in
glass using 1100 x 1200 mm substrates, an anti-reflective coating system for display,
and a high precision plate with low
thermal expansion and high compression resistance.

The allocation of the purchase price,
including the valuation of the IPR&D, will undergo an independent assessment to
validate the carrying value and to assess the reasonableness of the IPR&D charge of
$2.2 million that was taken in the fourth quarter of fiscal 2004. The Company
anticipates this assessment to be completed by the end of fiscal year 2005.

The following table discloses the
complete IPR&D percentage, the estimated value and the
estimated completion date of each project at the June 2, 2004 acquisition date (dollars in
thousands):

|Projects            | % Complete at
 Acquisition | Estimated Value | Estimated Completion
   date at time of
     Acquisition
|------------------- | -------------------------- | --------------- | --------------------------------------------------------
|                    |                            |                 |                                                         
|Touch Panel Coating |                            |                 |                                                         
|Project ZH1300      |                            |                 |                                                         
|4G AR Coater        |                            |                 |                                                         
|Ceramic Heaters     |                            |                 |                                                         
|                    |                            |                 |                                                         
|Total               |                            |                 |                                                         
|                    |                            |                 |                                                         

The estimates used in valuing
IPR&D were based upon assumptions we believe to be reasonable, but  are inherently
uncertain and unpredictable. Risks and uncertainties associated with completing
development within a reasonable period of time include the completion of all planning,
designing and testing activities that are necessary to create a product that provides the
functions, features and technical performance requirements suited for the market and
requested by our customers. Actual results may vary from potential results. In analyzing
the IPR&D acquired, we will explore the technologies listed above for further
development and potential integration in our current product offerings. However, it is
unlikely that we would continue to market the Helix products as they are either not
compatible with our current market focus or they are products similar to those we
currently market.

Research and Development.Research and development expenses grew 38.2% in fiscal 2004 compared to fiscal 2003.
Our research and development efforts were concentrated during the fiscal year on FPD
related products targeted towards larger glass sizes, including Generation 6 and 7 glass
sizes and the development of our recently introduced TRITON system. Research and
development expenses consist primarily of salaries, outside contractors, lab, and other
expenses related to our ongoing product and technology initiatives. As a percentage of net
revenues and due to the growth in revenues, research and development expenses declined to
7.3% in fiscal 2004 from 8.2% in fiscal 2003.

Selling, General and
Administrative.Selling, general and administrative expenses increased 15.8% in fiscal
2004, as we experienced cost increases related to directors & officers insurance,
compensation costs, professional fees related to compliance with the Sarbanes-Oxley Act,
as well as, additional costs absorbed for the Taiwan employees while they are in their
initial training period. However, as a result of the increased sales revenue, selling,
general and administrative expenses as a percentage of net revenues declined from 16.2% in fiscal
2003 to 12.2% in fiscal 2004.

Amortization of Other Intangible
Assets.In the fiscal year ended June 26, 2004, amortization of other intangible
assets related to our acquisitions was $4.3 million compared to $3.8 million in
the prior fiscal year. The majority of this increase was currency related due to the
strength of the Euro compared to the U.S. dollar. The intangible assets are carried on the
balance sheets of our German and Taiwan subsidiaries and the ongoing amortization will
fluctuate based on the strength of the Euro and the New Taiwan dollar compared to the U.S.
dollar. In June 2004, we completed the Helix acquisition in Taiwan. As a result of that
acquisition we have increased our intangible asset balances related to the patents and
customer lists that were acquired in the transaction. The patents will be amortized over
seven years and the customer lists will be amortized over five years. We expect the
amortization of other intangible assets to increase in the future to include these
charges.

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Interest Income, Net.At the
end of fiscal 2004, our average annual investment yield was 1.7% compared to 2.4% at the
end of fiscal 2003. We earned a net $2.1 million on our invested cash in fiscal 2004
compared to $2.0 million in fiscal 2003. The $2.1 million in fiscal 2004
includes a negative mark-to-market adjustment of $434,000 through April 20, 2004. In the
fourth quarter of fiscal 2004, we changed the accounting designation for our investment
securities from trading securities to securities held for sale. We
had an unrealized loss, net of tax, of $429,000, that was recorded in other comprehensive
income for fiscal year 2004. In the future in accordance with SFAS 115, only realized
income from investments will be reported in the statement of operations and all unrealized
gains and losses will be reported in other comprehensive income in the equity section of
the balance sheet. Although the annual yield was significantly reduced, net interest
income increased as a result of the investment of cash that was raised during a follow-on
offering of additional common stock in October 2003.

Other Income, Net.Net other
income includes items such as realized foreign currency transaction adjustments and an
approximate 1.0% royalty on our China JV sales. The majority of the increase was related
to an increase in realized foreign currency translation gains compared to the prior year.
During the fiscal year, the China JV renegotiated the terms of their line of credit, after
which our corporate guaranty was no longer required. The cash balance in Euros that was
used to secure the guaranty was released, and was repatriated to the U.S. We realized a
gain on the transaction.

Equity earnings of Joint Venture.The 59.7% increase in equity earnings was primarily due to the increase in the demand
for color STN glass supplied by the China JV to the market for cellular telephones with
color displays.

Income Tax Expense.The income
tax expense reflects the tax effect of the earnings of each operating subsidiary and their
respective tax rates. The income tax expense for fiscal 2004 increased as we reported
record net income during the fiscal year. Additionally, we recorded a valuation allowance
against a portion of the deferred tax asset because we believe it is more likely than not that a portion of  the
deferred tax asset will not be realized. There are several items which lower our effective
tax rates in some of the countries in which we operate, such as the tax effect of the
amortization of goodwill and other intangible assets in Germany, tax-free investment and
interest income in the U.S., and equity earnings of our China JV which are reported as tax
free because the earnings will be permanently reinvested in our China JV. We are also
applying for a tax holiday status in Taiwan related to our subsidiary corporation that was
formed to complete the Helix acquisition. Our effective tax rate for fiscal 2004 was 37.0%
compared to 55.0% for fiscal 2003.

Discontinued
Operations.On September 26, 2003, we sold our Hong Kong coated
glass business to NSG for $1.35 million in cash and a note receivable. We accounted for
the sale as a discontinuance of business and our financial statements have been restated
to reflect our business without the results of our Hong Kong coated glass business. The
$418,000 loss from discontinued operations reflected the operating results of that
discontinued business of $4,000 from June 29, 2003 through
September 26, 2003 combined with the settlement paid to Optera, Inc. of $650,000
net of $228,000 for taxes. The $783,000 gain was the after tax gain on the sale of assets
related to discontinued operations.

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# Year Ended June 29, 2002
Compared to Year Ended June 28, 2003

The following table presents certain
key highlights from the results of operations for the fiscal years ended June 29, 2002 and
June 28, 2003.

|                                             | Fiscal year ended
|-------------------------------------------- | -----------------
|                                             |                  
|                                             |                  
|                                             |                  
|                                             |                  
|Net revenues                                 |                  
|Gross profit                                 |                  
|Research and development                     |                  
|Selling, general and administrative expenses |                  
|Amortization of other intangible assets      |                  
|Interest income, net                         |                  
|Other income, net                            |                  
|Equity earnings of joint venture             |                  
|Income tax expense                           |                  
|Backlog                                      |                  

Net Revenues.This increase
reflects orders from Taiwanese display customers during fiscal 2003 compared with no order
activity from Taiwan during fiscal 2002. We had strong orders and increased revenues from
our architectural glass customers during fiscal 2003 which led to an increase in equipment
backlog from $41.1 million at the end of fiscal 2002 to $100.6 million at the end of
fiscal 2003.

Gross Profit.The increase in
gross profits was due primarily to the revenue growth as gross margins were 23.7% in both
fiscal 2002 and fiscal 2003.

Research and Development.In
fiscal 2003, growth in research and development for FPD related products was driven by the
development efforts targeted towards larger glass sizes, including generation 6 and 7
glass sizes. Research and development expenses consist primarily of salaries, outside
contractor, lab, and other expenses related to our ongoing product and technology
development for FPD, OLED, solar, and plastic bottle processes and other research and
development programs. As a percentage of net revenues, research and development expenses
were 7.1% in fiscal 2002 and 8.2% in fiscal 2003.

Selling, General and
Administrative.As a result of cost management initiatives introduced in fiscal 2003,
selling, general and administrative expenses increased only 2.4% in fiscal 2003. As a
percentage of net revenues, selling, general and administrative expenses declined from
18.1% in fiscal 2002 to 16.2% in fiscal 2003.

Amortization of Other Intangible
Assets.In the fiscal year ended June 29, 2002, amortization of other intangible
assets related to the LAC acquisition was $3.4 million. In the fiscal year ended
June 28, 2003, amortization of other intangible assets was $3.8 million.
The increase in amortization of other intangible assets was due to the currency
fluctuation between the U.S. dollar and the Euro. The intangible assets are carried on the
balance sheet of our German subsidiary and the strength of the Euro during fiscal 2003
increased this amortization amount as it is reported in U.S. dollars.

Interest Income, Net.At the
end of fiscal 2002, our average investment yield was 2.6% compared to 2.4% at the end of
fiscal 2003. The increase in net interest income resulted from excess cash that was
invested after the equity offering which closed in November 2001. This excess cash was
invested for only part of the fiscal 2002 year as compared to a full year of investment in
fiscal 2003.

Other Income, Net.Net other
income includes items such as realized foreign currency transaction adjustments and
royalties earned from our China JV. We receive an approximate 1.0% royalty on all sales by
our China JV, payable quarterly. In fiscal 2002, $762,000 was reported for the reversal of
unused reserves for the completion of the building in Alzenau, Germany. In fiscal 2003,
net other income resulted primarily from realized currency translation.

Equity earnings of Joint Venture.The increase in equity earnings was primarily due to increased demand for cellular
telephones with color displays.

Income Tax Expense.The income
tax expense reflects the tax effect of the earnings of each operating subsidiary and their
respective tax rates. The income tax expense for fiscal 2003 was increased by a valuation
allowance against a portion of the deferred tax asset because we believe it is more likely than not
that a portion of the deferred tax asset will not be realized. There are several items which lower our
effective tax rates in some of the countries in which we operate, such as the tax effect
of the amortization of goodwill and other intangible assets in Germany, tax-free
investment and interest income in the U.S., and equity earnings of our China JV which are
reported as tax free because the earnings will be permanently reinvested in our China JV
as a permanent investment.

Page 28 of 63

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Discontinued
Operations.  On September 24, 2002, we sold our Longmont coatings division
to Optera, Inc. for $5.2 million in cash. We accounted for the sale as a discontinuance of
business and our financial statements have been restated to reflect our business without
the results of our Longmont coatings division. The $85,000 loss reflected the operating
results of that business for June 30, 2002 through September 24, 2002. The $429,000 gain
reflected the after tax gain on the sale of assets related to discontinued operations.

# Quarterly Results of
Operations

The following table sets forth
summary unaudited quarterly financial information for the eight fiscal quarters ended
June 26, 2004. In the opinion of management, such information has been prepared
on the same basis as the audited financial statements appearing elsewhere in this report
and reflects all necessary adjustments (consisting of only normal recurring adjustments)
necessary for a fair presentation of unaudited quarterly results when read in conjunction
with the audited financial statements and notes thereto. The operating results for any
quarter are not necessarily indicative of results for any future period and any trends
reflected in such results may not continue in the future. Our results of operations may be
subject to significant quarterly variations.

The amounts below have been adjusted
to show the operating results of our Longmont and Hong Kong coated glass divisions, which
were sold on September 24, 2002 and September 26, 2003, respectively, as discontinued
operations.

|                                                | Fiscal 2003 Quarters Ended            | Fiscal 2004 Quarters Ended
|----------------------------------------------- | ------------------------------------- | --------------------------
|                                                |                                       |                           
|                                                |                                       |                           
|                                                |                                       |                           
|                                                | (in thousands, except per share data)
|Net revenues                                    |                                       |                           
|Cost of goods sold                              |                                       |                           
|                                                |                                       |                           
|Gross profit                                    |                                       |                           
|Operating expenses:                             |                                       |                           
|Research and development                        |                                       |                           
|Selling, general and administrative             |                                       |                           
|In process research and development             |                                       |                           
|Amortization of other intangible assets         |                                       |                           
|                                                |                                       |                           
|Income (loss) from operations                   |                                       |                           
|Other income, net:                              |                                       |                           
|Interest income, net                            |                                       |                           
|Other income, net                               |                                       |                           
|Equity earnings of Joint Venture                |                                       |                           
|                                                |                                       |                           
|Income (loss) from continuing operations before |                                       |                           
|income taxes                                    |                                       |                           
|Income tax benefit (expense)                    |                                       |                           
|                                                |                                       |                           
|Income (loss) from continuing operations        |                                       |                           
|Discontinued operations:                        |                                       |                           
|Income (loss) from discontinued operations,     |                                       |                           
|net of tax                                      |                                       |                           
|Gain on the disposal of discontinued            |                                       |                           
|operations, net of tax                          |                                       |                           
|                                                |                                       |                           
|Discontinued operations, net of tax             |                                       |                           
|                                                |                                       |                           
|Net income (loss)                               |                                       |                           
|                                                |                                       |                           
|Income (loss) per share:                        |                                       |                           
|Basic:                                          |                                       |                           
|Basic income (loss) from continuing operations  |                                       |                           
|Income (loss) from discontinued operations      |                                       |                           
|                                                |                                       |                           
|Basic income (loss) per share                   |                                       |                           
|                                                |                                       |                           
|Diluted:                                        |                                       |                           
|Diluted income (loss) from continuing           |                                       |                           
|operations                                      |                                       |                           
|Income (loss) from discontinued operations      |                                       |                           
|                                                |                                       |                           
|Diluted income (loss) per share                 |                                       |                           
|                                                |                                       |                           
|Weighted average common shares outstanding:     |                                       |                           
|Basic                                           |                                       |                           
|                                                |                                       |                           
|Diluted                                         |                                       |                           
|                                                |                                       |                           

Page 29 of 63

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The following table sets forth the
above unaudited information as a percentage of net revenues.

The amounts below have been adjusted
to show the operating results of our Longmont and Hong Kong coated glass division, which
was sold on September 24, 2002 and September 26, 2003 respectively, as discontinued
operations.

|                               | Fiscal 2003 Quarters Ended | Fiscal 2004 Quarters Ended
|------------------------------ | -------------------------- | --------------------------
|                               |                            |                           
|                               |                            |                           
|                               |                            |                           
|Net revenues                   |                            |                           
|Cost of goods sold             |                            |                           
|                               |                            |                           
|Gross profit                   |                            |                           
|Operating expense:             |                            |                           
|Research and development       |                            |                           
|Selling, general and           |                            |                           
|administrative                 |                            |                           
|In process research and        |                            |                           
|development                    |                            |                           
|Amortization of other          |                            |                           
|intangible assets              |                            |                           
|                               |                            |                           
|Operating income (loss)        |                            |                           
|Other (expense) income, net:   |                            |                           
|Interest income (expense), net |                            |                           
|Other income, net              |                            |                           
|Equity earnings of Joint       |                            |                           
|Venture                        |                            |                           
|                               |                            |                           
|Income (loss) from continuing  |                            |                           
|operations before income taxes |                            |                           
|Income tax benefit (expense)   |                            |                           
|                               |                            |                           
|Net income (loss) from         |                            |                           
|continuing operations          |                            |                           
|                               |                            |                           

Our quarterly results of operations
may be subject to significant fluctuations due to several factors, including the timing of
orders, manufacturing and customer budget cycles, Chinese New Year Holidays in Asia,
German summer vacation scheduling, and general economic conditions as they affect the industries
which use our products. The volume of equipment sales is significantly dependent on our
customers capital spending patterns.

During fiscal 2003, we experienced a
strong flow of orders for our systems across all of our product lines, but specifically
orders for our New Aristo system for the FPD market and our Terra-G system for the
architectural glass market which delivered a balance of revenue across our product areas and
provided the momentum that resulted in growth in backlog to record levels of
$100.6 million at the end of fiscal 2003 from $41.1 million at the end of fiscal
2002, and growth in revenues to a high of $49.7 million in the fourth quarter of
fiscal 2003 up 98.1% from the $25.1 million recognized in the first quarter of fiscal
2003.

During fiscal 2004, we began the
fiscal year with record backlog of $100.6 million and we recorded strong orders
across all of our product lines. We experienced a record order volume for our New Aristo
system for the FPD market during the second and third fiscal quarters. Our web coater
products recorded consistent orders throughout the year while orders for our Terra-G glass
coating platform were lower than the prior year as we experienced two quarters with no
bookings, and we worked through the backlog from the prior year. As the volume of display
orders decreased during the fourth quarter, we ended fiscal year 2004 with a backlog of
$73.6 million down 26.9% from the $100.6 million in backlog at the end of fiscal 2003.
Following the first fiscal quarter of fiscal 2004, we recorded three consecutive record
revenue quarters growing by 37.7% from $47.7 million in the first fiscal quarter to
$65.5 million in the fourth fiscal quarter as bookings momentum in the FPD market led
to a record number of New Aristo systems being built in our factory.

During fiscal 2004, we reported
growth in gross profits setting new records each quarter consistent with the growth in
revenues. Gross margins increased to record levels as well driven by our product mix and by the
implementation of our cost reduction strategies throughout all of our products. In the FPD
market, we sold larger New Aristo systems to multiple customers for Generation 6 and
Generation 7 sized substrates.

Selling, general and administrative
expenses grew from fiscal 2003 through 2004 associated with the professional fees related
to the compliance of Sarbanes-Oxley Section 404, increased premiums for Directors and
Officers insurance, as well as other compensation related expenses. Our selling, general
and administrative rose to $8.2 million in the fourth quarter of fiscal 2004. We
expect that a portion of the growth in selling, general and administrative costs
experienced in the fourth fiscal quarter resulted from one time charges that should not
reoccur. However, we believe that with the permanent inclusion of the costs associated
with the compliance with Sarbanes-Oxley Section 404, we will not return to the lower
selling, general and administrative levels we reported prior to the fourth quarter of fiscal 2004.

Page 30 of 63

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Our focus on flat panel display drove
our increase in research and development. With the FPD industry roll out of Generation 6 and 7 glass
sizes, we have invested in upsizing our New Aristo system to handle these larger
glass sizes. We also invested in research and development for the development of our TRITON
system for the TFT array market. The TRITON system was introduced in June at the FPD show
in Taiwan. We continue to develop emerging technologies related to our OLED and solar
products.

# Critical Accounting
Policies and Estimates

Our discussion and analysis of our
financial condition and results of operations is based upon our financial statements,
which have been prepared in accordance with U.S. Generally Accepted Accounting Principles.
During preparation of these financial statements, we are required to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue and expenses.
On an on-going basis, we evaluate our estimates, including those related to project costs,
collections, product returns, bad debts, inventories, investments, fixed assets,
intangible assets, income taxes, pension benefits and contingencies. We base our estimates
on historical experience and on various other assumptions that we believe are reasonable
under the circumstances. The results form the basis of making judgments about the carrying
values of assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or conditions.

We believe the following critical
accounting policies affect our more significant judgments and estimates used in the
preparation of our financial statements. See also Item 8 Financial Statements and
Supplementary Data and Note 2: Significant Accounting Policies.

We recognize revenues on a majority
of contracts relating to the construction and sale of thin film deposition equipment using
the percentage-of-completion method in accordance with the American Institute of Certified
Public Accountants (AICPA) Statement of Position (SOP) No. 81-1,
Accounting for Performance of Construction-Type and Certain Production-Type
Contracts. Pursuant to SOP 81-1, revenues are measured by the percentage of the
total costs incurred and applied to date in relation to the estimated total costs to be
incurred for each contract. Our management considers costs incurred and applied to be the
best available measure of progress on these contracts. Contract costs include all direct
material and labor costs and those indirect costs related to contract performance.
General, administrative, selling and research and development costs are charged to expense
as incurred. Changes in performance, contract conditions and estimated profitability,
including those arising from contract penalty provisions and final contract settlements,
may result in revisions to costs and income and are recognized in the period in which the
revisions are determined.

We generally offer warranty coverage
for equipment sold for a one-year period after final installation is complete. We estimate
the anticipated costs to be incurred during the warranty period and accrue a reserve as a
percentage of revenue as revenue is recognized. In addition, specific reserves are
provided for known and anticipated problems. These reserves are evaluated periodically
based on actual experience and anticipated activity and are adjusted if necessary.

We maintain an allowance for doubtful
accounts for estimated losses resulting from the inability of our customers to make
required payments. We determine the adequacy of this allowance by regularly evaluating
individual customer receivables and considering a customers financial condition,
credit history, and current economic conditions. If the financial condition of our
customers were to deteriorate, additional allowances may be required.

In consolidation, the financial
results of our foreign subsidiaries are translated into U.S. dollars using the current
rate method. Assets and liabilities are translated at the period-end spot exchange rate,
revenues and expenses at average exchange rates and equity transactions at historical
exchange rates. Exchange differences arising on translation are recorded as a component of
other cumulative comprehensive income (loss).

We write down our inventory for
estimated obsolescence or unmarketable inventory equal to the difference between the cost
of inventory and the estimated market value based upon assumptions about future demand and
market conditions. If actual market conditions are less favorable than those projected by
management, additional inventory write-downs may be required.

We estimate our actual current tax
exposure together with the temporary differences that have resulted from the differing
treatment of items dictated by U.S. GAAP versus U.S. tax laws. These temporary differences
result in deferred tax assets and liabilities. On an on-going basis, we assess the
likelihood that our deferred tax assets will be recovered from future taxable income. If
we believe that the recovery were less likely, we establish a valuation allowance against
the deferred tax asset and charge the amount as an income tax expense in the period in
which such a determination is made.

Page 31 of 63

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# Liquidity and Capital
Resources

We have funded our operations with
cash balances, cash generated from operations, proceeds from public offerings of our
common stock and bank borrowings. Cash used in operating activities was $4.7 million for
fiscal 2002, $4.3 million for fiscal 2003 and $9.3 million for fiscal 2004. As
of June 26, 2004, we had cash and marketable securities of approximately
$152.7 million consisting of cash and cash equivalents of approximately
$16.0 million, restricted cash of approximately $2.1 million, and marketable
securities of $134.6 million. Total working capital was $189.3 million.

We have established a post closing
escrow account in accordance with the purchase and sale agreement with Helix Technology.
At June 26, 2004, we have $3.5 million remaining in the escrow account.

Capital expenditures were
$0.9 million for fiscal 2002, $1.4 million for fiscal 2003, and
$9.4 million for fiscal 2004. We anticipate capital expenditures of approximately
$5.5 million in fiscal 2005. Our capital
expenditures have consisted primarily of purchases and manufacturing of process equipment
related to product development. The increase in capital expenditures in 2004 is related to
the investment in larger size display lab equipment for the development of hardware and
process technologies for the FPD market and alpha and beta systems related to the
development of our TRITON system for TFT array.

Cash used for investing activities
was $50.6 million, $9.5 million and $104.7 million in fiscal 2002, 2003 and
2004, respectively. During fiscal 2002, 2003 and 2004, we had net purchases of marketable
securities of $40.2 million, $8.1 million and $82.3 million, respectively.
During fiscal year 2004, we completed the acquisition of Helix for approximately
$13.0 million cash and stock valued at $2.1 million.

Cash generated from financing
activities was $60.8 million, $3.0 million, and $100.2 million for fiscal
2002, fiscal 2003, and fiscal 2004, respectively. The fiscal 2004 increase is primarily due to the
cash raised of $94.0 million from the public offering of stock for 3,450,000 shares of
common stock at $28.75 per share, which closed in October of 2003.

We believe that our working capital
and operating needs will continue to be met by cash on hand, and cash from operations. Our
operating capital requirements depend on a number of factors, including the amount and
timing of orders we receive, the timing of payments received from customers, and capital
requirements associated with new product introductions. If we require additional capital,
we may consider various alternatives such as an additional bank financing or the public or
private sale of debt or equity securities. There can be no assurance that we will be able
to raise such funds on satisfactory terms if and when such funds are needed.

# Contractual Obligations
and Commercial Commitments

We have the following contractual
obligations and commercial commitments as of June 26, 2004 (in thousands):

|                             | Payments Due by Period
|---------------------------- | ----------------------
|                             |                       
|                             |                       
|                             |                       
|Contractual Cash Obligations |                       
|Operating leases:            |                       
|Buildings                    |                       
|Office equipment             |                       
|Other                        |                       
|                             |                       
|                             |                       
|                             |                       

|                                     | Amount of commitment expiration per period
|------------------------------------ | ------------------------------------------
|                                     |                                           
|                                     |                                           
|                                     |                                           
|Other Commercial Commitments         |                                           
|Bank guaranty                        |                                           
|Other commercial commitments         |                                           
|Escrow account for Helix acquisition |                                           
|                                     |                                           
|Total commercial commitments         |                                           
|                                     |                                           

There were no currency forward
contracts outstanding as of June 26, 2004.

Page 32 of 63

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Operating leases primarily include
leases for offices, factories and office equipment throughout our operations. The bank
guaranty represents progress payments made to the Company, primarily from customers in
China, deposited in a restricted account until the contract terms are fulfilled
and the guarantys required by the German government for custom duties on
imports received into Germany. Our other commercial commitments consist of software
licenses and third party service contracts.

# Recent Accounting
Standards

In January 2003, the Financial
Accounting Standards Board (FASB) issued Interpretation 46 (FIN 46), Consolidation
of Variable Interest Entities. FIN 46 requires an investor with a majority of the
variable interests in a variable interest entity to consolidate the entity and also
requires majority and significant variable interest investors to provide certain
disclosures. A variable interest entity is an entity in which the equity investors do not
have a controlling interest or the equity investment at risk is insufficient to finance
the entitys activities without receiving additional subordinated financial support
from the other parties. FIN 46 was effective for variable interest entities created after
January 31, 2003 and for older entities in the first reporting period beginning after June
15, 2003. We do not have any variable interest entities, and
have not created any variable interest entities.

# ITEM 7A: Quantitative
and Qualitative Disclosures about Market Risk

# Market Risk Exposure

Market risk represents the risk of
loss that may impact our financial position, results of operations or cash flows due to
adverse changes in financial market prices. Our exposure to market risk for changes in
interest rates relates primarily to our investment portfolio. We generally place our
investments with high credit quality issuers and by policy are averse to principal loss
and seek to protect and preserve our invested funds by limiting default risk, market risk
and reinvestment risk.

As of June 26, 2004, our investments
consisted primarily of equity securities, corporate, government and municipal bonds, money
market mutual funds and restricted cash of $2.1 million.  These investments earned approximately
$2.1 million for fiscal year 2004, at an average interest rate of approximately 1.7%.
The impact on interest income of a decrease of one percent in the average interest rate
would have resulted in a decline of approximately $1.1 million of interest income for
fiscal year 2004.

# Foreign Exchange Exposure

We are exposed to foreign exchange
risk associated with accounts receivable and payable denominated in foreign currencies. At
June 26, 2004, we had approximately $14.0 million of accounts receivable and
approximately $22.2 million of accounts payable denominated in Euros. A one percent
change in exchange rates would result in an approximate $81,000 net impact on pre-tax
income based on the foreign currency denominated accounts receivable and accounts payable
balances at June 26, 2004.

Sales of our products are denominated
primarily in Euros. Historically, we engaged in international currency hedging transactions to
mitigate our foreign exchange exposure related to sales of certain equipment, and the
effects of foreign exchange rate changes on foreign currency transactions. Currency
hedging transactions have not been significant to date.

Notwithstanding the above, actual
changes in interest rates and foreign exchange rates could adversely affect our operating
results or financial condition. The potential impact depends upon the magnitude of the
rate change. We are exposed to changes in interest rates and foreign currency exchange
rates primarily in our cash balance, foreign currency transactions and the operating
results of our foreign affiliates.

International manufacturing
operations are based in Germany and in the future will be expanded to
Taiwan.  These operations constitute a significant portion of our revenues
and identifiable assets. These identifiable assets are based in Euros in Germany  and
 are based in New Taiwan dollars in Taiwan. International operations result in a large volume
of foreign currency commitments and transactions and significant foreign currency net
asset exposures.

Page 33 of 63

---



Our cash position includes amounts
denominated in foreign currencies, primarily Euros. The repatriation of cash balances from
certain of our affiliates could have adverse consequences to the statement of operations
as well as adverse tax consequences. However, those balances are generally available
without legal restrictions to fund ordinary business operations, with the exception of
approximately $3.5 million which is in a post closing escrow account to be used for
the acquisition of Helix (Note 12), and with the exception of $5.9 million of
guarantys related to progress payments primarily from our customers in China and
custom duties for items received in Germany. The $5.9 million guaranty is comprised
of $2.1 million of pledged cash and $3.8 million which is pledged under a line
of credit. Our bank guaranty securing 50% of the China JV debt was released
in the third quarter of fiscal 2004.

Page 34 of 63

---



# FORWARD LOOKING
STATEMENTS

We have made forward looking
statements in this report and in the documents incorporated by reference into this
report within the meaning of Section 27A of the Securities Act and Section 21E
of the Securities Exchange Act of 1934, as amended. These statements, including estimates
of future net sales, future net income and future earnings per share, contained in the
section titled Managements Discussion and Analysis of Financial Condition and
Results of Operation, are subject to risks and uncertainties. Forward looking
statements include the information concerning our possible or assumed results of
operations. Also, statements including words such as believes,
expects, anticipates, intends, estimates,
or similar expressions are forward looking statements. We have based these forward looking
statements on our current expectations and projections about the growth of our business,
our financial performance and the development of our industry. Because these statements
reflect our current views concerning future events, these forward looking statements
involve risks and uncertainties. Investors should note that many factors, as more fully
described in Risk Factors, Managements Discussion and Analysis of
Financial Condition and Results of Operation, Business and elsewhere in
this report could affect our future financial results and could cause our actual results
to differ materially from those expressed in forward looking statements contained in this
report. Important factors that could cause our actual results to differ materially from
the expectations reflected in the forwarding looking statements in this report include,
among others:

| |  | insufficient
capital resources;
| | - | -------------------------------

| |  | adverse
economic conditions;
| | - | ----------------------------

| |  | unanticipated
difficulties in product development;
| | - | --------------------------------------------------

| |  | unexpected
changes in regulatory requirements;
| | - | ----------------------------------------------

| |  | foreign
currency fluctuations;
| | - | ------------------------------

| |  | failure
of our strategic partners to fulfill their obligations;
| | - | ---------------------------------------------------------------

| |  | our
ability to protect our proprietary technology; and
| | - | ------------------------------------------------------

| |  | unanticipated
changes in accounting policies.
| | - | ---------------------------------------------

We do not undertake any obligation to
update our forward looking statements after the date of this report for any reason, even
if new information becomes available or other events occur in the future.

Page 35 of 63

---



# ITEM 8: Financial
Statements and Supplementary Data

# Index To Consolidated
Financial Statements

|Applied Films
Corporation and Subsidiaries 
Consolidated Balance Sheets as of June 26, 2004 and June 28, 2003                                        
Consolidated Statements of Operations for the fiscal years ended June 26, 2004, June 28, 2003, and
     June 29, 2002                                                                                       
Consolidated Statements of Stockholders' Equity for the fiscal years ended June 26, 2004, June 28, 2003,
     and June 29, 2002                                                                                   
Consolidated Statements of Cash Flows for the fiscal years ended June 26, 2004, June 28, 2003, and
     June 29, 2002                                                                                       
Notes to Consolidated Financial Statements | Page38
39
40
41
42
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------

Page 36 of 63

---



# Report of Independent
Registered Public Accounting Firm

To the Board of Directors and
Stockholders of Applied Films Corporation:

We have audited the accompanying
consolidated balance sheets of Applied Films Corporation and subsidiaries as of June 26,
2004, and June 28, 2003, and the related consolidated statements of operations,
stockholders equity, and cash flows for each of the three years in the period ended
June 26, 2004. Our audits also included the financial statement schedule included in Item
15(a)2 for the fiscal years ended June 26, 2004, June 28, 2003, and June 29, 2002. These
financial statements and schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements
and schedule based on our audits.

We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the financial
statements referred to above present fairly, in all material respects, the consolidated
financial position of Applied Films Corporation and subsidiaries at June 26, 2004 and June
28, 2003, and the consolidated results of their operations and their cash flows for each
of the three years in the period ended June 26, 2004, in conformity with U.S. generally
accepted accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth therein.

/s/ ERNST & YOUNG
LLP

Denver, ColoradoSeptember 7, 2004

Page 37 of 63

---



Applied Films
Corporation and SubsidiariesConsolidated Balance
Sheets

|                                                                      | June 26, 2004 | June 28, 2003
|--------------------------------------------------------------------- | ------------- | -------------
|                                                                      |               |              
|ASSETS                                                                |               |              
|CURRENT ASSETS:                                                       |               |              
|Cash and cash equivalents                                             |               |              
|Restricted cash                                                       |               |              
|Marketable securities                                                 |               |              
|Accounts and trade notes receivable, net of                           |               |              
|allowance of $525 and $653, respectively                              |               |              
|Revenue in excess of billings                                         |               |              
|Inventories, net of allowance of $937 and $1,400, respectively        |               |              
|Prepaid expenses and other                                            |               |              
|Deferred tax asset                                                    |               |              
|Current assets associated with discontinued operations                |               |              
|                                                                      |               |              
|Total current assets                                                  |               |              
|                                                                      |               |              
|Property, plant and equipment, net of accumulated                     |               |              
|depreciation of $7,901 and $6,752, respectively                       |               |              
|Goodwill                                                              |               |              
|Intangible assets, net of accumulated amortization                    |               |              
|of $15,731 and $10,613, respectively                                  |               |              
|Investment in joint venture                                           |               |              
|Deferred tax asset, net                                               |               |              
|Restricted cash                                                       |               |              
|Other assets                                                          |               |              
|                                                                      |               |              
|Total assets                                                          |               |              
|                                                                      |               |              
|                                                                      |               |              
|LIABILITIES AND STOCKHOLDERS' EQUITY                                  |               |              
|CURRENT LIABILITIES:                                                  |               |              
|Trade accounts payable                                                |               |              
|Accrued expenses                                                      |               |              
|Billings in excess of revenue                                         |               |              
|Current portion of deferred gross profit, deferred gain and lease     |               |              
|obligation                                                            |               |              
|Deferred tax liability                                                |               |              
|Current liabilities associated with discontinued operations           |               |              
|                                                                      |               |              
|Total current liabilities                                             |               |              
|                                                                      |               |              
|Long-term portion deferred tax liability                              |               |              
|Long-term portion of gross profit, deferred gain and lease obligation |               |              
|Accrued pension benefit obligation                                    |               |              
|                                                                      |               |              
|Total liabilities                                                     |               |              
|                                                                      |               |              
|STOCKHOLDERS' EQUITY:                                                 |               |              
|Common stock, no par value, 40,000,000 shares authorized, 14,838,215  |               |              
|and 11,161,873 shares issued and outstanding                          |               |              
|at June 26, 2004, and June 28, 2003, respectively                     |               |              
|Warrants and stock options                                            |               |              
|Other cumulative comprehensive income                                 |               |              
|Retained earnings                                                     |               |              
|                                                                      |               |              
|Total stockholders' equity                                            |               |              
|                                                                      |               |              
|Total liabilities and stockholders' equity                            |               |              
|                                                                      |               |              

The
accompanying notes are an integral part of these Consolidated Financial Statements.

Page 38 of 63

---



Applied Films
Corporation and SubsidiariesConsolidated Statements
of Operations

|                                                               | For The Fiscal Years Ended           
|-------------------------------------------------------------- | -------------------------------------
|                                                               |                                      
|                                                               |                                      
|                                                               |                                      
|                                                               | (in thousands, except per share data)
|Net revenues                                                   |                                      
|Cost of goods sold                                             |                                      
|                                                               |                                      
|Gross profit                                                   |                                      
|                                                               |                                      
|Operating expenses:                                            |                                      
|Research and development                                       |                                      
|In-process research and development                            |                                      
|Selling, general and administrative                            |                                      
|Amortization of other intangible assets                        |                                      
|                                                               |                                      
|Income (loss) from operations                                  |                                      
|                                                               |                                      
|Other income, net:                                             |                                      
|Interest income, net                                           |                                      
|Other income, net                                              |                                      
|Equity earnings of joint venture                               |                                      
|                                                               |                                      
|Income (loss) from continuing operations before income taxes . |                                      
|                                                               |                                      
|Income tax provision                                           |                                      
|                                                               |                                      
|Income (loss) from continuing operations                       |                                      
|                                                               |                                      
|Discontinued operations (Note 3):                              |                                      
|Income (loss) from discontinued operations, net of tax         |                                      
|Gain on disposal of discontinued operations, net of tax        |                                      
|                                                               |                                      
|Discontinued operations, net of tax                            |                                      
|                                                               |                                      
|Net income (loss)                                              |                                      
|                                                               |                                      
|Preferred stock dividends                                      |                                      
|                                                               |                                      
|Net income (loss) applicable to common stockholders            |                                      
|                                                               |                                      
|Income (loss) per share:                                       |                                      
|Basic:                                                         |                                      
|Income (loss) from continuing operations                       |                                      
|Income (loss) from discontinued operations                     |                                      
|                                                               |                                      
|Basic income (loss) per share                                  |                                      
|                                                               |                                      
|Diluted:                                                       |                                      
|Income (loss) from continuing operations                       |                                      
|Income (loss) from discontinued operations                     |                                      
|                                                               |                                      
|Diluted income (loss) per share                                |                                      
|                                                               |                                      
|Weighted average common shares outstanding:                    |                                      
|Basic                                                          |                                      
|                                                               |                                      
|Diluted                                                        |                                      
|                                                               |                                      

The
accompanying notes are an integral part of these Consolidated Financial Statements.

Page 39 of 63

---



Applied Films
Corporation and Subsidiaries Consolidated Statements
of Stockholders Equity (in thousands, except
shares)

|                                                                                            | Common Stock | Preferred Stock | Other Cumulative Comprehensive |            | Retained | Total Stockholders'
|------------------------------------------------------------------------------------------- | ------------ | --------------- | ------------------------------ | ---------- | -------- | -------------------
|                                                                                            |              |                 |                                |            |          |                    
|                                                                                            |              |                 |                                |            |          |                    
|Balances, June 30, 2001                                                                     |              |                 |                                | 6,832,701  |          | $                  
|                                                                                            |              |                
|Comprehensive loss:                                                                         |              |                
|Net loss                                                                                    |              |                 |                                | -          |          |                    
|Unrealized loss on foreign currency translation                                             |              |                 |                                | -          |          |                    
|                                                                                            |              |                 |                                |            |          |                    
|Total comprehensive loss                                                                    |              |                 |                                | -          |          |                    
|                                                                                            |              |                
|ESPP stock issuance                                                                         |              |                 |                                | 8,799      |          |                    
|Exercise of warrants and stock options                                                      |              |                 |                                | 105,980    |          |                    
|Issuance of shares in connection with secondary    offering (net of offering costs of $823) |              |                 |                                | 3,573,502  |          |                    
|Conversion of Series A Convertible Preferred Stock    (net of costs of $6)                  |              |                 |                                | 506,328    |          |                    
|Preferred stock dividends                                                                   |              |                 |                                | -          |          |                    
|                                                                                            |              |                 |                                |            |          |                    
|Balances, June 29, 2002                                                                     |              |                 |                                | 11,027,310 |          |                    
|                                                                                            |              |                
|Comprehensive income:                                                                       |              |                
|Net income                                                                                  |              |                 |                                | -          |          |                    
|Unrealized gain on foreign currency translation                                             |              |                 |                                | -          |          |                    
|Unrealized gain on hedged transactions                                                      |              |                 |                                | -          |          |                    
|                                                                                            |              |                 |                                |            |          |                    
|Total comprehensive income                                                                  |              |                 |                                | -          |          |                    
|                                                                                            |              |                
|ESPP stock issuance                                                                         |              |                 |                                | 15,635     |          |                    
|Exercise of stock options                                                                   |              |                 |                                | 118,928    |          |                    
|                                                                                            |              |                 |                                |            |          |                    
|Balances, June 28, 2003                                                                     |              |                 |                                | 11,161,873 |          |                    
|                                                                                            |              |                
|Comprehensive income:                                                                       |              |                
|Net income                                                                                  |              |                 |                                | -          |          |                    
|Unrealized gain on foreign currency translation                                             |              |                 |                                | -          |          |                    
|Recognition of unrealized gain on hedged transactions                                       |              |                 |                                | -          |          |                    
|Unrealized loss on securities                                                               |              |                 |                                | -          |          |                    
|                                                                                            |              |                 |                                |            |          |                    
|Total comprehensive income                                                                  |              |                 |                                | -          |          |                    
|                                                                                            |              |                
|ESPP stock issuance                                                                         |              |                 |                                | 8,457      |          |                    
|Exercise of stock options                                                                   |              |                 |                                | 131,194    |          |                    
|Issuance of shares in connection with the    Helix acquisition                              |              |                 |                                | 80,826     |          |                    
|Issuance of shares in connection with secondary    offering (net of offering costs of $744) |              |                 |                                | 3,450,000  |          |                    
|Exercise of warrants                                                                        |              |                 |                                | 5,865      |          |                    
|                                                                                            |              |                 |                                |            |          |                    
|Balances, June 26, 2004                                                                     |              |                 |                                | 14,838,215 |          | $                  
|                                                                                            |              |                 |                                |            |          |                    

The
accompanying notes are an integral part of these Consolidated Financial Statements.

Page 40 of 63

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Applied Films
Corporation and Subsidiaries Consolidated Statements
of Cash Flows

|                                                                                   | For The Fiscal Years Ended
|---------------------------------------------------------------------------------- | --------------------------
|                                                                                   |                           
|                                                                                   |                           
|                                                                                   |                           
|                                                                                   | (in thousands)            
|Cash Flows from Operating Activities:                                              |                           
|Net income (loss)                                                                  |                           
|Adjustments to net income (loss) from continuing operations:                       |                           
|(Gain) loss from discontinued operations                                           |                           
|                                                                                   |                           
|Income (loss) from continuing operations                                           |                           
|Depreciation and amortization of intangible assets                                 |                           
|Write off of in-process research and development                                   |                           
|Deferred compensation and non-cash compensation expense                            |                           
|Amortization of gain on lease and deferred gain on equipment sale to joint venture |                           
|Equity earnings of Joint Venture                                                   |                           
|Loss on disposal of equipment                                                      |                           
|Changes in:                                                                        |                           
|Restricted cash                                                                    |                           
|Accounts and trade notes receivable, net                                           |                           
|Revenue in excess of billings                                                      |                           
|Inventories                                                                        |                           
|Prepaid expenses and other                                                         |                           
|Accounts payable and accrued expenses                                              |                           
|Billings in excess of revenue                                                      |                           
|Income taxes                                                                       |                           
|                                                                                   |                           
|Net cash flows used in operating activities                                        |                           
|                                                                                   |                           
|                                                                                   |                           
|Cash Flows from Investing Activities:                                              |                           
|Purchases of property, plant, and equipment                                        |                           
|Purchases of marketable securities, net                                            |                           
|Funds used for the acquisition of LAC                                              |                           
|Funds used for the acquisition of Helix                                            |                           
|                                                                                   |                           
|Net cash flows used in investing activities                                        |                           
|                                                                                   |                           
|                                                                                   |                           
|Cash Flows from Financing Activities:                                              |                           
|Proceeds from borrowings of long-term debt                                         |                           
|Repayment of long-term debt                                                        |                           
|Restricted cash                                                                    |                           
|Stock issuance on stock purchase plan and stock options                            |                           
|Proceeds from secondary offering                                                   |                           
|Offering costs                                                                     |                           
|Dividends paid on preferred stock                                                  |                           
|                                                                                   |                           
|Net cash flows provided by financing activities                                    |                           
|Cash flows from discontinued operations                                            |                           
|Effect of exchange rate changes on cash and cash equivalents                       |                           
|                                                                                   |                           
|Net (decrease) increase in cash                                                    |                           
|Cash and cash equivalents, beginning of period                                     |                           
|                                                                                   |                           
|Cash and cash equivalents, end of period                                           |                           
|                                                                                   |                           
|                                                                                   |                           
|Supplemental cash flow information:                                                |                           
|Cash paid for interest, net of amounts capitalized                                 |                           
|                                                                                   |                           
|Cash paid for income taxes, net                                                    |                           
|                                                                                   |                           
|                                                                                   |                           
|Non-cash investing activity:                                                       |                           
|Issuance of common stock in connection with Helix acquisition                      |                           
|                                                                                   |                           
|                                                                                   |                           
|Non-cash financing activity:                                                       |                           
|Capital lease obligations incurred for the purchase of equipment                   |                           
|                                                                                   |                           

The
accompanying notes are an integral part of these Consolidated Financial Statements.

Page 41 of 63

---



# Applied Films
Corporation and SubsidiariesNotes to Consolidated
Financial Statements

# June 26, 2004

# NOTE 1: COMPANY
ORGANIZATION AND OPERATIONS

Applied Films Corporation
(Applied Films, the Company, we, or our)
is a leading provider of thin film deposition equipment to diverse markets such as the
flat panel display (FPD), the architectural and solar glass, and
the consumer products packaging and electronics industries. Our deposition systems are
used to deposit thin films that enhance the characteristics of a base substrate, such as
glass, plastic, paper or foil. These thin films provide conductive, electronic,
reflective, filter, barrier and other properties that are critical elements of our
customers products. Our thin film deposition systems provide our customers with high
yield and throughput, flexible modular configurations, and innovative coating and process
technologies.

We have exited the contract coated
glass business over the last six years. Beginning in fiscal 1999, we moved the majority of
our production of coated glass from Longmont to our joint venture in China (China JV).
Because of the 50%-50% ownership structure of our China JV, the revenues and expenses of
our China JV are not consolidated and do not appear as revenues and expenses in our
financial statements. Our 50% portion of the China JV net income is reported as
Equity earnings of joint venture in our consolidated statements of operations.
In September 2002, we sold our Longmont coatings division, which included certain
assets related to our contract glass coating business, to Optera, Inc. In September 2003,
we sold our coated glass sales business located in Hong Kong to Nippon Sheet Glass Co.,
Ltd. (NSG). The financial statements for the prior periods have been restated to reflect
the effect of the sale of those businesses and the results have been included as
discontinued operations.

Over the last four years, we have
enhanced our position as a market leading manufacturer of thin film deposition equipment.
In December 2000, we completed the acquisition of the LAC business of Unaxis which
improved our position in FPD and enabled our entry into additional markets.

In June 2004, we completed the
acquisition of the In-Line Systems division of Helix Technology, Inc. in Taiwan. The
acquisition provides us with an additional 32 people who are familiar with our products,
as well as a facility that will serve as our Asian manufacturing base, where we expect to
manufacture some of our display systems beginning late in fiscal 2005. We believe
manufacturing in Taiwan will allow us to reduce our manufacturing costs, and reduce the
transit time for systems sold to our customers in Asia. The addition of technical
personnel in Asia will enhance our customer service.

Certain prior year amounts have been
reclassified to conform to the current year presentation.

# NOTE 2: SIGNIFICANT
ACCOUNTING POLICIES

Principles of
Consolidation

The accompanying consolidated
financial statements include the accounts of the Company and its wholly-owned
subsidiaries. All intercompany accounts and transactions have been eliminated in
consolidation. The results of the China JV are accounted for using the equity method of
accounting in the consolidated financial statements and the results appear in Equity
earnings of Joint Venture (Note 5).

Use of Estimates

The preparation of financial
statements in conformity with U.S. generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosures of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

Fiscal Year

The Company has adopted a fiscal year
ending on the Saturday nearest June 30, which will result in fiscal years composed of 52
or 53 weeks. Fiscal years 2004, 2003, and 2002 all include 52 weeks.

Page 42 of 63

---



Cash and Cash
Equivalents

The Company generally considers all
highly liquid investments with an original maturity of less than 90 days to be cash
equivalents.

Restricted Cash

At June 26, 2004 and June 28, 2003,
the Company has pledged $2.1 million and $14.1 million, respectively, in cash,
to provide security for bank guarantys to certain customers in China, for their cash
deposits on contracts. The Company also has $3.8 million of guarantys which are
pledged under a line of credit at June 26, 2004. At June 28, 2003, the Company
had pledged $5.0 million in cash to provide the bank guaranty for 50% of the debt of
the China JV. This guaranty was released in fiscal 2004.

Marketable Securities

Through April 20, 2004, the Company
classified all of its short-term investments that do not qualify as cash equivalents as
trading securities. Starting on April 21, 2004, the Company elected to reclassify all of
its short-term investments from trading securities to available-for-sale securities.
Available-for-sale securities are carried at fair value, with the unrealized gains and
losses, net of tax, reported in other comprehensive income. Realized gains and losses and
declines in value judged to be other-than-temporary on available-for-sale securities are
included in interest income. The cost of securities sold is based on the specific
identification method. Interest and dividends on securities classified as
available-for-sale are included in interest income.

Securities held principally for the
purpose of selling them in the near future are classified as trading securities. Since
1997 we have classified our investments as trading securities and in April 2004, in
accordance with SFAS 115, we determined that a more appropriate classification is to
classify our investments as securities available for sale, because the securities are not
held to make a profit from short-term fluctuations in market prices. We commonly hold our
investments to maturity but can sell them at any time as short term cash needs arise.

The following is a summary of the
Companys available-for-sale securities as of June 26, 2004 (in thousands):

|                            | Available for Sale Securities
|--------------------------- | -----------------------------
|                            |                              
|                            |                              
|                            |                              
|Corporate bonds             |                              
|Municipal debt securities . |                              
|Government bonds            |                              
|Equity securities           |                              
|Money market funds          |                              
|                            |                              
|Total                       |                              
|                            |                              

During the period April 21, 2004
through June 26, 2004, marketable equity available-for-sale securities with a fair value
at the date of sale of $27.9 million were sold. The gross realized gains on such
sales totaled $4,000. Through April 20, 2004, the Company recognized $434,000 of
unrealized losses with respect to trading securities. Upon the reclassification of
securities from trading to available-for-sale, in accordance with Statement of Financial
Accounting Standard (SFAS) 115, the Company recorded an unrealized loss on marketable
securities of $429,000 net of tax, in other comprehensive income, through the end of
fiscal year 2004.

At June 28, 2003, the Companys
trading securities were invested as follows (in thousands):

|                          | June 28, 2003
|------------------------- | -------------
|                          |              
|Corporate bonds           |              
|Municipal debt securities |              
|Government bonds          |              
|Equity securities         |              
|Money market funds        |              
|                          |              
|Total trading securities  |              
|                          |              

Page 43 of 63

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The net carrying value and estimated fair
value of marketable equity securities at June 26, 2004, by contractual maturity, are shown
below (in thousands):

|                                      | Amortized Cost | Estimated Fair Value
|------------------------------------- | -------------- | --------------------
|                                      |                |                     
|Due in one year or less               |                |                     
|Due after one year through five years |                |                     
|                                      |                |                     
|Total marketable equity securities    |                |                     
|                                      |                |                     

Inventories

Inventories consist of materials used
in the construction of systems or spare parts and work in process for contracts accounted
for under the completed contract method of accounting. Inventories are stated at the lower
of cost (first-in, first-out) or market. Inventories consist of the following (in
thousands):

|                                    | June 26, 2004 | June 28, 2003
|----------------------------------- | ------------- | -------------
|                                    |               |              
|Materials for manufacturing systems |               |              
|Work-in-process                     |               |              
|                                    |               |              
|Total inventory                     |               |              
|                                    |               |              

Property, Plant, and
Equipment

Property, plant and equipment are
stated at cost. Replacements, renewals and improvements are capitalized and costs for
repairs and maintenance are expensed as incurred. Depreciation is computed using the
straight-line method over the following estimated useful lives. Leasehold improvements are
depreciated using the straight-line method over the lesser of the useful life of the asset
or lease term.

|                               | Estimated Useful Lives
|------------------------------ | ----------------------
|                               |                       
|Building                       |                       
|Machinery and equipment        |                       
|Office furniture and equipment |                       

The composition of property, plant
and equipment follows (in thousands):

|                                                               | June 26, 2004 | June 28, 2003
|-------------------------------------------------------------- | ------------- | -------------
|                                                               |               |              
|Land                                                           |               |              
|Building                                                       |               |              
|Machinery and equipment                                        |               |              
|Office furniture and equipment                                 |               |              
|Leasehold improvements                                         |               |              
|Construction in progress and other                             |               |              
|                                                               |               |              
|                                                               |               |              
|Less accumulated depreciation                                  |               |              
|                                                               |               |              
|Property, plant and equipment, net of accumulated depreciation |               |              
|                                                               |               |              

Depreciation expense was
approximately $2.1 million, $2.0 million, and $2.2 million, for the years
ended June 26, 2004, June 28, 2003, and June 29, 2002,
respectively.

Goodwill and Other
Intangible Assets

The goodwill and intangible assets
are carried on the balance sheet of the Companys German subsidiary and Tainan,
Taiwan subsidiary. During the fourth quarter of 2004, the Company completed the
acquisition of the In-Line Systems division of Helix Technology in Tainan, Taiwan. As a
result of the acquisition, the Company has preliminarily recorded approximately $1.1
million and $1.0 million of patents and customer lists, respectively. The Company is in
the process of completing a fair value analysis of the assets. Upon completion of this
analysis, these preliminary amounts may change. Increases or decreases in the book value
are due to currency fluctuation between the U.S. dollar, the Euro, and the Taiwan dollar.
The increase in accumulated amortization of intangible assets is due to the current
amortization expense in the current period and currency fluctuation between the U.S.
dollar, the Euro, and the Taiwan dollar. The composition of intangible assets follows (in
thousands):

Page 44 of 63

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|                                                   | June 26, 2004 | June 28, 2003
|-------------------------------------------------- | ------------- | -------------
|                                                   |               |              
|Intangible assets:                                 |               |              
|Patents                                            |               |              
|Customer lists                                     |               |              
|                                                   |               |              
|Intangible assets                                  |               |              
|Less accumulated amortization                      |               |              
|                                                   |               |              
|Intangible assets, net of accumulated amortization |               |              
|                                                   |               |              

The patents are amortized over seven
years and the customer lists are amortized over five years. As a result of adopting SFAS
No. 142, the Company no longer recognizes amortization expense on its goodwill. Annually,
and more frequently if a triggering event occurs, the Company is required to test the
carrying value of goodwill for impairment. During the fourth quarter of fiscal 2004 the
annual impairment test on the goodwill recorded with respect to the LAC acquisition was
completed and it was determined that there was no impairment of the goodwill related to the LAC
acquisition.

The aggregate amortization expense
for fiscal years ended June 26, 2004, June 28, 2003, and
June 29, 2002 is $4.3 million, $3.8 million, and $3.4 million,
respectively. The intangible asset balances are reported on the German and Taiwan
subsidiarys balance sheets and will be subject to unrealized foreign exchange
fluctuations between the Euro, the Taiwan dollar and the U.S. dollar. The estimated
aggregate amortization expense for the intangible assets for each of the five succeeding
fiscal years is estimated as follows (in thousands):

|                                     | Fiscal Years Ended
|------------------------------------ | ------------------
|                                     |                   
|
|                                     |                   
|Intangible assets:                   |                   
|Patents                              |                   
|Customer lists                       |                   
|                                     |                   
|Total estimated amortization expense |                   
|                                     |                   

Impairment of Long
Lived Assets

With the exception of goodwill, the
Company evaluates the carrying value of all long-lived assets whenever events or
circumstances indicate the carrying value of assets may exceed their recoverable amounts.
An impairment loss would be recognized when the undiscounted estimated future cash flows
expected to result from the use of an asset are less than the carrying amount of the
asset. Measurement of an impairment loss is based on fair value of the asset computed
using discounted cash flows if the asset is expected to be held and used. Measurement of
an impairment loss for an asset held for sale would be based on fair market value less
estimated costs to sell.

The Company performs an annual
impairment test to ensure that the fair value of the asset exceeds the carrying value of
its China JV on the Companys balance sheet. The annual impairment test that was
completed during the third quarter of fiscal 2004 determined that there was no impairment
of the investment in the China JV.

The Company believes no circumstances
indicating an impairment exists in any of its other long-lived assets.

Accrued Expenses:

The significant components of accrued expenses
are as follows (in thousands):

|                            | June 26, 2004 | June 28, 2003
|--------------------------- | ------------- | -------------
|                            |               |              
|Accrued losses on contracts |               |              
|Accrued warranty            |               |              
|Accrued compensation        |               |              
|Other accruals              |               |              
|                            |               |              
|Total accrued expenses      |               |              
|                            |               |              

Accrued losses on contracts are costs
incurred on specific projects in excess of the contracted revenue. Accrued losses on
contracts are recognized when the loss becomes probable and the amount of loss can be
reasonably estimated. Loss provisions are based upon excess costs over the net revenue
from the products contemplated by the specific order. Contract accounting requires
management to make estimates of future costs over the performance period of the contract.
These estimates are subject to change and result in adjustments to cost of goods sold,
which are reflected in the margins on contracts in progress.

Page 45 of 63

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Accrued compensation represents those
costs associated with employee compensation costs such as salaries, vacation, bonus,
profit sharing, anniversary awards, insurance benefits and taxes.

Accrued warranty represents the
estimated warranty costs associated with contracts in progress and completed projects that
have entered into the warranty period. Accrued warranty is calculated as a percentage of
the total project costs. These costs are amortized over the life of the warranty period
for each specific project.

Other accruals represent all other
incurred and anticipated costs, not included in the categories above such as insurance,
accounting, legal, and non-payroll related benefits.

Income Taxes

The Company accounts for income taxes
in accordance with SFAS 109, Accounting for Income Taxes. SFAS 109 requires
deferred tax assets and liabilities to be recognized for temporary differences between the
tax basis and financial reporting basis of assets and liabilities, computed at current tax
rates. Also, the Companys deferred income tax assets include certain future tax
benefits. The Company records a valuation allowance against any portion of those deferred
income tax assets, which it believes, it will more likely than not fail to realize.

The China JV earnings are taxed in
its local jurisdiction and therefore no provision for taxes on earnings has been accrued
in the Companys tax provision during fiscal years 2002, 2003 and 2004.

Deferred Gain

During 1997, the Company entered into
a lease transaction with a third party for the Companys manufacturing and
administrative facility in Longmont, Colorado, which included a purchase option early in
the lease period. The Company sold this purchase option to another third party, who
exercised this option and purchased the building. The Company then entered into a new
lease of the facility, which includes a purchase option (Note 10). The Company received
$834,000 from the original purchase option, which is deferred and is shown on the balance
sheet in current and long term liabilities as deferred gain and is being amortized on a
straight-line basis over the term of the lease of 15 years.

Spare Parts Revenue
Recognition

Spare parts revenues and related
costs are recognized when title to the goods passes to the customer according to the terms
specified in the purchase order. The Companys spare parts are warranted to be free
from material defects caused by workmanship and within its design or customer
specifications and are inspected for workmanship and compliance to specification prior to
shipment. Customers who experience defects in material may return product for credit or
replacement. Applied Films maintains a reserve to cover sales returns for quality defects
from its customers. The provision for estimated sales returns and allowances is recorded
in the period of the sale and is typically in the range of 0.5% to 1.0% of sales.

Equipment Sales
Revenue Recognition

The percentage of completion method
of accounting is used for products valued at greater than $1 million and a construction
time of greater than six months. In accordance with the American Institute of Certified
Public Accountants (AICPA) Statement of Position (SOP) 81-1,
Accounting for Performance of Construction-Type and Certain Production-Type
Contracts. Pursuant to SOP 81-1, revenues are measured by the percentage of the
total costs incurred and applied to date in relation to the estimated total costs to be
incurred for each contract. Management considers costs incurred to be the best available
measure of progress on these contracts. Contract costs include all direct material and
labor costs and those indirect costs related to contract performance. General and
administrative costs are expensed as incurred. Changes in performance, contract conditions
and estimated profitability, including those arising from contract penalty provisions and
final contract settlements, may result in revisions to costs and income and are recognized
in the period in which the revisions are determined. The Company's contracts under the percentage of
completion method do not provide for the right of a customer to return the machine once
title has transferred.

Page 46 of 63

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Revenues in excess of billings
represent revenues recognized under the percentage of completion method prior to billing
the customer for contractual cash payments. Billings in excess of revenue represent
amounts billed pursuant to the contract terms, which occur prior to the Companys
recognition of revenues on the contract for financial reporting purposes.

Contracts in progress are as follows (in thousands):

|                                                             | June 26, 2004 | June 28, 2003
|------------------------------------------------------------ | ------------- | -------------
|                                                             |               |              
|                                                             |              
|Costs incurred on contracts in progress and estimated profit |               |              
|Less:  billings to date                                      |               |              
|                                                             |               |              
|Revenue in excess of billings, net                           |               |              
|                                                             |               |              

The Company typically collects 80-85%
of the cash due on the total project by the time the equipment ships from its facility.
The remaining 15-20% balance that is due following the ship date, is billed in accordance
with the contract terms and those subsequent billings are generally collected within 30
days after billing.

The Company generally offers warranty
coverage for equipment sales for a period of one year after final installation is
complete. The Company estimates the anticipated costs to be incurred during the warranty
period and accrues a reserve as a percentage of revenue as revenue is recognized. These
reserves are evaluated periodically based on actual experience and anticipated activity
and are adjusted if necessary.

Changes in the Companys product
warranty liability were as follows (in thousands):

|                         | Fiscal Year Ended
|------------------------ | -----------------
|                         |                  
|                        
|                         |                  
|Beginning of period      |                  
|Warranties issued        |                  
|Repairs and replacements |                  
|                         |                  
|End of period            |                  
|                         |                  

The completed contract method of
accounting is used for standard products that are typically valued at less than $1 million
and have a machine construction time of less than six months. For projects accounted for
using the completed contract method of accounting, we accumulate the project costs in work
in process until we complete the fabrication of the system. Once fabrication of the system
is complete, the customer evaluates the machine at Applied Films manufacturing
facility according to any specific acceptance criteria outlined in the contract. Upon
acceptance, the machine is shipped and installed at the customers facility and title
is transferred to the customer. Applied Films recognizes the revenue, upon transfer of
title. Our contracts under the completed contract method do not provide for the right of a
customer to return the machine once title has transferred.

Deferred Gross Profit

During fiscal years 2002, 2001 and
1999, the Company sold certain thin film deposition equipment to the China JV
(Note 5). Because the Company owns 50% of the China JV, the Company recorded 50% of
the revenue and related cost of the sales and has deferred 50% of the gross profit,
approximately $0.0, $1.3 million and $1.4 million, respectively, which will be recognized
on a straight-line basis over ten years, consistent with the depreciation schedule at the
China JV and the estimated depreciable life of the equipment. The thin film equipment sold
to the China JV in fiscal year 2002 was sold at cost and did not result in gross profit.
The amortization of the gross profit is included with Equity earnings of joint
venture in the accompanying consolidated statements of operations. The deferred
gross profit recognized in fiscal 2004 was $297,000 and $297,000 for fiscal 2003. The
remaining deferred gross profit was $1.6 million on June 26, 2004,
$1.9 million on June 28, 2003, and $2.2 million on
June 29, 2002.

Research and
Development Expenses

Research and development costs are
expensed as incurred and consist primarily of salaries, supplies, lab expenses, and
depreciation of equipment used in research and development activities. The Company
incurred approximately $16.8 million, $12.2 million, and $9.2 million, of research
and development expenses for the fiscal years ended June 26, 2004,
June 28, 2003, and June 29, 2002, respectively, net of reimbursements
for funded research and development received from a German governmental agency. The
Company is reimbursed up to 50% of the costs incurred for specific research and
development projects. The reimbursement terms are contained in an agreement between the
Company and the agency and is paid when the research is completed and accepted by the
agency. The Company received reimbursements of $713,000, $599,000, and $795,000, in the
fiscal years ended June 26, 2004, June 28, 2003, and
June 29, 2002, respectively.

Page 47 of 63

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Foreign Currency
Transactions

The Company generated 81%, 70%, and
58% of its revenues in fiscal years 2004, 2003, and 2002, respectively, from sales to
foreign corporations located outside of Europe, which are primarily in Asia and the United
States. In addition, many of its raw materials are purchased from foreign corporations.
The majority of the Companys sales and purchases are denominated in Euros, with the
remainder denominated in U.S. dollars. For those transactions denominated in currencies
other than the functional currency, the Company records the sale or purchase at the spot
exchange rate in effect on the date of sale. Receivables from such sales or payables for
such purchases are converted to the functional currency using the end of the period spot
exchange rate. Realized gains and losses are charged or credited to income during the
year.

Foreign Currency
Translation

The financial results of the
Companys foreign subsidiaries are translated to U.S. dollars using the current-rate
method. Assets and liabilities are translated at the year end spot exchange rate, revenue
and expenses at average exchange rates and equity transactions at historical exchange
rates. Exchange differences arising on translation are recorded as a component of other
cumulative comprehensive income (loss).

Other Cumulative
Comprehensive Loss

SFAS 130, Reporting
Comprehensive Income, establishes a standard for reporting and displaying
comprehensive income and its components within the financial statements. Comprehensive
income includes charges and credits to equity that are not the result of transactions with
shareholders. Other cumulative comprehensive income for the Company represents foreign
currency items associated with the translation of the Companys investment in its
foreign subsidiaries and the China JV, unrealized gain on foreign currency hedge
activities and unrealized losses on available for-sale securities.

Comprehensive Income
(Loss)

A summary of the comprehensive income
(loss) is as follows (in thousands):

|                                                      | June 26, 2004 | June 28, 2003 | June 29, 2002
|----------------------------------------------------- | ------------- | ------------- | -------------
|                                                      |               |               |              
|Net income (loss)                                     |               |               | $            
|Other comprehensive income:                           |               |              
|Currency translation adjustment, net                  |               |               |              
|Recognition of unrealized gain on hedged transactions |               |               |              
|Unrealized loss on marketable securities              |               |               |              
|                                                      |               |               |              
|Comprehensive income (loss)                           |               |               | $            
|                                                      |               |               |              

Page 48 of 63

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Following are the components of
comprehensive income (loss) (in thousands):

|                                                      | Beginning Balance | Amount | Valuation Allowance | Ending Balance
|----------------------------------------------------- | ----------------- | ------ | ------------------- | --------------
|                                                      |                   |        |                     |               
|June 29, 2002                                         |                   |        |                     |               
|Unrealized loss on foreign currency translation       |                   |        | $                   | (7,020        
|                                                      |                   |       
|June 28, 2003                                         |                   |       
|Unrealized gain on foreign currency translation       |                   |        |                     | (7,995        
|Unrealized gain on hedged transactions                |                   |        |                     | -             
|                                                      |                   |        |                     |               
|                                                      |                   |        |                     | (7,995        
|                                                      |                   |       
|June 26, 2004                                         |                   |       
|Unrealized gain on foreign currency translation       |                   |        |                     | 11,024        
|Recognition of unrealized gain on hedged transactions |                   |        |                     | 480           
|Unrealized loss on marketable securities              |                   |        |                     | -             
|                                                      |                   |        |                     |               
|                                                      |                   |        | $                   | 11,504        

*Amounts related to unrealized losses
on marketable securities are recorded net of tax, but have corresponding full valuation
allowances recorded against the related deferred tax asset.

Net Income (Loss) Per
Common Share

The Company follows SFAS 128,
Earnings per Share which establishes standards for computing and presenting
basic and diluted earnings per share (EPS). Under this statement, basic
earnings (loss) per share is computed by dividing the income or loss available to common
stockholders by the weighted average number of shares of common stock outstanding. Diluted
earnings per share is determined by dividing the income or loss available to common
stockholders by the sum of (1) the weighted average number of common shares outstanding
and (2) the dilutive effect of outstanding potentially dilutive securities, including
convertible preferred stock, stock options and warrants determined utilizing the treasury
stock method. Diluted loss per share in 2002 is determined by dividing the loss available
to common stockholders by the weighted average number of shares; no weight is given to the
dilutive effect of stock options.

Page 49 of 63

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A reconciliation between the number
of shares used to calculate basic and diluted income (loss) per share is as follows (in
thousands, except per share amounts):

|                                                      | Fiscal Year Ended
|----------------------------------------------------- | -----------------
|                                                      |                  
|                                                      |                  
|                                                      |                  
|Basic Income (Loss) Per Share                         |                  
|Income (loss) from continuing operations              |                  
|Income (loss) from discontinued operations            |                  
|Preferred stock dividend                              |                  
|                                                      |                  
|Net income (loss) after the preferred stock dividend  |                  
|                                                      |                  
|Weighted average number of common shares outstanding  |                  
|                                                      |                  
|Income (loss) per share                               |                  
|Basic:                                                |                  
|Income (loss) from continuing operations              |                  
|Income (loss) from discontinued operations            |                  
|                                                      |                  
|Net income (loss)                                     |                  
|                                                      |                  
|Diluted Income (Loss) Per Share                       |                  
|Income (loss) from continuing operations              |                  
|Income (loss) from discontinued operations            |                  
|Preferred stock dividend                              |                  
|                                                      |                  
|Net income (loss) after preferred stock dividend      |                  
|                                                      |                  
|Weighted average number of common shares outstanding  |                  
|Assuming exercise of stock options                    |                  
|Assuming repurchase of treasury stock                 |                  
|                                                      |                  
|Weighted average number of common shares outstanding, |                  
|as adjusted                                           |                  
|                                                      |                  
|Income (loss) per share                               |                  
|Diluted:                                              |                  
|Income (loss) from continuing operations              |                  
|Income (loss) from discontinued operations            |                  
|                                                      |                  
|Net income (loss)                                     |                  
|                                                      |                  

The diluted share base for fiscal
year 2002 excludes incremental shares of 831,000 relating to assuming exercise of stock
options and 546,000 assuming repurchase of treasury shares. These shares are excluded due to
their antidilutive effect as a result of the Companys loss from continuing
operations during fiscal year 2002.

Statement of Financial
Accounting Standards 123

SFAS 123, Accounting for
Stock-Based Compensation, defines a fair value based method of accounting for
employee stock options or similar equity instruments. However, SFAS 123 allows the
continued measurement of compensation cost in the financial statements for such plans
using the intrinsic value based method prescribed by Accounting Principles Board Opinion
25, Accounting for Stock Issued to Employees (APB 25), provided
that pro forma disclosures are made of net income or loss, assuming the fair value based
method of SFAS 123 had been applied. The Company has elected to account for its
stock-based compensation plans for employees and directors under APB 25.

Accordingly, for purposes of the pro
forma disclosures presented below, the Company has computed the fair values of all options
granted during fiscal 2004, 2003, and 2002 using the Black-Scholes pricing model and the
following weighted average assumptions:

|                        | 2004 | 2003 | 2002
|----------------------- | ---- | ---- | ----
|                        |      |      |     
|Risk-free interest rate |      |      |     
|Expected lives          |      |      |     
|Expected volatility     |      |      |     
|Expected dividend yield |      |      |     

Page 50 of 63

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To estimate expected lives of options
for this valuation, it was assumed options will be exercised at varying schedules after
becoming fully vested. All options are initially assumed to vest. 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. Fair value computations are highly sensitive to the volatility
factor assumed; the greater the volatility, the higher the computed fair value of the
options granted.

The total fair value of options
granted was computed to be approximately $7.1 million, $2.6 million, and
$5.8 million, for the years ended June 26, 2004, June 28, 2003,
and June 29, 2002, respectively. The amounts are amortized ratably over the
vesting period of the options. Pro forma stock-based compensation, net of the effect of
forfeitures, was $2.3 million, $2.2 million, and $2.2 million, for the
fiscal years ended June 26, 2004, June 28, 2003, and
June 29, 2002, respectively.

The Company has elected to account
for its employee stock plans in accordance with Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees (APB Opinion No. 25), as amended
by Financial Accounting Standards Board (FASB) Interpretation NO. 44), Accounting
for Certain Transactions involving Stock Compensation an interpretation of APB Opinion NO.
25, and to adopt the disclosure-only provisions as required under Statement of
Financial Accounting Standards No. 123,  Accounting for Stock-Based
Compensation (SFAS 123). The following table illustrates the effect on net income
and earnings per share if the company had applied the fair value recognition provisions of
SFAS 123 to stock-based employee compensation, as amended by Statement of Financial
Accounting Standards No. 148 Accounting for Stock based Compensation, Transition and
Disclosures (SFAS 148) (in thousands, except per share data):

|                                                     | Fiscal Year Ended
|---------------------------------------------------- | -----------------
|                                                     |                  
|                                                     |                  
|                                                     |                  
|Net income (loss) applicable to common shareholders: |                  
|As reported                                          |                  
|Add:  Stock-based employee compensation expense      |                  
|included in reported net income, net of tax          |                  
|Deduct:  Total stock-based employee compensation     |                  
|expense determined under fair-value based method     |                  
|for all awards, net of tax                           |                  
|                                                     |                  
|Pro forma net loss                                   |                  
|                                                     |                  
|Income (loss) per share:                             |                  
|Basic - as reported                                  |                  
|                                                     |                  
|Diluted - as reported                                |                  
|                                                     |                  
|Basic - pro forma                                    |                  
|                                                     |                  
|Diluted - pro forma                                  |                  
|                                                     |                  

Derivative Instruments
and Hedging Activities

In June 1998, the FASB issued SFAS
133, Accounting for Derivative Instruments and Hedging Activities. SFAS 133
establishes accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. SFAS 133
requires that changes in the derivatives fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows a derivatives gains and losses to offset related results on
the hedged item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive hedge
accounting.

The Company has entered into foreign
currency forward contracts to mitigate the risk of changes in exchange rates on firm sale
commitments denominated in foreign currencies. These contracts qualify as fair value
hedges pursuant to SFAS 133. Accordingly, the fair value of the derivative instruments is
recorded on the balance sheet and is offset by changes in the fair value of the related
firm commitments. The ineffective portion of the derivative instruments are recorded
currently in income. There were no hedged transactions at June 26, 2004 or
June 29, 2002, however, at June 28, 2003, the unrealized gain on
hedged transactions was $480,000.

Page 51 of 63

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Recent Accounting
Standards

In January 2003, FASB issued
Interpretation 46 (FIN 46), Consolidation of Variable Interest Entities. FIN
46 requires an investor with a majority of the variable interests in a variable interest
entity to consolidate the entity and also requires majority and significant variable
interest investors to provide certain disclosures. A variable interest entity is an entity
in which the equity investors do not have a controlling interest or the equity investment
at risk is insufficient to finance the entitys activities without receiving
additional subordinated financial support from the other parties. FIN 46 was effective for
variable interest entities created after January 31, 2003 and for older entities in the
first reporting period beginning after June 15, 2003. We have not created any variable
interest entities.

# NOTE 3: SALE OF THE HONG
KONG COATINGS DIVISION  DISCONTINUED OPERATIONS

Effective
September 26, 2003, the Company sold its coated glass business located in Hong
Kong to NSG for approximately $1.4 million. The assets sold include the right to
direct 50% of the China JV production, customer lists of the business, the coated glass
inventory and any outstanding purchase orders of the coated glass business located in Hong
Kong.

Proceeds from the sale of the
business were $747,000 in cash and $600,000 in a promissory note. The note accrues
interest at 5% per annum, is due on September 26, 2004, and does not have a
prepayment penalty. The Company recorded a $783,000 gain, net of taxes of $415,000 as a
result of this transaction.

The Company accounted for the sale of
the Hong Kong coated glass business as a discontinuance of the business. As a result,
certain financial information has been restated to give effect to the classification of
the Hong Kong coated glass business as a discontinued operation. The net revenues of the
discontinued operation were $933,000, $6.1 million and $7.3 million for the
fiscal years ended June 26, 2004, June 28, 2003 and June 29, 2002, respectively.

# NOTE 4: LONG-TERM DEBT

In fiscal year 1998, the Company
entered into an Amended and Restated Credit Agreement (the Agreement) with a
domestic bank providing for a revolving credit facility (Credit Facility) with
a maximum availability of $11.5 million. This Agreement expired on
September 17, 2002, and the Company did not renew the Credit Agreement.

Interest expense was $138,000 for the
fiscal year ended June 29, 2002.

# NOTE 5: INVESTMENT IN
JOINT VENTURE

In June 1998, the Company formed a
50/50 China JV with NSG in China to manufacture, process, sell and export certain types of
thin film coated glass. Each party contributed $3.2 million in cash to the China JV
as equity. During fiscal 2002, 2001 and 1999, the Company sold new and refurbished
equipment to the China JV for use in the process of thin film coating of glass. The sales
prices were approximately $1.2 million, $5.6 million and $5.1 million,
respectively. Because the Company owns 50% of the China JV, the Company recorded 50% of
the revenue and related cost of the sales and has deferred 50% of the gross profit of each
sale, approximately $0, $1.3 million and $1.4 million, respectively, which will
be recognized on a straight-line basis over ten years, consistent with the depreciation
schedule at the China JV and the estimated depreciable life of the equipment. The
amortization of the deferred gross profit is included with Equity earnings of joint
venture in the accompanying consolidated statements of operations.

The China JV began operations during
the fourth quarter of fiscal 1999. The Company records 50% of income or loss from
operations of the China JV after eliminating the impact of inter-entity transactions. The
functional currency for the China JV is the local Chinese Yuan Renminbi. The
Companys investment in the China JV is translated into U.S. dollars using the
period-end exchange rate. The earnings recorded by the Company from the China JV are
translated at average rates prevailing during the period, which have remained fixed by the
Chinese government for a number of years. The cumulative translation gain or loss, if any,
is recorded as Other cumulative comprehensive income (loss) in the
Companys consolidated financial statements.

During the third quarter of fiscal
2004, the China JV entered into an unsecured credit facility that did not require bank
guaranty from either of the parent companies. Subsequently, the Companys guaranty of
50% of the debt of the China JV was released. As of June 28, 2003, the Company had
provided a letter of credit under its commercial loan facility to guarantee approximately
$5.0 million of the debt of the China JV.

Page 52 of 63

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In addition, during fiscal years
2004, 2003, and 2002, the Company received cash royalty payments from the China JV
totaling $399,000, $404,000, and $220,000, respectively. The Company recorded sales to the
China JV of $544,000, $783,000 and $459,000 in fiscal years ended June 26, 2004,
June 28, 2003 and June 29, 2002, respectively.

Summarized statement of operations
information for the China JV is presented below (in thousands):

|                                                     | Fiscal Year Ended
|---------------------------------------------------- | -----------------
|                                                     |                  
|                                                     |                  
|                                                     |                  
|China JV:                                            |                  
|Operating revenues                                   |                  
|                                                     |                  
|Net income                                           |                  
|                                                     |                  
|Applied Films' equity in earnings:                   |                  
|Proportionate share of net income after eliminations |                  
|Amortization of deferred gain on sale of equipment   |                  
|                                                     |                  
|Equity earnings of joint venture                     |                  
|                                                     |                  

Summarized balance sheet information
for the China JV is presented below (in thousands):

|                                    | June 30, 2004 | June 30, 2003
|----------------------------------- | ------------- | -------------
|                                    |               |              
|Assets:                             |               |              
|Current assets                      |               |              
|Property, plant, and equipment, net |               |              
|                                    |               |              
|                                    |               |              
|                                    |               |              
|Capitalization and liabilities:     |               |              
|Current liabilities                 |               |              
|Short-term debt                     |               |              
|Equity                              |               |              
|                                    |               |              
|                                    |               |              
|                                    |               |              

As of June 26, 2004, the
Company does not have accounts payable to the Joint Venture. At June 28, 2003,
the Company had accounts payable to the China JV of approximately $578,000. As of June 26,
2004 and June 28, 2003, the Company had receivables from the China JV of approximately
$273,000, (including royalty receivables of $156,000) and $238,000, respectively.

# NOTE 6: WARRANTS AND
STOCK COMPENSATION PLANS

In January 2001, the Company issued
warrants to purchase 75,949 shares of common stock at $22.33 per share and
warrants to purchase 17,468 shares at $20.09 per share in connection with a Series A
convertable preferred stock offering. The Series A Convertible Preferred
Stock was converted into 506,328 shares of common stock in December 2001. The warrants are
immediately exercisable, and may be exercised any time over a five and three year period,
respectively. The Company determined the fair value of these warrants to be approximately
$733,623 using the Black-Scholes option pricing model using the following weighted average
assumptions:

|                        | 
|----------------------- | 
|Risk-free interest rate | 
|Expected life           | 
|Expected volatility     | 
|Expected dividend yield | 

The estimated fair value of these
warrants was recorded in stockholders equity with an offset to the amount attributed
to the Series A convertible preferred stock. These securities also contain certain
registration rights with respect to the underlying shares of common stock.

On October 17, 2003, the
holder of a warrant to purchase 17,468 shares of common stock at a price of $20.09 per
share exercised the warrant through a cashless option permitted under the terms of the
warrant. As a result, on October 17, 2003, the Company issued 5,865 shares in
satisfaction of the warrant and received no payment for the shares.

Page 53 of 63

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Stock Options

In May 1993, the board of directors
approved the Companys 1993 Stock Option Plan (the 1993 Plan) covering
276,500 shares of common stock. The exercise price of these options was determined by the
board of directors. The options granted in fiscal years 1994 and 1995 vested over a four
year period and, under its original terms, were not exercisable until after an initial
public offering of common stock was completed by the Company. Accordingly, the Company
accounted for the 1993 Plan as a variable plan until June 30, 1995, at which
time the board of directors declared that the options then outstanding were exercisable,
subject to their vesting terms. The Company recorded approximately $597,000 of deferred
compensation related to all options, which was equal to the excess of the estimated fair
market value of the common stock as of July 1, 1995 over the exercise price. As
of July 3, 1999, all of the compensation has been expensed.

In April 1997, the Company adopted
the 1997 Stock Option Plan (the 1997 Plan) covering 272,500 shares of common
stock, as amended. The exercise price of options granted under the 1997 Plan is determined
by the board of directors based upon estimated fair market value. The options granted are
to vest ratably over four years. In October 1999, the shareholders of the Company approved
an increase of 100,000 shares to the 1997 Plan, increasing the shares available for
granting to 372,500 shares. In October 2000, the shareholders of the Company approved an
increase of 650,000 shares to the 1997 Stock Option Plan, increasing the shares available
to 1,022,500 shares. Options vest 25% one year after the grant date of the option, and 25%
every year after for three years, and expire no later than ten years after the grant date
of the option.

On October 22, 2003, the Company
adopted the Long Term Incentive Plan covering 1.2 million shares of common stock. The Plan
provides for the granting of stock options, stock appreciation rights, restricted stock,
performance shares and other stock-based awards. The exercise price of options granted
under the Long Term Incentive Plan is determined by the board of directors based upon
estimated fair market value. Options vest 25% one year after the grant date of the option,
and 25% every year after for three years and expire no later than ten years after the
grant date of the option.

Stock Appreciation Rights (SARs)
 The board of directors may approve the grant of SARS that are related to options
only. A SAR may be granted only at the time of grant of the related option. The SAR
granted will be exercisable only to the extent that a related option is exercisable. The
value of the SAR will be determine by multiplying the difference between the fair market
value of a share of common stock on the date of exercise over the option price by the
number of shares of common stock with respect to which the SAR is exercised. The SAR
exercise may be in cash, in shares of common stock or in some combination of cash and
stock.

Restricted Stock  Restricted
stock may be issued either alone or in addition to other awards granted under the Plan.
The board of directors will determine the eligible person, the number of shares to be
awarded, the price, the time that each award will be subject to forfeiture, the vesting
schedule and rights to acceleration. The awards can be different per individual receiving
the award. Each restricted stock award must be accepted within 30 days after the award
date by executing an award agreement and paying the price designated. The recipient of the
restricted stock will not be permitted to sell, transfer, pledge, or assign shares awarded
for a certain period of time as determined by the board of directors.

Performance Shares  Performance
shares may be awarded either alone or in addition to other awards granted under the Plan.
The board of directors shall determine the eligible persons, the time at which performance
shares shall be awarded, the number of performance shares to be awarded and during which
receipt of the performance shares will be deferred. The board of directors may condition
the grant of performance shares upon the achievement of specific business objectives,
measurements of individual, business unit, Company or Subsidiary performance, or such
other factors or criteria as determined. The awards can be different per individual
receiving the award. The recipient of the performance shares will not be permitted to
sell, transfer, pledge, or assign shares awarded for a certain period of time as
determined by the board of directors.

Other Stock-Based Awards  Other
Stock-Based Awards of common stock may be granted either alone or in addition to other
awards under the Plan. The board of directors will determine whom, the time of such award,
the number of shares to be awarded and all other conditions of the awards. The awards can
be different per individual receiving the award.

Outside Directors
Options

In July 2001, the Company amended the
Outside Director Stock Option Plan to cover an aggregate of 124,000 shares of common
stock. The exercise price of the options under this plan is determined based upon the
estimated fair market value. Options under this plan vest 100% one year after the grant
date of the option and expire ten years after the grant date of the option.

Page 54 of 63

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Employee Stock
Purchase Plan

On September 5, 1997, the
Board of Directors adopted, and the stockholders subsequently approved, the Applied Films
Corporation Employee Stock Purchase Plan (Purchase Plan) as amended in October
2000. The Purchase Plan was amended April 17, 2002 to institute two six-month
Option Periods each year commencing on the first business day of May and November,
respectively. The Purchase Plan permits eligible employees to purchase shares of common
stock through payroll deductions. Shares are purchased at 85% of the fair market value of
the lower of the common stock on the date of the beginning of the period or the
Purchase Date. Purchases are priced on the last business day of
April and October, respectively, for the purchases of as many full shares, but not less
than one (1) full share, as may be purchased with the funds in his or her Purchase
Account. Up to 100,000 shares of common stock may be sold under the Purchase Plan. Shares
sold under the Purchase Plan may be newly issued shares or shares acquired by the Company
in the open market. Unless terminated earlier by the Board of Directors, the Purchase Plan
will terminate on September 5, 2007. The Purchase Plan is intended to qualify as
an employee stock purchase plan under Section 423 of the Internal Revenue Code
of 1986, as amended, and will be administered in accordance with the limitations set forth
in Section 423 and the rules and regulations thereunder.

During fiscal years 2004, 2003, and
2002, the Company issued shares to employees of 8,457, 14,042, and 8,799, under this plan,
respectively, at a purchase price ranging from $2.81 to $38.50 per share. A total 51,259
shares have been issued under the plan since inception.

A summary of the Companys Stock
Option Plans are as follows:

|                                                | For The Fiscal Years Ended
|----------------------------------------------- | --------------------------
|                                                |                           
|                                                |                           
|                                                |                           
|                                                |                           
|                                                |                           
|Outstanding at beginning of year                |                           
|Granted                                         |                           
|Forfeited                                       |                           
|Exercised                                       |                           
|                                                |                           
|Outstanding at end of year                      |                           
|                                                |                           
|Exercisable at end of year                      |                           
|                                                |                           
|Weighted average fair value of  options granted |                           
|                                                |                           

The following table summarizes
information about employee stock options outstanding and exercisable at June 26, 2004:

|                | Options Outstanding | Options Exercisable
|--------------- | ------------------- | -------------------
|                |                     |                    
|                |                     |                    
|                |                     |                    
|$2.75 - $5.26   |                     |                    
|$9.51 - $10.53  |                     |                    
|$14.00 - $18.00 |                     |                    
|$18.36 - $19.95 |                     |                    
|$23.94 - $29.39 |                     |                    
|$29.43 - $29.43 |                     |                    
|$29.64 - $29.64 |                     |                    
|$32.75 - $33.14 |                     |                    
|$38.27 - $38.27 |                     |                    
|$38.50 - $38.50 |                     |                    
|                |                     |                    
|                |                     |                    
|                |                     |                    

Page 55 of 63

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# NOTE 7: INCOME TAXES

The Company accounts for income taxes
through recognition of deferred tax assets and liabilities for the expected future income
tax consequences of events, which have been included in the financial statements or tax
returns. Under this method, deferred tax assets and liabilities are determined based on
the difference between the financial statement and tax basis of assets and liabilities
using enacted tax rates in effect for the year in which the differences are expected to
reverse. Provision has not been made for additional foreign taxes on undistributed
earnings of our foreign subsidiaries and the China JV where such earnings will continue to
be reinvested.

Income (loss) from continuing operations before
income taxes consists of the following (in thousands):

|                                  | Years Ended
|--------------------------------- | -----------
|                                  |            
|                                  |            
|                                  |            
|Domestic                          |            
|Foreign                           |            
|                                  |            
|Income (loss) before income taxes |            
|                                  |            

The net deferred tax asset
(liability) is comprised of the following (in thousands):

|                                  | June 26, 2004 | June 28, 2003
|--------------------------------- | ------------- | -------------
|                                  |               |              
|                                  |              
|Inventories                       |               |              
|Accrued expenses                  |               |              
|Deferred gain                     |               |              
|Goodwill and intangible assets    |               |              
|Net operating loss carry forwards |               |              
|Valuation allowance               |               |              
|                                  |               |              
|Total deferred tax assets         |               |              
|                                  |               |              
|Property, plant and equipment     |               |              
|Uncompleted contracts             |               |              
|                                  |               |              
|Total deferred tax liabilities    |               |              
|                                  |               |              
|Total deferred tax asset, net     |               |              
|                                  |               |              

Income tax (benefit) provision
related to continuing operations for
the fiscal years ended June 26, 2004, June 28, 2003, and
June 29, 2002, consist of the following (in thousands):

|                                                    | Years Ended
|--------------------------------------------------- | -----------
|                                                    |            
|                                                    |            
|                                                    |            
|Current provision (benefit):                        |            
|Federal                                             |            
|State                                               |            
|Foreign                                             |            
|                                                    |            
|Total current provision (benefit)                   |            
|Deferred provision (benefit):                       |            
|Federal                                             |            
|State                                               |            
|Foreign                                             |            
|                                                    |            
|Total deferred provision                            |            
|                                                    |            
|Total tax provision (benefit) related to continuing |            
|operations                                          |            
|                                                    |            

Reconciliations between the effective
statutory federal income tax provision (benefit) rate and the Companys effective
income tax provision (benefit) rate as a percentage of net income (loss) related to continuing operations before taxes were
as follows:

Page 56 of 63

---



|                                                      | June 26, 2004 | June 28, 2003 | June 29, 2002
|----------------------------------------------------- | ------------- | ------------- | -------------
|                                                      |               |               |              
|Statutory federal income tax (benefit) provision rate |               |               |              
|State income taxes                                    |               |               |              
|Foreign income taxes and other                        |               |               |              
|Equity earnings in Joint Venture                      |               |               |              
|Foreign tax exempt interest                           |               |               |              
|Valuation allowance                                   |               |               |              
|Valuation allowance due to net operating loss         |               |              
|utilization                                           |               |               |              
|Other                                                 |               |               |              
|                                                      |               |               |              
|Effective income tax (benefit) provision              |               |               |              
|                                                      |               |               |              

As of June 26, 2004, the Company had
net operating losses available to offset future taxable income of approximately
$10.2 million in the United States which expire through 2025 and $36.6 million
in Germany which have an indefinite life. The valuation allowance increased by
approximately $1.3 million in fiscal 2004 and increased by approximately
$7.2 million in fiscal 2003. As of June 26, 2004, approximately $1.3 million of
the valuation allowance is related to the benefits of stock option deductions, which will
be credited to paid-in-capital when realized. The current year unrealized benefit
generated is approximately $652,000.

# NOTE 8: EMPLOYEE BENEFIT
PLANS

Profit Sharing Plan

In August 1992, the Board of
Directors adopted a profit sharing plan for all non-bonus eligible employees. The amount to be
contributed to the profit sharing pool, subject to the approval of the Companys
board of directors, is generally 15% of operating income excluding any amortization of
intangibles related to acquisitions. With the exception of our employees in Germany, whose
compensation is governed by a company tariff agreement, profit sharing is paid pro rata based on the
total employee base to
employees in cash, quarterly, based on a combination of their length of service with the
Company and their pay level. The Company expensed approximately $327,000, $75,000, and
$77,000, in fiscal years 2004, 2003, and 2002, respectively, related to this plan.

Pension Plan

Applied Films GmbH & Co. KG maintains a noncontributory
defined benefit pension plan covering substantially all employees of Applied Films GmbH & Co. KG. Benefits are
based primarily on compensation during a specified period before retirement of a specified
amount for each year of service. The assumed pension liability of $13.3 million is
reflected in the accompanying consolidated balance sheet as of June 26, 2004,
and is subject to adjustment based upon an assessment of the actuarial value of the
obligation. This plan has no assets as of June 26, 2004.

Page 57 of 63

---



The following table sets forth the
benefit obligation, the funded status of the pension plan, amounts recognized on the
Companys consolidated financial statements, and the principal weighted average
assumptions used (in thousands):

|                                          | Year Ended
|----------------------------------------- | ----------
|                                          |           
|                                         
|                                          |           
|Change in benefit obligation:             |           
|Benefit obligation at beginning of year   |           
|Service costs                             |           
|Interest costs                            |           
|Actuarial (gain) loss                     |           
|Foreign exchange loss                     |           
|Benefits paid                             |           
|Transfers                                 |           
|                                          |           
|Benefit obligation at end of year         |           
|                                          |           
|Funded status:                            |           
|Unrecognized net actuarial gain           |           
|Unrecognized prior service cost           |           
|                                          |           
|Net amount recognized                     |           
|                                          |           
|Amounts recognized in the balance sheets: |           
|Accrued pension benefit obligation        |           
|                                          |           
|Net amount recognized                     |           
|                                          |           
|Weighted-average assumptions              |           
|Discount rate                             |           
|Expected return on plan assets            |           
|Rate of compensation increase:            |           
|Employee                                  |           
|Retired                                   |           
|Components of net periodic benefit cost:  |           
|Service cost                              |           
|Interest cost                             |           
|Expected return on plan assets            |           
|Amortization of prior service costs       |           
|Recognition of actuarial (gain) loss      |           
|                                          |           
|Net periodic benefit costs                |           
|                                          |           

The following benefit payments, which
reflect expected future service, as appropriate, are expected to be paid (in thousands):

|            | 
|----------- | 
|Fiscal Year | 
|            | 
|2005        | 
|2006        | 
|2007        | 
|2008        | 
|2009        | 
|            | 
|            | 
|            | 

# NOTE 9: SIGNIFICANT
CUSTOMERS

During fiscal years 2004, 2003, and
2002, approximately 81%, 70%, and 58%, respectively, of the Companys net revenues
were exported to customers outside of Europe where the Company manufactures its systems.
The Companys ten largest customers accounted for, in the aggregate, approximately
65%, 53%, and 62%, of the Companys net revenues in fiscal 2004, 2003, and 2002,
respectively. Revenues from our two largest customers in fiscal 2004, LG International and
AFG Industries, Inc., represented 13% and 12% respectively, of our net revenues for that
year. Revenues from these customers for fiscal 2004, consisted of thin film deposition
equipment and spare parts. The loss of, or a significant reduction in purchases by, one or
more of these customers would have a material adverse effect on the Companys
operating results.

Page 58 of 63

---



The following table represents the
breakdown of net revenues (as adjusted for discontinued operations) by geographic region
(in thousands):

|                 | Fiscal Year Ended
|---------------- | -----------------
|                 |                  
|                 |                  
|                 |                  
|Asia             |                  
|United States    |                  
|Europe and other |                  
|                 |                  
|                 |                  
|                 |                  

|                 | Fiscal Year Ended
|---------------- | -----------------
|                 |                  
|                 |                  
|                 |                  
|Asia             |                  
|United States    |                  
|Europe and other |                  
|                 |                  
|                 |                  
|                 |                  

The following table represents the
breakdown of net long-lived assets (as adjusted for discontinued operation) by geographic
region (in thousands):

|                 | Fiscal Year Ended
|---------------- | -----------------
|                 |                  
|                
|                 |                  
|Asia             |                  
|United States    |                  
|Europe and other |                  
|                 |                  
|                 |                  
|                 |                  

The Companys sales are
typically denominated in Euros. As a result, the Company recognized approximately
$1,340,000, $823,000, and $(15,000), of foreign currency exchange rate gain (loss) on
foreign currency exchange rate fluctuations for the fiscal years ended
June 26, 2004, June 28, 2003, and June 29, 2002,
respectively. The Company has $14.0 million and $8.4 million of its accounts
receivable denominated in Euros, and $22.2 million and $9.9 million of its
accounts payable denominated in Euros as of June 26, 2004 and June 28,
2003, respectively.

# NOTE 10: LEASES

The Company is obligated under
certain non-cancelable operating leases for office, manufacturing and warehouse
facilities, and various equipment. Beginning in April 2002, the Company entered into an
eight-year lease for the Companys manufacturing and administrative location in
Germany. Under this lease, payments are fixed for the entire term of the lease and there
is an option to renew the term for an additional five years. The Company entered into a
lease for the Companys manufacturing and administrative location in Longmont,
Colorado, which commenced on January 30, 1998; payments were fixed until the
first day of the second lease year, at which time payments increase annually one and
one-half percent plus one-half of the increase in the Consumer Price Index per annum.
Lease payments for the Longmont location have been normalized over the term of the lease.
The initial lease term is 15 years, with two additional five year options to extend. Both
of these facility leases are accounted for as operating leases.

In connection with the sale of the
Longmont Coating Division, the Company and Optera, Inc. entered into a sublease pursuant
to which Optera, Inc. is subleasing approximately 40,900 square feet at the Companys
Longmont, Colorado facility, which contains approximately 126,000 square feet. The term of
the sublease began on September 24, 2002 and will terminate on
March 31, 2005. Optera, Inc. has the option to renew the sublease for additional
periods of one year each commencing at the expiration of the initial term and continuing
until the expiration or termination of the Companys lease for the Longmont, Colorado
facility. The subtenant also holds a right of first refusal with respect to the assignment
or subleasing of, and holds an option to lease, certain additional space in the Longmont,
Colorado facility. Basic rent under the sublease for the initial term is $252,000
annually.

Page 59 of 63

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The future minimum payments under the
operating leases are as follows (in thousands):

|Fiscal Year                  | Operating leases
|---------------------------- | ----------------
|                             |                 
|2005                         |                 
|2006                         |                 
|2007                         |                 
|2008                         |                 
|2009                         |                 
|2010 and thereafter          |                 
|                             |                 
|Total minimum lease payments |                 
|                             |                 

Rent expense under operating leases
was $6.7 million, $6.6 million, and $5.7 million, for fiscal years ended
June 26, 2004, June 28, 2003, and June 29, 2002. During
fiscal 2004, rent expense is net of sublease income of $252,000.

# NOTE 11: FAIR VALUE OF
FINANCIAL INSTRUMENTS

Financial instruments consist of cash
and cash equivalents, marketable securities, accounts receivable, accounts payable, and
notes receivable. Carrying values of cash and cash equivalents, accounts receivable, and
accounts payable approximate fair value. Investments are reported at fair value.
Management believes differences between fair values and carrying values of notes
receivable would not be materially different because interest rates approximate market
rates for material items.

# NOTE 12: HELIX
ACQUISITION

The Company completed the acquisition
of the In-Line Systems division of Helix Technology, Inc., Taiwan (the In-line
Division) on June 2, 2004. The In-line Division produces equipment for the FPD
industry and other industries. The acquisition will allow the Company to expand its
operations to include manufacturing in Asia. The aggregate consideration and costs paid by
the Company was $15.1 million consisting of $12.5 million of cash and 80,826 shares of
Applied Films Corporation common stock valued at $26.59 per share (total value of $2.15
million, based upon the average of the closing market prices for the three days before and
after, and the day of the close of the transaction, June 2, 2004), and $497,000 in
transaction costs. The acquisition was accounted for under the purchase method of
accounting.

The accounts of this acquisition have
been included in the Companys consolidated financial statements from the acquisition
date. The purchase price was allocated based upon the estimated fair value of the
identifiable assets acquired. The excess of the purchase price over fair value of net
identifiable assets was allocated to goodwill. The $15.1 million purchase price was
allocated as follows (in thousands):

|Inventory                           |  |  | $ | 1,261  | 
|----------------------------------- |  |  | - | ------ | 
|Goodwill                            |  |  |   | 2,891  | 
|Other intangible assets             |  |  |   | 2,113  | 
|Property, plant and equipment       |  |  |   | 6,658  | 
|In-process research and development |  |  |   | 2,226  | 
|                                    |  | 
|Total allocation of purchase price  |  |  | $ | 15,149 | 
|                                    |  | 

The Company is currently undergoing
an independent third party valuation of the assets acquired and the purchase price
allocation. The valuation should be completed during the second quarter of fiscal 2005.
Intangible assets are being amortized on a straight line basis over periods of five to
seven years. The in-process research and development charge represents the intangible
value of in-process research and development projects that had not yet reached technical
feasibility. The related technology had no alternative use and requires substantial
additional development by the Company. In-process research and development was charged to
operations during fiscal year 2004.

At June 26, 2004, $3.5 million of the
purchase price is being held in an escrow account pending final settlement and
reconciliation of acquired assets in accordance with the terms of the purchase agreement.
The final payment is anticipated to be made by the end of the second quarter of fiscal
year 2005.

Page 60 of 63

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# NOTE 13: QUARTERLY
INFORMATION (unaudited)

The following table sets forth
summary unaudited quarterly financial information for the eight fiscal quarters ended
June 26, 2004.

|                                                             | Fiscal 2003 Quarters Ended            | Fiscal 2004 Quarters Ended
|------------------------------------------------------------ | ------------------------------------- | --------------------------
|                                                             |                                       |                           
|                                                             |                                       |                           
|                                                             |                                       |                           
|                                                             | (in thousands, except per share data)
|Net revenues                                                 |                                       |                           
|Cost of goods sold                                           |                                       |                           
|                                                             |                                       |                           
|Gross profit                                                 |                                       |                           
|Operating expenses:                                          |                                       |                           
|Research and development                                     |                                       |                           
|Selling, general and administrative                          |                                       |                           
|In process research and development                          |                                       |                           
|Amortization of other intangible assets                      |                                       |                           
|                                                             |                                       |                           
|Income (loss) from operations                                |                                       |                           
|Other income, net:                                           |                                       |                           
|Interest income, net                                         |                                       |                           
|Other income, net                                            |                                       |                           
|Equity earnings of Joint Venture                             |                                       |                           
|                                                             |                                       |                           
|Income (loss) from continuing operations before income taxes |                                       |                           
|Income tax benefit (expense)                                 |                                       |                           
|                                                             |                                       |                           
|Income (loss) from continuing operations                     |                                       |                           
|Discontinued operations:                                     |                                       |                           
|Income (loss) from discontinued operations, net of tax       |                                       |                           
|Gain on the disposal of discontinued operations, net of tax  |                                       |                           
|                                                             |                                       |                           
|Discontinued operations, net of tax                          |                                       |                           
|                                                             |                                       |                           
|Net income (loss)                                            |                                       |                           
|                                                             |                                       |                           
|Income (loss) per share:                                     |                                       |                           
|Basic:                                                       |                                       |                           
|Basic income (loss) from continuing operations               |                                       |                           
|Income (loss) from discontinued operations                   |                                       |                           
|                                                             |                                       |                           
|Basic income (loss) per share                                |                                       |                           
|                                                             |                                       |                           
|Diluted:                                                     |                                       |                           
|Diluted income (loss) from continuing operations             |                                       |                           
|Income (loss) from discontinued operations                   |                                       |                           
|                                                             |                                       |                           
|Diluted income (loss) per share                              |                                       |                           
|                                                             |                                       |                           
|Weighted average common shares outstanding:                  |                                       |                           
|Basic                                                        |                                       |                           
|                                                             |                                       |                           
|Diluted                                                      |                                       |                           
|                                                             |                                       |                           

# ITEM 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

# ITEM
9A:  Controls And Procedures

The Company maintains certain
disclosure controls and procedures that are designed to ensure that information required
to be disclosed in the Companys Exchange Act reports is recorded, processed,
summarized and reported within the time periods specified by the Securities and Exchange
Commission and that such information is accumulated and communicated to the Companys
management, including its Chief Executive Officer and Chief Financial Officer, as
appropriate, to permit timely decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, the Companys management
recognizes that any controls and procedures, no matter how well designed and implemented,
can provide only reasonable assurance of achieving the desired control objectives, and
managements duties require it to make its best judgment in evaluating the
cost-benefit relationship of potential controls and procedures.

The Company and its management,
including the Chief Executive Officer and Chief Financial Officer, engage in a variety of
perpetual procedures to evaluate the effectiveness of the design and implementation of the
Companys disclosure controls and procedures. Based on the foregoing, the
Companys Chief Executive Officer and Chief Financial Officer have concluded that,
except as otherwise noted below, the Companys disclosure controls and procedures
were reasonably effective in meeting the desired objectives as of June 26, 2004.

In connection with the audit of the
Companys consolidated financial statements for the fiscal year ended June 26, 2004,
our independent auditors, Ernst & Young LLP, identified and communicated to the
Company and its Audit Committee a significant deficiency (as defined under the
standards established by the Public Company Accounting Oversight Board) relating to the
Companys internal controls over its financial reporting for income taxes. The
significant deficiency related to the lack of adequate resources and processes to ensure
proper initial recording, management review and oversight of certain accounting matters
related to income taxes. The Company has since devoted and will continue to devote
resources to improve its contols to remedy this significant deficiency. Ernst & Young
LLP has not identified any material weaknesses in connection with their audit of the
fiscal 2004 financial statements. The Companys efforts to strengthen its financial
and internal controls continue, and the Company expects to complete remediation of the
significant deficiency by the end of fiscal 2005.

There has been no change in the
Companys internal controls over financial reporting during the Companys most
recent fiscal quarter that has materially affected, or is reasonably likely to materially
affect, the Companys internal control over financial reporting. The significant
deficiency described above was identified and changes to remedy the significant deficiency
were begun after the fiscal year end date of June 26, 2004.

Page 61 of 63

---



# PART III

# ITEM 10: Directors and
Executive Officers of the Registrant

Information required to be furnished
by Items 401 and 405 of Regulation S-K is included in our definitive Proxy Statement for
our 2004 annual meeting of shareholders to be filed with the Securities and Exchange
Commission within 120 days after the end of the fiscal year to which this report relates
(the 2004 Proxy Statement) and is incorporated herein by reference.

We have adopted a Code of Conduct and
Ethical Guidelines Statement, which applies to all of our officers, directors, and
employees. A current copy of the code is posted at our website
http://www.appliedfilms.com.

# ITEM 11: Executive
Compensation

Information required to be furnished
by Item 402 of Regulation S-K is included in our 2004 Proxy Statement and is incorporated
herein by reference.

# ITEM 12: Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information required to be furnished
by Item 403 of Regulation S-K is included in our 2004 Proxy Statement and is incorporated
herein by reference.

|                              | Equity Compensation Plan Information
|----------------------------- | ------------------------------------
|                              |                                     
|                              |                                     
|                              |                                     
|                              |                                     
|                              |                                     
|Equity compensation plans     |                                     
|approved by security holders  |                                     
|Equity compensation plans not |                                     
|approved by security holders  |                                     
|Total                         |                                     

(1)
          We have not granted warrants or rights applicable to this chart.

# ITEM 13: Certain
Relationships and Related Transactions

Information required to be furnished
by Item 404 of Regulation S-K is included in our 2004 Proxy Statement and is incorporated
herein by reference.

# ITEM 14: Principal
Accountant Fees And Services

Information required to be furnished
by Item 9(e) of Schedule 14A of Regulation S-K is included in our 2004 Proxy Statement and
is incorporated herein by reference.

# PART IV

# ITEM 15: Exhibits,
Financial Statements, Schedules, and Reports on Form 8-K

|(a) | The
following documents are filed as part of this report:
|--- | ---------------------------------------------------------

| | 1. | Financial
Statements
| | -- | --------------------

| | The
Registrants consolidated financial statements, for the year ended
June 26, 2004, together with the Report of Independent Registered Public
Accounting Firm are filed as part of this Form 10-K report. See ITEM 8:
Financial Statements and Supplementary Data. The supplemental financial information
listed and appearing hereafter should be read in conjunction with the financial statements
included in this report.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Page 62 of 63

---



| | 2. | Financial
Statement Schedules
| | -- | -----------------------------

| | Except
for Schedule II set forth below, financial statement schedules are not submitted because
they are not applicable or because the required information is included in the
consolidated financial statements or notes thereto. 
Schedule II
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Valuation and Qualifying Accounts | (dollars in thousands)
| | --------------------------------- | ----------------------
| |                                   |                       
| |                                   |                       
| |                                   |                       
| | 2004                              |                       
| | 2003                              |                       
| | 2002                              |                       

| | 3. | Exhibits
| | -- | --------

| | Reference
is made to the Exhibit Index that begins on the last page of the body of this Form 10-K
Annual Report preceding the exhibits.
| | ---------------------------------------------------------------------------------------------------------------------------------------

|(b) | Reports
on Form 8-K
|--- | -------------------

| | (i) | The Registrant filed a Current Report on Form 8-K dated June 1, 2004, disclosing
               in Item 9 a press release announcing that it completed the acquisition of the
               In-line Systems division of Helix Technology, Inc.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (ii) | The Registrant filed a Current Report on Form 8-K dated April 21, 2004,
               disclosing in Item 12 an earnings press release announcing results for the
               second quarter of fiscal 2004.
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(c) | Exhibits
|--- | --------

| | The
response to this portion of Item 15 is included in the Exhibit Index to this Annual
Report.
| | -----------------------------------------------------------------------------------------------

|(d) | Financial
Statement Schedules
|--- | -----------------------------

| | The
response to this section of Item 15 is in Item 15(a)(2) above.
| | ------------------------------------------------------------------

Page 63 of 63

---



# SIGNATURES

Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
registrant has duly caused this annual report to be signed on its behalf by the
undersigned, thereunto duly authorized.

| |  | APPLIED
FILMS CORPORATIONBy: /s/ Thomas T. Edman  
Thomas T. Edman  Chief Executive Officer and PresidentDate: September 7, 2004
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed by
the following persons in the capacities indicated on September 7, 2004. The persons named
below each herby appoint Thomas T. Edman and Lawrence D. Firestone, and each of them
severally, as his attorney in fact, to sign in his name and on his behalf, as a director
or officer of the Registrant, and to file with the Commission any and all amendments to
this report on Form 10-K.

|Signature                                                | Title
|-------------------------------------------------------- | -----
|                                                        
|/s/ Richard P. Beck
Richard P. Beck        |      
|                                                        
|/s/ Thomas T. Edman
Thomas T. Edman        |      
|                                                        
|/s/ Lawrence D. Firestone
Vincent Sollitto |      
|                                                        
|/s/ Allen Alley
Allen Alley                |      
|                                                        
|/s/ John S. Chapin
John S. Chapin          |      
|                                                        
|/s/ Gerald J. Laber
Gerald J. Laber        |      
|                                                        
|/s/ Vincent Sollitto
Vincent Sollitto      |      

---



EXHIBIT INDEX

|Exhibit No. | Description
|----------- | -----------

| | 3.1 |  | Amended and Restated Articles of Incorporation of Applied Films Corporation, as amended,
are incorporated by reference to Exhibit 3.1 of Registrants Current Report on Form
8-K dated January 16, 2001.
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.2 | Amended
and Restated Bylaws of Applied Films  Corporation are  incorporated by reference to
Exhibit 3.2                  of Registrant's Registration Statement on Form S-1, as
amended (Reg. No. 333-35331).
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4.1 | Specimen
 common  stock  certificate  is  incorporated  by  reference  to Exhibit  4.1 of
 Registrant's                  Registration Statement on Form S-1, as amended (Reg. No.
333-35331).
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4.2 |  | Specimen Series A Preferred Stock certificate is incorporated by reference to Exhibit 4.1
of Registrants Current Report on Form 8-K dated January 16, 2001.
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.1 | 1993
 Stock  Option  Plan is  incorporated  by  reference  to  Exhibit 4 of  Registrant's
 Registration                  Statement on Form S-8 (Reg. No. 333-51175).
| | ---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.2 | 1997
Stock Option  Plan,  as amended,  is  incorporated  by  reference to Exhibit 10-2 of
 Registrant's                  Registration  Statement on Form S-1, as amended (Reg.  No.
 333-35331),  by reference to Exhibit 4.2 of                  Registrant's  Registration
 Statement on Form S-8 (Reg.  No.  333-47967) to reference to Exhibit 4.2 of
                 Registrant's  Registration  Statement on Form S-8 (Reg. No.  333-38426)
any by reference to Exhibit 4.2                  and 4.3 of  Registrant's  Registration
 Statement  on Form  S-8  (Reg.  No.  333-56376)  and the  Fifth
                 Amendment  to the  1997  Stock  Option  Plan  is  incorporated  by
 reference  to  Exhibit  10.2 to the                  Registrant's Annual Report on Form
10-K/A for the fiscal year ended June 29, 2002.
| | ---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.3 | Employee
Stock Purchase Plan, as amended,  is incorporated by reference to Exhibit 10.3 of
Registrant's                  Registration  Statement on Form S-1, as amended (Reg. No.
333-35331),  by reference to Exhibit 4 to the                  Registrant's  Registration
 Statement on Form S-8 (Reg. No.  333-47951) and by reference to Exhibit 4.2
                 on Registrant's  Registration  Statement on Form S-8 (Reg. No.
 333-56378) and the Fourth  Amendment to                  the Employee  Stock  Purchase
 Plan is  incorporated  by reference to Exhibit 10.3 to the  Registrant's
                 Annual Report on Form 10-K/A for the fiscal year ended June 29, 2002.
| | ---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.4 | Outside
 Director  Stock  Option Plan is  incorporated  by  reference  to Exhibit  4.1 of
 Registrant's                  Registration  Statement on Form S-8 (Reg. No.  333-95367),
 and by reference to Exhibits 4.2 and 4.3 of                  Registrant's Registration
Statement on Form S-8 (Reg. No. 333-75164).
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.5 | Non-Employee, Non-Director Officer and Consultant Non-Qualified Stock Option Plan dated
October 24, 2001 is incorporated by reference to Exhibit 10.3 of Registrants
Quarterly Report on Form 10-Q for the fiscal quarter ended December 29, 2001.
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.6 | Long
Term  Incentive  Plan is  incorporated  by reference to Exhibit 4.3 of  Registrant's
 Registration                  Statement on Form S-8 (Reg. No. 333-114809).
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.7 | Severance
Agreement between Applied Films Corporation and Thomas T. Edman dated July 26, 2002.
| | ---- | ----------------------------------------------------------------------------------------------

| | 10.8 | Severance
Agreement between Applied Films Corporation and Lawrence D. Firestone dated July 26, 2002.
| | ---- | ----------------------------------------------------------------------------------------------------

| | 10.9 | Form
of Indemnity  Agreement  between  Registrant  and each of its Directors and Executive
 Officers is                  incorporated  by  reference  to Exhibit  10.4 of
 Registrant's  Registration  Statement on Form S-1, as                  amended (Reg. No.
333-35331).
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.10 | Lease Agreement dated January 30, 1998, between 9586 East Frontage Road, Longmont, CO
80504 LLC and Registrant is incorporated by reference to Exhibit 10.9 of Registrants
Quarterly Report on form 10-Q for the fiscal quarter ended December 27, 1997.
| | ----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---



| | 10.11 | Lease Agreement between RWE Systems Immobilren GmbH & Co. KG/Lahmeyer Grandbesitz GmbH
& Co. KG and Applied Films GmbH & Co. KG dated January 31, 2001 for the Alzenau,
Germany facility, incorporated by reference to Exhibit 10.22 of Registrants Annual
Report on Form 10-K for the fiscal year ended June 30, 2001.
| | ----- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.12 | Agreement,
 dated November 18, 1997, between Nippon Sheet Glass Co., Ltd., NSG Fine Glass Co., Ltd.
and                  Registrant is incorporated by reference to Exhibit 10.8 of
Registrant's  Annual Report on Form 10-K for                  the fiscal year ended June
27, 1998.
| | ----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.13 | Equity
Joint Venture  Agreement  between  Applied Films  Corporation  and Nippon Sheet Glass
Co., Ltd.,                  dated  February 17, 1999,  is  incorporated  by reference to
Exhibit 10.25 to the  Registrant's  Annual                  Report on Form 10-K for the
fiscal year ended June 29, 2002.
| | ----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.14 | Contribution Agreement dated December 29, 2000, between Balzers Process Systems GmbH and
Leybold Coating GmbH & Co. KG is incorporated by reference to Exhibit 2.3 of
Registrants Current Report on Form 8-K dated December 31, 2000.
| | ----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.15 | Bravo Intellectual Property License Agreement dated December 31, 2000, between Balzers
Process Systems GmbH and Leybold Coating GmbH & Co. KG is incorporated by reference to
Exhibit 2.4 of Registrants Current Report on Form 8-K dated December 31, 2000.
| | ----- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.16 | Newco Intellectual Property License Agreement dated December 31, 2000, between Balzers
Process Systems GmbH and Leybold Coating GmbH & Co. KG is incorporated by reference to
Exhibits 2.5 of Registrants Current Report on form 8-K dated December 31, 2000.
| | ----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.17 | Securities Purchase Agreement dated January 16, 2001, between Registrant and the
purchasers identified on the signature pages thereto is incorporated by reference to
Exhibit 10.1 of Registrants Current Report on Form 8-K dated January 16, 2001.
| | ----- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.18 | Registration Rights Agreement dated January 16, 2001, between Registrant and the investors
identified on the signature pages thereto is incorporated by reference to Exhibit 10.2 of
Registrants Current Report on Form 8-K dated January 16, 2001.
| | ----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.19 | Common
 Stock  Warrant No. 1 dated  January 16, 2001 is  incorporated  by  reference to Exhibit
10.3 of                  Registrant's Current Report on Form 8-K dated January 16, 2001.
| | ----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.20 | Common
 Stock  Warrant No. 2 dated  January 16, 2001 is  incorporated  by  reference to Exhibit
10.4 of                  Registrant's Current Report on Form 8-K dated January 16, 2001.
| | ----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.21 | Common
 Stock  Warrant No. 3 dated  January 16, 2001 is  incorporated  by  reference to Exhibit
10.5 of                  Registrant's Current Report on Form 8-K dated January 16, 2001.
| | ----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.22 | Asset
Purchase  Agreement dated September 24, 2002, by and among Applied Films  Corporation and
Optera,                  Inc. is  incorporated  by reference  to Exhibit 2.1 of
 Registrant's  Current  Report on Form 8-K dated                  September 24, 2002.
| | ----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.23 | License Agreement dated September 24, 2002, by and among Applied Films Corporation and
Optera, Inc. is incorporated by reference to Exhibit 2.2 of Registrants Current
Report on Form 8-K dated September 24, 2002.
| | ----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---



| | 10.24 | Sublease dated September 24, 2002, by and among Applied Films Corporation and Optera, Inc.
is incorporated by reference to Exhibit 2.3 of Registrants Current Report on Form
8-K dated September 24, 2002.
| | ----- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.25 | Services Agreement dated September 24, 2002, by and among Applied Films Corporation and
Optera, Inc. is incorporated by reference to Exhibit 2.4 of Registrants Current
Report on Form 8-K dated September 24, 2002.
| | ----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.26 | Noncompetition Agreement dated September 24, 2002, by and among Applied Films Corporation
and Optera, Inc. is incorporated by reference to Exhibit 2.5 of Registrants Current
Report on Form 8-K dated September 24, 2002.
| | ----- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.27 | Supply Agreement dated September 24, 2002, by and among Applied Films Corporation and
Optera, Inc. is incorporated by reference to Exhibit 2.6 of Registrants Current
Report on Form 8-K dated September 24, 2002.
| | ----- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 21.1 | Subsidiaries
of Applied Films Corporation
| | ---- | -----------------------------------------

| | 23.1 | Consent
of Ernst & Young LLP.
| | ---- | -----------------------------

| | 24.1 | Power
of Attorney (included on the signature page hereto).
| | ---- | ----------------------------------------------------------

| | 31.1 | Certificate of the Chief Executive Officer and President of Applied Films Corporation
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- | ------------------------------------------------------------------------------------------------------------------------------------------------

| | 31.2 | Certificate of the Chief Financial Officer of Applied Films Corporation pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- | ----------------------------------------------------------------------------------------------------------------------------------

| | 32.1 | Certificate of the Chief Executive Officer and President and of the Chief Financial
Officer of Applied Films Corporation pursuant to Section 409 of the Sarbanes-Oxley Act of
2002.
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

*Previously filed

---



EXHIBIT 21.1

|Affiliate                                                     | Formation Jurisdiction                | Ownership 
|------------------------------------------------------------- | ------------------------------------- | ----------
|                                                             
|AFCO GP, Inc                                                  | Colorado, USA                         | 100% Owned
|                                                             
|Suzhou NSG AFC Thin Films Electronics Co., Ltd                | Peoples Republic of China             | 50% Owned 
|                                                             
|Applied Films Corporation, Taiwan Branch Office               | Republic of China (Taiwan)            | 100% Owned
|                                                             
|U.S. Applied Films Corporation Shanghai Representative Office | Peoples Republic of China             | 100% Owned
|                                                             
|Applied Films Shanghai Company Ltd.                           | Peoples Republic of China             | 100% Owned
|                                                             
|Applied Films Asia Pacific Limited                            | Peoples Republic of China (Hong Kong) | 100% Owned
|                                                             
|Applied Films Taiwan Co., Ltd.                                | Republic of China (Taiwan)            | 100% Owned
|                                                             
|Applied Films Japan Kabushiki Kaisha                          | Japan                                 | 100% Owned
|                                                             
|Applied Films Korea Ltd.                                      | Korea                                 | 100% Owned
|                                                             
|AFCO C.V                                                      | Netherlands                           | 100% Owned
|                                                             
|Applied Films Belguim N.V                                     | Belguim                               | 100% Owned
|                                                             
|AFCO Deutschland Holding GmbH                                 | Germany                               | 100% Owned
|                                                             
|AFCO Verwaltung GmbH                                          | Germany                               | 100% Owned
|                                                             
|AFCO GmbH & Co. KG                                            | Germany                               | 100% Owned
|                                                             
|DAF Export Corporation                                        | Barbados                              | 100% Owned
|                                                             
|                                                             

---



# Exhibit 23.1

CONSENT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by
reference in the Registration Statements (Form S-3 No. 333-59984 and Forms S-8 Nos.
333-114809, 333-75164, 333-56376, 333-56378, 333-38426, 333-95367, 333-51175, 333-47951,
and 333-47967) of Applied Films Corporation of our report dated September 7, 2004, with
respect to the consolidated financial statements of Applied Films Corporation included in
the Annual Report (Form 10-K) for the year ended June 26, 2004.

/s/ ERNST & YOUNG
LLP

Denver, ColoradoSeptember 7, 2004

---



Exhibit 31.1

# CERTIFICATIONS

I, Thomas T. Edman, certify that:

|1. | I have reviewed this annual report on Form 10-K of Applied Films Corporation;
|-- | -----------------------------------------------------------------------------

|2. | Based on my knowledge, this annual report does not contain any untrue statement
          of a material fact or omit to state a material fact necessary to make the
          statements made, in light of the circumstances under which such statements were
          made, not misleading with respect to the period covered by this quarterly
          report;
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. | Based on my knowledge, the financial statements, and other financial information
          included in this report, fairly present in all material respects the financial
          condition, results of operations and cash flows of the registrant as of, and
          for, the periods presented in this report;
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4. | The registrants other certifying officers and I are responsible for
          establishing and maintaining disclosure controls and procedures (as defined in
          Exchange Act Rules 13a-15e and 15d-15e) for the registrant and we have:
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | designed
such disclosure controls and procedures, or caused such disclosure           controls and
procedures to be designed under our supervision, to ensure that           material
information relating to the registrant, including its consolidated
          subsidiaries, is made known to us by others within those entities, particularly
          during the period in which this report is being prepared;
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | evaluated
the effectiveness of the registrants disclosure controls and           procedures
and presented in this report our conclusions about the effectiveness           of the
disclosure controls and procedures, as of the end of the period covered           by this
report based on such evaluation; and
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | disclosed
in this report any change in the registrants internal control           over
financial reporting that occurred during the registrants most recent
          fiscal quarter that has materially affected, or is reasonably likely to
          materially affect, the registrants internal control over financial
          reporting;
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|5. | The registrants other certifying officers and I have disclosed, based on
          our most recent evaluation, to the registrants auditors and the audit
          committee of registrants board of directors (or persons performing the
          equivalent function):
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | All
significant deficiencies and material weaknesses in the design or operation           of
internal controls over financial reporting which are reasonably likely to
          adversely affect the registrants ability to record, process, summarize
and           report financial information; and
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Any
fraud, whether or not material, that involves management or other employees           who
have a significant role in the registrants internal control over
          financial reporting.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: September 7, 2004

| |  | /s/ Thomas T. Edman  
Thomas T. Edman  Chief Executive Officer/President
| |  | --------------------------------------------------------------------------------------

---



Exhibit 31.2

# CERTIFICATIONS

I, Lawrence D. Firestone, certify
that:

|1. | I have reviewed this annual report on Form 10-K of Applied Films Corporation;
|-- | -----------------------------------------------------------------------------

|2. | Based on my knowledge, this annual report does not contain any untrue statement
          of a material fact or omit to state a material fact necessary to make the
          statements made, in light of the circumstances under which such statements were
          made, not misleading with respect to the period covered by this quarterly
          report;
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. | Based on my knowledge, the financial statements, and other financial information
          included in this report, fairly present in all material respects the financial
          condition, results of operations and cash flows of the registrant as of, and
          for, the periods presented in this report;
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4. | The registrants other certifying officers and I are responsible for
          establishing and maintaining disclosure controls and procedures (as defined in
          Exchange Act Rules 13a-15e and 15d-15e) for the registrant and we have:
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | designed
such disclosure controls and procedures, or caused such disclosure           controls and
procedures to be designed under our supervision, to ensure that           material
information relating to the registrant, including its consolidated
          subsidiaries, is made known to us by others within those entities, particularly
          during the period in which this report is being prepared;
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | evaluated
the effectiveness of the registrants disclosure controls and           procedures
and presented in this report our conclusions about the effectiveness           of the
disclosure controls and procedures, as of the end of the period covered           by this
report based on such evaluation; and
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | disclosed
in this report any change in the registrants internal control           over
financial reporting that occurred during the registrants most recent
          fiscal quarter that has materially affected, or is reasonably likely to
          materially affect, the registrants internal control over financial
          reporting;
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|5. | The registrants other certifying officers and I have disclosed, based on
          our most recent evaluation, to the registrants auditors and the audit
          committee of registrants board of directors (or persons performing the
          equivalent function):
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | All
significant deficiencies and material weaknesses in the design or operation           of
internal controls over financial reporting which are reasonably likely to
          adversely affect the registrants ability to record, process, summarize
and           report financial information; and
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Any
fraud, whether or not material, that involves management or other employees           who
have a significant role in the registrants internal control over
          financial reporting.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: September 7, 2004

| |  | /s/ Lawrence D. Firestone  
Lawrence D. Firestone  Chief Financial Officer
| |  | ----------------------------------------------------------------------------------------

---



Exhibit 32.1

Each of Thomas T. Edman, Chief
Executive Officer and President, and Lawrence D. Firestone, Chief Financial Officer,
Treasurer, Senior Vice President and Secretary of Applied Films Corporation, certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:

|1) | the Annual Report on Form 10-K for the fiscal year ended June 26, 2004 which
          this statement accompanies fully complies with the requirements of Section 13(a)
          or 15(d) of the Securities Exchange Act of 1934, and
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2) | the information contained in the Annual Report on Form 10-K for the fiscal year
          ended June 26, 2004 fairly presents, in all material respects, the financial
          condition and results of operations of Applied Films Corporation.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: September 7, 2004

| |  | /s/ Thomas T. Edman  
Thomas T. Edman  Chief Executive Officer and President/s/ Lawrence D. Firestone  
Lawrence D. Firestone  Chief Financial Officer, Treasurer,Senior Vice President and Secretary
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A signed original of this
certification has been provided to Applied Films Corporation and will be retained by
Applied Films Corporation and furnished to the Securities and Exchange Commission upon
request.