# 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 1934For the fiscal year
ended July 2, 2005 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 checkmark
whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12-b2).
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
$20.77 as of December 24, 2004, was $ 304,771,004. As of September 9, 2005 there
were outstanding 14,953,975 shares of the Companys Common Stock (no par value).

Documents Incorporated by Reference:
Portions of the Companys Proxy Statement for the 2005 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 July 2, 2005, June 26, 2004, and June 28, 2003,
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 glass, solar cell, 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 silicon, 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.FPDs, are used in a wide variety of consumer and industrial
products, including laptop and flat panel desktop computer monitors, liquid crystal
display (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
Glass.Thin film coated glass is used in buildings for commercial and
residential exterior window glass and automotive window applications. Applying certain
thin films on glass significantly reduces heat transfer through the glass, improving the
efficiency of heating and cooling systems in buildings. Demand for architectural glass is
driven by the need for energy conservation in commercial and residential construction and
by overall growth related to construction.

Solar cell.  Thin
film coatings are used in solar energy collection applications. The demand for alternative
energy sources, such as solar cells, is driven by the need to replace limited fossil
energy with unlimited renewable energy sources which will reduce the load on municipal
power grids worldwide. These coatings form optically absorbing and electrically conducting
layers, which allow sunlight to be converted to electrical power.

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Consumer Products Packaging and
Electronics.Thin film deposition systems (web coaters or
roll coaters) in the consumer products packaging and electronics, 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 capacitors drives our
electronics market.

We have sold over 116 FPD thin film
deposition systems, 53 architectural glass and solar cell deposition systems and 518 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 180 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
emissive 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 and introduced new
products to existing markets that we serve. We have recently introduced our TRITON
deposition system using Physical Vapor Deposition (PVD) to deposit thin films for the
transistor or array side of the LCD, which significantly expands our total available
market for display coaters. We have introduced the ATON system using PVD to deposit films
in the silicon wafer based solar cell market. 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 printed circuit board, display and custom 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 that 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.  After several years of research we have recently entered
several high growth markets, including thin film based 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 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 explore and 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.

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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.

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 sourcing materials from low cost regions, operating costs,
transportation costs, component costs and product design. We have also announced an
expansion of our Tainan, Taiwan manufacturing facility to further reduce the cost, shorten
the manufacturing time and reduce the shipping costs for our display coaters.

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 Large Area Coatings division of Unaxis (LAC) business
successfully completed our strategy of transforming our business from coating glass to
manufacturing thin film deposition equipment, and acquisition of the in-line systems
division of Helix Technology in Tainan (Helix) 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 in fiscal 2004, our
only business segment is the manufacture and sale of deposition equipment. For further
discussion see ITEM 8: Financial Statements and Supplementary Data  Note 2:
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 four 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                    
|NEW ARISTO (OLED)                            |                   |                                    | Evaporative            
|Architectural  Glass:                        |                   |                                   
|TERRA-G or TG                                |                   |                                    | PVD                    
|AXL                                          |                   |                                    | PVD                    
|Solar Cell                                   |                   |                                   
|ATON                                         |                   |                                    | PVD                    
|NEW ARISTO (Solar)                           |                   |                                    | PVD/PECVD              
|Consumer Products Packaging and Electronics: |                   |                                   
|TOPMET                                       |                   |                                    | Evaporative            
|MULTIMET                                     |                   |                                    | Evaporative            
|SMARTWEB                                     |                   |                                    | PVD / Evaporative      

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

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# 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 (PDP), used in computer monitors and high definition
televisions.

NEW ARISTO.Our NEW
ARISTO is an advanced thin film deposition system that accommodates the largest mother
glass substrate sizes, 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, vertical deposition, low cost of ownership
and the capability for double-sided coatings.

TRITON.Our TRITON
is an advanced high throughput vertical deposition platform designed to accommodate
generation 6 and larger substrate sizes. Specifically designed and built for the Thin Film
Transistor (TFT) array process, TRITON incorporates advanced designs that
target demands of current and future TFT-LCD markets.

NEW ARISTO
(OLED).Our NEW ARISTO (OLED) system is an advanced thin film deposition
system for research and development and production applications in the OLED market. The
NEW ARISTO (OLED) applies most of the thin films necessary for an OLED device including
the metal layers and organic layers in vacuum. The NEW ARISTO (OLED) is targeted at
providing OLED manufacturers with the ability to produce OLED devices. We believe this is
the first vertical in-line deposition system developed for the OLED market.

Architectural Glass

Our architectural thin film
deposition systems apply Low-Emissivity or Low-E coatings on large glass substrates used
in building glass and automotive glass.

TERRA-G or TG.Our
Terra-G or TG thin film deposition system is our most advanced coating system designed for
the large architectural glass market. The Terra-G or TG 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 or TG 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.

AXL.  Our AXL thin
film deposition system is our latest and most flexible coating system designed for large
architectural glass applications. The AXL series uses large planar magnetron or rotary
cathodes and uniformly deposits multiple thin films across a large area at very high
throughput rates. The AXL can be up to 100 meters long and can deposit up to 20 different
thin films on a single side of glass during the process.

Solar Cell.Our
solar cell thin film deposition systems apply silicon based absorber layers and conductive
layers on glass substrates that convert sunlight into electrical current for energy
collection in solar cells.

ATON.Our ATON thin
film deposition system is a horizontal sputtering system that uses PVD to apply silicon
nitride and other thin film layers for polycrystalline wafer based 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 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
thin film deposition system provides a solution for coating metal layers on flexible
substrates. The TOPMET uses thermal evaporation to deposit thin film layers of aluminum in
a vacuum onto flexible substrates, usually plastic film, paper or textiles in roll format.

MULTIMET.Our
MULTIMET thin film deposition system uses evaporative deposition technology to deposit
thin films and patterned thin films on very thin foil at high speed in a vacuum for the
capacitor market.

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SMARTWEB.Our
SmartWeb system is designed as a modular, clean room compatible sputter roll to 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 significant cost benefit of
ownership for medium throughput applications.

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. The China JV 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 or color filter panels.

# Sales, Marketing and
Customers

Our customer base is global. We have
sales offices in the United States, Germany, Hong Kong, Belgium, Taiwan, Korea, Japan,
China, and we will open an office in Indonesia in fiscal year 2006. We also utilize sales
representative organizations 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 2005, our ten largest
customers accounted for approximately 64% of our net revenues. Revenues from our two
largest customers in fiscal 2005, represented 15% and 12%, respectively, of our net
revenues. Revenues from our two biggest customers in fiscal 2004, represented 13% and 12%
respectively, of our net revenues for that year. Revenues from our largest customer in
fiscal 2003 represented 13% of our net revenues for that year. In fiscal years 2005 and
2004 one of our largest customers was the same company. Approximately 84% of our fiscal
2005 net revenues, 81% of our fiscal 2004 net revenues and 70% of our fiscal 2003 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.

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 smaller size NEW ARISTO thin film deposition systems at
this facility. In April 2005, we announced the construction of a 42,500 square foot
building that will require an estimated investment of $10.0 million to complete. The
new building will replace the existing 41,000 square foot facility and allow us to build
larger size thin film deposition systems in Taiwan. We expect the facility to be
operational in fiscal 2007.

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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 and Taiwan. We also lease sales
offices in Belgium, Hong Kong, Korea, Japan, Taiwan, and China.

# Competition

The key competitive factors in each
of our markets include the systems cost of ownership and 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.In the FPD market, we compete against Ulvac Technologies, Inc.
of Japan (ULVAC) in the color filter market for LCDs, and ULVAC, AKT, a subsidiary of
Applied Materials, Unaxis Management Inc. (UNAXIS), and Anelva Ltd. of Japan in the TFT
array market for FPDs.

Architectural Glass Deposition
Equipment.In the architectural glass market, we primarily compete against
Von Ardenne, AG, of Germany and VACT, Inc. of the United States.

Solar Cell Deposition
Equipment.In the solar cell market, we primarily compete against ULVAC,
UNAXIS, Von Ardenne and Roth & Rau AG of Germany and Centrotherm Systemtechnik of
Germany.

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, Galileo Vacuum Systems, Inc. a member of the FATA
Group S.p.A. in Italy 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 232 engineers
and scientists in our company of which 60 are involved in research and development and 22
hold PhD degrees as of July 2, 2005. 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, 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 materials;
| | - | ----------------------------------------------------

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

| |  | Direct
current, alternating current, RF current and superimposed combinations of these power
sources for reactive and non-reactive magnetron sputtering;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Rotatable
and Planar Magnetron cathodes;
| | - | ----------------------------------------

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| |  | 
| |  | 

| |  | Alternating
current magnetron (TWINMAG(TM)) 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 $12.2 million in fiscal 2003, $16.8 million in fiscal 2004,
and $21.7 million in fiscal 2005.

# 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 180 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.

# The Helix Acquisition

Effective June 2, 2004, we
acquired the in-line systems division of Helix Technology, Inc. in Taiwan (Helix). This
established an Asian manufacturing center for us which brings us closer to our Asian
customer base. We also acquired certain intellectual property in that transaction. Prior
to the completion of this acquisition, all of our manufacturing operations were in
Germany.

In our initial valuation
of Helix, we utilized recognized valuation techniques.  We obtained projected financial
results from Helix, adjusted those projections based on our knowledge of the market and
then valued Helix on a discounted cash flow model using those projections, an appropriate
weighted cost of capital as a discount factor and an appropriate terminal multiple of
EBITDA.

It was our intention that after the
closing of the Helix acquisition we would not continue to market Helix products because
they are either not compatible with our current market focus or are products similar to
those we already market. The primary purpose for the Helix acquisition was to add
manufacturing capacity in Taiwan. The factory in Tainan is capable of producing Gen 4 and
Gen 5 NEW ARISTO systems and if the market does not demand this size of equipment then the
factory will not be utilized or will be substantially underutilized. Following the
acquisition, the employees in Tainan were trained at our factory in Germany on our
existing equipment platforms and have been instrumental on the machine installations
during the year. In fiscal year 2006, we plan to manufacture a Gen 5 NEW ARISTO system in
the existing factory. Although manufacturing that system will not increase our
consolidated revenues, it will generate revenues in Taiwan and we expect that it will
reduce our direct manufacturing cost. If the existing factory is not utilized, the annual
financial burden is estimated to be approximately $866,000 per year in wages, facility
costs and other administrative expenses, excluding the amortization of intangibles.

In April 2005, we announced our
intention to build a building in Tainan that will be capable of producing Gen 6 and larger
sized NEW ARISTO systems. The larger factory will replace the one we currently have and
will be capable of production in fiscal 2007.

# 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.

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# 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 LCD 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.

# Employees

As of July 2, 2005, we employed a
total of 625 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 through our workers council on behalf of our German
workforce.

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.

# 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

AF-Mag, ARGUS3, ARISTO,
A-Series, ATON, ATX-700, AXL, BTX, DuoMag, EcoVeRa, ESCOSYS, GMS Tester, HoloVap,
MULTIMET, MULTIWEB, NEW ARISTO, OPTOPLEX, PatVap, SmartWeb, SOLARISTO, SpeedCoat, Terra-G,
TOPBEAM, TopMet, ToraMag, TreatMag, TriMag, TRITON, Twin-AF-Mag, Twin-AR-Mag, TwinMag and
VES 400 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 2005 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                      
Jang-Ho  Bae             
Joachim Nell            
James P.  Scholhamer    
Allen H.  Alley       
Richard P.  Beck      
John S.  Chapin       
Gerald J.  Laber      
Vincent Sollitto, Jr. | 43
47 
47
46
39
51
72
64
61
57 | President and Chief Executive (2), Director
Senior Vice President, Chief Financial Officer, 
Secretary and Treasurer (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) (6)          
Director, Chairman of the Board (1) (3) (6)
Director                   
Director (6)               
Director (1) (4) (6)

(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 as Vice-Chairman
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) and on the board of
directors of TTM Technologies, Inc. (NASDAQ: TTMI) and is chairman of its compensation
committee. 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, until July 2005, Mr. Firestone served on the board of directors of
HyperSpace Communications, Inc. (AMEX: HCO), and he served 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.

Jang-Ho 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 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.

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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 semiconductor and flat panel display 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.)

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. Since 1997 Mr. Alley has served as
President, CEO, and Chairman of the Board of Pixelworks (NASDAQ:PXLW). From 1992 to 1997,
Mr. Alley served as the Vice President Corporate Development, Engineering and Product
Marketing at InFocus (NASDAQ:INFS). From 1986 until 1992, Mr. Alley served as General
Partner with Battery Ventures. From 1983 to 1986, Mr. Alley was the Director of Mechanical
Computer Aided Engineering of Computervision Corporation. From 1976 to 1983, Mr. Alley
served in various product design engineering positions with the Boeing Commercial Airplane
Company and the Ford Motor Company. Mr. Alley 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, is a member of its audit committee and chairman of
its governance committee. 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 TTM Technologies, Inc. (NASDAQ:TTMI), he serves
as chairman of its audit committee and on the governance committee. 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 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 (NASDAQ:SLNK); Centennial Specialty Foods
(NASDAQ: SmallCap Market: CHLE); QualMark Corporation (OTBB:QMRK); and
Scotts Liquid Gold, Inc. (OTC:SLGD), and he serves as the chairman of their audit
committees. Mr. Laber is a Certified Public Accountant and 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.

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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
been the President and Chief Executive  Officer and a 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 36 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 our capital equipment market;
| | - | ----------------------------------------------------

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

| |  | possible
saturation of equipment capacity in any of our markets, particularly the FPD market;
| | - | ---------------------------------------------------------------------------------------------

| |  | 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
| | - | ----------------------------------------------------------------------------

| |  | fluctuations
in foreign currency exchange rates, and
| | - | ----------------------------------------------------

| |  | difficulty
in integrating acquisitions
| | - | --------------------------------------

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 glass, solar cell, and
the consumer products packaging and electronics markets, and cell phone handset market.
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.

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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.

The FPD market experiences downturns,
and there can be no assurance as to future demand for active matrix LCDs, TFT, or plasma
display panels or demand for additional equipment to manufacture such products.
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.

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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 payment.

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;
| | - | --------------------------------------------

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| |  | 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.
| | - | ----------------------------------------------------

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 70% of our net revenues in
fiscal 2003, 81% of our net revenues in fiscal 2004 and 84% of our net revenues in fiscal
2005. The principal international markets into which we and our China JV sell our products
include China, 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 China JV 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 the profitability of
the China JV. 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
currency exchange risks, including risks of high pricing based upon manufacturing costs
measured primarily in euro;
| | - | ---------------------------------------------------------------------------------------------------------------------------

| |  | 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 (SARs), Avian flu (bird flu) or other
contagious disease;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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We conduct business in foreign
currencies, and fluctuation in the values of those currencies could result in foreign
exchange losses and impact our euro-based manufacturing costs, negatively affect our
competitive position.

In fiscal 2005, approximately 91% of
our net revenues were denominated in euros and approximately 5% were denominated in the
Taiwan dollar. Any strengthening or weakening of the euro or Taiwan 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 or Taiwan and less competitive with products produced by competitors outside Europe
or Taiwan. Our China JV transacts much of its business in Chinese Renminbi. Any
fluctuation of the Chinese Renminbi could adversely affect the profitability of the JV and
therefore our equity earnings. 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 euros. 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. Our consolidated financial statements are expressed in U.S. dollars.

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 64% of our net revenues in fiscal 2005. Revenues from our two largest
customers in fiscal 2005, represented approximately 15% and 12%, respectively, of our net
revenues. Revenues from our two biggest customers in fiscal 2004, represented 13% and 12%
respectively, of our net revenues for that year. Revenues from our largest customer in
fiscal 2003 represented 13% of our net revenues for that year. In fiscal years 2005 and
2004 one of our largest customers was the same company. 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 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,
ATON, SmartWeb, AXL, NEW ARISTO (Solar), and our NEW ARISTO (OLED)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.

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We manufacture all of our thin
film deposition equipment at one facility, and our China JV operates at one facility. 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 currently produce all of our thin
film deposition equipment in our manufacturing facility located in Alzenau, Germany and
plan to produce in Tainan, Taiwan. 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. Our China JV produces all of its coated
glass in its facilities leased in Suzhou, China. A disruption at our China JV facility
could adversely affect our equity earnings.

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. We may develop new technologies or
systems that consume significant resources and ultimately do not function as expected in
the markets that we serve. In addition, if our systems contain defects or which 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.

Risks associated with our China
JV, which could adversely affect our earnings.

The earnings of our 50% China JV are
reported as equity earnings on our income statement; we do not include the revenues or
expenses of the China JV on our income statement. The results of our China JV depend on
the continuing cooperation of Nippon Sheet Glass Co., Ltd., or NSG, the other 50% owners.
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. The operating results of the China JV and
therefore our equity earnings, 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.

The operations of the China JV 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 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.

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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.

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 2005, 84% of our revenue
was derived from sales to customers in 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.

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

We prepare our financial statements
in conformity with accounting principles generally accepted in the U.S., 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.

As of July 2, 2005, we have
$78.6 million in goodwill and intangible assets on our balance sheet of which
$63.4 million is goodwill, not amortized related to the LAC and Helix acquisitions.
We conduct 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 conduct an evaluation as conditions demand
to evaluate for impairment. This asset could become impaired and our financial statements
would be adjusted. 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.

Certain changes in accounting or
financial reporting standards issued by the Financial Accounting Standards Board, the
Securities and Exchange Commission or other standard-setting bodies may have an adverse
affect on our financial condition, results of operations and/or cost of doing business.

Our financial statements are subject
to the application of U.S. GAAP, which is periodically revised and/or expanded.
Accordingly, we are required to adopt new or revised accounting standards from time to
time issued by recognized authoritative bodies. It is possible that future changes we are
required to adopt could change the current accounting treatment that we apply to our
consolidated financial statements and that such changes could have a material adverse
effect on our financial condition and results of operations.

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.

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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 have cash available for
acquisitions, and have made, and may in the future make, acquisitions of, or significant
investments in, businesses with complementary or aligned products, services and/or
technologies. Acquisitions involve numerous risks, including but not limited to:
(1) diversion of managements attention from other operational matters;
(2) inability to complete acquisitions as anticipated or at all; (3) inability
to realize synergies expected to result from an acquisition; (4) failure to
commercialize purchased technologies; (5) ineffectiveness of an acquired
companys internal controls; (6) impairment of acquired intangible assets as a
result of technological advancements or worse-than-expected performance of the acquired
company or its product offerings; (7) unknown and/or undisclosed commitments or
liabilities; (8) failure to integrate and retain key employees; and
(9) ineffective integration of operations. Mergers and acquisitions are inherently
subject to significant risks, and the inability to effectively manage these risks could
materially and adversely affect our business, financial condition and results of
operations.

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.

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.

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# 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 are freely tradable without restriction or further registration. 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.

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.

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---



# 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.

|               | 2004 | 2005  
|-------------- | ---- | ------
|
|               |      |       
|First Quarter  |      | $34.70
|Second Quarter |      | 35.00 
|Third Quarter  |      | 38.95 
|Fourth Quarter |      | 31.41 

On September 6, 2005, the last
reported sale price of our common stock on the NASDAQ National Market was $22.67 per
share, and there were approximately 37 stockholders of record of the common stock. We
estimate that there are approximately 6,492 beneficial owners of the common stock.

To date, Applied Films has not
declared or paid cash dividends to its common stockholders. Applied Films has no plans to
declare and pay cash dividends.

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

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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 income data for the years ended June 28, 2003, June
26, 2004, and July 2, 2005, and the consolidated balance sheet data as of June 26, 2004
and July 2, 2005, have been derived from audited consolidated financial
statements included elsewhere in this annual report on Form 10-K. The consolidated
statement of income data for the years ended June 30, 2001 and June 29, 2002 and the
consolidated balance sheet data as of June 30, 2001, June 29, 2002, and June 28, 2003,
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 in discontinued operations, the 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.

|                                                        | Fiscal Year Ended                    
|------------------------------------------------------- | -------------------------------------
|                                                        |                                      
|                                                        |                                      
|                                                        |                                      
|                                                        | (in thousands, except per share data)
|Consolidated Statement of Income Data:                 
|Net revenues                                            |                                      
|Cost of goods sold                                      |                                      
|                                                        |                                      
|Gross profit                                            |                                      
|Operating expenses:                                     |                                      
|Research and development                                |                                      
|Selling, general and administrative                     |                                      
|In-process research and development (1)                 |                                      
|Amortization of intangible assets                       |                                      
|                                                        |                                      
|Income (loss) from operations                           |                                      
|Other 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                     |                                      
|Net income (loss)                                       |                                      
|Preferred stock dividends                               |                                      
|                                                        |                                      
|Net income (loss) applicable to common stockholders     |                                      
|                                                        |                                      
|Earnings (loss) per share:                              |                                      
|Basic:                                                  |                                      
|Income (loss) from continuing operations                |                                      
|Income (loss) from discontinued operations              |                                      
|                                                        |                                      
|Basic earnings (loss) per share                         |                                      
|                                                        |                                      
|Diluted:                                                |                                      
|Income (loss) from continuing operations                |                                      
|Income (loss) from discontinued operations              |                                      
|                                                        |                                      
|Diluted earnings (loss) per share                       |                                      
|                                                        |                                      
|Weighted average common shares outstanding:             |                                      
|Basic                                                   |                                      
|Diluted                                                 |                                      

|1) | The In-process research and development (IP R&D) is related to our
          acquisitions comprised of the LAC acquisition in fiscal year 2001 and the Helix
          acquisition in fiscal year 2004 and fiscal year 2005.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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|                                                    | June 30,2001   | June 29,2002 | June 28,2003 | June 26,2004 | July 2,2005
|--------------------------------------------------- | -------------- | ------------ | ------------ | ------------ | -----------
|                                                    |               
|                                                    | (in thousands)
|Consolidated Balance Sheet Data:                   
|                                                    |                |              |              |              |            
|Cash, cash equivalents and marketable securities(2) |                |              | $            | 25,905       |            
|Restricted cash(1)                                  |                |              |              | 331          |            
|Working capital(2)                                  |                |              |              | 17,025       |            
|Total assets(2)                                     |                |              |              | 167,042      |            
|Long-term debt, net of current portion              |                |              |              | 6,483        |            
|Total stockholders' equity                          |                |              | $            | 89,192       |            

|(1) | At July 2, 2005, restricted cash represents cash that was for custom
          duties on imports received into Germany. Prior to fiscal year 2005, restricted
          cash represents cash that was pledged to provide bank guaranties on behalf of
          certain customers, for their cash deposit on contracts, to guarantee up to
          $5.0 million of the debt of the China JV, and for custom duties on imports
          received into Germany.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Cash, cash equivalents, marketable securities, working capital and total assets
          increased in November of fiscal year 2002 and October of fiscal year 2004 due to
          follow-on common stock offerings, net of offering costs, of $67.0 million
          and $93.3 million, respectively.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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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 (FPD), the
architectural glass, solar cell, 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 silicon, 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.

In December 2000, we completed the
acquisition of the Large Area Coating (LAC) business of Unaxis which improved our position
in the FPD market 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 Asian manufacturing base, where we expect to manufacture
some of our display systems. We believe manufacturing in Taiwan will allow us reduce the
delivery time and manufacturing costs for systems sold to our customers in Asia.

We also own 50% of a joint venture in
China that manufactures and sells coated glass for the LCD industry. Because of the
50%-50% ownership structure, we do not consolidate the China JVs results and our
portion of the China JVs net income is reported as Equity earnings of joint
venture in our consolidated statements of operations.

Revenues for our thin film deposition
equipment are primarily 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. Revenues on other equipment sales
are recognized under the completed contract method of accounting. We operate with a
certain amount of unrecognized revenue, referred to as backlog, which includes the portion
of unearned revenue on contracts utilizing the percentage of completion method of revenue
recognition plus the total value of contracts that utilize the completed contract method
of revenue recognition on our contracts in progress. This is an operational measure not a
measure of receipts or accounts receivable. 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 $100.6 million at the end
of fiscal 2003, $73.6 million at the end of fiscal 2004 and $55.8 million at the
end of fiscal 2005.

Sales of our systems and backlog are
denominated in euros, and the value is subject to fluctuation against the dollar. Revenues
generated from customers outside of Europe were 81% for fiscal 2004 compared to 84% in
fiscal 2005. Since the Helix acquisition closed in June 2004, no system revenues were
generated from our facility in Taiwan. When we engage in a system related sales contract
other than one denominated in euros, we 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.

For the fiscal years ended June 26,
2004 and July 2, 2005, our net revenues in euros reported in equivalent U.S.
dollars was $216.7 million and $164.9 million, respectively, or 95% and 91%
respectively of total net revenues. As of July 2, 2005, the U.S. dollar
equivalent of accounts receivable denominated in euros was approximately
$10.5 million, or approximately 71%, of total accounts receivable. As of
July 2, 2005, the U.S. dollar equivalent of accounts payable denominated in
euros was approximately $12.3 million, or approximately 95%, of total accounts
payable.

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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 in discontinued operations, the results of our coated glass divisions in Longmont
and Hong Kong that were sold.

|                                                      | 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 intangible assets                     |                  
|                                                      |                  
|Operating income (loss)                               |                  
|Other income, net                                     |                  
|Equity earnings of joint venture                      |                  
|                                                      |                  
|Income from continuing operations before income taxes |                  
|Income tax expense                                    |                  
|                                                      |                  
|Income from continuing operations                     |                  
|Discontinued operations, net of tax                   |                  
|                                                      |                  
|Net income                                            |                  
|                                                      |                  

# Year Ended June 26, 2004
Compared to Year Ended July 2, 2005

The following table presents certain
key highlights and the percentage change from the results of operations for the fiscal
years ended June 26, 2004 and July 2, 2005 (in millions).

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

For fiscal 2005, in comparison to the
same period in the prior year, the euro appreciated by approximately 2% against the U.S.
dollar which has increased our revenue and costs, principally cost of goods sold, research
and development, selling, general and administrative and amortization of intangible
assets.

Orders and
Backlog.Overall, orders declined 18.4% from $201.6 million in fiscal
2004 to $164.5 million in fiscal 2005, which led to a decline in backlog from
$73.6 million at June 26, 2004 to $55.8 million at
July 2, 2005. A 22.3% increase in orders for our web coaters and a 26.4%
increase in orders for customer service were offset by a 27.4% decline in orders for FPD
equipment and a 49.4% decline in orders for architectural glass equipment. The growth in
orders from the web coater market came from increased order activity in Asia and the
growth in customer service primarily came from our increasing installed base of systems
exiting their warranty period. The decline in order activity for our display coaters was
primarily the result of the lack of capital spending in Taiwan as display manufacturers
absorbed their installed capacity and positioned themselves to raise capital to fund
further expansions in the future. The decline in order activity for our architectural
glass coaters was the result of the stalled expansion plans in China from the Chinese
government imposed banking and credit regulations which has impacted capital expansion in
China while the banks re-balance their loan portfolios. In addition, the investment
climate in the U.S. and Europe for architectural glass coaters remained weak where coated
glass capacity presently exceeds demand.

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During fiscal 2005 we received orders
for new product offerings. We received an order for our new TRITON system from a Korean
FPD customer and we received an order for our new ATON system from a European solar cell
manufacturer.

Net Revenues.The 20.2%
decrease in net revenues was driven by the weakness in orders particularly for our
architectural glass coaters as revenues for those systems declined by 72.3% from the prior
year. Revenues for our FPD systems, web coaters and customer service increased by 10.4%,
14.4% and 17.3%, respectively, due to orders placed in the later part of fiscal year 2004.

Gross Profit.The 10.4%
decrease in gross profits in fiscal 2005 compared to fiscal 2004 was due to the reductions
in revenues. Gross profit margins increased from 26.5% in fiscal 2004 to 29.8% in fiscal
2005 driven by our product mix and by the implementation of our cost reduction strategies
and a $3.6 million reduction in cost of goods sold from changes in our estimates for
warranty accruals, loss contract reserves and accrual for cost of sales not posted.

Research and Development.Research and development expenses grew 29.2% in fiscal 2005 to $21.7 million
compared to $16.8 million for fiscal 2004. Our research and development efforts were
concentrated during the fiscal year on FPD related products targeted towards larger glass
sizes, including Generation 7 and 8 glass sizes and the development of our recently
introduced TRITON system, for which we received our first order in the third fiscal
quarter. Additionally, we concentrated on further development of our OLED technology as
well as solar cell technology which led to the introduction and initial sale of our ATON
system during the fiscal year. Research and development expenses consist primarily of
salaries, outside contractors, lab, and other expenses related to our ongoing product and
technology initiatives. Due to the decrease in revenues and the increase in spending,
research and development expenses as a percentage of net revenues increased to 11.9% in
fiscal 2005 from 7.3% in fiscal 2004.

Selling, General and
Administrative.Selling, general and administrative expenses increased 11.9% in fiscal
2005, as we experienced cost increases related to professional fees associated with
compliance with the Sarbanes-Oxley Act, directors and officers liability insurance, and
compensation costs, as well as, additional costs absorbed while our Tainan employees in
Taiwan were in training. As a result of the decreased revenues, and increase in spending,
selling, general and administrative expenses as a percentage of net revenues increased
from 12.2% in fiscal 2004 to 17.1% in fiscal 2005.

In-Process Research and
Development.  During fiscal 2005 as a result of the final purchase price
allocation related to the Helix acquisition, we adjusted the final value of the IPR&D
from the $2.2 million reported in fiscal 2004 to $2.0 million. The principal
projects at the time of the acquisition 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 all of which were discontinued after our acquisition.

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) which was revised
from $2.2 million in fiscal year 2004 to $2.0 million in fiscal year 2005 upon
completion of our procedures related to the acquisition:

|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 managements assumptions, which we believe to be
reasonable. These estimates 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. We will not market the Helix products, as they
are either not compatible with our current market focus or are products similar to those
we currently market.

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Amortization of Intangible Assets.In the fiscal year ended July 2, 2005, amortization of intangible assets
related to our acquisitions was $5.5 million compared to $4.3 million in the
prior fiscal year. This increase was related to the amortization of the intangibles
associated with the Helix acquisition. In addition, in June of 2005, we acquired a
$2.0 million patent license agreement in the U.S. which will increase amortization
expense on a go forward basis. The intangible assets that 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 Taiwan dollar compared to the U.S. dollar.

Other Income, Net.Other
income, net increased by approximately $600,000 to $4.6 million in fiscal 2005 from $4.0
million in fiscal 2004. Included in other income, net is investment income, which
increased to a net $3.5 million on our invested cash in fiscal 2005 compared to
$2.1 million in fiscal 2004. The $2.1 million in fiscal 2004 included a negative
mark-to-market adjustment of $434,000 through April 20, 2004. Our average annual
investment yield was 2.1% for fiscal 2005 compared to 1.7% for fiscal 2004.

This increase was offset by a
decrease in other net income of $736,000 to $1.2 million in fiscal 2005 from
$2.0 million in fiscal 2004. This reduction was primarily from a $1.2 million
decrease related to realized foreign currency transaction gains compared to the prior
year, offset by a decrease in loss on disposal of non operating assets of approximately
$600,000, and an increase in miscellaneous other items included in other income net of
approximately $136,000. During fiscal 2004 our China JV renegotiated the terms of its
credit facility and no longer required a cash secured guaranty from the parent companies.
As a result, once the guaranty was released, we repatriated the cash that was held in
euros and recorded a foreign currency gain of $673,000. Net other income includes items
such as realized foreign currency transaction adjustments and an approximate 1.0% royalty
on our China JV sales.

Equity earnings of Joint Venture.The 56.6% increase in equity earnings was primarily due to higher profitability
related 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. Our effective tax rate on income from continuing operations for
fiscal 2005 was 147.4% compared to 29.2% for fiscal 2004. Income tax expense for fiscal
2005 increased as we incurred tax expense on several items not included in the statement
of income during the fiscal year, such as $4.3 million in dividends from our China
JV, $5.8 million in dividends from our AFCO C.V., a wholly owned subsidiary and
$2.0 million in withholding taxes paid by our German entity. We also recorded a
valuation allowance against deferred tax assets in Germany and in Taiwan, as we believe it
is more likely than not that the deferred tax assets 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 amortizing goodwill and intangible assets in Germany. We will apply for a tax
holiday status in Taiwan related to our subsidiary corporation that was formed to complete
the Helix acquisition. However, to the extent that we record valuation allowances against
the deferred tax assets, this may limit our ability to report the benefits of these tax
strategies.

Following our fiscal year end, we
have evaluated the changes in facts and circumstances regarding the China Joint Venture
(China JV), known as STEC. Since the China JVs inception in 1999, we
have viewed our share of the undistributed earnings of the China JV as permanently
re-invested. After considering the current business environment at China JV, including the
dividends paid during the 2005 fiscal year, we no longer expect our portion of the China
JVs retained earnings to be permanently reinvested. As a result of this decision,
under the accounting guidance of APB 23 and SFAS 109 Accounting for Income Taxes
 Special Areas, we recorded a $4.8 million non-cash provision for income taxes
which is reflected in the fourth quarter of our fiscal 2005 financial statements. These
accrued taxes will become due upon monetization of undistributed earnings from the China
JV. In the future, the Company will accrue income taxes quarterly at the US tax rate on
the equity earnings of the China JV.

Discontinued
Operations.On September 26, 2003, we sold our Hong Kong coated
glass business to NSG for $1.35 million. 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 fiscal 2004 $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 plus a settlement
paid to Optera, Inc. of $650,000 net of $228,000 for taxes. The after tax $783,000 gain
was from on the sale of assets related to discontinued operations.

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# 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 (in millions).

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

For fiscal 2004, in comparison to the
same period in the prior year, the euro appreciated by approximately 12% against the U.S.
dollar which has increased our revenue and costs, principally cost of goods sold, research
and development, selling, general and administrative and amortization of intangible
assets.

Orders and
Backlog.Overall, orders declined 2.8% from $215.3 million in fiscal
2003 to $201.6 million in fiscal 2004, which led to a decline in backlog on
June 26, 2004 to $73.6 million from $100.6 million on
June 28, 2003. The 127.0% increase in orders for our FPD coaters and the 13.5%
increase in orders for customer service were offset by a 15.6% decline in orders for web
equipment and a 65.3% decline in orders for architectural glass equipment. The growth in
orders from the FPD coater market came from increased order activity from Taiwan and Korea
as we received orders for generation 4, 5, 6, and 7 sized systems and the growth in
customer service primarily came from our increasing installed base of systems exiting
their warranty period. The decline in order activity for our web coaters was the result a
weaker market as the web coater market was strong in 2003. The decline in order activity
for our architectural glass coaters was the result of absorption of the installed capacity
at the glass manufacturers following the record order levels during fiscal 2003. In
addition the investment climate in the U.S. and Europe for architectural glass coaters was
weak, where coated glass capacity exceeded demand.

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.

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

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 Intangible Assets.In the fiscal year ended June 26, 2004, amortization of 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 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
adjusted our intangible asset balances related to the patents and customer relationships
that were acquired in the transaction. The patents will be amortized over seven years and
the customer relationships will be amortized over five years. We expect the amortization
of intangible assets to increase in the future to include these charges.

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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 final allocation of the purchase
price, including the valuation of the IPR&D, was completed in fiscal 2005.

Other Income, Net.Other
income, net increased by approximately $400,000 to $4.0 million in fiscal 2004 from $3.6
million in fiscal 2003. Included in other income, net is investment income which increased
to 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 available 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 income and all unrealized gains and
losses will be reported in other comprehensive income in the equity section of the balance
sheet. At the end of fiscal 2004, our average annual investment yield was 1.7% compared to
2.4% at the end of fiscal 2003. 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.

Additionally, other income, net
increased due to realized foreign currency transaction gains resulting from the China JV
renegotiation of the terms of their line of credit. After the renegotiation 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 United States. We realized a foreign
currency gain of approximately $673,000 on the transaction. This gain was offset by a loss
on disposal of non operating assets of approximately $690,000 and other miscellaneous
income of approximately $364,000. Net other income includes items such as realized foreign
currency transaction adjustments and an approximate 1.0% royalty on our China JV sales.

Equity Earnings of Joint Venture.The 59.7% increase in equity earnings was primarily due to higher profitability
related to the increase in the demand for higher margin 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 assets because we believed it was more likely than
not that a portion of the deferred tax assets would 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 intangible assets in Germany,
tax-free investment and interest income in the Dutch subsidiary, and equity earnings of
our China JV because the earnings were permanently reinvested in our China JV. We will
apply for a tax holiday status in Taiwan related to our subsidiary corporation that was
formed to complete the Helix acquisition. Our effective tax rate on income from continuing
operations, for fiscal 2004 was 29.2% compared to 18.4% 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.

# Critical Accounting
Policies and Estimates

The preparation of consolidated
financial statements and related disclosures in conformity with accounting principles
generally accepted in the U. S. requires management to make judgments, assumptions and
estimates that affect the amounts reported. Note 1 of Notes to Consolidated Financial
Statements describes the significant accounting policies used in the preparation of the
consolidated financial statements. Certain of these significant accounting policies are
considered to be critical accounting policies, as defined below.

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A critical accounting policy is
defined as one that is both material to the presentation of the consolidated financial
statements and requires management to make difficult, subjective or complex judgments that
could have a material effect on the financial condition and results of operations.
Specifically, these policies have the following attributes: (1) The Company is
required to make assumptions about matters that are highly uncertain at the time of the
estimate; and (2) different estimates the Company could reasonably have used, or
changes in the estimate that are reasonably likely to occur, would have a material effect
on the financial condition or results of operations.

On an on-going basis, we evaluate our
estimates, including those related to project costs, warranties, collections, product
returns, inventories, investments, fixed assets, intangible assets, income taxes, pension
benefits and contingencies. Estimates and assumptions about future events and their
effects cannot be determined with certainty. We base our estimates on historical
experience and on various other assumptions believed to be applicable and reasonable under
the circumstances. These estimates may change as new events occur, as additional
information is obtained and as our operating environment changes. These changes have
historically been minor and have been included in the consolidated financial statements as
soon as they became known. Based on a critical assessment of its accounting policies and
the underlying judgments affecting the application of those policies, management believes
that our consolidated financial statements are fairly stated in accordance with accounting
principles generally accepted in the U. S., and provide a meaningful presentation of the
financial condition and results of operations.

We believe the following critical
accounting policies affect our more significant judgments and estimates used in the
preparation of our financial statements.

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 at completion. Based on our historical experience of estimating
contract costs, we believe that our estimates are prepared appropriately and represent our
best estimate 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.

The completed contract method of
accounting is used for standard products that are sold at values less than 1 million
or have a machine fabrication time of less than six months and for certain other products
if the form of the sales contract dictates such treatment. 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. The Company recognizes the revenue, upon transfer of title
which for certain projects does not occur until after customer acceptance at its facility.
The Companys contracts under the completed contract method do not provide for the
right of a customer to return the machine once title has transferred.

We generally offer warranty coverage
for equipment sold for a one-year period after final installation is accepted by the
customer. We estimate the anticipated costs to be incurred during the warranty period and
accrue a reserve as a percentage of revenue. 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.

During the third quarter of fiscal
2005, we evaluated our warranty accruals, loss contracts reserves and accrual for cost of
sales not posted and determined that due to improved product specifications, contract
execution, and the maturity of the Companys projects a change in estimates was
required which resulted in a reduction in the reserves, accruals and a corresponding
reduction in cost of goods sold of approximately $3.6 million. See Note 1.

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 could be required.

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We record an adjustment for inventory
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. In addition, we have written
down inventory of $1.3 million for additional costs anticipated related to the
installation of the TRITON beta system.

We estimate our actual current tax
exposure together with the temporary differences that have resulted from the differing
treatment of items dictated by generally accepted accounting principles in the United
States versus the tax law in the country the subsidiary resides. 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.
To the extent that we believe the recovery is less than 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.

# New Accounting
Pronouncements

In March 2005, the FASB published
FASB Interpretation No. 47, Accounting for Conditional Asset Retirement
Obligations, which clarifies that the term, conditional asset retirement
obligations, as used in SFAS No. 143, Accounting for Asset Retirement
Obligations, refers to a legal obligation to perform an asset retirement activity in
which the timing and (or) method of settlement are conditional on a future event that may
or may not be within the control of the entity. The uncertainty about the timing and (or)
method of settlement of a conditional asset retirement obligation should be factored into
the measurement of the liability when sufficient information exists. The interpretation
also clarifies when an entity would have sufficient information to reasonably estimate the
fair value of an asset retirement obligation. This interpretation is effective for fiscal
years ending after December 15, 2005. The adoption of this Interpretation is not
expected to have a material effect on the Companys consolidated financial position
or results of operations.

In June 2005, the FASB issued
SFAS No. 154, Accounting Changes and Error Corrections, which replaces APB
Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting
Accounting Changes in Interim Financial Statements. Statement 154 changes the
requirements for the accounting and reporting of a change in accounting principle. APB
Opinion No. 20 previously required that most voluntary changes in an accounting
principle be recognized by including the cumulative effect of the new accounting principle
in net income of the period of the change. SFAS No. 154 now requires retrospective
application of changes in an accounting principle to prior period financial statements,
unless it is impracticable to determine either the period-specific effects or the
cumulative effect of the change. The Statement is effective for fiscal years beginning
after December 15, 2005. We do not expect the adoption of this statement will have a
material impact on our financial statements.

In November 2004, the FASB issued
SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4, to
clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted
material (spoilage) should be recognized as current period charges, and that fixed
production overheads should be allocated to inventory based on normal capacity of
production facilities. This statement is effective for the Companys fiscal year
2006. The Company does not anticipate that SFAS 151 will have a significant impact on our
overall results of operations or financial position.

In December 2004, the FASB issued
SFAS No. 123(R) Share-Based Payment. SFAS 123(R) requires the recognition of
compensation cost relating to share-based payment transactions in financial statements.
That cost will be measured by the fair value of the equity or liability instruments issued
as of the grant date, based on the estimated number of awards that are expected to vest.
SFAS 123(R) covers a wide range of share-based compensation arrangements including share
options, restricted shares, restricted share units performance-based awards, and employee
share purchase plans. Statement 123(R) replaces FASB Statement No. 123, Accounting
for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting
for Stock Issued to Employees. Statement 123(R), as amended, is effective for the
Companys fiscal year 2006. As a result, we will be required to implement SFAS
123R in the quarter ending October 1, 2005. We have evaluated the impact of
adopting SFAS 123R upon our financial position and results of operations. Based
upon our evaluation, we anticipate that adoption will result in significant non-cash
expense of approximately $800,000 for the first quarter of fiscal 2006 due to the
number of unvested stock options outstanding. This charge will be distributed and reported
in cost of goods sold, research and development and sales, general and administrative
expenses.

The Company has selected the
Black-Scholes method of valuation for stock based employee compensation in fiscal 2006.
Refer to Note 4 for the historical perspective.

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On April 20, 2005, the Companys
Board of Directors approved accelerating the vesting of all the Companys outstanding
stock options having an option exercise price above the closing stock price on that date,
which was $21.61 (underwater options). The underwater options are held by
current employees, including executive officers, and past employees. As a result of the
vesting acceleration, options for approximately 578,000 shares became immediately
exercisable. The Company reported the avoided future compensation costs resulting from the
acceleration of vesting in its fiscal 2005 year end financial statements within its pro
forma footnote disclosure, as permitted under the transition guidance provided by the
Financial Accounting Standards Board.

# Liquidity and Capital
Resources

Cash used in operating activities was
$4.4 million for fiscal 2003 and $10.4 million for fiscal 2004, and cash
provided by operating activity for fiscal 2005 was $18.9 million. The operating cash
in fiscal 2005 was generated primarily from a distribution from its China JV of
$4.3 million and from the reduction of revenue in excess of billings of
$19.2 million which is revenue that was recognized in fiscal 2004 using the
percentage of completion revenue recognition method that was subsequently recorded as
billings in fiscal 2005 and has been collected. As of July 2, 2005, we had cash
and marketable securities of approximately $159.8 million consisting of cash and cash
equivalents of approximately $25.7 million, and marketable securities of
$134.1 million. Total working capital was $200.5 million. In our business we
usually receive customer cash payments during the build process or prior to shipping a
system. In many cases we utilize our cash to support the working capital of the projects
in progress. We also use cash for acquisitions. As such we maintain certain liquidity in
our investment portfolio that will insure available funds to support our business. We
believe that our balance sheet strength and liquidity helps our competitive position in
the market place and as we look at acquisition opportunities.

In addition to the cash and liquidity
that is required to operate the business and demonstrate our strength in the
marketplace, we have outlined in our strategy that we will Pursue Selective
Acquisitions.In conjunction with the addition of our new products that provide
organic growth of our company, 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. In our industry and
given our concentration of revenues and customers outside of the United States, most
acquisition opportunities will be international in nature and scope. With international
acquisitions, there is typically a reluctance to accept a foreign companys stock as
consideration for a transaction. Therefore, we believe that our balance sheet strength and
liquidity helps our position as we look at acquisition opportunities, and
enables meaningful discussions to take place. As a result we believe it is of strategic
importance that we maintain a significant level of invested cash to allow us to explore
all of the acquisition opportunities that are available in our markets.

Capital expenditures were
$1.4 million for fiscal 2003, $8.8 million for fiscal 2004, and
$6.8 million for fiscal 2005. We anticipate operating capital expenditures of
approximately $9.1 million in fiscal 2006. This does not include the planned building
construction of our new Tainan facility, in fiscal 2006, which will require an estimated
capital investment of $10.0 million. The increase in capital expenditures in fiscal
2004, and the continued increase in fiscal 2005, was 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 beta
system for TFT array, as well as for development of our OLED technology and the ATON
system for solar cell products. In fiscal 2005, the accumulated costs related to the
TRITON beta system were reclassified out of construction in progress and are recorded in
work-in-process inventory as of July 2, 2005. Our capital expenditures have consisted
primarily of purchases and manufacturing of process equipment related to product
development.

Cash used for investing activities
was $7.4 million, $98.6 million and $9.1 million in fiscal 2003, 2004, and
2005, respectively. During fiscal 2003, 2004, and 2005 we had purchases of marketable
securities of approximately $82.0 million, $362.6 million, and
$134.1 million, respectively. During fiscal 2003, 2004, and 2005 we had sales of
marketable securities of approximately $74.0 million, $280.9 million, and
$133.4 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 $1.0 million, $95.2 million, and $1.5 million, for fiscal
2003, fiscal 2004, and fiscal 2005, 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 for
at least the next year. 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.

---

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---



# Contractual Obligations
and Commercial Commitments

We have the following contractual
obligations and commercial commitments as of July 2, 2005 (in thousands):

|                                   | Payments Due by Period
|---------------------------------- | ----------------------
|                                   |                       
|                                   |                       
|                                   |                       
|Contractual Cash Obligations       |                       
|Operating leases:                  |                       
|Buildings                          |                       
|Office equipment                   |                       
|Other                              |                       
|                                   |                       
|Total operating lease obligations  |                       
|                                   |                       
|Purchase obligations               |                       
|Other commercial commitments       |                       
|                                   |                       
|Total Contractual Cash Obligations |                       
|                                   |                       
|                                   |                       
|                                   |                       
|                                   |                       
|Other Commercial Commitments       |                       
|Bank guaranties                    |                       
|Forward contracts                  |                       
|Pension liability                  |                       
|                                   |                       
|Total commercial commitments       |                       
|                                   |                       

Operating leases primarily include
leases for offices, factories and office equipment throughout our operations. Our other
commercial commitments consist of software licenses and third party service contracts.

Purchase obligations represent
agreements to purchase goods and services consisting of (a) outstanding purchase orders
for goods and services; (b) contractual requirements to make specified minimum payments
even if the Company does not take delivery of the contracted goods; and (c) contractual
requirements to pay a penalty if the contract is cancelled. While the amount above
represents purchase agreements the actual amounts to be paid may be less in the event that
any agreements are renegotiated, cancelled or terminated.

At July 2, 2005, the
Companys German subsidiary had $17.0 million of guaranty lines of credit in
place with certain banks, with varying maturities. The Company is not able to draw any
funds under these lines. The lines of credit are used to guaranty customer deposits on
certain contracts. If the Company were unable to perform its contractual obligations, to
which the customer deposits relate, it could be required to perform under these
guaranties. The lines of credit reflect fair value as a condition of their underlying
purpose. At July 2, 2005, the Company has guaranties of $6.1 million outstanding under the
guaranty lines of credit.

At July 2, 2005 the Companys
German subsidiary has two forward exchange contracts, maturing March 31, 2006 to
purchase approximately $13.0 million in U.S. dollars. The Company did not qualify
these forward sales contracts as hedging instruments, as defined by FAS 133, and as such,
recorded the changes in the fair value of these derivatives immediately in Other
income net in the Consolidated Statements of Operations. The Company recorded a net gain
of approximately $156,000 from changes in fair values of these foreign currency exchange
contracts in fiscal year 2005.

# 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 and market
risk.

---

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---



As of July 2, 2005, our
investments in marketable securities consisted primarily of auction-rate securities,
corporate, government and municipal bonds, money market mutual funds and restricted cash.
These securities are liquid and earned approximately $3.5 million for fiscal year
2005, with an average investment earning rate over the fiscal year of approximately 2.1%.
The impact on income of an increases or decrease of one percent in the average interest
rate would have resulted in a change of approximately $1.6 million of income for
fiscal year 2005.

# Foreign Exchange Exposure

We transact business in various
foreign countries, and are exposed to changes in foreign currency exchange rates primarily
related to the operating results of our foreign affiliates. Our primary foreign currency
cash flows are generated in countries in Europe and Asia. In 2005 compared to 2004, the
U.S. dollar weakened on average approximately 2% against the euro and strengthened 6%
against the Taiwan dollar. It is highly uncertain how currency exchange rates will
fluctuate in the future. Actual changes in foreign exchange rates could adversely affect
our operating results or financial condition. The potential impact depends upon the
magnitude of the rate change.

Sales of our systems are denominated
primarily in euros. In fiscal 2005 our net revenues in euros reported in equivalent U.S.
dollars was approximately $216.7 million. We are exposed to foreign exchange risk
associated with accounts receivable and payable denominated in foreign currencies. At
July 2, 2005, we had approximately $10.5 million of accounts receivable and
approximately $12.3 million of accounts payable denominated in euros. A one percent
change in exchange rates would result in an approximate $18,000 net impact on pre-tax
income based on the foreign currency denominated accounts receivable and accounts payable
balances at July 2, 2005. We believe our exposure to changes in foreign currency
exchange rates for our cash is limited as substantially all of our cash is denominated in
U.S. dollars.

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.

Our primary manufacturing operations
are currently 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 Taiwan dollars in
Taiwan. International operations result in a large volume of foreign currency commitments
and transactions and significant foreign currency net asset exposures.

Our cash position includes amounts
denominated in foreign currencies. The repatriation of cash balances from certain of our
affiliates could have adverse consequences to the statement of income as well as adverse
tax consequences. However, those balances are generally available without legal
restrictions to fund ordinary business operations, with the exception of $6.2 million
of guaranties related to progress payments primarily from our customers in China and
custom duties for items received in Germany. The $6.2 million guaranty is comprised
of $61,000 of pledged cash and $6.1 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.

---

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---



# 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 or market 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.

---

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---



# ITEM
8:  Financial Statements and Supplementary Data

# Index To Consolidated
Financial Statements

|Applied Films
Corporation and Subsidiaries                                                                                | Page
|------------------------------------------------------------------------------------------------------------------------- | ----
|                                                                                                                          |     
|Report of Independent Registered Public Accounting Firm - Deloitte & Touche LLP                                           |     
|                                                                                                                          |     
|Report of Independent Registered Public Accounting Firm - Deloitte & Touche LLP                                           |     
|                                                                                                                          |     
|Report of Independent Registered Public Accounting Firm - Ernst & Young LLP                                               |     
|                                                                                                                          |     
|Consolidated Balance Sheets as of July 2, 2005 and June 26, 2004                                                          |     
|                                                                                                                          |     
|Consolidated Statements of Operations for the fiscal years ended July 2, 2005, June 26, 2004, and June 28, 2003           |     
|                                                                                                                          |     
|Consolidated Statements of Stockholders' Equity for the fiscal years ended July 2, 2005, June 26, 2004, and June 28, 2003 |     
|                                                                                                                          |     
|Consolidated Statements of Cash Flows for the fiscal years ended July 2, 2005, June 26, 2004, and June 28, 2003           |     
|                                                                                                                          |     
|Notes to Consolidated Financial Statements                                                                                |     

---

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---



# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors
and Stockholders of Applied Films CorporationLongmont, CO

We have audited the accompanying
consolidated balance sheet of Applied Films Corporation and Subsidiaries (the
Company) as of July 2, 2005 and the related consolidated statements of
operations, stockholders equity, and cash flows for the fiscal year then ended. Our
audit also included the financial statement schedule listed at Item 15(a)2 for the fiscal year
ended July 2, 2005. These consolidated financial statements and financial statement
schedule are the responsibility of the Companys management. Our responsibility is to
express an opinion on these consolidated financial statements and financial statement
schedule based on our audit.

We conducted our audit 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 audit provides a reasonable basis for our
opinion.

In our opinion, such consolidated
financial statements present fairly, in all material respects, the financial position of
Applied Films Corporation and Subsidiaries at July 2, 2005, and the results of
their operations and their cash flows for the fiscal year ended July 2, 2005, in conformity
with accounting principles generally accepted in the United States of America. Also, in
our opinion, such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.

We
have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Companys internal control
over financial reporting as of July 2, 2005, based on the criteria established in
Internal ControlIntegrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated, September 15, 2005,
expressed an unqualified opinion on managements assessment of the effectiveness of
the Companys internal control over financial reporting and an unqualified opinion on
the effectiveness of the Companys internal control over financial reporting.

/s/ DELOITTE &
TOUCHE LLP

Denver, COSeptember 15,
2005

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---



# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors
and Stockholders of Applied Films Corporation Longmont, CO

We have audited managements
assessment, included in the accompanying Managements Report on Internal Controls over
Financial Reporting, that Applied Films Corporation and Subsidiaries (the
Company) maintained effective internal control over financial reporting as of
July 2, 2005based on the criteria established in Internal
ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations
of the Treadway Commission. The Companys management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility is to
express an opinion on managements assessment and an opinion on the effectiveness of
the Companys internal control over financial reporting based on our audit.

We conducted our audit 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 effective internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over financial
reporting, evaluating managements assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinions.

A companys internal control
over financial reporting is a process designed by, or under the supervision of, the
companys principal executive and principal financial officers, or persons performing
similar functions, and effected by the companys board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A companys internal control over
financial reporting includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts
and expenditures of the company are being made only in accordance with authorizations of
management and directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements.

Because of the inherent limitations
of internal control over financial reporting, including the possibility of collusion or
improper management override of controls, material misstatements due to error or fraud may
not be prevented or detected on a timely basis. Also, projections of any evaluation of the
effectiveness of the internal control over financial reporting to future periods are
subject to the risk that the controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may
deteriorate.

In our opinion, managements
assessment that the Company maintained effective internal control over financial reporting
as of July 2, 2005, is fairly stated, in all material respects, based on the criteria
established in Internal ControlIntegrated Frameworkissued by the Committee
of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial reporting
as of July 2, 2005, based on the criteria established in Internal
ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations
of the Treadway Commission.

We have also audited, in accordance
with the standards of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheet of Applied Films Corporation and Subsidiaries (the
Company) as of July 2, 2005 and the related consolidated statements of
operations, stockholders equity, and cash flows for the fiscal year ended July 2,
2005 of the Company and the financial schedule listed at Item 15(a)2 for the fiscal year
ended July 2, 2005, and our report dated September 15, 2005 expressed an unqualified
opinion on those financial statements and the financial statement schedule.

/s/ DELOITTE &
TOUCHE LLP

Denver, COSeptember 15,
2005

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---



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 sheet of Applied Films Corporation and subsidiaries as of June 26,
2004, and the related consolidated statements of income, stockholders equity, and
cash flows for each of the two 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 and June 28, 2003. 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 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
consideration of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Companys internal control over
financial reporting. Accordingly, we express no opinion. An audit also includes examining,
on a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates made by
management, and 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 the
consolidated results of their income and their cash flows for each of the two 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

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---



Applied Films
Corporation and Subsidiaries

Consolidated Balance
Sheets

|                                                                     | July 2, 2005 | June 26, 2004
|-------------------------------------------------------------------- | ------------ | -------------
|                                                                     |              |              
|ASSETS                                                               |              |              
|CURRENT ASSETS:                                                      |              |              
|Cash and cash equivalents                                            |              |              
|Restricted cash                                                      |              |              
|Marketable securities                                                |              |              
|Accounts and trade notes receivable, net of allowance of $396 and    |              |              
|$525, respectively                                                   |              |              
|Revenue in excess of billings                                        |              |              
|Inventories                                                          |              |              
|Prepaid expenses and other                                           |              |              
|Deferred tax assets                                                  |              |              
|                                                                     |              |              
|Total current assets                                                 |              |              
|                                                                     |              |              
|Property, plant and equipment, net                                   |              |              
|Goodwill                                                             |              |              
|Intangible assets, net of accumulated amortization of $20,608 and    |              |              
|$15,731, respectively                                                |              |              
|Investment in joint venture                                          |              |              
|Deferred tax asset                                                   |              |              
|Restricted cash                                                      |              |              
|Other assets                                                         |              |              
|                                                                     |              |              
|Total assets                                                         |              |              
|                                                                     |              |              
|                                                                     |              |              
|LIABILITIES AND STOCKHOLDERS' EQUITY                                 |              |              
|CURRENT LIABILITIES:                                                 |              |              
|Trade accounts payable                                               |              |              
|Accrued warranty                                                     |              |              
|Accrued compensation                                                 |              |              
|Accrued expenses                                                     |              |              
|Billings in excess of revenue                                        |              |              
|Current portion of deferred gross profit and deferred gain           |              |              
|Deferred tax liability                                               |              |              
|                                                                     |              |              
|Total current liabilities                                            |              |              
|                                                                     |              |              
|Deferred tax liability                                               |              |              
|Deferred gross profit, deferred gain and other obligations           |              |              
|Accrued pension benefit obligation                                   |              |              
|                                                                     |              |              
|Total liabilities                                                    |              |              
|                                                                     |              |              
|COMMITMENT AND CONTINGENCIES                                         |              |              
|STOCKHOLDERS' EQUITY:                                                |              |              
|Common stock, no par value, 40,000,000 shares authorized, 14,947,834 |              |              
|and 14,838,215 shares issued and outstanding at July 2, 2005 and     |              |              
|June 26, 2004, respectively                                          |              |              
|Warrants                                                             |              |              
|Cumulative other comprehensive income                                |              |              
|Retained earnings                                                    |              |              
|                                                                     |              |              
|Total stockholders' equity                                           |              |              
|                                                                     |              |              
|Total liabilities and stockholders' equity                           |              |              
|                                                                     |              |              

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

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---



Applied Films
Corporation and Subsidiaries Consolidated 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                                |                                      
|Selling, general and administrative                     |                                      
|In-process research and development                     |                                      
|Amortization of intangible assets                       |                                      
|                                                        |                                      
|Income (loss) from operations                           |                                      
|                                                        |                                      
|Other income, net:                                      |                                      
|Other income, net                                       |                                      
|Equity earnings of joint venture                        |                                      
|                                                        |                                      
|Income from continuing operations before income taxes   |                                      
|                                                        |                                      
|Income tax provision                                    |                                      
|                                                        |                                      
|                                                        |                                      
|Income (loss) from continuing operations                |                                      
|                                                        |                                      
|Discontinued operations (Note 2):                       |                                      
|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)                                       |                                      
|                                                        |                                      
|Earnings (loss) per share:                              |                                      
|Basic:                                                  |                                      
|Income (loss) from continuing operations                |                                      
|Income from discontinued operations                     |                                      
|                                                        |                                      
|Basic earnings (loss) per share:                        |                                      
|                                                        |                                      
|Diluted:                                                |                                      
|Income (loss) from continuing operations                |                                      
|Income from discontinued operations                     |                                      
|                                                        |                                      
|Diluted earnings (loss) per share                       |                                      
|                                                        |                                      
|Weighted average common shares outstanding:             |                                      
|Basic                                                   |                                      
|                                                        |                                      
|Diluted                                                 |                                      
|                                                        |                                      

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

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

|                                                          | Common Stock |  |  | Cumulative Other | Total
|--------------------------------------------------------- | ------------ |  |  | ---------------- | -----
|                                                          |              |  |  |                 
|                                                          |              |  |  |                 
|                                                          |              |  |  |                  |      
|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 loss                            |              | 
|on hedged transaction                                     |              |  |  | -                |      
|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       |      
|                                                          |              |  |  |                  |      
|Comprehensive income:                                     |              | 
|Net (loss) income                                         |              |  |  | -                |      
|Unrealized gain on foreign  currency translation          |              |  |  | -                |      
|Unrealized gain on securities,  net of tax                |              |  |  | -                |      
|                                                          |              |  |  |                  |      
|Total comprehensive income                                |              |  |  | -                |      
|                                                          |              | 
|ESPP stock issuance                                       |              |  |  | 15,040           |      
|Restricted stock issuance                                 |              |  |  | 2,775            |      
|                                                          |              | 
|Exercise of stock options                                 |              |  |  | 91,804           |      
|                                                          |              | 
|Tax benefit from nonqualified stock options               |              |  |  | -                |      
|                                                          |              |  |  |                  |      
|Balances, July 2, 2005                                    |              |  |  | 14,947,834       |      
|                                                          |              |  |  |                  |      

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

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Applied Films
Corporation and Subsidiaries Consolidated Statements
of Cash Flows

|                                                                        | For The Fiscal Years Ended
|----------------------------------------------------------------------- | --------------------------
|                                                                        |                           
|(in thousands)                                                          |                           
|                                                                        |                           
|Cash Flows from Continuing Operations - Operating Activities:           |                           
|Net income (loss)                                                       |                           
|Adjustments to net income (loss) from continuing operations:            |                           
|Income (loss) and gain on disposal of discontinued operations           |                           
|                                                                        |                           
|Income (loss) from continuing operations                                |                           
|                                                                        |                           
|Depreciation and amortization                                           |                           
|Acquired in-process research and development expense                    |                           
|Non-cash compensation expense                                           |                           
|Amortization of gain on lease and deferred gain on equipment            |                           
|sale to joint venture                                                   |                           
|Equity earnings of joint venture                                        |                           
|China joint venture distribution                                        |                           
|Loss on disposal of equipment                                           |                           
|Income tax benefit from exercise of nonqualified stock options          |                           
|Deferred income taxes                                                   |                           
|Changes in:                                                             |                           
|Restricted cash for customers and suppliers                             |                           
|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 payable                                                    |                           
|                                                                        |                           
|Net cash flows provided by (used in) continuing operations -            |                           
|operating activities                                                    |                           
|                                                                        |                           
|Cash Flows from Continuing Operations - Investing Activities:           |                           
|Purchases of property, plant, and equipment                             |                           
|Purchases of patents                                                    |                           
|Purchases of marketable securities                                      |                           
|Sales of marketable securities                                          |                           
|Funds (used for) provided by acquisitions                               |                           
|Restricted cash for China JV                                            |                           
|                                                                        |                           
|Net cash flows used in continuing operations - investing activities     |                           
|                                                                        |                           
|Cash Flows from Continuing Operations - Financing Activities:           |                           
|Stock issuance on stock purchase plan and stock options                 |                           
|Proceeds from secondary offering                                        |                           
|Offering costs                                                          |                           
|                                                                        |                           
|Net cash flows provided by continuing operations - financing activities |                           
|Cash flow from Discontinued operations - Operating activities           |                           
|Cash flow from Discontinued operations - Investing activities           |                           
|Effect of exchange rate changes on cash and cash equivalents            |                           
|                                                                        |                           
|Net increase(decrease) 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           |                           
|                                                                        |                           
|Additions to property, plant and equipment through accounts payable     |                           
|                                                                        |                           
|Stock issued related to cashless exercise of warrants                   |                           
|                                                                        |                           
|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.

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# Applied Films
Corporation and SubsidiariesNotes to Consolidated
Financial Statements

# NOTE 1: COMPANY
OPERATIONS AND 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 3).

Use of Estimates

The preparation of financial
statements in conformity with accounting principles generally accepted in the U.S., U.S.
GAAP, 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 dates of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates. On an
on-going basis, the Company evaluates its estimates, including those related to project
costs, warranties, collections, product returns, inventories, investments, fixed assets,
intangible assets, income taxes, pension benefits and contingencies.

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 year 2005 included 53 weeks and fiscal years 2004 and 2003 included 52
weeks.

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 July 2, 2005 and June
26, 2004, the Company had restricted cash outstanding totaling $61,000 and
$2.1 million, respectively, for pledged cash for custom duties on imports into
Germany and on behalf of certain customers for their cash deposits on contracts.

Marketable Securities

The Company records its short-term
investments as available-for-sale securities. Available-for-sale securities are carried at
fair value, with the unrealized gains and losses, net of tax, reported on the consolidated
balance sheet in cumulative 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 other income, net. 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 other income, net. Interest and dividends not received
of $1.1 million and $1.2 million at July 2, 2005 and
June 26, 2004, respectively, are included in accounts, trade notes and other
receivables on the balance sheet. The Company commonly holds its investments to maturity
but can sell them at any time as short term cash needs arise.

From 1997 through
April 20, 2004 the Company had classified its investments as trading securities.
In April 2004, in accordance with SFAS 115, the Company determined that because the
securities were not held to make a profit from short-term fluctuations in market prices,
it was more appropriate to classify its investments as securities available-for-sale.

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The following is a summary of the
Companys available-for-sale securities as of July 2, 2005 and June 26,
2004 (in thousands):

|                          | Available-for-Sale Securities - July 2, 2005
|------------------------- | --------------------------------------------
|                          |                                             
|                          |                                             
|                          |                                             
|Corporate bonds           |                                             
|Municipal debt securities |                                             
|Government bonds          |                                             
|Auction rate securities   |                                             
|Money market funds        |                                             
|                          |                                             
|Total                     |                                             
|                          |                                             

|                          | Available-for-Sale Securities - June 26, 2004
|------------------------- | ---------------------------------------------
|                          |                                              
|                          |                                              
|                          |                                              
|Corporate bonds           |                                              
|Municipal debt securities |                                              
|Government bonds          |                                              
|Auction rate securities   |                                              
|Money market funds        |                                              
|                          |                                              
|Total                     |                                              
|                          |                                              

For the year ended
July 2, 2005, available-for-sale securities with a fair value at the date of
sale of $17.2 million were sold. The gross realized gains on such sales totaled
$19,000.

The amortized cost and estimated fair
value of marketable securities at July 2, 2005, 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 |                |                     
|Due after five years                  |                |                     
|Money market funds                    |                |                     
|                                      |                |                     
|Total marketable securities           |                |                     
|                                      |                |                     

The following table provides the
breakdown of the short-term  investments  with  unrealized  losses at July 2, 2005 (in
thousands):

|                          | In Loss Position for
 Less Than 12 Months | In Loss Position for
12 Months or Greater | Total
|------------------------- | ----------------------------------------- | ----------------------------------------- | -----
|                          |                                           |                                           |      
|                          |                                           |                                           |      
|                          |                                           |                                           |      
|Corporate bonds           |                                           |                                           | $    
|Municipal debt securities |                                           |                                           |      
|Government bonds          |                                           |                                           |      
|Auction rate securities   |                                           |                                           |      
|Money market funds        |                                           |                                           |      
|                          |                                           |                                           |      
|Total                     |                                           |                                           | $    
|                          |                                           |                                           |      

The Company  reviews its  investment
 portfolio to identify  and  evaluate  investments  that have  indications  of possible
other-than-temporary  impairment.  Factors considered in determining whether a loss is
temporary include the length of time and extent to which fair value has been less than
the cost basis,  the  financial  condition and near-term  prospects of the investee,
 credit quality and the Companys ability to hold the investment for a period of
time  sufficient to allow of any  anticipated  recovery in market  value.  The Company
has  determined  that the gross unrealized losses on its short-term investments at July
2, 2005 are temporary in nature.

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Inventories

Inventories consist of materials used
in the construction of systems and spare parts and work-in-process for contracts accounted
for under the completed contract method of accounting, including the TRITON beta system.
Inventories are stated at the lower of cost (first-in, first-out) or market. Included in
work-in-process is the TRITON beta system. The value of the TRITON beta system was reduced
to reflect the lower of cost or market. Inventories consist of the following (in
thousands):

|                                                    | July 2, 2005 | June 26, 2004
|--------------------------------------------------- | ------------ | -------------
|                                                    |              |              
|Materials for manufacturing systems and spare parts |              |              
|Work-in-process                                     |              |              
|                                                    |              |              
|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 |                       
|Leasehold improvements         |                       

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

|                                                               | July 2, 2005 | June 26, 2004
|-------------------------------------------------------------- | ------------ | -------------
|                                                               |              |              
|Land                                                           |              |              
|Building                                                       |              |              
|Machinery and equipment                                        |              |              
|Office furniture and equipment                                 |              |              
|Leasehold improvements                                         |              |              
|Construction in progress                                       |              |              
|                                                               |              |              
|                                                               |              |              
|Less accumulated depreciation                                  |              |              
|                                                               |              |              
|Property, plant and equipment, net of accumulated depreciation |              |              
|                                                               |              |              

Depreciation expense was
approximately $2.8 million, $2.1 million, and $2.0 million, for the fiscal
years ended July 2, 2005, June 26, 2004, and June 28, 2003,
respectively.

Goodwill and
Intangible Assets

Goodwill represents the excess of
purchase price over the fair value of net assets acquired. Intangible assets (identified
as patents, customer relationships and non-compete agreements) are recorded at fair value
determined at the time of acquisition. The goodwill and intangible assets are carried on
the balance sheet of the Companys German subsidiary and Taiwan subsidiary. The
Company has completed a fair value analysis of the assets and the final allocation of the
purchase price related to the acquisition of the in-line systems division of Helix
Technology in Tainan (Helix) and has adjusted the preliminary balances to reflect the
results. (Note 10). Going forward increases or decreases in the gross asset value will be
due to currency fluctuation between the U.S. dollar, the euro, and the Taiwan dollar or
any impairment adjustments. The increase in accumulated amortization of intangible assets
is due to the amortization expense in the current period and currency fluctuation between
the U.S. dollar, the euro, and the Taiwan dollar. During fiscal 2005, the Company acquired
a license for the rights to a patent for $2.0 million. The composition of intangible
assets follows (in thousands):

|                                                   | July 2, 2005 | June 26, 2004
|-------------------------------------------------- | ------------ | -------------
|                                                   |              |              
|Intangible assets:                                 |              |              
|Patents and related licenses                       |              |              
|Customer relationships                             |              |              
|Non-compete agreements                             |              |              
|                                                   |              |              
|Intangible assets                                  |              |              
|Less accumulated amortization                      |              |              
|                                                   |              |              
|Intangible assets, net of accumulated amortization |              |              
|                                                   |              |              

The patents are amortized over seven
years and the customer relationships and non-compete agreements are amortized over five
years. As a result of adopting SFAS No. 142 Goodwill and Intangible assets,
the Company no longer recognizes amortization expense on its goodwill. Annually, and more
frequently if a triggering event occurs, the Company tests the carrying value of goodwill
for impairment. During fiscal 2005 the annual impairment test on the goodwill recorded
with respect to the Large Area Coatings division of Unaxis (LAC) and Helix acquisition was
completed and it was determined that there was no impairment of the goodwill.

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The aggregate amortization expense
for fiscal years ended July 2, 2005, June 26, 2004, and
June 28, 2003, was $5.5 million, $4.3 million, and $3.8 million,
respectively. The aggregate amortization expense for the intangible assets for each of the
five succeeding fiscal years is estimated as follows using the foreign currency exchange
rates as of July 2, 2005 (in thousands):

|     | Estimated Amortization Expense
|---- | ------------------------------
|     |                               
|2006 |                               
|2007 |                               
|2008 |                               
|2009 |                               
|2010 |                               

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 performed an impairment
test of the equity investment in the China JV recorded on the Companys balance
sheet, for all years presented. The Company 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 long-lived assets.

Accrued Expenses

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

|                            | July 2, 2005 | June 26, 2004
|--------------------------- | ------------ | -------------
|                            |              |              
|Accrued losses on contracts |              |              
|Accrued income tax payable  |              |              
|Other accruals              |              |              
|                            |              |              
|Total accrued expenses      |              |              
|                            |              |              

Accrued losses on contracts are
recognized on specific projects when contract costs in excess of the contracted revenue
becomes probable and the amount of loss can be reasonably estimated. 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.

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.

During fiscal years 2005, 2004, and
2003, the Companys intent was to permanently reinvest undistributed earnings from
the China JV, therefore no provision for taxes on earnings had been accrued in the
Companys tax provision. During fiscal year 2005, the China JV distributed
approximately $4.3 million in excess cash that was not needed for operations to each
of the owners. Although the cash dividends were not recorded as income on the
Companys income statement, they were subject to tax in the U.S. and the current
income tax expense was recorded in the Companys income statement.

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Following the Company's fiscal year end,
management has evaluated the changes in facts and circumstances regarding the China Joint Venture
(China JV), known as STEC. Since the China JVs inception in 1999, we
have viewed our share of the undistributed earnings of the China JV as permanently
re-invested. After considering the current business environment at China JV, including the
dividends paid during the 2005 fiscal year, we no longer expect our portion of the China
JVs retained earnings to be permanently reinvested. As a result of this decision,
under the accounting guidance of APB 23 and SFAS 109 Accounting for Income Taxes
 Special Areas, we recorded a $4.8 million non-cash provision for income taxes
which is reflected in the fourth quarter of our fiscal 2005 financial statements. These
accrued taxes will become due upon monetization of undistributed earnings from the China
JV. In the future, the Company will accrue income taxes quarterly at the US tax rate on
the equity earnings of the China JV.

Deferred Gain

During 1997, the Company entered into
a lease transaction with a third party for the Companys administrative facility in
Longmont, Colorado, which included a purchase option early in the lease period. The
Company sold this purchase option to a third party who exercised this option and purchased
the building. The Company then leased the facility, which includes a purchase option (Note
8). The Company received $834,000 from this sale leaseback transaction. This amount 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. Historically, product returns have been insignificant and infrequent.
Therefore, the Company does not maintain a reserve to cover sales returns for quality
defects from its customers.

Equipment Sales
Revenue Recognition

The percentage of completion method
of accounting is used for most products sold at values greater than 1 million or a
manufacturing 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.

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 that occur prior to the Companys
recognition of revenues on the contract for financial reporting purposes.

Contracts in progress are as follows
(in thousands):

|                                                                   | July 2, 2005 | June 26, 2004
|------------------------------------------------------------------ | ------------ | -------------
|                                                                   |              |              
|Costs incurred on contracts in progress and estimated profit       |              |              
|Less:  billings to date                                            |              |              
|                                                                   |              |              
|Revenue in excess of billings net of billings in excess of revenue |              |              
|                                                                   |              |              

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.

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The completed contract method of
accounting is used for standard products that are sold at values less than 1 million
or have a manufacturing time of less than six months and for certain other products if the
form of the sales contract dictates such treatment. For projects accounted for using the
completed contract method of accounting, the Company accumulates the project costs in
work-in-process until the Company completes 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. The Company recognizes
the revenue, upon transfer of title which for certain projects does not occur until after
customer acceptance at its facility. The Companys contracts under the completed
contract method do not provide for the right of a customer to return the machine once
title has transferred.

The Company generally offers warranty
coverage for equipment sales for a period of one year after final acceptance. 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. 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.

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

|                                   | Fiscal Year Ended
|---------------------------------- | -----------------
|                                   |                  
|                                   |                  
|                                   |                  
|Beginning of period                |                  
|Warranties accrued net of releases |                  
|Repairs and replacements           |                  
|                                   |                  
|End of period                      |                  
|                                   |                  

During the third quarter of fiscal
2005, the Company evaluated its warranty accruals and determined that due to improved
contract execution, a change in estimates was required which resulted in a reduction in
the warranty accruals and a corresponding reduction in cost of goods sold of approximately
$1.2 million.

Deferred Gross Profit

During fiscal years 2002, 2001 and
1999, the Company sold certain thin film deposition equipment to the China JV
(Note 3). Because the Company owns 50% of the China JV, the Company recorded 50% of
the revenue and related cost of the sales and deferred 50% of the gross profit of
approximately $0.0, $1.3 million and $1.4 million, respectively, which are being
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 2005, 2004 and 2003 was $297,000 each year. The
remaining deferred gross profit was $1.3 million on July 2, 2005, and
$1.6 million on June 26, 2004.

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 $21.7 million, $16.8 million, and $12.2 million, of
research and development expenses for the fiscal years ended July 2, 2005,
June 26, 2004, and June 28, 2003, respectively, net of reimbursements
for funded research and development received from German and European Union governmental
agencies. The Company is reimbursed by the governmental agencies up to 50% of the costs
incurred for specific research and development projects. The reimbursement terms are
contained in agreements between the Company and the governmental agencies and
reimbursements are paid when the research is completed and accepted. The Company received
reimbursements of $1.8 million, $713,000, and $599,000, in the fiscal years ended
July 2, 2005, June 26, 2004, and June 28, 2003,
respectively. These reimbursements are reported as a reduction of research and development
costs.

Foreign Currency
Transactions

The Company principally purchases raw
materials from euro based suppliers and manufactures its products in Germany. The majority
of the companys sales and purchases are denominated in euros, with the remainder
denominated in U.S. dollars.

The Company generated 84%, 81%, and
70% of its revenues in fiscal years 2005, 2004, and 2003, respectively, from sales to
corporations located outside of Europe, which are primarily in Asia and the United States.
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. When the Company engages in a system related sales contract other than one
denominated in euros, the Company may enter into a currency hedging transaction to
mitigate the Companys foreign exchange exposure for the duration of the contract.
The Company currently has two outstanding foreign currency forward contracts related to
intercompany loans. There are no outstanding foreign currency forward contracts related to
sales contracts at July 2, 2005. 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.

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The Company currently has two
outstanding foreign currency forward contracts related to intercompany loans (see
Derivative Instruments and Hedging Activities).

Foreign Currency
Translation

The financial results of the
Companys foreign subsidiaries, whose functional currencies are other than U.S.
dollars, 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 cumulative other
comprehensive income.

Cumulative Other
Comprehensive Income (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. Cumulative other 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 gain (losses) on available-for-sale marketable securities.

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

|                                                             | Beginning Balance | Yearly Change, net of tax | Deferred Tax Valuation Allowance Impact | Ending Balance
|------------------------------------------------------------ | ----------------- | ------------------------- | --------------------------------------- | --------------
|                                                             |                   |                           |                                         |               
|June 28, 2003                                                |                   |                           |                                         |               
|Unrealized gains (losses) on foreign currency translation    |                   |                           | $                                       | (7,995        
|Unrealized gain on hedged transactions                       |                   |                           |                                         | -             
|                                                             |                   |                           |                                         |               
|                                                             |                   |                           |                                         | (7,995        
|                                                             |                   |                           |                                         |               
|June 26, 2004                                                |                   |                          
|Unrealized gains on foreign currency translation             |                   |                           |                                         | 11,024        
|Recognition of unrealized gain (loss) on hedged transactions |                   |                           |                                         | 480           
|Unrealized losses on marketable securities                   |                   |                           |                                         | -             
|                                                             |                   |                           |                                         |               
|                                                             |                   |                           |                                         | 11,504        
|                                                             |                   |                           |                                         |               
|July 2, 2005                                                 |                   |                          
|Unrealized gains on foreign currency translation             |                   |                           |                                         | 23,616        
|Unrealized gains (losses) on marketable securities           |                   |                           |                                         | (660          
|                                                             |                   |                           |                                         |               
|                                                             |                   |                           | $                                       | 22,956        
|                                                             |                   |                           |                                         |               

|* | Amounts related to unrealized gains (losses) on marketable securities are recorded net of
tax, but have corresponding full valuation allowance recorded against the related deferred
tax asset.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Net Income 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 per share is computed by dividing net income by the weighted average number of
shares of common stock outstanding. Diluted earnings per share is determined by dividing
net income by the sum of (1) the weighted average number of common shares outstanding and
(2) the dilutive effect of outstanding potentially dilutive securities, stock options and
warrants determined utilizing the treasury stock method.

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

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

For the years ended July 2, 2005,
June 26, 2004 and June 28, 2003, options and warrants for 843,492, 160,189 and 494,649
shares, respectively, were excluded from the calculation since their exercise prices were
above the average price of the stock for the year and accordingly were anti-dilutive.

Stock Based Compensation

SFAS 123, Accounting for
Stock-Based Compensation, (SFAS 123) 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
(APB ) 25, Accounting for Stock Issued to Employees, as amended by
Financial Accounting Standards Board (FASB) Interpretation No. FIN 44, Accounting
for Certain Transactions including Stock Compensation and Interpretation of APB Opinion No
24, and to adopt the disclosure only provisions as required under SFAS 123. The
Company has elected to account for its stock-based compensation plans for employees and
directors under APB 25 for periods through July 2, 2005.

Accordingly, for purposes of the pro
forma disclosures presented below, the Company has computed the fair values of all options
granted during fiscal 2005, 2004, and 2003 using the Black-Scholes pricing model and the
following weighted average assumptions:

|                        | 2005 | 2004 | 2003
|----------------------- | ---- | ---- | ----
|                        |      |      |     
|Risk-free interest rate |      |      |     
|Expected lives          |      |      |     
|Expected volatility     |      |      |     
|Expected dividend yield |      |      |     

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.

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The total fair value of options
granted was computed to be approximately $7.5million, $7.1 million, and
$2.6 million, for the years ended July 2, 2005, June 26, 2004, and
June 28, 2003, 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 $7.9 million, $2.3 million, and $2.2 million, for the
fiscal years ended July 2, 2005, June 26, 2004, and
June 28, 2003, respectively.

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):

|                                                                              | For The Fiscal Years Ended
|----------------------------------------------------------------------------- | --------------------------
|                                                                              |                           
|                                                                              |                           
|                                                                              |                           
|Net income (loss) applicable to common shareholders:                          |                           
|As reported                                                                   |                           
|Add:  Stock-based employee compensation expense,                              |                           
|included in the report 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 income (loss)                                                   |                           
|                                                                              |                           
|Income (loss) per share:                                                      |                           
|Basic - as reported                                                           |                           
|                                                                              |                           
|Diluted - as reported                                                         |                           
|                                                                              |                           
|Basic - pro forma                                                             |                           
|                                                                              |                           
|Diluted - pro forma                                                           |                           
|                                                                              |                           

Included in the total stock-based
employee compensation expense determined under fair-value based method for all awards is
$4.1 million resulting from the acceleration of the vesting of all the Companys
underwater options for approximately 578,000 shares during the fourth quarter of fiscal
2005. See Recent Accounting Standards.

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 sale
contracts 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.

The Companys German entity had
foreign exchange forward contracts maturing March 31, 2006 to purchase
approximately $13.0 million in U.S. dollars. The foreign currency exchange contract
is related to an intercompany loan between the U.S. and Germany. The intercompany loan is
denominated in U.S. dollars. The Company did not qualify these forward sales contracts as
hedging instruments, as defined by FAS 133, and as such, recorded the changes in the fair
value of these derivatives immediately in Other income net in the Consolidated
Statements of Operations. The Company recorded a net gain of approximately $156,000, $0, and
$480,000 from changes in fair values related to foreign currency exchange contracts in
fiscal year 2005, 2004, and 2003, respectively. The Company did not have any forward sales
contracts in fiscal 2004. At July 2, 2005 included in accounts and trade notes
receivable is the asset totaling $156,000 related to the fair value of the foreign
currency exchange contract.

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Recent Accounting
Standards

In March 2005, the FASB published
FASB Interpretation No. 47, Accounting for Conditional Asset Retirement
Obligations, which clarifies that the term, conditional asset retirement
obligations, as used in SFAS No. 143, Accounting for Asset Retirement
Obligations, refers to a legal obligation to perform an asset retirement activity in
which the timing and (or) method of settlement are conditional on a future event that may
or may not be within the control of the entity. The uncertainty about the timing and (or)
method of settlement of a conditional of an asset retirement obligation should be factored
into the measurement of the liability when sufficient information exists. The
Interpretation also clarifies when an entity would have sufficient information to
reasonably estimate the fair value of an asset retirement obligation. This Interpretation
is effective for fiscal years ending after December 15, 2005. The adoption of
this Interpretation is not expected to have a material effect on the Companys
consolidated financial position or results of operations.

In June 2005, the FASB issued
SFAS No. 154, Accounting Changes and Error Corrections, which replaces APB
Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting
Accounting Changes in Interim Financial Statements. Statement 154 changes the
requirements for the accounting and reporting of a change in accounting principle. APB
Opinion No. 20 previously required that most voluntary changes in an accounting
principle be recognized by including the cumulative effect of the new accounting principle
in net income of the period of the change. SFAS No. 154 now requires retrospective
application of changes in an accounting principle to prior period financial statements,
unless it is impracticable to determine either the period-specific effects or the
cumulative effect of the change. The Statement is effective for fiscal years beginning
after December 15, 2005. The Company does not expect the adoption of this statement
will have a material impact on the Companys financial statements.

In November 2004, the FASB issued
SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4, to
clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted
material (spoilage) should be recognized as current period charges, and that fixed
production overheads should be allocated to inventory based on normal capacity of
production facilities. This statement is effective for the Companys fiscal year
2006. The Company does not anticipate that SFAS 151 will have a significant impact on the
Companys overall results of operations or financial position.

In December 2004, the FASB issued
SFAS No. 123(R) Share-Based Payment. SFAS 123(R) requires the recognition of
compensation cost relating to share-based payment transactions in financial statements.
That cost will be measured based on the fair value of the equity or liability instruments
issued as of the grant date, based on the estimated number of awards that are expected to
vest. SFAS 123(R) covers a wide range of share-based compensation arrangements including
share options, restricted share plans, performance-based awards, share appreciation
rights, and employee share purchase plans and specifically including charges for
share-based compensation granted in the past but vesting after the effective date of the
rule. Statement 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based
Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued
to Employees. Statement 123(R), as amended, is effective for the Companys
fiscal year 2006. As a result, the Company will be required to implement SFAS 123R in
the quarter ending October 1, 2005. The Company has evaluated the impact of
adopting SFAS 123R on the Companys financial position and results of operations.
Based upon the Companys evaluation, the Company anticipates that adoption will
result in significant non-cash expense of approximately $800,000 for the first
quarter of fiscal 2006 due to the number of unvested stock options outstanding. This
charge will be distributed and reported in cost of goods sold, research and development
and sales, general and administrative expenses.

The Company has selected the
Black-Scholes method of valuation for fiscal 2006.

Reclassifications

Certain prior year amounts have been
reclassified to conform to current year presentation. These reclassifications include:
accrued interest on marketable securities to accounts receivable on the balance sheet; and
reclassifications on the cash flow statement including restricted cash for China JV from
financing to investing, the reporting of gross purchases and sales of marketable
securities and separation of cash flows from discontinued operations into operating and
investing components.

# NOTE 2: 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 Nippon Sheet Glass, Ltd. (NSG) for approximately $1.4 million and recorded a
final after tax gain, in the second quarter of fiscal 2004 of $783,000 on the transaction.
The assets sold include the right to direct 50% of the China JV production, customer
relationships of the business, the coated glass inventory and any outstanding purchase
orders of the coated glass business located in Hong Kong.

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The Company accounted for the sale of
the Hong Kong coated glass business as a discontinuance of the business. The net revenues
of the discontinued operation were $933,000 and $6.1 million for the fiscal years
ended June 26, 2004 and June 28, 2003, respectively.

# NOTE 3: 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 deferred 50% of the gross profit of each
sale, 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 amortization of the deferred gross profit is included with Equity earnings of
joint venture in the accompanying Consolidated Statements of Operations.

The Company records 50% of income or
loss from operations of the China JV after eliminating the impact of inter-entity
transactions. In the first calendar quarter of each year the China JV makes an adjustment
to retained earnings related to statutory reserves insurance. This adjustment required the
Company to modify its equity earnings in the China JV during the third fiscal quarter. The
effect of this adjustment, in the third quarter of fiscal 2005, was to reduce equity
earnings in the China JV by $256,000. The functional currency for the China JV is the
local Chinese 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. Until July of
2005, these rates have remained fixed by the Chinese government. The cumulative
translation gain or loss, if any, is recorded as Cumulative other comprehensive
income in the Companys consolidated financial statements. The Company receives
royalty income from the China JV. The royalty is approximately 1.0% of the China JV sales.

During the third quarter of fiscal
2004, the China JV entered into an unsecured credit facility that does not require a bank
guaranty from either the Company or NSG. Subsequently, the Companys
$5.0 million guaranty of 50% of the debt of the China JV was released.

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                     |                  
|                                                     |                  
|Applied Films portion of royalty income (included in |                  
|other income, net)                                   |                  
|                                                     |                  

During the fiscal year 2005, the
China JV distributed approximately $4.3 million in excess cash that was not needed
for operations to each of the owners. Although the cash dividends were not recorded as
income on the Companys income statement, they were subject to tax in the U.S. and
current income tax expense was recorded in the Companys income statement.

Following our fiscal year end, we
have evaluated the changes in facts and circumstances regarding the China Joint Venture
(China JV), known as STEC. Since the China JVs inception in 1999, we
have viewed our share of the undistributed earnings of the China JV as permanently
re-invested. After considering the current business environment at China JV, including the
dividends paid during the 2005 fiscal year, we no longer expect our portion of the China
JVs retained earnings to be permanently reinvested. As a result of this decision,
under the accounting guidance of APB 23 and SFAS 109 Accounting for Income Taxes
 Special Areas, we recorded a $4.8 million non-cash provision for income taxes
which is reflected in the fourth quarter of our fiscal 2005 financial statements. These
accrued taxes will become due upon monetization of undistributed earnings from the China
JV. In the future, the Company will accrue income taxes quarterly at the US tax rate on
the equity earnings of the China JV.

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The Company recorded spare parts
sales to the China JV of $699,000, $544,000, and $783,000 in fiscal years ended
July 2, 2005, June 26, 2004, and June 28, 2003, respectively.

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

|                                    | June 30, 2005 | June 30, 2004
|----------------------------------- | ------------- | -------------
|                                    |               |              
|Assets:                             |               |              
|Current assets                      |               |              
|Property, plant, and equipment, net |               |              
|                                    |               |              
|                                    |               |              
|                                    |               |              
|Capitalization and liabilities:     |               |              
|Current liabilities                 |               |              
|Short-term debt                     |               |              
|Equity                              |               |              
|                                    |               |              
|                                    |               |              
|                                    |               |              

As of July 2, 2005 and June
26, 2004, the Company had receivables from the China JV of approximately $118,000 and
$273,000, (including royalty receivables of $51,000 and $156,000), respectively.

# NOTE 4: 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 convertible
preferred stock offering. The Series A Convertible Preferred Stock was converted into
506,328 shares of common stock in December 2001. The remaining warrants are
immediately exercisable, and may be exercised any time over a five year period, from the
date of issuance. 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.

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 and the options vested over a four year period.

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. 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.

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On October 22, 2003, the Company
adopted the Long Term Incentive Plan covering 1.2 million shares of common stock. The Plan
provided for the granting of stock options, stock appreciation rights, restricted stock
units, 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.

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 or restricted stock units may be granted either alone
or in addition to other awards under the Plan. The board of directors or a committee of
the board will determine who will receive an award, 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 on the date of grant. 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.

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 were 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.

On June 15, 2005, the
Purchase Plan was amended to remove the 15% discount as well as the six month look-back
clause and the current offering period was modified from six months to four months for one
period, ending October 31, 2005. The plan will then resume its normal six month offering
period without the look-back provision or the discount. The reason for this change was to
avoid expense to the Company related to the employee stock purchase plan.

During fiscal years 2005, 2004, and
2003, the Company issued to employees shares of 15,040, 8,457, and 14,042, respectively
under this plan, at a purchase price ranging from $2.42 to $32.96 per share. A total
69,028 shares have been issued under the plan since inception.

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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 |                           
|                                               |                           

On April 20, 2005, the Companys Board
of Directors approved accelerating the vesting of all the Companys outstanding stock
options having an option exercise price above the closing stock price on that date, which
was $21.61 (underwater options). The underwater options are held by current
employees, including executive officers and past employees. As a result of the vesting
acceleration, options for approximately 578,000 shares became immediately exercisable.

The following table summarizes
information about employee stock options outstanding and exercisable at July 2, 2005:

|                | Options Outstanding | Options Exercisable
|--------------- | ------------------- | -------------------
|                |                     |                    
|                |                     |                    
|                |                     |                    
|$2.75 - $10.53  |                     |                    
|$14.00 - $18.09 |                     |                    
|$18.10 - $20.27 |                     |                    
|$20.28 - $29.63 |                     |                    
|$29.64 - $38.50 |                     |                    
|                |                     |                    
|                |                     |                    
|                |                     |                    

# NOTE 5: 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 its foreign subsidiaries for 2005, 2004, and 2003, where such earnings will
continue to be permanently reinvested.

Following our fiscal year end, we
have evaluated the changes in facts and circumstances regarding the China Joint Venture
(China JV), known as STEC. Since the China JVs inception in 1999, we
have viewed our share of the undistributed earnings of the China JV as permanently
re-invested. After considering the current business environment at China JV, including the
dividends paid during the 2005 fiscal year, we no longer expect our portion of the China
JVs retained earnings to be permanently reinvested. As a result of this decision,
under the accounting guidance of APB 23 and SFAS 109 Accounting for Income Taxes
 Special Areas, we recorded a $4.8 million non-cash provision for income taxes
which is reflected in the fourth quarter of our fiscal 2005 financial statements. These
accrued taxes will become due upon monetization of undistributed earnings from the China
JV. In the future, the Company will accrue income taxes quarterly at the US tax rate on
the equity earnings of the China JV.

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

|                           | Years Ended
|-------------------------- | -----------
|                           |            
|                           |            
|                           |            
|Domestic                   |            
|Foreign                    |            
|                           |            
|Income before income taxes |            
|                           |            

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

|                                          | July 2, 2005 | June 26, 2004
|----------------------------------------- | ------------ | -------------
|                                          |              |              
|Inventories                               |              |              
|Accrued expenses                          |              |              
|Deferred gain                             |              |              
|Goodwill and intangible assets            |              |              
|Net operating loss carry forwards         |              |              
|Valuation allowance                       |              |              
|                                          |              |              
|Total deferred tax assets                 |              |              
|                                          |              |              
|Property, plant and equipment             |              |              
|Undistributed earnings of China JV        |              |              
|Uncompleted contracts                     |              |              
|                                          |              |              
|Total deferred tax liabilities            |              |              
|                                          |              |              
|Total deferred tax (liability) asset, net |              |              
|                                          |              |              

Income tax provision (benefit)
related to continuing operations for the fiscal years ended July 2, 2005,
June 26, 2004, and June 28, 2003, consisted of the following (in
thousands):

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

|                                                          | July 2, 2005 | June 26, 2004 | June 28, 2003
|--------------------------------------------------------- | ------------ | ------------- | -------------
|                                                          |              |               |              
|Statutory federal income tax provision rate               |              |               |              
|State income taxes                                        |              |               |              
|Foreign income taxes and other                            |              |               |              
|Equity earnings in joint venture                          |              |               |              
|Foreign interest expense subject to tax                   |              |               |              
|Cash dividends from foreign entities                      |              |               |              
|Valuation allowance                                       |              |               |              
|Valuation allowance due to net operating loss utilization |              |               |              
|Other                                                     |              |               |              
|                                                          |              |               |              
|Effective income tax provision                            |              |               |              
|                                                          |              |               |              

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As of July 2, 2005, the Company had
net operating losses available to offset future taxable income of approximately
$6.1 million in the Asian subsidiaries, primarily Tainan, which expire through 2010
and $36.3 million in Germany which have an indefinite life. During the fiscal year
2005, the Company utilized $10.2 million of net operating loss carry forwards that were
available in the United States. The valuation allowance decreased by approximately
$3.5 million in fiscal 2005 and increased by approximately $1.3 million in
fiscal 2004. As of July 2, 2005, approximately $1.9 million of the utilized
valuation allowance was related to the benefits of stock option deductions, and was
credited to paid-in-capital in fiscal 2005. There is no unrealized benefit remaining to be
recognized.

# NOTE 6: EMPLOYEE BENEFIT
PLANS

Profit Sharing

In August 1992, the Board of
Directors adopted a cash profit sharing program 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 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
$83,000, $327,000, and $75,000, in fiscal years 2005, 2004, and 2003, respectively,
related to this plan.

Retirement Plans

Applied Films Japan Kabushiki Kaisha,
has implemented a retirement plan during fiscal year 2005 for employees working in the
Japan office. Retirement benefits are based on years of service and an adjusted base
salary. If an employee leaves or retires before 20 years of service the retirement benefit
is reduced. The liability recorded in accrued pension benefit obligation at
July 2, 2005 was approximately $166,000.

Applied Films Korea Ltd. has a
retirement insurance plan which is a required retirement plan under labor standard law,
and the premiums are required to be paid 100% by the employer. The plan is designed to
secure employees retirement payment upon separation. The plan, when funded, is maintained
by an insurance company on the employers behalf when the employees leave. The plan
at July 2, 2005 and June 28, 2004 has a balance of approximately $532,000 and $205,000,
respectively and is unfunded.

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 pension liability of $14.5 million is reflected in the accompanying
consolidated balance sheet as of July 2, 2005, and is subject to adjustment
based upon an assessment of the actuarial value of the obligation. This plan has no assets
as of July 2, 2005. The measurement date for the fiscal year 2005 is
May 12, 2005.

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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 loss (gain)                     |           
|Foreign exchange (gain)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        |           
|                                          |           
|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, for
retired employees, as appropriate, are expected to be paid (in thousands):

|Fiscal Year | 
|----------- | 
|            | 
|2006        | 
|2007        | 
|2008        | 
|2009        | 
|2010        | 
|2011-2015   | 

# NOTE 7:  SIGNIFICANT
CUSTOMERS

Our only business  segment is the
manufacture  and sale of deposition  equipment.  During fiscal years 2005,  2004, and
2003,  approximately 84%, 81%, and 70%, 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  64%,
65%, and 53%, of the Company's net revenues in fiscal 2005,  2004, and 2003,
respectively.  Revenues  from our two largest  customers  in fiscal  2005,  represented
 approximately  15% and 12% respectively,  of our net  revenues  for the  year.  Revenues
 from  our two  largest  customers  in  fiscal  2004, represented  13% and 12%
 respectively,  of our net revenues for that year.  Revenues from our largest  customer
in fiscal 2003,  represented  13% of our net revenues for that year.  Revenues  from
these  customers for fiscal 2005, 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.

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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 |                  
|                 |                  
|Net revenues     |                  
|                 |                  

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

The following table represents the
breakdown of net long-lived assets 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
$103,000, $1,340,000, and $823,000, of foreign currency exchange rate gain on foreign
currency exchange rate fluctuations for the fiscal years ended July 2, 2005,
June 26, 2004, and June 28, 2003, respectively. The Company has
$10.5 million and $14.0 million of its accounts receivable denominated in euros,
and $12.3 million and $22.2 million of its accounts payable denominated in euros
as of July 2, 2005 and June 26, 2004, respectively.

# NOTE 8: COMMITMENTS

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. On January 30, 1998, the
Company entered into a lease for the Companys manufacturing and administrative
location in Longmont, Colorado. The Company has the option to purchase the building at a
premium. Under this lease, 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 expense (including the annual
increase of one and one-half percent) for the Longmont location have been recorded
straight line over the term of the lease. Because the CPI is subjective and not reasonably
estimated, the Company has not included the CPI increase in the straight line calculation.
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.

The Company currently subleases
approximately 40,900 square feet at the Companys Longmont, Colorado facility, which
contains approximately 126,000 square feet to Optera, Inc. The original term of the
sublease expired on March 31, 2005, and Optera, Inc. extended the sublease for
an additional period of one year through March 31, 2006. Optera, Inc. has an
option to extend their sublease for additional one year periods annually thereafter. This
option continues 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 at the same terms in the Longmont, Colorado facility. Basic rent under
the sublease for the initial term is $252,000 annually.

In connection with the Helix
acquisition, beginning in June 2004, the Company entered into a two year lease for a
41,000 square foot manufacturing and administrative location in Tainan, Taiwan which
expires May 31, 2006. Under this lease, payments are fixed for the entire term
of the lease and there is an option to extend the lease at like terms until either party
notifies the other of its desire to terminate.

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In connection with a new 42,500
square foot building construction in Tainan, Taiwan, the Company entered into a land lease
for the land on which the building will be built, beginning in June 2005 through
December 31, 2024.

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

|Fiscal Year                  | Operating leases | Other Commitments
|---------------------------- | ---------------- | -----------------
|                             |                  |                  
|2006                         |                  |                  
|2007                         |                  |                  
|2008                         |                  |                  
|2009                         |                  |                  
|2010                         |                  |                  
|2011 and thereafter          |                  |                  
|                             |                  |                  
|Total minimum lease payments |                  |                  
|                             |                  |                  

Rent expense under operating leases
were $5.9 million, $6.7 million, and $6.6 million, for fiscal years ended
July 2, 2005, June 26, 2004, and June 28, 2003. During
fiscal 2005 and 2004, rent expense is net of sublease income of $252,000. For fiscal year
2006, the estimated sublease income is $189,000.

At July 2, 2005, the
Companys German subsidiary had $17.0 million of guaranty lines of credit in
place with certain banks, with varying maturities. The Company is not able to draw any
funds under these lines. The lines of credit are used to guaranty customer deposits on
certain contracts. If the Company were unable to perform its contractual obligations, to
which the customer deposits relate, it could be required to perform under these
guaranties. At July 2, 2005, the Company has guaranties of $6.1 million outstanding under the
guaranty lines of credit.

# NOTE 9: 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 10: HELIX
ACQUISITION

The Company completed the acquisition
of the In-Line Systems division of Helix Technology, Inc., Taiwan (Helix) on
June 2, 2004. At the time of the acquisition, Helix produced 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 $14.8 million consisting of $12.0 million of cash and $2.15 million
equivalent of Applied Films Corporation common stock (which equated to 80,826 shares
valued at $26.59 per share 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 approximately $661,000 in transaction costs. The acquisition was
accounted for under the purchase method of accounting.

In valuing Helix, for the acquisition we
 utilized recognized valuation techniques.  We obtained projected financial results from
Helix, adjusted those projections based on our knowledge of the market and then valued
Helix on a discounted cash flow model using those projections, an appropriate weighted
cost of capital as a discount factor and an appropriate terminal multiple of EBITDA.
 After our initial valuation, and after we concluded we would not sell Helix products
after the closing, we  allocated the purchase price by performing a discounted cash flow
valuation of Helix service business,  the value of cost savings we would achieve by
manufacturing our systems in Taiwan using Helix knowledgeable work force,  the
value of Helix patent technology to our business, and the value of the key customer
relationships, primarily with flat panel display manufacturers, that Helix had
established.  We then used those projections, an appropriate weighted cost of capital as
a discount factor and an appropriate terminal multiple of EBITDA to determine the
purchase price allocation.

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 $14.8 million purchase price was
allocated as follows (in millions):

|                                    | 
|----------------------------------- | 
|Inventory                           | 
|Goodwill                            | 
|Intangible assets                   | 
|Billings in excess                  | 
|Property, plant and equipment       | 
|In-process research and development | 
|                                    | 
|Total allocation of purchase price  | 
|                                    | 

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The Company has completed the
valuation of the assets acquired and the purchase price allocation. 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 and was adjusted in fiscal year 2005.

# NOTE 11: QUARTERLY
INFORMATION (unaudited)

The amounts below have been adjusted
to show in discontinued operations results of our Hong Kong coated glass division, which
was sold on September 26, 2003.

The following table sets forth
summary unaudited quarterly financial information for the eight fiscal quarters ended
July 2, 2005.

|                         | Fiscal 2004 Quarters Ended            | Fiscal 2005 Quarters Ended
|------------------------ | ------------------------------------- | --------------------------
|                         |                                       |                           
|                         |                                       |                           
|                         |                                       |                           
|                         | (in thousands, except per share data) |                           
|Net revenues             |                                       |                           
|Gross profit             |                                       |                           
|Income (loss) from       |                                       |                           
|continuing operations    |                                       |                           
|                         |                                       |                           
|Discontinued operations, |                                       |                           
|net of tax               |                                       |                           
|                         |                                       |                           
|Net income (loss)        |                                       |                           
|                         |                                       |                           
|Fully diluted earnings   |                                       |                           
|(loss) per share         |                                       |                           
|                         |                                       |                           

During the fourth quarter of fiscal
2005, we had a combination of regular income tax expense on earnings at our profitable
subsidiaries, and tax expense on non-income statement items such as dividends and
valuation allowances on our manufacturing subsidiaries in Germany and Taiwan.
Additionally, we incur approximately $300,000 per quarter for withholding taxes related to
our interest payments on intercompany debt in Germany. As a result of the German thin
capitalization tax legislation enacted in July 2004.

The income tax expense for the fourth
quarter was $8.2 million, which consists of $4.0 million related to the addition
of a $1.0 million valuation allowance in Taiwan and Germany and $1.1 million for
taxes paid on dividends received. With the receipt of the dividends to the U.S. we have
fully utilized the U.S. net operating loss carry forwards and going forward any income in
the U.S. will be taxed.

In addition, following our fiscal
year end, we have evaluated the changes in facts and circumstances regarding the China
Joint Venture (China JV), known as STEC. Since the China JVs inception
in 1999, we have viewed our share of the undistributed earnings of the China JV as
permanently re-invested. After considering the current business environment at China JV,
including the dividends paid during the 2005 fiscal year, we no longer expect our portion
of the China JVs retained earnings to be permanently reinvested. As a result of this
decision, under the accounting guidance of APB 23 and SFAS 109 Accounting for Income
Taxes  Special Areas, we recorded a $4.8 million non-cash provision for income
taxes which is reflected in the fourth quarter of our fiscal 2005 financial statements.
These accrued taxes will become due upon monetization of undistributed earnings from the
China JV. In the future, the Company will accrue income taxes quarterly at the US tax rate
on the equity earnings of the China JV.

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

Effective September 10, 2004, Applied
Films Corporation (the Company) dismissed Ernst & Young LLP as its
independent registered public accounting firm. Effective September 10, 2004, the Company
engaged Deloitte & Touche LLP as its independent registered public accounting firm to
audit the Companys financial statements for its current fiscal year, subject to
satisfactory completion by Deloitte & Touche of its standard client acceptance
procedures. The dismissal of Ernst & Young and the engagement of Deloitte & Touche
was approved by the Companys Audit Committee on September 10, 2004. This decision
was based on the results of a competitive bid process for annual audit work and the
associated compliance work related to the Sarbanes-Oxley Act.

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No Ernst & Young report on the
Companys combined consolidated financial statements for either of the past two
fiscal years contained an adverse opinion or disclaimer of opinion, nor were they
qualified or modified as to uncertainty, audit scope or accounting principles. During the
last two fiscal years of the Company and through the termination of Ernst &
Youngs services on September 10, 2004 (the Relevant Period), there were
no disagreements with Ernst & Young on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure which, if not
resolved to Ernst & Youngs satisfaction, would have caused Ernst & Young to
refer to the subject matter of the disagreement(s) in connection with its reports. Also,
during the Relevant Period, there were no reportable events as described in Item
304(a)(1)(v) (Reportable Events) of the Securities and Exchange
Commissions Regulation S-K.

During the Relevant Period, neither
the Company nor (to the Companys knowledge) anyone acting on behalf of the Company
consulted with Deloitte & Touche regarding either the application of accounting
principles to a specified transaction (either completed or proposed) or the type of audit
opinion that might be rendered on the Companys financial statements.

The Company provided Ernst &
Young with a copy of the foregoing disclosures. A letter from Ernst & Young to the
Securities and Exchange Commission stating its agreement with such statements was attached
as Exhibit 16.1 to the Form 8-K.

# ITEM 9A: Controls and
Procedures

(a)    
          Evaluation of Disclosure 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,
the Companys disclosure controls and procedures were effective in meeting the
desired objectives as of July 2, 2005.

(b)    
          Managements Report on Internal Control over Financial Reporting. The management of the Company is
responsible for establishing and maintaining adequate internal control over financial
reporting. The Companys internal control system was designed to provide reasonable
assurance to the Companys management and board of directors regarding the
preparation and fair presentation of published financial statements. All internal control
systems, no matter how well designed, have inherent limitations. Therefore, even those
systems determined to be effective can provide only reasonable assurance with respect to
financial statement preparation and presentation.

Company management assessed the
effectiveness of the Companys internal control over financial reporting as of
July 2, 2005. In making this assessment, it used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control-Integrated Framework. Based on our assessment using these criteria we believe
that, as of July 2, 2005, the Companys internal control over financial
reporting is effective.

Managements assessment of the
effectiveness of internal control over financial reporting as of July 2, 2005, has been
audited by Deloitte & Touche LLP, an independent registered public accounting firm, as
stated in their report included in Item 8 in this Annual Report on Form 10-K.

(c)    
          Change in Internal Controls. 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 reported in the June 26, 2004 Form 10-K related to a deficiency in the
design of our procedures utilized to calculate the tax provision under FAS 109. We lacked
sufficient internal tax expertise that would allow us to prepare and evaluate the tax
provision before external auditor review. Additionally, given our international scope and
the various different tax compliance and filing deadlines, much of the tax information
related to the provision were management estimates. During fiscal 2004, our German
subsidiary, which is the largest of our entities had filed multiple years of tax returns
dating back to the date of the acquisition. In doing so, and in conjunction with the
annual audit, we realized that at year-end we did not have processes and controls in place
to assure regular and repeatable application of the procedures. Our fiscal 2004 reported
financial statements included all appropriate adjustments to the income tax accounts.

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We believe we have remedied this
deficiency as follows. Following the fiscal 2004 year end, we calculated tax provision,
executed the procedures surrounding FAS 109 and the tax provision quarterly versus
annually to allow us to more frequently review the FAS 109 computations on a continual
basis. In addition, our internal staff has received formal training on FAS 109 rules and
regulations. We also hired external tax consultants, from another big four accounting
firm, to evaluate our procedures, the application of our procedures, the various entities
and subsidiaries and their tax treatment, well as the temporary and permanent differences
related to those operations and the calculation of the provision. We feel that the higher
frequency of four times per year of actually performing the calculation as well as the
additional training and engagement of an outside consultant has allowed us to deliver
complete and tested FAS 109.

# ITEM 9B: Other
Information.None.

# 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 2005 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 2005 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 2005 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 2005 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 2005 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 2005 Proxy Statement and
is incorporated herein by reference.

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# 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 July 2, 2005,
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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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)
|--------------------------------- | ----------------------
|                                  |                       
|                                 
|                                  |                       
|                                  | 2005                  
|                                  | 2004                  
|                                  | 2003                  
|                                  |                       

| | 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) | Exhibits
|--- | --------

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

|(c) | Financial
Statement Schedules
|--- | -----------------------------

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

---

Page 67 of 67

---



# 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 President
      Date: September 15, 2005
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

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 15, 2005. The persons named
below each hereby 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
Lawrence D. Firestone |      
|                                                             
|/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.
| | --- | ---------------------------------------------------------

| | 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, incorporated by reference to Exhibit 10.8 of Registrants Annual Report on
Form 10-K for the fiscal year ended June 26, 2004.
| | ----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.8* | Severance
Agreement between Applied Films Corporation and Lawrence D. Firestone dated July 26,
2002, incorporated by reference to Exhibit 10.7 of Registrants Annual Report on
Form 10-K for the fiscal year ended June 26, 2004.
| | ----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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).
| | ----- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---



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

| | 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.
| | ----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---



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

| | 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 Deloitte & Touche LLP.
| | ---- | ---------------------------------

| | 23.2 | 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.
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

*Management contracts or compensatory
plans or arrangements.