Registration No. 333-               

4900 Constellation Drive

David G. Reamer

Copies to:

    Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

    If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  [   ]

    If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  [   ]

    If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  [   ]

    If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  [   ]

    If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box.  [   ]

CALCULATION OF REGISTRATION FEE

    The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission acting pursuant to said Section 8(a), may determine.

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy securities in any state where the offer or sale is not permitted.

SUBJECT TO COMPLETION, DATED           , 2000

PROSPECTUS

                Shares

Common Stock

         Applied Epi, Inc. is offering              shares of its common stock. This is our initial public offering and no public market currently exists for our shares. We expect the initial public offering price to be between $      and $     per share.

      We have applied for quotation of our common stock on the Nasdaq National Market under the symbol “APEP.”

      Investing in our common stock involves risks that are described in the “Risk Factors” section beginning on page 6 of this prospectus.

      The underwriters may also purchase up to an additional            shares from Applied Epi at the public offering price, less the underwriting discount, within 30 days from the date of this prospectus to cover over-allotments.

      Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

      The shares will be ready for delivery on or about           , 2000.

Joint Book-Running Managers

Donaldson, Lufkin & Jenrette	Merrill Lynch & Co.

Wit SoundView

The date of this prospectus is              , 2000.

Inside Gatefold Pages:

      The first page of the gatefold includes the following quotations, “Applied Epi’s equipment and services are used to produce compound semiconductors that enable the fiber optic and wireless communications infrastructure” and “Enabling Communications.” We also include pictures of the multiwafer handling cluster tool, portions of the periodic table and six pictures representing various applications that incorporate compound semiconductors.

      The second page of the gatefold includes the heading “Market” and the following text, “Compound semiconductors are core components of a wide variety of communications applications that address the growing demand for connectivity and information bandwidth.” Next to this quotation is a picture of two people accessing the Internet via a laptop personal computer.

      Also included on this page is the heading “Technology” and the following text, “Most compound semiconductors are produced using epitaxial technologies. Their advanced physical properties provide high-performance fiber optic and wireless systems with:

	•	Higher operating speeds
	•	Optoelectronic properties
	•	Lower power consumption
	•	Reduced signal noise and distortion.”

Next to this text is a picture of a portion of the periodic table and an epiwafer.

      On the bottom of page two of the gatefold are the words “Connectivity” and “Bandwidth.”

      Page three of the gatefold includes the heading, “Solutions” and the following text “Our equipment and related components address the critical epitaxy process for the manufacture of compound semiconductors.” We also include pictures of the GEN2000, the GENII and some of our performance products with the following text next to each applicable picture:

HIGH VOLUME PRODUCTION SYSTEMS

      GEN2000™ Multi-Wafer System

	•	Low cost per wafer
	•	High production capacity and throughput
	•	Unique cluster tool wafer management system
	•	Flexible modular design

LOW VOLUME PRODUCTION AND RESEARCH SYSTEMS

      GENII™ Single-Wafer System

	•	Ideal for optoelectronic materials
	•	Flexible modular design

PERFORMANCE PRODUCTS

      SUMO® Cells

	•	High source material capacity
	•	High epilayer uniformity and reproducibility

      Valved Crackers

	•	High source material capacity
	•	Precision molecular beam control

      At the bottom of the third page is the word “Solutions.”

      On the bottom right hand corner of each of these pages is also the Applied Epi logo.

Table of Contents

      You should rely only on the information contained in this prospectus. Neither we nor the underwriters have authorized any person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We and the underwriters are not making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate as of the date on the front cover of this prospectus only. Our business, financial condition, results of operations and prospects may have changed since that date.

       This summary highlights selected information described more fully elsewhere in this prospectus. This summary is not complete and does not contain all the information you should consider before investing in our common stock. You should read the entire prospectus carefully, including the risks set forth in “Risk Factors” and the financial statements and their related notes, before making an investment decision.

       We are a leading provider of epitaxial equipment and related components used to produce compound semiconductors for the fiber optic and wireless markets, as well as for other consumer applications. Our product line includes epitaxial equipment and related components used in both high and low volume commercial production, and research and development. For 14 years, we have offered products and services designed to cost-effectively meet the increasingly demanding production requirements of the global high-performance communications infrastructure. Our customers use our equipment and components to manufacture compound semiconductors for a wide variety of communications applications, including fiber optic modules and subsystems, mobile phones, wireless networks and satellites. Other uses for compound semiconductors include several rapidly growing consumer applications, such as digital versatile disks (DVDs), low cost lighting and signage and global positioning systems.

      The growing demand for information and connectivity is driving the continued rapid expansion of wireless and fiber optic networks, and the products that rely on these networks. In the past, communications equipment and products relied on silicon semiconductor technology to meet performance requirements. However, fiber optic and current generations of wireless networks, and their related products, require higher performance and greater functionality than silicon semiconductors can provide. As a result, compound semiconductors have emerged as a key enabling technology to meet these higher performance requirements.

      Compound semiconductors are composed of two or more elemental materials usually consisting of a metal and a non-metal. The intrinsic physical properties of compound semiconductors enable electrons to move approximately five times faster than through silicon semiconductors, allowing these semiconductors to operate at significantly higher speeds. In addition, compound semiconductors have optoelectronic properties that enable them to emit light, a fundamental requirement of fiber optic applications and a function not achievable using silicon semiconductors. Other key advantages include lower power consumption and reduced signal distortion, which are critical to the performance of current generations of wireless technologies.

      According to Strategies Unlimited, the compound semiconductor market was approximately $11 billion in 1999 and is expected to grow 24% to $13.6 billion in 2000. Communications applications that use compound semiconductors account for approximately 50% of this market. Driven by the anticipated high demand for fiber optic and wireless communications, this segment is expected to grow faster than the overall compound semiconductor market.

      For the majority of compound semiconductors, epitaxy is the critical first step of the fabrication process, ultimately determining device functionality and performance. Epitaxy is the process of precisely depositing atomically thin crystal layers, or epilayers, of elemental materials onto a substrate. After the epilayers are grown on the substrate, it is known as an epiwafer. The unique performance characteristics of compound semiconductors are dependent on the chemical composition, number, and precise thickness of the epilayers. As a result, epitaxy is considered to be the highest value-added step

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      We have been an innovator in the compound semiconductor market since our inception, and believe that we offer the broadest product selection of epitaxial equipment and related components for the compound semiconductor industry. Our GEN2000 is the world’s first high volume production MBE system incorporating ultra high vacuum (UHV) cluster tool architecture, designed to provide our customers with increased productivity and lower cost of ownership. With its ability to process seven 6” wafers simultaneously, it is also currently the world’s largest capacity production MBE system. We shipped our first GEN2000 in the third quarter of 2000. We also provide a full line of low volume production and research MBE systems that are capable of performing in a wide variety of environments. Our most popular system in this class, the Modular GENII, has an installed base of over 200 systems, giving us what we believe is a leading share in the market for low volume production and research MBE systems.

      We are also a leading supplier of key components to the MBE equipment market, including our proprietary effusion cell technology, control hardware and electronics, process control software, spare parts and consumables. We estimate that more than 70% of the world’s compound semiconductor manufacturers using MBE systems use our effusion cells, the most critical component for the successful operation of an MBE system.

      Our goal is to become the leading supplier of integrated equipment and related process solutions to compound semiconductor manufacturers for use throughout their fabrication line. Key elements of our strategy are as follows:

	•	further penetrate the high volume MBE equipment markets;
	•	leverage our current technology and relationships to penetrate the MOCVD market;
	•	expand our product offering to offer complete fabrication line solutions;
	•	enhance our customer relationships, including opening a Process Integration Center; and
	•	extend our technology leadership.

      We have a diverse global customer base with no single customer accounting for more than 10% of our sales in 1998 or 1999. We sell our products to compound semiconductor manufacturers and epiwafer suppliers, as well as research and academic institutions. In 1999, our major commercial customers in the fiber optic market included Bandwidth9, Inc., JDS Uniphase Corporation, Lucent Technologies Inc., Mitsubishi Chemical Corporation and NEC Corporation, and in the wireless market included Agilent Technologies, Inc., IQE plc, Raytheon Company, RF Micro Devices, Inc. and Sanders, a Lockheed Martin Company. International sales represented approximately 32% of our sales in 1997, 35% in 1998, 40% in 1999 and 38% in the six months ended June 30, 2000.

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Additional Information

       We were incorporated in Minnesota in 1986 under the name Effusion Products, Inc. In 1987, we changed our name to Chorus Corporation and in July 2000, we changed our name to Applied Epi, Inc. Our executive offices are located at 4900 Constellation Drive, St. Paul, MN 55127, and our telephone number is (651) 482-0800. The address of our website is www.applied-epi.com. Information contained on our website is not part of this prospectus.

      SUMO® and Uniblock® are our registered trademarks. Applied Epi™, GEN2000™, GEN200™, GENII™, GENIII™, Molly™ and certain other names not included in this prospectus are our trademarks. Registrations of the Applied Epi™ name and logo as well as other names used in our business are pending. Each trademark, trade name or service mark of any other company appearing in this prospectus belongs to its holder.

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The Offering

      The number of shares of common stock to be outstanding after this offering is based on the number of shares outstanding as of September 25, 2000. This information:

	•	excludes an aggregate of 6,000,000 shares of our common stock currently reserved for issuance under our 1993 Stock Option Plan, of which 1,952,248 shares are subject to outstanding options at a weighted average exercise price of $4.92 per share;
	•	excludes an aggregate of 6,000,000 shares of our common stock currently reserved for issuance under our 2000 Stock Plan, of which 242,000 shares are subject to outstanding options at an exercise price of $12.50 per share; and
	•	excludes conversion of phantom stock units issued under our Employee Performance Stock Ownership Plan into 621,482 shares of our common stock and excludes an aggregate of 734,388 units available for future issuance under the plan.

      Unless otherwise indicated, all information in this prospectus gives effect to the four-for-one stock split to be effected prior to this offering and assumes that the underwriters will not exercise their over-allotment option.

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Summary Financial Data

       The tables below summarize our financial data set forth in more detail in the consolidated financial statements at the end of this prospectus. The pro forma as adjusted balance sheet data reflect the sale by us of      shares of common stock offered by this prospectus at an assumed initial public offering price of $     per share, after deducting the estimated underwriting discounts and commissions and offering expenses payable by us.

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       Your investment in our common stock involves a high degree of risk. You should carefully consider the risks described below and all of the information contained in this prospectus before deciding whether to purchase our common stock. These risks and uncertainties are not the only ones facing our company. Additional risks and uncertainties that we are unaware of or currently deem immaterial may also become important factors that may harm our business. The occurrence of any of the following events could harm our company or the value of your shares. If any of these events occur, the trading price of our shares could decline, and you may lose all or part of your investment.

Risks Related to the Compound Semiconductor Industry

      Because the demand for epitaxial equipment and related components and services depends on the demand for applications that use compound semiconductors, our success in selling our products and services depends on the continued growth in demand for existing applications, and on the successful development and commercialization of emerging applications, that incorporate compound semiconductors. The rate of this growth could slow as a result of production overcapacity resulting in market saturation or in connection with changes in technology, consumer preferences or declines in disposable income resulting from a general economic downturn. The timing, duration and severity of any future downturn cannot be predicted. In the medium term, we believe that the most significant potential for future growth in the demand for epitaxial equipment and related components and services will be from currently emerging applications that use compound semiconductors. The commercial markets for these applications are still in their formative stages. If these and other emerging applications using compound semiconductors do not develop, or if demand for current applications does not grow, we would have difficulties in selling our products and services and our sales and profitability would be harmed.

      The compound semiconductor industry is characterized by rapid technological change, evolving industry standards, changing customer requirements and frequent new product introductions. Commitments to developing any new epitaxial system must be made well in advance of sales, and technology and standards may change while we are developing new models, making our systems outdated or uncompetitive before their introduction. To remain competitive, we expect to incur significant capital expenditures and devote significant resources for research and development. We may be unable to successfully design or manufacture new products and may have difficulty penetrating new markets. Our future success will depend, to a significant extent, on our ability to keep pace with changes in the market and on our ability to enhance our current products and introduce new products. If we do not anticipate or respond adequately to technological developments or customer requirements, we could lose market share and our sales and profitability would be harmed.

Risks Related to Our Business

      Competition in the market for epitaxial equipment and related components and services is intense and we face substantial competition from a number of companies, some of which have greater financial, marketing, manufacturing and technical resources than us. Our competitors could spend

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      We are entering new product and technology areas with the introduction earlier this year of our first high volume production MBE systems, the GEN2000 and GEN200, and with our current development of production MOCVD equipment to expand our product line. Our prior experience in manufacturing and marketing, and our historical sales, have been derived from MBE components and low volume production and research MBE systems. Many of our competitors have significantly more experience in developing, manufacturing and marketing high volume production MBE and production MOCVD systems. Our future growth, sales and profitability will be harmed if our high volume production MBE systems do not gain market acceptance. Delays in development or our inability to successfully develop and commercialize a production MOCVD system could harm our future growth, sales and profitability. In addition, some of our customer contracts for high volume production MBE systems currently require, and contracts for MOCVD systems we develop may require, that the system meet predetermined performance criteria. Our failure to satisfy these criteria would harm our ability to gain market acceptance for these systems and harm our future growth, sales and profitability.

      All of our current products and services are related to MBE technology, which is one of several competing technologies used in the compound semiconductor manufacturing process. Customers may prefer alternative manufacturing techniques, such as MOCVD, to produce compound semiconductors. In addition, customers may manufacture products that employ alternative compound semiconductor technologies, such as silicon germanium. Technologies such as these could offer a competitive alternative to some of the compound semiconductor devices currently manufactured with MBE technology. Compound semiconductors are also manufactured by ion implant technology, which is not an epitaxial technology. If any alternative compound semiconductor manufacturing technology develops further, gains wider market acceptance and reduces or eliminates the competitive advantages of MBE, we may have difficulty selling new MBE systems and related components and services and our sales and profitability would be harmed.

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      Our sales and operating results may vary significantly from quarter to quarter due to a number of factors particular to us and the compound semiconductor industry. Not all of these factors are in our control. These factors include:

	•	the volume and timing of orders for our products, particularly our epitaxial production systems, which have relatively high average selling prices;
	•	the timing of customer acceptance of our epitaxial systems. In most cases, we do not recognize revenue from our system contracts until the customer accepts the system. Customer acceptance may occur upon installation or in some cases, upon demonstrated system performance some time after installation;
	•	the timing of our announcement and introduction of new products and of similar announcements by our competitors;
	•	downturns in the market for our customers’ products; and
	•	regional economic conditions, particularly in Europe and the Asia-Pacific region, from which we derive significant sales.

      These factors and other unanticipated events may cause our operating results for future quarterly periods to be below the expectations of analysts and investors. A large portion of our operating expenses, including depreciation, salaries and certain manufacturing expenses, is currently fixed and expected to increase as we grow. If net sales do not meet our expectations in a particular quarter, our profitability would be harmed and our stock price may decline. These factors also cause our period-to-period comparisons of our results of operations to be less meaningful and they should not be relied upon as indicative of future operating results.

      Our success is dependent on the efforts of some of our key employees, particularly Paul E. Colombo, our founder and Chairman, and David G. Reamer, our President and Chief Executive Officer. These individuals would be very difficult to replace. If either of these individuals were to leave us, the loss of their services would harm the development and implementation of our long-term strategy, customer relationships, operations and growth. Neither of these individuals is bound to serve us for any specified term nor do we have non-compete agreements with them.

      It is important to our future success that we attract and retain qualified scientific, technical, operations, sales, and management personnel. The competition for attracting and retaining these employees is intense. Industry demand for skilled employees, particularly scientific and technical personnel with compound semiconductor experience, exceeds the number of skilled personnel available. In the future, we may experience difficulty in hiring and retaining highly skilled employees with appropriate qualifications. If we do not succeed in attracting new personnel and retaining current personnel, our business could be harmed by the loss of accumulated knowledge of our business and a reduction in our ability to design, develop, manufacture, and market new epitaxial equipment and related components and services to meet evolving industry standards.

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      Sales of our epitaxial equipment will depend primarily upon the decision of a prospective customer to increase its manufacturing capacity, which involves a significant capital commitment by the customer. The sales process associated with the purchase of our systems is typically complex and lengthy and could exceed one year while customers evaluate and receive internal approvals for the purchase of these systems. During this period, we will likely spend funds to continue our marketing and sales efforts to sell our systems. These expenditures and efforts may not result in sales of new epitaxial equipment and reduce our profitability.

      Because we have lengthy manufacturing cycles, which can exceed six months for our current systems, we may assume forward purchasing risks by outsourcing the manufacture of mechanical parts and electronic assemblies to our subcontractors and dedicating substantial resources to the manufacture of new epitaxial equipment prior to any commitment to purchase by a customer and without generating any sales from our customers. In addition, orders already placed by a customer are subject to cancellation. In most cases, revenue from the sale of our systems is not recognized until final customer acceptance. Customer acceptance may occur upon installation or in some cases, upon demonstrated system performance, which may take up to 120 days or more from the date of shipment. Our costs would increase and profitability would suffer if our customers delayed or canceled orders, or if we were unable to recognize revenue in a timely manner.

      A loss or a significant reduction or delay in sales, particularly system sales, to any of our major customers could materially and adversely affect our profitability. During 1999, our top ten customers accounted for an aggregate of 46% of our sales. We expect that sales from a relatively small number of customers will account for an increasing portion of our sales, particularly with the introduction of our high volume production MBE systems which have relatively high average selling prices. Moreover, the market for commercial production MBE systems, such as our GEN2000 system, is currently estimated to be less than 50 potential customers. We do not have long-term or other non-cancelable commitments from our customers to purchase our systems and related components.

     Our rapid growth may place a strain on our resources.

      We are experiencing rapid growth and plan to expand our manufacturing facilities, expand our product offering with MOCVD equipment and other compound semiconductor fabrication line equipment and process solutions, establish and develop a Process Integration Center, and consider further internal development as well as strategic joint ventures and acquisitions in connection with the development of new products and technologies. We believe that this growth could place a significant strain on our management, information technology and operating systems, financial and sales staff and other current employees, who may be forced to spend significant amounts of their time implementing these strategic initiatives. In addition, our manufacturing capacity and employee base may not be adequate to support increases in orders for our products, and we may not be able to expand quickly

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      We purchase certain raw materials used to manufacture our epitaxial equipment and related components from a limited number of suppliers. For example, we purchase a material called tantalum from the only two primary sources in the world. Tantalum is currently in short supply, which has resulted in price increases and may cause future shortages. In addition, there are only three primary sources of pyrolytic boron nitride in the world, and we currently use two of them. Our manufacturing operations depend upon obtaining adequate supplies of these and other raw materials on a timely basis, and our operations and ability to satisfy our customer obligations could suffer if tantalum or any other raw material we use became unavailable due to a shortage, commercially unreasonable pricing, disruption or termination of our relationship with the supplier or any other reason. We expect the demand for these raw materials to grow in the future, which may result in additional shortages or price increases. We do not have long-term supply agreements with our raw material suppliers and purchase such materials on a purchase order basis.

      Our success depends in part on our proprietary technology. We attempt to protect our intellectual property rights primarily through patents, trade secrets and non-disclosure agreements. However, we might not be able to protect some of our technology, and competitors might be able to develop similar technology independently. Our patents might not be sufficiently broad to protect our technology and any existing or future patents might be challenged, invalidated or circumvented. Additionally, our rights under our patents may not provide competitive advantages. If parties to non-disclosure agreements with us breach these agreements, we may not have an adequate remedy. The laws of certain foreign countries might not afford our intellectual property the same protection as do the laws of the United States and as a result, we may have an increasingly difficult time adequately protecting our intellectual property rights as our sales in foreign countries grow. If we are unable to pay royalties under certain license agreements for patents we use in the manufacture of effusion cells, our rights to use those patents and manufacture these products could be harmed. We may also need to engage in litigation in the future to enforce or protect our intellectual property rights or to defend against claims of invalidity, and we may incur substantial costs as a result.

      Some of our current or future products could infringe patents or proprietary rights of others. Litigation may be necessary to defend ourselves against claimed infringement of the rights of others or to determine the scope or validity of the proprietary rights of others. Litigation, whether or not meritorious, could be expensive and divert management resources from operating our company. Furthermore, a party making a claim against us could secure a judgment awarding substantial damages, as well as injunctive or other equitable relief that could block our ability to provide products or services, unless we obtain a license to such technology. Licenses for any intellectual property of third parties that might be required for our products or services might not be available on commercially reasonable terms.

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      One of our strategies is to expand by acquiring other businesses and technologies. However, we currently have no commitments or agreements with respect to any acquisition. We might not be able to successfully identify, negotiate or finance any acquisition, which could diminish our ability to expand our business and remain competitive. We cannot predict whether or when any prospective acquisition candidate will become available or the likelihood that any acquisition will be completed.

      In order to expand our product and service offerings and execute our growth strategy, we may acquire products, technologies or businesses that we believe are complementary. Acquisitions involve numerous risks, including:

	•	diversion of management’s attention away from our core, day-to-day business since these transactions may be time-consuming and place strain on our resources;
	•	inefficient integration of the acquired business or technology, including difficulties in the integration of the operations, information systems, services, products and personnel, thereby reducing the anticipated benefits of the acquisition;
	•	potentially dilutive issuances of equity securities;
	•	the potential loss of key employees of the acquired company;
	•	our inability to maintain the goodwill of the acquired businesses;
	•	the incurrence of additional debt;
	•	the assumption of known and unknown liabilities; and
	•	the write-off of development costs, and the amortization of expenses related to goodwill and other intangible assets and charges against earnings.

Any of the above risks, if they occur, could harm our business.

      Sales to our customers located outside the United States accounted for approximately 32% of our sales in 1997, 35% in 1998, 40% in 1999, and 38% for the six months ended June 30, 2000. Sales to our customers in the Asia-Pacific region and Europe represent the majority of our international sales. We believe that international sales will continue to account for a significant percentage of our sales and will continue to expose us to the following risks that may reduce our sales or increase our costs, thereby negatively affecting our profitability:

	•	political and economic instability may inhibit export of our products and services;
	•	shipping and installation costs of our systems may increase;
	•	we may experience difficulties in the timeliness in collection of foreign accounts receivables and may be forced to write off such receivables from a foreign customer;

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	•	a strong dollar may make the price of our epitaxial products and services less attractive to a foreign purchaser who may decide to postpone making the capital expenditure or purchase the required products or services from a foreign competitor;
	•	tariffs and other barriers may make our products and services less price competitive;
	•	we may have difficulty staffing and managing our international operations;
	•	we may have difficulty or be delayed in obtaining the export licenses required to export some of our products to various destinations, such as China and Taiwan;
	•	the laws of certain foreign countries may not adequately protect our patents and other intellectual property; and
	•	our results of operations can be hurt by fluctuations in foreign currency exchange rates.

      We assemble and test all of our products in our manufacturing facility in St. Paul, Minnesota. The assembly and testing of our products is a highly complex and precise process, requiring sophisticated and costly equipment and a specially designed facility. As a result, a disruption in the operation of our manufacturing facility, whether due to technical or labor difficulties, utility failures, destruction or damage to the facility as a result of tornado, fire or any other reason, could harm our sales and profitability. In addition, we are in the process of expanding our manufacturing facility and delays in the construction of that facility, adjacent to our current manufacturing facility, could harm our future growth.

      We are subject to various federal, state and local environmental, health and safety laws and regulations. We maintain small amounts of acids and other chemical agents for our manufacturing and service operations. In addition, we provide chemical decontamination and cleaning services on our customers’ MBE systems and related components that involve the handling, and in some cases disposal, of arsenic or phosphorus-based compounds and other hazardous materials. Operation and development of epitaxial equipment could result in the release of hazardous materials. In addition, MOCVD systems use larger amounts of hazardous materials than MBE systems. If our control systems and safety procedures are unsuccessful in preventing release of these materials into the environment or exposure of our personnel to occupational hazards, we may be subject to liability under environmental, health and safety laws and could incur significant expenses.

      Our products are used by our customers under extreme temperature, vacuum and pressure conditions to manufacture compound semiconductors. If our products fail or are defective, we could face business interruption, personal injury or product liability claims. In addition, we outsource the fabrication of certain parts and sub-assemblies of our equipment and components, which could expose us to additional product liability for defective or sub-standard parts and sub-assemblies manufactured by our suppliers. If an exceptional occurrence of damage or personal injury were to occur, our

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Risks Related to this Offering

      After this offering, it is anticipated that our officers and directors will beneficially own or control, directly or indirectly,        % of our shares of common stock. As a result, if some of these existing shareholders choose to act together, they will have the ability to control all matters submitted to our shareholders for approval, including the election and removal of directors and the approval of any business combinations. This may delay or prevent an acquisition or cause the market price of our stock to decline. Our directors and officers may have interests different from yours. For example, they may be more interested than other investors in selling our company or pursuing different business strategies.

      There has been no public market for our common stock prior to this offering. The initial public offering price for our common stock will be determined through negotiations between the underwriters and us. This initial public offering price will vary from the market price of our common stock after the offering. If you purchase shares of common stock, you may not be able to resell those shares at or above the initial public offering price. The market price of our common stock may fluctuate significantly in response to many factors, some of which are beyond our control, including the following:

	•	actual or anticipated fluctuations in our annual and quarterly operating results;
	•	changes in market valuations of companies in the compound semiconductor industry and in the industries which the compound semiconductor industry serves;
	•	changes in financial estimates by securities analysts;
	•	variations in our operating results which may cause us to fail to meet analysts’ or investors’ expectations;
	•	announcements by us or our competitors of significant technological innovations, contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
	•	additions or departures of key personnel;
	•	future sale of equity or debt securities; and
	•	general economic, industry and market conditions.

      In addition, the stock market has experienced extreme volatility that often has been unrelated to the performance of particular companies. These market fluctuations may cause our stock price to fall regardless of our performance. In the past, some companies that have experienced volatility in the market price of their stock have faced securities class action litigation. If we were faced with securities class action litigation, it could result in substantial costs and a diversion of management’s attention and resources.

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      We may be required, or could elect, to seek funding if we acquire businesses, products or technologies, or fund internal development efforts. In the event we are required to raise funds we may not be able to do so on favorable terms, if at all. Further, if we issue new equity securities, shareholders may experience dilution or the holders of new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock.

      Our current shareholders hold a substantial number of shares, which they will be able to sell in the public market in the near future. Sales of a substantial number of shares of our common stock after this offering could cause our stock price to fall, impairing our ability to raise capital through the sale of additional stock.

      The initial public offering price is substantially higher than the book value per share of our outstanding common stock immediately after the offering. Accordingly, if you purchase common stock in the offering, you will incur immediate dilution of approximately $          in the book value per share of our common stock from the price you pay for our common stock.

      Our board of directors has the authority to issue up to 25,000,000 shares of preferred stock. Our board of directors can fix the price, rights, preferences, privileges and restrictions of the preferred stock without any further vote or action by our shareholders. The issuance of shares of preferred stock may delay or prevent a change in control transaction. As a result, the market price of our common stock and the voting and other rights of our shareholders may be adversely affected. The issuance of preferred stock may result in the loss of voting control to other shareholders.

      Our charter documents also contain other provisions which may discourage, delay or prevent a merger or acquisition of us, including:

	•	a classified board of directors, with each class of directors subject to reelection every three years, which limits our shareholders’ ability to quickly change a majority of the board of directors;
	•	a 70% shareholder vote requirement for the removal of a director by shareholders; and
	•	procedural and other requirements that could make it difficult for shareholders to effect certain corporate actions.

      We are also subject to Sections 302A.671 (Control Share Acquisition Act) and 302A.673 (Business Combination Act) of the Minnesota Business Corporation Act which may have the effect of limiting third parties from acquiring significant amounts of our common stock without our approval.

      These provisions could also have the effect of discouraging others from making tender offers for our common stock. As a result, these provisions may prevent the market price of our common stock

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      Our management has broad discretion in the use of the net proceeds of this offering and could spend the net proceeds in ways that may not yield a favorable return. We may also use the proceeds to acquire complementary businesses or technologies, although no specific acquisitions are currently planned. Until we need to use the proceeds of this offering, we plan to invest the net proceeds in short-term, interest-bearing securities.

       This prospectus contains forward-looking statements that involve risks and uncertainties. These statements relate to future events or our future financial performance and include statements about our plans, objectives and services as well as our expectations and intentions. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continues” or the negative of such terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risks outlined under “Risk Factors,” that may cause our or our industry’s actual results, levels of activity, performance or achievements expressed or implied by any forward-looking statements to differ materially from those predicted.

      Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after the date of this prospectus to conform these statements to actual results.

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       We estimate that the net proceeds from our sale of the            shares of common stock in this offering will be approximately $           million, at an assumed initial public offering price of $     per share, after deducting estimated underwriting discounts and commissions and offering expenses payable by us. If the underwriters’ over-allotment option is exercised in full, we estimate that our net proceeds will be approximately $           million.

      We are conducting this offering primarily to create a public market for our common stock, facilitate future access by us to public equity markets and increase our visibility in the marketplace. We presently intend to use a portion of the net proceeds of this offering for the following purposes:

	•	approximately $5.0 million for construction and development costs of our Process Integration Center;
	•	approximately $5.0 million to expand our manufacturing facilities;
	•	approximately $6.0 million for distributions to our current shareholders in connection with the termination of our S corporation status; and
	•	approximately $        million for distributions to holders of performance units in connection with the termination of our Employee Performance Stock Ownership Plan upon completion of this offering.

      We may use a portion of the net proceeds to acquire or make investments in complementary products, technologies or businesses. We have no present commitments or agreements with respect to any of these kinds of acquisitions or investments, although they are an integral part of our growth strategy.

      We have no specific plans at this time for the use of the remaining proceeds and expect to use these proceeds for working capital and general corporate purposes. Our management will have broad discretion concerning the allocation and use of a significant portion of the net proceeds of this offering. Pending such uses, we plan to invest the net proceeds in short-term, interest-bearing securities.

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       We intend to retain any future earnings for investment in the development and expansion of our business other than the dividends we intend to pay as discussed below under “S Corporation Status.” In addition, terms of our credit agreement with U.S. Bank National Association prohibit us from paying dividends or making any cash distributions on our capital stock, other than distributions to allow our shareholders to pay their S corporation taxes, without the bank’s prior written consent.

       Beginning in 1997, we have been treated for federal and state income tax purposes as an S corporation under Subchapter S of the Internal Revenue Code and comparable state laws. As a result, our earnings have been taxed for federal and state income tax purposes directly to our shareholders rather than to us. In connection with this offering, we will convert from an S corporation to be taxed as a C corporation. As a result of the termination of our S corporation status, we will record a net deferred tax asset and corresponding income tax benefit effective upon the termination date. The amount of the deferred tax asset would have been approximately $978,000 if the termination date had been June 30, 2000. The actual amount will be determined after giving effect to our operating results through the termination date.

      We expect to distribute approximately $4.0 million from the net proceeds of this offering to our S corporation shareholders, representing our S corporation income that had been taxed to our shareholders and not previously distributed to them as of December 31, 1999, plus an additional amount equal to our estimated taxable income earned during 2000 prior to the conversion to a C corporation. We estimate that this additional amount would have been approximately $2.0 million if the conversion to a C corporation had occurred on June 30, 2000. The actual amount will be determined after giving effect to our operating results through the S corporation termination date.

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       The following table sets forth our actual, pro forma and pro forma as adjusted capitalization as of June 30, 2000. Our pro forma as adjusted capitalization gives effect to the sale of shares of common stock in this offering at an assumed initial public offering price of $     per share, after deducting estimated underwriting discounts and commissions and offering expenses and the payment of the previously undistributed S corporation earnings. You should read this table in conjunction with our consolidated financial statements and the accompanying notes included elsewhere in this prospectus, “Selected Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

      Outstanding shares in the table above:

	•	exclude, as of September 25, 2000, an aggregate of 6,000,000 shares of our common stock currently reserved for issuance under our 1993 Stock Option Plan, of which 1,952,248 shares are subject to outstanding options at a weighted average exercise price of $4.92 per share;
	•	exclude, as of September 25, 2000, an aggregate of 6,000,000 shares of our common stock currently reserved for issuance under our 2000 Stock Plan, of which 242,000 shares are subject to outstanding options at an exercise price of $12.50 per share; and
	•	exclude conversion of phantom stock units issued under our Employee Performance Stock Ownership Plan into 621,482 shares of our common stock and exclude an aggregate of 734,388 units available for future issuance under the Plan.

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       The net tangible book value of our common stock as of June 30, 2000 was approximately $8.3 million, or approximately $0.39 per share. Net tangible book value per share represents the amount of our shareholders’ equity, less goodwill and other intangible assets, divided by the total number of shares of common stock outstanding. Dilution per share to new investors represents the difference between the amount per share paid by purchasers of shares of common stock in this offering and the net tangible book value per share of our common stock immediately after the completion of this offering.

      After giving effect to the sale of the        shares of common stock offered by us at an assumed initial public offering price of $     per share and after deducting estimated underwriting discounts and commissions and offering expenses, our net tangible book value as of June 30, 2000 would have been approximately $        million or approximately $     per share. This represents an immediate increase in net tangible book value of $     per share to existing shareholders and an immediate dilution in net tangible book value of approximately $     per share to new investors, or approximately   % of the assumed initial public offering price of $     per share. The following table illustrates this per share dilution:

      The following table illustrates as of June 30, 2000 the difference between the number of shares of common stock purchased from us, the total consideration paid to us and the average price paid by existing shareholders and by the new investors purchasing our common stock in this offering, before deducting the estimated underwriting discounts and commissions and offering expenses:

      The foregoing discussion and table are based on actual shares outstanding on June 30, 2000 and assume no exercise of any stock options outstanding as of June 30, 2000. As of June 30, 2000, there were options outstanding to purchase 1,586,248 shares of common stock at a weighted average exercise price of $3.55 share. To the extent any of these options are exercised, there will be further dilution to investors. See “Capitalization,” “Management — Stock Plans,” “Description of Capital Stock” and Note 8 of Notes to Consolidated Financial Statements included elsewhere in this prospectus.

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       The selected statement of operations data presented below for the years ended December 31, 1997, 1998 and 1999, and the balance sheet data as of December 31, 1998 and 1999 are derived from our consolidated financial statements (presented on an “as if pooling” basis; see Note 1 of Notes to Consolidated Financial Statements), which have been audited and are included at the end of this prospectus. The selected statement of operations data for the years ended December 31, 1995 and 1996, and the balance sheet data as of December 31, 1995, 1996 and 1997, are derived from our consolidated financial statements, which have been audited and are not included in this prospectus. The selected statement of operations data for the six months ended June 30, 1999 and 2000, and the balance sheet data as of June 30, 2000, are derived from our consolidated financial statements, which have not been audited and are included at the end of this prospectus. In the opinion of management, the unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of our results of operations for such periods and financial condition as of that date. The pro forma as adjusted balance sheet data reflect the sale by us of            shares of common stock offered hereby at an assumed initial public offering price of $           per share after deducting the estimated underwriting discounts and commissions and offering expenses payable by us and the payment of the previously undistributed S corporation earnings.

      The historical results presented below are not necessarily indicative of the results to be expected for any future period. The selected financial data set forth below is qualified in its entirety by, and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto included at the end of this prospectus.

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       The following discussion and analysis should be read in conjunction with “Selected Financial Data” and our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of certain factors including the risks discussed in “Risk Factors” and elsewhere in this prospectus.

Overview

      We are a leading provider of epitaxial equipment and related components used to produce compound semiconductors for the fiber optic and wireless markets, as well as for other consumer applications. For 14 years, we have offered products and services designed to cost-effectively meet the increasingly demanding production requirements of the global high-performance communications infrastructure. We sell our products to compound semiconductor manufacturers, epiwafer suppliers and research and academic institutions. Our product line consists of both high and low volume production MBE systems, research MBE systems and key components of these systems. We are also currently developing a production MOCVD system.

      We began manufacturing MBE equipment and related components in 1986 with our introduction of material specific effusion cells. Since then, we have continued to expand our product line to meet the increasing demands of the compound semiconductor industry. We began development of our first low volume production MBE system in 1987 and sold the first system in 1989. In 1988, we invented our solid source MBE valved cracker products. In December 1993, we enhanced our capabilities in MBE technology by acquiring the Modular GENII technology from IMBE, Inc., a subsidiary of Intevac, Inc. In 1995, we invented our SUMO effusion cells and also acquired Superior Vacuum Technology, Inc. (formerly a division of Perkin Elmer). This acquisition allowed us to expand our MBE technology capabilities with vacuum and robot design technologies, which have in part enabled us to develop our automated UHV multiwafer handling cluster tool.

      In 1997, we began developing a high volume production MBE system and also further expanded our effusion cell product line by inventing our corrosive series valved cracker products. From 1998 and through June 1999, we loaned funds to Spectracom, Inc. (a related party) for the development of high power 980nm pump laser technology. Our involvement with Spectracom enhanced our understanding of fiber optic technologies. Spectracom was sold to ADC Telecommunications, Inc. in June 1999. Our first high volume production MBE system, the GEN2000, was introduced in January 2000 and the first system was shipped in the third quarter of 2000. We began developing our first production MOCVD system in 2000 and expect to introduce it in the second half of 2001.

      Historically, we have derived our revenue from the sale of our components, such as effusion cells and crucibles, and low volume production and research MBE systems. However, while these products are expected to continue to generate significant revenues for us, the majority of our current backlog consists of orders for high volume production MBE systems, including the GEN2000 and GEN200.

      Our United States sales efforts are managed from our corporate headquarters in St. Paul, MN, and sales offices in Boston, MA and Santa Clara, CA. Our European sales efforts are managed from our office in Greater Manchester, United Kingdom. Our Asia-Pacific sales efforts are managed by our Asia-Pacific sales manager based at our St. Paul, MN, headquarters. We also have sales representatives located in Taiwan, Singapore, China, Korea, India, France and Japan. A significant portion of our sales is to customers outside the United States. International sales accounted for approximately 32% of our sales in 1997, 35% in 1998, 40% in 1999 and 38% for the six months ended June 30, 2000.

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      In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101 — Revenue Recognition in Financial Statements. SAB 101 addresses several issues, including the timing for recognizing revenue from sales that involve obligations on the part of the vendor subsequent to shipment or transfer of title. In accordance with SAB 101, we recognize revenue when our obligation to our customers is satisfied. For high volume and certain low volume production and research systems, our obligation is satisfied based upon final customer acceptance. Customer acceptance is determined at either installation or, in some cases, demonstrated system performance some time after installation. The post shipment obligation associated with the sale of our high and low volume production and research systems is expected to range from 30 to 120 days. For our performance products and the remaining systems, we recognize revenues when the products are shipped. There are no customer acceptance criteria associated with the sale of performance products.

      Typically, we require that buyers of our high and low volume production and research systems pay approximately 20% of the price of the system upon submission of their order, 50% upon shipment and 30% upon final customer acceptance. In limited cases, final payment is due after demonstrated system performance.

      Our operating expenses are classified into four general categories: selling; general and administrative; research and development; and amortization of deferred stock-based compensation. Selling expenses consist primarily of salaries and other related costs for sales and marketing personnel, certain direct sales commission and other related activities. General and administrative expenses consist primarily of salaries, professional services and other administrative expenses. Research and development expenses consist primarily of salaries, benefits and materials. Amortization of deferred stock-based compensation represents the amortization over the related period of the difference between the exercise price of options granted and the estimated fair market value of the underlying common stock on the date of grant. We have amortized deferred compensation charges of $1.7 million for the six months ended June 30, 2000. In August 2000, vesting was accelerated on 899,448 options originally issued in April 2000 to two of our officers. This accelerated vesting will result in a new measurement date and a non-cash compensation charge in the quarter ended September 30, 2000 of approximately $7.4 million. As a result of the above, unamortized deferred stock-based compensation charges will reduce future earnings or increase future losses by the following annual amounts: $10.1 million in 2000; $1.2 million in 2001; $0.5 million in 2002; and $0.1 million in 2003.

      In April 2000, our majority shareholder sold 569,112 shares of our common stock to four current employees at $1.40 per share. Accordingly, a charge to compensation expense was made to the extent the stock price was below the deemed fair value of the shares sold and a corresponding entry was made to record additional paid-in capital of $5.5 million in the six-month period ended June 30, 2000.

      In connection with the conversion of phantom stock units issued under our Employee Performance Stock Ownership Plan into cash and 621,482 shares of our common stock, we expect to record significant compensation expense relating to stock-based compensation. This amount will be based on the initial public offering price and will be recorded in the quarter in which we complete our initial public offering.

      We have two subsidiaries, Applied Epi Europe, Inc. and Applied Epi International, Inc. Applied Epi International was incorporated in 1992 as an Interest Charge Domestic International Sales Corporation (IC-DISC) to perform foreign sales activities and to obtain tax benefits related to our foreign sales. Applied Epi Europe was incorporated in 1993 for the purpose of sales and distribution of our products in Europe.

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Results of Operations

      The following table sets forth the relationship between various components of operations, stated as a percentage of sales, for each of the periods indicated. Our historical financial data for 1997, 1998 and 1999 were derived from, and should be read in conjunction with, our audited consolidated financial statements and the related notes included at the end of this prospectus. The historical financial data for the six months ended June 30, 1999 and June 30, 2000 were derived from our unaudited consolidated financial statements, which, in the opinion of management, reflect all adjustments necessary for the fair presentation of the financial condition and results of operations for such periods.

Results of Operations

Six Months Ended June 30, 2000 Compared to Six Months Ended June 30, 1999

     Sales

      Sales increased $3.4 million, or 50.0%, to $10.2 million in the six months ended June 30, 2000, compared to $6.8 million in the same period in 1999. This increase was attributable to an increase of $1.9 million in the sales of our low volume production MBE systems and a $1.5 million increase in the sales of our performance products.

     Gross profit

      Gross profit increased $1.9 million, or 63.3%, to $4.9 million in the six months ended June 30, 2000, compared to $3.0 million in the same period in 1999. Gross margin for the first six months of 2000 increased to 48.6% compared to 43.3% for the same period in 1999, primarily due to the

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     Selling, general and administrative expenses

      Selling, general and administrative expenses increased $0.8 million, or 61.5%, to $2.1 million in the six months ended June 30, 2000, compared to $1.3 million in the same period in 1999. Additional salaries, benefits and office expenses associated with an increase in headcount accounted for $0.5 million of this increase. Higher professional fees primarily related to a resolved litigation matter, as well as increased costs in connection with marketing expenditures related to our GEN2000 system accounted for the remainder of the increase. Selling, general and administrative costs, as a percentage of sales, increased to 21.1% in the first six months of 2000 from 18.9% in the same period in 1999 primarily due to the increase of these items. We anticipate that selling, general and administrative costs in the remainder of 2000 and for 2001 will increase in absolute dollars as we hire additional administrative, sales and marketing personnel and expand our facilities.

     Research and development expenses

      Research and development expenses increased $0.5 million to $0.7 million in the six months ended June 30, 2000, compared to $0.2 million in the same period in 1999. Research and development costs, as a percentage of sales, increased to 7.3% in the first six months of 2000 from 3.4% in the same period in 1999. We expect that research and development as a percentage of sales will continue to increase as we continue to devote additional resources to our MBE and MOCVD product development.

     Stock-based compensation

      We have recorded deferred compensation for the difference between the exercise price of some stock option grants and the deemed fair market value of our common stock at the time of those grants. Deferred stock-based compensation is being amortized over the vesting periods of the applicable options, resulting in an expense of $1.7 million for the six months ended June 30, 2000.

      In April 2000, our majority shareholder sold 569,112 shares of our common stock to four current employees at $1.40 per share. Accordingly, a charge to compensation expense was made to the extent the stock price was below the deemed fair value of the shares sold and a corresponding entry was made to record additional paid-in capital of $5.5 million in the six-month period ended June 30, 2000.

     Interest and other income (expense), net

      Net interest expense was $93,000 in the six months ended June 30, 2000, compared to net interest income of $1.6 million in the same period in 1999. The decrease reflects the reduction in interest income resulting from the June 1999 repayment to us of a loan by Spectracom, as well as increased interest expense in connection with the mortgage on our facilities.

     Provision for income taxes

      We did not record a provision for income taxes due to our S corporation status.

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     Net income (loss)

      Net income decreased $8.4 million to a net loss of $5.3 million in the six months ended June 30, 2000 compared to net income of $3.1 million in the same period in 1999. This decrease is primarily attributable to a $7.2 million charge for deferred stock-based compensation. Pro forma net loss of $5.8 million in the six months ended June 30, 2000 includes a provision for income taxes of $0.5 million. This amount varies from a normal effective tax rate of approximately 40% due to the non-deductibility of the stock-based compensation charge and the tax benefit of IC-DISC sales.

Year Ended December 31, 1999 Compared to Year Ended December 31, 1998

     Sales

      Sales decreased $0.1 million, or 0.6%, to $15.4 million in 1999, compared to $15.5 million in 1998. Increased demand for our performance products was offset by the sale of a lower number of low volume production MBE systems.

     Gross profit

      Gross profit in 1999 remained flat at $6.8 million, compared to 1998. Gross margin for 1999 improved to 44.3% compared to 44.1% for 1998. The gross margin improvement in 1999 reflected an increase in revenues from sales of our higher margin performance products as a percentage of total revenues.

     Selling, general and administrative expenses

      Selling, general and administrative expenses increased $0.2 million, or 7.4%, to $2.9 million in 1999, compared to $2.7 million in 1998. This increase was due to increased advertising expenses and a modest foreign currency loss, partially offset by a decrease in office expenses. Selling, general and administrative costs, as a percentage of sales, increased to 18.7% in 1999 from 17.5% in 1998 primarily due to the increase of these items.

     Research and development expenses

      Research and development expenses decreased $0.2 million, or 28.6%, to $0.5 million in 1999, compared to $0.7 million in 1998. Research and development costs, as a percentage of sales, decreased to 3.1% in 1999 from 4.6% in 1998.

     Interest and other income, net

      Net interest and other income decreased $0.1 million to $1.6 million in 1999, compared to $1.7 million in net interest income in 1998. This decrease reflected the reduction in interest income resulting from the June 1999 repayment to us of a loan by Spectracom.

     Provision for income taxes

      We did not record a provision for income taxes due to our S corporation status.

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     Net income

      Net income was approximately $5.1 million in both 1999 and 1998. Pro forma net income was approximately $3.8 million in 1999 and includes a provision for income taxes of approximately $1.3 million.

Year Ended December 31, 1998 Compared to Year Ended December 31, 1997

     Sales

      Sales increased $3.6 million, or 30.3%, to $15.5 million in 1998, compared to $11.9 million in 1997. This increase was primarily attributable to an increase of $2.1 million in the sales of our low volume production MBE systems and an increase of $1.5 million in the sales of our performance products.

     Gross profit

      Gross profit increased by $1.1 million, or 19.3%, to $6.8 million in 1998, compared to $5.7 million in 1997. Gross margin for 1998 declined to 44.1% compared to 47.9% for 1997, primarily as a result of the increase in low volume production MBE system sales as a percentage of total revenues, startup costs associated with the shipment of our first GENIII system, increased overhead associated with a move to new facilities in July 1998, and the write-off of materials purchased in connection with a canceled order.

     Selling, general and administrative expenses

      Selling, general and administrative expenses increased $0.1 million, or 3.8%, to $2.7 million in 1998, compared to $2.6 million in 1997. This increase was due to increased salaries, benefits, office expenses and facility costs, partially offset by a foreign currency gain. Selling, general and administrative costs, as a percentage of sales, decreased to 17.5% in 1998 from 22.3% in 1997 due to the increase in sales.

     Research and development expenses

      Research and development expenses decreased $0.8 million, or 53.3%, to $0.7 million in 1998, compared to $1.5 million in 1997. Research and development costs, as a percentage of sales, decreased to 4.6% in 1998 from 12.3% in 1997.

     Interest and other income (expense), net

      Net interest and other income was $1.7 million in 1998, compared to $42,000 in net interest and other expense in 1997. This change reflected interest income of $1.6 million associated with a loan by us to Spectracom.

     Provision for income taxes

      We did not record a provision for income taxes due to our S corporation status.

     Net income

      Net income increased $3.8 million, or 292.3%, to $5.1 million in 1998, compared to $1.3 million in 1997.

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Quarterly Results of Operations

      The following tables present consolidated statements of operations data in dollars and as a percentage of sales for the ten quarters ended June 30, 2000. In management’s opinion, this unaudited information has been prepared on the same basis as our audited consolidated financial statements appearing elsewhere in this prospectus. All adjustments which management considers necessary for the fair presentation of the unaudited information have been included in the quarters presented. Our results from operations may vary substantially from quarter to quarter. Accordingly, the operating results for any quarter are not necessarily indicative of results for any subsequent quarter, entire year or any future period.