Advanced Energy Industries Inc (AEIS) 2003 Q2 法說會逐字稿

Good afternoon. My name is Matthew, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Advanced Energy Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be question-and-answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you.

Ms. Kawakami, you may begin your conference.

Thank you very much. Good afternoon, and thank you all for joining us today. Today's speakers will be Doug Schatz, Chairman and Chief Executive Officer, who's calling in from the West Coast today, and Mike El-Hillow, Executive Vice President and Chief Financial Officer. They'll provide an overview of the results and then will be available, along with Dennis Faerber, our Chief Operating Officer, to take your questions.

By now, you should have received your copy of the press release that we issued approximately one hour ago. If you still need a copy of the release, please contact us at 970-221-4670, or view the release on our website at Advanced-Energy.com.

Before we get started this afternoon, I would like to remind everyone that except for any historical information contained herein, the matters discussed in this conference call contain certain forward-looking statements subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Such risks and uncertainties include, but are not limited to, the volatility and cyclicality of the semiconductor and semiconductor capital equipment industries, the timing of orders received from our customers, and our ability to execute on the cost-reduction initiatives currently underway. Other risks are described in our Forms 10-K, 10-Q, and other reports that are filed with the SEC. In addition, we assume no obligation to update the information that we provide today during this conference call.

With that, I'd like to go ahead and introduce Doug Schatz.

Thank you, Cathy, and thanks for joining us this afternoon.

As we expected, the second quarter of 2003 represented a continued linear demand trend with revenues of approximately $63m coming in slightly ahead of our prior guidance. This represents a 12-percent increase, compared to first quarter 2003 sales of $56m. The revenue up side was driven primarily by increased demand for our power products in the semiconductor and data storage markets, and for our mass flow control products in the semiconductor market. We are seeing early indications that demand momentum should continue and will increase moderately in the near term, and we do remain cautiously optimistic for sustainable growth in 2004. We've been working hard to rebuild and redefine our organization so that we can be best positioned for new opportunities in the future. Particularly as industry conditions do begin to improve, these future opportunities require us to have the scale and cross-functional capabilities so that we can leverage a variety of product lines into a variety of opportunities with the highest degree of efficiency. As we pursue these growth opportunities and reduce our fixed costs, we focus on operational excellence and execution.

As a key part of that focus, we're targeting an aggressive total approach to our cost infrastructure that should take us to a quarterly operating cash flow breakeven of $55-60m in sales as we exit 2003.

We're moving toward these goals, in part, by leveraging a world-class, low-cost China-based manufacturing facility and a world-class tier-one Asian supply base. Our move to China continues to be on plan, and we recently began production on a high-volume power platform at our Shenzhen manufacturing facility.

We're now in the process of transferring some VC power platforms with additional lines and technologies scheduled to transfer before the end of the year. The China clean room facilities are now completed, and Vanguard productions of our mass flow control centers will begin this fall. Mainstream mass flow control products will be transferred to China by the end of this year.

Our move to a tier-one Asian supply base also proceeds as planned. And while there are over 800 part numbers to qualify, we are making good progress. We expect these initiatives will continue to proceed on schedule. Our biggest challenge in both of these areas has been coordinating the copy-exact qualifications with our OEM and end-user customers. We're working very closely with our customers to continually move this process forward.

In addition to the progress we're making operationally, we're also continually expanding our leadership position in the marketplace with innovative technology solutions and extending our deep customer relationships. AE is well positioned to continue the technology and market leadership that we enjoy in power, flow, plasma, and ion sources and through thermal products as this industry moves into its next growth phase. We are able to leverage the breadth of our product portfolio to solve critical customer issues and extend the relationships with those key customers. This ability, along with our continuous commitment to R&D, has driven important recent design wins and applications, such as dielectric etch and HDCVD, capturing an even greater share of the 300-millimeter market opportunities. We are responding to our customers' needs, and we are winning.

In power, our Apex-integrated match RF supply, navigator matching network, and VHF, or very high-frequency solutions that have been primary drivers behind these semiconductor-related wins.

Our power group also continues to gain share and expand opportunities in the high-powered glass-coating market with our large, high-powered solutions.

In our plasma and ion sources group, we launched the high-efficiency Xstream platform last month for CVD chamber frame. This new product was showcased at the SEMICON West Trade Show last week and offers customers unsurpassed performance and flexibility for their reactive gas processes, improving systems throughput and optimizing the use of expensive resources.

These products all represent the significant competitive advantage that we bring to our customers' processes, particularly in 300-millimeter, where Differentiated technology advantage really matters.

So from both operational and technological aspects, we're focused on building a company where the pieces fit together and work well with one another so that we can continuously bring more value. That translates to competitive advantage to our customers.

We now have the management team in place to make the constructive changes necessary to ensure execution at all levels of our strategic initiatives, and we are confident that these initiatives best position the company to maximize our growth potential not only as the industry begins on a recovery path, but throughout future cycles as well.

I'll now turn the call over to Mike so he can review the financial results with you. Thank you.

Thanks, Doug. I will review the results of the second quarter 2003 and then provide guidance for the third quarter of 2003.

Revenue for the second quarter of 2003 was $62.9m, a decrease of 7 percent, compared to the second quarter of 2002 revenue of $67.9m. Revenue for the second quarter of 2003 increased 12 percent compared to the first quarter 2002 revenue of $56.2m.

Gross margin was 32.2 percent of sales for the second quarter, compared to 32 percent for the first quarter and 35.8 percent for the year-ago period. As the year progresses, we will begin to see the impact of our move to tier-one suppliers and the overall lower costs of our China facility.

Net loss for the second quarter of 2003 was $5.8m, or 18 cents per share, compared to the second quarter 2002 net loss of $5.1m, or 16 cents per share. This compares to the first quarter 2003 net loss of $8.6m, or 27 cents per share.

If we look at the second quarter sales by market, semiconductor capital equipment represented 60 percent of total sales, or $37.8m. This is a quarter-over-quarter increase of 14 percent in dollar terms.

In the second quarter of 2002, sales from semiconductor capital equipment customers represented 75 percent of total sales, or $50.6m.

Applied Materials, our largest semiconductor capital equipment customer, represented 18 percent of total second quarter sales, or $11.6m, down from 23 percent in the first quarter 2003, or $13.1m. In dollar terms, sales to Applied declined 11 percent. In the second quarter of 2002, Applied represented 34 percent of total sales.

Flat panel display applications represented 8 percent of total second quarter revenue, or $5.2m, which represents a decline of 22 percent in dollar terms, compared to the first quarter of 2003 amount of $6.7m. This market represented 4 percent of total second quarter 2002 sales, or $2.7m.

The quarter-to-quarter change was due to customers absorbing a significant amount of equipment bought in the second half of 2002.

The data storage industry, which is comprised of digital video disk, compact disk, and computer data storage markets, was 13 percent of total second quarter sales, or $8.3m, which represents a 113-percent increase in dollar terms, compared to the first quarter of 2003. This market represented 6 percent, or $4m, in the second quarter of 2002.

The significant increase is representative of capacity purchases primarily for DVD production. This is a seasonal effect, and we do not expect this growth to be sustainable in the current third quarter.

Advanced product applications represented 19 percent of second quarter revenue, or $11.7m, which represents a decrease of 7 percent compared to the first quarter of 2003. Sales for this market were 15 percent of total sales, or $10.5m in the second quarter of 2002. This category includes a variety of applications, such as IKOR power supply for the high-end computing market, industrial coating, architectural glass coatings, and laser and medical applications.

Global support was $7.4m in the second quarter of 2003, which represents an increase of 9 percent compared to the first quarter of 2003. Global support represented $4.3m of total sales in the second quarter of 2002, and as you can see with the acquisition of AERA, we have begun to significantly increase our global support business.

Looking at sales by geographic region, domestic sales represented 44 percent of total sales, compared to 52 percent in the prior quarter and 68 percent in the second quarter of 2002. Europe increased to 22 percent of sales, compared to 17 percent in the prior quarter and 13 percent a year ago. Asia-Pacific represented 34 percent of sales, compared to 31 percent in the prior quarter and 19 percent a year ago. We ended the second quarter of 2003 with a total backlog of $32.8m, which represents a 31-percent increase compared to the first quarter of 2003 backlog of $25m.

R&D spending was $12.6m, or 20 percent of sales during the quarter. This compares to $13.4m, or 24 percent of sales in the first quarter 2003 and $12.6m, or 19 percent of sales, in the second quarter of 2002.

SG&A was $13.8m in the second quarter of 2003, or 22 percent of sales, compared to $14m in the first quarter of 2003, or 25 percent of sales, and $15.7m, or 23 percent of sales in the second quarter of 2002. The sequential and annual decrease was due to our ongoing cost-reduction measures and will continue to decrease throughout 2003.

Headcount at the end of the second quarter was 1,266, of whom there were 1,155 full-time and 111 temporary employees. That compares with a headcount of 1,394 people at the end of the first quarter of 2003. The majority of our second quarter headcount reductions occurred at the end of the quarter; therefore, we expect to see the benefit of our actions beginning in the third quarter of 2003.

Our balance sheet continues to be strong with cash, cash equivalents and marketable securities of $149.4m. Our cash and marketable securities position decreased in the second quarter of 2003 by $11.4m, primarily due to our operating loss net of non-cash expenses, purchases of equipment for our China facility, and the repayment of $2.3m of notes payable in capital lease obligations.

Our trade accounts receivables increased to $40.6m, compared to $37.2m in the prior quarter, due to the higher sales base, especially in the last month of the quarter. DSOs decreased to 57 days, compared to 62 days in the first quarter of 2003 and 58 days in the second quarter of 2002.

Second quarter inventory was $55.7m, compared to $56m in the first quarter of 2003. Inventory turns were 3.1 turns in the 2003 second quarter and 2.7 turns in the first quarter of 2003 and second quarter of 2002. Total days inventory was 119 days, down from 137 days in the first quarter of 2003 and 135 days in the second quarter of 2002.

Our capital expenditures in the second quarter were $5.1m, up from $3.4m in the first quarter of 2003 and $2.7m in the second quarter of 2002. The higher spend was due to continued investments in China.

Depreciation was $3.1m in the second quarter, compared to $3.1m one year ago. We expect capex to be approximately $12-13m in 2003.

Based on current customer order patterns, we anticipate annual revenues to increase 3 to 8 percent in the third quarter to a range of $65-68m and a loss per share of 11 to 13 cents. Gross margin will continue to improve and should be approximately 34 percent. R&D will be approximately $12.5m, and SG&A will be approximately $13.5-13.8m.

For the quarter, we expect our cash burn from operations to be $4-6m, and we may again pay down some of our short-term Japanese debt. Also, in the second half of 2003, we will take additional charges totaling approximately $1.5-2m as we complete our operational changes.

Doug, Dennis, and I will now be happy to answer any questions, so, Operator, please open the line for questions. Thank you.

Caller instructions.

Your first question is from Brett Hodess of Merrill Lynch.

Hi, this is Tom Ditlin in for Brett. A quick question on just the gross margins. Could you guys go through how they got to where they were in the current quarter? It seemed like they would've expanded just a little bit more with the increase in revenues.

Tom, this is Mike El-Hillow. We talked about this last week at the analysts' meeting. As we make these operational changes and move to tier-one suppliers, I mean we're having some last-lost purchase costs and just other, quite frankly, efficiency costs. If you take out those costs, which are, you know, one-time items over maybe a three- to five-month period, then the margins would've increased to what you would've expected.

Okay.

But at the end of the day, it's just the significant changes that we are making.

Okay. And can you talk a little bit about maybe some integrated subsystems that you're working on and any progress there?

One example of the integrated subsystem is the new Xstream. We've also got some other products that we haven't announced, and I think I said that at the last conference call. What we're finding right now is that the customers' major wins and the major opportunities have to do with excellence of the foundation products. So we've been picking up, as I said earlier, a lot of wins, and that's been an awful lot of development activity in the core products, new generation RF and, particularly in the UHF RF products. And it's basically the same thing that's going on in flow and sources. The customers slowed down their interest in going through complex subsystems. It's still there, but they're very focused on positioning themselves and their tools for the strongest fundamental components that they can get. So that's where we've shifted a lot of our R&D resources is making sure we satisfy them and pick up market share.

Okay. So do you think the mile for integrated subsystems is much more of next-cycle phenomenon than a current-cycle phenomenon?

I think that in order to really take advantage of that, our customers have to be able to move forward in the marketplace themselves as far as moving up the value chain. And I think -- I don't know whether I'd even call it next cycle. I think as the needs get more critical to the point where you have to have these different kind of super systems right now working with each other in order to get performance, I think that's what'll drive the need. It doesn't look like cost, except in the simplest integrations, is driving a need for integration right now.

Okay. All right. Well, thank you.

Your next question is from Steven Pelayo of Morgan Stanley.

Yeah, hi, this is Gary Hsueh for Steven Pelayo. I've got a couple of questions here. Looking at your guidance for, you know, 3- to 8-percent sequential revenue growth in the September quarter, does that really reflect the kind of conservatism or cautious outlook? Or does that indicate any kind of bumpiness in kind of the forecast demand or build rates you're seeing from your customers?

Gary, this is Mike. As Doug said earlier in the speech, the demand pattern remains linear. I mean it's not level linear, but it's fairly straightforward. So we continue to see that throughout the quarter. Quite frankly, with a little bit of a pick-up in the June month -- as I said, our shipments were higher in June, and that accounts for a little bit lower cash flow, but our receivables went up, but our DSO is in great shape. We expect to see that. I wouldn't say it's a matter of conservatism. We exited the quarter with almost $33m of backlog, and the number we give you is shippable backlog for the quarter. We discount future quarters. So we've continued to see demand, and it's interesting. You know, we look at some other companies in the industry, and it appears they're not seeing the same based upon their guidance, and it's not so much what we're seeing from the customers or what we're hearing from our sales people than just talking as a management team. As Doug said, we continue to take market share, what we can see, and I think our continued strength in the order patterns is reflecting that.

Okay. And my second question, Mike, is actually on, you know, the target for breakeven at $55-60m happening in the fourth quarter. Just roughly to get there, do we need to see any more reductions in the fourth quarter for R&D and SG&A? Or do you kind of expect some pretty hefty pick-ups in incremental gross margins to get you there in the fourth quarter?

It's a number of things, Gary, and I think, first and foremost, what we are putting together here is a more variable operating model that would allow us to, quite frankly, pick and choose the level of operations. But as a management team, what we want to be able to do is have enough variability in all segments of our workforce in that if we choose to break even at the $55-60m level, we can do it by flexing investment opportunities, by flexing other parts of our organization.

So what you've seen in the past three months is the beginning of that. At the end of the second quarter, we sold our printed circuit board facility. We've kept some of those employees, but the majority of the employees went with the company that bought that facility, so total flexibility now with PCB. In past cycles, when things were good, it was easy to own a PCB facility. When things are bad, we had to absorb that overhead.

So the operating model is moving forward. The savings in materials is moving forward, although, as Doug said, we're working with our customers. The reduction in our overhead is moving forward. A lot happened at the end of June. Doug, Dennis, and I are working together to move that forward.

In the R&D area -- we said it before and we'll say it again -- we are going to continue to protect that as long as we possibly can, but we have charged our business units with going out and finding partners in the R&D area that will allow us to quickly respond to our customers' needs while at the same time maintaining the lowest-possible fixed cost in that area. So we're on schedule.

Okay. I guess -- you know, kind of inaudible, you know, you had 34-percent incremental gross margins in the second quarter, and I believe, you know, the China facility was kind of masking some other issues. When can we see, you know, kind of the duplication of costs kind of alleviate and get better gross margins moving forward?

I think you'll see some of that in the fourth quarter. I think you will not see much of that in the third quarter. That's why our earnings guidance is the 11 to 13 cents. Some in the fourth quarter significantly picking up in the first quarter of next year.

Okay, fantastic. Thanks.

Thank you.

Your next question is from Stuart Muter of Adams, Harkness & Hill.

Good afternoon. A question for Doug. With the new Xstream product, are you targeting the flat-panel display opportunity?

We're going after everything. So I mean basically it's the highest performance downstream plasma source that we know of. It has the highest disassociation rates. It's got the widest performance envelope, the highest amount of power. It will ignite under the highest pressures with the lowest content of alternate gas itself. It's the highest-performance thing out there. There are a lot of applications for it. We're initially targeting the ones we have already experience with, and that's obviously CVD Clean, but, yeah, we're looking at opportunities in multiple applications and multiple companies.

Okay, so you have a roadmap to get to the flow rates required for these larger flat panel substrates?

We have a technology roadmap. We're actually working with some people in cleaning now, but not necessarily with that specific product.

Okay, and could you provide an update on the legal issues there? Is it causing any problems in the business environment with your customers?

Our customers have absolutely had no interest in even talking about it. Our perception is they're considering that it's almost a non-issue. We went through an awful lot of care to make sure that we honored what the judge and what the court described as inaudible area of possible infringement, and we think we did a superb job around that. So we're not anticipating a significant business issue.

Okay, thanks, Doug.

Um-hmm.

Your next question is from Ben Teng of JP Morgan.

Hi, a couple of questions. First off, can you comment on how you guys are doing with Tokyo Electron now? Are they going to -- you know, when do you expect them to get to the 10-percent customer, or are they already there?

I'll just comment on the second part, Ben, in that they are not a 10-percent customer. As to the first part, I'll leave that to Doug or Dennis.

Well, we have, you know, almost 100 percent of the 200-millimeter business in flow, I believe. I mean it's the default standard dazara. We've used that relationship plus building technical relationship in the power area to propose to them some new technology. Like all the customers we're working with, we're getting very good reception, and we're looking forward to an expanded relationship in the future, and it'll be done on the merits of the product and the capabilities of the company.

Okay. And I think one of the drivers we were counting on, you know, for the component guys was that the OEM companies were shrinking their supplier base. And if they get caught up in an upturn, do you think they'll slow down that activity? Or how would you characterize where they're at? Like, you know, I mean most of these guys are saying they want to go from 500 suppliers down to, you know, 150 or 200. Where would you characterize where they're at and what you think will happen if they get caught in an upturn?

Yeah, you know, I think there was a lot of discussion about that at SEMICON because it was the first time when people could actually start imaging that ramp was still a word in the English language. And immediately, you know, concerns came up about what companies would actually be able to perform in a ramp. And it's clear that there are a lot of small companies, particularly in the area of machine shops and smaller companies, that do a lot of special activities, custom activities, that they might not be able to handle any kind of a ramp. So there is some concern that I've heard that the smaller players represent a fairly significant risk to the whole industry. But we've also seen that there's been real activity to look at going through a highly energetic shift away from the smaller suppliers. And, you know, generally that wouldn't affect us or our primary competitors because we're the guys they're trying to shift the business into. At the same time, there are almost always smaller players with either lower prices or some other projected advantage trying to get into these larger OEMs, and we're seeing a real resistance now for those OEMs to entertain that. They just -- they realize that this last part of the cycle has really damaged a lot of smaller companies, and they don't want to add more smaller companies if they have to manage in a downturn.

So let me ask the question now on your outsourcing activities, and the same question. I think you guys mentioned that your target was the outsource or to have -- outsource the 800 parts or have some tier-one suppliers for like 800 parts. Where are you guys at right now, you know, relative to that number? And if you don't achieve that by a certain time, how does that affect your gross margin profile?

I could answer that, but, Mike, do you want to pick that up? You've got Dennis there.

Let me just per one part. Ben, the visibility to get to the cost savings we want are there. I mean we've dealt with the suppliers. The products are available. The cost savings are there. And a great deal of the internal qualification is done. So as I said earlier, it's qualification with the customer. So I don't see it impacting us significantly. If it's delayed, we're talking in terms of a month, two months. We're not talking in terms of half a year or a year. So we're not overly concerned with that per se, but one of the things we are running into is that our customers are cutting back their employee bases, too, and those are the ones that will do this, but we're right on schedule. Dennis?

Yeah, I think another comment I'd make is the whole shift to tier-one was certainly and is a cost play, but it's also a flexibility play. The companies we're working with are some of the largest companies in their fields, and that actually gives us a lot more in the way of capacity as well as clout with lower-level suppliers going forward in a ramp. So, if anything, I think we'll be positioned stronger for a ramp as we go through this transition.

So, you know, this kind of last-lot effect that you talked about of why, you know, the gross margin didn't see as much improvement as you guys would've liked, that's over in the second quarter or --?

Well, there'll be a little more --

-- third quarter?

-- in this quarter. There's also the runoff of the old higher inventory that we're facing. That's an add is the duplicate of cost between the Chinese facility and the U.S. facility, so they're all things that happen in a transition. They will still be there in the third quarter. That's why you're not seeing a significant improvement in our gross margin projection, but we believe we'll get through a great deal of that in the third quarter, and we expect to see a much larger improvement in the fourth quarter with really seeing the savings in the first quarter of next year and, quite frankly, beyond because we're just not going to stop there. We're going to keep looking to redesign our products, look for better suppliers. As we partner with suppliers and give them more business, we expect to see even further savings from them.

Yeah, I think one of the ways to look at it is that we have structurally changed already. And now we're going through a lot of the detail, the logistics detail, as Mike says, the qualification detail. It's a lot of work that has a lot of, again, just detail, a lot of small transactions associated with it, and they just have to flow that through the pipe. But the company has already changed, and you'll see the results of the change not only coming quarter after quarter over the next few quarters, but that should continue for quite a while.

Thank you very much.

Your next question is from Jim Covello of Goldman Sachs.

Good afternoon, gentlemen. William Franks for Jim Covello. Could you please talk a bit about the inventory levels you're seeing at your customers? And, also, could you comment on the current pricing environment in terms of your comparison with recent quarters and your feeling for prices going forward? Thank you.

I'm going to repeat the question because it was very soft on our part. It was commenting on inventory levels at our customers and the pricing environment.

That's correct.

Okay. From the standpoint of inventory levels of the customer, basically we track that very closely. And it's the same thing we said at the end of the last quarter; we don't believe it is a problem. Our customers have been trying to reduce their inventories over a number of years, and we believe they have done that. There are some pockets out there that we haven't seen. If they are, we believe they'd be very small.

As to the pricing environment, it hasn't changed at all. It's been difficult now for several years. But what we do know in the pricing environment is that our customers are prepared to pay for value, and we continue to show that in our products, especially in the power area. We typically have a higher average selling price because our products are valuable in the marketplace. So I've gone to customer meetings. Doug has. Dennis goes to customer meetings. Our customers are looking for value, and they're willing to pay for it because value means better efficiency, better throughput, and so we can keep moving forward. That being said, they do demand the value.

There's one other thing, too, that was kind of interesting, and it started coming out at SEMICON, was that as this perceived capacity demand started increasing, or at least talk of it started increasing, we actually heard where some customers were going to the fabs' end-users and actually starting to raise prices. So that's the first time we've heard of that in years, and it's kind of interesting. Whether it's going to be sustained or whether it's real, we don't know. You know, but that was indiscernible one more interesting data point.

Great. If I could just sneak one more in, if possible? Could you provide any color about percentage of revenues from subsystems versus subcomponents? Do you have any data on that?

The way -- we know that some of our peers/competitors talk about integrated subsystems, but if you take a look at all of our power products, they're all integrated subsystems, so we don't quite know how to categorize things. If you look at the slow-controlled business, a reasonable percentage of the flow controls aren't just isolated flow controls, but they're integrated subsystems. So I don't think it's a useful metric for us. It might work for other people, but it doesn't seem to work for us because a large part of what we provide is -- it's really engineered beyond just the component, and even though we have specifications on our products, we're generally at the core of the plasma process, and our commitment to our customers to make that process perform, and that's where -- one of the places we really excel. So it's notvolts and amps, and it's not, you know, blocks of metal. What it is kind of, like Mike said earlier, it's a guarantee of a value proposition.

I don't mean to make it abstract, but I don't -- almost everything we've always done is integrated more than our competitors in the market generally have done.

That's great. Thank you very much.

Your next question is from Morali Uburri of Banc of America.

Yeah, quick question. What percentage of your products is expected to come out of China by the end of this year?

Morali, we're really staying away from trying to track it that precisely, but what we said last week is by the end of 2004, we expect to be in excess of 70 percent. We expect that to be fairly linear, but it also gets back to not only qualification of the parts; it's also qualification of the products from our customers. I mean we believe that once our customers are satisfied with, say, a couple of the products, that they'd see the process; they'd go over and see our facility in China. We're going to be having a customer over there in the next month, quite frankly, to audit our facility. We do believe then there's a potential ramp up when they get comfortable. So you can think about it along the linear line. I don't think it's going to be much different than that, but there's nothing that we'd expect to happen any kind of volume in this next quarter.

That's fair enough. And are you guys planning to ship the products directly out of there, or would it come back to the OEM's manufacturing base in the U.S. and then go out?

Well, initially our plan is to ship to the OEMs for integration. We have talked with a few of the OEMs about direct shipping geographically longer term, but we're not doing that on the front end. In the early stages of this, we're actually shipping some of these products back to the Fort Collins facility in AE for full characterization before we ship to the customers. That's just in a transitory stage as we qualify the products. So I think it's certainly for the intermediate team for 2003, most of 2004, we'll be shipping to the OEMs' factories for integration there.

Yeah, and I'd like to expand on that a bit, Dennis, because you guys have gone after the tier-one suppliers, which means that we've really decreased the length of the supply chain. We not only can take advantage of the logistics on that side, but it opens up the possibility that our -- has been almost the holy grail for a lot of our customers is this concept called merge in transit, where they wouldn't do integration at their facilities anymore; they'd do it at the customers, or at least within the region. And so we're opening up that possibility for Asia.

Another thing that's been really interesting is we've been setting the pace for everyone in terms of quality, and we just -- we continue to drive superb results, and so on these units that we're actually validating and manufacturing in China, we've been running at zero defects on the retests coming back into the U.S. to make sure that we're validating our processes. So it's pretty exciting that not only is the quality very high in China, but it's reproducible, and that's going to give our customers a tremendous amount of confidence.

All right. Thanks, guys.

Your next question is from Martin Tang of Needham & Company.

Hi, guys. A couple of questions. Do you have any market share data on your mass flow controller's ECM power subsystem?

Indiscernible, Martin. This is Mike. We don't want to break it up in that level of detail, but when we bought AERA two years ago, we talked about a market share in the high 20s, low 30s. There was some backdrop for both leaders indiscernible for a couple of percentage points about a year ago. We believe it has recovered to be in the high 20s, low 30s again.

Okay.

It's in place where it was before.

Okay. And some of your competitors in the mass flow indiscernible believe have announced controllers that integrate both a pressure transducer and, you know, regulators and sensors in their mass flow controllers. Do you have -- are you guys announcing, you know, the same kind of products?

Well, we've had pressure and sensitive mass flow with two different types of technologies for about two years. AERA had one in design when -- before we acquired them, and the first acquisition that we made in this area was Amco on the Mach One that's pressure insensitive. You know, if you look at multi-gas, multi-flow modules, basically there isn't any technology that’s being sold at any volume that's ahead of what we've announced.

My question is, you know, there's a lot of talk about integrated gas sticks, and I think during the SEMICON West show, I think MKS 8-pi MSC that has -- it was close to integrated gas stick and also has, I think, some form of web, you know, capability. I was wondering, are you guys going to follow that kind of trend, or, you know, do you have product that is close to that kind of integration?

You know, I’m not as knowledgeable about what the MKS offering was. Someone else might have that, but I don't have it, and so I really can't respond to it.

Okay. Also, the revenues from Applied declined slightly. Is that significant?

Is that significant? Is that what the question was?

Is that significant? Do you have any idea why it went down?

Not in particular. I know it declined for us. It also declined for the other peers in the industry. That's just indiscernible it should be. It has nothing to do with market share or design wins. Our position with Applied is as strong as it's ever been. Has more to do, I think, the shipments outside -- their products or their customers and the mix there.

There might be another thing, too, Mike, in that we're actually -- we're seeing Applied starting to get the benefits of their ERP system as they manage differently than they used to. So I think they might actually be able to run a little bit leaner, and, of course, that's good for all of us.

Okay, thanks.

Your next question is from Steven Pelayo with Morgan Stanley.

Yeah, hi, this is Gary. I’m not sure if you addressed this, but, you know, bookings growth up to 70.7 from 59 last quarter -- is there any pattern in that that you can discern? Or is that just kind of broad across, you know, all product lines?

We had some real strength in the quarter in data storage, actually.

In bookings?

Yeah, a little bit in bookings actually, towards the end of the quarter. But generally speaking, it's very linear across all the groups, and we expect it to continue. We do believe that the flat panel there will be a little bit weaker, but there was nothing really discernible in, you know, week-to-week make-up, nor was anything discernible in the absolute numbers themselves.

Okay. And, Mike, one -- another quick question about 3PL. I just would've expected your inventory levels to be, you know, somewhere 30 to 40 or maybe even low 40s range. Is it possible that, you know, some kind of transition in your supply chain to Asia may be kind of causing some pick-ups in 3PL?

No, let me just clarify that. You said you thought our inventory would be at what level, 30 to --?

Somewhere lower than, let's say, $50m in terms of inventories.

I think that that's going to -- that would be really difficult, and I don't think we've ever really talked along those lines. But we will admit that the reduction in our inventory is going slower than we had hoped for, but it has nothing to do with the pipeline itself. We're just doing a lot of indiscernible in the operating level. The move to 3PL -- I mean the initial move to 3PL was custom our owned inventory. Until they work that off, it doesn't get to be supplier-owned inventory. But finishing the quarter above the $55m is not what we would've expected. But, quite frankly, we didn't expect anything below $50m either. We would've thought we'd be in the $53m range, and then it explains we would've had a couple million dollars more in cash. But it's nothing more than timing that the program is still moving forward and moving forward, I think, satisfactorily.

Okay. So you're just flushing out some actually higher-cost material out of inventory so far, also reflected in gross margin?

Inaudible because, otherwise, they would have to fund that.

Got it.

But we still own it.

Okay, thanks.

You're welcome, Gary.

Your next question is from Bill Mauerman of Lone Star Asset Management.

Hi, guys.

Hello, Bill.

Regarding your comments on the quarter and it kind of being back-end loaded, was it on the magnitude of like 50 percent of the business came in the last month of the quarter?

Oh, no. And the only reason I made the comment is because our receivables went up quarter over quarter by $3m. But I just wanted to tie it together. Our DSO went down. It was in -- if you looked at it month by month, it was a $21m, $19m, $23m. I mean it wasn't big, but, you know, we're focusing on our cash balances. We're very sensitive to cash. And we -- so the increase in receivables isn't because of all the receivables. It's just how the orders came through. But other than that, not a significant amount, but we're cash sensitive.

Gotcha. Okay, and then one other quick question. With the pick-up in business, have you started seeing some of your customers pull in orders sooner than they had planned initially or anything to that regard? Or has it gotten that good yet?

It hasn't gotten that good yet from what we can see.

So they're pretty much ordering based on the schedules that they give you and not pulling anything in then?

So far.

Okay, great. Thanks a lot.

You're welcome.

Great quarter.

Thank you, Bill.

Your next question is from Ali Irani from CIBC World Markets.

Hi, guys. This is Mariane in for Ali. You know, Mike, you were talking about your linear order patterns in the quarter. Can we assume that the third quarter is shaping up very linearly, pretty much how the second quarter was?

Same thing, but as I said, we exited June with a higher June. It's just -- it's going up and to the right. But, you know, fairly easy, the kind of hill that I could even run up, Mariane.

Great. And then you were just talking -- once again, kind of working off of that -- that the data storage, you know, you saw some sizable bookings come in for that, but you're expecting flat-panel display to be weaker. Can we assume that for the second half of '03, you're expecting these flat panel customers to continue absorbing their product?

Only for the next quarter. We'll address it that way. We don't want to go beyond that quarter. We're hearing some rumblings that they're skipping generations a little bit and they're absorbing it. But we also -- people we talk to, it's still vibrant. We wouldn't have expected it to be this strong, quite frankly, you know, six months ago, but it's staying pretty strong.

Great. And then, finally, one last question. Could you just remind me where your breakeven level is for gross margins?

Breakeven level for gross -- I’m missing the -- what level of gross margin would we expect when we are breakeven?

Yes, when you are breakeven, exactly.

Thirty-eight to forty percent.

Okay, great. Thank you.

You're welcome.

You have a follow-up question from Bill Mauerman of Lone Star Asset Management.

Hi. I’m sorry I didn't ask this earlier. When I was listening to the replay of your presentation at SEMICON last week, you talked about how you're going to try and keep different manufacturers in China from copying the products that you're moving over there by spreading out the pieces. Could you kind of go into a little more detail on that because --?

Yeah, I could. I was the one who said that, I think. The -- one of the things that we wanted to make sure of was we didn't put all of the subassemblies and final assembly and test inside of a given manufacturer. And because we have, you know, probably 1,200 to 1,500 parts per subsystem, we can pretty easily break out different types of manufacturing and send that to different suppliers, and then we're doing the final integration. So if you look at where the IP is located, no one ever really gets to see -- no one outside of Advanced Energy ever gets to see how the pieces all work together. They're not aware of what the testing strategies are and what the performance criteria is.

Got you. Okay, but when you say Advanced Energy, you mean you're trying to facilitate Advanced Energy?

Yeah, that's Advanced Energy.

Is there any -- I just read all these articles about how GM, you know, was manufacturing a car, and now there's a similar car coming off production lines, and there was another customer who was just having components built there, and they started seeing end-product coming off. I mean what kind of control do you have over your China facility that these other companies didn't?

Well, I think everybody worries about that. A lot of it -- and Dennis has experience with this, and he could chime in -- a lot of it is not just the parts that go together, particularly in products like ours where a lot of the performance of the integrated system is determined by unpublished specifications. So it's not like in the digital business, where they can just copy things, put them together, and it'll perform the same way. This is a lot harder to reverse-engineer because a lot of it isn't a standard part, and there aren't many engineers that are familiar with working with this type of technology. So we get a little bit of a barrier to entry that way.

The other thing is, if you look at where the real opportunity is, it's selling to the higher-volume manufacturer, and that's the OEM. And the OEM has to have global support, and if you look at one of our products, if you know that it's already being made in the lowest-cost region and that you have to use that level of component, the amount of benefit that the OEM would get or even more leverage is the end-user to buy something that isn't supported and save a few thousand dollars on a inaudible is really foolhardy when if that's down for a half an hour, you could've paid for the whole power supply company or flows control manufacturer or -- I mean it just doesn't -- there isn't a lot of advantage for an OEM to be buying a marginally lower-cost product, at least right now.

Got you. Yeah, that makes sense now that I think about it because it would seen like, you know, the customer base is small relative to like a car where it's millions of people and if they see somebody else showing up on their doorstep with a similar product, they're going to ask where it came from.

Yeah, and there's another part to it, too, Bill. It's that our products are -- and I’m not just talking about AE -- but our products are designed in concert with the process engineers' expectations and designs for their own systems. And so it's incredibly important that you've got this intimate relationship, design relationship, that happens real-time up to the moment that the product leaves wherever the development happened. And so we're there, and we have the engineers that have that knowledge, so it's a pretty big barrier to get across unless somebody was just making a very, very low-cost system and, you know, that potentially is a threat in the future, but it certainly doesn't seem to be a big one right now.

Got you. Okay. And then one more thing I was hoping I could get clarified. I think this was a presentation that Mike gave at a Smith Barney conference. But did I hear you correctly that you're at some point going to moving R&D over to China, too, because of an ample supply of engineers and the lower cost for the R&D side? Or did I misunderstand that?

Inaudible, right, Mike?

What I said is that we want to have access to a location that has the highest-level engineering graduates over the next 10 years. Indiscernible this is nothing new term. This is the R&D center for the company. But we all know, as people talk about, over the next 10 years, China is going to be the center for electronics. And so if we so choose to move over there, we already have a foothold in China.

Got it.

And I think if you go back to what I just said a minute ago, Bill, it's really more to that. Like as China builds their own infrastructure, and everyone knows they will, that we need to have people that are a short distance away that have native tongue capability, that have the kind of knowledge that we have, to be able to work with the customer real-time. And that same thing goes for Europe, and the same thing goes for the U.S. So where the designs are done is where you need the tip of your arrow in terms of development. So I think probably within five years you'd see AE having development centers, R&D centers, in Asia, in the U.S., and in Europe.

Got you. Okay. Thanks a lot for clarifying that.

You're welcome.

You have a follow-up from Martin Tang.

Just a quick question on the breakeven. Did you guys give out the breakeven for this quarter and what it would be at the end of this year?

We did not give out what the breakeven would be, but, you know, on a strictly fixed to variable, it's probably around $65m right now, and by the end of the year, we do plan to be in the $55-60m range. We're moving towards that target.

And so most of the cost savings have come in from -- were they from cost of goods sold or, you know, SG&A?

All will come from cost -- the move to the tier-one suppliers as we work inventory down, as we find our facilities around the world to reduce our overhead, and we're going to continue to drive down what I'd call the non-customer-related value-added expenses that we have within the organization we're trying to each and every day. By the same token, us, like other companies, all the companies are facing increasing pressures on just being a public company. And, you know, when you're talking about a $60m breakeven, it doesn't take much to impact that. Ultimately, we're driving down to that level.

Yeah, well, there's another thing at play, too, that you guys can't see is our fixed-to-variable ratio has changed pretty significantly, you know, over the past six months. So even though you'll see a total amount in our line item, within that is a much higher variable expense.

Okay. Thanks, Doug.

Uh-huh.

Sir, it appears that there are no additional questions.

Okay.

We want to thank everyone for joining us this afternoon then, and we will speak to you very soon. Thank you.

Yes, thank you very much.

This concludes today's teleconference. You may now disconnect.