Advanced Energy Industries Inc (AEIS) 2003 Q3 法說會逐字稿

Good afternoon. My name is Wesley, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the third-quarter 2003 results conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the conference over to Ms. Cathy Kawakami.

Thank you. Good afternoon and thank you for joining us today. Doug Schatz, our Chairman and Chief Executive Officer, and Mike El-Hillow, our Executive Vice President and Chief Financial Officer, will be today's speakers and will provide an overview of the results. Dennis Faerber, our Chief Operating Officer, along with Doug and Mike, will then take your questions.

By now you should have received your copy of our press release that we issued approximately one hour ago. If you still need a copy of the release, you can call us at 970-221-4670 or view the release on our Website at www.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 the orders received from our customers, and our ability to execute on the cost reduction initiatives currently underway. Other risks are described in our Form 10-K, 10-Q and other reports that are filed with the SEC. Additionally we assume no obligation to update the information we provide during this conference call.

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

Thanks, Cathy, and thank you for joining us this afternoon. Our third-quarter results came in as expected with sales of approximately 69 million, an increase of 9 percent sequentially. Sales to flat-panel, data storage and architectural glass customers were particularly strong in the third-quarter based on improving order trends and market share gains. These end markets all realized double-digit growth in the third-quarter.

Operationally we undertook several initiatives over the past year to increase the flexibility of our business model and to reduce costs. These initiatives were large in scale, aggressive in timing and critical to the goals we have set for our business. We were able to reduce the start-up time of the China operation due to the experience of our operations team. We continue to make solid progress on all fronts.

In the second quarter, we began manufacturing our first product line in China, and as we enter the fourth quarter, we are manufacturing three products from our power family and three more, including mass flow, are in the process of starting up. China-based manufacturing of our MX2 lines will enable us to maintain market leadership as we pursue new design and opportunities by delivering high-value products at lower cost to our customers. This initiative is our top priority for the flow group.

During the third quarter, we passed the factory audit to two major OEM customers, and they both had extremely positive feedback about what they saw there. This was a major milestone in the qualification process. Three OEMs are already taking China built product, and we anticipate adding to that list in the very near-term. Our move to Tier 1 Asian suppliers is going as planned, and we're seeing the tangible results of the cost reduction benefits and quality improvements that we initially anticipated. We have phased one key commodity line out of our domestic supplier base already and are now working with suppliers in China and Malaysia. We are on track with our anticipated savings, and the onetime start-up costs associated with this transition will largely be behind us by the end of the first quarter in 2004. These initiatives are critical to our internal goals for trough probability in future cycles. Although we are still incurring duplicated costs, as the programs are implemented, we are already seeing the initial improvements and the increased flexibility this strategy will bring to the business.

Taking a look at the end market trends, sales to semiconductor OEMs were relatively flat sequentially based on the fact that our sector is in the very early stages of turning the corner. We continue to see anecdotal evidence that we are in the early stages of gradual improvement, and we remain cautiously optimistic that the industry is poised for growth in 2004.

As Mike will discuss in a moment, we're anticipating flat fourth quarter sales based in part on the shortened quarter due to the industrywide shutdown during the holidays, including three weeks at Advanced Energy. Continued strength in flat-panel display is being driven by both consumer demand for flat-panel TVs and computer monitors and by the Next Generation glass size retooling at the fabs. Advanced Energy is in a good position to benefit from the continued growth of this market due to our technology lead and strong customer relationships.

Sales to data storage customers in both the computer hard drive and CD/DVD markets increased during the third-quarter. The computer hard drive market has been at overcapacity for several years, but OEMs are now retooling with new technology to meet the requirements for higher density drives. They are turning to AE to meet their requirements for this more advanced processing. Although this is a small part of our business on a relative basis, the new processing requirements require more stations per tool creating a larger opportunity for us.

On the entertainment side of data storage, sales in 2003 were driven in large part by production of recordable disks. This processing requires 10 power supplies per tool versus one power supply for prerecorded disks, and the complexity of the process is becoming more and more similar to that of semiconductor manufacturing. The prerecorded DVD has also been strong, and our customers are continuing to ramp for the holiday season. The seasonality of this business is changing a bit because lead times are shrinking, so we're seeing customers order into Q4 to meet the holiday demand. We are well-positioned in data storage at all of the major equipment providers.

Architectural glass was also a strong market during the third-quarter. We displaced the competitor with our new crystal high-power power supply, marking this product's first major OEM order. This product has traditionally had an end-user customer base. The crystal product is the only leading power supply designed specifically for large area glass coating applications, and it secured this OEM win due to the inherent process stability that it provides even in the most challenging process environments. This market is expected to trend up due to new requirements for coated glass windows and new home construction and due to large-scale hotel projects in areas such as China.

In addition to recent design wins such as the crystal product, our technology lead is being validated by share gains and continued successes on the design win front across our end market. We are leveraging the strength of our product groups to create high-value solutions that meet critical customer needs, and our ongoing investment in R&D is reflected in our continued success in winning key designs.

We discussed the strength of our VHF and RF product portfolio last quarter. We are continuing to gain traction at key customer accounts with these product lines. Our customers turn to AE when technology matters, such as for the increasingly complex hard disk drive manufacturing process and for manufacturing semiconductors at smaller lines with using very high frequency power supplies.

Our MSC products are well- positioned in the marketplace, also. We have standard default status on many 200 millimeter platforms and OEM customers, as well as on key 300 millimeter CVD platforms. We also announced during the quarter that our D980 flow controller was selected for poly etch by a leading chip manufacturing. The D980 has been noted for its superior performance and reliability and has enabled us to capture key wins to date.

On the operations side, we're leveraging the strengths of our worldwide sales manufacturing and operations to improve our global operating efficiency. To achieve and maintain operating profitability throughout future industry cycles, our management team has developed the leadership experience necessary to see us through this transition to a more variable operating model, and we're committed to meeting our operational goals.

I will now turn the call over to Mike so that he can review the financial results with you.

Thanks, Doug. I will review the results of the third quarter 2003 and then provide guidance for the fourth quarter. Revenue for the third quarter of 2003 of 68.6 million was slightly ahead of our expectations and 9 percent higher than the second-quarter 2002 revenue of 62.9 million. Year-over-year revenue decreased 3 percent compared to third quarter 2002 revenue of 70.7 million.

Gross margin was 33.7 percent for the third quarter compared to 32.2 percent of sales for the second-quarter and 37.6 percent for the year ago period. The sequential improvement in gross margin reflects the higher sales volume and increasing benefits we are experiencing as the results of our move to Tier 1 suppliers and the overall lower cost of our China facility. These savings have been tempered by the duplicative costs associated with the manufacturing supply transitions as we maintain our ability to meet whatever ramp the semiconductor industry may experience in the upcoming year.

As Doug mentioned, our China facility is now fully operational, and it should the customers allowing us to become more aggressive in transitioning customers and reducing the redundant costs as we drive to a much lower breakeven as we exit 2003.

Net loss for the third quarter of 2003 was 27.4 million or 85 cents per share, including pretax charges of 2.2 million related to restructuring charges and an intangible asset impairment and a non-cash charge of 22.4 million relating to the Company's deferred tax asset. The third quarter 2003 net loss compares to the third quarter 2002 net loss of 5.6 million or 17 cents per share and the second quarter 2003 net loss of 5.8 million or 18 cents per share.

The Company's decision to provide a full valuation allowance against its deferred tax assets is in response to the accounting literature rather than any concern on our part of recognizing the tax benefits as the industry and the company returns to profitability.

Looking at end market, semiconductor capital equipment represents 55 percent of total sales or 38 million, relatively flat compared to 37.8 million in the second quarter of 2003. In the third quarter of 2002, sales from semiconductor capital equipment customers represented 68 percent of total sales or 48.1 million. Applied Materials, our largest semiconductor capital equipment customer, represented 17 percent of total third-quarter sales, while 11.5 million essentially flat with the second-quarter sales of 11.6 million. In the third quarter of 2002, Applied represented 28 percent of total sales or 19.6 million. We anticipate flat sales in orders for semiconductor customers in the fourth quarter, taking into account the industry shutdown.

Flat-panel display sales represented 10 percent of total third-quarter revenue or 7.1 million. This represents a sequential increase of 36 percent in dollar terms compared to 5.2 million of total sales in the second quarter of 2003. Flat-panel display represented 8 percent of total sales in the third-quarter of 2002, a year-over-year increase of 22 percent in dollar terms. We expect flat-panel sales to increase modestly in the fourth quarter.

The data storage industry, which is comprised of digital video disks, compact disks and computer data storage markets, was 13 percent of total third-quarter sales or 9.2 million. This represents an 11 percent increase in dollar terms compared to the second quarter of 2003. This market represented 8 percent or 5.4 million in the third quarter of 2002.

The continued increase is representative of capacity for the DVD and high drive production. We believe data storage will be moderately down in the fourth quarter, given that the holiday ramp is expected to continue into the first part of the quarter.

Advanced product applications represented 21 percent of third-quarter revenue, up 14.2 million representing a 22 percent sequential increase in dollar terms. Sales to this market were 16 percent of total sales or 11.4 million in the third-quarter of 2002. This category includes a variety of applications, such as our IKOR power supply for the high-end computing market, industrial coatings, architectural glass coatings, and laser and medical applications.

Looking at sales by geographic region, domestic sales represented 42 percent of total third-quarter sales compared to 44 percent in the prior quarter and 58 percent in the third quarter of 2002. Europe remained flat at 22 percent of sales with Spain as in the second-quarter of 2003, an increase compared to 15 percent in the year ago period. Asia-Pacific represented 34 percent of sales, also flat compared to the prior quarter, and that is compared to 27 percent in the year ago period.

We ended the third quarter of 2003 with a total backlog of 33.4 million, which is up just slightly compared to the prior quarter backlog of 32.8. R&D spending was 13 million or 19 percent of sales during the quarter. This compared to 12.6 million or 20 percent of sales in the second quarter of 2003 and 12.2 million or 17 percent of sales in the third quarter of 2002. We have maintained our R&D spending in 2003 while reducing expenses in other areas of our business, and this several significant opportunities available to us.

SG&A was 13.7 million in the third quarter of 2003 or 20 percent compared to 13.8 million in the second quarter of 2003 or 22 percent of sales. This compares to 17 million or 24 percent of sales in the third quarter of 2002. This decrease of over $3 million is due our ongoing cost reduction measures and will continue to decrease as we move into the first half of 2004.

Headcount at the end of the third quarter was 1,318 people, of which there were 1,189 full time and 129 temporary employees. That compares with a headcount of 1,256 people at the end of the second quarter of 2003. The sequential increase is due to higher temporary employees and continued expansion of our China employee base.

Our balance sheet continues to be strong with cash, cash equivalents and marketable securities of 136.4 million. Our cash and marketable securities positions the increase in the third quarter 2003 by 13 million, primarily due to our operating loss, continued purchases of equipment for our China facility and working capital needs. Our of 50.7 million is 10 million higher at the end of Q3 because we shipped almost 27 million in September as part of the highest shipping month in the quarter.

DSOs increased 61 days compared to 57 days in the second quarter of 2003 and 59 days in the third quarter of 2002. Our DSO is still significantly lower than the industry average. This end of quarter shipping space, which is unusual for the Company, reduced our end of quarter cash, the 142 million that we had expected at the beginning of the quarter. If we had had a normal shipping pattern, then our cash balances would have been essentially as expected. Also, in early October, we received our tax refund of almost $14 million, further enhancing our cash balance as we approach an operating level that should begin to generate cash.

Third quarter inventory is 58.6 million compared to 55.7 million in the second quarter of 2003. Inventory turns were 3.2 turns in the third quarter, 3.1 turns in the second quarter and 2.7 turns in the third quarter of 2002. Total days in inventory were 115 days, down from 119 days in the second quarter of 2003 and 135 days in the third quarter of 2002.

The sequential dollar increase in inventory was due to the expanded China operation. Similar to the redundant expense levels that we will address in the near-term, we should also see improvement in this area.

Our capital expenditures in the third quarter was 7.1 million, up from 5.1 million in the second quarter and 2.4 million in the third quarter of 2002. The higher spend was due to continued investments in China as we have accelerated the move of our MSE manufacturing to China. Depreciation was 3 million in the third quarter compared to 3.3 million in the second-quarter and 3.4 million one year ago. We expect CapEx to be approximately 4 to 5 million in the fourth quarter of 2003.

Based on current customer order patterns as well as the industrywide shutdown and shutdown schedule, we anticipate relatively flat revenue in the fourth quarter with a loss per share range of 14 to 16 cents. I want to point out that this range assumes no tax benefit given the reversal of the Company's deferred tax asset during the third quarter. We will also continue to be subject to tax expense related to foreign entities, which is estimated at less than $500,000 in the upcoming quarter.

will continue to improve slightly and should be approximately 34. to 34.5 percent. R&D will be approximately 12.5 million and SG&A approximately 13.3 million. For the quarter, we expect our cash burn from operations to be 7 to 8 million, and we may again pay down some of our short-term debt in these steps.

We continue to make progress toward our goal of operating breakeven excluding amortization at the 60 million quarterly sales level. Because of the duplicate of costs we are occurring, the actual impact of these issues are hidden in year-to-date 2003 results. We remain committed to achieving our operating breakeven goal as we exit 2003, and we are poised to make additional changes as necessary.

Doug, Dennis and I will now be happy to answer any questions. So, operator, please open the lines.

(OPERATOR INSTRUCTIONS). Brett Hodess, Merrill Lynch.

I am wondering if you can give us some commentary on the semiconductor OEMs a little bit more. You had noted that there a sometimes a light, but it is looking sort of flat going into this quarter. Normally when would you start to see orders pick up from them relative to when their shipments might start to pick up? Do you have a feel for that?

We usually see it between basically a quarter and a quarter and a half before we see their revenues really pick up. This is kind of an unusual time in the year. It is an unusual time for orders to be picking up because everybody is already prescheduled the holiday shutdowns, and it is almost become a characteristic of the industry whether it is needed or not, everyone tends to schedule all the vacation days toward the end of the year.

So we were definitely seeing not only a more upbeat attitude, we are seeing our customers starting to ask us about ramp readiness. We saw a little bit of that back at SEMICON. We are seeing it being much more broadly shared now. We think that clearly they see this whole thing of utilization as getting to be such a high percentage, and it's just that the orders have not dropped. But from what we can tell, there is anticipated demand coming, and what it will look like, we do not know. But I would say before it turns into real shipments for our customers, it is probably another quarter out.

A second question if I can on the China manufacturing side. Clearly the MSC is ramping up in that facility. What would you think the timing would be or not in terms of moving the core power supplies into China at this stage?

Okay. I will do my part, and then Dennis can give you some input, too. Our core power supplies are actually the first things that we have moved to China. So that is what the focus has been as we initiate the activation of the China facility. As far as timing of number of products, I think Dennis can address that a little bit more.

There are two aspects of this, too. One is that the product lines themselves moving there, and then the second aspect is the percentage of the product line that is actually being manufactured in the U.S. or in China for given customers as we go through the acceptance process.

Yes, Doug. There are a couple of dimensions to this. As Doug mentioned, our original target has been to move our power supply products to China. That was the original format, and we are proceeding on that track. Our intent by the end of 2004 is to have the majority of our production on power coming out of China.

We brought in FCs online recently in terms of part of our ramp strategy based on the strength we're seeing in the Chinese operations in right now. The thing we are working through and we are keeping dual manufacturing in place as we go through the qualification phase on this is we are right now in the process of really qualifying a number of our products with our key OEMs here in the United States.

Does the qualification of the power supplies being a more complex product take longer in the China facility than the NFCs ?

Yes. The answer is definitely yes. This requires pretty extensive testing because it can't be exact with each of the OEMs. We go through and provide a lot of the initial data, and we work together with them on that. So the process is a bit more involved in the MSCs. But we are working with key OEMs that clearly see the power of our facility, and they see the benefit long-term in getting the qualifications done. So we're right now in the process of those discussions.

It is kind of exciting when you have your large customers go through a site evaluation and come back describing it as the best facility of its type they have seen in Asia.

That is great. Good luck.

Stuart Muter, Adams, Harkness & Hill.

A couple of questions for me. First, do you anticipate any further restructuring charges in Q4?

At the present time, we don't really have anything in place. As we said earlier, we are going to do whatever we need to do to achieve our operating breakeven, but today not. A year ago we did say that over the period as we drive down to the breakeven, we expected to have the size of $3 to $5 million. Year-to-date we've had 3.5 million, so over that period as we finish our drive for low breakeven, you can expect that we are going to have some more. But that could be in this quarter, but may be in the first quarter. That must have been in the 5 million.

Could you talk about the timing of reducing the redundant costs from the shift to manufacturing in China and your restructuring efforts? Should we expect to see a lot of those costs disappear in Q1?

Q1 is the focal point. As we said, we expect our margin to increase marginally in the fourth quarter of this year. Now that the plant is fully operational, we have much more flexibility to drive these costs out, but then we always have to be aware of the customer concerns and also the ramp readiness. As Doug said earlier, we are hearing from our customers about being ready for the ramp, and so while the lower breakeven is at the top of the list, keeping our customers happy is probably a little bit higher. So we should expect to see that out in the first quarter for sure.

Thank you.

Jim Covello, Goldman Sachs.

A question for Mike. What was it that the auditor saw that made them uncomfortable and forced the deferred tax asset write-down, because I know that had not been part of the plan? That is my first question, and I have some follow-ups.

The literature on this is not particularly black and white. It is mostly. But also the firms themselves haven't come to grips with how they want to look at it. When I looked at this earlier in the year, the test as we understood it was over a three-year period you had to have profit, and of course, the literature said over a three-year period you have 12 consecutive quarterly losses. As the year transpired, that was turning into three cyclical years of losses, so early in the year, we expected by the end of the year, but certainly by the first fourth quarter of next year, it could have been the 12 quarter since last time we had a profit, so we would be turning a profit.

So the literature changed or the interpretation of the literature changed. Nothing more than that. We took the conservative approach in this particular quarter writing it off. We talked about it for several days, quite frankly, with our auditors and the management team, and at the end of the day, we thought the prudent way was to write this off rather than to have the possibility of getting some comments from the regulatory authorities. That is really all.

Following on with that then, I guess my expectation is you were going to come a little closer to breakeven in the fourth quarter, even excluding or if you forget about the 0 percent tax rate. As I understood on the call, it is really two issues. It is some incremental redundant costs in China or in the U.S. from the move to China, and then some additional opportunities that you described that your customers have presented you with. Is that right, and then can you talk about the additional opportunities?

Two questions. From the standpoint of the costs, you are absolutely right. Early in the year, as Doug pointed out in his opening remarks, we took some very aggressive goals. In hindsight, the goals may have been a little bit too aggressive, but I will tell you the execution has been tremendous. So we get to the end of the year and the location in China beginning to supply some Tier 1 suppliers has grown spectacularly.

What we have not been able to do as quickly as we would have wanted was reduce the costs. It is just a part of doing business. We could have moved it faster. We were just focusing on the numbers, but as more customer satisfaction -- but now that we are shipping products out of China, and to follow-up on the question about qualification, we believe that once that customer is qualified, one or two power parts, that is the part that we qualified much faster. We can move much faster.

So whether it's duplicative costs -- as we have told you earlier in the year, we are bringing product back to the United States. We had that review there. We continue to do that. We just don't want to anything that in the end-game will take away from all the hard work on China just by keeping costs in place for one more quarter. With that being said, the management team is committed now to taking these costs out because the China facility is a proven location.

Regarding the additional opportunities in the power area per se, we have talked about them earlier in the year, but generally they are in our VHF products with some of the major OEMs around the world. These opportunities were just so compelling that it would make no sense for us to be focused on the R&D goal of $11 million or $12 million quarterly expense. And hopefully over the next three to five months, we will be announcing some very significant design wins.

Thanks. Maybe just one more question. Can you talk a little bit about the asset impairment charge of intangible assets that you took?

Within our intangible assets over the acquisitions we made over the last few years, the biggest part is the controller acquisition we made and EMCO, and then the power acquisition that we made. This impairment relates to the flow acquisition. It is a small impairment. I don't mean to minimize it. It's about $1 million.

I don't mean to minimize it in terms of $1 million, but in terms of intangible assets, over the years, we were capitalized -- looking at the intangible asset allocations, we described certain of the assets to certain types of the acquisitions. I don't want to go into the specifics of it, but it was one specific application that we went to a test recently and based upon the rules we had to write it off. Of interesting note, we have made significant acquisitions in the macro area over the last few years, and we said when we bought these companies, they offered us a lot of upside, and our national business continues to be very strong even with the downcycle. But it had more to do with the specific allocations several years ago that any weakness in the business.

Stephen Pelayo, Morgan Stanley.

This is Gary Hsueh for Stephen Pelayo. A couple of questions here. It sounds like the transition in China has been going flawlessly. Congratulations there. I was wondering now that you have better visibility on that, if you could bracket what kind of gross margin improvement we can get on flat revenues in Q1?

To go out there, we would really be giving you the forecast for Q1, so we really prefer to get away from that. But part of our guidance was as we go down the $60 million breakeven level that our gross margins would be in the 37 to 40 percent range, up from about a 31 to 32 percent range. Some of that is China, some of that is Tier 1, and some of it is taking out overhead elsewhere around the world. So that will give you a frame of reference.

But one of the things we did say, and we have committed to today, is as we exit 2003 that we will meet our goal of breakeven at the $60 million level taking the Company amortization. So I think you can assume that we are going to be going up into the high 30s within the first quarter, if that is the essence of the level.

Actually I have a second question there. In terms of your expectations for first quarter '04 and writing down the deferred tax asset line there, are you seeing any impact or do you expect any impact from lunar New Year shutdowns at your end-user customers?

Not that we are aware, but, quite frankly, we have not looked that far out in our planning, and we are focused on the fourth quarter. Historically it has not been a major problem for us, so we don't expect it will be again.

One final pie-in-the-sky question about datastorage. What are your expectations about a secular trend to 120 gig densities maybe next year? Is there a secular trend that continue and grow the datastorage revenue line materially higher next year?

Every time we think data storage is going south, it keeps going north. We have seen it, and we had the recovery in the computer data storage a year ago. There just seems to be pent-up demand. We don't expect a significant increase, but we continue to see it this year. On a panning horizon, we would expect to see some continued growth once we get out of the holiday season and the entertainment crowd.

But I think what we are seeing is just pent-up demand that has been there for several years in all parts of our business, and as Doug said earlier, in the semiconductor part of our business, the biggest part of our business, we are hearing much more positive talk. But there is just this uncertainty because of industry shutdowns, etc., maybe some concerns about macroeconomic conditions, but it just seems poised to takeoff.

But we should point out that as a company we have not been particularly bullish about 2003 nor about 2002. We have always focused on 2004, and that is one of the reasons we took this very aggressive goal of China and Tier 1 suppliers in 2003. We knew had to have this transition done before the ramp, and quite frankly, the transition is done. We could meet the ramp. Now it's a matter of moving through this gradually to reduce the duplicative costs. So next year is anybody's guess, but I will tell you those other markets that were 21 percent of our sales this quarter continue to be a very important part of our revenue base, and we expect them to be going forward.

Ted Berg, Lehman Brothers.

I have some questions on the breakeven as well if we could go into that a little bit more. It sounds like if revenues are flat in March -- I know you did not guide to that, but if we assume that they are flat -- would we assume we would be making some money? Wouldn't gross margin be somewhere north of 40 percent? You just mentioned in the question before that gross margin might be in the high 30s in the March quarter?

What I was talking about was our breakeven goal of 650. So in the first quarter, if our sales are 60, we would expect to be in the high 30s. If sales are 68, then absolutely we would expect additional contribution to the gross margin line.

So basically the breakeven goal just shifted from December to March, and it is still the same breakeven goal and still the same breakeven numbers that we are using.

Same breakeven goals, same breakeven numbers correct.

So all the duplicate costs, do they basically all go away by the March quarter, or is there still improvement to lower the breakeven further around into 2004 as some of those duplicate costs go away?

We would not to want to say that all the costs are gone by the first quarter, but the majority of them are. One thing we want to point out is that we took the to a $60 million breakeven as a goal because that is where we expected our trough evidence to be in the future, and we thought it was a good milestone.

We have learned a lot in this last year, both internally -- we brought in some new people, Dennis included, who once they get there, we are going to work every day to keep finding better ways to do business. One of our biggest goals is a variable operating model. We made some progress this year but, quite frankly, not the progress we had expected because we were focused on China, we were focused on Tier 1 suppliers. So I'll say it's a start, but a much longer destination as we look at various ways to continue to be more efficient, get better use of our facilities.

One thing we're committed to, unless there is some specific crying need, we are not going to have to this company. We are going to find a base to run various shifts. We have got to keep driving down our cost space. At the end of the first quarter, the duplicate costs will come out as the market allows them to come out and as our ability allows them to come out. But as we said, we are looking at all avenues to continue to improve our operating results.

On the three-week period that employees will have off in this quarter, is that all paid that three weeks? Does that detract from SG&A expenses and cogs directly for expenses or whatever?

In the middle of the year, we informed our employees that we would probably be taking some shutdown days caused by industry conditions and, accordingly, to find a way to observe their own vacations as the year went on. So for employees that were able to do that, chances are they recognized it as part of our accrued vacation. We have very few employees we believe who will not be able to do that, but if that is the case, we will fund our employees. But unfortunately that time off will be without pay.

If I can ask one last question. In the past, you talked about design wins for 300 millimeter applications where you think that will give you higher share at 300 millimeter in power supplies versus what you have had in 200 millimeter, and you already had a high share in 200 millimeter. I wonder if you could elaborate on that and some of the applications where you have had some those share gains. Are these in other areas outside of RF that you have had a relatively smaller position, or are these primarily, all these design wins at 300 millimeter, the key PVD applications and other deposition applications?

I will grab that one. The area that we had the most opportunity in as far as semiconductor production goes was in inept, because it was the area that consciously related the longest period of time to focus our RF engineering on. We changed that about a year and a half to two years ago as we told you.

It turns out that most of the technology for 300 millimeter was shifted to the much higher frequencies. We have not only the leading technology but from our point of view, and we think our customers', the leading skillset. We've got the stable technology at the right price and we've got not just an engineering capacity to develop a box, but it is the knowledge of how to apply that through instrumentation matching that works, process impact, etc.. So we think we have good evidence that we've got a very strong position now as we go through the 300 millimeter transition. We also see some of that will go back into 200 millimeter.

Anecdotally, internally I heard the other day that out of 38 major contests that we were in we were winning 35 or 135 of them. Now those last 3 could be 90 percent of the market, but I don't think so. Really they are putting a lot of effort into this area with most people, probably not only in the industry but in the world as least as far as a group goes, and I think that will definitely see the impact of that in orders as the market moves out.

What is that time frame over that 38 contest that you had?

You know, I don't know. I did not ask that. I probably should have, but I think they would probably be looking at it for a point of view of the tools that we will be shipping because it seems like all of us know that we have probably won some large percentage of previous design win contests, and those products never emerge because they are all obsoleted because of the extended downturn. But I am guessing that would cover a year and a half to two-year timeframe.

Okay. Thanks a lot.

Mark Fitzgerald, Bank of America.

This is Morali for Mark. I notice that your applied revenues fell to below 20 percent I think for the second time in a row. Is this somewhat of a blip, or is this like an ongoing trend?

We looked at it very closely. We made some phone calls. In fact, we talked . It seems to be transitory. We were surprised last quarter when we went below 20 percent for the first time that I can remember. We talked to a supplier that is a major supplier of supply materials, but then we looked at some of the other major suppliers, and they also went below 20 for the first time. In this particular instance, we're not overly surprised.

Basically quarter-over-quarter, the sales were flat. As we said earlier, the semiconductor part of our business did not grow sequentially. So the percentage change is probably more controlled by the strength that we saw in the other parts of our business flat-panel and data storage, but it still did go down.

So we look at it in a lot of different ways. When a company has a major customer , people get concerned customer. As we broaden our customer base, when people continue broadening it up on that, but the bottom line is our position with suppliers is as strong as it has ever been. In getting back to the point of our design wins, they are at all the major OEMs, including .

So you think it is something that is hopefully going to pick up down the road?

We would expect it would.

To the best of our knowledge, we have picked up market share with all of our customers. In sporadic or isolated areas, there might be some effective lumpiness in shipments, but we cannot identify any of that. I think it is just something that is going on with the lumpiness of the order patterns of our customers themselves. We don't see anything particularly changing about them or our relationship with them.

That makes sense. Are you seeing any more improvements in pricing pressures? You think customers are sounding a little more optimistic, or is it still remaining pretty much the same as before?

They seemed to develop a very capable skill of fearlessly applying pricing pressure. That is real, but it is not vicious, let us put it that way.

This is more of a long-term question, but there was some recent talk about the R&D evaluation being changed in China or something of that sort. Have you guys looked at it to see if that's going to impact your numbers at all, because between the Tier 1 suppliers and your production, you seem to have somewhat of an exposure, right?

You've got to break it up into two parts. Number one, the production we do within China, and that is our concern of ours, not a major concern. The Tier 1 suppliers .

Thanks guys.

Derek Winger , Jefferies & Co.

Thank you. Just some financial details. Three questions. The interest expense for the quarter, the depreciation and amortization expense for the quarter, capital spending for the quarter and the estimate for the year on capital spending?

The depreciation and amortization for the quarter was 5.6 million. CapEx spending for the quarter was 7.1 million. We expect that in the next quarter we will spend another 4 to 5 million in CapEx, and then interest expense for the quarter was about 2.7 million.

Philip Lee , J.P. Morgan.

What kind of tax rate are you modeling for 2004? In terms of the duplicative costs, what would be your estimate for the range of that on a dollar basis per quarter?

The tax rate for next year, we are probably going to go back to 35 percent. We had 37 percent for this year, but as we turn to profitability and we get higher income out of the United States, the 35 will probably take them 12.

The duplicative costs we really prefer not to go into that level of detail, but I will say it is not a small number. When we are talking about the impact on gross margin, we are not talking in terms of basis points. We will be talking in terms of percentage points. It is substantial. It is also something that we have a handle on, and we have the people in place. We have brought in new people, quite frankly, over the last few months to address this issue.

Would you say that the drive to breakeven, most of that is going to be driven by gross margin?

The drive to breakeven for the entire year was focused primarily on cost and SG&A. We wanted to protect our R&D as long as possible. As we move forward, as we said earlier, we are going to look at every avenue to achieve that goal. If we are able to accelerate our improvement in cog and getting rid of duplicative costs, it allows us more flexibility in our organization. But if not, as a management team, we are committed to make the changes we have to make. So I am giving you a rather general answer because right now it is in a state of discussion among the management team. It is one that is given the highest priority and one that we will resolve in the next month because we made a commitment to our Board and our shareholders, and we will meet that commitment.

Alexander Paris, Barrington Associates.

I apologize. I got on the call a little late without the statement, and I was just trying to discern what your actual operating results were in the fourth quarter on a per share basis? You had two non-recurring charges, and then the taxes I presume just went through the balance sheet.

The tax we saw a live tax expense in the operating results. The $2 million went through the operating statement, but we have a significant tax break. Giving you that number, there is obviously a movement within the industry that they are just going to report numbers under GAAP. However, we did give you the breakout, and it is safe to assume that on a comparative basis, those are three things you should back out. You should tax effect the $2.3 million of discretionary intangible asset impairment using the 37 percent. You should back out the entire 22.4 million -- I think it's 22.4 million -- of deferred tax asset write-down.

And then in the fourth quarter, it sounds like the bottom line is not quite as good as you would have expected earlier. Part of that is the transition costs relative to China are larger than they would have been, and then you have the absence of any tax credit.

That is correct.

Can you tell me what the tax credit -- the difference that makes in the fourth quarter?

We have been taking tax credits of 37 percent out. So in that quarter, we have a loss -- we talked about a loss of 14 to 16 cents, and in the past, we have taken a tax credit of 37 percent.

I see. Okay. Thank you very much.

Bill Mauerman , Lone Star Associates Asset Management.

A couple of quick questions if you care to answer them. Do you know what percentage or do you care to share what percentage in dollar value in sales in the current quarter came out of China, as far as percentage of units and total dollar value of sales?

We cannot say that, Bill. You take our large customers, they could be flowing things through into China. We have got some direct sales into China, end-user products, but they are pretty far below 10 percent. It is something we don't have any visibility of ourselves.

At some point, you will be able to tell what percentage of your sales are coming out of China, right?

Are you asking what we are shipping out of China?

Exactly. What you are shipping out of China.

We prefer not to discuss this at the present time. What we have said is that by the end of next year we have about 70 percent of our coming out of China. We said there are two major customers taking shipments right now. What we will say is that it is fairly de minimus. In the fourth quarter, we do expect an increase there. I won't say through the end of next year, but we also don't expect it to be spiked up-and-down.

The other question I have is, was there any foreign exchange gain or loss in the current quarter, and with the dollar weakening against the Yen and all the sales coming from Aera, is that something you're looking at going forward and that you are addressing and trying to hedge against?

We had a small foreign exchange gain in the quarter because of the Yen, less than $250,000. We have hedged that. We have some -- the gain we have locked in against the Yen. Against the Euro, we were pretty good during the quarter. But going back and forth, we look at it monthly.

We are not an overly aggressive hedging Company, not one that tries to forecast the next three to six months of activity and do net operating hedging. We have very strong financial management in Japan and in Europe, our two main outside the U.S. locations currently, and we have added one in China. We have what we call basically a FX team and they talk constantly. It is run out of the United States. So over the next six months, it has come well within our radar screen, especially as we move to China and the R&D. But in the near-term, it has not been a problem for us.

Thanks a lot and good quarter.

Robert Stern, Needham & Co.

Could you tell us what your service business was in the third quarter and talk about any trends in the service business?

Our global support was about $7 million in the third quarter, and we have seen strengthened global support for the last year, year and half. But we were growing prior to the Aera acquisition, and we continue to grow in that area. We do expect to continue to move that business forward. So to give you a sense, 6.7 million in Q1; 7.4 million in Q2, about 7.4 million in Q3. So you are looking at a good percentage of our sales, 11 percent of our sales. There are other companies that have higher percentages there, but we have made significant progress.

As we move down the road and we put more products in the marketplace, we do expect to grow that business.

Is profitability in that business improving?

The profitability in that business is improving and is always very strong.

(OPERATOR INSTRUCTIONS). There are no further questions at this time.

Okay. Thank you for joining us, and we look forward to talking to you individually next quarter.

Thank you for joining today's third-quarter 2003 results conference call. This does conclude the conference. You may now disconnect.