Advanced Energy Industries Inc (AEIS) 2003 Q4 法說會逐字稿

At this time I would like to welcome everyone to the Advanced Energy fourth quarter and year end 2003 conference call. (OPERATOR INSTRUCTIONS). Ms. Kawakami, you may begin your conference.

Thank you. I wanted to welcome everyone. Thank you for joining us this afternoon. Doug Schatz, 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 before we open the call to take your questions.

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

Before we get started this afternoon, I would like to remind everyone that expect 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 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. All the risks are described in our Form 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 to you during this conference call. I would like to now turn the call over to Doug Schatz.

Thank you, Kathy, and thanks for joining us this afternoon. Today we reported fourth quarter 2003 sales of 74.7 million, a 9 percent sequential increase reflecting continued increases in our order activity. Both the semiconductor equipment and flat-panel display customers were particularly strong in the fourth quarter, both posting double-digit quarter-over-quarter growth.

In addition we posted income from operations for the first time in 10 quarters. We believe this positive momentum will continue driven primarily by trends in the semiconductor industry. And we are currently expecting an approximately 30 percent sequential sales increase in the first quarter of 2004.

We experienced strength across all product lines in the fourth quarter. A strong record of design wins throughout the downturn is showing through in our financial results, particularly as the industry accelerates purchases of 300 millimeter equipment.

Our power and full (ph) product lines are well-positioned to benefit from 300 millimeter opportunities in high-growth markets such as etch and CVD. Currently 300 millimeter sales of our power products are approximately 40 percent of total power products sales, which is trending in line with the industry.

We estimate approximately 30 percent higher dollar power -- persistent revenue on a 300 millimeter tool as compared to a similar 200 millimeter tool. However, we have expanded our 300 millimeter revenue opportunity far beyond that, given that we hold a much stronger position in 300 millimeter etch than in 200 millimeter etch applications.

In addition to the move to larger wafers we are benefiting from the move to smaller line width, given the precision, reliability and repeatability demonstrated by our products -- all factors to become increasingly necessary in these advanced process steps. We have built solid positions in copper and low-k dielectric applications as well, putting AE in the strong position to benefit as the industry moves to not only larger wafers sizes and smaller geometries, but also to these new materials. Our focused R&D programs enable us to capture these significant opportunities. Our products continue to win where technology matters.

On the mass flow side, our Aera MFCs were named default standard at major end users and OEMs during the fourth quarter for a variety of semiconductor applications. We announced last week that our digital MFC was named default standard at a major Japanese semiconductor manufacturer. This broadens our installed base of digital mass flow controllers. And as an example of the pull through demand we're gaining as a result of the close partnership we have with both OEMs and end users.

In this case, our MFC will be used in 300 millimeter HDPCVD processes, demand precise control of the gas flow into the process chamber. The Aera MFC outperformed all other MFCs and provided superior accuracy throughout the entire control range.

Looking at our progress in transitioning our manufacturing organization, China is meeting our expectations in terms of total production contribution, and is on track toward our goal to manufacture 70 percent of all power and mass flow products by the end of 2004.

Five major power product platforms have been transferred to China. And we have begun wrapping MFCs based on the Q4 process and product transfer efforts between our Japanese MFC facility and Hajgeogy (ph) and the Shenzen (ph) operation. Three major customers have visited our China manufacturing location and have commented on the state-of-the-art facility. We are now qualified by our top customers, except one, and have approval to ship power products in volume directly from Shenzen.

As we exited 2003 we had nearly 30 percent of total material spending at Tier 1 Asian suppliers. We will continue to complete qualification of the remaining parts in the first half of 2004. And we will begin qualification of MFC components. Our goal is to have 50 percent of our total materials spend transferred to Tier 1 Asian suppliers as we exit 2004.

The combination of China manufacturing and Tier 1 suppliers gives us leverage and security as we move into an industry ramp period with upside capacity capabilities, both internally and in our supply base. At the same time these transitions present new opportunities to improve quality through use of Six Sigma methods which we are driving in China, and better process control capabilities with the Tier 1 suppliers.

We believe we have made the right decisions over the last few years, both strategic and tactical, to further extend our market position. The changes we are implementing in our operating model are real and sustainable. And our Company, shareholders and customers will benefit from these improvements as the industry continues to transition to the most responsive and efficient suppliers that have manufacturing and customer support capability in all key regions around the world.

We're well-positioned to meet the challenge of rapidly scaling our production to meet customer commitments with an expanded and innovative technology offering.

I would like to turn the call over to Mike now so he can discuss with you the financial results and deliver them in greater detail.

Thanks Doug. And good afternoon everyone. I will review the resource for the fourth quarter and full year 2003, and then provide guidance for the first quarter of 2004.

Revenue for the fourth quarter of 2003 of 74.7 million was ahead of our expectations, and 9 percent higher than the third quarter 2002 of 68.6 million. Year over year revenue increased 30 percent compared to fourth quarter 2002 revenue of 57.4 million.

Gross margin was 35.6 percent for the fourth quarter compared to 33.7 percent of sales for the third quarter. This also compares to a 7.8 percent gross margin for the fourth quarter of 2002, which included an 11.5 million charge in excess amounts of inventory and product transition warranty cost.

Although we're making significant incremental progress, the previously discussed transition cost associated with our move to China manufacturing and Asian based supplier, somewhat reduced the near term improvement in our gross margin on the higher sales level. As Doug mentioned, these changes are being made for long-term benefit of the Company. And the capabilities we are adding are critical to maintaining our world-class manufacturing and customer support capability.

Net loss for the fourth quarter of 2003 was 2.4 million, or 8 cents per share compared to the fourth quarter 2003 net loss of 22 million or 68 cents per share, and the third quarter 2003 net loss of 27.4 million or 85 cents per share. The fourth quarter 2002 included pretax charges of 13.1 million related to excess amounts of inventory and warranty reserves and other items. The third quarter 2003 net loss included pretax charges of 2.2 million related to restructuring charges and intangible asset impairment, a noncash charge of 22.4 million relating to the Company deferred tax asset.

Looking at end market sales, semiconductor capital equipment represented 62 percent of total sales, or 46.3 million, up 22 percent compared to 38 million in the third quarter of 2003. As Doug discussed, we're seeing strong growth in orders for semiconductor capital equipment customers in the first quarter of 2004, as overall industry fundamentals improve, and we gain traction of 300 millimeter. In the fourth quarter of 2002 sales to semiconductor capital equipment customers represented 59 percent of total sales, or 34 million.

Applied Materials, our largest semiconductor capital equipment customer represented 22 percent of total fourth quarter sales, or 16.2 million, up from third quarter sales of 11.5 million. In the fourth quarter of 2002, Applied's percentage was 22 percent of total sales of 12.6 million.

Flat panel display sales represented 13 percent of total fourth quarter revenue, or 9.9 million. This represents a sequential increase of 38 percent in dollar terms compared to 7.1 million of total sales in the third quarter of 2003. Flat panel display represented 16 percent of total sales in the fourth quarter of 2002, a year-over-year increase of 9 percent in dollar terms.

Much of this growth was driven by gen side equipment demand, although we believe there will be a pause until fabs begin ramping for gen 7 production the second half 2004. We're in a strong position for the transition to gen 7, given our ability to secure these new design wins with our GT products and next generation tools.

The data storage industry which is comprised of the optical data storage market, including digital videodisc and compact discs, and the magnetic data storage market was 7 percent of fourth quarter sales, or 5.1 million, which represents a decline in dollar terms of 44 percent when compared to the third quarter of 2003. This market represented 3 percent of total sales, or 1.7 million in the fourth quarter of 2002. Data storage is a seasonable business driven primarily by the holiday buying month. The decline was largely due to the current market saturation of optical data storage.

Advanced product applications represented 18 percent of fourth quarter revenue, or 13.5 million, a 5 percent decline compared to the third quarter of 2003. Advanced product applications represented 22 percent of total sales, or 12.7 million in the fourth quarter of 2002.

In addition to architectural glass, this category includes a variety of application such as our IKOR power supply for the high-end computing market, industrial coating, and laser and medical applications. We continue to gain traction in the architectural glass coating market, and secured a new design wins by displacing a competitor with our crystal high-power system.

Looking at sales by geographic region, United States sales represented 50 percent of total fourth quarter sales, an increase of 25 percent in dollar terms compared to 43 percent of total third quarter 2003 sales, and 53 percent of total sales in the fourth quarter of 2002.

Sales in Europe represented 13 percent of total sales, a decrease of 35 percent in dollar terms compared to 22 percent of total sales in the third quarter, and 14 percent of total sales in the year ago period.

Asia-Pacific represented 36 percent of sales, up 16 percent in dollar terms compared to 34 percent of total sales in the prior quarter, and 33 percent of total sales in the year ago period.

We ended the fourth quarter of 2002 with a total backlog of 53.7 million compared to the third quarter backlog of 33.4 million. R&D spending was 12.8 million, or 17.1 percent of sales during the quarter. This compares to 13 million, or 18.9 percent of sales in the third quarter of 2003 and 13 million, or 22.6 percent of sales in the fourth quarter of 2002.

Our R&D investment is focused on core technology areas, pursuing new opportunities, and working closely with our customers to develop next generation solutions. We believe this investment enabled us to capture a large number of 300 millimeter design wins, and will continue to further our technology lead in high-growth markets.

SG&A was 11.3 million in the fourth quarter of 2003, or 15.2 percent of sales compared to 12.5 million in the third quarter of 2003, or 18.3 percent of sales. This compares to 17.3 million, or 30.1 percent of sales in the fourth quarter 2002.

In order to better compare quarter over quarter changes in general and administrative expense, we are reporting G&A and amortization of intangible assets separately for your analysis. The amortization of intangible assets was 1.2 million in the fourth quarter of 2003, 1.1 million in the third quarter, and 1.9 million in the fourth quarter of 2002.

Fourth quarter income from operations was 319,000 compared to a third loss from operations of 5.7 million, including 1 million of restructuring charges in each period. The full year 2003 revenue increased 10 percent to 262.4 million, up from 238.9 million for the year 2002. Net loss for the full year 2003 was 44.2 million, or $1.37 per share compared to 41.4 million, or $1.29 per share for the full year 2002.

Gross profit for the federal year 2003 was 87.9 million, or 33.5 percent. Gross profit for the full year 2002 was 68.8 million, or 28.8 percent. R&D was 51.6 million or 19.7 percent of sales for the year 2003 compared to 49 million or 20.5 percent in 2002. SG&A expenses were 49.3 million or 18.8 percent of sales for the full year 2003, a significant improvement (technical difficulty) and 5.4 million for the full year 2002.

Head count at the end of the fourth quarter was 1,347 people, of which there were 1,201 full-time and 146 temporary employees. That compared with a head count of 1,318 people at the end of the third quarter of 2003.

Our balance sheet continues to be strong with cash, cash equivalents and marketable securities of 135.2 million. Our Accounts Receivable was 61.9 million for the fourth quarter of 2003, compared to 54 million at the end of Q3. DSOs decreased to 60 days compared to 61 days in the third quarter of 2003, and 65 days in the fourth quarter of 2002.

Fourth quarter inventory was 65.7 million compared to 58.6 million in the third quarter of 2003. Inventory turns were 3 turns in the fourth quarter, 3.2 turns in the third quarter, and 2.7 turns in the fourth quarter of 2002.

Total days in inventory was 123 days, up from 115 days in the third quarter of 2003, and down from 135 days in the fourth quarter of 2002. The sequential increase in inventory was due to purchases of critical parts to meet customer needs.

Our capital expenditures in the fourth broad were 4.9 million, down from 7.1 million in the third quarter of 2003, and up from 3.4 million in the fourth quarter of 2002.

We expect CapEx in the range of 5 to 6 million in the first quarter of 2004, due in part to continued investing in our manufacturing operations, as well as IT infrastructure, and approximately 12 to $14 million for the year. Depreciation was 3.2 million in the fourth quarter compared to 3 million in the third quarter, and 4.1 million one year ago.

Looking to the first quarter of 2004, we are experiencing increasing demand largely driven by our semiconductor capital equipment customers. We believe first quarter sales could increase approximately 30 percent compared to Q4 2003, to the 95 to $100 million range with earnings per share of 12 to 17 cents. Gross margin will continue to improve and could range from 37.5 percent up to 40 percent.

In light of the sales volume we announced supporting our progress in reducing redundancies within the manufacturing operations has been necessarily slower than our original plan. We do continue to make headway, and that will show through in the margin improvement over the next several quarters.

We will continue to pursue strategic market opportunities to invest in R&D, which will be approximately 12.5 to 13.5 million in the third quarter. SG&A will be approximately 15.5 to 16.5 million, an increase compared to the fourth quarter of 2003 due to the fact that in the fourth we will take no shutdown days. SG&A guidance in includes amortization of intangible assets.

Similar to the other companies in the industry, we provided an valuation allowance of deferred taxes in the third quarter of 2003. As we return to profitability, our reported effective tax rate will be substantially below our historical normalized rate of approximately 35 percent.

As we enter 2004, we believe that our reported effective tax rate will be in the 15 percent to 25 percent range, depending on where we generate our actual taxable income. For planning purposes we are using 20 percent.

We exited 2003 at an operating breakeven level of approximately 70 million as we supported our customers significantly increasing needs. In 2004 we will continue to transition our supplier base and improve our manufacturing efficiencies. From an operating expense standpoint in 2004 we will prudently increase our discretionary cost while we absorb a significant increase in healthcare and other administrative costs, such as Sarbanes-Oxley compliance, of almost 1.5 million per quarter.

From an operating leverage standpoint for every dollar of quarterly incremental sales increase, we are targeting sequential quarterly incremental operating margin of 30 to 40 cents early in the cycle, with the expectation that we will gradually increase that contribution over time to approximately 50 cents. We expect our first quarter cash burn to be approximately 2.5 to 3 million principally due to the fixed asset acquisition.

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

(OPERATOR INSTRUCTIONS). James Covello with Goldman Sachs.

A couple of quick questions. Doug, can you remind us on an apples-to-apples basis how much more has your total adjustable market increased this cycle versus the last? I go back and look at the peak quarter in the last cycle of about 100 million in revenue. You will be there in March, but I know you have increased the total adjustable market significantly.

I think we went from about 600, and with the acquisition of Aera we added about another 500 on to that, so about 1.1.

And then market share within that?

Growing. It is hard to get those numbers. But really it is both in power and flow, we are growing market share.

Right, if I could get a follow up. Could you talk a little bit about your lead times and any capacities constrains you might be facing at this point, or you foresee in the next couple of quarters?

We have had a tremendous amount of drop-in orders. Basically I would not even call them contractual, but they are basic agreements that we were trying to keep all of our stocks so we could get about a four-week lead time in the high-volume accounts. We have actually been shipping in under four weeks in a large percentage of those orders. But we are trying to get enough advanced information so we can get our longer lead time materials in place.

We were working the capacity literally on a daily basis. We are seeing lead times slip. We are seeing them come in. So at the same time we are building a healthy amount of back order, and China with its capacity turning on, is really starting to decrease the lead times as well. So fundamentally we have seen in our supply chains and few critical parts, some of our suppliers having a harder time. I think it is pretty common in the industry. And I think some of those suppliers are feeding a lot of peers. But we have been able to work those issues and shorten them down. So we feel that we have made extremely good progress. And we are near the top of the list in being able to respond to or customers.

Do you think having the added capacity in China this cycle is one of the things that is preventing lead times from stretching out? How significant of a role do you think the added capacity in China is playing?

Part of the cost of this having, if you would, double infrastructure is that we have a whole bunch of people that are extremely talented working those high-volume products that we have already shipped. So we are able to apply an awful lot of intensity to solving supply chain problems. So it has definitely helped.

And, Jim, this is Mike. In addition to that, if you look at our mix of semiconductor at 62 percent, we have a significant amount of non semiconductor customers, and those customers have been taking product from China for several months. It is within the semi part of the industry where we've had, well, we will say delayed customer (indiscernible), but that has accelerated. But within the semi industry we typically (indiscernible) role. So from a standpoint of helping with lead times it has allowed us to off load some of the data storage and flat-panel business, which has remained strong for actually all of 2003.

That is great. If I could sneak in one final question. As the cycle ramps and your working capital starts to work against you from a cash flow standpoint, I know you have a shelf registration statement on file. Can you talk a little bit about the plans to raise cash to improve the balance sheet as we move through the cycle?

We put the shelf registration up to take advantage of the market opportunities that we thought was going towards the end of 2003. So we will not specifically answer the question other than to say that we put the shelf up there, and we will take advantage of it when we think it is prudent in the near-term. We do not have any working capital needs to correct over the next six to nine months. This is more of a longer-term change in our capital structure and the composition of our balance sheet.

Ali Irani with CIBC World Markets.

And first, I think congratulations are in order for meeting your promises and exceeding them and your milestones. Clearly looking at your business through 2004, I am hoping you can give us an idea of where your margins could grow on the operating level cycle to cycle, and I mean higher here, given the impact that your China manufacturing is having on the business?

And I am hoping also that you can give us a couple of qualitative examples of where you are gaining market share in the power part.

I will take the first part of that question. We talked about the incremental operating margin starting off 30 to 40 cents for every sales dollar going up to 50 cents. We have been talking about this for about a year that we really do expect that as the up cycle matures, if you will, we talked about achieving previous peaks, if you will, on an operating margin level of about 25 to 26 percent.

On a gross margin level, if you adjust the previous piece of the acquisition of Aera, which had a little bit lower gross margin, but the same operating margin, we expect we will be able to get to the 46, 47 percent range. But I think a key thing here is that we really do believe since we are taking market share our next up from the peak should exceed the previous peak, all things being equal.

We are facing significant pricing pressure, as everyone in the industry, but the changes to the Tier 1 suppliers, and ultimately taking up the inefficiencies will allow us to get our operating model very close to the prior up cycle adjusted for a lower supplier cost and also the need to maintain the right level of pricing to keep growing our market share.

When you look at this, Michael, why would we not expect you to exceed your prior cycle margins earlier in the cycle impact? Because it sounds to me that you're getting both the benefit of better volume through the market share that you are gaining, but also this new cost advantage. And when I look at your business right now, you still have some duplicate manufacturing and it is helping you ramp up in the cycle. But I would think that at some point you're going to get rid of that, right?

Absolutely. And we talked about it in 2003. And we have acknowledged that there was some difficulty. Quite frankly, the up cycle started a little bit earlier than we wanted. We have to satisfy our customers' needs. We are taking the cost out, but we are not in any way going to impact how our customers view us for what I would say is a short-term savings.

But that being said, Ali, with China really ramping the way Doug spoke about, we really do have the visibility now to start taking the cost out. That is why we said in our guidance that early in the cycle it will be 30 to 40 cents incremental sales dollars, plus gradually ramping the 50 cents. You will see us (indiscernible) 50 cents as we possibly can.

And, Doug, a couple of examples for us. You have been talking about these design wins for some time. And it seems that it starting to kick in, since your sequential growth certainly is ahead of the rest of your peer group. Maybe a couple of examples just for a smile here?

Okay. You know, Ali, obviously we can't use customer names. But generically I will give you two views. One, I think we may the comment earlier that we really focused on where we could get leverage with our RF products. So in looking at RF, the largest growing application that we did not have a strong position in was in etch. We have been focusing on etch, so we have been able to pretty radically change our market share in the industry by going after etch, and winning it in the 300 millimeter, but also it swayed back into some 200 millimeter applications.

Doug, are you represented now in etch in all three of the major vendors or is still upside to your market share?

There is still a lot of upside. I think we are probably about half to 2. We're probably half of where I thing we can go to, kind of roughly looking at it. To give you an idea, this is for all power products, it is just limited to that. I have got a competitive sheet with all of the design wins opportunities that were in front of us that we have been working on for the past twelve months. And we basically divide them into greens and reds. And that out of the 38, I think there was only four reds. So we had 38 greens, which are either won or really at a point where we figured we would win. So a tremendous -- it is almost a graphical indication of what we have been able to do in the marketplace.

Jay Deahna with J.P. Morgan.

Nice job. Two question. It looks like based on the last month or so of information from some of your customers. It looks like 200 millimeter is going to be a bigger percentage of the mix over the cycle than a lot of us were thinking as recently as one or two quarters ago -- maybe even 40 percent of CapEx next year. I am wondering what that means for you? And secondly in terms of the execution challenges ramping rapidly over the next several quarters, what do you worry most about in terms of executing your business?

200 millimeter, Jay, is basically good for a large part of our business. They are mature products. We would like to get those to be products that the OEMs can pick up from China, because there is a lot of volume in those products. Not shipping the 300 millimeter -- or let's say doing it later in the cycle -- is buying with us, just because we have accelerating growth then. So that we don't really view as anything negative.

We are bringing a lot of new products online, a new technology in etch. So that gives us a chance to really bring those products up to volume. And because they have not necessarily been shipped out of the U.S., we can actually create those products from the first time in China, so we can be qualified from China rather than having to be requalified. So that, in general, we don't see any issue there.

The other part of it, what do we do with capacity? I guess the thing that we would say is where we cannot sleep at night is if something happens to one of our suppliers. We have got got plenty of capacity. We are developing even more capability. Obviously in China, but also in the U.S. We are putting some systems in place that will streamline the planning and control worldwide. So most of the limitations I think we would run into would be if there is really another leg to the ramp and it starts going up higher, and that starts cutting -- there is a global impact on components and on our current suppliers, but I think we are even in better shape there with the move to Tier 1 suppliers. So that is not a particular concern to us.

Just a quick follow up, based on the inputs that you're getting from your customers does this feel like a '96, '97 thing, '99, 2000 type of cycle which is a little on the shorter side, or does it feel more like a '93 to '95 cycle?

I don't know, Jay, we still don't get that much visibility. But I think we are hearing pretty consistently that we can feel pretty comfortable four to six quarters out. Then two quarters out is a lot clearer for people. There are indications that there could either another leg up, let's say, in four quarters, or that it might extend out another couple of quarters. But that is way beyond anyone's ability and to accurately forecast.

Lastly, do you have any timing expectations for closing any of the U.S. operations and running with China exclusively? Can you gauge the timing of that yet?

Jay, we have talked about getting production out to China to 70 percent by the end of 2004. A lot will depend upon the strength, the scope of the up cycle. From where we are sitting right now, we have a lot a capacity, but we also have few redundant lines. So I would not expect anything significant to happen over the next six months. Then when we get the six months, we will look to what the demand is going to be over the next 12 to 18 months, and then we will address robot (ph) capacity. But we don't envision anything in the near-term.

Stuart Muter with Adams, Harkness & Hill.

And let me add my congratulations to a positive operating result. A couple of questions first for Mike. In terms of the transition cost being higher than expected in Q4, is that mainly because the ramp is here, or is it just taking a little bit longer in terms of the transition to China?

Not so much the transition to China, but it's a little bit of both, Stuart. When you think about what we have done in the last twelve months, taking a lot of production into a country halfway around the world. And that plant, as Doug said in his presentation, we have had major customers go through there and absolutely marvel at the state of our facility that we have there.

But then what happened was we hit a significant amount of demand from our customers. And fast and foremost we have to meet that. So some time in the day we spend thinking about the transition costs, but most of the time is spent meeting the customers' needs. Now that we have got a little bit of visibility beyond this quarter, and more experience with China, and more confidence that our customers will accept product from and China, I think we can be more aggressive.

But quite frankly, we are not making any promises because it depends entirely on the our what customers are asking us to support them with. As Doug said earlier, we are getting broadband and we have to meet those needs.

Following up on Jay's question about the 200, 300 millimeter mix. Have you guys had to readjust the mix of product transitions to China, or you had you have a lot of 200 millimeter going to China already?

The first things that we moved to China were our more stable products. So we wanted to have the least amount of risk in bringing up the new facility. So those typically were the older products, not old products, but older products that had already stabilized. So a lot of the 200 millimeter that is approved to go to these customers is already in China. And we are taking approval now to move some of our even higher volume runners. But they tend to be 200 millimeter first.

A couple of more questions for Mike, pretty quick. Do you expect any further structuring charges in Q1?

That will be about 350 to $500,000 of restructuring in Q1. But it is not with new actions, it is the roll out of things we did last year.

Okay and that is in the bottom-line guidance?

It is.

And one more. Any idea what the tax rate could be in 05?

Well historically it's been at about 35 percent. A lot will depend upon how much product we are getting out of China. We would really like to see a way to get that tax rate down to 31 or 32 percent. But I just have no crystal ball to say we are going to be able to get it there. And you can look at a lot of different things -- what will happen with the R&D tax credit. That's a very important part of our effective tax rate. We are going to continue to invest in R&D, but I would be very disappointed on a go forward, all things being equal with the U.S. and other countries tax laws, if we are not going to find a way to get below 35 percent.

Wayne Smith with Touchstone Investment.

Congratulations on a good quarter. I was just calling -- I had a couple of questions regarding the guidance you guys had given for where you thought you would hit breakeven. My understanding is you are going to -- hoping to get to $60 million breakeven, and I thought it was in the first quarter. Is that not the case now? Or is that still on target for the first quarter?

The target of 60 million was set a year and a half ago when we didn't have much visibility as to when the industry was going to turnaround. As we got through the year and we started getting higher demand from our customers, we did change that guideline. First of all, we are prepared to admit that we did not quite achieve that goal. We would not have achieved that goal even if the thing had been extended, because of the move to China. But the fact is the $70 million breakeven that we are at the end of Q4, quite frankly is where we wanted to be.

The big difference is to get to the $60 million breakeven, would be to take R&D investment down to about 10 to $10.5 million. And we are going to continue to drive that over the next 12 to 18 months by looking at a variable operating model, and then eliminating the duplicate of cost that we have. There are just two major items.

You can look at the progress we made in SG&A expenses year-over-year. We have taken it down 5 to $6 million. So the other things are more operationally focused, and as a management team and we had this discussion with our Board of Directors, we will continue to find a way to implement a variable operating model to get breakeven sales down to what we believe will be trough sales in the next 12. And that's a critical distinction.

We settled on $60 million earlier because our operating goal was not to lose money in the next down cycle. With marketshare wins, etc., we are able to get that rate up of quarterly sales. We will go as far as we have to. But we have no intention of going below a level that will prevent us from burning cash.

Okay. You talked a little bit about that you feel pretty good about -- I thought you said the next to the six quarters when you were giving guidance on the tax rate for '05. And I was just wondering -- I must've missed it. Did you give guidance for the year on the call here?

No.

No. Oh, no.

I guess my question then would be, if you are feeling so good about the next four to six quarters, why not?

These are just inputs from our customers basically telling us they feel pretty confident that they have got four to six quarters of steam left in this engine. So we are not giving guidance.

Than I have a separate then question related to that. I have been talking to a few analysts coming into the quarter, and a lot of guys have been expecting you to way blow out the revenue number for the score, because they had a feeling that things were going well, and from the patter everybody else was talking about. And so I am just wondering, because of some of the supply constraints you talked about with of your vendors and stuff, did we push some stuff that was going to be in Q4 into Q1? Or can we expect this kind of growth for Q1, Q2, or is this going to be a little bit bigger pop from Q4 to Q1 because of the way things have rolled out here?

One of the things that happened in the fourth quarter, Wayne, is that we did have some shut down. We did keep our operation open, but there was probably a little bit of demand that could have gone into Q4 if our suppliers had been able to supply us with the parts, but it was not significant. Beyond that we really had no comment in Q2 and beyond.

Mark Fitzgerald with Banc of America Securities.

Mike, can you give us an idea with these transition costs, the duplication -- what dollar value are we talking about in terms of when you finally accrue these things?

As it happens right now, looking at current level of operations, it is probably impacting us 1.5 to 2.5 percent in our gross margin. So you think get a sense by our operating level.

Okay. If I hear you correctly, basically you're saying you are going to hold on to these costs for most of this year simply because you need to make sure that you can meet the demand ramp for your customers? Is that correct?

No, let me just clarify it. First and foremost we are going to meet our customers' demand, that is critical. but we still have our eye on the ball of taking these cost out. But if we had to make a choice between impacting our ability to shorten lead times and meet customers needs, and taking out, I will say, another 5 or $750,000 to give you a number, my sense is we are going to focus on meeting the customers' needs. Because we are in it for the long-term.

We did not go and open up a plant in China because we were trying to reduce cost for two years. We are in China because we believe that it is going to be one of the great centers of electronics in the future, and we want to be there. We want to be there not only as a manufacturer, but ultimately, as Doug has said on a number of occasions, as the move to China continues engineers are coming out of China. We are going to be doing, my guess is, some design in China over the next three to five years. So it is a longer-term issue.

If we thought that these cost we're going to get in the way of us meeting our shareholders needs, that would be another matter. But I don't mean to minimize the duplication, but the critical things that we face in meeting customer demand as this ramp occurs. And as someone said earlier, on a sequential basis we are seeing significant growth, what appears to be more obvious than some other companies in the industry.

But earlier you said that for the next six months this duplicate cost would really -- you would be running with it. Is that fair?

It is there, but it is only fair from the standpoint we want to set realistic expectations. We are trying to try to take those cost out, but we don't want the investment community or our shareholders to think that that is first and foremost on our minds.

Okay. You to get the R&D down to 10.5 million, which is the longer-term goal there, 10 to 18 months, is that moving R&D to China as well?

No, it is basically focused on signing outsourcing partners. And one other thing is you develop partners early on in the game, identifying them for the critical needs. The straws we have talked about in R&D is to keep in-house the core competencies that set us apart in this industry. We are the technology leader. But there are some other day to day R&D things, like if other areas of a business that we can have outsourcing partners. But you have got to develop those partners early so that they invest in these things. And these types of engineering firms they split up their capabilities to other industry so that they are not as impacted by the cycles that we face.

And, Mark, we are also -- I mean R&D dollars I think are usually associated with people, and we have got some fantastic people. But we also spend a tremendous amount of money on prototyping and other parts of development. We've got a major program going on now to work on efficiencies in those areas. So we're reducing cycle time, improving quality of all of our products, and also changing the efficiency of the processes we use.

Okay. I guess, still though what I am wrestling with is to achieve these 25 to 26 percent operating margins, and trying to get some sense on the timing of this, it sounds like this is a late '04 into '05 type of strategy, given these trends in terms of R&D and the duplication issue?

Actually, Mark, we prefer not to comment other than to say we will get to the operating margins as fast as we can. But much of it ties around customer demand.

Okay, but to achieve 25 to 26 I assume that duplication is not going to be there, and the R&D would be a factor. Is that fair?

No. No. To achieve the 25 to 26 it is only the duplication, and also continuing the move to Tier 1 suppliers. The 25 to 26 would envision continued investment in R&D at current levels or above.

And, obviously too, it depends upon how high the idea ramp goes.

Okay. Is there a dollar value to that 25 to 26 that you're looking at at this point, assuming duplication is --?

I don't think we have talked about. If you look at our previous peak, the fourth quarter of 2000, and adjusted for acquisitions our sales were approximately $140 million. What we have said over the last six months is that in in a range of 150 to 165, we would expect to achieve those prior peaks in operating margins, with a little to give in the way of the gross margin line, made up of the efficiencies that Doug talked about.

Brett Hodess with Merrill Lynch.

This is Mike Loden (ph) for Brett Hodess. Just a couple of questions. It sounds like with the recent wins you have had in Japan with the Aera line, you've had some successes there. I am wondering if you have been able to leverage any of those successes into some of the other product lines like the power, for example, with some of the Japanese customers?

In general what we have been able to do is leverage on both ends. Like we can take our strong OEM relationships, which really don't develop with the normal competition in flow controllers, we have been able to leverage the strong OEM relationships to help create added volume and added marketshare. And at the same time, because we're in the fab and building a stronger relationship, we are getting a lot of potential pull through into the power products. That is Japan and all over Asia actually.

And then the second question was, it sounds like you've had some successes in etch and getting your position in power turned around there, and also in high-density plasma CVD. I am wondering what other applications you guys are targeting as going after Aera over the next few quarters?

I don't think for competitive reasons -- I don't think we discussed those. But we have got a lot of interesting things going on.

Tim Matella (ph) with Value Asset Management (ph).

Sorry guys. I jumped on the call a little late. Did you give any guidance for gross margins?

Gross margin in the first quarter should be approximately 37.5 and approaching 40 percent.

Ted Berg with Lehman Brothers.

On the clarification on the guidance, do the operating expenses that you gave, do those include the amortization expense in there? Or does the earnings per share guidance of 12 to 17 cents, does that include amortization expense?

We may have confused the issue. We are breaking out the amortization expense in our press release, but the SG&A guidance we gave does include amortization expense of about 1.1 million. And it is in the 12 to 17 cent, yes.

And the 350 to 500,000 in planned restructuring charges are also in that EPS guidance?

That is correct.

Okay. With the big increase in revenue that you're looking for, it seems like gross margins would have been higher than the midpoint of where you are guiding to. Is the primary reason why they are not hired is the duplicate manufacturing costs?

That is one thing that is driving it, Ted, but quite frankly also industry mix a little bit too. And the semi industry for us is very important, but it's a little bit less than the gross margin as opposed to some of the other industries. Not significantly less, but when you're ramping up and everyone's looking to basis points, that is affecting. So it's a combination of both.

More of the mix shift favoring semi customers?

No, I quite frankly I would say it is about half and half.

Okay. How much of it is due at all, or can you comment on the work on 300 versus 200 millimeter gross margins for your products? When do you expect 300 millimeter margins to get to parity? In the past you have said towards the end of '04. Is there any update on that?

I would say right now the 300 millimeter margins are somewhat similar to 200 millimeter margins. But obviously we have some very good but mature products that are better, but the gap is not as wide as we thought it might have been.

Okay. Okay. And then when do you plan to start generating free cash flow on a pretty consistent basis quarter to quarter? When does the increase in working capital stops sucking up cash? And when do you start to generate free cash?

We should start generating free cash in the second quarter. (multiple speakers) receivables and quite frankly try to reduce our inventories. But right now most of it is tied up in receivables for Q2.

Kevin Vassily with Susquehanna Capital Group.

Two questions actually. First, in the prepared remarks I think, Doug, you mentioned you have one major customer who had not yet qualified products out of China. Do you have a time frame on when you would expect that? Maybe you can comment on why they have not yet qualified? And then I will follow-up after the answer.

I am not sure of the date. We have -- you know, we have got a whole list of products and we are working with customers -- both on the products and the customers in general. The only reason that they have not changed is because they are conservative. There is not any issue. So we don't anticipate any problem.

Actually we think there is going to be kind of an over center effect here. All of the transparency tests that have been made on all of the products with every customer, they have found that there is complete transparency. So we have not changed the parts. All we have changed is the Tier 1 suppliers and the point of integration. The point of integration we are controlling. And then we test the units when they come back to validate from all of our process steps that everything is within control of the process.

So we don't expect to see anything but transparency. And the customers are seeing that. It can be expensive for them to go through that validation procedure. It takes them time, and it takes away their access from greater capacity.

So what we think is going to happen is these customers will qualify two or three products and go, why we are we wasting our time doing this? We thought it would be a natural direction to go. Of course, we cannot speak for our customers, but once people feel confidence in the process, which is all about -- what quality is all about, then I don't think -- I think the resistance will go away. It is just purely caution on their part.

Do you see it impacting their position in their marketplace?

Potentially they get access to a lot greater capacity. So that cuts down the potential response time. So that is good for them. But there is nothing negative in their markets that I'm aware of at all.

No, I mean not necessarily negative in their markets, but more so maybe a decision that could have a negative impact on their ability to address their own markets by eliminating their capacity.

No, I think we have seen a few cases already, Kevin, where all of a sudden they will have some drop-in orders. And they have got a choice of six weeks, because they have expanded demand by 4 or 500 percent. So they have got a choice of maybe six weeks or a choice of two weeks. And it is amazing what that does actually to facilitate getting the product transitioned to China.

Okay. The second question was with regard to another prepared comment that you had. And I am not sure I heard it correctly. Did you make the comment on the revenue opportunity increase on a product to product basis from 300 millimeter to 200 millimeter? Did I hear that correctly?

We had two different comments. I think one was 300 millimeter, we get about a 30 percent uptick on cost -- our total content per tool compared to a 200 millimeter tool.

Same product, just different wafer sized tool?

Yes, you could say it is the different took type, so let's say HDPCVD. That is because of a larger wafer you need more power. More power you need different a different power supply. That power supply is, say if you needed twice the power, it does not cost the customer twice the amount of money to supply that power. So the 30 percent kind of represents purity of the gross margin line.

Okay. Now does that relationship hold across all the product lines that you offer, or is that more focused on the power side?

It is almost all on the power, because as you go into flow you have got one chamber, and the complexity can drive the total building materials on a tool. But there is no difference generally in the amount of gas that is needed for 200 to 300 millimeter, at least in anyway where it actually changes the cost of the product supply.

Mark Fitzgerald with Banc of America Securities.

Mike, on your assumptions for China and the benefit here, what kind of the exchange rate when you looked out 12 to 24 months -- are you assuming this is constant, that there is no issues in terms of the won becoming unpegged?

(indiscernible) of the won will continue to be pegged to the dollar. And obviously watch it closely you will the negotiations that go in the macroeconomic world. One of the things we have pointed out in past conference calls is that while we do produce in China, the move to Tier 1 suppliers ultimately, while we will have a significant amount from China, more than half will come from outside of China. So it is an issue that we are watching very closely.

It also ties into how we are going to handle capacity in the United States -- in a United States location. We have got to make sure that we're ready both commercially and economically to meet our customers' needs. But long-term we are assuming that the R&B (ph) and the dollar will stay pegged certainly over the next 12 to 18 months.

At this time there are no further questions. Ladies and gentlemen, are there any closing remarks?

Thank you for joining our call. I hope we continue this momentum. Everybody is pretty positive here at the Company. Thank you for listening to us today.

This concludes today's Advanced Energy fourth quarter and year end 2003 conference call. You may now disconnect.