Advanced Energy Industries Inc (AEIS) 2005 Q3 法說會逐字稿

Good afternoon. My name is Ronnie and I will be your conference operator today. At this time, I would like to welcome everyone to the Advanced Energy third quarter 2005 financial results conference call. [OPERATOR INSTRUCTIONS]. Thank you Ms. Kawakami, you can begin your conference call.

Thank you. Good afternoon, everyone, and thank you for joining us today. Hans Betz, President and Chief Executive Officer, and Michael El-Hillow, Executive Vice President and Chief Financial Officer, will be today's speakers and will provide an overview of the third quarter results before they open the call to take your questions.

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

Before we get started this afternoon, I need 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 the cyclicality of the semiconductor, semiconductor capital equipment and flat panel display industries, the timing of orders received from our customers, and our ability to successfully execute the supply chain transition that is currently under way. Other risks are described in our forms 10-K, 10-Q and other reports we file with the SEC. In addition, we assume no obligation to update the information that we provide during this conference call.

I will now turn the call over to Hans.

Thank you. Good afternoon, everyone, and thank you for joining us.

This quarter, we reported a revenue of $81.9 million, a sequential decrease of 6.4% compared to the second quarter of 2005, as we experienced a continued softness in the order patterns of our semiconductor OEM customers. These declines were somewhat offset by the strength in flat panel, and in other industrial applications. Despite the sequential decrease, our continued operational improvements enabled us to increase the gross margin from 36.7% in the second quarter, to 37% in this quarter.

With the recent completion of our financing and the redemption of all the outstanding notes we are also making significant improvements to our balance sheet. We were able to further reduce the inventory by $3.2 million sequentially, even as the sales declined. We generated cash from operations of $5.4 million. Our remaining cash balance, combined with the working capital lines provides us with a capital we need to meet our strategic objectives and the flexibility required to take advantage of potential long-term opportunities.

This operational performance illustrates the continued benefits we have gained from the completion of the China manufacturing transition, and the achievement of some key milestones in our localized chain transition, supply chain transition. Today, all 26 platforms identified for transfer to volume production in China have been successfully transferred. In volume terms, roughly 85% of our total volume, including power and mass flow controllers is now manufactured in our Shenzhen facility in China.

Our Fort Collins manufacturing operations has been realigned to focus on new products and advanced manufacturing, and Hachioji, the Japan location will undergo the same transition. Close to 90% of our mass flow volume production has already been transferred to our Shenzhen location. Going forward, the transfer process will continue as new products are ramped to production qualities in one of these global design locations and then put into volume productions at the centralized Shenzhen manufacturing site.

The localization of our supply chain to Asia is a multi-step process in nature and we have achieved a key milestone by reaching 70% of our total materials spent to shift to local suppliers there. We expect continued improvement to our material cost over time as we are able to keep our relationship with these new partners and qualify additional types of supplies in this region. We expect improvement to gross margin for the fourth quarter as this critical project continues to gain momentum.

We are also beginning to benefit from cost savings driven by our targeted insourcing program. By leveraging our skilled labor force, and utilizing resources already built into our manufacturing process, we have been able to further lower costs, improve quality, and even shorten lead time in certain examples. In general, China manufacturing gives us flexibility to incorporate insourcing opportunities as part of our global operations strategy.

As we discussed in our last conference call, the use of plasma in manufacturing and high value power delivery is quickly evolving into main stream and high growth areas ranged from food packaging solar or organic LED manufacturing. We are focusing on opportunities that have the potential of high growth and high margin as we continue to expand our boundaries in these areas.

As we pursue markets in addition to the semiconductor, we are already seeing early success. In this quarter, we marked the record quarter of sales to the solar cells market. This market is still small, but fast growing, and is still growing faster, as manufacturers improve technology in solar cell applications. We are well positioned with some key OEMs in this market, and we are pursuing additional opportunities in RF and DC.

In data storage, we see stronger demand in the small form factor [inaudible] markets. In the third quarter, our Pinnacle DC and parts DC products achieved a key design win that an existing customer with their new technology platform. This market will see increases driven by handheld consumer devices such as portable MP3 players, and by new breakthrough technologies like [blueray] and perpendicular recording.

The two and a half months that I have been Advanced Energy's Chief Executive Officer, I have been impressed by the people, by the products, the tremendous work that have been done to transfer this company into a new business model. In that short time, I have been around the world, meeting with customers and employees, and around the country, successfully completing our secondary offering. The feedback I have received from all of these has been positive and very good for Advanced Energy's future and I look forward to work with the people here to drive for continued success.

And I would like to turn the call over to Mike to review the financials.

Thank you, Hans. And good afternoon, everyone.

I will review the results of the third quarter and provide guidance for the fourth quarter. Sales were approximately $82 million in the third quarter 2005, down 6.2%, compared to second quarter 2005, so $87.4 million, and down 12.4% from third quarter 2004 sales of $93.6 million.

This sequential decline is attributed primarily to softness in orders from our semiconductor equipment customers, which we expect to continue in the fourth quarter 2005, and the impact of the sale of our [M clone] product line at the end of the second quarter. Despite the lower sales, third quarter 2005 gross margin improved to 37% of sales, compared to 36.7% of sales in the second quarter of 2005, and 31.8% of sales in the third quarter of 2004. Gross margin continues to improve even on lower sales, as we realize additional savings and efficiencies from our global manufacturing and sourcing programs.

Before I discuss end market sales of the third quarter 2005, I need to make a correction to the information we provided for semiconductor and flat panel display sales in the past two quarters. Due to a classification error that was recently discovered, some sales were included in the flat panel display category when they were actually semi conductor related. The following information reflects the corrections. First quarter 2005 sales to semiconductor customers should have been $52.7 million or 61% of sales, rather than reported $46.1 million or 53% of sales. Second quarter 2005 sales to semiconductor customers should have been $54.9 million, or 63% of sales, rather than the recorded $45.4 million or 52% of sales.

First quarter 2005 sales of flat panel display customers should have been $11.2 million or 13% of sales, rather than the reported $17.8 million or 21% of sales. Second quarter 2005 sales for flat panel customers should have been $8.8 million or 10% of sales rather than the reported $18.3 million or 21% of sales. To help you update your notes with the corrected information, we will provide an end-market sales schedule on our web site that covers the last eight quarters. For the third quarter of 2005, semiconductor capital equipment represented 59% of total third quarter 2005 sales or $48.4 million, down in dollar terms compared to $54.9 million in the second quarter of 2005.

As expected, the declining order environment continued through the third quarter. Applied Materials, our largest semiconductor capital equipment customer, represented 19% of third quarter 2005 sales or $15.9 million, down 20% in dollar terms from second quarter 2005 sales of $19.8 million. Flat panel display sales represented 13% of total third quarter 2005 revenue, or $10.8 million, an increase compared to $8.8 million in the second quarter of 2005.

Last quarter we discussed an additional design win for our SUMMIT DC into generation 7 and 8 flat panel manufacturing. We he expect flat panel to continue the upward trend in the fourth quarter based on the SUMMIT DC products. Sales to [Allback], our largest customer in the flat panel display segment were $8.7 million or 11% of sales for the quarter.

In addition to DC power supplies, we are also well positioned with our MSC product line and continue to win design slots at major OEMs. We are also targeting CVD and Etch applications with our RF products which opens up new growth opportunities for us in this market. The data storage industry was 6% of total third quarter 2005 sales, up $4.7 million, compared to second quarter 2005 sales of $5 million. The magnetic disc market has been weak as end users continue to debate over format before making large-scale equipment purchases.

Advanced Energy will benefit from either HD, DVD, or blueray, just as we have with all prior CD and DVD formats. Sales to high drive equipment providers remains at a higher level on a year-over-year basis driven by handheld consumer applications such as portable MP3 players..

Advanced product applications represented 22% of third quarter 2005 revenues or $18 million which is relatively flat in dollar terms, compared to the second quarter 2005 amount of $18.7 million. Notably, sales to industrial coating customers were up sequentially as we achieved design wins and benefit from additional sales opportunities within the solar cell markets. In addition to industrial coating and architectural glass, this includes a variety of applications such as our Icore power supply from the high end computing market.

Global support represented $12.8 million, a record quarter for the Company, or 16% of total third quarter sales, an increase of 10% in dollar terms compared to $11.7 million or 13% of total second quarter 2005 sales. Our focus on new growth initiatives such as annual service contracts, and fixed rate repair agreements continues to drive increased service revenue.

Looking at sales by geographic region, the United States sales represented 50% of total third quarter 2005 sales, a decrease of 12% in dollar terms compared to 53% of total second quarter 2005 sales. Sales in Europe represented 11% of total third quarter sales, an increase of 2% in dollar terms compared to 10% of total sales in effective quarter. Asia Pacific represented 39% of sales, down 1% in dollar terms compared to 37% of total sales in the prior quarter.

We ended the third quarter of 2005 with a backlog of $43.2 million, compared to the second quarter backlog of $32.8 million, as we are seeing customers extend their order horizons, especially in Japan, for the flat panel industry. R&D spending was $10.5 million, or 12.9% of sales during the quarter, compared to $11 million or 12.6% of sales in the second quarter. We are continuing to control costs in R&D as part of our focus of select growth opportunities and cost controls. We expect R&D to remain at approximately $10.5 million in the fourth quarter of 2005.

SG&A was $13.6 million in the third quarter of 2005, or 16.6% of sales compared to $14 million in the second quarter of 2005, or 16% of sales. The sequential decrease reflects lower section 404 compliance costs, offset somewhat by trade show expenses that occur seasonally in the third quarter. We expect to further reduce SG&A to approximately $13.2 million for Q4 2005, due to lower commissions and legal costs.

Amortization of intangible assets was $504,000 in the third quarter of 2005, $518,000 in the second quarter and $1.1 million in the third quarter of 2004. We expect amortization to be approximately $500,000 in the fourth quarter 2005. Operating income was $2.5 million for the third quarter of 2005, compared to $5.5 million in the second quarter of 2005, and $1.9 million in the third quarter of 2004. Third quarter 2005 operating income included a $3 million litigation settlement charge that we announced earlier this month, and $210,000 of restructuring charges. Excluding these charges are improving operating model generated $5.7 million, or 6.9% of sales, representing an incremental operating margin of approximately $0.41 in incremental sales above a quarterly sales break even level of $68 million.

As we have discussed over the last year, our goal by the end of 2005 was to have a $70 million quarterly sales break even operating model, and to provide a minimum of $0.40 of incremental operating margin above that level. We exceeded our goal both in terms of timing and break even amounts. The net loss for the 2005 third quarter was $3.9 million, or $0.10 per share. Third quarter net loss includes previously mentioned litigation settlement restructuring charge, $2.1 million related to the early call premium of convertible debts and a non-cash charge of $1.1 million related to the write-off of deferred debt issuance costs. The third quarter of 2005 net loss also included a tax provision of $1.6 million on pretax income earned outside of the United States.

As we have discussed previously, the Company is unable to provide a tax benefit from its U.S. tax loss carry forwards until it has demonstrated sustained profitability in the United States. Pretax losses were incurred in the third quarter of 2005 in the United States, primarily due to the litigation settlement and debt cost totaling $6.3 million as discussed previously. If we had not incurred those charges our effective cash rate for the quarter would have been approximately 40%, as we had guided throughout the year.

Second quarter 2005 income from continuing operations was $3.3 million, or $0.10 per diluted share. Included in the second quarter 2005 income from continuing operations was an after-tax gain from the sale of certain marketable equity securities of $1.1 million. The third quarter 2005 net loss was $1.1 million or $0.03 per share. Head count at the end of the third quarter was 1,540 people, compared with a head count of 1,521 at the end of the second quarter 2005.

After raising approximately $106 million by selling 11.5 million shares, and paying $190 million to redeem our convertible debt, We ended the quarter with $55.9 million in cash, cash equivalents and marketable securities. Combined with our $40 million working capital line of credit, we have the financial flexibility necessary to meet our critical objectives and growth plans. We also generated $5.4 million in cash from operations in the third quarter of 2005.

Credit account receivables were $65.9 million for the third quarter of 2005 compared with $61.5 million at the end of the second quarter of 2005. DSOs increased slightly to 65 days in the third quarter compared to 64 days in the second quarter. The highest sequential receivable balance was due to having a significant portion of our shipments in the last month of the quarter.

We continued to work down inventory, which decreased $3.2 million, compared to the second quarter of 2005. Third quarter inventory was $55.8 million, compared to $59 million in the second quarter of 2005. Inventory turns were 3.7 in the quarter, compared to 3.6 turns in the second quarter. Total days inventory was 99 days down from 101 days in the second quarter of 2005. Year-to-date we have reduced inventory by approximately $17.4 million.

Our capital expenditures in the third quarter were $3 million, compared to $2.2 million in the second quarter of 2005 and $5.1 million in the third quarter of 2004. We expect Capex to be approximately $3.5 million for the 2005 fourth quarter, resulting in 2005 year total CapEx of approximately $11.5 million. Fixed assets depreciation was $3.1 million in the third quarter, flat compared to the second quarter, and down from $3.7 million in the year ago period.

To summarize our fourth quarter guidance, we believe that sales will be in the $75 million to $80 million range. At the upper end of our sales guidance, which is down 2.56% sequentially, we could still improve gross margins by about 25 basis points to 37.25%. At the lower end of our sales guidance, gross margins could be approximately 36.5%, down slightly from the third quarter.

R&D could be approximately $10.5 million, SG&A approximately $13.2 million, and amortization approximately $475,000. Operating income could be in the range of $3.25 million to $5.25 million, resulting in incremental operating margin of $0.40 above the quarterly sales break even level of $67 million, compared to the $68 million in the third quarter as we continue our drive to the low $60 million break even range by the end of 2006. Non-operating income could be approximately $300,000, reflecting the elimination of interest expense because the repayment of our convertible debt.

Our earnings per share could be in the range of $0.05 to $0.07 cents, within an effective tax rate of 40% and outstanding shares of approximately 44.75 million. Cash, cash, equivalents and short term investments are expected to increase 4 million to approximately 60 million, and inventory levels are expected to stay at about the $55 million level.

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

[OPERATOR INSTRUCTIONS]. Your first question comes from Jim Covello of Goldman Sachs.

Hi, this is Amanda Hindlian in for Jim Covello. I have a big picture question looking out into 2006, if I look at the Street EPS numbers for AE it looks like the Street is modeling more than 100% year-over-year EPS growth in 2006 and recognizing that entering '05, the margins were somewhat depressed and you had the double mortgage issue that was an overhang, how do you think about possibly achieving 100% year-over-year EPS growth, and another way to ask it, is what can we think about in terms of incremental margin improvements as we move throughout '06?

The early part of your question was kind of garbled but let me see if we gathered all the facts. Basically we keep driving the lower break even. We did $68 million in the third quarter, and 67 in the fourth quarter. We expect to see gradual improvement in 2006, down to about the $60 million range by the end of the year. Our operating model last quarter provided, you know, $0.40, $0.41 incremental operating margins. It will do the same thing in the lower break even level in the fourth quarter and so as you look forward, that's how we are driving in the business.

We will continue driving costs out of materials to get that variable debt, that major variable cost to the lowest possible amount, try to improve our freight and warranty costs, as we get better in doing what we are doing at our new locations. Much of the improvement has already occurred and continues to hold opex close. Very close to current spending levels. So the entire organization has rallied around the incremental operating margin model, the entire organization has rallied around lowering break even, because while we have tremendous opportunities at the top line by going to new markets we obviously can't control consumer interests.

So the goal is going to lower that break even, be profitable, at any level of sustained sales, and then be able to leverage this improving operating model quarter-over-quarter.

That's helpful. Thank you.

Your next question comes from Robert Maire of Needham.

Can you hear me?

Yes.

Could you tell us what your -- what indication you are getting from your semiconductor equipment customers in the near term. Is is the reason for the -- the lower guidance going forward inventory issues with the customer or just business tapering off as we get towards the end of the year? Can you give us a little more color on what you are hearing out of those customers?

This is Michael El-Hillow. In the last quarter in the last few years, for whatever reason the industry has shut down the last week of the year during the holidays. There's no doubt the fourth quarter has turned out to be a short quarter in this industry. If you are in the middle of a ramp we will get around detail that but there's no doubt that the fourth quarter is a shorter quarter.

As to what we are hearing from our customers, we're hearing a lot of different things from our customers, and I think, as you sensed, in the last couple of weeks, as other companies have announced, there's a significant, I will say dichotomy going on at the OEM levels and so we are facing that day in and day out.

The important thing is when you look at our 2004 market share and power, 50%, and our low 20% MFCs, but we think we can grow. We are pretty much customer-agnostic. No matter what company tends to win, we generally tend to win, also. So the market right now is a little bit off balance for sure. The consumer confidence in the United States is a little bit up and down the and the uncertainties are still there. Beyond that, it's not a whole lot as entering the fourth quarter.

Okay, and just one follow-on question. In terms of gross margins you have made pretty great strides, given your outsourcing to China, and fixing the manufacturing process and such, I would assume we are still on track for gaining another bunch of basis points as you redesign your products for local sourcing. Given where you have gotten to, are you expecting similar sorts of gains or perhaps better gains than you were originally anticipating? Because it looks like you are a little ahead of what you are projecting in terms of the gross margin gains.

We certainly saw a strong jump in the first two quarters of 2005, somewhat moderated in the third quarter because of volume. When we were recently on the road, we were showing the end of 2006 operating model. But to give you a frame of reference, we said for the second quarter, in sales in the mid-80s range or so let's use third quarter guidance on sales of $85 million, we expected gross margin in the 36.5 to 37.5% range. A year from now we expect it to be about 41%.

So, even at the high end of our guidance in Q4, we are still showing about a 30 basis point improvement quarter over quarter, 25 or 30 basis point improvement. I think you could expect something similar over the next four or five quarters. But it will be more gradual than it was earlier this year.

We hope to see a 25 to 50 basis point improvement each quarter, and by the end of the year, get an extra 3 to 4% in gross margin, not just by material cost but lower logistics costs, improved warranty costs as we get more efficient and quite frankly, just better at doing what we are doing on the manufacturing locations.

So the summary is the transition to China has gone fairly well it sounds like if anything ahead of schedule, correct?

Absolutely.

Okay.

And we really did accelerate that at the end of the first quarter where we basically took a lot of changes in the Fort Collins facility. We realigned that facility early in the second quarter. We are shifting most of the Hachioji Japan manufacturing to China by the end of the year. but we've moved very, very quickly, end of first quarter, into early second quarter, and then continued in the third quarter.

Great. Thank you.

Your next question comes from [Chris Blansed] of JP Morgan.

Hi, guys. I had I a couple of quick questions. Regarding Hachioji. What type of transition will happen there over the next few quarters? Is it a dramatic head count reduction? Or what are we going to look for?

It's mostly happened in the third quarter. Now we are just moving the products to -- to Shenzhen, we are moving the supplier bases as much as we can out of Japan. So the savings we have seen from overhead reductions are basically behind us. The savings going forward are mostly going to be from continuing to move the supplier base at the Pac Rim and getting more efficient throughout our other operations. That feature should start in the third quarter.

So basically the head count will be relatively flat then?

At current volumes, yes.

And then the last question, given the recent settlement with MKS, how much influence is this having on your forward guidance, if any, relative to prior if the settlement hadn't gone through.

There's very little. That business has basically -- we have been out of that area of the business now for a while. It's having no impact on our guidance going forward.

And my last question is, the sale of your products to the solar market, what kind of gross margins are we are looking at those relative to the corporate average?

When we go from industry to industry, generally speaking, if it's a -- a legacy product, the margins are pretty good. But as you go into new industries, you generally get a little bit higher margin. So if you say that our margins are -- obviously our margins right now are an average of 37% in the solar industry that they are in the mid-40s.

All right, thank you very much.

Your next question comes from Timothy Arcuri of Citigroup.

Hi, a couple of things. I guess back on the question about the guidance, if you take all the big customers, obviously your biggest OEM customer has not given guidance yet, but if you take all the OEMs that have given guidance, the shipments are roughly flat to up 5%, roughly in December versus September.

If you then couple that with your comment that flat panel will be up in December, it really implies that your semi business is down quite a bit more than what the big customers are guiding shipments to in December. So can you give us a little color on that? Am I not looking at that right?

Well, Tim, I tell you, you are looking at it right but as we answered on past calls, we've got a 50% market share in power. You know what the each individual is guiding to, everyone is going to say they are win or lose anything they think their competitor is going to lose. So we don't go to that level of granularity.

The bottom line is this, though, we said out going in the third quarter and continues in the fourth quarter. There is a weakness in semiconductor in general. The fact that shipments are up, we know -- we talk about shipments but they also have orders and they have the deferred revenues that they bring down, and it's getting a little bit unclear as to how much they are taking out of the deferred revenues but at the end of the day, our market share continues steady to increasing across the board, but the end user market and the OEM markets are showing some weakness.

Okay. Okay. I guess more of a question for me, can you talk a little bit about inventory turns-- it seems like there's a lot of room for improvement there. I'm wondering what your goal might be. I think previously, you talked about getting to six times inventory turns by the end of the next year.

I'm sorry, go ahead.

I guess "A" is that still the goal and "B" if it is, how do we get there from here?

It certainly is the goal and I think we have also talked about differentiation between manufacturing turns and service turns, we expect manufacturing turns to be a little bit higher and services a little bit lower but an average of six. Our operations have made tremendous strides in reducing inventory. Unfortunately there's a certain base level you have to have.

The real key is if you were to go to the fourth quarter of next year and let's say for some strange reason the sales will be $115 million, you are not going to see a significant increase in inventory. We need to keep that top line going. We will keep taking inventory down lightly but we need to take the top line to get to those average of six, manufacturing might be eight or nine, and service might be two to three to four, depending, to service inventory, obviously you need to keep it near your customers; all we are trying to change that model, also.

So you think that even if you were doing 115 a year from now, you could get there with the current inventory level?

Yes, basically yes. Because we are getting better at knowing where the inventory should be. Some of the logistics costs we've had in the last year have been because we've had inventory in China that needs to be in the U.S. and vice versa. We are getting much better at that.

Okay. Thanks.

Your next question comes from Stuart Muter of RBC Capital Markets.

Hello, yes, this is Mahir Sanganini in for Stewart. I have a question on your global support segment. That's supposed to be -- usually it's seasonally strong in Q4; is that correct for you? And what kind of gross margin do you have in global support?

I don't know that global support has been seasonally strong. We -- we continue to grow our global support business just because our install basis going up we have new contracts, et cetera, service contracts, fixed price contracts, our gross margins on service revenues are higher than our average gross margin, maybe 3 to 4 percentage points higher.

But the seasonality is not the -- if there's some type of seasonality, it might be caused by this: Companies have annual budgets. And when they get towards the end of their year, they may even defer some service work into their budget loosens up the year after, but our service business continues to move forward and grow and grow. I mean it's growing on a compound annual growth rate of about 30% since 1997, and in a 12.5, $12.8 million and that significant percentage of revenue, it just keeps moving and the new offerings keep it going.

So that may be hiding some seasonality, but, I mean, I have not seen, in the seven or eight years I have been in this industry. I have come from another company that had a very large service business also.

Okay, that's helpful. Just another question. On the incident of mass flower controller, does that serve both FBD and the semi cap market and what percent of your revenue is that, and are you getting some market share in that segment?

It's certainly the semi business. We don't break out the percentage of our mass flow business but we have said in the past that our power business is by far and away the biggest part of our business but mass flow is a very very important part of our business. It's essentially semi but it is a very important product in our product line.

Okay. Thank you.

Your next question comes from Steven Pelayo of Fulcrum Global Partners.

Mike, I'm always asking you on the tax rate here. You took in on the U.S. P&L the $6 million from legal and debt settlement costs there. Can you give us a general idea if you did not have those, would you have been profitable and then been able to access your NOLs? What are we thinking here going forward for the tax rate? Because we keep guiding to the 40%, and I keep waiting for you guys those, those NOL benefits.

If you add the $6.2 million, if you will to our pre-tax income, to keep the tax amount the same, you will come out to right about a 39, 41% tax rate. Next quarter, again we have guided to 40%, but I do believe with the elimination of the interest expense, with the payoff to debt which is all U.S.- based and those two items in the third quarter are both U.S.- based we possibly could begin to lower our tax rate. The problem we have with the fourth quarter is when you do an effective tax rate calculation, do you it for the entire year. And that's what you apply and then we end up applying in the fourth quarter. If the guidance we were giving in the fourth quarter was first quarter 2006, my sense is we would be guiding to about a 25% tax rate.

Okay. Fair enough. And then just a question for Hans, the big picture. Now that you have been on board for a little while, you have taken the around-the-world trip here, I'm curious the Company is down to its fighting weight, if you guys are at the 60, $65 million breaking rate this year, EPS probably would have already been double or triple this year. What's the next steps for you? Where do you want to head this company? And what kind of milestones should we be looking for to ask about in the next few quarters, I guess?

I mean, do we have time to get an excellent operational performance and I think having the Chinese facility full online and having breakeven down as it is and having material costs as they are, it's a very clear next step that has to be growing the top line. And this is -- besides the fact that I have been around and just to get acquainted with the employees and get the customer feedback, one of the key elements I was talking to with my -- with my staff, I think we have a clear view what to do next.

I mean, the core market is something we -- in my view and our view we can really gain market share by using the China facility and the operations performance as a weapon. And on the other side, we will aggressively go into these new emerging markets in which we have a couple of good starting points, primarily in those companies which are in the industrial area, like web coating, like the solar market, and we pointed out earlier, we had to make the first important strike into the solar market already, and this is something we would like to pursue aggressively, going forward. So that's primarily the growth of the top line is the key priority in the next quarters to come.

And do you think these new markets that you are addressing can have, I don't know, what we consider meaningful impact to 2006, if, let's say, $20, $25 million in revenue opportunity, do you think you can see that incremental additional revenue opportunity hit even in '06, from these new market opportunities?

Yeah, we made a calculation in how -- what we can gain in the different areas we may grow into. And we came up with a number, which was around 25 to $30 million, we can grow in these markets.

Okay. Excellent. Thanks a lot.

You're welcome.

Your next question comes from Brett Hodess of Merrill Lynch.

Two questions. First I'm wondering if the weakness in the semi side was equivalent for the flow and the the power product lines, or if one of the product lines saw better strength or more weakness and then a quick follow on.

Brett, power is probably a little bit weaker but I think it may have more to do with the fact that we've introduced some new products in the mass flow area, that we know we are addressing these in the 300-millimeter arena. The difference is not significant but you've asked the question, directionally, power's a little bit lower.

And then on the accelerated options that you announced today, it says in the press release that it will eliminate 5 to $6 million in stock compensation over the next '06, '07, '08 is that five or six million per year each year, or --

No, no, next year it's about eliminating a million a quarter. We'll go through our detailed calculations under FASB 123r. But to give you a frame of reference, as of today, with the option mix, and how we see it today, you are looking at expense in each quarter next year of about $0.5 million.

Okay. Great. Thank you.

You're welcome.

Your next question comes from Dave Egan of Lehman Brothers.

Okay, one clarification on the new market opportunity. You just mentioned Hans that you thought you could grow it into $25 million. Is that -- that's the total opportunity today -- where today we are at 18?

I mean, it is probably a bit hard to make a clear picture of what we can grow in these new markets, because look at two markets which are extremely fast growing these days, the solar cell market as well as the organic LEDs, we are in the -- in some of those new markets already in them, I think if we look at the opportunities, for example, on the food packaging, and the food packaging, we already have a reasonable large order, in order to upgrade the element for packaging.

It's hard to say what we can grow into, but I think a 20, $25 million -- what we can gain out of that is, in my view, a more conservative number rather than an extremely optimistic one. And the other point is even the architectural glass, architectural glass has some kind of new applications which going forward seem to be an extremely interesting point because they are in the bigger scope of energy savings and this is something which in the actual situation is hard to judge at which point in time, they may come full speed, but this will come. So what we try to do is to get in those companies which are strong in these areas already, and we are very aggressively going to those companies.

Do you -- do you think that these new market opportunities will continue to -- will have the kind of lumpiness that we have seen to date in some of the -- some of the markets? Or will they be -- will we see consistent revenues and business from them?

I see consistent business in revenue and I think going forward, I mean, we have made the first strides in those markets and I would assume if we use our facility in order to have an aggressive pricing situation, we should be better positioned in order to have not only constant revenue stream out of that, but a growing revenue stream.

Okay. I'm sorry, go ahead.

And we see a couple of companies which have been itself very well positioned in those areas and we are in those companies to a degree which has a lot of improvement in order to further gain in the shares of those companies which are operating in those markets.

Okay. That's great. In terms of flat panel, some of the major panel makers are still spending quite a bit, especially in the back half of this year, what is your point of view on that market in 2006?

The flat panel market is one of the nicest markets because there's a natural growth in there, and we are strong in this market as far as the PVD portion is concerned and as far as the flow is concerned. We are not consistent yet as far as the RF is concerned, in terms of the CVD portion of the process, as well as Etch person. So by being in one of those accounts strongly, either in PC or in Flow, we will do everything, everything, in order to gain the RF portion of the market, as well.

If you go back in history, you can see that the same situation unfolded as we went into the semiconductor market. We were strong there in the DC side and all the time we captured a good portion of the RF market in this area. We would like to do the same thing in the flat panel market.

Okay. Great. One last question, in terms of the gains that you are making in gross margins, what are you doing to do to retain those profits, and not have it eaten away from pricing pressure away from your clients that see that you are actually having better gross margins than -- and maybe have a little bit more you could give them in terms of pricing.

There's no 100% protection against this, but what we tried to do and I think we have done in the past and pretty successful in doing that, that we keep the technology still running on the highest level we can. So it's very important for the Company to have this kind of lowering the break even and having everything in the operational side perfect, but we are still very, very aggressive in having the leading edge technology and that's probably the only way to protect yourself to a certain degree but 100% protection is not possible, of course.

Okay. Thank you very much.

You're welcome.

Your next question comes from Avinash Kant of Adams Harkness.

Hello.

Hello Avinash.

Your next question comes from Tim Summers of Stanford Financial Group.

Michael, could you remind us what the quarterly revenue rate of MCO was?

About $1.5 million, Tim maybe 1.5 to $1.75 million.

And also during the quarter did you see any of your semiconductor OEM customers adjust their component pull rates or their demand forecasts?

The only thing we said in the prepared text is that we have seen them expand their order horizon. That's why our backlog is up. But other than that, there was no real change in how they -- how they viewed the world from our lenses.

Under what circumstances would they expand their order horizons?

Oh, I think you get to the end of year and the holiday season gets in the way, most of them are closing down the Christmas to New Year's holiday. I think a lot of people right now are just kind of at the edge thinking that we are going to see an acceleration orders people have been talking about it in anticipation of that, they will expand their order horizon.

It's also the -- getting back to one of the things Hans said, we are coupling closer with our suppliers and we are asking our suppliers to be more open with their demand needs. For us to meet their lead times, we need to have a better sense of where they are going. I think the closer relationships if you recall when we were doing our equity road show, one of the things that Hans kept pointing out was we had this ever increasing partnership that's going on among the OEMs and the sub-tier suppliers. Yes, they are asking for price decreases but they are asking for lead times and performance and for to us do that, they need to give us better visibility.

Okay. Great, Michael. Thanks.

You're welcome, Tim.

Your next question comes from Avinash Kant from Adams Harkness.

Good afternoon. A couple of clarifications. Can you let us know what is in the other income line in the third quarter, and how we should be thinking about it for Q4?

In the other -- right now you enthusiasm -- should think about other income that's say, $300,000, what's specifically in the other income line in the quarter, we have the $3.1 million of the financing costs, early call premium and deferred financing costs and then we have some interest expense because the debt was outstanding for the whole quarter, and net interest expense and then the remaining would be foreign exchange gain of loss.

So that's 1.6 so you have $3.1 million of debt costs for retiring the debt, about $1.6 million, $1.5 million of net interest expense with the debt preretirement and some FX gains and losses. But on a go forward basis, the FX gains is not that big of a portion of that number. We don't have significant amount. We have a little bit of a debt in the Pac Rim but by and large what you are going to see is now net income at that level, operating income of around say $300,000.

Okay. And I think you did talk about, it do you expect to take any charges in the current quarter, December quarter?

No, we took $210,000 restructuring charges in the third quarter. When we started the year, we gave a guidance of $2.5 million we ended up less than 3. All things being equal, no. We are running the business, now. We will be making some changes, but unless something really unusual happens, we expect the days of restructuring charges near term are going to go away.

And if I understood it right, you did say that given the option expensing, you would have roughly half a million a quarter in expenses going forward in '06?

In '06. It goes down beyond that but then it depends upon options that we issue in the future but for '06 planning horizon about $500,000 a quarter.

Thanks so much.

You're welcome, Avinash..

[OPERATOR INSTRUCTIONS]. Your next question comes from Marisa Hernandez of UBS.

Hi. Thank you for taking my question. I was wondering if you could tell us what products are you selling to the solar market?

Essentially power supplies to do coatings.

Okay. Thank you.

You're welcome. President

There are no further questions.

Thank you, everyone, for joining us this afternoon. We appreciate your time, effort and participation and we look forward to speaking to you very soon.

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