Advanced Energy Industries Inc (AEIS) 2005 Q4 法說會逐字稿

Good afternoon. My name is Corey, and I will be your conference facilitator. At this time, I would like to welcome everyone to the Advanced Energy fourth quarter's 2005 financial results conference call.

[OPERATOR INSTRUCTIONS].

Thank you. Ms. Kawakami you may begin your conference.

Thank you, good afternoon, everyone, and thank you all for joining us today.

Hans Betz, President and Chief Executive Officer, Steve Rhoades, our Chief Operating Officer, and Mark Hartman, our Principal Financial and Accounting Officer will be today's speakers on the call. Hans and Mark will begin with some prepared remarks, and then we'll open the call to take your questions along with Steve Rhoades.

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 you can contact us at 970-221-4670 or you can view the release on our website at www.advanced-energy.com.

Before we get started, I would like to remind everyone except for any historical information contained herein, the matters discussed in the 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. These risk and uncertainties include but aren't limited to the volatility and 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 on the supply chain initiative currently under way. Other risks are described in our forms 10K, 10Q, and other reports we filed with the SEC. In addition, we feel no obligation to update the information we provide to you on today's conference call.

With that, I will go ahead and turn the call over to Hans Betz.

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

We have reported revenue of 80.4 million in the fourth quarter of 2005, which was at the high-end of our expected result even excluding the contribution from IKOR. Although the fourth quarter began on cautious note, we ended 2006 with much stronger momentum. In order to stay true to our target financial model, improving margins beyond the high-end of our expectations of 37.6% of sales. We are on track to meet the financial goals we are targeting by the end of 2006, and our corporate objectives and internal performance matrix are driving towards success. We have a clear strategy to gain market share in the markets we currently serve and to expand our market opportunities by the soon emerging plasma processing markets. This strategy will be successful by properly leveraging our technology leadership, global operations, and our deep customer relationships.

This requires a heightened focused on everything we do. First, is customer focus. We have always been a technology driven company, and we have been very successful at leading the marketplace based on our differentiated technology. However, industry dynamics are changing and we must strengthen our customer focus. Looking at the semiconductor industry as an example, this is a market that is beginning to mature. In maturing markets, you must know exactly what the customer is willing to pay for, based on exactly what the customer needs are and what the drivers are behind those needs.

In emerging market, on the other side, you must know what the solutions are needed early in the process, and you must know the target markets and the target customer well enough in order to have a good idea of which players will thrive long-term. Our sales, marketing, and service teams are working more closely together to ensure that we are increasing the level of engagement with our current and target customers so that we can most effectively address the manufacturing solutions they require.

The efforts are already producing results. Our expansion into the solar market gained traction during the fourth quarter through a number of design wins in both DC and RF power at OEMs, as well as end-users. Notably our Summit DC platform had its first solo win at a solar equipment manufacturer, making a significantly extended total market opportunity for this advanced product. This is an emerging market that is estimated to grow at a 30% annual growth rate over the next five years.

Within our currently served markets, flat panel offers significant growth potential. Our dominant decision or generation of PVD manufacturing with our power solutions and in a variety of flat panel applications with our flow products, ensures that we will grow at least with the market. Now, we have expanded our source market opportunity with a breakthrough design win into the Etch market with an innovative RF product. We made a proactive effort to pursue the CVD and [inaudible-accent] flat panel, which is comparable in market size to PVD. We are actively engaged with customers as we target additional opportunities in this growing market.

On the semiconductor side, we have had an opportunity to penetrate a key chip and based OEM for some time, but we have not capitalized on this opportunity in the past. We did not have the right people in place to make our focus on this customer the priority that it should be. This has changed. We were recently hired Kenny [Kitagawa] as the President of Advanced Energy, Japan, and he is very proactive about creating a deeper relationship with this OEM. He comes from this industry, having served as a regional manager in Japan for architect as well as Novelis.

Next we have significantly improved our product focus. The divestiture of certain product lines outside of our core focus are tangible evidence of our commitment to our core technology. This helps to streamline our R&D, manufacturing, and sales efforts.

On an organizational level we promoted Steve Rhoades to Chief Operating Officer, and Steve has been very successful in implementing a number of programs to reduce the complexity of our operations. This includes a much improved product life cycle management program that would use the number of active parts by about 1,000. These programs strive efficiency throughout the entire organization. Our worldwide operations have been at the center of our need to focus efforts on our core strength for the past two years. It is now a success story. [inaudible-accent] facility is able to flex with cycles and is handling meeting the challenges of first quarter production increase we have.

Recently we were accepted into LSA, which is a freight alliance with eight other high tech companies. This group is able to sign contracts with logics providers at substantial discount to what an individual company would pay. A view of this has another opportunity to increase the sophistication and cost effectiveness of our global freight programs.

Our supply chain transition to the Asian region continues to progress and drive additional synergy with our global manufacturing size. We continue to expect additional growth across margin benefits of approximately 300 basis points as this efforts continue throughout the year. We have a strong global presence that we'll reap additional rewards as more of our customers move their manufacturing operations to the Asian region. We already are seeing this trend gain momentum.

Our focus on retaining and attracting key global talent has improved as well with the addition of a senior Vice President of HR, reporting directly to me. Fiona Wood joined us earlier this year with a background in global HR strategy and is already putting a plan in motion. Our employees strive for success, and we're committed to enhancing our ability to provide the proper tools and rewards to make Advanced Energy a great place to work worldwide.

Finally, all of these efforts are driving improved financial results. As we exit 2006, we expect to generate cross profit margin greater than 40% for any quarterly revenue level above $80 million. We are moving closer to the achievement of our 2006 target models as we continue to pursue to a defined set of profitable growth opportunities. These opportunities become clearer as we gain more valuable insight from customers and leverage our critical resources across a highly focused set of core competencies. We believe we are well positioned to capture those opportunities and grow at a higher rate than the industry we serve while maintaining profitability at any stage of the industry cycle.

I would now like it turn the call over to Mark Hartman to review the financials.

Thanks, Hans, and good afternoon, everyone.

I will review the results of fourth quarter and full year 2005 and provide guidance for the first quarter of 2006. I want to point out that the results of IKOR operations have been excluded from the fourth quarter 2005 results in the comparable quarterly and annual results based on the sale of this product group in November 2005.

For the 2005 fourth quarter, sales were 80.4 million, up 2.1% compared to 78.8 million in the third quarter of 2005 and down 5.2% compared to 84.8 million in the fourth quarter of 2004. As Hans mentioned, demand for our market leading solutions increased as we exited the quarter to remain strong in the first quarter, particularly related to semiconductor OEM customers. We anticipate a 9 to 13% increase in sequential sales to the 88 million to 91 million level in the first quarter of 2006. For a perspective on the sales line, including IKOR in the fourth quarter and the prior third quarter results, sales would have been 81.6 million in the fourth quarter or flat compared to third quarter sales of 82.0 million. We anticipated 2 million in IKOR revenue for the fourth quarter.

Gross profit was 30.2 million or 37.6% of sales for the fourth quarter of 2005 compared to 28.9 million or 36.7% of sales in the third quarter of 2005 and 13.3 million or 15.7% of sales in the fourth quarter of 2004. The increase reflects the slight sequential sales increase, as well as increased efficiency throughout our global manufacturing operations. There is additional upside within the model to continue improving gross margin based on supply chain transition and product life cycle management programs. We continue to target an incremental gross margin contribution of 50% or greater above our current 66 million break even level and ahead of our plan. Based on our anticipated sales growth in the 9 to 13% range, we anticipate gross margins of 39 to 40%.

Looking at end market sales, semiconductor capital equipment represented 62% of total fourth quarter 2005 sales or 49.3 million, a 2% increase compared to 61% of total third quarter 2005 sales or 48.4 million. Applied Materials, our largest semiconductor capital equipment customer, represented 24% of total fourth quarter 2005 sales or 19.0 million, up 19% compared to third quarter 2005 sales to Applied Materials of 15.9 million. This sequential increase reflects our strong relationship in positioning with our largest customer.

Flat panel display sales represented 15% of total fourth quarter 2005 sales or 12.3 million, up 13% compared to 10.8 million in flat panel sales during the third quarter of 2005. Sales to OVAC, our largest customer in the flat panel display segment were 13% of total sales or 10.6 million, an increase of 22% compared to the third quarter of 2005. This strength reflects our strong position in the PVD market for all generations of flat panel manufacturing, which is a market position that is expanding as we achieve design wins in the RF side of our business on CVD and Etch platforms. The data storage industry represented 7% of total fourth quarter 2005 sales or 5.7 million, a 20% increase compared to 4.7 million in sales to the data storage market in the third quarter of 2005.

Advanced Energy is a dominant player in this space as we have been for some time. The sequential growth was driven by the magnetic hard drive industry. New tools are required to enable perpendicular media, a method used to increase the data density on the magnetic hard drives. These improved storage devices are used in mainstream consumer products, such as MP3 players and handheld video games. In recording media, we will benefit from HD, DVD, or Blueray once the standard is set just as we have with all prior CD and DVD formats.

Advanced product applications represented 16% of total fourth quarter 2005 sales or 13 million, down 11% sequentially compared to 14.8 million in the third quarter. This sequential decrease was largely driven by lower sales to the architectural glass market, which tends to be somewhat lumpy. Global support represented 10.6 million of total fourth quarter 2005 sales or 13%, an 18% decrease compared to 12.8 million in the third quarter of 2005. The sequential decline represents some seasonality in the fourth quarter.

Looking at sales by geographic region, United States sales represented 48% of total fourth quarter 2005 sales, essentially flat in dollar terms compared to 49% of total third quarter 2005 sales. Sales in Europe represented 10% of sales an 11% decrease in dollar terms compared to 11% of total third quarter 2005 sales. Asia Pacific represented 42% of sales, a 9% increase in dollar terms compared to 40% of sales in the third quarter of 2005. We ended the fourth quarter of 2005 with total backlog of 49.8 million compared to third quarter backlog of 43.2 million.

R&D spending was 9.6 million or 12% of sales during the quarter compared to 9.6 million or 12% of sales in the third quarter of 2005 and 12 million or 14% of sales in the fourth quarter of 2004. We are continuing to control costs in R&D as part of our increased project scrutiny within corporate profitability and growth targets. We expect R&D to remain at approximately 12% of sales in the first quarter or in the 10.8 million range and in line with our target financial model.

SG&A was 13.7 million in the fourth quarter of 2005 or 17% compared to 13.4 million or 17% in the third quarter of 2005 and 12.3 million or 15% of total sales in the fourth quarter of 2004. We expect SG&A to be approximately 15% of first quarter 2006 sales or approximately 14 million.

Amortization of intangible assets was 481,000 in the fourth quarter of 2005, 504,000 in the third quarter of 2005, and 538,000 in the fourth quarter of 2004. We expect amortization to be approximately 450,000 in the first quarter of 2006.

Operating income was 6.2 million for the fourth quarter of 2005 compared to 2.2 million in the third quarter of 2005 and compared to an operating loss of 22.3 million in the comparable year end, year ago period. Fourth quarter 2005 operating income includes 166,000 of restructuring charges. Excluding these charges, our improving operating model generated 6.4 million or 8% of sales, representing an incremental operating margin of approximately $0.44 on each incremental sales dollar above a quarterly sales break even level of 66 million.

Income from continuing operations was 5 million or $0.11 per diluted share in the fourth quarter of 2005 compared to a loss from continuing operations of 4.2 million or $0.11 per share in the third quarter of 2005 and a loss from continuing operations of 23.3 million or $0.71 per share in the fourth quarter of 2004.

Fourth quarter 2005 net income was 10 million or $0.22 per diluted share compared to net loss of 3.9 million or $0.10 per share in the third quarter of 2005 and a net loss of 23 million or $0.70 per share in the fourth quarter of 2004.

Fourth quarter 2005 income from continuing operations reflects a tax rate of 21%, which is lower than the company's anticipated tax rate of 40%, due to the mix of foreign and domestic income in the respective taxing jurisdictions. Based on the continued implementation of our global strategy, we estimate an effective rate of 20% in 2006 as we generate income in the U.S. we will be utilizing the benefits of the NOLs. For the full year 2005 revenue was 325.5 million or a 14% decline compared to 380.5 million for the full year 2004. Net income for the full year 2005 was 12.8 million or $0.34 per diluted share compared to a net loss of 12.8 million or $0.39 per share for the full year of 2004.

Gross profit for the full year 2005 was 117.1 million or 36% of sales compared to 114.5 million or 31.1% of sales in 2004. R&D expense was 39.7 million or 12% of sales compared to 40 million or 13% of sales for the full year 2004. SG&A expense was 53.6 million or 16% of sales for the full year 2005 compared to 54.2 million or 14% of sales in 2004. Amortization of intangible assets were 2.1 million for the full year 2005 compared to 3.9 million for the full year 2004. Head count at the end of the fourth quarter was 1,527 people compared to 1,540 people at the end of the third quarter of 2005.

We ended the quarter with 59.7 million in cash, cash equivalents, and marketable securities, an increase of 3.8 million compared to the third quarter of 2005. We expect to increase our cash, cash equivalents, and marketable securities balance to the $70 million level during the first quarter of 2006.

Trade accounts receivable were 64.9 million for the fourth quarter of 2005 compared to 65.9 million in the third quarter of 2005. DSO were in 67 days in the fourth quarter compared to 65 days in the third quarter of 2005.

Fourth quarter inventory was 56.2 million, a slight increase compared to 55.8 million in the third quarter of 2005 as we were preparing for the increase in orders. Year-over-year we have reduced inventory by approximately 17 million. Inventory turns were 3.7 in the fourth quarter of 2005, the same as in the third quarter and compared to 3.2 turns in the fourth quarter of 2004. Total days inventory was 98 days compared to 99 days in the third quarter of 2005 and 114 days in the fourth quarter of 2004.

Our capital expenditures in the fourth quarter of 2005 were 2.8 million compared to 3 million in the third quarter of 2005 and 1.5 million in the fourth quarter of 2004. We expect CapEx to be approximately 6 million for the full year 2006.

Fixed asset depreciation was 3.3 million in the fourth quarter compared to 3.1 million in the third quarter of 2005 and 3.3 million in the year ago period.

To summarize, our first quarter 2006 guidance, we believe that sales should be in the 88 million to 91 million range based on improving order environment. We expect to improve gross margin to 39 to 40%. R&D should be approximately 10.8 million, SG&A approximately 14 million, and amortization approximately 450,000. Operating income should be in the range of 9.5 million and 10.4 million, resulting in an incremental operating margin of approximately $0.42 above a quarterly sales break even level of 66 million at the high-end of our guidance. As we continue our drive to the low 60 million break even range by the end of 2006.

Non-operating income should be approximately 375,000. Our earnings per share should be in the range of $0.17 to $0.19 with an effective tax rate of 20%, based on current profitability expectations within foreign and domestic jurisdictions. Included in the earnings per share amount is approximately 600,000 in stock based compensation expense or $0.01 per diluted share after tax based on the adoption of FAZ 123-R in the first quarter. We are modeling shares of approximately 45.5 million.

Cash and cash equivalents and short-term investments are expected to increase 8 to 10 million to approximately 70 million, and inventory levels are expected to increase a bit to approximately 59 million as we continue to meet growing customer demand.

Our guidance reflects continued progress towards our target financial model. To reiterate the specifics of this model at 105 million quarterly sales levels or a 15% increase compared to the high-end first quarter guidance, we would expect gross margins of 43% and operating margins of 17% as we exit 2006. The strength of our financial model combined with our dominant market position and heightened focus on our core technologies create a powerful combination, particularly as the industries we serve gain momentum in the near term.

That concludes our prepared remarks for today. Now Hans, Steve, and I will be happy to take your questions.

[OPERATOR INSTRUCTIONS].

Your first question comes from the line of Timothy [Arcuri] with Citigroup.

Hi. This is [Artis Malig] for Timothy [Arcuri]. Can you comment on your gross margins as semi versus non-semi or any kind of color?

We don't break out our gross margins in those specific markets like that.

Okay. That's all I had.

Your next question comes from the line of Robert Maire with Needham.

By the way, congratulations on the really nice progress you're making. Very good job. In terms of your redesign of your product for local sourcing at your new manufacturing facility, in Shenzhen. Can you tell us where you are in that process and how much redesign has been completed and are we on track there and is the gross margin improvement that you're expecting to get out of that relatively on track so far? Maybe give us a little further detail about that?

Steve is answering the question.

Hey, Robert, this is Steve Rhoades. We got about 75% of our material localized to the factories where it is manufactured, primarily in China we did about 90% of our total revenue out of the China facility right now, and as far as the gross margin, we are actually, I think a little bit ahead of where we projected to be for this revenue level and this time in our transition. Just get a word right, we hadn't really redesigned products to place them in the Asian market.

It has been primarily a transition of our existing designs over to a new suppliers, larger suppliers that could be more flexible and help us achieve both our cost goals and delivery goals. That's actually worked out quite well for us. We are not seeing delivery issues now even with the near term ramp that we've seen in primarily the semiconductor markets, so we're actually very much on track with what we're trying to do in our transition over to low cost region.

Okay. And in terms of completion of that, how much longer, how many more quarters before you think that's pretty much finished with and will have realized most of the gross margin we see out of that transition?

As we said before, we expect to make further progress throughout this year, heading toward the model that Mark laid out at the end of his prepared remarks. We still have maybe another 15% of material to localize. We are also executing new designs that have been designed to lower cost targets than some of our legacy products, and those will be introduced both in the market and into the China facility over the course of this year.

And what percentage or what sort of designs are you now originating from Asia? Or is most of the design work still being done?

All the design work is being done in Fort Collins and the other three sites we have where we have design teams, Washington, Hachioji, Japan, and Schjolberg, Germany as we've done in the past. Right now we are not doing basic design work in the Shenzhen facility, and we don't have plans to do that in the near future.

Your largest customer obviously reported some really good numbers yesterday, and the impression I think most investors left with is that this up-turn seems to be stronger and sharper than the previous up-turns, which were more like sort of blips or very short lived minor up-turns, and they seem to feel that it is going to last a longer period of time. What sort of indication or lead times or guidance are you getting from your customers in terms of that and confidence level that you're seeing out of them?

A couple of questions there I think. First on lead times, we've been working really hard to expand and strengthen our relationship with our top OEMs, and one of the main things we ask them for was a little further look into their own forecast, and we've actually got good cooperation on that out of several of the large OEMs. We've seen an expansion of their [inaudible] windows to about lead time plus a month, lead time plus six weeks, so that's actually really helped us in terms of getting our factory set up so that we can meet their delivery requirements and their needs for the ramp up.

In terms of the longevity of this up-turn, I am not very good at that sort of thing, and I am not sure who is. I can't really say that this is better or worse than what's happened in the past. It looks quite strong for us in this quarter. It looks very strong for us in the next quarter, and it is hard to see a lot pass.

Okay. One final thing. I would assume you're not having an issue meeting the current ramp, your new facility sounds like it is ramping --

We have a very flexible supply chain. We have lots of capacity in China. We saw the uptick in orders early in the fourth quarter, and we got ready for it, and right now we're not on anybody's radar for delivery.

Great. Thank you and congrats again.

Thank you.

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

Yeah, thank you. First a question for Steve. Just some clarification on manufacturing out of Shenzhen. How much of your product is coming out of China at this point in terms of revenues?

It is between 85 and 90% of our revenue coming out of China right now.

Great. And of the 300 basis point improvement, if revenues were flat through the course of the year, how much of that is driven by continued, I guess local sourcing in Asia, of your materials and how much is driven by design change programs?

The bulk of what we expect this year is out of localization and improvements in logistics. We have quite a few efforts in those areas, and the upside of that is that we are introducing design changes out into the future on new products that is going to continue to hone this model and make it stronger going forward. The bulk of what we're planning right now is aimed at supply chain work and work on moving material around the world.

Okay. That's helpful, and a quick question for Hans, looking at Q1, how do you see the revenue mix by segment changing? Semi looks like it should be up. Do you expect flat panel and data storage and advanced products to be up, if you could provide some commentary on that, that would be helpful.

What we see, as Steve was eluding already to, was a very strong uptick in semiconductors. We have a continued strong growth in flat panels. We have a sluggish market, as everybody knows in the storage, which is mainly driven by a very low market growth on the optical storage, which is a bit compensated on the pretty strong heart describe market, but all in all the first quarter is being dominated by a very hot semiconductor business.

Okay. And do you expect the Advanced Products to be up or down in Q1?

They are up. Of course you don't see that in the revenue in absolute numbers because semiconductor is so strong, but as I mentioned before, we see strong increase in, for example solar, and we have a very good normal business at the flat panel side.

Excellent. Thank you.

You're welcome.

Your next question comes from the line of Jim Covello with Goldman Sachs.

Good afternoon. This is Amanda Hindlian for Jim Covello. I have one question. Your sales are clearly set to improve in Q1, but your revenue growth both in Q4 and Q1 appears to be lagging growth at MKS by a little bit. I'm hoping you can help us understand why that may be. Is it an issue of timing or market share?

No, the math is pretty simple. We have around about 62% semi business in our revenue, MKS has a lot more, so if you are looking at what we increase in on next year and what MKS is guiding, so you will easily see that because of the very strong semiconductor market they have to have a stronger increase than we have.

Thank you.

Your next question comes from the line of Shawn Boyd with Westcliff Capital Management.

Good afternoon. Congratulations.

Thank you.

A couple quick questions. On just confirming the order that you -- the target model that you guys laid out in exiting '06 at 43% gross margins and 17% operating margins, what kind of quarterly revenues was that?

105 million.

Okay. That was fourth quarter '06?

Correct.

Okay. And on the book, in terms of the backlog and the strength that you're seeing in the orders, backlog of 50 million now, judging from your answer to the earlier question in terms of visibility, would you, do you feel like your visibility is stretching beyond a quarter at all, or do you still feel like you're only safe on one quarter at a time here?

I think it is pretty good visibility within a quarter, which is an improvement over where we were in the past. We don't have the big window any but our largest semiconductor OEMs and flat panel OEMs, and that's where we've been concentrating to try to get that visibility. I would say we have a very good one-quarter look now, which is an improvement over where we've been.

Okay. And on the incremental margins, again just confirming, did I hear 50% incremental margins on revenues beyond 60 million now?

This is Mark. You're speaking of incremental gross margins and 50% on 60 million as we're exiting 2006.

Where we stand today, though, what we said in the prepared remarks was on incremental operating margin that we were at $0.44 on 66 million, above 66 million in sales.

Right. And as I recall from last quarter the number was -- you guys were targeting more like 40, so I guess I am just wondering, is the transition going well enough that you're now racheting that up to the 44 or are you still using a 40 target?

Let me try to clarify for you. So the 40% incremental operating margin is what we've been speaking to, and that's our target model that we have been executing everything against. The 50% that you had before was the incremental gross margin.

Okay. Gotcha.

But we are a bit ahead of plan. We had said that we would achieve our incremental operating margin at sales at 68 million in Q4, and we actually were able to achieve that on for all of our sales above $66 million in Q4. So we're a little bit of ahead of where we had planned to be.

Right, which is great. And last question, given that you're now 85 to 90% of revenues coming out much Shenzhen, are there, one of the things we've been thinking about in the past is kind of the duplicate cost structures. Is there still that much duplication, and if so, what is it and can you quantify it at all?

We've taken most of the duplicate cost structure out between our factories around the world, and think that we're at a sustained level on head count and expense in Fort Collins and Hachioji and a couple other locations relative to our total expense. We're not looking for large changes in our expense structure going forward in manufacturing.

Okay. Great. Congratulations.

Thank you.

Your next question comes from the line of Brett Hodess with Merrill Lynch.

Hi, I was wondering if you can just talk a little bit about the competitive front at this stage, given that yourself and MKS are both strong competitors in power. Are you seeing a stable competitive environment? Is it more or less competitive and is pricing -- can you comment on that? Is that in line with what you'd expect or more or less given the stage of the cycle?

There are two questions in one. First the competition between MKS and Advanced Energy is there, but if you look, going forward, the path MKS is walking on is more and more different than than what we are doing. MKS is staying at the semiconductor arena but having the intention to provide a broader product suite. We, on the other side, we stay very strong on our core technology, and we will use the core technology in order to reach into new emerging markets. So that means the actual competition is getting less and less because we are diverging in some ways. As far as the pricing is concerned, I don't think that we are getting into a price war because we are always having tried to edit to produce and provide added value so our product, which based on leading edge technology. We will follow this way going forward.

On the other side, we are prepared to have a price for it necessary because we probably are much better positioned with our China facility in order to get into those because this is by far the lowest production which can be provided, and on the other side, getting into these kind of new emerging markets, this is something which was partly driven by the fact that semiconductor is a maturing market with increasing price pressure, and we think that in the new markets, which are much more dependent on technology, that's not as we see it in the semiconductor industry.

Are the new markets, though, large enough to drive enough volume so that the cost structure and margin can be as good as semis?

I mean still at this point in time from the absolute numbers, semi is by far the largest market. We do have 62%, as I mentioned earlier, but on the other side, if we are looking at the growth rate of the new emerging markets, we can expect that in a couple of years from now we have substantial volume coming out of that, and fortunately if you look at the forecast, which has a certain consensus, the next two years, I think, semicon business is probably a pretty healthy business still. So that means at a time in which the semiconductor business is flattening off, we are prepared and we are pretty sure to have substantial volume out of new markets.

Thank you.

You're welcome.

Your next question comes from the line of the [inaudible] Shaw with Lehman Brothers.

Hi, guys. I have a question on the global industry outlook for 2006. Assuming CapEx grows by 10 to 15% and equipment revenues grow by 15 to 20%, what kind of revenue grow do you guys expect you can show?

You are extremely optimistic if you say that CapEx or semiconductor equipment is growing on the yearly base on 15 to 20%. What most of the people are betting on is around 7 to 6 to 8% on the average, so what we see is a pretty strong Q1 and Q2 at this point, and I think we will participate in that up swing.

As far as Q3 is concerned, it is pretty hard to predict. There are of course some indicators that they may be longer than most of the people thought at the beginning because if you look at the actual situation who is announcing fabs, it is exclusively processors and memories, flash memories as well as D rams, and there is no founder yet, and there is a certain hope that in the second half of '06 the founders may step in and having a prolonged up-turn. It is absolutely no visibility what can tell us what the second half will do. The first half is strong, no question about that.

Okay. Great. Thank you.

Your next question comes from the line of Philip Lee with J.P. Morgan.

Hi, guys. Can you talk about the revenue opportunity regarding the power supplies that the Japanese OEM equipment supplier that you guys mentioned earlier in the call?

We still are in the situation, which we have put just a new president in place, and I think we are in a much better situation in, let's say, a couple of months from now. At this point I think we'll not elude on this point.

And secondly in terms of your revenue from solar and your revenue from flat panel, how high can that get as a percentage of revenue for each of those categories during fiscal '06?

Oh, I mean flat panel, we have at this point 16% or 15% as revenue, and it depends very much on what I said before, how strong over the entire year semiconductor will be. If we have a very strong 2006 at semiconductor the side, it will not exceed that percentage. If it flattens off at the end of '06 or at second half of '06, there is good chance it is higher. As far as the solar is concerned, solar is still growing strong, but on a very low level, so that means it will not really influence the number in terms of percentage of our total revenue. It is still small.

What kind of growth can you see in flat panel in dollar terms from '06 compared to '05?

I mean you can look at what the forecast is telling you, which is in the order of, I think, 12%, something like that, but we have no visibility at this point in time in order to translate that in which or which growth rate we would have in '06 on our flat panel business. It is just too early.

Okay. Thanks.

Your next question comes from the line of Timothy [Arcuri] with Citigroup.

Hi, guys. Actually I had several things. Sorry, but I came on the call late here, so I heard you guys talking about kind of a strategic outlook, the difference between what you're doing and what your chief competition is doing, and I wonder in that outlook, how important is the flow business to you because if you're focused on your core competency, which really is power, and as you see the flow business kind of consolidating around possibly two and/or three different vendors, I am wondering, A, how strategic this is, and, B, if it was decided that you would sell the business, would it be accretive to gross margin?

First, the answer is it is still a very strategic product line for us. The reason is we are very strong in the flat panel flow business, and flat panel is one of the core market we would like to address. If you are strong in that market by any product line, it opens up the door because you have already required relationship with the customer in order to get into it with the power. Again, we have a very strong flow business, and we don't see any need in order to either get into a price war or even sell this business. I think that there is in indication for it, and no need for either.

Okay. Okay. I guess maybe just a follow up to that, then, Hans. I know you don't want to break out the revenue by product line, but I seem to remember that the business is doing somewhere around $15 million a quarter, is that even in the right ballpark?

Yeah, I think so.

Okay. And then I guess the other question I had is that, I also have in my notes about three or four months ago, the model as you extend it out to even higher revenue levels, say up in the $125 million range, I have the model was about 45 million gross margin or sorry, 45% gross margin and about 22% operating. Is that still in tact?

That's still in tact.

Okay. And then I guess last thing, do you think that power as a percentage of the billed materials is maxed out in the flat panel world, or do you think that it can still go higher? Thanks.

This is Steve. If you look in a Generation 8 system or a PVD tool, for example, power is a significantly higher fraction of the total bill of materials than it was a Gen 7. Right now that trend is still increasing in flat panel space.

Okay. Thanks, Steve.

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

Thank you. Congratulations on the good numbers. If I was the accounting fella, I would get choked up, too.

Thank you.

Just a couple of housekeeping questions, Hans, I think you said that service revenue declined 18% 4Q over 3Q due to seasonality. Does that suggest that's going to bounce back in the first quarter to show double digit growth?

I am sure on that, and I think this is still valid what I said before, and we will have up-turn on the service business in the Q1.

And then also on the R&D expenses, they declined, I guess about a million dollars quarter over quarter, but you're saying they're going to jump more than a million back in the first quarter. What caused them to decline in the fourth quarter, and what's the reason for them jumping back in the first quarter?

The decline in the fourth quarter primarily and partly related to we actually had a shut down as typical in our industry between Christmas and New Years. The uptick in the first quarter is partially related to variable components, and also as our target model has allowed us, we made strategic decisions to really leverage our model and produce and look at our capabilities in R&D and spend more there for our future.

Okay. Thank you.

Your next question comes from the line of Kevin Vassily with Susquehanna.

Yeah, hi. Thanks. Question on flat panel, again, sort of keep coming back to this. Maybe you can talk a little bit more about the RF opportunity you referenced in your opening remarks. Is this for a new product in the marketplace that you've penetrated, when do you expect to see volume shipments into this application, and would you say that the revenue opportunity is similar to what you've got right now on the PVD side with ULVAC?

It is Steve. It is a Korean OEM. It is a smaller opportunity than ULVAC. ULVAC is a 90% player in the PVD market in flat panel. It is an important product. We expect to see shipments in the second quarter of this year, and so starting from the second quarter, and it is just the first part of our effort to continue our expansion into the Etch and CVD portions of the flat panel space.

Would you say that of Etch and CVD, aside from this early kind of small Korean OEM, that Etch is the most near-term opportunity with other vendors, or do you foresee seeing a CVD penetration before another Etch customer?

We're working aggressively in both spaces. We've already had wins on the flow side in both of those sectors with a number of OEMs including the biggest ones out there. In terms of the order of us trying to win design slots in Etch versus CVD, it is very hard to predict. We definitely have efforts on both sides of that game.

Okay. Thank you.

Your next question comes from the line of Steven Pelayo with Soleil Securities.

Great, thank you. Steve, first question for you. You're break even at 66 million right now, marching toward 60 million by the end of the year. Is that going to be pretty linear in the way it comes or is there some kind of step function in any point, and what would be the reasoning behind that step function?

We're ahead of the game, but I would still expect it to be a linear march toward that goal by the end of year, Steve. We'll certainly work as hard as we can to accelerate that if we can. Right now we expect that to be roughly linear through the year.

You guys talk about an incremental gross margin above a certain break even level. However, when you just look at your guidance of revenue 88 to 91 and gross margins of 39 to 40%, that actually implies the incremental gross margin, quarter over quarter from what we're seeing more in the 55 to 59% range. A, is my math right there, and, B, I guess, is that the kind of thing we should be expecting going forward until we get to the 60%, pardon me, until we get to the 60 million run rate where it probably starts [inaudible] a bit?

Steven, this is Mark. Your math is correct. We are still running towards that. The dependence really there is just the mix of what we actually see within the quarter between our different product lines.

Okay. And just one clarification on the fourth quarter. Your gross margins came in above your guidance. Revenues are really just slightly above it. I am just curious, how did that come to pass there, was it just, I guess 37.6 or 37.25 at the top end. Was there anything more behind that or is that just running ahead of plan as Steve was hinting?

We're running ahead of plan. We saw some additional efficiencies in labor and overhead during the quarter that helped us and some improvement in our warranty costs and just generally trying to polish every portion of the cogs model so we can as aggressively as possible achieve our target model that we've been talking about for about a year now.

Excellent. Thanks, guys.

Your next question is from the line of Alex Paris with Barrington Research.

Hi. Just a quick question. Would you be able to provide a stock option expense for 2005, an estimate?

I'm sorry, do you mean for 2006?

I guess for '05 and '06? I know you mentioned the first quarter of '06, but just kind of a round about estimate for '05. I know your books aren't closed yet, but if you could provide that.

So in 2006 as we reference here, it is about 2006 in Q1, and we're seeing that as a relatively good assumption for each quarter here out. For 2005 it was probably around 500,000.

Alright, thank you so much.

You have no further questions at this time.

So thank you for joining us today. We are encouraged by the positive industry indicators and drivers in the first quarter 2006. We are well positioned to benefit from this enhanced order momentum.

Just in closing I want to mention that there will be a table available on the Investor Relations section of our corporate website. It is going to provide eight quarter historical perspective that is just for the sale of IKOR, So you will be able to update your models. This will be posted very shortly. And we want to thank you again for participating today.

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