Advanced Energy Industries Inc (AEIS) 2012 Q2 法說會逐字稿

Welcome to Advanced Energy's second-quarter 2012 earnings conference call. At this time all participants are in a listen-only mode. Later on we will conduct a question-and-answer session.

(Operator Instructions)

As a reminder, today's conference is being recorded for replay purposes. And I would now like to turn the conference over to Annie Leschin, Investor Relations. Miss Leschin, you may begin.

Thank you operator, and good morning, everyone. Thank you for joining us today for our second-quarter 2012 earnings conference call. With me on today's call are Garry Rogerson, Chief Executive Officer; Danny Herron, Executive Vice President and CFO; Yuval Wasserman, President of the Thin Films Business Unit; and Gordon Tredger, President of the Solar Energy Business Unit.

By now you should have recieved your copy of the earnings release that was issued yesterday evening. For a copy of the release, please visit our website, AdvancedEnergy.com or call us directly at 970-407-4670. This quarter, Advanced Energy will be participating in the Needham Advanced Industrial Technologies conference on August 7, in New York, the Pacific Crest Anl Leadership Forum, on August 14, in Vail, Colorado. And the Citi Technology Conference on September 6, in New York.

Finally I'd like to remind everyone that except for the historical financial information contained herein, the matters discussed on this call contain certain forward-looking statements subject to known and unknown risks and uncertainties, that could cause actual results to differ materially than those expressed or implied but such statements. Statements that include the terms believe, expect, plan, objective, estimates, anticipates, intends, targets or the like, should be viewed as forward-looking and uncertain.

Such risks and uncertainties include but are not limited to, the volatility and cyclicality of the industries we serve, the timing or orders received from our customers, and unanticipated changes in our estimates, reserves or allowances, as well as other factors listed in our press release. These and other risks are described in forms 10-Q and 10-K and other reports filed with the SEC.

In addition, we assume no obligation to update the information that we provide you during this call, including the third quarter guidance provided today, and in our press release. Guidance will not be updated after today's call until our next scheduled quarterly financial release. I'd now like to turn the call over to Garry Rogerson, CEO of Advanced Energy. Gary?

Good morning, and thank you for joining us. I will begin today with a summary of the quarterly results, and an update on the progress we've made on our strategic plan, including cost reductions and next steps to maximizing customer relationships and growing revenues.

Let me begin with slide 4. Our second quarter performance was sound, with a 9% sequential increase in revenues, to $116 million and substantial improvement over last quarter in profitability, to $0.18 of non-GAAP earnings per share. These results reflect our unwavering focus on lowering our cost structure, and keeping those costs under control, regardless of market fluctuations. Again, we do not see these costs returning in the future. Having lowered our quarterly break even to the stop of $100 million revenue level, we are now seeing the direct benefit of higher volumes equating to stronger profits.

We continue to manage our working capital very well, ending the quarter with $149 million of cash. We believe the second quarter of 2012 represented a turning point for AE, demonstrating the powerful potential of our new developing operating model. From here, our next internal goal is to reach a $2 earnings per share target for 2014 that we laid out at our analyst day. The strong outlook for our solar energy business, combined with the return of our thin films market, should be sufficient to reach those levels.

We are, though, working however, on a variety of ways to ensure that we achieve this internal goal. Through further cost reductions, to product and market expansions, either organically or inorganically, and to other ways to utilize our cash.

Turning to slide 5, step 1 in our strategic plan was to reduce our cost structure by $16 million to $20 million annually. Having instilled a more cost conscious culture across the organization, we have already far exceeded that. Reaching upwards of $30 million in annualized cost savings, with the opportunities for more. Now, we are moving on to step 2, finding new ways to lower our cost of manufacturing while maintaining product quality and performance.

With an experienced supply chain team in place in Shenzhen, we are just beginning to see the potential for outsourcing many of our materials and components, to even lower cost areas, and utilizing modern manufacturing tools to gain greater efficiencies and lower costs. While these savings will take longer to materialize, we believe we have the ability to save another $15 million to $20 million in manufacturing costs throughout the organization.

Overall, I'm quite proud of the incredible strides the entire AE team has made in reducing our costs and achieving our three main goals. One, balancing the cyclicality of our business, two reaching profitability in our solar business, and three, improving margins and bringing more profits to the bottom line. With our further efforts, we should have the opportunity to break -- to lower our break even yet further.

Turning to slide 6, during the quarter we have generated over $33 million in cash, excluding repurchases. In addition, we completed our $75 million stock repurchase plan, buying back a total of 6.4 million shares. By lowering our costs and managing our cash more effectively, we're now looking at how best to reinvest some of those dollars, position us closer to our customers, and grow our revenues.

Turning to slide 7, what we constantly hear from our customers is how happy they are with our product, performance, and service. By exceeding and anticipating their needs, we continue to solidify our relationships and benefit from their success as much as our own. This positions us in next-generation products, and allows us to enter new geographies and expand into new markets and applications.

In our thin films business, we won roughly 70% of the designs we targeted this quarter. Not only did we have some very significantly large wins in the semiconductor market, but we are gaining a presence in areas outside of the traditional semi and non-semi markets. The semiconductor wins position us for future revenue streams in 2013 and beyond.

In our solar energy business, we have improved our performance in each of the last two quarters. Currently, we have a record backlog heading into the third quarter, driven by our utility business and strong customer relationships. We've also begun to ramp shipments of our new commercial products.

North America continues to be a very strong market for us, and having established our own manufacturing in Canada, we are closer than ever to our key customers in that growing region. As we take our industry-leading products and service offerings to new territories, we are carefully selecting our partners such as SGEG, with whom we are developing low -cost inverters for the Asian markets. Finally, as we have mentioned, we are actively looking at the growing list of potential acquisitions for our business units, to align with our strategy and add to our product line or geographic presence, and have quickly accreted.

In summary, when you look at where we were just a few quarters ago, we have made meaningful progress in building and growing a profitable business. The last three quarters we have demonstrated our ability to lower and control costs, while contributing more to the bottom line. At the same time, we are expanding our reach by entering new geographies, introducing new products and discovering new applications for our products in adjacent markets.

Our vision is to create a sustainable, well-balanced growth business, while even as our markets experience cyclicality our business can remain profitable. As you no doubt heard recently, a few of our semi-cap customers lowered their outlook for the third quarter. While the semiconductor market is an important component of our business, it is no longer the majority.

We have diversified into a variety of other thin film markets, and built a leading solar energy franchise in North America. Both of which should help offset some of the cyclicality we are seeing in the semiconductor market. Today we're a Company with two unique business units that work separately, but in concert with one another, benefiting from each other's technology, product, and manufacturing.

Given our progress to date, we're on our way to achieving our 2014 internal goals of 11% [CAGR] total revenue growth, cash generation of $180 million to $200 million, and earnings per share of $1.90 to $2.10. As we sit here today, the restructuring has exceeded our expectations. We've achieved meaningful improvement of profitability in both of our businesses, and we've seen plenty of opportunities to drive revenue growth across our markets. Now, let me turn the call over to Yuval.

Thanks Garry, beginning with slide 9, in the second quarter we saw strong performance across most of our non-semiconductor thin films markets, more than making up for the 5% sequential decline in our semiconductor business. While the semiconductor market wrestled with ongoing oversupply in NAND and DRAM, and slower than expected growth rates in memory content for tablets and smartphones, our non semi-business showed improvement driven by customer wins and entry into new markets in the industrial sector.

This led to a 7% sequential increase in thin film revenues during the quarter, to $64.8 million or 56% of total sales. Operating income more than doubled over the last quarter to $8.9 million, or 14% operating margin as a result of our fixed cost reductions, and ongoing spending control.

Turning to slide 10, having realized most of our initial cost reduction goals, we are now implementing several other programs to drive further efficiencies in our business. For example, this quarter we began to employ new software tools to aid in our efforts to lower material costs, by better managing our purchases, optimizing our inventory, and improving supply cycle times. We expect further cost savings and cycle time reduction, due to the broader implementation of the man flow technology and mixed lines manufacturing, in our Shenzhen factory.

In keeping with our strategy to become more customer focused, we took several steps this quarter to drive further efficiencies, localize resources close to our customers, and expand our served markets. First, we recently realigned our thin films organization, creating two different teams, one dedicated to semiconductor or (inaudible) market and another to thin films industrial products and applications.

While our core business in semiconductor involved a great deal of precision and design time, other markets outside of semiconductors have greater flexibility in implementing changes throughout the product life cycle. This new structure will allow us to tailor our products and services to the differing needs of these markets, and address the growing demand for solutions in a variety of new applications, including inductive heating, food packaging and sterilization, gas abatement, and industrial coating.

Second, our strategy to position ourselves closer to our customers and collaborate earlier in the design and development processes, is showing results. Our (inaudible) and impending move of our San Jose headquarters, are accelerating a number of designs wins in next generation nodes.

During the quarter, we secured 50 wins across our semiconductor and non-semiconductor industries. The semiconductor wins position us for future revenue streams in 2013 and beyond. They span applications ranging from PVD to Etch and abatement, and incorporates our recently launched Paramount and Navigator II product platforms.

In our non-semiconductor market, where design wins can generate more near term revenue, we achieved wins for automotive, optical and hand-held device coatings, using our Ascent, [PD2], Paramount, Navigator and Sekidenko products. In gas abatement, using a litmus remote plasma source. These wins demonstrate the ongoing strength of our R&D, the breadth of our offerings and our ability to secure future business.

Working with our customers to meet next generation process needs, prompted two new product introductions this quarter. First, we launch our Ascent AMS DC power solution at the SVC Tech-con Conference in early May, which incorporates our patented RF management system to address large-area sputtering in applications such as solar PV and flat panel displays. ¶ We also introduced a Navigator II FastCap Matching Network, at the Seneca West trade show in July. Which features the industry's fastest match solution, available for sub 22-nanometer technology node, next-generation thin films plasma processes.

Turning to our outlook, we anticipate a near-term pause in the semiconductor market, demonstrated by the industry's recent announcements. As for our thin films market, we still anticipate a pickup in flat panel investment later in the second half of the year, and see a number of opportunities to enhance our industrial business while the PV solar panel market remains weak.

Building on our success in reducing new controlling costs, we continue to pursue additional cost reduction initiatives both in our operations and our global distribution network. And are proactively seeking new markets for our power conversion solutions to better offset market cyclicality. As a market leader in RF and DC power solutions, Advanced Energy is well positioned to gain share as our end markets recover. I would now like to turn the call over to Gordon to discuss our solar energy business.

Thanks Yuval. Turning to slide 12, revenues in our solar energy business increased 12% sequentially to $50.8 million this quarter, or 44% of our total sales, due primarily to large-scale utility shipments in our target US market. Most notably, we ended the quarter with record bookings and a strong pipeline of opportunities for the second half of this year and 2013, leaving us very optimistic about our prospects for building this business.

During the second quarter we shipped 210 megawatt's, versus the 179 in the previous quarter, with commercial and utility scale products over 250 kilowatts accounting for the majority. We generated $2.7 million in operating income this quarter versus $0.5 million in the first quarter, a direct result of our recent cost reduction initiatives.

Now turning to slide 13, in less than a year we have taken a number of steps to significantly improve our cost structure and lower our break even point. Now we are focusing on a number of longer-term cost reduction initiatives, as we turn our attention to optimizing our supply chain and effectively executing on our pipeline of R&D projects to realize our cost objectives.

First, as we have discussed, we are now manufacturing some of our sub-assemblies out of Shenzhen, and plan to increase the utilization of our Shenzhen manufacturing facility through the remainder of 2012. Next, we are transitioning the bulk of our supply team management to Shenzhen in the second half of this year.

We plan to automate more of these processes by utilizing new software tools to facilitate materials planning, green light supplier selection and generate requests for quotations. We expect to recognize additional savings this year and believe that we can achieve even more savings next year. These steps should lead to greater efficiencies and further operating income improvement.

We are also making meaningful progress in growing this business on a geographic basis. First, in the US we are seeing the power of the AE brand reflected in our strong backlog and order pipeline. At the recent Intersolar conference in San Francisco, we met with numerous customers who praised our products and service offerings, and expressed their desire to explore ways for us to grow with them.

In that light, we have continued to increase our bench strength by hiring additional account managers, field applications engineers and service support personnel during the quarter. We are looking forward to meeting with more customers at the Solar Power International Conference in Orlando during September.

Next, in Canada we established our own manufacturing location as of the end of June, as we have become more entrenched in the market. We now have a scalable operation in Canada where we are able to control our costs and quality directly. And ramp manufacturing volume with growth and demand.

With our sales applications and service support personnel operating from the same facility, we have a local presence from which we can target and serve the customer base, and maintain the superior service levels for which AE is so well known. We have already won some significant orders that should benefit us in the second half of 2012, and we are seeing strong demand for our products, positioning us to be a leading player in this market.

Third, in the emerging Asia Pacific markets, we're taking very deliberate steps to make ensure that we select the appropriate markets, partners and products with which to enter and succeed in these highly competitive markets, such as India. This quarter we expanded our relationship with SGEG, our Chinese partner, and plan to develop a product utilizing SGEG's low-cost platform, and our technology, designed for the requirements of the Asian markets. Once complete, we plan to market and sell this product to a number of Asian territories outside of China.

On a regular basis, we are being introduced to prospective projects through our customers. Clearly a result of the strong relationships we have built. Japan, South Africa and South America are but a few of the opportunities where our customers have expressed their desire to work with us, due to the reliability of our products, our reputation for responsive service, our financial stability, and our knowledge of their needs.

From initial integration and design, to helping maximize energy harvest throughout the life of the project, our applications engineering and service support capabilities, continue to be a differentiating factor. As always, we will select the market opportunities where our product and service offerings fit best, and that meet our financial goals.

For example, the recent introduction of our 500 kilowatt mono-polar product, the AE500TX, is not only a good fit for the larger-end commercial market, but also provides a secondary benefit as we are selling smaller-scale inverter products with approximately half of the orders for these inverters. Though it is still early in the ramp of this product our pipeline for the 500 model polar inverter remains solid and we're enthusiastic about its prospects going forward.

Overall, we are positioned for success. We have built a strong business platform that we can leverage for sustained growth and improved operating profit, over the next several quarters. While the solar panel market remains a bit tenuous, the demand for large-scale inverters in the US is solid, even after the expiration of the 1603 cash grant program.

Utility scale projects signed over the past two to three years continue to be deployed and having won three significant projects that total over 200 megawatt's in our utility segment last quarter, we have a record backlog and opportunities in the pipeline that should lead to healthy growth for the remainder of 2012. With Advanced Energy's products and service in high demand, and several emerging markets starting to show promise for us, we believe there is a great deal of opportunity yet ahead. I would now like to turn the call over to Danny, to discussion our financial performance.

Thank you Gordon, during the course of my remarks I'll refer to both GAAP and non-GAAP results. Non-GAAP measures exclude the impact of the reception benefit and after tax gain on the sale of our mass flow control assets, recorded in the second quarter. A reconciliation of non-GAAP income from operations and per share earnings as provided in the press release tables.

Turning to the highlights of the quarter on slide 15, total revenues were $115.7 million, an increase of 9% sequentially and a decrease of 16% compared to the prior-year quarter. During the quarter, we completed our $75 million share repurchase program, with the purchase of $35.2 million of stock. We ended the quarter with a strong balance sheet including $149 million in cash, having generated $33.5 million in cash flow, excluding the share repurchases.

Turning to the performance of our thin film business unit on slide 16, the [minimum] on non-semiconductor markets improved our thin films revenue, which increased 7% sequentially to $64.8 million in the quarter, contributing 56% to total sales. Compared to the first quarter, we saw a 64% increase in flat panel sales, to $2.2 million, a 69% increase in beta storage and industrial to $9.6 million. A 14% increase in solar equipment to $3.5 million and an 8% increase in service to $12.9 million. These results were partially offset by the 5% decline in semiconductor sales, to $36.6 million.

Turning to performance in our solar energy business unit. We saw a continued momentum in our inverter sales, as revenues grew both quarter-over-quarter and year-over-year. Solar energy revenues increased 12% from last quarter, to $50.8 million, driven by utility scale deployments in the US market, compared to the same quarter last year, solar sales increased 24%.

Turning to our P&L on slide 17, our cost reduction initiatives reduced operating expenses by 14% versus the same quarter last year. Sequentially, operating expenses declined $4 million, aided by lower other operating expenses, as well as a significant reduction in incentive compensation, to bring year-to-date accruals in line with full-year expectations.

The pause in capital equipment spending in the semiconductor markets in the second half, is being partially offset by the strength in our solar energy business, leading us to expect that operating expenses for the balance of the year, should be in line with our current year-to-date average run rate. Currently our P&L performance is in line with our strategic plan, total operating expenses excluding the restructuring of $32.6 million, a decrease of 14% versus the same period last year.

R&D expenses decreased 15% year-over-year to $14.5 million or 13% of sales during the quarter. SG&A decreased 16% year-over-year to $16.7 million or 14% of total sales. I would also like to remind everyone that at the start of 2012 we began fully allocating our corporate overhead, into each of our business units. This change impacts operating income for each business by approximately 3% to 5%. Nonetheless our 9% increase in total revenues led to significantly improved operating income, of $8.9 million in our thin film business, and $2.7 million in our solar energy business.

Turning to slide 18, the cost reductions we have taken to date remain intact, and we do not expect these expenses to return, even as the markets recover. Having finished the first phase of our cost reduction plan, we are now focused on driving growth and further improving profitability. As the rest of the team mentioned, these longer-term efforts will include centralizing and automating the supply chain and inventory management, and utilizing a variety of tools to improve our gross margin.

The remainder of our restructuring plan is expected to be implemented over the next 3 months to 9 months as we further reduce our cost structure by consolidating certain facilities and centralizing other activities, that should result in charges of about $2 million to $6 million. Principally for facility consolidation, and another $2 million to $3 million for severance cost. Once complete, the restructuring plan along with other cost saving initiatives, and margin improvements are expected to deliver annual savings in excess of $30 million.

Turning back to the second quarter on slide 17, we paid taxes of approximately $4.3 million or 33% in the quarter, due to shifting of business unit profitability. Given the projected mix of our business moving forward our solar energy in the near term -- given the projected mix of our business more towards solar energy in the near term, which mostly occurs in the higher taxed US, we have adjusted our full year 2012 tax rate to 32%. Our tax rate assumption does not include the favorable impact of 1% to 2% if the R&D tax credit is approved prior to year-end.

Income from continuing operations was $8.8 million or $0.22 per diluted share. This compares to income from continuing operations of $0.8 million or $0.02 per diluted share in the first quarter, and income or $13.6 million or $0.31 per diluted share, in the same period last year. On a non-GAAP basis, income from continuing operations was $7.3 million or $0.18 per share during the second quarter, excluding an after tax gain of $1.5 million from the sale of mass flow control manufacturing assets.

Turning to our balance sheet on slide 19, we ended the quarter with cash and investments of $149 million, $1.7 million decrease over the first quarter. Excluding share repurchases, cash flow was $33.5 million for the quarter. Trade working capital decreased by $8.7 million during the quarter. Stock option expense was $2.2 million and depreciation and amortization was $4.4 million for the quarter.

Finally, turning to guidance for the third quarter on slide 20. We expect revenues to be between $116 million and $124 million, and non-GAAP EPS to be between $0.17 and $0.20. The guidance reflects our view that sales to the semiconductor market will decline as the industry faces a pause. However, a pick up in our solar energy business should help to offset this slow down. Obviously our margins will be lower, given the mix shift between the business units. We also expect to recognize a restructuring charge in the range of $3 million to $4 million, mainly due to space consolidation.

This concludes our prepared remarks for today. Operator, I'd like to open the call for questions.

(Operator Instructions)

Krish Sankar, BofA Merrill Lynch.

Garry, I just wanted to find out your view on inverted demand in the second half in the US and especially what it means for Advanced Energy.

Yes, I mean, we can only speak specifically of Advance Energy. As you know, we got record back logs and there's a hell of an activity out there in the US, so we're very, very comfortable. Now, remember, we do pick and choose what we go for. You saw our margins improved again this quarter, so we don't go for everything, but there's a lot out there for us to go for, so we're pretty comfortable for the year.

Gordon would you like to say anything on that?

Well we have a strong opportunity pipeline going forward, so demand seems to be very strong from the customers that we've been engaging with at inter solar and following up afterwards.

It's important to know the space we're in. I mean, we're in utility where as you know and we told you last time, we've got a hot product. I mean, we really do have a hot product and we released products into the high end of the commercial. But again, now gaining traction very nicely.

So we're very comfortable at the present time. Now that's not to say we can't fall off a cliff, but we are extremely comfortable with the prospect list this high, our backlog is strong, and the profitability of solar, it continues to improve.

So Garry or Gordon is it fair to say you still feel confident that your inverter revenues in 2012 will grow from 2011?

Absolutely.

I hope we sounded confident.

Yes.

Yes.

And we've said before we'd grow 20% year-on-year.

Yes, and we're well on track to do that.

And then a final question on the on the guidance of September, I understand semi is going to be sequentially down, inward, just kind of grow. But I was just trying to get a sense, if you look at the whole thin films revenues, would that overall thin films revenue come down in September or would it be flat versus June?

Just before you answer that question, Yuval, just coming back to solar, just in case you missed it we have absolutely a record backlog in solar. We've got some really nice orders in house, and the prospect list is strong for this quarter. Orders that we may get this quarter is strong.

So at this present time we're comfortable with our 20% growth year-on-year for this business. Obviously if we had any doubts, we'd be telling you immediately, Yuval.

The question was about semiconductors Krish?

Yes, I was trying to get a sense of would your thin film revenue overall into September be flat versus June or would it be down?

It will be slightly down.

Slightly down. Okay. All right. Thank you very much. Thanks guys.

Edwin Mok, Needham.

Can I ask you a question about competition in solar space, have you seen your more competitors coming to this space. And I know your a large competitor talked about they have actually seen some delays or issue there with the supply change here in the US. Have you seen that in the marketplace?

I mean obviously we can't comment about other people's supply chain. We have an outstanding group of people in Shenzhen as you know, who supply chain for solar and that's accompanied by company issue. We're in good shape on supply chain, and as I said we've got strong backlog, so we've got good visibility as well. So we're in good shape.

Okay. So maybe I'll ask it differently. In terms of price competition, have you seen more price competition in the marketplace? I understand, you know, bids for utility scale project has been pretty aggressive. But on the other side we've heard that price has been pretty stable. So, any comment--?

I mean firstly we only choose to go for the business we want to go for. Secondly, we have probably -- and I've used the word Rolls-Royce before I shouldn't use it, I know. And we do have an unbelievable service for our inverters so we do command a reasonable price. We get into a situation where we win, and the customer wins, and that's a situation we want to get into. We can not -- we can't comment on competition. I mean they do whatever they feel like doing, you know.

From the standpoint of Advanced Energy, I mean, year-on-year our gross margins were roughly flat. There's price competition, but we've been talking about our cost reduction initiatives for the last couple quarters, they're on track. And we're seeing them gaining traction. So we're pretty comfortable with where we are right now in terms of being able to be compete going forward.

Edward, let me point out, you know, last year we were not fully allocating our cost. So last year in Q1 we made $500,000 with the full allocation we would have probably lost $1 million, and this year we made $2.7 million. So, as Gordon said, the gross margins while we don't disclose them, they're relatively flat year-over-year and our cost reductions have brought true profitability to the bottom line. In fact, you know a lot of companies still don't allocate their full cost. If we were doing it like maybe others in the marketplace our margins would be 3 or 4 points, better on the operating income percent of sales.

And the reason we do that of course is because we want to be cost conscious. This idea of pulling out corporate costs is just like taxation without representation, really. I mean, the general managers of the business units have a problem with it, so we shove it into the business units.

Great, that was very, very helpful. Jumping on a different side, I was curious, Yuval I think I heard you talked about flat panel only picked up late second half of 2012, why do you feel confident that, that will improve?

We constantly talking to both our OEM customers and also the end users. And as you know Samsung delayed a few times their investment in the next -- the next wave of investment. And we look at right now at the potential pickup in Q4 for us driven by both capacity but also technology investment.

But to be fair, it doesn't matter to us really if it's Q4 or Q1 of next year. The key to us is that costs are coming down, our break evens are very low now, and we can get them lower. And when that peak does come, again, the cash should come in, or the profits should come in and the cash should follow.

So, we're holding our costs down, we're waiting of course for that volume to come, and when it comes, we'll do well. But also we're trying to spread our wings. Yuval has spoken about new markets we're going into to protect ourselves from these cycles. We've got some good wins outside of semiconductor at the present time, and we're really focusing on efforts in that area. So I think over time you'll see us getting out, not getting out -- we'll continue --.

Expanding beyond.

Expanding beyond semiconductors.

Right.

Great, that was helpful. And lastly just since we brought up the topic of cost savings, so if I look at incrementally from first quarter to second quarter was a pretty big step down in operating expense, right? But you guys are keeping your cost reduction targets at exceeding $30 million, right? I was wondering if there's like incremental steps that you guys are taking that has improved your plans, just want to say by half. Just kind of wondering why the targets are the same even though you have, you know, made huge progress actually in the last quarter or so?

Actually, Q2 was an interesting quarter. We had really good performance, but we also had expectations shift for the full year. So whereas at the end of the Q1 we were probably expecting to be well above plan.

Now we're expecting to be on plan, so we made some adjustments to our incentives, to reflect that. That's the nice thing about our new compensation plan, when you do well we accrue at a higher rate and when the expectations come down, we reduce the incentive compensation. So, that's biggest -- one of the largest reasons for the Q-over-Q change.

But if you recall in my comments, I suggested you take the Q2 year-to-date run rate for operating expenses, and that would be good for going forward. We think we'll continue to average at that level for the remainder of the year. As Gary mentioned, our costs are out and I can tell you the culture here has changed in the last 12 months. The costs won't be coming back.

Remember what we're talking about. We're taking -- it's mainly in that $30 million and above operating costs that have come out.

We're now focusing on gross margin improvement, and we're seeing, as I said before, $15 million to $20 million that we can take out. Obviously some of that comes out in pricing as we move forward in the solar business perhaps, but hopefully we can drive our break even down further.

So if you think about our cost reduction, number one we took operating costs out. Number two, we moved -- we are moving assembly to Shenzhen. Number three, we're outsourcing from Shenzhen, and that's what we're talking about when we're talking about that $15 million to $20 million. It's really more outsourcing from Shenzhen.

Number four, which we haven't actually talked about that yet, which is probably the most exciting one when we take this $45 million out, is a design for Shenzhen. So now we're designing products which will come out in three years time probably, two to three years. I don't know, where -- that will reduce the costs further because we'll be designing for this new model that we have. So our target now is now $45 million in total. $45 million to $50 million.

Great, that's all I have. Thank you.

Colin Rusch, ThinkEquity.

Well done on the continued execution. Can you talk a little bit about the growth opportunities for these non-semi thin film applications? It does seem like there's a fair amount of activity for semi-based businesses moving into industrial applications. I'd love to understand what you see as the trajectory for those opportunities that you've got in house already.

Sure, our focus is first to take the capabilities and the applications that we have developed in the semi area and extend them to adjacent market. And we have seen wins in the PVD area for special coatings applications going to the automotive industry, and that's worldwide. And recently we've seen growth in Asia, increase in demand for application for electronic consumer products for unique coatings both functional and decorative coatings for hand held devices.

We expanded our engineering activities and application activities into the food packaging and sterilization businesses. And we have recently took our remote plasma source product line and positioned it for abatement applications for taking care or basically disposing of corrosive or toxic gases. And that applies to many industries as people become more green, we expect to grow this business as well.

Do you have a sense of the magnitude of the growth opportunity there?

We do not disclose it right now. Some of these wins are under confidentiality.

Can you talk a little bit about the growth opportunity in solar just from a geographic standpoint because obviously a lot of remote sites that are now being developed and certainly your solution would potentially be a fit there. Could you talk about how you're approaching those opportunities, and when we might start to see some more significant growth in potentially South America, North Africa, the Middle East and Southeast Asia?

Yes, so we see the growth opportunities from these international markets that you're talking about we're obviously -- I think last quarter we -- we talked about the fact that we had hired someone that was going to -- an experienced person that was going to be looking at these markets for us. We're going to be methodical about it.

We've already announced our plans to enter India with our partner, partners at Bergen. We spent a lot of time looking at the Indian market, but these aren't going to be quick wins for us. As we discussed before, you know, we're really focused on growing the business profitably, and so we'll be taking the feedback that we're gathering from these markets, coming up with the products that we know we will win in those markets, finding the partners that will allow us to provide the type of service and support that AE is known for here in the US, and will keep, you know, updating you as we go forward and enter some of these new geographic regions.

Great, thanks a lot guys.

That's a great answer. If you think about Canada, it's taken us three years to develop the Canadian market, and now we've got traction. We went in there. We got a little bit of distribution. We tried to understand what the customers needed. We revamped our products for the Canadian market, and now we're off to the races.

That's exactly the same as in India. In India we're in there now. We're learning about the marketplace. We are getting ready with products that we would -- still the customers would like and we'll start shipping them. It is a three year process to get through. India for instance is a very, very difficult market, it's very easy to get orders in India. It's extremely easy to get orders. It's very difficult to get paid in India.

A lot of companies outside of our industry have gotten in an absolute mess doing that. We don't want to get in that mess, we want to have product designs for the Indian market, understand how they're going to pay us and do a good job. And then we're going into others after that.

Mark Bachman, Avian Securities.

Garry, you've used the term record backlog several times here on the solar business. Can you put some numbers around this in terms of how large this backlog is. And also, can you just kind of frame, you know, when the shipments or when the delivery, some sort of time frames on when this backlog will be delivered?

We don't disclose that, but I hope you hear from our voices that we're confident in our ability to execute on what we said for solar in this year. So we talked about a 20% average growth rate over the last three -- over the next three years, and 20% growth rate this year.

We are confident that with the backlogs we have and the excitement out there at the present time that we can get there. Obviously if we can't get there, we would inform you as quickly as possible. Before I said immediately, but we'll try and inform you as we always do as quickly as we can.

But there's nothing to suppose at this moment why we won't have 20% growth this year. And as I said, the backlogs are very strong and they're decent margin backlogs as well. So we're in good shape.

So Garry I can hear the excitement here. How do I think about this, you're now pumping out you know, you said a run rate here of $200 million this quarter. Can I think about that there's only a couple quarters of backlog, or can I think that hey, we've got at least four quarters here of run rate to this record backlog that you're talking about?

I'm going to let Danny give you a few numbers and maybe then I'll think of another way of answering that question.

Overall, if you look at the guidance for the quarter $116 million to $124 million. If you think about that, we're probably looking at a 10% to 15% decline in our thin film business and probably a 25% to 30% improvement in our solar business.

As Gorden mentioned earlier, the pipeline's very strong. We certainly are coming into quarter very well positioned and certainly have the confidence that we'll achieve those numbers for the quarter. As you know this business isn't a business where you get a contract, that takes you out for several, several quarters.

You might get one or two large contracts that do that but mostly you'll come into a quarter with most of your quarter covered and other stuff to ship, and then you have the long -- the big contracts I'll refer to your previous Zachary deal. That was obviously a 12 month to 18 month contract, but you don't have a whole lot of those, but you do have some. Gordon, anything to add?

No, I mean if you think about the utility segment as Danny said, you do get these contracts that give you that forward visibility. But you still have orders that, you know, come into play where you're working off a -- you know, a lead time, and you know, the deals are smaller. On the high end, you know, commercial business, we do see situation situations where people expect shipments almost immediately.

So when we say we've got record backlog, that tells you it's unprecedented for us so it's giving us the confidence in the second half of the year. And when we talk about the fact that we have, strong prospects, that indicates our confidence in the higher end commercial business as well.

And Gordon have you been able to win any projects larger than Zachary then?

That's a very good question. We've landed some very nice, large projects. We wouldn't say whether they're larger or smaller than Zachary, but we have landed some decent business.

Okay, excellent. Danny, real quick, can you outline cash flow generation for us in Q2 how did it happen? Just give us a few of the components there before your cash flow statement comes out in the Q. And then how do we think about then cash flow generation in Q3 as well?

Well, if you think about Q2, we generated $33.5 million of cash. That was after-- that was before the repurchases of $35.2 million of stock. In the $33.5 million, there's probably two items that you could say aren't re-occuring.

We got a $5 million tax refund, and we gained about $2.5 million in cash on the sale of our flow manufacturing asset. The rest of it was a combination of $9 million reduction in trade working capital, the operating income that we produced as well as our amortization and depreciation, about $4 million a quarter. Even if you back out the tax and the sale of the flow business, it was still a $27 million, $28 million cash generation. Very strong quarter.

We expect Q2 we expect to continue to drive our DSO down. We came down this quarter from 101 days down to 80. We continued to focus on that with dedicated teams to collect money, as well as our inventory reductions have also come down. So we'll continue to focus on it, but I think this quarter it should be our operating income plus the non cash items of stock compensation and amortization. And then we should see some further reduction in trade working capital.

Yes, I think the only area where I would be a little bit wary, Danny, is that the growth we're experiencing in our solar business means that inventory is coming in at a faster pace. So we need to turn it quickly so there may be a cash drain in that arena. The growth is so strong in that arena, we need to, you know, balance ourselves a little bit with that.

Okay. On the working capital side?

Yes.

Perfect. And then last question on this cash flow, any plans, any ideas about putting in a new stock -- in a new stock plan here -- stock repurchase plan?

Utilization of cash is firstly, making the organization more efficient and you've heard some of the things we're doing to make our organization more efficient. Number two is acquisitions, and we really do have to acquire. We have to broaden our product line within semiconductor, within thin films, sorry -- within thin film and dilute the semiconductor part. So there's an urgency to acquire there.

Now, when I'm talking about acquisitions, we've used the word bolt on or tuck in. Really it's tuck in acquisitions that we are excitedly looking for and that list is building. And I would think in time we would use cash to acquire companies or product lines or technology just to accelerate our revenue growth.

The risk to our strategic plan is not our costs. We can drive our costs down. We can improve our margins. We've got fantastic teams here now.

The risk to our strategic plan is getting the growth number, getting to that $700 million. And the way we can help is through selective, accretive, quickly acquisitions. Cash that's left we will then consider using for buy backs -- for stock buy backs.

Perfect. Thank you. Danny just one housekeeping question, will you go back through why your tax rate is coming up? Was that just solely for the US exposure, and then how should we think about that tax rate for all of 2013.

Yes, for 2012 we have a shifting of where income is being recognized. Obviously we have a very efficient tax structure in certain countries, but with the shift in thin film profitability going to solar we have seen an increase in our tax rate. I would suggest that will be roughly 32% for the full year number.

Now that doesn't include a retroactive reduction if the R&D tax credit is passed in the fourth quarter as most people are expecting it will. That would bring that 32% down by 1% or 2%. In 2013 given what we know today and our thought of what will happen in thin film, we'll probably go back to under 30% on our tax rate as we get a re-shifting of the probability by business unit.

Thank you so much guys and again nice execution here again.

Rafi Hassan, Susquehanna Financial.

Garry, in Q3 of last year you did about $52 million of solar revenue and this quarter you came almost close to that but the margins, the margins are very similar. So how should I think about all the cost cutting that you have undertaken in solar and when are we going to see a more meaningful margin expansion there?

I think you're muddling numbers up a little bit. Probably we're not clear. Let Danny answer that.

You're referring to Q3 of last year when the revenue was the same?

Yes, solar revenue of $52 million.

Yes, I'll need to go back through the Q3 numbers and see if there were any one timers. I don't recall right now, it seems like we probably had some engineering and operating one timers that were in there, so let me -- let me go look at that and when we call you later this morning I'll give you an update there.

Our allocations certainly are different year-over-year. Last year we were not allocating all of our G&A cost, so on average last year that was about $6 million a quarter. So that means that the solar business was probably shy $2.5 million dollars of corporate charges that they would be getting this year. So that could be the driving force, because there is no doubt our costs are down in that business year-over-year on the controllable item, so it's got to just be a timing thing.

So let me looking forward and giving your guidance to get to midpoint of your EPS guidance, margins are coming down because of the solar. So that's also been impacted by fewer dollars of similarly the revenue. So we got margins coming down but your solar business on a relative basis should see a margin expansion.

So two part question. First, how should I think about margin expansion in the solar business in the second half of this year. And number two, how should I think about Q3 guidance, how does gross margin changes compares to operating margin?

Well, you're absolutely right. We have a mix shift between our business units. So the one that has the larger operating percentage income right now is declining slightly, and the other one is increasing. So just mathematically you are going to have an overall decline on a percentage basis.

But if you look at our numbers of guidance for Q3 it reflects continued improvement in our solar business and a slight decline in our thin film business. And as -- I think the best way to model this, is think about the operating expenses on a year-to-date basis, use the average year-to-date run rate per quarter, and go forward and think about those expenses staying flat and now grow whatever model assumption you have for gross margins in the solar business. And whatever gross margin assumption you have in thin film and you'll get to a blended number that will be relatively the same as what we would see internally.

And I think you'll see, the overall businesses improve, and as Gordon grows volume by $10 million or $20 million in a quarter, that gross margin's going to fall to the bottom, because our cost is not going up. The same thing with you Yuval.

Would your 2% solar operating margin double or triple by Q4?

Well, if you run the math, if they get $20 million more revenue and say they get, you know, 25% or 35% margins, whatever your assumption is, that's another $5 million or $6 million or $7 million of operating income over what they had this quarter. So, you can do the modeling and see a very profitable business.

And that brings me to a point. You know Garry mentioned in his remarks we have a clear pathway to our goal of $2 a share. If you just take where we are today and then you have thin film revenue coming back to where it was, and you have our solar business growing at its 22% cager that we laid out for you last November, you can get to our $2 a share pretty easily by 2014. Because once again the costs are staying in check, and the costs actually are accelerating with the extra $15 million to $20 million that we think is available in our gross margin, we will probably get there even sooner.

Now, can I -- one correction to what you're saying. Within the solar business we're actually adding salespeople and service people at the present time because of the large prospect list. So there is some increase in our selling costs at the present, and sales people tend to take three to six months to get off to the races. So there is a cost there but we -- but we all -- so just so you know, I mean the growth is there -- growth is there and we're adding salespeople, so there is a cost there.

Thank you.

Your next question is coming from the line of CJ Muse from Barclays.

Hi this is (technical difficulty) call in for CJ Muse. I guess, you know, touching on the assembly side you talked about 3Q being a pause. Just wondering if you currently have any of facilities recovery in 4Q and if so which end projects do you anticipate to drive that recovery?

The visibility that we have for Q4 is relying mainly on our customers' input, and right now we see a mixed picture. And it really depends on some of the decisions that will be made regarding Q1 at the end user for investment, because we usually lagging about one quarter behind in our shipment.

But we continue to -- we continue to focus on preparing to next year what we believe will be an improvement next year. And we continue to win design wins in areas that will secure our future both for 450 millimeter wafers and technology solutions for 22 nanometer nodes. So in terms of Q4, I can not give you a clear answer regarding that. What we hear from customers, that as expectation will be slightly up compared to Q3, but the information is really mixed, depends who you talk to.

Yes, again, remember what we said before. Our costs are in control. They're coming down, if anything, within thin film. So we're in effect when that volume does come, we're in good shape, but we're also expanding into new markets.

Someone asked before how big are those markets that we're expanding into. They're huge, and there's lots of opportunity for us outside of thin film. It will obviously take us time to get into them, but we are already, as Yuval said, starting to win some business.

And we're structuring ourselves slowly to cope with this new type of business. It's very, very different to the semiconductor business and actually it's held us back. Semiconductor in some ways has held us back from this other business and Yuval has restructured his organization so that it can now take this new business on. It's really exciting. I mean there's some great applications that we can get involved in.

And then just a follow up on your comments regarding talking acquisitions. How should we think about, you know, the potential sizes of these deals and what level of cash you're comfortable with on the balance sheet?

Okay. So your question is how should we think about the acquisitions. We're mainly looking at small technological acquisitions that fill holes for us. That would cold down our distribution channels, could be manufactured in Shenzhen.

We're not thinking of having little manufacturing sites all over the place. We'll have one manufacturing site, centers of R&D, excellence and our wonderful distribution channel and names. That's how we think about it.

So these are more tuck in like acquisitions into the Company, so they are going to be small. They may be small in revenues now, but our hope or our plan will be that those small revenues would grow because of our distribution, and their costs would go down because of our manufacturing. So that -- you can think of smallish acquisitions, accretive reasonably quickly. I don't think any acquisition of this type is accreted immediately. There's always work in the first six months but accretive after that, and off we go.

We're looking at targets that will be very complimentary to our product portfolio, and addressing areas that we believe we can buy faster than make. And also acquisitions will take us beyond the thin film business into adjacent or really totally new markets.

Thank you.

James Covello, Goldman Sachs.

Hi guys, it's Mark Delaney calling in for Jim. Thanks for taking the question. I guess first there's been a lot of consolidation recently in the semi equipment industry at some of your customers, and also a number of international cost restructuring's along the lines that you're doing yourselves. So I was wondering if you could talk about those change customer dynamics how that's impact your semi-equipment business?

So the consolidation in the market definitely reduces the number of customers we deal with. And they become bigger and more strategic, and enhance the focus on new engagement model that we have to really get really closer to them and engage with them in an early stage of development of their products. We have taken a few steps towards that, you know, direction with the building of the engineering center in San Jose for example. The upcoming move of the California headquarters closer to our key customers, investment in engineering centers in Asia closer to our customers. All these, you know, preparations and the investments were in anticipation for a strategic relationship with the customers.

That already has helped us to accelerate some of the wins we have recently won, specifically in the semi area in 22 nanometer technology and beyond and 450 millimeter wafer sized investments. And what we believe is going to happen, our customers will rely on a smaller set of suppliers that are much more strategic, intimately linked and that will also allow us to reduce our cost of developing, the cost of R&D, and will protect us in terms of, you know, our business model going forward.

Thank you Yuval, that's helpful. And then as follow up question, with the cost reduction efforts that you have underway and the new products that you're working on that will be rolling out in the next couple of years, do you think the total corporate average gross margin can exceed 40% by 2014?

Well, obviously that all depends on the mix of the solar business and the thin film business. I think it'd be -- I don't see the solar business going to 40% plus margins like you have in thin film, but I think the mix of the two -- what I do know is that our EPS will continue to grow. And as we mentioned we see a very clear pathway to our $2 target that we laid out last year.

Okay. Thank you very much.

At this time I'm showing no further questions in queue. I would like to turn the call back over to Mr. Garry Rogerson for any closing remarks.

Thank you very much for being here today. Just a few key points that maybe we should remember.

Solar is now profitable and we're looking for growth, continued growth in the solar business, the backlogs are really strong. Thin film is in a down at the present time, but remains profitable. We're expecting to find new markets in thin film and new geographies in solar, and we have plenty of cash. We're in absolutely great shape in relationship to our strategic plan and going forward.

So thank you again for being here. See you soon. Bye bye.

Ladies and gentlemen, that concludes today's conference, we thank you for your participation. You may now disconnect. Have a great day.