Advanced Energy Industries Inc (AEIS) 2012 Q3 法說會逐字稿

Good day ladies and gentlemen, welcome to the Advanced Energy Industries earnings conference call. At this time all participants are in a listen-only mode. Later we will facilitate a question and answer question, at which time you may press star one to participate. (Operator Instructions). As a reminder, this conference is being recorded. I would now like to turn the call over to Annie Leschin, you may proceed.

Thank you Operator, and good morning everyone. Thank you for joining us today for our third 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. Gordon is returning from the Canadian Solar Show, and will be joining us via cell phone, so we apologize in advance for any background noise. By now you should have received your copy of the earnings release that was issued yesterday evening. For a copy of the release, please visit our website at advancedenergy.com, or call us directly at (970) 407-4670.

This quarter Advanced Energies will be hosting its Analyst Event on November 15th in New York and also webcasting. We hope you will join us.

Finally I would 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 from those expressed or implied by such statements. Statements that include the terms believe, expect, plan, objected, estimates, anticipates, intends, target, 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 of 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 this Forms 10-Q, 10-K, and other forms reports filed with the SEC. In addition, we assume no obligation to update the information that we did provide you during this call, including our 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 would now like to turn the call over to Garry Rogerson, CEO Advanced Energies. Garry?

Good morning, and thank you for joining us. I will begin today with a summary of the quarterly results and then provide an update on the progress we have made executing on our strategic plan. Beginning with slide four. Overall we achieved our goals this quarter, with total revenues of $117.5 million, $0.20 of nonGAAP EPS, and $25 million in cash generated during the quarter, a sound result. Despite the slowdown in our Thin Films business that was by and large expected, we compensated with revenue growth and expanded margin contribution from our solar energy business.

Turning to slide five, in Solar we had large shipment of solar inverters to utilities, which drove good revenue growth and more importantly, improved operating profits. In the last year we have transformed the cost structure of our solar business. This quarter we reached our 2014 operating margin target, of 10% to 15%. This is a good accomplishment given we barely broke even in the first quarter of 2012. This quarter shows that with a disciplined sales approach and a passion for cost containment and reduction, we can both grow revenue and expand margins at the same time.

In our Thin Films business we continue to win a high percentage of designs at key customers in our core markets, reflecting our ongoing investment in R&D. We believe this is an differentiator in the industry, and one that is enabling us to enter new adjacent markets such as gas abatement and opthalmic lens coatings. Our results are very impressive in light of the fact that we are in the midst of a major revenue trough in our Thin Films markets. The performance was due to a continued diversification into new markets and a structured reduction in costs.

Turning to slide six, our efforts to reduct costs in both businesses were again clear this quarter. Operating expenses were at the lowest level in two years, and nonGAAP profitability rose to $0.20 per share. None of this would have been possible a year ago. We have made fundamental changes to the structure of our business, to position ourselves to more profitably weather cyclical downturns, and generate significantly more profits during industry peaks in Thin Films, and actually make money in Solar when we grow revenue.

To highlight just how significant our turnaround has been, let me compare this quarter's results with those of a year ago. Last year our operating income included an incentive reversal of $3.1 million, while this year has a normal inventive accrual. After adjusting for the difference in incentives, we produced $3 million more in profits, and generated $25 million of cash, on $11 million less of revenue this quarter, and a much less favorable product mix by Solar,a remarkable change.

The potential of our financial model that we laid out a year ago is becoming a reality. As a more cost-conscious, cash-focused company with an established solid foundation from which to build and grow our business, we are driving even more efficiency improvements in manufacturing towards the implementation of processes, such as demand flow technology. With our new supply chain management team located in Shenzhen, China, we are further outsourcing certain parts and components to lower our cost of manufacturing. In fact, we reduced our annualized cost of material in the third quarter in our solar business by about $10 million. Overall we have just begun to recognize the significant benefits of maximizing our world class Shenzhen facility, and there is much more to come. In parallel we are stepping up our efforts to accelerate revenue growth for a more disciplined design approach, utilizing Lean and localized R&D, applying our product and technologies to new applications in adjacent markets and geographies.

We are also exploring a variety of ways to utilize our cash, such as investing in complimentary technologies and revenue streams to fuel additional growth in both businesses, and return value to shareholders. Having recently completed our buy back, our focus now is to deploy cash and potential accretive acquisitions. AE has fundamental changed the way it operations, and is now focused directly on driving long term sustainable growth, profitability, and shareholder value. We are looking forward to seeing you in a few weeks at our Analyst Day, and taking you thorough our path to reach $2.00 in earnings per share..

Now let me turn the call over to Yuval.

Thanks, Garry. Beginning with slide eight, third quarter revenues in the Thin Film business declined 12% sequentially to $56.8 million, and decelerating demand across our markets impacted sales worldwide. Operating income declined to $6.1 million, or 11% operating margin. Slowdowns and delays in capital spending seemed pervasive this quarter from semiconductors to flat panel display to solar equipment, companies are facing high inventories, low utilization rates, and growing challenges for next generation technologies. For example, the anticipated pick-up in the flat panel TV screens in the second half of 2012 has not materialized. With only touch panels driving the industry at present, and the migration to next generation AMOLED technologies suffering from cost and yield issues, revenues and investments look to be muted for the next several quarters.

The Semiconductor market is also confronting a myriad of challenges. Slower than expected growth in memory for mobile devices continues to cause oversupply in NAND and DRAM. The equipment needed for next generation 14-millimeter nanotechnology node is expected to be less than was required for 22-nanometers, and the equipment we used is further constraining the outlook for capital spending next year. What we know from experience is that while the Thin Films market are cyclical, investment in next generation technology is not. Our practice of consistently investing in R&D has solidified our relationship with large semi OEM customers. This puts us at the forefront of their next generation designs, and provide us entry into new markets.

This quarter our successful record of design wins at existing and new customers continue. We had 43 design wins this quarter, with two-thirds of those we participated in across all of our served markets, and nearly three-quarters of the semiconductor opportunities specifically in Etch and DVD content. We expect our industrial wins to drive short-term revenues while our semi design wins will transition to high volume ramps in 2013 and beyond. Our advanced [RF Paulson] capability developed in the last year is enabling our customers to create processes for their next generation technology nodes, and overcome challenges they have seen in 22-nanometers prior to the availability and introduction of RF Paulson. This capability is fast becoming an important differentiator for AE, and is allowing us to penetrate major OEMs worldwide in etch and DVD.

We are also seeing more customer evaluations in new application development capabilities outside of our traditional thin film markets, with the creation of our thin film industrial team, this is affording us the flexibility to pursue new markets that can generate near term revenues. For example, the gas abatement design win that we announced this past quarter is now generating hundreds of units in shipments and millions of dollars in revenue. More recently, we won designs at the major Japanese touch panel manufacturer and an opthalmic lens coater, and an automotive headlight coater, to whom we are already shipping products. These are but a few of the many opportunities that lay ahead for the thin film industrial markets.

While we develop new avenues for growth to offset market technicality, which are simultaneously pursuing programs to further reduce our costs internally and throughout global network. This quarter we took several steps to drive more efficiencies and localize resources closer to our customers. First, similar to our new localized engineering center in San Jose, we have begun to establish an engineering office in Sung-Nam Korea, to become more intimately involved in our customer's design process. Next, we will launch a new distribution channel strategy to align a global support for the already existing and new customers global footprint.

We are enhancing our local capabilities through select partnerships and co-locating with our partners. Beginning in October, our partner [Abarra Filtech EFE] will provide product and service, sales and support for AE Thin Film products in Japan. EFE's network will aid our Japanese customers by providing broader and deeper support and engagements, reflecting our commitment to these customers.

In summary, the Thin Films markets continue to struggle with various challenges and stages of cyclicality. Recent capital spending announcements by significant customers provide further evidence that the outlook for most of our thin film market could remain at cycle lows for the next few quarters. However, our continuing investment in R&D and the designs wins that we have secured this year, in both semi and the thin film industrial markets, lay the foundation for us to accelerate our growth as customers move to next generation technology, and markets recover. We remain focused on developing new avenues to accelerate revenues, reduce costs, increase efficiencies, and improve profitability.

I would now like to turn the call over to Gordon to discuss our solar energy business.

Thanks Yuval. Beginning with solar revenue. Revenues in our solar energy business increased 20% sequentially to a record $60.7 million this quarter, representing 52% of the Company's total sales. Growth was fueled by large utility shipments, as well as large scale commercial sales in our target US market, as well as a growing contribution from Canada. During the quarter we shipped 251 megawatts versus 210 megawatts last quarter. After several quarters of implementing our various cost reduction efforts, we reached our 2014 target operating margins of 10% to 15% ahead of schedule. Operating profit grew to 12% of sales, or $7.4 million, compared to just 5%, or $2.7 million last quarter.

As Garry mentioned, Solar operating margins may be closer to 10% in the next few quarters due to product mix, but we are beginning to see the scalability and profitability of our model as we strive to grow and build our business. To expand on low cost production efforts I am pleased to report that we have successfully completed phase one of our plan to transfer subassembly manufacturing to our facility in Shenzhen, well ahead of schedule. A similar plan will be focused on driving improvements in manufacturing and cost of goods, having centralized the supply chain in Shenzhen, we are looking at a variety of ways to take additional costs out of our products. We are now beginning to outsource certain components from the factory in Shenzhen, and move some of our newer products to Shenzhen, for lower cost volume production. These steps are expected to result in significant additional savings, and with the Company's enhanced tax focus, we believe there will be future opportunities down the road.

As our profits grow we will be making strategic investments in our business where opportunities present themselves. For example, this quarter we continued to increase our presence in the US and Canadian markets with the addition of more customer-facing personnel, including applications engineers, sales people and service personnel, to better serve these regions by maintaining our high quality differentiated customer service and support. We are also thoughtfully evaluating organic and inorganic strategies to enhance our products, technologies, and distribution channels, so as get in a position to accelerate our expansion outside of the US. In Canada we have had several significant wins this quarter. Our newly established Canadian manufacturing facility is successfully up and running, and it is a key selling point for potential Canadian customers.

This facility demonstrates AE's commitment to this market, and allows us to scale with our customers. Based on the opportunities we currently see in the pipeline for the next few quarters, we expect Canada to become an important market for us. In other regions we are making progress developing products with our various partners, and establishing local relationships to position us for success in our chosen territories. In China we are diligently working with our partner SGEG to jointly develop our products specifically for China. Once complete SGEG will have the rights to market that product in China. With the rights to this product, AE intends to further design and modify this product as a low cost inverter for sale in other emerging Asia Pacific markets. To be successful in various territories, we must be very strategic in our selection of the geographic markets that are best suited to our products, and our choice of partners with whom to enter these regions.

In closing, we are pleased with our current performance. This quarter is just an example of how we are focused on cost reduction over the last year is beginning to demonstrate real results. We have a solid backlog and a strong pipeline of opportunities that we believe put us in good position as demand for large scale commercial and utility scale products continues. However, we do not anticipate the same sequential increase in revenues that we saw the last two years in the fourth quarter, given the expiration of various cash grants and tax programs. While the broader solar industry remains in a period of oversupply, with reductions in government subsidies and ongoing consolidation, we believe our ongoing cost reduction efforts, strong customer relationships, unparalleled customer service, and solid balance sheet, position us for continued success in the North American market and worldwide.

I would like now to turn the call over to Danny to discuss our financial performance. Danny?

Thank you Gordon. During the course of my remarks, I will refer to both GAAP and nonGAAP results. NonGAAP measures exclude the impact of the restructuring charges recorded in the third quarter. A reconciliation of nonGAAP income from operations and per share earnings is provided in the press release table.

Turn to the highlights of the third quarter on slide 14, total revenues were $117.5 million, an increase of 2% sequentially, while a decrease of 9% compared to the same period a year ago. We ended the quarter with a strong balance sheet, holding $173.7 million in cash and investments, having generated $24.7 million in cash flow. More recently, we also put in place a $50 million revolving credit facility for potential acquisitions and working capital purposes.

Turning to the revenue performance on slide 15, revenue for the Thin Films business unit increased 12% sequentially to $56.8 million, or 48% of total sales. The majority of the decline was driven by the 19% sequential drop in semiconductor revenues to $29.7 million. On a sequential basis, results across our thin film markets were mixed this quarter, with flat panel sales decreasing $1.9 million, and solar equipment declining to $0.7 million. While Data storage and industrial sales increased to $10.9 million, and service increased to $13.6 million.

Turning to performance in our Solar Energy business unit, we had a record quarter with sequential revenues increasing 20% from last quarter to $60.7 million. Growth was driven by utility scale deployment for the US, as well a meaningful contribution from the Canadian market.

Turning to slide 16 during the quarter we took a $3 million restructuring charge as we further reduced our footprint by consolidating our service operation in Japan to Korea. Our charges are expected to be implemented over the next three months as we further reduced our footprint, by consolidating our service operations in Japan into our Korean facility. The remainder of our restructuring charges are expected to be implemented over the next three months, as we further reduce our cost structure by consolidating certain facilities and centralizing other activities. This should result in charges of about $1 million to $2 million, principally for facility consolidation and another $1 million for severance costs.

These restructuring actions, along with other cost saving initiatives and margin improvements for delivering annual savings in excess of $30 million. Our ongoing cost reduction initiatives reduced operating expenses by 6% to $35.8 million this quarter versus $38.2 million in the same quarter last year. However in the third quarter a year ago we benefited from a $3.1 million reversal of year-to-date incentive compensation. It is including that charge, operating expenses declined even more, down 13.5% year-over-year.

With our lower expense structure, total operating income excluding restructuring charges and amortization of intangibles improved to 12.2% from 10.8% sequentially, and 11.5% in the third quarter of 2011. This was driven by the strong operating performance of our Solar energy business, and 12% operating margins, or $7.4 million. This compares to operating income of just $2.7 million, or 5% of the second quarter of 2012, and $1.3 million or 2% in the third quarter of last year.

In our Thin Film business, operating margin was 11%, or $6.1 million,down from $8.9 million in the second quarter due to lower revenues caused by overall industry declines. Turning back to the third quarter on slide 17, income from continuing operations was $5.7 million, or $0.15 per diluted share. This compares to income from continuing operations of $8.8 million, or $0.22 per diluted share in the second quarter, and income of $7.2 million, or $0.16 per diluted share in the same period last year. On a nonGAAP basis excluding the $3 million restructuring charge, income from continuing operations was $7.6 million, or $0.20 per share during the third quarter.

Taxes were $4.3 million, or 43% in the quarter, as a greater proportion of our revenues were generated in the US. In the near term, because we expect a higher percentage of our revenues to come from our Solar energy business, which mostly occurs in our higher tax US market, we have adjusted our full year 2012 tax rate to 36%. This assumption does not include the potentially favorable impact of 1% to 2.5% from the R&D tax credit should it be approved prior to year end.

Turning to our balance sheet on slide 18, during the quarter we generated $24.7 million in cash to end the quarter with $173.7 million. Trade working capital decreased $2.2 million during the quarter, stock option expense was $2.8 million, and depreciation and amortization was $4.5 million for the quarter.

Before I move to our guidance for the fourth quarter, I would like to quickly recap the actions we have taken over the last twelve months. In September 2011 we began an aggressive restructuring plan, to focus our Company on shareholder value and profitability. We restructured our Thin Films business in September of 2011,Our Solar energy business in December of 2011, initiated a $75 million share repurchase in November of 2011, and changed our compensation program in the first quarter of 2012. In addition to these actions we have completed the move of our subassemblies to Shenzhen, and reduced our footprint across the world.

All of these actions have laid the groundwork to position our need to remain profitable in low revenue quarters and maximize profits when the capital equipment investment cycles return to normal levels. This quarter was a perfect example of how these cost reduction initiatives are working. Excluding the incentive reversal that took place last year in the third quarter, and the incentive accrual that we took this quarter, operating income improved $3 million year-over-year on an annual revenue decline of $11 million.

Finally turning to guidance for the fourth quarter on slide 20, we expect revenues to be between $105 million and $115 million, and nonGAAP EPS to be between $0.13 and $0.18 per share. The guidance reflects our view that sales to our Thin Film markets will continue at cyclical lows, due to lower CapEx spending and the uncertain demand environment, although we do not expect to see the sequential increase in solar revenue that we have seen in the past few years, due to the expiration of certain cash and tax grant programs. Overall momentum in our Solar energy business should help to offset the slowdown in capital spending. We expect that our operating expenses will remain at the current year-to-date run rates, and believe that Solar energy margins normalize at the lower end of our 10% to 15% target range. We also expect to recognize our final restructuring charge of $2 million to $3 million in the fourth quarter.

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

Thank you. (Operator Instructions). The first question comes from the line of Krish Sankar from Bank of America Merrill Lynch. You may proceed.

Thank you for taking my question. I have two of them. Garry, I don't know if you can give any early view into what do you think overall you think the industry is going to do on the inventory side in 2013, and what it means to advance, and if you expect to continue to grow in 2013 on the Solar Energy side, and what kind of numbers should we think about?

That is a very good question. A year ago we said we would grow roughly 20% per year over a 3-year period, and that is what we think we are going to do now. The backlog is pretty high at the present time, and the activity in the US and Canadian marketplace is also very strong. And we are well positioned obviously, very strong in utility, very strong in high end commercial. We expect on average over this period to grow roughly 20% per year, and this year, the year we are in now won't be an exception to that. We will be roughly thereas we go forward. We are in a good position.

Got it. And then in your Q3 revenues of $60 million or even in terms of megawatt shipment of 251, can you try to give us some color on the split geographically between US, Canada and others?

I will pass that to Gordon in a second. That is also a good question. I think the good thing about the quarter by the way, was that we are starting to make money in Solar. Gordon's actions in choosing the customers that we take, not growing with the market, focusing on making money, as opposed to focusing on growing revenues is actually starting, we are starting to see the light. It is going to be a bumpy ride as we move forward, but clearly we can see that it is possible to do. Gordon, do you want to talk about geography?

Yes. At the present time our results are driven by our operations in the United States and Canada. Canada is growing in importance, and we are looking actively at regions outside of the US and Canada for next year. We are making our distribution plans, we are looking at developing the new products that are going to be required to be successful there. As we have said, we will continue to update as we achieve milestones in terms of our international expansion to underpin the growth strategy for next year.

I think really important our products are designed for the US and Canada. That is why we are successful for the US and Canada. It is very difficult to bring an European product in and sell it, so we are in a good position.

The flip side of that, sadly, it is very difficult to get out of the USA. We need to design products for the different countries, and virtually every country has different requirements and different regulations. That is why you are seeing people hit brick walls when they try and enter new countries, because the regulations are different, and the products are different, and of course the cultures are different, but that is probably the third part of that puzzle.

Is there anything, like you did $61 million in Q3, is that like a 90/10 split between US and Canada? Or is it like 80/20, 50/50, just trying to get a sense?

They are good numbers. The first numbers are good numbers. Mainly the US, and a touch of Canada. The touch of Canada is growing.

Got it. Then just a final question from my end. The product you are developing with SGEG in China for the Chinese market, is that the target to be the 10% to 15% margin op range, or would that be slightly lower?

To be clear about the SGEG product, it is a product that we are collaborating with them on, so that they can sell it in China. We will receive some royalty income associated with their sales in China. The exciting part of that relationship for us is we have the rights to that product for all regions outside of China. And as other countries are demonstrating that they are very price sensitive, having access to a high quality, low-cost product that we can commercialize specifically for some of these lower-cost regions, is going to be very important for our success in the future.

Yes, I think this collaboration that we are now with SGEG from three or four months ago is one of the keys to our growth in 2014. The product they have developed is spot-on in costs. It is a really, really low cost. They know how to design low-cost product. We will adapt that and take it into other low-cost markets.

For instance India. India is a country where we are learning at the present time. We are not going to crow about big orders in India. We are learning. We have got excellent distribution in India, we now need to develop the right products for India, and then we will grow in India. And SGEG is a company that is absolutely going to help us. We have seen some wonderful things in design come out of that shop. By the way, just I shouldn't say it one way because we are also adding a lot to their product.

Yes, our expertise in controls is really going to help them come up with a world-class product.

Great. Thank you, and congratulations on the execution, guys.

Thanks, Krish.

The next question is from the line of Joe Maxa of Dougherty & Company, you may proceed.

Thank you. On that SGEG product, when is the ballpark time frame that would be available?

As we just said for us we are thinking it is going to help us in 2014..

Okay, and you'll get royalties if they sell something before that in China?

We have an agreement with them that when they sell in China we will get something, yes.

So overall in solar, if you are looking for 20% growth next year around average, when do you anticipate you will be able to reach the high end if at all on that operating margin?

Well, I think at the end of this time period we said we would be somewhere between 10% and 15%. That is where we will be. We will probably be nearer the high end if we grow at that 20% per year, but we are very happy with our progress so far. Actually, if you look at our progress in everything we have said we would do, it has not been bad. I think you should start to believe us.

And on the competition that you briefly touched earlier, can you give us a little more on what you are seeing on pricing pressure? It sounds like it is not very significant given your results, but I would just like an update on what you are seeing out there?

Obviously we don't talk about competition. They do their thing. We do our thing. What I would like to say is that we are focused on making money, or attempting to make money, and to grow the business at a reasonable rate, so that is what we are doing. Gordon, do you want to say anything else?

Yes. There are definitely competitors out there that like to lead on price. As we have said before, we feel that we have got a good strong product offering for people in the industry, in the markets that we serve. We also support our products very well, and so we have been very successful with that.

Okay, thank you, guys.

Thanks Joe.

Your next question is from the line of Edwin Mok from Needham and Company. You may proceed.

Hi guys, thanks for taking my questions. First question on the guidance just to be clear, are you guys expecting sort of a flattish solar and better business in the fourth quarter, and that would imply kind of a low double digit or a little more than a 10% decline since then?

Yes, our guidance assumes that we will probably be flat to slightly down in the semi and thin films area, and probably flat to up in the solar business unit.

Okay. That is helpful.

Just as a point. As we get more into the utility area, it is really a warning, because gets much more lumpy the business. You can expect to see lumps from us as we go forward. Probably, I mean the shipments in Q3 were a touch over, they weren't overstated, they were the numbers. But we had a few strong shipments into utility, so you are going to see a lumpy business. On the other hand for Q4 as we said, there is no regulations forcing anyone to buy in Q4. Last year that was probably artificially high. We are thinking we will be a touch up in Q4 from Q3.

Great. That was a good call. Actually, that leads to my next question. It sounds like, at least based on what you guys are seeing, there is no cash ground fall off this year like last year, and therefore you won't see a big comp ramp up in the fourth quarter, right? So should we expect less now in the decline for the March quarter then, as a result of barring all of these inequities on monthly order--?

The first quarter, January, February, March on both accounts will be a tough quarter. Thin Films, sorry to jump from Solar to Thin Film. Thin Films is not going to be a joy ride in Q1 of next year. And Solar of course, it is winter and we are in the US, so we would expect to see a seasonal dip. I can imagine that Q1 will be a hard slope for us. But because we have our costs in control, we feel that we can get through these things quite nicely. We are not taking any actions internally at the present time, a year ago we scaled ourselves to the business that we expect to get, so we feel in good shape to get through this without touching our R&D, without touching our sales. In fact in Solar, we are increasing our sales. In Thin Film we are increasing distribution in countries like China. So we are actually investing through this period. So I don't know what the question was, but that is the answer.

That was actually a very good answer. So one more question related to Solar. On the operating margins of the last quarter was very strong, like 12%, and I think your guidance you said was roughly around 10% in the coming quarter, probably just because of a result of the revenue level. You also mentioned that product mix plays a factor for you? Can you comment on that?

We don't tell what you the product mix is, so let's not go there, but there was a shift into the utility side, and a few minutes ago I said it is lumpy. The business is lumpy. So we had a shift into utility. That meant our margins improved a little bit. So, yes.

Now this quarter we are probably going to get more of a balance towards commercial. Which would mean the margins would come down a little. In general our margins are improving as the volume is increasing and the costs come under control. Last quarter, just to give you an example, last quarter, we obviously review every quarter. In the last quarter our supply chain in the Solar business took out $10 million of costs annualized on product they buy. The product they buy in. In one quarter they took out $10 million. When Danny said we have taken out $30 million so far, it is actually north of $40 million. Obviously the cost of manufacture and price erosion go together. We always say the $30-odd million that is gone will never come back. I suspect some of the costs that we are taking out for the products today will be lost in pricing erosion, which is normal on any piece of capital equipment. But that is where we are.

Great, very helpful call. Last thing on the Thin Film side, thanks for giving some description on some of the markets that you guys are targeting, such as the gas abatement. Any chance you can give us your way of thinking about market sizing, in terms of how big do you think those markets are, where do you think you can get to in a one year time horizon, and anything beyond that would be helpful, thank you.

Hi, Edwin, this is Yuval. The abatement, the gas abatement business we started delivering to this year, we started with just between $1 million to $3 million type of revenue per quarter, but that will materialize to north of $10 million a year as a first step for this market. The market is very large because of some regulations associated with PFC abatement requirements, and our product is a point diffused product that is being used on the vacuum line that goes from processing chambers, as opposed to large products that are more centralized. So the cost of ownership of this product is very attractive. The market is very large, north of $100 million. It will take us some time to get there, but we are making good progress right now. I will annualize the opportunity for the short term, north of $10 million a year.

Great, that was helpful. Thank you.

Edwin, can I just continue that answer?

Sure.

In a more general way. Firstly, at the moment we feel that we are building a great foundation for the Company, whether it is on our margin improvement program, whether it is our focus on cash, we think we have got a nice foundation. We have got a nice structure to grow in. And Yuval is taking us into new markets, and obviously in Power, there are many, many new markets we can go into. We have to be selective, and not be all things to all people.

But at the same time in both businesses we will be utilizing cash to grow the business. So before I used to say we are just starting to look at acquisitions, year two of our strategic plan, we need to grow our revenue base. We need to position ourselves for year three. That will mean utilizing some of our cash hopefully, we have to be realistic here to grow the top line and get us into new markets. So I think what you are going to see is Yuval pushing into new markets organically, you are going to see Gordon pushing into new countries in effect, slowly, carefully, we don't want to get bloody noses. And at the same time we will layer on top of that acquisitions. We can do that because we now have got a decent foundation from which to grow from. Just as a comment.

Thank you.

Your next question is from the line of Mark Bachman from Avian Securities. You may proceed.

Hi, Garry, can you clarify one thing for me. You made mention about the SGEG product coming about in 2014. But Gordon's slide says first half of 2013. Can you clarify those two points?

Let Gordon explain that to you.

Mark, the product will be released in China, and we anticipate launching the product some time in the second half of next year. But what Garry is talking about is when you will actually see a substantial revenue impact for us, for our sales into places like India. Garry and I are just addressing two different aspects along the timeline. Go ahead.

SGEG is with us designing a product that they are going to release some time next year into the marketplace in China. We will get a royalty from that, but don't get carried away with the royalty. The reason why we are wanting this, is because they know how to design low cost products that we have the right to take out of China, probably modify it because the Chinese product doesn't work as-is in India, or wherever, so we will have to parallel some other things to it to get it there for the Indian market.

Then we have to take our time in these markets. I really stress we don't want to get a bloody nose as we go into these places. It is so easy. We have all been to these countries where it is very different. Payment terms are different, where the products are located is different, everything is so different there, and we don't want to get a bloody nose in the it. Others have, and certainly I have in the past. I have bloodied my nose and thought it was very easy to get into India, and it is not easy, and we don't want to do that. We want to learn from our experiences, and get it right.

Excellent. Thanks for that. Gordon, can you explain the SGEG product a little bit more in detail, in other words, which end markets are you going to go after there in China?

That is something that SGEG is working on. They will distribute in China, that are responsible for the distribution plan in China. As Garry has alluded, we will receive a royalty stream, but it is not going to be something that has an enormous impact on our P&L. We are more focused on the technology, understanding how we can adopt it to these other markets that we have been talking about, so we will make our margin selling that product directly into territories outside of China.

Okay, I guess I was trying to just get some color whether or not you were going to go after, say commercial-type installations? Do you expecting to after utility-type installations? How do we think about whatthis product is going to address?

We think about this product as something that would support ground mount installations. It is certainly not intended to be a product for roof-top commercial business.

A utility type, low-end utility.

Low-end utility. Okay. Lastly Gordon, does the Japanese market, does that hold any promise for you, given where the Thin Films business has gone? Does the Japanese market in inventers open up some doors for you at all?

Yes, Japan is an interesting country. As you know, AE has an established presence there that we are leveraging. It is also a very complex market. Layers of distribution, and very specific technology requirements, and very demanding customers. Along with the theme about bloody noses, we want to make sure that we understand the requirements, we understand the customer needs, that we have products that line up with those, and we are organizing our distribution so that we can make a big push into Japan. It is not going to be a significant contributor to our revenues in the short term, and as I have said, as we achieve milestones along our plan we will constantly be updating.

Yuval can you comment on Thin Film in Japan, and what we are doing now?

Sure, Mark, we have modified, as we indicated in the call, we have modified our product, and developed a hybrid model, in addition to our direct sales and service in Jana, we have teamed up with Abarra which is a very powerful company in Japan, that has a very broad footprint in Japan, which will increase our localized presence, and will increase the number of service and sales offices in that country. That infrastructure will allow us to drive more products into Japan, and also can be the starting point for the inverter business when it is ready, to take the inverter products also to Japan more quickly and effectively when we are ready.

Yuval, thanks for that, that is very helpful. Gordon, one last question from me on the Japanese market, should investors expect any jet certifications then on your inverter products in 2013 for the Japanese market?

Jet certifications in 2013, I would say that would be a realistic goal for us. We won't be able to sale in Japan unless we are--.

We have to. Yes, the answer is yes if we are going to sell into Japan.

Excellent. Thank you so much, gentlemen.

Your next question is from the line of Mehdi Hosseini, Susquehanna International. You may proceed.

Thanks for taking my question. A follow-up to the Thin Films business, how should I reconcile the operating margin profile back in Q4 of last year, you gave about $54 million but operating margin of 14%, and in Q3 of this year a few million dollars more in revenue, but the operating margin is 300 basis points lower. Is that a mix issue in the thin film, or something else?

This is Danny, it is actually a corporate allocation change from last year. If you recall last year we weren't allocating all of our corporate expenses out, this year we are. That is worth 3 or 4 points of operating margin to the business units, and it impacts both Solar and Thin Films. Because of the actions you all took last September, our breakeven is considerably less than it was in the past, and we are actually doing better today than we would have been doing a year ago. If revenues returned to where they were a year ago, we would be certainly above the operating income and that is with a higher corporate allocation.

Got it. Danny, why did the SO go up almost ten days? I am sorry, inventory?

Inventories, is we get ready for shipments in Q4, we had some increases in our inventory in our Solar unit as that business unit has accelerated in volume. You can't grow your volume 20% sequentially quarter-over-quarter without making more product, and you have more tied up in working process and finished goods as the quarter end comes. Overall while our inventoried may have slipped up a little bit, I would look at the overall cash generation for the Company this year. We are up to $85 million since the beginning of the year in cash generation. This was another good quarter at $25 million of cash. Year-to-date before the share buy back we have actually generated $85 million in cash this year.

But I thought you said Solar business in Q4 is not going to follow the normal seasonality year end rush to finish installations?

Garry has talked about the lumpiness of the utility segment. You are seeing a bit of an inventory bump associated with the Solar business primarily. I suppose you should look at that as an opportunity that as those shipments flush through, we will be in position to normalize our inventories.

Got it. One question for Garry. You talked about the next phase of your plan is to grow revenue. When you look at M&A opportunity, what is the priority? Is going horizontal has the higher priority, or how should we think about the M&As that you are entertaining?

Again, we can only speak generalities here, because we have to be a little bit pragmatic and realistic about what there is out there, and I wouldn't want to talk about anything at the present time. Except to say that we have a very nice active list today. Obviously we have got to get them, and we are not going to get them if they are not accretive to us, so they had some very high hurdles to jump before we would take one.

After saying that, if we go to the Thin Films business as it has been said very eloquently, we need to expand into new markets. We cannot be beholden to semiconductor. We love semiconductor. We love our customers. But we need other customers as well. We need to get out of this 10% of our business, or 20% of our Thin Films is coming from one customer, and we need to grow the business. We need to go into new markets.

But I look at the mix of Thin Films, it is service and industrial that is actually relatively doing better.

Right.

That is correct.

Should we think about industrial and services where there will be opportunities?

Yes.

Yes, we need to fuel that fire. That industrial segment is, I mean it is huge, as you know. There are many, many markets with many, many applications within that broad industrial area. We need to be careful that we go to where we want to go. Let me just dwell on our model for a little bit, so we understand what we are trying to do as a Company. The Company only wants one manufacturing site. Really, that manufacturing site, we really want to our outsourcing center. So that is where the supply chain is, that is where everything is. In my ideal world, that is where everything is going to go though.

We are then going to have R&D centers across the world. For instance, I am in Fort Collins today, this is a Center of Excellence for Thin Films, and they will fuel that factory. Then we will have a global, when we have a global distribution, that will distribute whether it is for Solar or Thin Films. That is the model we are having. So when we're looking for acquisitions, they have got to fit into that model. I don't want to have more factories. Actually don't want more factories. We are not big enough to do that. That is crazy. So we're hooking for technology, product lines that our people can sell, products that can be quickly shifted into Shenzhen, that is what we are looking for.

Going back to what type of products within Thin Films, we want to get more into the industrial markets. There are plenty of places to go. I don't want to say any of them at present, but you know a lot of them. Within solar it is a different kettle of fish, really. There it is just how do we become more global with our products. It is a make or buy position. Can we buy our products and get into markets quicker than we can make them? Again, in the back of our mind we are saying we don't want factories. I don't want any factories. I only want my one Shenzhen facility, and I want to be outsourcing from that facility. If that helps you, that is good.

Sure. Thank you.

(Operator Instructions). The next question comes from the line of Jim Covello from Goldman Sachs.

Actually it is Mark [Joeany] calling. Thanks for taking the questions.

Hi Mark.

How are you guys doing? Nice quarter. I was hoping that you could give us an update on how you think your inverter market share in the USA is tracking year-to-date?

I am going to pass that to Gordon, but just as a quick comment, I am not really worried about our market share. I know a lot of you are. I am more worried about making a few dollars. Growing and making a few dollars. The market is not my biggest worry, within our little niches we do very well. If you choose to be in utility, people will pay money for a classy product, we actually do very well in that marketplace. Gordon, I will leave you that one?

I think the focus is exactly what Garry has talked about. We have been focusing this year on building profitable, sustainable growth. We are not interested in the short term market share winds. That is what some folks are chasing. What we are looking to do is increase our distribution in the US, and make sure that as people begin to struggle, we are in a position to thrive. We have continued investing in distribution in the US all year. Field applications personnel to support the customers application, and also service personnel to support customers after the installation and commissioning. So I think we are well positioned in the US right now for success in 2013. And we will continue to invest in further growth as we move forward.

That is helpful. Thank you. As a follow-up question, I understand the outlook for Thin Films is that market will be challenging for the next couple of quarters. I was wondering if you could help us understand if order run rates are continuing to still decline, or have they started to stabilize?

Right now what we are looking at is flat to slightly down quarter-over-quarter. We don't have real good visibility towards 2013 yet.

In fact, Mark, just we have given a broader range of guidance this quarter, because we are a little bit unsure on that semi marketplace. We are still a little bit unsure on what is going to happen in this quarter. That is why we have given a broader range. I don't actually like to do it, but we have because of that nervousness about what is happening with those few customers.

Great. I appreciate all of the color. Nice quarter, good luck guys.

With that, thanks everyone for being on the phone today. A hell of a difficult time. I hope all of your families are okay, and everyone is safe. We look forward to seeing you at our Analyst Day, to talk more about this financial model that we are developing, which is clearly going to be our big advantage compared with anyone else out there. A financial model that we can grow from, get that $2.00 per share, and move forward to that even. We look forward to seeing you in a couple of weeks. Thank you, and bye bye.

Ladies and gentlemen, this concludes your presentation. You may now disconnect. Have a good day.