ATS Corp (ATS) 2003 Q3 法說會逐字稿

Good morning, ladies and gentlemen and thank you for standing by.

Welcome to the ATS third quarter conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. If anyone has any difficulties hearing the conference please press the star followed by the zero for assistance.

I remind that you our presentation today may contain forward-looking statements reflecting the company's expectations regarding its future growth, results and performance. These forward-looking statements reflect the current views of the company's management and are subject to various risks and uncertainties which could cause the company's future growth results and performance to differ materially from those expressed and/or implied by these statements.

Certain of these risks are described in the ATS annual report. ATS disclaims any intention or obligation to update or revise these forward-looking statements.

This call is being recorded for replay purposes on Thursday, February 5, 2004 at 10:00 a.m. Eastern Time.

And I would now like to turn the conference over to Mr. Klaus Woerner, President and Chief Executive Officer of ATS. Please go ahead, Mr. Woerner.

Thank you very much, operator.

Good morning, ladies and gentlemen. I'm joined today by Ron Jutras, Carl Galloway and Bruce Seeley.

I will open the call by saying despite strong revenue growth in all three business groups, we are disappointed with our performance in the third quarter. Our objective is to achieve strong and growing earnings, and for reasons Ron will discuss in his remark, we did not succeed. What I want you to note before Ron provides his analysis is that we are not content with this performance, even though some items such as tax and exchange rates are outside, largely outside our control, the accepted -- it is our responsibility to overcome challenges, internal and external, and we are taking action to improve profitability that includes not only aggressive sales, marketing and technology developments but improving our processes, wherever possible.

We believe our strategy is the right one and a review of the competitive landscape confirms this. And we are confident that we can get back on track with the earnings momentum overall, and as Ron will tell you, we believe we can bring precision components back into the black over the next two quarters.

Now, here is Ron with his financial summary.

Thank you, Klaus. And good morning.

Let me begin by quantifying the impact of two external factors on our performance. FX and income taxes.

First, we estimate that the change in the average U.S. to Canadian dollar exchange rates reduced our Q3 consolidated revenues by $19 million. And our operating results by $6 million. Tables in the MD&A provide more details on the substantial impact of currency changes on both consolidated and segmented performance.

With respect to income taxes, the new Ontario government has increased future corporate interest rates, and for ATS, this meant a non-cash income tax charge of approximately $2.1 million in the quarter, as we adjusted all of our accumulated income tax liabilities to the higher tax rates. Without this charge, net earnings would have been $.5 million, or 1 cent per share. Essentially the same as the result of both the third quarter of last year, and in the second quarter of this year.

Clearly, these external factors had a big impact but as Klaus said, there is no disputing that we are disappointed by our bottom line performance in Q3.

I'll begin my commentary on the performance of the individual segments compared to Q3 of last year, with the Precision Components Group or PCG.

Revenue grew 31% in the third quarter, as a result of higher thermal solutions volumes and the contribution from the MPP acquisition. Revenue from the launch of new automotive precision component programs offset declines in other programs which expired during the past year.

As shown in the tables in the MD&A, the impact of FX changes since last year had a major impact on PCG operating performance. Backing out the estimated $2.6 million impact, so that PCG earnings would have been $1 million, 300% higher than Q3 of last year.

Although it's anyone's call, we think it is unlikely that FX rates will improve significantly for the foreseeable future. Our goal is to further improve PCG performance so that we can achieve acceptable profitability in spite of the FX.

Our efforts are focused on increasing our capacity utilization and production efficiencies to support increased revenues, while reducing our costs. We believe there is good reason for optimism.

Our operating costs have been high because of the launch and ramp costs related to a number of PCG programs. These costs are in the form of higher labor and scrap, and reduced yield, until the manufacturing processes are optimized. We're making solid progress in reducing these launch costs.

Our employment in PCG peaked in October and since then we've reduced the work force by 129 people, that's about 11%. The reduction was 54 people in January alone. The vast majority of the staff reductions were temporary contract positions, brought on specifically to support the initial launch activities.

Today, the PCG work force is smaller than it was at the end of August, in spite of higher revenue. And we expect further improvements in the fourth quarter. These reductions are possible because our production efficiencies on our new programs are improving.

Increased production yields and lowering manufacturing costs will have a compounded positive impact on operating results.

We also expect to realize savings for the entire PCG group in the coming months from our expanded Asian sourcing strategy, with our addition of a full time China-based manager. During the next year, this initiative will primarily focus on securing savings by sourcing additional lower cost purchases of components, tools, and supplies from China. Our goal is to save an additional $1-2 million from these sourcing activities over the next four quarters, for our PCG operations alone.

We believe all these initiatives along with increased revenues from new program ramp-ups will allow us to bring PCG back to profitability over the next two quarters.

The power seat sub-assembly contract launched in May continued to successfully ramp up during the third quarter, with revenue of $5.6 million. That's an increase of 45% over the second quarter of this year.

There have been some changes in product mix and some product design changes under this program since we won the business. And that's reduced average unit sales prices. However, total unit volumes on this contract remain on plan.

Combined with the substantial change in U.S. exchange rates, we now estimate our revenue from this program will be around $30 million in fiscal 2005, compared to earlier estimates of around $40 million. Importantly, in spite of the FX, we believe that at our forecasted unit volumes and prices, returns from this assignment will still be attractive.

Looking beyond fiscal 2005, into fiscal 2006, there are a number of good additional prospects that give us confidence that volumes will expand further in FY '06 and revenue under this program should surpass the $40 million per annum level providing additional upside.

Looking next at the Automation Systems Group, or ASG, revenue in Q3 of this year was 12% higher than in Q3 of last year, in spite of the negative currency impact which was substantial. Third quarter operating earnings of $3.5 million in ASG were 21% higher than in the third quarter of last year, in spite of the $3.4 million negative FX impact.

However, operating results during the third quarter were less than satisfactory, as they were lower than the $5.8 million recorded in the second quarter of this year.

Third quarter operating earnings were significantly impacted by higher-than-expected rework, modification, and installation costs on some first-time systems that were either completed or near completion during the third quarter. I think it is important to note that these higher costs do not reflect deficiencies in processes or procedures. We understand the importance of managing projects closely and we're continuing to do so.

We are negotiating price increases on a few of these jobs. However in many cases these first time systems are strategic projects. Where we made the right long-term decision and absorbed the costs because we expect to see attractive repeat systems orders. In fact, we are already beginning to see repeat orders.

To improve ASG results going forward we've also made management changes in our West Coast operations to improve our project execution in these facilities.

As we've discussed in past, factory utilization has been a major factor in holding back ASG earnings improvements. Our factory utilization in Q3 was still not well balanced across a number of our facilities including the largest plants in Cambridge and on the West Coast.

I would like to be a little bit more specific. Our design resources have been overloaded since the late summer, reflecting the strong booking activity, and the increase in the proportion of first time systems in the backlog. The custom design and build nature of our automation business means that these first time systems inherently take longer to design. Consequently the benefits of the higher booking activity and the flow of work into the high revenue generating shop floor activities remained less than optimal during the period.

While our design resources remain very heavily loaded, we expect significant improvements in our shop utilization in the fourth quarter as the floor -- work to the floor continues to increase and projects scale up.

Automation systems new order bookings were $94 million in the quarter. This is similar to the amount in Q3 of last year, in spite of the big change in exchange rates.

For the first three quarters of fiscal 2004, order bookings were $344 million, that's 12% higher than the amount recorded in the first three quarters in fiscal 2003. Orders booked during the first five weeks of the current quarter totaled a very respectable $54 million dollars.

We had expected order bookings, stronger -- to be stronger in the third quarter, however we continue to see some delays in placement of some substantial orders. These orders have not gone away and we are confident they will materialize.

As one example I would like to give you, we have been selected as a supplier by one health care customer on a large project for multiple systems. And we had expected to receive the order in the third quarter. However, their order placement process had not been completed for the overall project, so instead they issued an engineering order to authorize to commence design only. The result is that the lion's share of the order value is delayed even while we're working on the designs. We now expect to get the bulk of the order for the actual build portions of the projects within the next two months.

The single value -- if the full value of the single order had been released, it would have taken our Q3 bookings easily over the $100 million level. There are numerous other solid prospects in the sales pipeline which we expect to convert to firm orders in the near future.

The automation order backlog stood at $181 million at December 31, 2003. That's 19% higher than the $152 million on hand a year earlier. On a comparative basis, the change in FX rates over the past year reduced the value of the period end backlog by about $26 million dollars.

The period end backlog also does not include $11 million of the intercompany automated systems backlog primarily related to the SSP initiative.

The Solar segment had a record third quarter with revenues increasing 46% over the level in Q3 of last year, driven by strong demand in Europe.

Our subsidy programs in Germany were improved and took effect ahead of expectation. These new subsidies increased rebates for PV energy producers, and also increased the scope of qualified projects from primarily residential applications to include larger commercial installations. We expect these developments will create new opportunity force large scale commercial power projects in Europe.

We also are watching the U.S. market closely, as pressure to increase energy self-sufficiency and expand the use of clean renewable energy power grows. These are clearly positive elements in the PV market.

The large increase in revenue produced significantly improved economies of scale in our solar operations and more than offset higher R&D expenditures during the quarter. As a result, we achieved a record high quarterly operating profit of $2.1 million during the third quarter for this segment. This was 678% higher than the operating profit of $.3 million in Q3 of last year and an even greater improvement from the break even operating performance in the second quarter.

We expect our solar revenues to continue to show significant year over year growth in Q4. However, we also expect Q4 revenue to be lower than the record high levels recorded in Q3 of this year.

This is a result of lower installation activity, during the winter months. We expect shipment volumes to increase as we enter the spring, driven by the new subsidy programs in Europe. We also expect that prices per watt will continue to decline, primarily as a result of aggressive pricing by Japanese suppliers who are benefiting from their weak currency.

Turning to our Spheral Solar Power initiative, the construction of the factory was completed during the third quarter. However, this was behind schedule. We now expect our first SSP shipments to commence this summer. This represents a delay of about four months over our initial launch schedule, which proved to be too aggressive because of the delays in completion of the factory and development activities.

By December 31, we had invested $68 million of our original commercialization budget of $85 million, that's before government assistance. We now expect to invest between $95 million and $100 million on the commercialization program for SSP. We expect that government funding will reduce the net funding requirement for ATS to approximately $65 to $70 million dollars, so that's an increase of about $10-15 million.

The higher expected costs are primarily related to delivery decisions to internalize production of some critical processes to reduce risks, and SSP's operating costs of outsourcing. This represents the biggest part of the increase, or approximately $8 million.

As well, we decided to increase the physical size of the factory and the related water treatment processes so it could house approximately 40 megawatts of SSP cell production when the appropriate time comes. This adds about $2.5 million.

And finally, we opted to build some redundancy in surplus capacity in some of the critical processes to mitigate some of the risks in the launch plan.

Most importantly, while our investment is now expected to be higher than originally planned, and this will increase depreciation costs once we get operational, our costing models continue to indicate that our original cost per watt production targets are achievable. That's because of savings we've identified and expect to realize in a number of other operating expenses.

It should also be noted that the capital investment to double the Cambridge factory capacity to 40 megawatts, when the time comes we will be significantly less than the first 20 megawatts because of the steps we've taken.

The company's cash position was $47.6 million at December 31, 2003, $10.7 million less than the amount at the start of the period. Cash flow from operating activities was $16.9 million in the third quarter. Capital expenditures of $23.9 million were major in the quarter, $15.5 million of which was for the SSP initiative. $2.7 million was spent on other investments, the larger portion of which was the deferred development activities related to the SSP initiative. Looking at the balance sheet, it shows the company remains on healthy financial footing, with a debt to equity that remains less than 0.1 to 1.

That covers the financial aspects of the quarter.

Now I will turn the call back to Klaus.

Thank you, Ron.

I believe Ron covered our outlook by group sufficiently for me to conclude with a few high level observations.

The challenge we have is to build on our sales momentum but also to drive a better bottom line. This will come about in automation systems from higher manufacturing utilization and more repeat work, as Ron said.

As you know, we have been penalized a few times in the recent past for taking on some new first-time orders that turned out to be more complex than we originally estimated. This isn't true for all first-time assignments, but it was clearly a factor in the most recent quarter. First-time projects are an important part of our -- of growing our business, to put us in position for more lucrative higher margin repeat work and in some cases enable our progress to do very exciting high growth areas.

Let me give you a very recent example involving a medical device customer during the third quarter, we incurred higher than expected costs to complete one particular first time automation assignment worth just under $2 million. That was somewhat disappointing. But by meeting the customer's requirements, we secured approximately US $7.5 million of repeat systems work from the same customer, before the end of the third quarter. We expect more repeats in the near future.

Although the first time project cost is in Q3, this strategic involvement will help our sales and profitability going forward. This demonstrates the value of engaging in first-time work.

The decision to accept lower margin on the first-time system because of opportunities for more lucrative repeat jobs is not a new strategy. In past, it's allowed us to capture attractive business with good margins and we expect this experience to be repeated. In fact, as I just said, we've already started to see repeat orders being placed, a trend we expected to accelerate both near and long term.

To drive long term earnings growth we will continue to move into new areas and selectively take on first time work. In fact, we see some very good order prospects in health care coming up, as a result of our recent push into pharmaceutical areas.

Overall, the pace of activities is very, very strong. But it is new or repeat systems we always keep the bottom line in mind. That's why we've had such a strong push in developing standard automation technology over the past two years.

Having more standard platforms at the ready will help us to enhance our margin in the future, by reducing our cost to produce most of our systems. They are definitely helping us to build sales momentum in this challenging period.

In fact, I might add that the $7.5 million dollars in repeat order from the medical device customer I mentioned a moment ago included supertrack technology as a center part of these assignments. Over 20% of our new third quarter bookings incorporated supertrack.

Without these technologies, and without the staff to pursue and uncover opportunities, revenue growth would not have been possible this year. Although it doesn't speak to recent earnings performance, ATS is doing the right thing in a competitive context. We've outpositioned our competitors during this downturn, we have formed important new customer relationships that will be very good for our future, and our existing customers are very satisfied.

Again, I realize this doesn't mean much today, but it will tomorrow. For today I can only conclude that we are not content with third quarter performance, we are taking action to enhance our prospects and this includes reduction and business improvements through technology and market development, work flow in our automation systems and position components is improving for our base system, that means more work is flowing from design to production and for precision components, new customer programs are ramping up and our cost efficiencies are improving.

In short, everyone of us here is committed to getting back on track from an earnings perspective.

Now, Ron, Bruce, Carl and I will be pleased to hear you from.

Operator, would you please open the call to questions, please.

Sure, thank you, sir.

Ladies and gentlemen we will now conduct the question-and-answer session. If you have a question, please press the star followed by the one on your touch-tone phone. You will hear a three-tone prompt acknowledging your request. Your questions will be polled in the order they are received. If you would like to decline from the polling process, please press the star followed by the two. Please ensure you lift the hand set if are you using the speaker set before pressing any keys.

One moment please for your first question.

Your first question comes from Jay McKinnel that from Raymond James. Please go ahead.

Good morning.

Looks like the main downside surprise here was on systems margins. You had indicated last quarter that because of the strong opening backlog, that you expected the margins to pick up, you said in the second half. At the time, were you expecting that was going to be mainly the fourth quarter? Or was the weakness this quarter actually a surprise to you?

As I think we indicated on the call, both Klaus and I said that we expected our improvement in the current quarter. We clearly expected an acceleration through the back half but we did expect stronger earnings in the third quarter and as we indicated there were some costs that came in that were higher than we expected on some of the programs which were first time systems.

Right.

And you mentioned, Klaus in particular mentioned one program, the medical device program, did the -- did the margin impact come from a relatively small number of contracts or was it spread over a larger proportion of the mix?

It was -- the --.

It was across several industries.

But a handful I would say a handful of contracts. Less than a dozen. Would be the concentration.

Right. Okay.

And you also mentioned the sort of the imbalance in your factory utilization. I heard you say that the West Coast operation is still running below optimal levels. You mentioned Cambridge but I didn't understand -- I didn't catch whether that was on target or sort of below.

On target now for the fourth quarter.

I think in the third quarter we said that we were running a sub optimal, and we had -- quite frankly our design groups were working gobs and gobs of overtime in the third quarter. We weren't seeing the increase in the overtime on the factory floor, but now that is starting to materialize in the fourth quarter, so the increase in the amount of work flowing through the factory floor is obviously going to have a benefit there.

Right. Okay.

Just moving on to to Solar for a second, and just coming back to the incremental investment, you mentioned development challenges, I think, in the press release, could you give us little bit more color on what some of those are?

The bulk of our activity in SSP and of course [inaudible], it is really related to, you know, taking our prototype processes and scaling them back up to full blown commercial manufacturing. So there's process development work that needs to dob done in that and development often has risks of some delays and we've seen some of that take place. And there's also been some changes in how we go about doing the business that has increased our costs.

Overall, I would say that the bulk of the increased costs is really related to more in the capital equipment side than it is on the development side. And that is just the way it unfolds.

Okay.

And at the end of the day, you're not anticipating any major changes in the economics of producing the product going forward?

As I indicated I think we're still on track with our cost targets.

Right. Okay.

And just a final question on photowatt. You mentioned an expected seasonal decline in Q4. I noticed that last year, it looked like it tapered off by almost 50%. Is that a normal seasonal decline? Or was it exaggerated?

I think it was exaggerated.

And let me just give you a little bit of background and try and make it brief, but last year, what we had was we had subsidy programs which were basically rolling over at December 31. And so -- but there tended to be a rush to acquire product as we led up to December 31 and the drop in the subsidy program, which tended to pull revenues forward into the fourth quarter.

What happened this year is that the subsidy programs were actually renewed at higher levels which took effect on January 1 in Germany. So we expect that that is going to continue to fuel strong demand. So that the offset that we're going to see that is going to take our revenues down is really the fact that it is difficult to get people do to go up on roofs and install solar panels during the winter months, so that's why we're expecting revenues to come up, but we are expecting that demand has been stabilized to a much greater degree because of the new subsidy programs.

We're seeing great opportunities from the standpoint of large power installations which are now covered under the subsidy programs, which will also have a stabilizing impact, because these tend to be power fields.

So were the volumes in Q3, would those represent in your view sort of sustainable volumes or I'm thinking back to -- I believe it was sometime late last winter, early last spring where you announced a relatively large contract, is it the result of sort of a one-time contract flowing through? Or is it sustainable demand?

What it was was is that I think there is a strong demand in Europe and I think the subsidy programs are driving demand, Jay.

So I think that we expect revenues to be down in Q4, as I said, because of the seasonal issue of winter. But we still are seeing strong demand, and we expect that demand to continue strong going forward because of the broadening of the subsidy program.

So I don't think there is any one thing that I can point to in the third quarter that took the volumes up. As I think I indicated last conference call, that the demand was very strong going into the quarter, and continued to be so through the period.

We see a lot of good prospects for continuing demand going forward.

Right. Okay.

And lastly, could you just repeat your comments on the breakout of the Cap Ex spending in the quarter?

Yeah, we said that the total cap ex spend can was $23.9 million and the $15.5 million of that was for SSP.

Okay. All right.

I will get back in queue. I've got some others but I will let other folks take a shot.

Thanks very much.

Appreciate that.

Your next question comes from Pat Chieflo from Merrill Lynch. Please go ahead.

Thanks very much.

Ron, in light of the current tax rate environment and in light of the current currency rate environment, can you sort of maybe review what the new or if the profitability of the -- the long term profitability of the company has changed at all and, you know, once we get back to more normalized business model level, what could we expect in terms of bringing the revenues down to the bottom line? And you know, feel free to to be as quantitative as you can.

And I think first of all, I think the big problem we've had with FX in our systems business has been the speed of the change. Because what happens is that, you know, we had on an ongoing basis both through purchases and forward contracts -- the problem is that timing doesn't necessarily match up, and so you tend to get caught from that perspective.

Longer term, the change in FX rates in our systems business really represents additional pricing pressure. And we think we've got a number of things that we've been focusing on over the past three years that give us competitive advantages in our marketplace.

You know, right now, when you look at the current environment, we're at the early stages of an economic upturn in capital spending. And we're much stronger than our competition out there by any measure that you would choose to look at.

You know, we're pushing into new sectors, we're capturing market share, we have strong technology, our capacity and our knowledge base is very much intact, and we're strong financially, and I think customers understand that. So I think, you know, the issue of FX really comes back to your competitive stance in the marketplace when it comes to the systems group, and I think we're pretty comfortable with how we stand there.

But if you look at the Precision Components Group , I think the challenge is bigger because again the contracts tend to be longer in term. But as I also indicated, I think we have a number of initiatives that are helping us to reduce our costs and we're successful when launching new programs.

There is clearly work that needs to be done in this area but we're confident of the outcome.

So I think that what we are is we are now operating under the assumption that exchange rates are likely to stay in the current range for the foreseeable future. And our challenge is really to overcome these issues.

Okay.

And next, what has the interest been like on the SSP products? I know commercial launch has been pushed out a bit, but I remember on, you know, a couple of previous calls we talked about having -- expecting some interest from customers before commercial launch, and I was wondering if you could give us an update on that.

There are negotiations with Elk that are now into the definitive contract, we haven't concluded them yet but they're proceeding well. So that's a very positive development we see going forward. And right now -- and we've laid all the ground work from the standpoint of the distribution channels, including the work we've done with distributors, the work we've done with other development partners, all those things are very much in place. I think the key issue for us is to get our commercial processes up. And that's what we're focused on.

So we're confident about the market. And the appetite, and for the product, our challenge is to bring the production processes up.

Okay.

And just lastly, is there any way -- there was a material ramp in revenues this quarter. Was any of it the result of potentially some product delays that occurred last quarter that were pushed into this quarter? And if there was, is there any way to quantify that?

You're talking about in the Precision Components Group.

Overall on the sales, yup.

In the Precision Components, or automation systems?

I think the product delays last quarter were -- you're right, Precision Components.

Yeah, the there were some delays through the last quarter, through the second quarter, in ramping some of the programs, we've seen that they've ramped more aggressively in the third quarter, and they continue to ramp as we look forward in the fourth quarter and the first quarter of the next year.

Okay. Thank you.

Your next question comes from JP Benson from CIBC. Please go ahead.

Good morning, I've got two questions, and the first relates to foreign exchange.

A big hit in the quarter. I guess what I'm wondering is if the dollar, the Canadian dollar, stabilizes at current levels, at what point is this going become less of a drag? Because I guess you've probably got an offsetting factor in that some of your hedges at higher exchange rates are starting to roll off, which in fact is probably been giving you some protection up till now, so I'm just trying to kind of weave my way through that maze, if you could provide any color there.

I think what we've tried to do is give you a pretty good understanding of our FX position with the improved disclosure and the MD&A, which gives you an idea what our current hedge position is and the average rates attached to those.

Clearly, the bulk of the decline in the exchange rate really occurred during the period from December through the summer period. We've always said that our hedging activity primarily gives us about a six-month protection window. So it actually, you know -- the impact is huge year over year but we're now operating under the lower exchange regime and have been, I would say, for the bulk of the the -- certainly the bulk of the third quarter.

Okay.

And just more of a conceptual question. You're well documented, your principal competitors on their knees, but it seems like, you know, particularly on these first-time systems awards, you still have to take pricing that is quite a bit less than what would be ideal. Why is that the case given the strength of your competitive position in the marketplace?

I didn't really say that we have to. I mean in the odd case, I think, in order to get -- to be getting over the strategic volume to us, okay, there may be -- there may have to be somewhat more competitive the first time around, because obviously, our, you know, competitors would love to get their business as well. But as I said too, I mean if it is a one-time opportunity we don't follow on, then we would rather pass a low margin project than buy into it.

So only if you see strategic, you know, long-term value, maybe do this, but then -- it's really the exception, not the rule. I mean it is a competitive world out there. There is no question about it. But at a certain point, we walk rather than buy into something that we know up front is not going to contribute to the bottom line.

I might want to add just one important comment too, to that, is that a lot of these projects where at the -- at the -- basically at the end, so we got into some higher costs right at the end of these projects, so to some degree these were projects that required six, six months ago, or more. Which was I think -- it was certainly a -- we were seeing the competitive situation being higher at that particular point in time.

But again, we didn't go into these projects basically heavily discounting them. We didn't go in buying them. I think that we went in obviously at a competitive pricing basis but we were comfortable with the prices we went in, and we all signed up to those prices going into them.

But the environment is a little better, so the pricing should pick up?

Absolutely.

I think the big thing is that we're seeing the opportunity to -- for the repeats, which is the biggest factor, JP. And right now, the amount of repeat opportunities we see now, I would say are essentially record high levels. And I think that's reflective of the current economic environment and I think it also reflects our push into new market sectors and it also reflects the stage of the economic upturn for capital spending that we're starting to see.

Back to the foreign exchange, I mean you're still mismatched in capacity and your facilities and I realize some of the facilities are very special purpose and are really only good for doing certain kinds of work, but is there much of an ability to move more of the work to the United States where that the relative cost basis, obviously, that the balance has shifted?

I think over time, there is.

I think what we're seeing though is we're seeing a better balancing of it. Like we're now at the point where our backlog is sitting at a substantially higher level than it has been -- the last few quarters it has moved up into a new -- I would say a new plateau, and the order activity subsequent to the end of the year was also pretty darn strong at the end of the day. And we expect to see continued order strength going forward.

So those are all factor which are going to help us to better balance the workload on our factories. So we're feeling better about the situation from that standpoint.

In all facilities.

Than we have for some time.

In the U.S. as well.

Okay. That's all for me. Thanks very much.

Thank you.

Your next question comes from Peter Sklar from BMO Nesbitt Burns. Please go ahead.

Ron, you said in your comments about the $54 million of order intake in the current quarter to date, I didn't quite catch how many weeks that was.

It is essentially -- it is close to five weeks. Just a little bit under.

So five of 13 weeks?

That's right.

Okay.

I want to talk -- ask you one question about SSP. You -- management seems quite optimistic about the prospects in terms of the sales potential. You've effectively made the decision to double your capacity, I believe, with the decision to go from 20 to 40 megawatts.

Sorry, Peter, we just laid -- put into the infrastructure, to go from 20 to 40, without major disruptions to the operation. So all the power supplies, and all the fluid handling systems and all that is geared toward -- it was sized for 40 megawatts, okay, and we only built a -- building equipment for an initial 20 megawatts.

Okay.

Minimal disruption to go from 20 to 40.

Okay.

My question is, what specifically is driving your continuing optimism on the marketing potential of this? Is there -- is there anything going on in terms of potential customer reaction? Or is this still continue to be your view of the technology and the potential economics?

I think it is both.

I think we're seeing opportunities -- you know, since we made the announcement with Elk, we've been inundated by phone calls, and people are looking for a truly integrated PV product. They want to get something that can be incorporated right into the building facade, the roofing shingle, as opposed to a bolt on technology. So there's tremendous appetite from that perspective.

And on the cost side, like I said, we're still on track with our internal cost targets, which is really one of our economic drivers of our decision to go forward.

So ultimately we're progressing with our development plan, we're comfortable with what we see from a cost standpoint. We know a lot more today than what we did when we kicked off the program. And from a market perspective, we think we like what we're seeing there as well.

And as you know, PV is growing in importance. The announcement last week about GE, you know, moving into acquire the assets of the bankrupt Astropower, you know, and they've got a big portfolio in PV, I mean in renewal energy, again just reinforces this is definitely a growth market for the future. And so, you know, I think the timing is right.

Is any of your prototype production out with potential customers that they're testing it?

Yup. Yes.

We have submitted samples. And of course are also continuing, you know, with producing samples for the new interested parties and so on, and so we are daily making cells and modules, really for different applications.

Okay.

Ron, just one last question. In terms of costs you're capitalizing related to SSP, obviously you have the capital costs for the, you know, for the capital expenditure, the facilities during the quarter, I guess the systems that you bought from your other subgroup. But are there any other costs being capitalized?

As I indicated we had about 2. -- I think it was 2.7, that I said, was basically the deferred development costs that we were capitalized -- I'm sorry, 2.7 was the total amount that was in the other investment, but a substantial portion of that was for asset fee, which is essentially -- we run SSP essentially as a project within the company, so our costs are primarily driven around the actual development activities associated with the pilot line production, the sample production, and the equipment development. So really, that's what's going into the development activities.

It is not like we have a huge infrastructure that is run separate for that business at this particular point in time. It is run as a project. And we're following the Canadian Institute of Charter Accountants requirements that that's treated as deferred development and we're capitalizing it.

That 2.7, that is the increase in the -- that was the amount taken into the account during the quarter? Or to date?

No, that -- I will give you -- that's not the full amount to date. We will give you the exact amount, if you can just hold on a second.

Okay. And then I'm done.

Your next question comes from Cherlyn Radbourne from RBC Capital Markets. Please go ahead.

Hi, guys, I wonder if you could start by just giving us some more color on the complexion of your backlog and the new orders in the quarter and just the mix of repeat orders relative to first-time business, as compared to last quarter.

Sure, I was looking for the answer for Peter. Could you repeat your question?

Just some more color on your backlog and the new orders booked during the quarter and the mix of repeat orders relative to first-time jobs, compared to last quarter.

Oh, the content of repeat orders are definitely higher, substantially higher this quarter than it was last quarter.

And I wonder if you could just comment on -- ?

Some of the earlier development efforts that we made, like we said earlier, we were not that profitable, but we see now, you know, second, third generation of orders being placed.

I wonder if you could just provide some more color on the comment in the press release that customers remain cautious about placing orders, and you know, just what you think is holding them back, and whether that hesitation is specific to a particular industry, or whether it is more generalized cautiousness?

I think we gave an example, the type of situation we're seeing out there is, you know, is that we expected some stuff to break, and you know, that gave us an engineering order and got us kicked off and we're waiting for the full bulk of the order.

Sometimes it is just internal bureaucracy by large corporations that makes the order placement, you know, a drawn-out process like in this particular case it was, but the customer, you know, has given us an engineering order to start at least design, the design of the system, and will also, you know, extend if need be, that initial commitment to allow us to buy third party long-term delivery equipment, and so on. Until they finally are ready to place the full-blown order with us.

So we haven't lost the opportunity and that's the case with several, there are companies that for whatever reason, want to research, one more time, their position in the market before they commit to multimillion dollar investments for -- to increase their market share.

And one of the growth opportunities you've been quite bullish on is the prospect for your business based on new model introductions by the major auto manufacturers. And I wonder if you could just comment on whether you're seeing any result from that, either in the Automation Systems business or the Precision Components group.

Start with --

As far as the Precision Components Group, clearly a large part of the new revenue that we are ramping is related to new vehicle models that are launching.

Now, on your last conference call, you mentioned that were you looking to potentially add to the head count in your design department, and I was just wondering whether in fact you made any new hires in Q3.

Nothing of significance. In fact, I think our employment in systems has been relatively constant. Our total employment is up about 100. That's almost all in photowatt. Which is really related to the increased volumes that we're driving out of there. Some of that is temporary. Some of it is permanent.

Just coming back to your question, the number is 1.7 in the quarter. $1.7 million.

Yeah, but we did add some design resources because we said earlier our design department was really -- well ordered and currently, really, the push now with seeing the greater volume going through the factory, we again will probably have to increase our integration staff somewhat to help us cope with the workload. It is not -- we are not toppling or anything like this at all.

Let's make sure we get this in context because I think it was taken out of context the last time around. And we're talking about some relatively minor adjustments to the work force sizes. So that's what we're talking about, just to be very clear.

Okay. Just a last couple of quick questions, can you give us the third party content percentage in Q3?

The content was relatively high in the quarter, was about 51%, I think that largely reflects basically the scaling up of activity. There were a lot of projects completed in the quarter and there were a lot of -- the receivables number took a jump because of that as well where there was a lot of billing activity that took place. So it was really reflective of that.

To some degree the fact that our margins contracted also had an impact, but overall the third party content was high on a relative basis. We think that is certainly a temporary situation.

Another factor I should mention as well is that some of the SSP work has a reasonable amount of third party content as well which came through.

Okay. And last question, just based on the tax rate changes in Ontario, what rate should we use going forward for modeling purposes?

Basically, it is about an increase of a 1%, the adjustment to the tax rates.

Okay. Thanks. That's it from me.

Welcome.

Thank you.

Your next question comes from David Tyerman from Scotia Capital. Please go ahead.

Yes, good morning.

I just want to come back to FX on the systems side. Just to understand correctly, is it the situation where you do a hedge when you win a project, but obviously the hedge was at the time, at the rate at the time, and so that given the Canadian dollar has risen since then, that's what's taken off side on the margin and if so would we expect to see that process improve, as the Canadian dollar stabilizes, assuming it does?

I'm not sure I followed the question. Maybe we can talk you through a little bit of the process we take from a hedging standpoint.

Sure.

The process right now is we hedge essentially, we start hedging on contracts essentially when they get into what we call our high probability situation, we hedge a portion of the contract at that particular point in time. But once we believe that, you know, typically we've got verbal assurances that we have a contract or pretty convinced we're going to get it within a reasonable period of time, we start to get get into the hedging activity. We do typically adjust our hedge positions on a monthly basis. And we hedge a portion of the contract which we estimate is our net exposure.

That's essentially how we start to bring our hedges on. And as we said, that that hedge activity typically is effective for -- most projects would turn over within a six-month window.

So given that we should see margins pick up in this division, just by the nature of the Canadian dollar stabilizing over the next six months, assuming it stays somewhere near current levels?

We're looking at margins to improve primarily because -- you know, that possibility is there because we've adjusted our pricing books and all those types of things for levels. We're looking at margins to improve primarily because, you know, and -- and that would follow the path that Tennaco took, we could utilize to try to get to customers for them. We're expecting our margin improvements to come from some of the other factors we've talked about. Improved utilization, improved amount of repeat systems business, those types of things.

So do I take it from your comment there, Ron, that you think that the you utilization, et cetera, will be the bigger factor? Because I would have thought given the numbers you put in the MD&A, which were very helpful, that there is a pretty big change coming over the next year if those negatives goes to zero.

Well, I think the fact is that you've looked at the currency move from what 156 to 131, something in that neighborhood.

Right.

Huge movement so it is hard not to have a substantial impact when you're an exporter.

Right.

But the impact is going to be big.

But on the other side of it I think if you look at the underlying business, it's not like we've -- you know, we continue to progress. Like if you took the foreign currency out you can see the substantial improvement we would have achieved if the exchange rates had stayed the same.

Now that is kind of -- you know, we're providing analysis but at the end of the day, the FX is part of the business environment we're operating in. We're adjusting our business to deal with that, we have been adjusting it for some time, and you know, we're looking to the future, and competing very strongly on a global sense, in this regime.

Okay. Fair enough.

In terms of Q4, in terms of systems factory utilization gain, and some of the other factors that you mentioned, are we looking at very large changes here, or is this -- you can give us some sense of how you see this unfolding over Q4 and maybe even into next year?

Well I've got a bloody nose because I was disappointed by the current quarter. But on the other side of it, I feel pretty good about our business on a go-forward basis.

I think that our improvements will not necessarily be a tremendous acceleration and I'm always careful about, you know, people who all of a sudden jumping to the conclusion that our systems margins are going to jump back into the 15% level.

I think there will be a linear expansion of our margins on a go forward basis as we improve both our utilization and as we see more of the repeat systems come into the -- and taking a bigger foothold.

Now, on -- we've also said that we had some issues we're working through on our West Coast operations which will be a bit of a hold back as well, but I do expect to see improvements as we go forward through the fourth quarter and into next year.

Okay.

And the 15%, the fact you mentioned that I take it you still feel you can get back to that level at some point?

Yes. I think it is going to -- obviously, that is our goal.

Right. And do you have a sense of how long you think it would take to get there?

I'm not going to do that today.

Okay. Just helpful to have an idea.

Just on the SSP, the launch is being pushed back four months, can you give aus sense of how that business, you see it unfolding in term was revenues? Is it going to launch at very small volumes and then ramp slowly? Or is it a big jump? Or how does that go?

The launch plan is that essentially it starts out at very low volumes because there is work to be done, and scaling production up, just similar to what we see in other programs. In this case, there is a lot more complexity to the production processes.

But we expect that we will bring our initial shift on, which will be a heavy shift because there is a lot of front-end technical talent attached to that. And then as we scale our production up on a per shift, we will start to add subsequent shifts and that -- essentially what we've done is we've basically have pushed the launch schedule out by about four months. So initially, we said we hoped we would get close to our [inaudible] capacity by the end of the fiscal year. That's been pushed out by a good four months. And, you know but there is a lot of, you know, there is a lot of speculation in that, but going -- that's our our internal goal is.

Right. And when you say the -- on the $20 million, the first slug, how many shifts does that assume?

That's a 7/24 operation we're running. Megawatts. And that assumes certain amounts of downtime, those types of things as well.

Do you have you kind of a goal as to when you get it up to 7/24?

I would say that's a little bit difficult to call right now. I think we have to gauge that as we go. But you know, hopefully by the end -- by essentially into the 2006 fiscal year, fairly early on.

Okay. Early F '06?

Delicate balance from that perspective. The timing of shifts is going to be driven by our -- the status of our progress, so.

Right.

Then a question on the auto components, the components in general. Margins have never, as far as I can see, never been anywhere near the systems levels. Can you give us any thought on where you see this all going? Obviously the currencies is being a set back.

Let me be clear.

I think, that you know, it is obviously important to go back and reflect a little bit historically on where we are at, and in fact, I think the period through the late 90's, our EBIT margins in the Components group were running just a hair under 10%. And so it is was good solid operating performance, very much in line with our goals.

We made the decision that we were going to transition the business because of additional pricing pressure to move more into sub-assemblies. We started that transition about roughly two and a half years ago and clearly we've hit some bumps along the road and now the currency spread has added another challenge but as I indicated, I think there are a number of initiatives which are under way to help us improve our performance within the Components group, and like I say, there is work to be done. But we are very confident about where the outcome is is going to be.

I think getting back to 10% is a huge challenge. But clearly our first step is to get it back to profitability and to move from that point forward. As I said, we've got a goal to get to that and we think a solid plan that gets to profitability over the next two quarters.

Okay.

And when you say profitability, do you mean -- or say break even, do you mean on an EBIT basis or do you mean on a net income basis.

I'm talking about initially on an EBIT basis.

Okay. Fair enough.

And last question, on the thermal side, I was just wondering where there that is going. In the last call, you talked about, I think Chris talked about a trend of OEMs outsourcing the box makers and that might impact the progress of the division. Taking it to mean slow. Where are we, does this division sort of stabilize somewhere where it is now or is there more growth ahead?

I guess the one thing you're probably aware of is that volumes are always very strong during the third quarter. And they certainly were for us. Now, they naturally flow off because of seasonality, they slow down in the fourth quarter.

Right.

On the other side of it we've continued to attract new business. I think longer term we're wrestling a little bit with this business about what the appropriate steps to take with it are, and I don't think we've reached a conclusion on that, so I think you will just have to be patient with us until we work through the scenarios that are attached to that business and make a dis.

Okay. But what do you mean by wrestling with it?

Well, clearly, we've seen a structural change with the move of the market into Asia.

Yeah.

And we are formulating our response to that, that overall situation, we haven't yet concluded what the appropriate step is.

Great. Thanks very much.

Your next question comes from Marco Pencak from GMP. Please go ahead.

Good morning.

You can quantify for us what the approximate dollar value of the various, you know, first time costs overruns, in ASG was in the quarter?

I'm not going to put an exact number on it but suffice it to say we would have shown a definite improvement over our Q2 performance without them. That's on an absolute profit basis or a percentage of revenue basis or both? I was just talking about on an absolute dollar basis.

So your operating margin dollars would have been higher?

Absolutely.

Okay.

My second question is just based on the mix of business and sort of the flow and assuming constant FX rates do you expectation your ASG revenues in Q4 to be higher?

Yes we expect to be higher primarily because of the increased flow on -- we make the bulk of our revenue, when it hits the production floor.

Right.

Because for every hour that goes in through the design shop, that number gets compounded by a substantial margin once it hits the production floor.

I understand that. I just wanted to be sure there wasn't going to be some anomalous mix issues that may have compromised that.

Not expecting that.

Okay. The -- one of the things that you guys have done is you have strategically positioned yourselves to be leaders in new market segments and essentially sort of break new frontiers, and it strikes me from your comments and from Klaus's comments about continuing to invest in technology that is still a consistent strategy.

So my question therefore is does that mean prospectively that as you go to capture some of those opportunities, you're going to constantly be dealing with this first-time, you know, customer business, that has the attendant, you know, margin challenges associated with it?

Can you just give us a flavor -- I mean I recognize your comments about how you're seeing record levels of repeat business now, but what if over the next months, you guys get a whole bunch of first time guys that you guys have been calling on for a year or so and if you could just give me a feel for why, you know, how you might see that unfolding?

Okay. Obviously, breaking into new business, new technology sectors comes with a price. There is no question about it, Marco.

But we have done both -- we've developed the new markets, we've developed new standard products that are very, very suitable for these markets, but a lot of these effort are, you know behind us now, we're seeing a more routine approach to, you know, getting into new systems, and of course, as the amount of standard product we design into these systems decreases, our risk, startup risk decreases.

Plus of course there is also a large pool of knowledge that has been built around these new businesses, so like I say, it did make -- we did make a substantial investment in getting to this level, we're starting to see the benefits of it now.

Let me just explore this a little further.

If you look at your bookings to date as separate, and compare that to your sort of high probability prospect list, can you give me a sense of, you know, whether your new prospect list has, again, a very high proportion of repeat business or would that have a relatively higher mix of first-time business that has not yet formally fallen into your order booking.

We said earlier that, you know, going forward, the next three months anyway, that the amount of repeat work is substantially up over the last quarter.

Just to give you a little bit of color on that Marco, I think that the thing is that we've laid a lot of ground work over the past two years, and I think we're starting to reap what we sew. I think when we look at what is happening in the prospect list, we get very excited about it. It it gives us a lot of reason for enthusiasm for the future.

Our competition has not been able to move into these market sectors the way we have. We have developed our relationships over the past two, three years with many of these people. We have laid a lot of the ground work down with them and I think it's time to start to see the benefits of those factors on a go forward basis.

I concur.

I guess my concern is if we identify pharmaceuticals specifically where I know you have laid a lot of ground work without yet having seen the formal benefit in a very substantial fashion, you know, if you're successful in really establishing a very material beachhead there, whether that does also translate into, you know, a lot of first-time low margin business. So you're bookings pop, but as you go to deliver on those, you know, contracts, because it is a new sector, have you some challenges. I mean that's really what I'm just trying to understand.

I guess it's all relative at the end of the day. And you know, part of the point of this -- you're at the point in the economic cycle where people just aren't producing what they produced three years ago.

They've launched into new business sectors to they're building a different system that than they had before, so we're at that point in the cycle where the amount of first-time systems is proportionately very high. On the other side of it, the opportunity for the repeats is also correspondingly very high.

So I think we're just at that point but you're right I think as you move into new sectors there is a higher risk attached to those first-time systems.

Okay.

Correspondingly, we've worked -- we win and work our way through the first one, there is guaranteed to be repeat work behind it.

Right.

In the Precision Components Group, it strikes me that a lot of the business that you've won has had a lot of variability and mixed shift associate within specific contracts. And so, you know, given that that's been your historical experience, I mean does it make sense for you to revisit your pricing to essentially give you more cushion to absorb some of what seems to be, you know, the variability that flows within those contracts.

Just, I'm sure that Bruce will have something to add but I think the biggest variability has probably been as we -- in the thermal area. The microelectronics stuff has been extremely variable. I think that what we've seen in the automotive side has been a lot more stable. Maybe have you something to add to that.

I would agree with that. It is the thermal that has had the ups and downs.

Final question. On your SSP, the $10 to $15 million dollar increase, how much of that is incremental -- I'm not sure the details, how much of is that incremental Cap Ex, versus incremental, you know, capitalization of various costs? And have you yet determined when the transition from capitalization to expensing of your results is going to occur?

As I indicated, the bulk of the variance is actually -- is in the equipment and the facility side. That's certainly the vast majority of the cost.

In fact, you know, when you look at the variance from the standpoint of what we expect to spend on deferred development, I don't see a huge change that there.

Okay.

With respect to criteria, this is an area where we haven't made -- we haven't gone through and evaluated and made the final decision. This is something that clearly we're going through, in discussion with our audit community, our auditors and coming up with the appropriate criteria that is in complete compliance with the Canadian guidelines for this. We have to work our way through that Marco, it is too early to give you an answer there.

Okay. Thanks very much.

Your next question comes from Pierre Yves Terrisse from Dejardins Securities, please go ahead.

Yes, good morning.

Ron, I would like to start looking at your Precision Component group. You talked about sourcing from Asia. I didn't catch the amount of cost savings that you mentioned.

I said our goal over the next four quarters, so basically our calendar 2004 year, is $1 to $2 million dollars in additional savings. We've been - we have started sourcing, we previously, out of Asia. in the Precision Components Group, but that is our goal, the incremental amount for the current calendar year.

Okay.

And is there any color you can give us about the -- your first-time project that you referred to that you know, hurt the bottom line, you know, how much of that project are off the floor now, can you give us like a sense of where it stands now and what could be flowing into Q4?

The bulk of it is off the floor. As I indicated, it is basically they were either completed in the quarter or they were virtually complete during the quarter.

So some of the projects that are currently passing through are not the first time project you're referring to in Q3 that hurt the bottom line?

For the most part, we're pretty comfortable with the stuff that's been coming through the door. It's early on.

Okay.

And in terms of your SSP initiative, can you give us a sense of where it stands with Elk, at what stage it is? Is it still at a development cycle? Where do you stand on that front?

As indicated from a contractual standpoint we're working through the details of the contract. And that will allow us to go through the development stage.

I think it is important to note that, you know, we need to get some of the commercial product to come off the line before we we're able to move seriously into some of these integrated product development issues. This is where we need to have essentially the commercial product available for the -- we can do initial development work on these things but we need to get, you know, 6 by 24 inch cells, okay, into the process, okay, that we can provide in order to accelerate that development cycle.

You referred to some shipment in Q4. The shipment you referred to in Q4, is it like -- obviously it sounds like it is going to be solely on the commercial side.

We said that our first shipments are likely to be during the summer, which is a delay of about four months period.

So it is more likely Q1 of '05 or Q2 of '05?

That's correct.

Okay. That's all for me. Thank you.

The next question comes from David Tyerman from Scotia Capital. Please go ahead.

Yes, I just wanted to follow-up on Marco's question and your answer. And that was you said that ASG EBIT margins would have been higher in Q3 than Q2, if not for the first-time systems. My calculation is that that is at least $2.3 million swaying in the quarter, then, or 1.9% EBIT margins for the year. Is that correct, first of all?

And then secondly, is it reasonable to expect that to go away in one quarter? It sounds like a lot of those are going off the floor already. Or is this a process where it will improve over a few quarters?

You know, with respect to your math, the number doesn't surprise me. I haven't done the number as you've specifically calculated it but it doesn't surprise me. But again that, these are projects which we're wrapping up or completed.

So in Q4, we could see a $2.3 million swing alone from that kind of thing?

That wouldn't surprise me.

Okay. Thanks.

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Thank you very much, operator.

Thanks, everybody for listening. And so with no further questions, I would like to say goodbye for now. Thanks very much for attending. Thank you.

Ladies and gentlemen, this concludes our conference call for today, thank you for participating and please disconnect your lines.