ATS Corp (ATS) 2006 Q2 法說會逐字稿

Before the call begins, I must remind you that certain forward-looking statements may be made today including statements regarding possible future business. You are cautioned that such forward-looking statements involve risks and uncertainties. The company's results could differ materially from those anticipated due to a number of factors including but not limited to the risks and uncertainties found in the company's preaudit filings with Securities Administrators. Please review these filings found at SEDAR.com. Following the presentation, we will conduct a Question-and-Answer session. Instructions will be provided at that time for you to queue up for questions. If anyone has any difficulties hearing the conference, please press star-zero for operator assistance at any time. I would like to remind everyone that this conference call is being recorded on Thursday, November 10, 2005, at 10:00 A.M. Eastern. Now I would like to turn the call over to Mr. Ron Jutras, president and chief executive officer of ATS. Go ahead, Mr. Jutras.

Thank you, operator. Morning, everyone. I'm joined today by several members of my executive management team. This includes Mike Cibulsky, executive VP of operations, Automation Systems Group, Bruce Seeley, VP of Precision Components Group, Carl Galloway, vice-president and treasurer, Gerry Beard, vice-president and chief financial officer, and for the first time, Syl Ghirardi, president and CEO of ATS Solar Group, Gerry will provide a financial review and Syl will update you on ATS Solar Group progress shortly.

First, I'd like to update you on our corporate strategy initiatives and our outlook. As you know, we set out this year to develop a comprehensive strategic road map for our company. Our goal was to commit ATS to a deliberate and focused course of action that would deliver significantly improved financial performance for our shareholders. The course of action that will allow us to maximize the value of our people and leverage our business strengths globally to a much greater degree than ever before. One that responds to the rapidly changing global marketplace in which we operate. The board approved our plan in September giving us a clear mandate to proceed and we are now fully engaged in implementation. This is not the forum for a detailed discussion of strategy. But I would like to tell you what this plan what this plan means for ATS shareholders going forward. Means the ATS is changing. We are becoming more data-, and more process-driven. More deliberate in our actions and investments. More focused in our customer relationship management and more results-driven.

While I'm pleased with the progress we have made so far with our strategic plan, we also have a lot of work to do on implementation. That cannot come fast enough for me but it also must be done right to be lasting. I believe that good financial results over the long term are a byproduct of good strategic execution. We're early in the implementation process and the benefits of strategic work we have done so far are therefore not yet evident in our financial performance. But in the coming months, and in fact, even now you will see growing evidence of the fact that we are doing things differently in many important areas and I'm confident these will make a meaningful difference to our results as we move forward. An example is management of ASG capacity. We must have the right capacity in the right places to meet our needs going forward. Our ability to flex capacity is the key driver of our success. Planning capacity utilization is difficult because of the project nature of our ASG business and the lengthy lead time is to add skilled people and. difficult or not, it is something we must do and do well if we are to better align capacity with demand and opportunity, and deliver sustained improvement in margins. It is not just within each facility but globally across all our locations.

Over time, the processes were now employing and the data we were gathering will give us better tools to assess and manage total capacity. For example, on a global basis, we further developed our reporting systems for both sales forecasting and for department and factory resource loading. This gives us more valuable information about expected ASG capacity utilization and the tools to enable us to better manage production scheduling globally. As a result, we have enough information today to know we were carrying too much capacity in certain areas of ASG. The cost of carrying this excess capacity is evident from our ASG margins in the second quarter which I would characterize as disappointing and unacceptable. As we discussed in past, margin improvement is our highest priority, and we are committed to this goal. Consequently we announced today a reduction in our ASG work force and the closing of a 33,000-square-foot ASG facility located in Burlington. These current reductions combined with those already made since the start of the second quarter will reduce our ASG workforce by approximately 6%. This initiative affects positions in production and in overhead. Some in Canada and the U.S., some in France and Germany.

Gerry will discuss the financial impact of this action, but I can tell you that the expected future benefits are significant. We believe it will not detract from our overall technical capabilities. In fact, these actions are the product of very careful thought. Ensuring to retain our best and most promising people, our core knowledge and skills and with a view to give us the ability to flex our capacity in future. And I can tell you that going forward, all decisions regarding our capacity and our people will be done with the same care and analysis. As a knowledge based company, we cannot react in a knee jerk fashion when it comes to our internal capacity. We will never by upsizing and downsizing employment quarter to quarter. This never been the ATS way and it won't be under my leadership.

It can be equally said that we will not succeed if we carry capacity we can't utilize. That doesn't make good business sense for you, our shareholders, for our customers, nor for employees who also have a major vested interest in our corporate prosperity. Some would say that an ASG workforce reduction represents a change in our culture. I disagree. Because it does not change our thinking regarding the importance of our workforce and the need to retain and build our productive skills and our brain power. Our strategy for the future preserves these core principals because without them we would not have a future.

I mentioned that we also need to leverage our business strengths to a much greater degree in response to changing markets. Another way we are doing this is by realigning our ASG sales force to make it globally oriented as opposed to factory oriented. We are doing this to enhance our sale potential and global resource loading. In a world of customers are buying globally and our competitors are local, an automation sales force is that global and sell true global capabilities and our solutions in all markets is a powerful one. We believe ATS is the only automation company that can do this and now we are. Building a global ATS brand is a key part of our plan and this sales force realignment is only one step along the continuum.

The bigger task lies ahead and that is to standardize our ASG business processes globally, so that every factory operates to a common standard, provides a consistent customer experience, is able to work cooperatively with other ASG facilities to support the global needs of our customers. Not only will this strengthen the quality of service we can provide to customers and differentiate us further in the market, it will allow us to improve our global facility utilization and further allow us to lever the benefits of our size and the synergies of our incredible knowledge base and experience. This will take time, but the task has started. In fact, we already identified 30 key business processes. We benchmarked these to set best practice standards and then we will align our processes globally to achieve our goals. We've also initiated global supply chain management and value engineering initiatives. All are targeted to create competitive advantage and improve margins.

We think this will be one of the most rewarding things we can do for shareholders and customers. Customers, because they can rely on ASG with confidence to employ their global design-anywhere-build-anywhere strategies and shareholders because having strong facilities globally and the need to improve global utilization will enhance our investment returns. It will be good for our employees globally. Because our common processes will help them to work cooperatively and efficiently with AGS employees at other sites and share learning and improvement ideas. They can take full advantage of the power of the ATS brand as opposed to being left to their own devices to succeed. I believe very strongly the plan we begun to implement, and it's a substantial one with many different elements, will make ATS a much more valuable company.

Before I turn to our outlook, I have three other topics to cover that relate to our strategy. First, we completed a small but strategic acquisition in the second quarter within the ASG group. Specifically we acquired a small company located in Birmingham, England. This is our first business in the U.K. The small leased facility is well established with 25 employees, and it has some niche products. But it's strategic purpose as part of ATS is specifically to provide sales, service, and support for our growing list of important customers in the U.K. and to provide installation support to our install teams in the U.K. In this important role, it greatly extends the sales, service, support, and installation network of our existing ASG manufacturing operations, both in Europe and in North America. And this is without investments required for a full ASG manufacturing plant.

Gerry will talk about the financial limitations in this acquisition in his presentation. Suffice it to say that this was a compelling opportunity to fill a growing strategic need that had been on our target list for at least a couple of years, driven by a rapidly growing install base and list of customers in the U.K.

Second, also under the heading of strategically building out our global capabilities, PCG opened a new 17,000-square-foot manufacturing facility in the Shanghai region of China in August. Our PCG presence in China began with our supply chain management initiatives about two years ago and this next step with the start of manufacturing was taken in response to customer demand in China. Manufacturing is now ramping and our China PCG operations including both supply chain and manufacturing currently employ 26 people. We plan to be profitable in this facility by Q1 of next fiscal year. I think China is a topic on most people's lips today because it represents a huge opportunity. It also presents some unique and big challenges for all three of our business segments: ASG, PCG, and Solar. Our ASG experience operating in China since 1996 gives us a running start, but we also recognize the need to expand and further build our capabilities to serve the rapidly expanding manufacturing base in China and the growing investment needs of our multinational customers in this region. Consequently, we are currently finalizing our longer term ASG strategy for China. Our mission is to grow there on a deliberate and staged basis and ensure that we best deploy capital for maximum return.

And the final comment about strategy, September was an important month for trade shows. We were very active in showcasing our capabilities at six separate events as part of our strategic marketing efforts. In particular, we had a very warm reception at the Packaging Expo held in Las Vegas in late September. Our goal at this show, which was a new forum for ATS, was to demonstrate our comprehensive integration capabilities for the packaging industry and to identify potential supply partnerships. We more than met our goals for establishing our presence as a very capable and desirable integration partner in this relatively new market for ATS. The centerpiece of our display was a super track based, fill-packaging system called [flexsis pack]. What we developed -- that we developed to show our full innovative and flexible packaging capabilities.

The final topic of my prepared remarks today is our outlook. As you saw from our press release, our order bookings were strong at the end of the second quarter. Unfortunately, this was too late to have an impact on the quarter itself, but certainly on time to help the second half of the year. This order flow was not surprising considering we knew a lot of it was coming. You recall we indicated in August we were expecting approximately C$86 million of orders to be booked fairly quickly based on advanced engineering assignments and other assurances. During the second quarter, we received firm purchase orders for almost all of these advance orders. The remaining potential orders have not gone away, but we expect them to close this quarter. This is clearly good news. Furthermore, our quotation pipeline remains strong. We continue to have a promising and I think exciting list of order prospects on our high probability list.

My biggest concern today is the deteriorating condition of the North American automotive sector, which was brought very sharply into focus for many companies including ATS, with the Chapter 11 filing of Delphi in October. Automotive has been an important market for our Automation Solutions because of our ability to help auto parts companies significantly reduce costs and generate high quality. In fact, requests for quotation activity remains very strong today. The reality is, the industry is not healthy today, and this means we must intently focus on assessing the work that we can wisely take on. So, near term, automotive will not be a driver of our growth.

Delphi has been one of our largest automotive customers. Although we were successful in reducing a substantial amount of our financial exposure prior to their Chapter 11 filing, we did get caught in a substantial way as the results show. Going forward, we continue to work cooperatively with Delphi to hopefully recover these outstanding receivables. And we do intend to work with them throughout the restructuring because we are optimistic that when they emerge they will return to being an even stronger buyer of ATS Automation. However, we are also very committed to managing our exposure. In fact, we are intently focused on the financial condition of all of our automotive customers, and we are employing extra managers to manage credit risks in this unprecedented period of upheaval.

Looking at health care, the picture is much more positive. We continue to believe that health care will be a major driver of growth for ATS. In fact, we had excellent order flow during Q2 and our current prospects are outstanding in health care. We have also come to recognize that in health care we are working on larger, more complex longer lead time projects and this has lengthened the sales cycle. I can assure you, though, that the prospects we are working on are clearly progressing, and we are confident they will result in valued orders in the future.

We also have outstanding prospects in contract equipment manufacturing. Under Bruce Seeley's leadership, it generated over C$19 million of revenue for our Automation Systems Group in the first half of the fiscal year, with attractive margins. We believe contract equipment manufacturing has excellent potential. While technically sophisticated, this is a repetitive manufacturing business that makes excellent and growing use of the knowledge, capabilities, and resources of the PCG group. Clearly today, our various markets offer us different near-term growth opportunities, and this is exactly why our strategic efforts to maintain a diversified revenue base are so valuable. I will let my colleagues cove the outlook for Solar and PCG. Before I conclude I want to assure our shareholders that all of us at ATS recognize the need for better performance today even while we also position ourselves to secure a strong future. I believe the decisions and actions we are continuing to take, including those announced today, show that as a management team we are committed to both of these priorities, and ultimately, to rewarding our shareholders for their investment and support.

I believe it's very obvious we are changing as a company. We're changing to meet the new realities of our markets and respond to new opportunities. And we're changing culturally and operationally as we adjust to our new realities as a more structured and data-driven business. This is a lot of change all at once, which makes it challenging, but it's necessary. There aren't quick fixes. So I ask you for your continued support as we take the steps necessary to set ATS on the path to of substantial and lasting gains. I believe your patience will be very well rewarded. Thanks for listening. Now I'd like to turn the call over to Gerry.

Thanks, Ron. I will start my review with ASG and wrap up with some consolidated comments. As expected, ASG had a challenging quarter due to the low backlog of June 30th, and this was further compound by two provisions related to automotive customers. The first of these provisions related to the Delphi Chapter 11 filing for which we provide an allowance of C$4.7 million. This amount represents a provision for the accounts receivable exposure that was outstanding at the time of the Delphi bankruptcy. As Ron mentioned, we're actively pursuing the payment of current and future outstanding accounts with Delphi. However, given the lack of visibility as to the outcome of Delphi's restructuring, and the uncertainty as to how much of the prebankruptcy receivable we will ultimately collect, we felt it prudent to fully provide for this credit risk.

The second customer provision in the amount of C$1.1 million is related to an unresolved dispute with an automotive customer on a program that is now complete. Again, given the uncertainty of the outcome, especially in the context of current automotive market conditions, we felt it prudent to make a provision to resolve this matter. Clearly, the automotive market is becoming more difficult and as you know, although we successfully diversified our revenue by entering the health care market, the fact is that ATS still derives a significant portion of its revenue from automotive. As such, ATS has now put in place additional controls to help manage the credit risk on these projects.

On a regional basis, compared to Q2 last year, ASG's Eastern North American operations had a significant amount of underutilized capacity due to the low opening backlog to begin the second quarter. This resulted in lower revenue in earnings but as we talked about outlook here is improving. ASG's Asian operations show progress over the second quarter last year with higher revenue and increased profitability. ASG's West Coast operations also showed improved operating earnings despite a slight decline in revenue. European operations also made underlying progress. Excluding the C$600,000 cost of work force reductions in Europe, operating earnings in Europe improved over the second quarter last year.

As you've heard, we were taking action to remove underutilized capacity within our ASG divisions. As some of these work force reductions occurred in the second quarter and others have just occurred, work force reduction costs amounting to C$600,000 were expensed in the second quarter and we expect approximately C$2 million of additional costs to be incur in the third quarter. We expect annualized cost savings from the work force reductions of approximately C$9 million with the savings beginning in the third quarter and then increasing to their full extent in the fourth.

I would now like to review ASG order booking activity and backlog levels which are highlights of the quarter. Although a significant amount of booking activity took place too late to have a meaningful impact on second quarter results, ASG bookings of C$167 million in the quarter will have a positive impact on facility loading going forward.

More specifically, we expect the benefits of these bookings on revenue will be tempered in the third quarter during the design phase of these projects and should increase into the fourth quarter as the projects ramp up and the materials are purchased and integrated into the systems. Also quite positive, is that a substantial portion of the C$167 million of bookings are for the Cambridge operations, and this has had the effect of more than doubling the backlog levels at our largest facility.

As you know, Cambridge operations have recently seen low capacity utilization so this increase in bookings bodes well for improvements in utilization of this facility in the second half of the year, particularly into the fourth quarter. Also very encouraging is that the bookings in the quarter had a heavy weighting toward the health care market with ASG health care backlog almost doubling in the quarter to C$84 million. This has driven the health care backlog back up to the strong levels experienced in fiscal 2005.

To conclude on ASG, as Ron mentioned, we acquired a small automation company in the U.K. on economic terms that were very favorable to ATS. On the close of this transaction, ATS received cash of C$650,000, 25 very skilled and knowledgeable employees, the networking capital of the business, and we assumed a two-year unsecured interest-free loan.

Moving on to Solar, as you know, Photowatt had reduced activity levels in the second quarter due to its month-long summer shut down prescribed by European tradition. Comparing second quarter results to last year, Photowatt turned out a strong performance with operating earnings increasing over 500% compared to a year ago. This significant increase in profitability reflects a number of positive operating factors including throughput gains, continued improvement in production yields, and increased selling prices. Photowatt's revenues, when reported back into Canadian dollars declined slightly. However, excluding the impact of the strong Canadian Dollar relative to the Euro, Photowatt's revenue was 5% higher than the second quarter last year.

Turning to SSP, beginning to the third quarter, we will start to recognize SSP's results in our consolidated earnings. To give you an idea as to the effect of this, over the past couple of quarters we've been averaging C$5 to C$6 million of development costs, which if expensed, would have had an impact on EPS in the range of C$0.06 to C$0.07 per share. I believe it's important to note that although SSP will record losses from operations in the upcoming quarters, which will reduce the overall Solar Group operating results, ATS considers these startup costs as part of the overall investment in bringing this emerging technology to market, and these startup losses are no way representative of the future potential and value of SSP.

Let me shift to our third segment, the Precision Components Group. As expected, PCG experienced a difficult quarter in part due to summer automotive plant shutdowns, but PCG was also affected by the volatile North American automotive market and the strong Canadian Dollar. The strong Canadian Dollar reduced operating earnings by an estimated C$600,000 compared to the second quarter last year. Results were also affected by an arbitrary price reduction imposed by a customer that aggregated to a C$400,000 impact on profitability in the quarter. While conditions in the North American automotive market remain difficult, and the continued strengthening of the Canadian Dollar also remains a challenge, we remain committed to returning PCG to profitability through continued internal production improvements, improved asset utilization, and the ongoing transition of PCG's capabilities into more attractive areas including contract equipment manufacturing and higher value-added assemblies.

To complete this financial overview, a couple of final balance sheet comments. Net of government funding, our total investment in SSP is C$120 million. This consists of C$70 million for capital assets and intellectual property, C$46 million for deferred development costs, and C$4 million of inventory which consists mainly of silicon. To close out my remarks, we continue to have a sound balance sheet with a very healthy debt-to-equity ratio point 2 to 1, and we believe our considerable financial resources will be able to capitalize on our financial opportunities. Now I will turn the call to Syl.

Thanks, Gerry. I'm very excited about the progress we are making within so the Solar Group because that progress is both tangible and strategic. Gerry mentioned the tangible progress we were making with respective financial performance of Photowatt. This business continues to perform exceptionally well, and our outlook for the second half of fiscal 2006 remains positive. Demand in the solar market is continuing at a record levels and growing. Photowatt has done a great job to date offsetting rising silicon [feed] stock prices through efficiency improvements.

I know the silicon supply issue is looming large, so let me give you an update on our silicon resources. Photowatt has already secured a significant amount of capacity in the first quarter of fiscal 2007, and we have been creative in finding new sources of silicon for the future. We've also found ways to increase the yield and efficiency producing cells from silicon. This allowed us to sustain our margins. However, it will become challenging to continue to offset silicon increase prices through production efficiency gains. We have been meeting extensively with major silicon suppliers and we've been encouraged by the longer term silicon prospects. By 2008, new silicon supply expected to come on stream which should alleviate this pressure.

SSP has also found sources of silicon supply through fiscal 2007. SSP silicon needs are different than conventional solar technology because SSP requires a lower grade of silicon and uses less silicon in its processes. The SSP patented process technology also affords us the opportunity to convert lower quality silicon for use by Photowatt. To conclude on Photowatt, we expect good things from it for the balance of the year. Looking ahead, we are focusing on increasing its production capacity. We are taking delivery of new equipment this quarter. Everything should be in place in the fourth quarter, and beginning in fiscal 2007, we expect to have an annualized capacity of 40-megawatts of solar power up from around 32 today.

I mentioned at the outset we made both tangible and strategic progress. On the strategic side I presented my first Solar Group strategic plan to our board and we were actively engaged in the implementation steps. This plan articulates our funding, operating, marketing, and sales strategies so it's very comprehensive. With respect to tangible progress at SSP, there has been a bit -- quite a bit in the past few weeks.

First now, first now we are running SSP production continuously from front to back and we have been doing this for the past three weeks. Whilst our ramp-up is modest so far, we taken the major step forward improving the manufacturability of a project on a fully automated basis. We're now learning more about the manufacturing process and knowledge we gain will escalate. This, in turn, will help improve our run rate.

Let me be clear in setting expectations, however. Revenue for the balance of the year will not be material to ATS. What's more important at this early stage is validation, not pure output. That will come. This should not come as a surprise since this is a unique product and never tried before manufacturing process. And this brings me to what I would call a second tangible.

We expect that in calendar 2006, we will have gained sufficient production and technical validation to allow us to move forward in our strategic plan. As you'll appreciate, we need this validation to create optimal conditions for moving forward and for funding. Today, even before we complete our final stages of validation, we have already numerous funding opportunities ranging from an IPO or customer or supplier investments to funding by strategic investors. Since in my view the Solar Group is incredibly valuable asset with an outstanding future, we will choose a funding path that offers the best value for our shareholders. Here is the third tangible.

Because our plant is now running and starting to produce SSP product with a 6% to 8% efficiency we are making the most of this output. We were about to submit our [superflex] product for certification which we expect to receive early in the new calendar year. Certification is not a given but UL representatives have been in our factory several times over the past year and we performed well on critical tests that have been administered in-house to date. We will be shipping 50 superflex test modules in December to one of the world's largest aftermarket marine product distributors. We have been working with this company for some time, and they are committed to becoming a major customer.

In late November, we will also ship test modules to our integrated grouping system to our partners at Elk who are in turn installing them in three homes for U.S. validation and marketing purposes. Elk will submit samples of our integrated roofing system for UL certification in January, another step in the process that [inaudible] that we expect will take several months. We've also had good preliminary feedback from a commercial roofing membrane customer in Europe who conducted side-by-side comparisons of competitive thin film technology and SSP technology and found that ours outperformed in ease of application and power output.

Looking ahead, we have a lot of work to do and very active agenda. I know this area of development has been long, but things are starting to take shape, and our confidence is growing quickly as we take risks off the table. I hope you will continue to be patient and continue to be -- take active interest in Solar Group as it has great future. That concludes our prepared remarks. Now we would be pleased to answer your questions. Operator, could you please open the lines to the questions.

Thank you. One moment please. Ladies and gentlemen, we will conduct the Q&A session. [OPERATOR INSTRUCTIONS] Your first question comes from Cameron Jeffreys from Credit Suisse First Boston. Please go ahead.

Thanks very much. Good morning. Question on ASG margins, Ron, correct me if I'm wrong, you indicated you wanted to get back kind of into the double digit range in the back half of the year. I'm not sure if I have that right or not, but I believe I do. Wondering if that's still something you believe is achievable given the kind of the plans you are going through today or whether that might be a little bit optimistic.

I remain optimistic that we'll get to that level especially with the steps we have taken by the end of the fiscal year. I don't think that we will get there in the third quarter but I'm optimistic we will see the benefit both of the initiatives we launched today to reduce our spending. But also the fact that our backlog has increased, and I think these are very powerful drivers to help us improve our performance. One could argue that the work force reductions represent essentially a 2% boost or EBIT margins and ASG. If you take that in conjunction with some of the margins we produced quite frankly as we came out of the last fiscal year we'd be at that level. I remain optimistic when we get to that point. But we've got some work to do.

Okay. My second question on precision components just on the return to profitability which has been elusive to this point. We have seen pretty much more than two years of losses on a quarterly basis with the exception of a couple of marginal ones. I mean, is there a point in time where you might kind of look to change the plan with regards to the future of that business, say in the next six months? Or is it something that you're going to let your plans work through and maybe look at it a year from now and see where you are?

I think first of all in our prepared remarks, I think that the PCG group has been an important part of our business because of its ability to build relationships with our customers. But I think that over the past four or five years we kind of drifted away from that overall strategic intent, and PCG went off somewhat on a parallel course as opposed to an integrative course. Our focus for the near term remains to return our business back to profitability by driving the initiatives that we've talked about. Once we go through that process, I think we can start to look more strategically at the business and how do we get back to how it integrates with -- and generates value for our business on a go-forward basis. I think that you already see some of those things like the work that the PCG group is doing in contract equipment manufacturing is extremely encouraging. Unfortunately it doesn't get reflected in PCG results even though we're using the resource base of that to drive that business going forward. I think there are a number of changes taking place there, but our focus near-term needs to be to complete the initiatives we have that we believe gets us back to profitability.

And when would you believe -- when would do you think those initiatives will be in place? Kind of by the end of fiscal year? Is that a fair assessment of timing?

I expect that we will be at the break-even level by the end of the fiscal year.

Okay, perfect. My final question is just on pricing, just wondering if you can maybe give us a -- elaborate a little bit on pricing in the backlog. Obviously you had a pretty strong quarter in bookings. Can you just give us a sense as to kind of what you are seeing out there maybe by sector, particularly health care I guess is very strong. Thanks.

Well I think that, the pricing market I think is -- remains the same. I think there hasn't been a noticeable change. I think that we've -- obviously the pricing is driven a lot by I think the strength of the end market. It's also driven by the competitive nature of that environment, so you can quickly do the math and see that pricing is probably most sensitive in the automotive market, and I would confirm that that's the case. I think from our perspective, we're being very disciplined given the additional risks we see in the marketplace. I would also say in health care, we see great opportunities. It's a challenging business tought, and as I said there is a longer sales cycle attached to it. But we have been working very aggressively to build the skill sets that are necessary to support the penetration into this marketplace. We have been doing that for about four years. So it's not something that somebody can quickly jump into and be successful with. And I can tell you that we have additional work to do in this area but I'm pleased with the progress we are making in this marketplace. We think it's an attractive market both from the standpoint of it topline growth potential as well as its earnings potential. That's why we have clearly identified it as a market that we targeted for growth.

Great, thanks very much.

You're welcome.

Your next question comes from John Novak from CIBC World Market. Please go ahead. Mr. Novak, perhaps your line is on mute?

Ron, I have a question with respect to the funding strategy for Solar altogether. When we look at the competitive landscape a number of your competitors now are adding capacity at 100-megawatt chunks. It seems that you've been talking about the small increase of capacity at Photowatt for the last couple quarters and it's only now that it's getting underway and it seems to be less of a capacity increase than you originally anticipated. So I'm curious when the funding strategies is going to become more clearer both for Spheral and for Photowatt and when we will actually start to see major increases in capacity in those businesses.

Maybe I'll start with that and maybe Syl, will have a couple comments to add. I think we have been on a very progressive basis increasing capacity at Photowatt. You are right, we haven't gone out with a big flare people talk about with 100-megawatt expansions. I think that a lot of people have done that type of thing. They have gone out and they've raised capital in order to support that. We have been taking a much more progressive approach with respect to Photowatt to basically make sure that we have a good solid manufacturing business. I can tell you I was in Photowatt about three weeks ago and it had been a little while since I had been there, about 18 months, and I was very impressed with the substantial enhancements we have made in that business to improve our operating efficiencies. and we are seeing the benefits of that in the numbers coming through on a quarter by quarter basis. I think that while you look at the overall growth year-over-year and Photowatt for the first half of the year, and it's pretty-- I would say it's pretty -- it looks pretty conservative relative to what people are announcing. But I also think that the summer quarter is often a slow quarter for us. But I guess I just want to deal with, before I moved on to the funding issue that I think we have been progressive in the investment we have been making in our Photowatt business on an ongoing basis and we are seeing the benefits of that, both in terms of top-line growth, but more importantly I think on the bottom line.

I think turning to the SSP funding question, I think that we currently articulated our strategy for funding and we think it's the one that will produce the most value for our shareholders is to get SSP to the point where we are taking substantial risks off the table. And the biggest one of these is to validate the ability to manufacture the product. I think as Syl made in his -- commented in his presentation, we are making substantial strides in that area, and it's been a long arduous task. We are seeing the light. And I think that's very encouraging thing. So that does push us down the path and gets us closer to when we're at the point where we can go out and secure the funding that will be necessary for this business to reach its full potential. I think the plan for SSP is obviously, you know, a progressive one, but we would see that once we're through these hurdles we are quickly moving forward with our strategic plan which goes to the issue of developing the 100-megawatt factory, not only one but multiples. Because that's what it's all about. We didn't get into SSP for a 20-megawatt factory. We got into this initial program for SSP to validate the technology. The platform we use -- chose to do that was with the 20-megawatt initial platform. But it's the first step.

When do you think the validation will be completed?

We said we believe we will be at a point we can sufficiently validate that technology during 2006. That's calendar 2006.

And does Syl have any comments either?

It's refreshing to hear a question about building capacity and we are at the point now that, as Ron said, that we feel pretty good about the manufacturability of the product but we still have a long way to go. We have our plans our strategic plans outline the growth that you're talking about to take advantage of becoming a leader in the solar power industry. We know what capacities we need to invest. We know how much money we need. We also know that we need to make sure that we are -- we understand our technology, and we can scale it up in a faster way. Understanding the technology early on will make the ramp-up much faster.

And so can you quantify the funding requirements that you will need to build this out over the next three years?

We were not prepared to give out that information at the present time. I can tell you the opportunity is fantastic for us right now.

Okay, thanks. Ron, one last one. Can you just give us a sense of what the outlook for the computer electronics business is for the remainder of the year? It looks like it dropped off sequentially quite severely.

I think that a lot of our markets are seeing some volatility attached to them. We continue to see good prospects within computer electronics. And I think the big thing that's happened in computer electronic is it's probably the industry which has migrated most aggressively into Asia. And I think that's had some impact because businesses are dealing with those internal issues. But we continue to see good prospects in our quotation pipeline. I think that we need to go through this period of adjustment for that industry in particular. We continue to see good prospects in flat panel display and in the printer sector, those types of things. I think if you look at the backlog you can see we also saw some pickup there.

Thank you very much.

You're welcome.

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

Hi, Ron. I'm trying to get a sense of how the ASG order profile progresses here. LIke, you had a very good quarter in Q2. The orders in the first part of Q3 don't look like they are particularly strong. Maybe you disagree with that. Can you give us some sense here? Are we going to bounce up and down here and was Q2 an anomaly -- a particularly high anomaly?

I think my comments I think gave you qualitative comments with respect to that. I think we see good prospects in the pipeline. I think that when you look at the various industry sectors, clearly what we have a lot of pro-- prospects that in particular within the automotive market, we're being selective there. And I personally believe that means we're going to pass on some -- some obj-- some opportunities there. I think that's necessary as we look to manage our opportunities. I think that we're going to be very specifically going to those customers where we believe a very strong -- we have a very strong future with them on a long-term basis. So I think that we're going to be selective from that standpoint. Also taking a view to the credit risk, those types of things. That clearly mitigates, I guess, the order flow potential going forward for us. On the other side of it, I think we see excellent potential in our market sectors which we are aggressively going at. That's where the order booking activity is -- it's the roughly 40 days following the quarter, I'm pretty satisfied with it.

Okay. That implies then less than C$100 million is actually a reasonable run rate for a quarter?

I think that analysis proved faulty in past. I think if you look at that data you will see that. I think that -- I understand your visibility is limited. Quite frankly I think the number that we recorded in the quarter I think was very consistent with our internal goals. And we continue to see excellent prospects which we believe will convert into orders in the current quarter and going forward as well.

Okay. I just trying to reconcile you're saying automotive is tough, which is understandable, and you want to be careful, which is going to protect the shareholder from losses presumably. Computer electronics sounds like it has got some issues with customers migrating to Asia and Asia is one of the major legs of your stool to drive orders. Am I missing something there?

I think if you look at the activity in the quarter, you can see that our backlog in fact was the highest order booking activity in the second quarter we have seen since I think the fourth quarter of 2004.

Right.

So I believe that that's a substantial step up from where we have been. I think it reflects well on where we are going. And clearly I think that we need to prove that by putting the puck in the net more as we go through the balance of the period. Like I said, my number one concern is automotive right now. It's not because of lack of opportunity.

Right.

So I think that -- I think the other thing is we've done is I think that we've made it pretty clear there is some uncertainty in our markets clearly. Automotive being the biggest one. And I think that's one of the things that caused us to take the steps we have taken as well, to right-size our business based on what we see coming down the chute. I think we have taken the steps that are appropriate.

Okay. Fair enough. And then on the SG margins, I'm just wondering if you can kind of step us how we get from 2.5% to double digit in a very short time frame. I see 2% coming from your layoffs. Is all the rest from plant loading improving?

You take look at special charges in the quarter, okay. You start to add those up. They add up to a substantial amount. And then you start to get into the benefits of getting our total revenue numbers running at higher levels. And I think that you see contributions falling through fairly quickly.

Fair enough. And then the last question I had. Solar margin prospects, I think Syl mentioned it. I think you might have mentioned it and it's certainly mentioned in the text about the risk going forward from the silicon. Can you help us get an idea, are we looking at margins coming off very dramatically here potentially? Or how do you see this unfolding over the next year or so?

Well, the silicon supply is obviously concern to everyone. We are a little bit fortunate in terms that the SSP technology affords us the opportunity to convert some of the silicon that's used for SSP into Photowatt. That alleviates some of the issues. Prices of silicon are going up. We've got a good team at Photowatt, and able to offset a lot of those prices. Plus we are passing a lot of that off to our customers. Obviously we can't pass it all off to the customer. They will also be holding back. I don't see a dramatic drop in what's been going on. As a matter of fact, we are having good progress and good operations in Photowatt and I don't see a dramatic change.

I think, David, I think part of the issue here is that when you have a market which is extremely active, I think it's incumbent upon us to discuss the risks that are out there because the industry -- and I think these are generally -- general industry comments that the whole industry is faced with this issue. And markets can change here. I think we just want to make sure that our shareholders are aware of that risk.

Right. I wanted to get a sense. Are we on a verge of a significant drop and the message sounds to be keep, stay tuned but at this point you don't anticipate that.

I think we specifically stated we expect a strong balancing year at Photowatt.

Right. Okay. Thank you.

You're welcome.

Your next question comes from Marko Pencak from GMP securities. Please go ahead.

Good morning, guys. Just want to understand what's happening in SSP a little bit better. You shut the facility down during the summer to optimize some of the equipment. Sounds like you started it up. In your August conference call you said you were pleased with some of the things that you guys had done. And now you got the equipment running continuously for three weeks here. So, I guess the first question here is would I be correct in assuming all sort of the equipment in that part of the equation is pretty much set prospectively here?

Well, you know, when you take on a project this size, I'm actually not surprised at all at the delays that we've had, because this is a very complex process, a lot of complex steps throughout the factory. We were extremely pleased that we are at the point now where actually our equipment is running from one end to the other which it has never done before. So that shows the equipment is working. Now what we're trying to do is optimize. I had quite a bit of experience in dealing with startups and certainly in manufacturing around the world, and this is not that unusual. This is actually in line with what I would expect a manufacturing facility with a brand-new process to start up at. To date, we're pretty pleased with what we see in SSP. Sure, you're going to have a bit of bumps in the road. But the progression we were making is in the right line, and we're quite pleased.

Okay, but I want to be more specific because I want to make sure of what's happening here. Sounds to me like you guys have got the equipment you need, and therefore, you your capital expenditure is likely to -- might be small things but the bulk of it is for sure behind you. Is that correct?

I would say the bulk of our capital expenditure is, we believe, behind us, yes.

Okay. So now you have got this thing running stem to stern, so you've sort of got the line speeds all aligned. So is now the issue -- I'm trying to understand what validating commercial manufacturing really means for you guys. Because you now are presumably with the samples you've sent to customers, those are commercial quality, right?

Right.

Okay. So is it now just a question of yield that you are working on? Is it still that you have to play with settings for certain process steps to either maximize the efficiency of the product or improve yield? Walk me through what has to happen from now until you guys say to us on a conference call, we achieved that objective. Can you suggest a yield issue here? Is that a cost issue? I'm trying to understand.

You are on the right line. Number one is what you tried to do is make sure the machines are able to produce the product at rate and produce the products at a cost that is going to be competitive. That is what you are trying to do when we talk about commercial quality. Because you can make one off in the laboratory and pilot plant all day long, but one of, and that doesn't mean you have a process that can actually be manufacturable. We have. That's part of the process. During the summer shutdown just before I got here, really what it is, it wasn't a shutdown in that case. What it was doing was it was verifying that the machines were able to be set. When you have brand-new machines, you will have different settings and that changes slightly the process. Now we are ramping up, and we have certain targets in place. Everyone is geared up to meeting those goals in terms of ramping up the production and you're absolutely right. It's a yield issue. It's a quantity issue. And it's also be able to maximize the process for efficiencies.

And I think part of the costing is that we need to be able to run the processes through sufficient length of time, to be able to go in and support the -- I think from an external perspective as much as anything the cost dynamics of this product, its cost advantages.

Okay, but if I'm Elk Corp., you guys -- you're sending them product, they come back, let's say they get the UL certification and they're fine with the performance of the product. Clearly I understand you guys have to be able to represent to them that you can manufacture certain quantities so that they can execute their business plan. But are we -- are you guys now in sort of an iterative process where you run some stuff, you adjust some settings, you run some stuff. I'm just trying to understand, because calendar 2006 is a very broad time frame. And what I'm really just trying to understand is, you know, whether this is sort of an iterative process where we can't really apply a time frame or there is some more sort of concrete milestones that suggest that during the course of calendar 2006 we are not going to be in this state of we are still working on it. We've actually -- there is going to be a sort of tangible step that we've taken?

Your question is quite on -- but what you have to understand is what we are doing is delivering product in 2006 in various amounts and increasing amounts as every month goes by. So what we've got behind us is the issue about can we manufacture it, can we manufacture it at the right costs. Does the process work? That's virtually behind us. We just want to get more information about producing more product and sell more product so we can verify those milestones.

Elk, by the way, has been a fantastic partner with us. They are in constant communication with them and they see the opportunity here and we are quite pleased with the progress we were making with Elk.

Okay so really then, just from my interpretation of what you have just said here, so -- sounds like you're going to be consistently shipping quantities to your various clinical partners. And just as you improve your process throughput, that's what's going to govern sort of the ramp rate through calendar 2006. Is that right?

That's fairly close. Our issue right now is not customers. We got enough of those customers. What we are trying to do is prioritize the product coming out and giving it them to the right customers so that later on we build a foundation in the commercial segment, residential, and the consumer.

Okay, but that to me, and sorry to beat this. But to me that sounds like a strategic marketing decision as opposed to a manufacturing capability issue, right? Like if you guys solve -- I just want to make sure I understand what you are saying to me or saying to us is that, okay, the equipment is working. There are some certain process settings we are going to be playing with on an iterative basis to continue to increase our yields and that is the thing that is going to be able to increase the amount of product that the we produce although the only caveat to that is that I know there are basically three different products that you are doing and so maybe is why you are sort of answering the question the way you are is suggesting I go from one to another to a third and that switchover may affect the ramp-up rate.

No. The answer to the question is, yes. We are ramping up. We were going to be delivering. It's exactly what you said.

We are not expecting bump-ups from the standpoint of the end markets, no. That's not even on our hit list right now. No.

So it might be that at any time that in calendar 2006 you guys can sort of say, see, we achieved that.

Yes.

Absolutely.

Okay. My next question has to do with the -- Ron, when you talk about your concern about automotive, you've talked about how you may opt to not bid or bidding appropriately to win the business for automotive stuff. But are your comments about how you expect that automotive is still an issue, are you expecting that there may be charges from other customers akin to what you took with Delphi here that may affect the numbers?

No that's not what I'm saying.

Okay so really are you just saying the pricing is very tough and there's certain guys we don't want to effectively do business with.

I think that we have a responsibility to manage our risk in this profile given the level of uncertainty that we're seeing in it and I think the other thing we are saying is I don't want to spend the money to quote it if we're not going to go after it.

Right. Okay. My last question is, I'm curious about your visibility on your business. Because you -- if I look at the numbers you landed C$70 million out of the C$86 that you previously circled. But then you got C$54 million of business from sort of somewhere else.

Yup.

Can you just -- and you've talked about strong order prospects and all that. Can you just -- I'm curious in terms of customer-specific insights or how is it you got C$70 of C$86 and C$54 million came from somewhere else and is that the kind of thing that we should sort of be expecting prospectively.

Absolutely. I think that the last quarter - I think we made it very clear that we were giving you some additional granularity, where -- on orders that we felt were in essence still believe all of them are in the bag. But we don't have a hard purchase order for them yet. They are going through various stages. So to me it's not surprising at all that we picked up C$54 million because our quotation list goes substantially beyond those orders where the customer told us we got the work, but we haven't gotten the purchase order to you yet. I think the criteria we used last time was more grueling than that where we actually had to have been kicked off an engineering order or prototyping order or something with respect to that. When we look at our quotation pipeline, I think that -- I can tell you today there are orders where we've been told we've been selected but I don't have a purchase order to show you.

Okay. Very good. Thanks for the time.

You're welcome.

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

Couple of additional questions on the SSP business. I noticed that the deferred amount in the quarter was C$4.7 million versus C$6 million in the first quarter. And I'm just wondering what accounted for the improvement in the amount of the deferred capitalized cost.

Just depends on the activities going on in the particular quarter, if there is a high material usage in the quarter, the cost can go up. If there was lower material usage it's down. There is other costs of -- right in the facility, there's kind of a base level of costs and then there's an incremental level that will fluctuate from quarter to quarter.

Is that dependent on how much you are running the plant versus at the line is up versus down, that what you are saying?

No, I think it just reflects the fact this is development. This has been a largely development activity at this point in time and so you're going to have some volatility in your cost structure -- they're not fixed.

Okay. The other thing, I think I heard during the call that you said that the efficiency of the SSP cell is 6% to 8%, is that correct?

Correct.

And how do we reconcile that with other solar cells from leading manufacturers? I understand have efficiency of 15% and some are claiming as high as 20%.

Right Well. There's various ways of getting the efficiency. The traditional cell manufacturers are producing efficiencies around the 15%. Some have gone up to 20, but that's a very expensive process to do. We are starting off and right now we were achieving 6 to 8% which is well in line actually a little bit ahead of our schedule in terms of where we would be. And we will be ramping that up and we were hoping to get into the 9% range and then beyond and we -- there is no reason for us to -- theoretically there is absolutely no reason for us to get into the 15% range with our technology.

In fact, I can tell you that work we did on our pilot line had us into double digit efficiencies, Peter. Obviously, there's work to do on processes that because there is a lot of chemistry involved here to get to that level. Starting at this level, we are pretty satisfied with that. It's part of our ramp plan is improving -- improving not only yield but cell efficiency as well and we have a path forward for for that.

But this 6% to 8%, what are we talking about here? Are we talking about cell efficiency or yield in terms of --

You are talking about cell efficiency.

And why can't -- how can you improve the cell efficiency? Isn't a cell a cell as you manufacture it?

No, no.

No.

No.

Process.

We got time? It has a lot to do with the chemistry of the silicon and how we process it. It has a lot to do with how the machines are running and this is what we -- why even in the previous question about we were a bit concerned about which direction we are going. We were going the right direction in terms of increasing our yields and increasing the chemistry and increasing our machinery. It all works together. As Ron said, starting off at 6 to 8 is very good. Very good. And we hope to get higher than that and all of the guys at SSP are pretty well pumped up in terms of what they are coming out of it -- they've done a helluva lot of work and a lot of good work coming out of it now and we're seeing some of that pay off.

So if your cells are running at 9% and your competitors' are at 15%, explain to me again how you're competitive? Is that because you are delivering silicon at a lower price?

First of all, the way to market is now and probably in certainly the near future, you can sell virtually all the production you can get from cells regardless of the efficiency unless you get really low. There is a lot of thin film technologies right there -- right now at 4% to 5% are selling. They are selling. What it has to do is the -- to do with the square-footage of the cell itself. So that if I put a 4 by 8 cell, 4-foot by 8-foot and get 9%, that would be -- if somebody comes up with theirs at 15, their cell would be slightly smaller. So then it comes back to manufacturing and this is where the advantage of SSP comes in because our cost to manufacturing is much lower than anyone else.

I want to be very clear, Peter. It's very important you understand that our launch at 6 to 8% is not where we expect to be. We are very pleased with that. But that's the first step and that's one of the things on the launch -- the ramp plan is to improve that efficiency. So any projection that's done on a 6 to 8% efficiency, I think would be faulty. I just want to be very clear about that.

Okay. That's all have I. Thank you.

Your next question comes from Mac Whale from Sprott Securities. Please go ahead.

So I wonder if you can share with us some metrics on cost or pricing like where you are now and where you expect to be 12 months or through that calendar year.

I'd love to but it would give our competitors quite a bit of an advantage so I'd rather keep that to ourselves right now. We can tell you we were in line with our business plan.

Can you give it even as sort of a percentage? Like if you are in line with your business plan, I mean -- do you need to like double or can you give us in terms of efficiency like you need to get to 9% or 11% for your economics to work? Can you give it - in some other metric.

I can give you what's been out in the press already that we are -- our cost efficiency because we use less silicon and we use different kind cheaper silicon that we are quite a bit more efficient than all the other manufacturers.

Efficient from a cost stand-point.

From a cost, thanks.

And I guess just to -- I know you dealt with it a lot, given good comments on this and I-m just -- I want to go over it again because the terms that you use in the press release about validating your technology, it really seems like you're really validating the economics here. It sounds much more positive the comments you have been giving in terms of the progress you are making and what you expect to make in calendar '06. So is it better to characterize it as validating the economics?

You're right. It is validating the economics and also the manufacturability. Can we get it out at speed? Can we get it out consistent, absolutely right.

And in terms of capacity utilization through that calendar year, can you share any of that with us in terms of a goal?

Right now we have a line that we -- it's earmarked around 20 megawatts. And we're going to try to get that back up to the nameplate and then add more capacity to go forward. That's really going to be dictated by time and putting money in to get some more capital into the second line. But we're already thinking about the second line right now. We are not thinking about the first.

Okay. And back to Photowatt, I know you have different amounts of capacity in terms of wafers, cells, and modules. And when you're actually -- in terms of the wafer, I think it's around 20 megawatts, do you have to buy the boules and ingots. Or do you have to buy the wafers. I'm trying to get an idea of how exposed you are to actually poly silicon pricing.

We were a better position than most, the reason being that we're integrated from the back where we take the actual silicon and make it and we have our own furnaces and actually make the ingot and cut it into [sauce]. A lot of manufactures don't have that. That affords us the opportunity to go out and get different kinds of silicon. We don't -- we're not dependent on the manufacturers to give us either the wafers or give us the ingot. We can do all of it. We can process ingot, we can buy ingots, we can buy wafers or we can buy the raw silicon and that's where the advantage is. As I said before, the SSP process that we have also has the ability to convert that silicon into -- or cheaper silicon into usable silicon for Photowatt.

So you're roughly speaking really only 50% exposed to high purity poly silicon?

Well, we are all tied in. If silicon goes up, then our supplier of ingots or wafers, they're going to l adjust prices accordingly. I would think that would work out.

Okay. Okay. That's all have I. Thank you.

Thank you.

I think we were getting a little bit long so maybe we could take another question but then maybe we can bring our call to a close at that big a point in time if you don't mind. So is there any other additional questions?

Your last question comes from Frederick Baskay from Raymond James. Please go ahead.

Good morning. Just building up on the last question, can you give us some concrete examples of the steps you are taking to secure new silicon supplies into next years?

We put in place quite a comprehensive strategy how to get silicon. We have taken the steps and met with the key suppliers, probably the top five suppliers we've already met. We have very, very good reception. Again, there is a lot of silicon -- the silicon that we use at SSP is not really usable in some of the manufacturing process by others. So we have that opportunity. We have been able to secure some silicon from various parts of the world. There is China is gearing up. They've got three major manufacturers in China. You've got Norway that's building up. You've got Germany that's increasing its capacity. We've got Germany is doing it -- as I said, Germany is doing it as well. So there is quite a bit out there. Now the question is, you know, what's available to us? And the interest they have in us is the ability to convert our less expensive silicon to SSP and then obviously to Photowatt. The other advantage we have is there's a lot -- quite a few companies now gearing up in metallurgical silicon. It's something that the traditional manufacturers are unable to use in its current format but at SSP we are able to use some of that and there are some major companies starting that effort and we are very well connected with them.

I think going to little more near-term, we are being opportunistic in our ability to secure silicon and we have grown or we actually increased our inventories noticeably in the last quarter. And there is an active spot market and market that we are able to participate in and we have people that are fully engaged in those opportunities as well. So it's a multi-prong strategy to deal with this silicon supply side.

Thank you.

You're welcome. I just would like to thank you again for our call. I think that brings it to a conclusion and we look forward to speaking with you at the time of our next quarterly conference call. Thank you very much.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines.