Q3 2021 Advanced Energy Industries Inc Earnings Call
[music].
Greetings and welcome to advanced Energy's third quarter 2021 conference call.
At this time, all participants will be in listen only mode.
A brief question and answer session will follow the formal presentation.
If anyone today should require operator assistance. Please press star zero from your telephone keypad.
Please note this conference is being recorded.
At this time I will now turn the conference over to Mr. Ed Edwin Mok, Vice President of strategic marketing and Investor Relations you May now begin Sir.
Thank you operator, good afternoon, everyone welcome to advanced energy third quarter 2021 earnings conference call with me today are Steve Kelley, our president and CEO and Paul Oldham, Our executive Vice President and CFO.
I've not seen our earnings press release, you can find it on our website at IR Dot advance energy Dot com.
There you'll also find the third quarter slide presentation.
Before I begin I'd like to mention that we will be participating at several investor conferences in the coming months.
Let me remind you that todays conference call contains forward looking statements are subject to risks and uncertainties that could cause actual results to differ materially and are not guarantees all future performance.
Information concerning these risks can be found in our SEC filings.
All forward looking statements are based on management estimates as of today November H 2021 and the company assumes no obligations to update them medium and long term targets present today should not be interpreted as guidance on today's call. All financial result will be presented on a non-GAAP financial basis unless.
Otherwise specified exclude from non-GAAP results, all amortization stock compensation integration and transition costs unrealized foreign exchange gains or losses and restructuring items, a detailed reconciliation between GAAP and non-GAAP measures can be found in today's press release with that let me pass the call to our president.
C O Steve Kelley.
Good afternoon, everyone.
And thanks for joining the call.
In the third quarter.
We delivered results above the midpoint of our guidance.
Stronger factory output pushed our revenue.
Gross margin.
And earnings per share to the upper part of our guidance range.
Demand remains extremely robust across all of our target markets.
In addition, our new products continue to be well received by customers, who depend on aes innovative technologies to achieve their efficiency.
Power density and precision power goals.
We remain focused on the key factors driving our long term success.
Industry, leading innovation.
<unk> customer relationships.
Standing quality.
Our strong leadership team.
And a culture focused on results and speed.
Over the course of the year, we have taken substantial steps to increase the capabilities of the advanced energy leadership team.
Yeah.
Our latest addition to the team.
Bernal.
Joined the company in September is R. E V P.
And C O L.
Eduardo has an impressive record of achievement in the semiconductor industry.
With specific expertise in operations and supply chain management.
Okay.
Before joining advanced energy.
He led the global backend manufacturing organization at NXP semiconductors.
It was able to drive significant performance improvements over a multiyear period.
Eduardo will be based in Singapore, and Malaysia, and we are delighted to have him on board.
Now I'd like to touch on our supply chain challenges, specifically shortages of key Ics.
These shortages continued to constrained shipments and limit our financial performance.
We are working diligently and with a high sense of urgency.
To mitigate the shortages.
Expediting suppliers.
Find replacement part.
And where necessary.
Designing boards to eliminate problematic Ics.
Many of our customers are playing an important role in the mitigation efforts by expediting qualifications of new parts.
And by joining discussions with our key suppliers.
We are seeing some incremental progress on the parts front.
As reflected in our third quarter performance.
However, the overall supply environment remains dynamic.
With little slack in the supply chain.
The effects of manufacturing or shipping disruptions quickly.
Quickly ripple through to the end customer.
Given the dynamic nature of the supply chain issues were.
We are taking a relatively conservative approach to our financial forecast.
However, given the amount of pent up demand for our products as indicated by a record backlog.
We see considerable revenue and profit upside tied to the successful mitigation of our supply constraints.
Despite the supply chain issues we.
We have maintained a full factory workforce.
In order to maximize our surge capacity.
As an additional measure loops.
We plan to keep our Shenzhen factory open into the second quarter of 2022.
Now I'd like to provide more color on each of our target markets.
As I mentioned earlier.
Demand is very robust across all of our markets.
The macro trends are solid.
And customers are designing in our new products.
In the semiconductor equipment space, our customers are forecasting strong unit growth in 2022.
Across a wide range of technologies.
We are well positioned to benefit from this growth given our strong position in both current generation and next generation conductor etch equipment.
In addition.
<unk>, we expect to gain share in the coming years and plasma power applications.
In areas, where we currently have a minor presence.
Such as dielectric etch.
And remote plasma source.
Our new Evo <unk> and Mac stream products for those applications are being evaluated and qualified by multiple customers.
And are expected to go into mass production in the coming years.
In the third quarter, we secured several strategic wins at Korean and Chinese OEM customers.
We also won an important remote plasma source design.
In medical we secured several wins in life science and therapeutic applications.
Any strategic win and ultrasound.
In industrial we secured a high profile win in the thin film area.
And received a large order for an indoor farming project.
We also won several proprietary designs and power control and thermal sensing applications.
In data center computing and telecom and networking.
We continue to see strong demand.
As multiyear digital transformation trends.
Drive sustained infrastructure investments.
In the third quarter.
We secured our next generation Hyperscale design the solution featuring power density roughly double that of current generation products.
We also won high value designs and telco edge.
Storage.
And network routing applications.
Before closing I'd like to summarize our key messages.
First.
Demand for our products is robust.
<unk> broad customer acceptance.
Of our new products and technologies.
Second we are working diligently to mitigate the impact of supply chain constraints.
Third.
We expect pent up demand for our products to drive several quarters of revenue upside above current run rate.
Our supply chain issues are successfully addressed.
And finally, we are positioning the company for sustained revenue growth with a strong lineup of differentiated products.
Targeting the right markets.
Paul will now review our financial results.
Provide detailed guidance.
Thank you, Steve and good afternoon, everyone in.
In the third quarter, we delivered revenue and earnings above the midpoint of our guidance.
Total revenue of $346 million declined 4% sequentially as our ability to ship products was limited by component supply and to a lesser extent COVID-19 restrictions in Malaysia.
Relative to our guidance gross margins were at the high end, resulting in earnings of 89 per share.
Customer demand remains high and we ended Q3 with record backlog of over $770 million.
The vast majority of this backlog is for proprietary products and roughly two thirds is for orders that are shippable as soon as we can build them highlighting the strong demand profile.
We believe this high level of shippable backlog represents meaningful upside to our current revenue levels for an extended period of time as the supply situation improves.
In the near term the availability and predictability of certain components, primarily critical Ics remains challenging and we expect supply constraints to continue to gate revenue.
In addition, as we projected our gross margins are being impacted by higher input costs in the form of premium buys expedite fees, some price increases and underutilization of our factories.
The majority of these costs are transitory and will naturally improve over time.
But we are also taking proactive actions to mitigate the headwinds on both availability and cost, which we expect to begin yielding results in Q4 and increase over time.
These include working with our customers on cost recovery and pricing, establishing strategic supply agreements with our suppliers and pursuing selected redesigns.
During this time, we are retaining our factory capacity to be able to deliver higher revenue as parts become available.
And expect to maintain our broader infrastructure about flat, while reallocating resources to accelerate our most important programs.
While we will see some inflationary pressure in spending we believe this approach is a good balance between managing short term challenges and funding an extended set of opportunities for upside and long term growth.
As revenues recover we expect to see good operating leverage and continue to believe we have the building blocks in place to achieve our medium and long term goals.
Now let me go over our Q3 revenues by market.
Semiconductor sales continued near record levels at $173 million up from last year, but down slightly from last quarter.
Demand remains strong.
And with Malaysian now allowed to operate at full capacity and modest improvement in parts supply, we expect Q4 semiconductor sales to grow sequentially.
Revenue from our industrial and medical markets fell 3% from Q2 to $81 million.
However, customer demand was broad based and our backlog increased by almost 50% sequentially.
We saw revenue strength in thin film coatings medical and thermal sensing where our teams were able to overcome some of the parts shortages.
Data Center computing revenue was $62 million and telecom and network revenue was $30 million.
Both down from last quarter due to supply constraints, which had been particularly acute for Ics used in these markets.
Our order book in these two markets continues to increase.
Non-GAAP gross margin for the quarter was 36, 1%. The sequential decline was primarily due to increased input costs and factory under utilization year.
Year over year. These costs are having an approximate 350 basis point impact to gross margins.
While we are making progress on mitigating actions and cost recovery, we expect margins to continue around these levels for another quarter or so as the higher cost materials roll through inventory and impact our cost of goods sold.
In addition, as Steve mentioned, we now plan to extend the operation of our Shenzhen factory through the end of Q2.
Which will impact gross margins in the near term, but provide additional shipment flexibility.
Non-GAAP operating expenses were $83 $6 million up about $1 million from last quarter. The sequential increase was mostly due to a full quarter of expenses from T M, which we acquired in June.
Operating margin for the quarter was 11, 9%.
Other expense was $1 $7 million, including $1 3 million of interest expense.
We expect other expense to be in the $2 million range going forward, including the interest cost on our additional debt.
Our non-GAAP tax expense was $5 $6 million or 14%, which was largely in line with our target of approximately 15% plus or minus.
Earnings for the quarter were <unk> 89 per share compared to a $1 25 last quarter.
Turning now to the balance sheet.
We ended the third quarter with total cash of $550 million and net cash of $153 million.
Operating cash flow was $18 million and Capex was $8 5 million.
During the quarter, we repurchased $52 $6 million of common stock at $86 93 per share taking advantage of market volatility to return cash to shareholders.
We also paid $3 $9 million in dividends.
Earlier in the quarter, we amended our existing credit agreement to increase our term loan by 85 million to $400 million increase our undrawn revolving line of credit to $200 million and extend the remaining term to five years.
With an attractive rate of LIBOR, plus 75 basis points. This refinancing provides us with additional financial flexibility for inorganic growth share repurchases and other corporate needs.
In Q3, our days of net working capital increased to 117 days inventory increased by $45 million and turns were two eight times as we continued to acquire raw material to support future shipments.
We believe this inventory is well matched to customer demand and although it may take a few quarters, we expect turns to rebound as critical part shortages abate.
Days payable fell to 76 days based on timing of payments on.
On the other hand, DSO improved to 57 days on strong collections.
Now, let me turn to guidance.
Market demand and our order book continued to be extremely strong.
However, we expect the supply environment to remain challenging in the near term.
As a result, we expect Q4 revenues to be approximately $355 million plus or minus $20 million.
Our Q4 guidance assumes semi revenue will grow sequentially.
We expect Q4 gross margin to be similar to Q3 based on higher material costs offset by incremental benefits of mitigating actions.
Operating expenses should be flat to up slightly largely due to the cost of inflation across a variety of areas.
As a result, we expect Q4 non-GAAP earnings per share to be 92, plus or minus 25.
Based on a share count of approximately $38 2 million shares.
We are taking a prudent approach for the next couple of quarters, assuming that the current supply environment will continue to limit revenue at around current levels in the near term.
We are confident that our mitigating actions will yield incremental benefits in the coming quarters.
With our large shippable backlog, we expect to see revenue upside of up to $50 million per quarter over our current run rate as supply normalizes.
Looking forward, we are more excited than ever about our expanding set of new opportunities and we'll continue to invest in R&D to accelerate our growth as.
As we take mitigating actions to manage component availability and cost continue to optimize our portfolio and rationalize our factory footprint, we expect to achieve gross margins at or above our long term goal of 41%.
We remain focused on executing our strategy and are confident in our ability to reach our long term revenue and earnings goals.
With that let's take your questions operator.
Thank you at this time, we'll now be conducting a question and answer session.
I'd like to ask a question today. Please press star one from your telephone keypad and a confirmation tone will indicate your line is in the question queue.
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One moment please poll for questions.
Thank you. Our first question comes from the line of Tom <unk> with D. A Davidson. Please proceed with your questions.
Hi, Yes, good afternoon, and thank you for the questions. Paul just following up on your last call that you talked about revenue growing up possibly $50 million a quarter once supply constraints ease.
As you talk to your suppliers when do you think that starts when when do you see it in to the IC supply issues.
Yeah. It's a good question Tom I think the challenge we have is in the near term we continue to see these critical parts being in short supply.
We have a highly engaged.
Work with our supply chain also with our customers to try to accelerate and increase the amount of parts.
And while it's hard to say exactly when that will turn around we do believe that over the course of next year. It will improve I think it's very possible by the time, we get to the end of next year, we could be seeing revenues running at that level current levels, plus $50 million, which would be significant for us we believe that could drive earnings power.
At time as high or maybe higher than six and $6 a share annualized.
Okay, that's very helpful.
When you look at your four segments could you kind of rank them in order of which ones are being the most affected by the supply constraints.
Yes, the ones that are being most affected are our higher volume markets, particularly the embedded power markets. These particular products use a higher number of these critical Ics Theres also more standardization across those products of your short one of these critical parts that might in fact impact multiple fan.
Please.
Probably the second most impacted is our industrial and medical products and then semi is actually performing quite well as you see whereas continue to operate near record levels, but certainly there are there are critical shortages, there as well and we could be doing much better if we had the parts in place.
Great.
And then finally.
When you look at the you talked about qualifying new parts to get around some of the IC shortages, how long does that process take.
Yeah, Tom This is Steve Kelley.
We started that process in earnest a three to four months ago for a number of our products.
Typically that price is going to take around nine to 12 months to the redesign.
To do the reliability testing get the qualification from our customers.
The good news for US is that our customers are highly motivated to qualify these new designs.
So we're seeing a record turnaround time, so it's possible we could get the close on a.
Quicker than we expect.
Okay well. Thank you both for your time today.
Thanks, Tom.
The next question comes from the line of Krish Shankar with Cowen and company. Please proceed with your question.
Yeah, Hi, Thanks for taking my question I have two of them to first one Paul just wanted to follow up you said that the revenue upset a few million a quarter maybe happen later.
Later next year that supply normalizes, along the same path.
How long do you think the gross margin or the component Boston is going to be a drag on gross margin is it beyond <unk> into <unk> of beyond that two midnight.
Thanks.
Yeah, I said in our prepared remarks that we thought this would last a couple of more quarters. Certainly we have a lot of these premium buys expedites that are rolling through now and some of that sit in inventory. So it certainly is impacting Q4 and will likely impact Q1, as well as we look beyond that it will depend on how quickly we can move to a more stable.
Supply level, where we're paying more normalized parts for these more normalized prices for these parts. So it's difficult to say in the near term, but certainly over the course of the year, we'd expect to see some improvement.
Probably the simplest way to think about it is it's probably the situation probably persist for another couple of quarters and then gradually improves from there we don't see a silver bullet crush where suddenly magically things get much better, but we've done a lot to take mitigating actions, including working with our customers on cost recovery on share.
Some of the price changes that we're seeing.
We're working with our suppliers to have better long term agreements and sources of supply, which should hopefully get us out of.
Some are some of the premium buys and things, we're having to do through distribution in other channels.
And as volume begins to improve obviously that helps our factory utilization as well. So all of those factors will contribute to margins getting getting back to where we'd like them. It's interesting. If you look at the actual numbers, it's pretty clear.
That if you excluded the.
Higher cost of materials were paying in the near term and the impact on our factories, we're certainly running.
At or around that 40% level. So some of these are transitory the premium buys will pass more quickly.
Some of them will be longer term and we think there'll be opportunity for price and other mitigating actions around redesign that Steve talked about earlier, but we feel confident as we look out you know.
In our last call we thought the exit rate of 2022, we can be back around that 40% level and we don't have a lot of visibility obviously, the timing could change, but that's I think not an unreasonable way to think about it.
Got it.
Really good color thanks for the call.
Quick follow up.
The $50 million incremental revenue.
First as you can given that in your prepared comments, you said that a lot more supply constraint issue on you know the.
And then telecom networking and data center side is the incremental $15 million more tied towards the legacy <unk> business is very way to think about it and I E.
You might see some price recovery in helping margin as the revenue comes back.
Yes, I think it's it's definitely more of a mix a krish theres significant upside in our semiconductor products.
For for a lot of reasons demands quite healthy there and remember not all of the semiconductor demand is in our backlog because of our jet.
<unk> been strategy with our largest customers so theres significant upside in the semi as well it's fair to think that it would affect both.
It would help all of our markets.
Fair enough fair enough and then just a final question for Steve.
Steve It seems like maybe I'm wrong on this but I'm just kind of curious.
It looks like Youre moving away from servicing the hyperscale market insight and moving shifting more to industry and medical a is that true. If so can you talk a bit about.
That strategy now is to them.
Part of the long term revenue and margin profile for the company. Thank you.
Yes, Chris I think it's fair to say the entire company is moving towards higher value added products that includes what we're doing for Hyperscale and enterprise computing customers.
If we take a look at our Miami Industrial Medical group.
The most attractive part of that market is it's almost entirely sole source at least for us.
And so we have put more engineering horsepower into the industrial medical business and we expect to grow that at a faster rate moving forward.
Thanks Pete.
Our next question is from the line of Quinn Bolton with Needham <unk> Company. Please proceed with your question.
Hey, guys. Thanks for letting me ask a question I wanted to follow up on Chris's question, maybe ask it slightly different way. If you look at the business today, obviously, there's a lot of pent up demand, but wondering how much of that affects the industrial medical and semi business versus the more embedded telecom and server businesses I would think that there may be more perishable demand.
And again that was embedded markets and so as the business comes back does it come back faster than industrial and medical and semi which are higher margin businesses or do you think there's actually better growth off a pretty depressed level and the more embedded.
But lower margin businesses as you've come through next year.
Yes.
Yeah, but let me just echo what Paul said earlier, we see shortages across all of our businesses, whether it's semiconductors industrial medical and the high volume of Hyperscale and enterprise computing businesses.
So it's hard to predict which comes back faster they will come back at the same time.
But I can say that are you know we're working hard.
And all of the businesses to close the gaps.
We are paying significant premiums every week to.
The source parts.
From various distribution and broker channels and working closely with our customers in all the segments to meet their needs. So.
We really cant predict which Marc will come back faster than another.
Understood and then the second question you mentioned, keeping the Shenzhen facility open through the second quarter wondering if you might be able to quantify how much of a impact that might have on your fixed expense base I imagine to extent you closed that down that there could be a nice gross margin lift in the second half of next year, especially.
<unk> revenue at that point should be ramping as you start to meet some of this pent up demand.
Yeah. That's that's right Quinn, we have said that the cost of keeping that site open from a fixed cost is between 50 and 100 basis points of gross margin.
Got it okay. Thank you.
Our next.
It is from the line of Wendy Hussaini with <unk>. Please proceed with your question.
Yes, thanks for taking my question.
Going back to your Q4 guide.
What would be your revenue be if there was no supply chain disruption.
Well I think it's easy to look at that and in the hypothetical say if there was no parts disruption you could add that $50 million in today at least we certainly have shippable demand that's well in excess of that where customers will take the products as quickly as we can get them and then it would be just a matter of manufacturing.
Pasty, which we certainly have enough manufacturing capacity to meet that number. So it's really all about it's really about all have all about having the critical parts. Yeah, Let me just add to that and I.
I mentioned in my.
Prepared remarks that we are maintaining our full workforce and all of our factories.
So we had the surge capacity to get well beyond $400 million a quarter in revenue. So we have the people in place and as the parts appear we could build that equipment are pretty rapidly.
Okay, and then you highlighted the growth in semi business in the <unk>.
Remember quarter versus September should I assume that the other business units will be flat to down and sandwich with Shaw.
Or with others.
This unit will be flat.
Yeah, I would say generally speaking the semi we expect to be up.
Industrial and medical are flat to up and the high volume would likely be.
The offset to that the high volume being telecom and networking and data center computing, but looking it's all about what parts, we get in and where they go. That's that's a critical thing so it's a little hard to predict exactly exactly the mix.
Okay, Okay, and just for purposes of modeling and assuming that that 50 million a day.
A business work to come back throughout 'twenty two.
Would you have to.
Expand your Opex should I assume that your Opex would go up maybe maybe one or $2 million per quarter or would you keep it.
Flattish from here on.
Yeah, our intent is to keep it flattish from here on we have as you know maddie sort of accelerated already investment in R&D, because we have a lot of opportunities ahead of us working with our customers. We're very excited about those.
There'll be a little bit of inflationary pressures, but our goal is to basically keep our infrastructure flat and then there'll be some inflation on top of that but but we don't need to add a lot of operating costs as revenues grow beyond just kind of your typical variable costs that are completely tied to to revenue so not much opex growth as revenue.
Recover.
Got it thank you.
As a reminder, you May press star one to ask a question.
The next question is coming from the line of Pavel Malakov with Raymond James. Please proceed with your question.
Thanks for taking the question.
Yeah.
A little bit of M&A.
Over the past year.
Yes.
Supply chain complications that you have.
Everybody else.
Clearly is experiencing.
Might create some distress.
Situations that you could opportunistically take advantage of it.
Fair enough.
Realistic scenario in terms of your.
Some of the potential M&A targets.
That's an interesting question Pavel.
What we're seeing actually as we have.
Some targets, we're looking at but they don't want to do a transaction because their financials are our distress because of their part shortages. So it's kind of a circle here. So I think as the parts shortages start to abate.
I think you'll see the potential for more deals in this space.
Okay.
The BSD opposite of yeah.
Okay fair enough.
Your dividend is now at its one year anniversary.
Congrats on that.
Should we anticipate.
A dividend increase.
Inquiry at any point in.
In 2002.
Yeah, well, obviously, that's something that the board will review on a regular basis at this point, we're not really in a position to comment on.
On that but look at our focus right now is on is on growing our business.
We think theres a lot of opportunities to do that organically and Inorganically. We're certainly investing a lot in working capital right now to support what we think is that upsize of growth.
So, we'll we'll take we'll take that in stride, but no comments on that at this point.
Alright, Thank you guys.
As a reminder, you May press star one to ask a question.
Thank you at this time, we've reached the end of the question and answer session now I'll turn the call over to Steve Kelly for his closing remarks.
Thanks for joining us today.
We are dealing with near term supply challenges, but.
We remain firmly focused on the timely introduction.
Of new products and technologies, the drivers of <unk> future revenue and profit growth.
With strong demand for our products a record order book.
And a solid pipeline of high value proprietary designs.
We are well positioned to meet or exceed our medium and long term financial targets.
We look forward to talking with many of you in the coming weeks.
Thank you.
Thank you. This does conclude today's conference you may disconnect. Your lines at this time and we thank you for your participation.