Advanced Energy Industries, Inc. (AEIS) Q3 2016 Earnings Report, Transcript and Summary

Good day ladies and gentlemen, and welcome to the Advanced Energy Industries’ Q3 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today’s conference call is being recorded. I would now like to turn the conference over to Annie Leschin. Please go ahead.

Thank you, operator, and good morning everyone. Welcome to Advanced Energy third quarter 2016 earnings conference call. With me on today’s call are Yuval Wasserman, President and CEO; and Tom Liguori, Executive Vice President and CFO. By now you should have received a copy of the earnings release that was issued yesterday afternoon. For a copy of this release, please visit our website at advancedenergy.com. Before we begin, I would like to mention that AE will be participating in the DA Davidson Materials Conference on December 7 in Boston and at the CEO Midtown CAP Summit in New York on December 8. As other events occur, we will make additional announcements. And now, I’d like to remind everyone that except for historical financial information contained herein, matters discussed on this call contain certain forward-looking statements subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Statements that include the terms believe, expect, plans, objectives, estimate, anticipate, intent, target, goals or the like should be viewed as forward-looking and uncertain. Such risks and uncertainties include, but are not limited to, the volatility and cyclicality of the markets we serve; the timing of orders received from our customers, and unanticipated changes in our estimates, reserves, or allowances, as well as other factors listed in our press release. These and other risks are described in Forms 10-Q, and 10-K, and other forms filed with the SEC. In addition, we assume no obligation to update the information that we have provided you during this call, including our guidance provided in yesterday’s press release. Guidance will not be updated after today’s call until our next scheduled quarterly financial release. And just as a reminder, we will refer to both GAAP and non-GAAP results in today’s call. Non-GAAP measures exclude the impact of stock-based compensation, amortization, restructuring, acquisition related costs and significant non-recurring items. A reconciliation of non-GAAP income from operations and per share earnings is provided in the press release table. We will be referring to earnings slides posted on the Investor Relations section of our Website. And with that, I’d like to turn the call over to Yuval Wasserman. Yuval?

Thank you, Annie. Good morning everyone and thank you for joining us for our third quarter earnings conference call. For the third consecutive quarter we topped previous highs across much of our business, including semiconductors and service and saw a noticeable pick-up in our industrial business. Total revenues came at $126.6 million. Non-GAAP EPS reached $0.77 and we generated nearly $35 million in cash. Our clear and focused strategy to invest in advanced precision power solutions is keeping us at the forefront of technology transitions and our customers’ roadmaps, while also expanding our SAM through additional applications. Our solid execution, a flexibility to meet our customers’ dynamically changing needs during this period of high growth demonstrates our commitment to operational excellence. All of this drove another quarter of outperformance and strong results as we near aspirational goals we set out last January. Third quarter semiconductor revenues climbed to $81.2 million as we saw robust demand especially towards the end of the quarter and strength from our Korean OEMs. The main themes [ph] and the technology upgrades that began several quarters ago are now in full swing, driving the market forward and enhancing its growth trajectory. The ramp of important technologies such as 3DNAND and 10 nanometer logic is accelerating while spending for logic, foundry and multi-patterning is showing positive signs. As a result, the third quarter continued what has been a year of significant achievement for AE semiconductor business. This quarter our design wins in the semiconductor again came predominantly from advanced memory applications and spanned geographies from China to Korea and the U.S. We also won important designs in plasma-enhanced ALD applications and advanced 3D packaging for advanced logic devices. Our past design wins continued to materialize into revenue growth this quarter with strength in advanced plasma processes related to 3DNAND application and in a smaller but important high voltage e-chuck applications. Overall our strategy in the semiconductor market is working. Our focused investment in enabling power solutions and resulting design wins are growing our business and adding to our position with existing and new applications. Following last year's award for supplier’s excellence, this year Advanced Energy received Applied Materials Supplier Innovation and Collaboration Award in recognition of our industry leading support and responsiveness. This is a testament to our ongoing pursuit for operational excellence, technical collaboration and commitment to provide active and rapid response to our customers’ needs. Looking for the fourth quarter, we expect to benefit from virtually all the market trends as demand for etch and deposition remain strong, particularly in applications where we are well positioned, such as advanced patterning, 3D devices and packaging. Couple this with the beginning of recovery in DRAM and the development of 7 nanometers and we believe we can outperform the broader wafer fab equipment industry. Total industrial revenue grew 21% sequentially in the third quarter after [ph] last quarter's 34% rebounded. The sizable increase once again came from the industrial thin film markets. Aided by the broader industrial market recovery, we saw a significant surge in investment in OLED flat panel display manufacturing and the strength in solar PV applications. In specialty industrial power, revenues declined slightly in the third quarter. Our power control module business rebounded as the industrial market recovered while high voltage applications such as X-ray and mass spectrometry came off the second quarter highs. Another highlight of the third quarter from the industrial standpoint was our design wins. In industrial thin films, we had wins ranging from glass coating to PV solar cell manufacturing to OLED displays. In the glass market we were selected to fully populate a new glass coating line with our bi-polar DC products. In addition to providing this new DC technology for greenfield factories, part of our strategy has been to offer customers the ability to upgrade existing glass factories with these new DC technology. With our products’ higher performance and advanced thin film properties, we are extending the life span of coating factories and lowering customers’ cost of ownership. In solar, we won a design in India and in flat panel display we continue to see wins for high end sputtering applications as the industry prepares for the new flat panel technology. In specialty industrial power, we began to see new wins in thermal applications, such as fluidized salt for solar energy storage, float glass and solar PV coating. In high voltage we had several wins primarily in our two main target applications of mass spectrometry and X-ray. We continue to garner design wins in medical equipment for both diagnostic and therapeutic applications. By and large our industrial products target an aggregate of markets, each with different capital investment cycles that are not linear in nature. In any given quarter the variability and project driven nature of these markets can impact our results both for the upside and downside as we saw over [ph] the surge in revenues in the third quarter. In the fourth quarter while the broader industrial markets continue the recovery and our specialty power applications increase, we do not expect to see the same level of demand for OLED which will impact our thin films and our total industrial business. On an annual basis we expect our revenue from industrial applications to balance out the various capital investment cycles and to result in target annual growth rates slightly above the GDP growth rate. In our service business, third quarter revenues marked another historical high at $18.9 million. Demand for our highly engineered service products was again significant as customers focused on extending the life of existing equipment by adding features, upgrades or retrofits. We continue to gain share with semiconductor customers as we expand our business in Japan, EMEA and China and to a lesser extent in the industrial and specialty power repair market as well. Looking at next quarter we expect to see roughly flat revenues as our differentiated offerings minimize the impact of the typical end of the year seasonal slowdown in service businesses. Clearly our service strategy is proving effective. We look for strength across our target regions as we're replacing incumbents, capture third party market share and see success with the sales of our engineered service products. To sum up, we are in the midst of one of the strongest years AE has known and we anticipate further growth in the fourth quarter. Central to our success has been our focus on precision power, our close relationship with customers, and our unmatched operational capabilities. Together with the current technology inflection points occurring in the semiconductor market and our expanding industrial SAM, we have increased our customer base and growing our position in precision power. As we look to future expansion, we are very carefully and deliberately reviewing a variety of inorganic opportunities to ensure a strategic and financial model alignment as we continue to build AE and generate long term value for our shareholders, customers and employees. I’d like to thank our customers, partners, shareholders and our valued employees for their support. Thank you for joining us and we look forward to seeing many of you in the upcoming quarter. I'd like now to turn the call over to Tom. Tom?

Thank you, Yuval. The third quarter was a milestone for us as we reached highs of semiconductor and service sales and industrial revenues grew 19.5% sequentially. Total revenue reached $126.6 million in the quarter, an increase of 6.6% over the second quarter. Non-GAAP operating margins improved to 29% from 27.8% in the second quarter. Our profitable financial model led to non-GAAP earnings of $0.77 per share. Let me begin with sales by market. Semiconductor sales increased 3.3% sequentially to $81.2 million as momentum for advanced precision power products continued across the industry. Industrial sales grew 19.5% quarter over quarter to $26.5 million due to the significant upswing in OLED investment and the ongoing recovery in many of the industrial markets we serve. Service revenues again outperformed this quarter reaching $18.9 million, an increase of 4.9% over last quarter. We again made significant share gains across our markets by increasing our capacity in customer-centric locations and providing highly engineered service products. The combination of growing revenues with flat OpEx led to higher non-GAAP operating margins of 29% in the third quarter, compared with 27.8% last quarter. We remain committed to making key investments in next-generation power conversion technology, strengthening our sales channel and improving our service capacity to meet our customers’ dynamic demands. Non-GAAP earnings per share reached $0.77 in the third quarter compared with $0.73 in the second quarter of 2016. The tax rate for the third quarter was 15.4%, up from 12.5% in the second quarter. For the year we expect a normalized annual tax rate of approximately 15%. Turning to the balance sheet. We generated $34.8 million of cash to end the quarter with $249.8 million in cash and marketable securities. Since the beginning of the year we have increased our cash position by $79.4 million reflecting the power of our financial model. Contributing to cash flow was the ongoing improvement in our working capital management. In the third quarter, net working capital days decreased to 77 days from 82 days, and we again lowered our receivable day sales outstanding and improved inventory turns. In summary, solid execution of our growth strategy in the first three quarters of 2016 has set the stage for a record year. As reflected in our guidance, we remain well positioned to capitalize on the technology trends in the semiconductor market. While the flat panel display market digests the large OLED investments from the third quarter, the broader industrial markets look to continue the recovery in the fourth quarter. We continue to pursue internal investments to further penetrate new and existing industrial applications, extend our reach in the semiconductor market and increase our service capabilities globally. Our level of engagement with strategic targets remains high. We see multiple opportunities that are potentially excellent strategic fits and attractive financially. We are optimistic that the quality of our M&A pipeline will enable us to grow our business. We will keep you informed of our progress on this important initiative. This concludes our prepared remarks for today. Operator, I'd like to open the call for questions.

[Operator Instructions] And our first question comes from Joe Maxa of Dougherty & Company.

Thank you. And congrats on a great quarter. I'm wondering -- regarding the semi cycle and the strength that you're seeing, I'm wondering what your expectations are, if you can have any visibility into next year, be expected to stay at these levels.

We agree with the general sentiment in the market right now but 2017 will be a growth year. I can give you a profile how the year will look like quarter by quarter. We expect yuan to continue to be positive but the rest of the year depends on the market investment cycles. Overall we agree with the general sentiment from forecasters, analysts and some of our customers about 2017 to be a positive constructive year.

Okay, that's helpful. And do you anticipate providing an update to these aspirational goals since you are going to be hitting those earlier than expected?

Yes, we will upgrade and update our aspirational goals as soon as we finish with our annual strategic planning process.

Thank you. And next question comes from Edwin Mok of Needham & Company.

Hi, great, thanks for taking my question and congrats for a great quarter. So first question I have is on the industrial group you mentioned there is some digestion in the flat panel display side. So wondering how do you kind of think about that overstake into your guidance for the fourth quarter, are we going back to the 2Q level, or is it just a moderate decline from where we are at? Can you give some color there?

So Edwin, Q3 was uniquely strong for us in flat panel display driven by OLED investment cycle. We expect Q4 to be declined. We expect the industry in general to continue to invest but for us as we predicted in the past, the business will continue to be lumpy as the investment in critical components that our customers buy usually buy in lumps as they build their product and ship it in longer lead times compared to ours. So yes, Q4 in OLED will be declined for us but not to previous levels. It will be slightly higher than previous levels.

And Edwin, keep in mind that it was only two or three quarters ago we were looking at industrial revenues that were pretty much $20 million every quarter and year over year were up substantially, quarter over quarter up substantially. So we may have a pause this quarter but overall we are winning more projects and it is showing in the revenue.

Correct.

Great, that's actually helpful color. And then talk a little bit also model. You guys have been delivering over 60% gross margin for many quarters, or I guess a couple of odds and the fourth quarter last year. But how do you kind of think about the margin in your business? Seems like the business really enables you to get rid of the costs, higher margin or kind of low 50s range, is that how we should think about your business and any color on what you would think about – what are the levers to further improve margins or what are the risk for margin on the downside?

Sure, that's a good question. First of all, we look at operating margins and you're correct, right. We came out with a model of 20% to 25% but it's very volume dependent. And that was at a volume of $80 million to $100 million of revenues a quarter. And now we're at 125 million plus. So we do not see anything that's really changing our margin structure. There is some operating leverage. So have revenues above 120? Yes, we should be above the 25% range. As Yuval said, now we're going through our strategic plan and as part of updating the aspirational goals we will be updating the financial model as well, because things have changed. And I think the key is that at these revenue levels margins look very healthy and sustainable.

Okay, great. That's helpful. Last question I have, you mentioned in the call, on the prepared remarks that you have a high level of engagement with some potential M&A targets. I know you probably can’t provide too much detail on that but this any way you can kind of help us at least think about is – are you guys more focused on doing larger acquisition or larger deals in the industrial space or is that a large pipeline or tuck-in and new comp [ph] where you can kind of describe in that broad stroke?

The focus is to grow the industrial revenues. And the focus -- we look at criteria that we want it to be equal to or better than a buyback in the short term. And long term it's all about returns, that is greater than our weighted average cost of capital. But you're correct, Edwin. In the pipeline, yes, there are smaller tuck-ins and there are larger acquisitions and we're actively engaged with all. And as you know these things take time and we want – we’re more focused on making a good decision that's good for the business and the shareholders. But we’re not driven by -- Tom, we’re driven by good decisions.

Edwin, as we disclosed in the past we have a very rigorous process and very disciplined approach to review the targets and they had to really have an excellent fit to our operational model, product portfolio, target applications and financial hurdles that these acquisitions need to meet.

Right. I mean is it fair to describe that valuations is pretty high right now, so it is very challenging to find something that meet those requirements?

We didn't hear the question, Edwin.

Sorry. What Yuval is saying, you guys have a rigorous process and shareholders always appreciate that. But will it be fair to say that valuation is a little high right now, so so much harder to find targets that meet those requirements?

Multiples or higher, that's true. We’re less focused on multiples, more on returns. I wouldn't say that because multiples are higher, it’s delaying the process. It’s more we want to do a good job.

Thank you. And our next question comes from Amanda Scarnati of Citi.

Thanks for taking the question. In the non-semi side and the industrial business, are there any other revenue drivers that can offset this potential slowdown in OLED in the fourth quarter that can drive revenues up? Or is it going to be a down quarter based on the OLED and [FIFO]?

Yes, that's a good, great question, Amanda. We continue to win design wins in two target markets that we are focusing on. One of them is the thermal application space with our power control modules and in this case we take our power control modules both to new geographical areas, like North America and to new industries such as the semiconductor industry. So the power control module product line is a growth target for us. The other is our high voltage – again high voltage applications space. In high voltage domain, we continue to win design wins in scanning electron microscopes globally in the medical industry both by diagnostic and therapeutic applications and also in mass spectrometry and X-ray applications. So we're right now building the future revenue by continuing to design unique wins that take us to new markets, new applications and new geographical regions.

On the semi cap side, with everything kind of turning to 3DNAND, you mentioned the transition to 7 nanometers that's starting. What percentage of your revenue is driven by these new technologies that are 3DNAND FinFET 7 nanometers have versus flagging etch technologies?

I think we do not delineate that. We see a combination of growth coming from the increase in demand based on volume increase, which is basically the increase in volume manufacturing of 3DNAND devices. Also migration from the older generation of 3DNAND devices to new generation of 3DNAND devices, that drives also multi-patterning and we also see an increase in logic devices demand and recently we have signs of investment cycle start for DRAM. So I would say it's a combination of volume increase for just manufacturing volume increase, migration to new technology for new devices and new technology materials that are supposed to support both the advanced 3DNAND architecture and also the 10 nanometer and 7 nanometer technologies.

Thank you. And our next question comes from Krish Sankar of Bank of America Merrill Lynch.

Hi, thanks for taking my question. Yuval, is there a way to characterize your OLED opportunity on a dollar basis, or tool or fab or relative to semi?

We don't break it down but we serve the flat panel display market with power supplies that go to PVD applications, large areas sputtering, also the CVD applications and another very important application we serve is the deposition processes for touch panels. And basically these are driven by both handheld devices and to some extent even large screen TVs manufacturing.

And then I had a question for Tom. The stock comp expense is running at about $0.03 on a quarterly basis. Looking into next year, would this still be part of --- to be excluded from non-GAAP or would it be included into the non-GAAP calculation?

We plan to leave it in the non-GAAP calculation. And there's many reasons, that's the way we view the business. That’s why even when we look at M&A, that's the way we're compensated. But it will stay in non-GAAP.

So it will be excluded from non-GAAP calculation.

Yes, yes. Thank you, Krish. It’s taken out to arrive at a non-GAAP number.

And then a final question for Yuval is, can you guys quantify how much of the high voltage as a percentage of sales or is it material enough right now or -- because it's so huge opportunity there but the numbers are still pretty low, is it right?

That is correct. It's still a small in comparison to the semi business. And it is still small but we view that as a future area for consolidation and growth for us. Within the very broad base of high voltage applications in the world, we right now are highly concentrating our efforts in analytical equipment such as mass spectrometry and X-ray and we continue to grow our high voltage applications. Also in semi as you know with the acquisition of high voltage product lines, we became a supplier for ion implantation high voltage product supply for e-beam related metrology and inspection tools. And right now we're entering the area of electrostatic charge. All in all, still small but very broad diversified and it's an area for us for future growth more so in the industrial world.

[Operator Instructions] And our next question comes from Pavel Molchanov of Raymond James.

Thanks for taking the question. When you talk about revenue uplift in both of your main verticals, I am assuming that most of the, if not all of the uplift, is coming from volume, but you don't often talk about pricing. So I thought I would just ask you to comment for the main verticals, are there any noticeable adjustments or changes in the pricing landscape for this equipment that you've been seeing?

Pavel, our relationships with our key customers are usually very long term relationship. So a lot of the pricing schemes that we have are contractual and long term in essence. And so we do not expect to see significant ASP erosion, if that was the question. When it comes to delineating between our semi vertical and industrial, unlike the common belief, you'll find out that the margins we have in industrial on average are higher than we have in the semi which is a good thing, right. We continue to develop enabling technologies, we continue to work closely with our customers to develop enabling solutions for them, which provide us long term protection for price and margins.

In terms of geography, you highlighted a couple wins in India. Are there any other geographies where -- which are either higher or lower than perhaps with what you've been expecting?

That's a good question. Pavel, thank you. So India for us is an emerging region. We talked about it in our last analyst day, we talked about the investments to make in India. We believe India long term is an industrial country that will generate business for us and we have a team in India that operates. We have won a design win in India in the solar, PV solar cell manufacturing business. There are some glass coating lines in India that we are involved with. In general, it's an emerging -- very small but emerging graphical region for us. Another area that is important is China. China has – the government has made a decision – strategic decision to invest significantly in local semiconductor manufacturing industry across all the value chain. Obviously we participate in that investment cycle. We continue to invest locally. We are local, we have -- a significant portion of our organization is in China. And we are engaged with our traditional customers but also with new customers, emerging customers in China in supporting their needs in technology and products. Lastly we also continue to invest in local service and distribution channels in China. End of Q&A

Thank you. And I'm showing no further questions at this time. I'd like to turn the conference back over to management for any closing remarks.

Thank you everyone for joining us today. We're excited about the quarter. We’re excited about the future and we're looking forward to seeing many of you in the upcoming quarter.

Ladies and gentlemen thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Have a great day everyone.