Good day, ladies and gentlemen, and thank you for standing by. Welcome to Advanced Energy Second Quarter 2020 Earnings Conference Call. At this time all participant are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference maybe recorded. [Operator Instructions] I would now like to hand the conference over to on your speaker’s today, Edwin Mok, Vice President of Strategic Marketing and Investor Relations. Sir, please go ahead.

Thank you, Michelle. Good morning, everyone. Welcome to Advance Energy's second quarter 2020 earnings conference call. With me today are Yuval Wasserman, our CEO; Paul Oldham, our CFO; and Brian Smith, our Director of Investor Relations. If you have not seen our earnings press release, you can find it on our website at ir.advanced-energy.com. There you also find a slide presentation to follow along our discussion today. Before I begin, I would like to mention that Advanced Energy will be participating at multi investor conferences in the coming months. As events occur, we'll make their announcements. Let me remind you that today's call contains forward-looking statements, that are subject to risks and uncertainties that could cause actual results to differ materially and are not guarantees for future performance. Information concerning these risks and uncertainties is found in our filings with the SEC. All forward-looking statements are based on management's estimates, projections and assumptions as of today, August 5, 2020 and the company assumes no obligation to update them. Long-term targets presented today, which include our aspirational goals and the integration targets should not be interpreted in any respect as guidance. On today's call, our financial results will be presented on a non-GAAP financial basis, unless otherwise specified. Any explanation -- an explanation of our non-GAAP financial measures, as well as reconciliations between GAAP and non-GAAP measures can be found in our press release today. With that, let me pass the call to our CEO, Yuval Wasserman. Yuval?

Thank you, Edwin. Good morning, everyone and thank you for joining us on this call. This was a good quarter for Advanced Energy with strong demand across several of our markets and solid execution, which enabled us to deliver financial results at or above the high end of our expectations in a continued challenging environment. The strength in demand is fueled by multiple technology trends that are driving the data economy in the fourth industrial revolution that result in an acceleration in adoption due to COVID-19. In line with our growth and diversification strategy, the acquisition of Artesyn has extended our exposure to these trends and verticals, and we are ahead of plan in driving the integration of the combined company and achieving our synergy goals. Our pure play power strategy focus in our integrated functional organization provide us with the synergy, operational excellence and capabilities, which allowed us this quarter to deliver sequential growth in three of our four market verticals, resulting in revenue of $340 million. We generated non-GAAP EPS of $1.18 above our guided range, and our highest operating cash flow in two years. In the midst of the current global pandemic, we continue to put the safety and health of our employees and our communities first. At the end of the second quarter, all of our major manufacturing sites had returned to a near-full capacity operating within hand safety protocols and physical separation that are above and beyond local government requirements. Our supply chain continues to improve, but we still see some bottlenecks that we require proactive action to manage shortages, and on-time delivery of raw materials. With the increasing global cases of COVID-19, the environment is very dynamic and unpredictable and our results may continue to be impacted more by operating conditions and capacity than…

Thank you, Yuval and good morning, everyone. Before I begin, please note that all financial measures presented today will be on a non-GAAP basis, unless otherwise stated. Excluded from non-GAAP results our amortization, stock compensation, integration and transition costs, unrealized foreign exchange gains and losses, and restructuring items. This quarter, we recorded $5.8 million in restructuring costs related to the transition of manufacturing from Shenzhen to Malaysia, and other actions associated with synergies related to the Artesyn acquisition. We also recorded $1.1 million in non-cash unrealized FX losses related to long-term lease and pension liabilities. A full reconciliation from GAAP to non-GAAP measures can be found in our press release issued earlier today. In our second quarter, we delivered outstanding financial results, exceeding expectations and guidance for revenue, gross margin, operating margin and cash flow generation. Our team's strong execution in the challenging environment enabled our non-GAAP EPS to be above our widened range and our annualized return on invested capital to increase to over 20%. Cash increased by $28 million and we generated additional synergies from the integration of Artesyn. Second quarter revenue was a record $340 million, up 7.7% from $315 million last quarter and up 152% from $135 million a year ago. On a pro forma basis, including a full quarter of Artesyn revenue in prior periods, Q2 revenue grew 24% year-over-year with strong growth in semiconductor and data center computing markets, partially offset by declines in industrial and medical, and telecom and networking. Excluding Artesyn, organic revenue grew 11.5% sequentially and 34% year-over-year to $180 million. Turning to revenue by market, sales in semiconductor in Q2 were $145 million, up nearly 9% from the strong first quarter and up 61% year-over-year. On an organic basis, semi revenue grew 60% year-over-year with strong demand from foundry logic…

Thank you. [Operator Instructions] Our first question comes from the line of Tom Diffely with D.A. Davidson. Your line is open. Please go ahead.

Yes. Good morning. Thank you for taking my question. So first, I'm curious as we ramp up the semiconductor business right now, you mentioned it's obviously a combination of markets in share gains, but I'm curious are you seeing the beginnings of an inventory increase at your customers yet or is that still to come?

I can't comment on that. I don't think we have enough visibility to report on our customers' inventory.

Yeah, just…

We - I am sorry.

I was going to say that through the cycle typically, didn't targets bled off when things slowed down, but then you outgrow the market because both your end markets go up faster and also there is a build in the channel. So, maybe not specifically for customers, but just in general, are you seeing a build of your tools in the marketplace from an inventory point of view?

Yeah, Tom. As Yuval said, it's hard for us to have exact visibility to our customers. But I can say that we continue to see steady pull. Our bin sizes, our levels aren't really changing, so we're not seeing increase in inventory in the bins. And our sense is our customers are consuming inventory at the rate we're shipping it.

Yeah, we don't see any abnormal behavior Tom, and our demand continued to be strong and we're very constructive towards Q3 in semi.

Great. And then, Paul, when you look at the new products, what do you think the impact will be on margins over time as they start to become more accepted in the marketplace?

Well, generally, our new products, Tom, I have more innovation, more capability, in semi, more power or accuracy. And as a result, we expect to sustain or grow our margins with our new products as we've done historically.

Another comment related to that, Tom, as we develop new products, we rely on a future combined operation organization and platform. There is a combination of the traditional AE and the Artesyn very efficient operation. So we expect to benefit from a much more efficient manufacturing and lower cost manufacturing for our future products.

Great.

Some of these products will be vertically integrated.

And, of course, as we transition the product portfolio and complete the synergy and activities with Artesyn, all of these things will contribute overall to our ability to continue to drive gross margins higher and above our goal of 40%.

Okay. And then finally…

And we’re making great progress towards that.

Yeah. Okay. And finally, Paul, you mentioned that there were some supply constraints. It seemed like that was more centered around the data center business. I was wondering if you could explain here, why hit that segment of your market more than the rest?

Yeah. I think, as you look at, at this point, our factories are largely up and running, but we still have point issues with supply. You noticed our inventory was also up this quarter. Part of that was an effort to make sure we had adequate supply to meet our customer needs. But you still need a full kit to ship products. And then, in this case, that particular market and a few products there were impacted the most by supply constraints in the factory and material.

Okay. Thanks for your time.

Thank you.

Thank you. And our next question comes from the line of Quinn Bolton with Needham & Company. Your line is open. Please go ahead.

Hey, guys. Nice job on the results and the guidance. Paul, I guess I'm scratching my head a little bit on the gross margin guidance. I know you guys had a much stronger gross margin in the second quarter. But when I look at the revenue mix shift in Q3, it sounds like semiconductor, which is your highest gross margin business, is going to be growing the fastest, so and overall revenue was up, so you should get better absorption in the factories. I'm just trying to understand why margin could be down 120 basis points at the midpoint.

Yeah. It's a good question, Quinn. This quarter, as I explained, we had pretty much everything go right. Obviously, we had COVID costs, which were unfavorable, but that continues. So as we look forward, we just don't see all of those things continuing to fall to the right side. And although semi is up, our mix within our overall product portfolio in the different product categories hasn't much impact as just one market or another. And so on balance, when we look at the operating activities in the third quarter, we do see margins down a little bit. I'll also note that while our factories are largely up and running, we are focused on reducing inventory and we have inventory position in the hubs and other areas, which we expect to draw down, which is part of the revenue increase in Q3, not necessarily all higher factory output.

Got it. Understood. And then, I guess just looking towards, with revenue guided to about $1.4 billion. On an annualized basis, it looks like you guys are well on your way to your aspirational 2022 goal. Just wondering, if you had any updated thoughts. I mean, it certainly seems like you're tracking to that kind of target perhaps even before 2022. But just as you look out, WFE I think is expected to be up high-single digits to 10% next year. In that kind of environment, how would you look at that aspirational goal and how close do you think you can get next year?

Good question, Quinn. And as we do almost every year, our intent is to update our goals, long-term goals, as we complete our strategic planning process. And within the next few months, we will find the right platform to announce our updated goals.

Great, we will look forward to it. Congratulations again on nice results.

Thank you very much.

Thanks, Quinn.

Thank you. And our next question comes from the line of Amanda Scarnati with Citi. Your line is open. Please go ahead.

Hi. Good morning. First question I have is on the data center side of the business, and I just want to clarify that I heard a comment correctly. I think you mentioned that the data center business was down and partly due to capacity constraints. Can you just talk about how that business is doing and if you're seeing more of an impact from demand or more of an impact from capacity constraints? And if you expect that at demand or the constraints to recover anytime in near-term?

So we - more specifically about the demand part of the capacity part of the question, this specific revenue stream that goes into data centers, not the hyperscale, was more affected by capacity constraints related to COVID-19 mainly in Philippine factories, as I think, Paul, you said. We continue to see the market continue long-term to be strong. We said we expect in general to be at the same level going forward, while hyperscale will draw -- will grow at much faster rate for us, because of our continuing market share gain and adding more customers of hyperscale giants to our list of customers. And that will take, as you know, very similar to what we see in other capital equipment related sales, it requires working closely with customers, with their engineers, going through the qualification and evaluation and certification and at that point, we migrate into a ramp. And we are right now, we believe that we are practically in the third inning of our journey into hyperscale. So we expect long term to continue to benefit from our growing presence and to grow faster than the market. Long-term, there is no doubt that the data center hyperscale world will grow as the use of data and the need for storage of data will continue to grow. The underlying demand is very strong. We may see fluctuations, mainly affected by COVID-19, in general, digestion period of this very large data centers, but we are very excited about our future as a fast follower to the market from two years ago. We're getting tremendous momentum and continue to gain design wins, primarily because of our very advanced power density and power conversion efficiency.

Yeah. That's right. And I'll just note, Amanda, as Yuval said, quarter to quarter, we can see -- we'll see a little variation just because of brand new customers, some of the supply issues. But as context recall that this business is up 89%, almost 2 times from where it was a year ago and from even late last year. So we're sustaining these much higher levels of business and expect that to continue.

Okay. And then on the industrial and medical side of the business, are you seeing any sort of increase in or speeding up rather of qualification times, due to COVID and needing to get new products to the market or was the increase that you saw in medical really due to existing things that you already had in the pipeline?

I'm not sure, if we see a dramatic change in the evaluation time of our products in medical. I think, we -- obviously, we saw a very mixed picture recently due to the increase in demand for our products, or solutions that are directly related to COVID-19, like respirators or gene sequencing tools. We continue to look at the medical application space as a growth engine for us. We are benefiting from the need, the current need for more capacity, but we also have new design wins that go into diagnostic and therapeutic applications that are not related to COVID-19. To give you like a calibration, I think we grew our marketing, our medical revenue from $50 million to $75 million?

Yeah, we're about $75 in the quarter.

Yeah. We're $75 million right now. And last time we talked about it, we were $15 million -- $50 million.

Its over $50.

Over $50. And we expect to continue to grow in this area. This is an area of investment of interest. It has all the attributes that we like to see in the target market. Customized solution for critical applications, sticky relationship with a customer, and once you get designs in and qualified, it becomes a long-term annuity.

Great. Thank you.

Thank you. And our next question comes from the line of Mehdi Hosseini with Susquehanna. Your line is open. Please go ahead.

Yes. Thank you for taking my question. I joined the call late, so I apologize if I'm asking a question that has already come up. A couple of big picture items. I go back to the targeted goals of more than $1.5 billion of revenue and pro forma earnings of $6.50. So you are, on the revenue side, if I just looked at your June quarter and annualized it, you're not that far from a targeted revenue. But on the EPS, perhaps there is some catching up and that has to do with additional leverage that is realized due to a better cost structure. Is that the right way to think about what you did and how you're tracking against these long-term goals?

Let me talk about revenue. Yeah. Let me talk about the revenue, Mehdi. As I said earlier, I think maybe you came late to the call. We anticipate to update our long-term aspirational goals within a few months after we finish our strategic planning process. And as we said earlier multiple times in Q1 and this quarter, we're making progress, really great progress towards our long-term goals. And I think in some aspects of the plan, we are ahead of plan. We are ahead of plan in the integration of Artesyn, we are ahead of plan in that growth rate. So when it comes to updating the future projection of the company, we will provide that within a few months. About gross margin, do you want to maybe talk about that?

Yeah. Let me just talk about the rest of the market. You're right. We are approaching on a revenue side, we're getting closer. But recall that our model was a fully synergized model. And we're making great progress on synergies. As I said, we've basically achieved our Phase 1 synergy goals within the first-three quarters. We thought that would take us 18 months to 24 months. But we need to achieve our Phase 2 goals to achieve that -- the EPS to your comment. So we feel like we're in good shape. We're actually tracking a little bit ahead of plan. We're seeing the benefit from faster revenue growth as many of our markets that we've recovered and we've grown share in data centers. But we'll continue to work on executing on the synergy plan and driving the leverage in the business over the next several quarters, driving towards those long-term goals.

One more comment about this, Mehdi. I wouldn't expect our business evolution to be linear, right. We live in a dynamic environment. We live in a very -- especially now, very large fluctuations related to COVID-19. But the one thing we also we need to note, as we note in our prepared comments today, we are selectively and purposefully investing more in R&D in some really, really important growth engines that in some time during the trajectory in developing our long-term strategy, we made decisions that are related to future growth. As we made a comment today, we have increased our R&D spend going forward, to address some really unique growth opportunities in the semiconductor etch that we're pursuing right now in collaboration with key OEMs. And we have decided to increase our spending in R&D. And as I said earlier, we're very bullish about our ability to meet our long-term goals, but it may not be linear.

Sure. It's just amazing how your list of problems have changed on a year-over-year basis and now you have good problems and that leads to my follow-up question. You've also shown a rebound in a net cash per share. And what are the plans for that, assuming that trend were to continue? And then maybe, I'll just add one more follow-up. How do you see semiconductor revenue into next year, assuming that memory mix would pick up and that's where your sweet spot is? And I expect continued growth, but I just -- I would love to hear your view. So, what to do with the cash and so...

Yeah. Let me start with our capital deployment. We were very open and clear about our capital deployment strategy. And we will continue to focus on actively looking for additional acquisitions. We will -- obviously doing a great job deleveraging our debt and we periodically review internally and with our Board whether or not we would like to execute on opportunistic shares buyback and other return to shareholders. We have a strong deleveraging power and cash generation power and our intent is to deploy our capital. When it comes to long-term semiconductor projections, listen to our customers at SEMICON West and reading some of you guys' reports, we're very constructive about the future and we believe that long-term, 2021 is perceived and expected to be a strong year for semi. And obviously, we will be benefited from that, not only because of the fact that we will grow with the market, we continue to gain market share. We continue to cross-sell embedded power products into semi. We continue to increase our SAM, and for that reason, we continue to focus on our mission to grow faster than the markets we serve.

Thank you.

Thank you. And our next question comes from a line of Krish Sankar with Cowen & Company. Your line is open. Please go ahead.

Yeah. Hi. Thanks for taking my question. I had a few of them. Yuval, is there a way you can characterize or quantify what your market share on the semiconductor side is between NAND and DRAM?

We never look at that, that way. And we never dissected our market share between DRAM and NAND. Some of our products end up on our customers' machines that may end up to either/or logic or memory or DRAM and NAND, not always we know exactly what the target application is within the fab. So I don't believe we have that.

Got it. No worries. And then on the data center side of your revenues, is there a way to characterize what percentage if you data center revenue is from hyperscale?

We haven't broken that out at this point, Krish.

All right. No worries. And then just a final question for Yuval. When you look at hyperscale and look at some of the telecom and networking site, my understanding is that most of them are going towards like 48 volt on the equipment side. Do you actually see the products merging down the road between hyperscale and telecom or do you think there is still going to be a distinct difference between the two?

We see some talks about cross-pollination. Right now, from our perspective, we are excited and focused on the migration to 48 volts in data center hyperscales. And we bring to the table unique technical advantage that came with the Artesyn innovation and engineering teams, more specifically related to power conversion efficiency and power density, which means basically you can increase the power without dramatically increase your footprint or your volume of the box and that means a par density. Related to that, the ability to go to market quickly with innovative and leading solutions, as a time-to-market plays an important role here. And as we go from a fast follower into a leader and enable customers with time-to-market, we also believe that our margins will improve.

Got it? Thanks, Yuval.

Thank you.

Thank you. And our next question comes from a line of Pavel Molchanov with Raymond James. Your line is open. Please go ahead.

Thanks for taking the question. Kind of a core key regulatory issue. Now that Hong Kong is no longer kind of treated independently under US law for trade purposes, I'm curious if you have any customers in Hong Kong or purchasing through Hong Kong that may be affected by the technology transfer restrictions?

Yeah. We don't have any large customers that we service out of Hong Kong. Obviously, we have operations there. There are transactions that flow through there. But we don't see any change or impact to us as a result of the recent changes from a day-to-day or transaction activity.

Understood. Okay. That's good to hear. And then a balance sheet question. You're continuing to pay down pretty modest amount for $0.4 million of debt per quarter, but obviously you have $380,000 of cash on the balance sheet. Is there any rationale for accelerating the debt paydowns, since that is one of your stated goals for capital allocation?

Yeah. It's a really good question, Pavel. And as you've seen, we have brought the debt down modestly. Our view as the environment has changed with the lower interest rates. And frankly, our ability to lock in extremely favorable financing is that we don't anticipate bringing that debt down very quickly. We'll see how interest rates go. But as you recall, with the swap we put in place earlier in Q2, our net cost or our total cost of debt is around 1.25% or lower. In that rate environment, we don't see really an advantage to accelerating the debt payback beyond the modest amounts we've been doing.

Okay. And then just a quick one on your geographic sales mix. Latin America right now stands out as the hardest hit global region from the pandemic. I'm curious what exposure, if any, you have to customers, kind of Mexico and South America region?

Certainly, South America, I'd say, it's quite small. There is some, mostly from embedded power products and Mexico, there is certainly some exposure because we have customers that have for embedded power that have operations in Mexico. But all in, it would be our smallest of our various regions.

Okay. Thanks very much.

Thank you.

Thank you. And I'm showing no further questions and I would like to turn the conference back over to Yuval Wasserman for any further remarks.

Thanks, everybody, for joining us today. We had a great quarter, despite of COVID-19. We continue to outperform and do better on the short-term and long-term plans, excited about the projection of the company and the future of the company. And I'm looking forward to talking to many of you during the quarter. Thank you.

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