Greetings, and welcome to the Advanced Energy's Third Quarter 2024 Earnings Call. At this time, all participants are in a listen-only. A question-and-answer session will flow the format presentation. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to introduce Edwin Mok, Vice President of Strategic Marketing and Investor Relations. Thank you. Mr. Mok. You may begin.

Thank you, operator. Good afternoon, everyone. Welcome to Advanced Energy Third Quarter 2024 Earnings Conference Call. With me today are Steve Kelley, our President and CEO; and Paul Oldham, our Executive Vice President and CFO. You can find today's press release and presentation on our website at ir.advancedenergy.com. Before we begin, let me remind you that today's call contains forward-looking statements that are subject to risks and uncertainties that could cause actual results differ materially and are not guarantees of future performance. Information concerning these risks can be found in our SEC filings. All forward-looking statements are based on management's estimates as of today, October 30, 2024, and the company assumes no obligation to update them. Any targets beyond the current quarter represented today should not be interpreted as guidance. On today's call, our financial results are presented on a non-GAAP financial basis unless otherwise specified. Excluded from our non-GAAP results are stock compensation, amortization, acquisition-related costs, facilities for expansion and related costs, restructuring and asset impairment charges and unrealized foreign exchange gains or losses. Please refer to a detailed reconciliation between GAAP and non-GAAP results in today's press release. Before I pass the call to Steve, as a counter announcement, on Tuesday, November 19, Advanced Energy will host our 2024 Analyst Day in New York City, where we will update our growth strategies, market views, long-term financial goals and demo our products. Welcome institutional investors and financial analysts to attend in person. A live webcast of the event will also be available on our website. More information can be found in today's earnings press release. With that, let me pass the call to our President and CEO, Steve Kelley. Steve?

Thanks, Edwin. Good afternoon, everyone, and thanks for joining the call. Third quarter financial results exceeded the midpoint of our guidance driven by higher demand in the semiconductor and data center markets. We experienced strong design win activity across all of our target markets and made solid progress on our factory consolidation plan. In semiconductor, we delivered our strongest revenue performance since the fourth quarter of 2022. In data center computing, we continue to benefit from strong investment in AI infrastructure as well as successful new products. In the third quarter, we delivered a record number of EBOs and eVerest qualification units for next-generation etch and deposition systems. We are working closely with our customers to fine-tune the performance of EVOS and eVerest subsystems to meet the demanding requirements of logic and memory processes. In addition to Plasma Power products, we also developed power solutions for semiconductor test and burn-in systems. This quarter, we secured a significant tester win by leveraging the performance of a high-density power module originally developed for data center applications. This is an example of reusing best-in-class technology across our markets to improve engineering efficiency and reduced development time. It's a key competitive advantage for Advanced Energy. Our factory consolidation actions are beginning to have a financial impact, as shown by our sequential improvement in gross margin. Further improvements are anticipated in the fourth quarter and beyond. As we execute our plan to reduce fixed costs, enhance productivity and improved product mix, we remain confident as markets recover, that we can achieve our gross margin target of over 40%. Now I'll provide some color on each of our markets. Third quarter semiconductor revenue increased 5% sequentially, exceeding our projections. We benefited from incremental demand in both leading and trailing edge logic process nodes. Looking forward, we…

Thank you, Steve, and good afternoon, everyone. Third quarter revenue was $374 million, slightly ahead of the midpoint of our guidance. With higher gross margin performance, we achieved earnings per share of $0.98, beating our guidance of $0.90. Semiconductor revenue was above our expectations as we captured incremental demand in a dynamic environment. Data center computing grew again on strong AI-related demand while inventory destocking continued to limit industrial and medical revenue. We are executing our plan to reduce costs and operations by consolidating manufacturing into larger sites and are beginning to see the results of this effort. Third quarter gross margin increased 100 basis points quarter-over-quarter, and we expect a sequential increase again in the fourth quarter. In addition, as we previously announced, we recorded a restructuring charge primarily related to the planned closure of our last production site in China by the middle of next year. Now let me go over our financial results in more detail. Total revenue of $374 million increased 3% sequentially, but decreased 9% year-over-year. Semiconductor revenue was $197 million, up 5% sequentially and 7% year-over-year. Our team acted swiftly to capture higher demand and deliver upside to our expectations. Service revenue also increased from the prior quarter. Industrial Medical revenue was $77 million, down 3% sequentially and 33% year-over-year. We believe this market is close to bottoming after several quarters of customer inventory destocking. We're encouraged that inventory in the channel continues to decline and that our distributor resale data suggests that end demand remains solid. Data center computing revenue was $81 million, up 11% sequentially and 18% year-over-year, driven by continued strength in hyperscale demand for AI applications. Telecom and networking revenue was $19 million, down 22% sequentially due to lower demand and timing of a meaningful networking customer program that moved…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Thank you. Our first question is coming from the line of Brian Chin with Stifel. Please proceed with your question. Q – Brian Chin: Hi, there. Good afternoon. Thanks for letting us ask a few questions. And congratulation on the results Maybe first question, can you just give maybe a rough idea of what drove the upside on the semi equipment revenue in Q3 and then maybe a little bit in the Q4 outlook? And also, just broadly, some rough idea of how much of your semi equipment revenue is typically leading versus trailing edge? A –Steve Kelley: Sure, Brian. As a reminder, in Q2, we saw growth in growth in Q1, Q3 showed over Q2, and we're anticipating further growth in semi revenues Q4. So the trend has been good. And what we've seen this year is that most of the growth has been driven by logic nodes. And we've seen it from both leading edge logic as well as trailing edge. We don't have an exact breakdown between leading edge and trailing edge because our equipment can be used in both applications. So I can't really help you there. Q – Brian Chin: Okay. Fair enough. And I'm not going to hold you to a prediction on WFE spending in 2025, but there have been some other customers of yours and other OEMs have commented on that. And so let's say it's mid-single-digit growth next year, kind of similar maybe to this year. And when you think also about the moving pieces where there's some concerns about trailing edge, particularly China, spending growing next year. I think people think it declines, maybe leading edges up. When you think about put all that together, what's your sense…

Yes. I think it's an interesting phenomenon. Obviously, what we see is that the refresh cycles are accelerating essentially. So we're working with our customers very closely on generation N+1 and N+2 right now. And so we're, I think, in not too distant past, there'll be 2 years between refresh cycles. It's moving closer to a year now. And that's tracking closely with the introduction of new GPU technology. And so with each new generation of GPUs the power requirements tend to go up. And so part of our value proposition for our customers is our ability to be nimble and to develop these solutions relatively quickly. And so what we've always sold on is power density, efficiency and reliability. And those become even more important factors for these AI data centers because they're expensive and they're power hungry. So if we could squeeze out more efficiency, it saves everybody money. And the power density comes into play because we're trying to basically deliver more power in the same size box. And our engineering team is very capable when it comes to power density, efficiency and reliability. Q – Brian Chin: Okay. Great. Thank you. Appreciate it.

Our next questions are from the line of Joe Quatrochi with Wells Fargo. Please proceed with your question.

Yes. Thanks for taking the question. Maybe one on the industrial medical side. Curious just kind of if you could kind of talk a little bit more about what you're seeing from just inventory destocking and your confidence level and that, that kind of starts to play out in return to better growth algorithm as we look into next year?

Yes, I'd be happy to, Joe. So just looking back, we started this inventory correction back in Q4 of 2023. So believe it or not, it's been a year. We're still not quite through it. Roughly half our business in Industrial & Medical goes through distribution. So the distribution metrics are an important barometer of market health. And so what we've seen this year is that after resales dipped in Q1, we saw a return to relatively strong resales in Q2 and Q3. And then we're expecting relatively strong resales in Q4. At the same time, we've seen distribution inventory continue to decline. And so we believe, looking at the trend lines that at some point late Q4 or sometime in Q1 we should be in a position where inventory and distribution is normalized. And our thesis is that once we see normalized inventory levels, we should see a return to growth from distributors as far as what they order from us. So that's our view. If we look more broadly, it's a little more difficult sometimes to gauge how much inventory the end customers are customers are holding. And so it's a mixed market. Some working through excess inventory from the supply chain crisis and some have already worked their way through it. And so that's part of the beauty industrial medical market is it's very broad. There are thousands of customers. And our objective is to continue to broaden our customer base, and that's going to lead to a steadier business over time.

Thanks. And maybe as a follow-up, just as I think about like the puts and takes of gross margin guide for the fourth quarter. Can you talk about just mix dynamic there? I mean I think semis is maybe a little bit better than we're thinking in industrial, flat to up, and then data center, it sounds like maybe flat. So can you just kind of parse out help us understand why 37% is still, kind of, the right way to think about gross margin, not maybe a little bit higher than that?

Yes. This is Paul. I'll make a couple of comments. First, we think that 37% is kind of right on track to our model considering we still have a lot of transition activity going on in manufacturing. So I think that's -- we continue to expect things to be up a little bit. We did see a little headwind to mix this quarter, interestingly enough at the product level. So we could get a little bit of benefit there. But I think we feel comfortable with the 37% where it's at. And again, remember, we do have some of these transition costs as we are now getting into full swing of the China factory closure and transition.

Thank you.

Our next question is from the line of Steve Barger with KeyBanc Capital Markets. Please proceed with your questions.

Thanks. Steve, great to hear about this continued momentum and design wins. I think you said there was a record funnel of new opportunities. Can you quantify that at all in terms of how that funnel looks compared to a year ago in terms of number of projects or dollars or however you're kind of tracking that?

Yes, Steve. We haven't given exact numbers on the funnel. But one thing we do track pretty closely is conversion rates. So we have an opportunity funnel and then we track what percentage actually turn into design wins. And I can tell you we're tracking above one in three. So that means one out of every three opportunities converts to a design win, which we verify with either a purchase order or some other written commitment from the customer. So I think that's pretty good. And the key for us is basically expanding the funnel, both through our website, where we've seen a lot of good uptake from new customers and also through our distributor network and with our direct sales force. So in distribution, it's interesting. We're basically the top offboard power supply vendor for each of our three biggest distributors have gained share over the last two years at each of those big distributors. And so the momentum is building in distribution as well as with our website as well as with our direct sales force.

Yes. That's really great to hear. And presumably, you're still relatively low share in those newer markets that you're serving? So lots of…

Yes, we're still single-digit market share in these new markets. So there's plenty of upside for us.

And if I look at the guidance, if a couple of things swing your way in 4Q, you'll be back to that $400 million in quarterly revenue. If that happens, would you think that's a baseline you'll build on as you go through next year? Or are there any seasonal things that would cause 1Q to be lower?

Yes, it's a good question. And obviously, we're not guiding out 2025 at this point. But we do see some seasonality in our -- in some parts of our business. The industrial and medical piece does have some seasonality as people cross fiscal year ends. So we'll see how people gauge their inventory coming into Q1. Also, certainly, last year, we saw some seasonality in our semi business, which declined from Q4 to Q1, and we largely attributed that to customers’ kind of stocking -- finishing their stocking activities in Q4, taking a little bit of a breather in Q1. So, we could certainly see some seasonal effects. And I guess we're not, at this point, projecting a big market turnaround or the bigger factors that tend to overcome the seasonal effects, at least not in the near term in our markets.

Understood. Thanks.

Our next question is from the line of Krish Sankar with TD Cowen. Please proceed with your question.

Hi, this is Robert Mertens on the line on behalf of Krish. Thanks for taking my questions and congrats on the strong quarter. It seems like the growth in in data center market was above your prior expectations come for the quarter and remained strong through the end of the year. What sort of visibility do you typically have for the products going into this business and sort of the sustainability of demand heading into next year?

Yes, it's interesting, we're getting more visibility because of the compression of the design cycles. And so we've won some major new designs just this past quarter that will start ramping as soon as December. So, things are happening more quickly, which is good news. And it seems like this cycle could last longer than normal. I think we've noted in past calls that typically the data center market goes through inflection points. Five or six quarters of strong consumption followed by a few quarters of digestion and we've seen that better in the past. It could be different this time. I think the influence of AI, the influence of these new generations of GPUs could very well extend the cycle.

Got it. Thank you. And then another question on the gross margin side. Obviously, you guys have been doing a lot of work on the manufacturing efficiencies, and it will grow with volumes as well. Did I hear correctly, you mentioned you're on track to grow 400 basis points. Is that in regard to next year?

Yes, it's a good question. I think if you step back and look at our overall long-term gross margin targets, they remain unchanged. And if you go back to Q1, we were around 35%, and we said we thought we could get to a 40% or better at $450 million roughly in revenue. If you look at the pieces of that, a little bit of that is material premiums needed to finish abating. We thought mix could play a little factor. The biggest things came from improving our manufacturing cost. We said that was 200-plus basis points and then, of course, getting the volume up. If you look at this point where we are now three quarters into the year, I think the material premiums have largely abated. There's always a little bit of noise, but I think that's kind of not a factor at this point. And we're a little ahead from a manufacturing cost perspective. So, we're encouraged that we've kind of reached that tipping point where we're seeing more benefits, lower cost, kind of tipping over and overweighing the transition costs. And that should continue on that track. And remember, we talked about closing our China manufacturing site. That's a pretty significant action. That will have its largest effect kind of at the end of Q2 of the coming years. So, we feel really good about that 200-plus basis points. As I mentioned earlier, mix was a little negative this quarter. We'd probably get a little bit of that back. And then volume has yet to kick in. So, when we look at those elements being a little over 36% this quarter, projecting 37% next quarter, we think we're on track to get to that 40% or better. And remember, as our new products get into the market and start to ramp, we think there's another 200 basis points to 250 basis points from what I'll call, structural mix, better margins from new products, higher percent of sole-sourced revenue. And that should come in over a course of a product cycle, so call it 12 to 24 months. That should put us firmly above the 40% and give us room to stay above 40% even in a down market. So we're encouraged that we're now finally starting to see maybe some of the fruits of our efforts. We think we're on that track. This is, I guess, our third quarter sequential improvement with Q1 being the bottom of gross margins. And when we look forward, we think we'll continue to stay on that path to get back to 40% as our markets recover.

Great. Thanks. I appreciate it.

Our next question is from the line of Rob Mason with Baird. Please proceed with your question.

Yes. Good afternoon. There was a -- Steve, you made the comments around the design wins on the semiconductor side, new products as you get into the second half of next year and into maybe further more so into 2026. I'm just curious, as you think about what your ramp looks like today, how much of that is from design wins that you've, I guess, banked today versus maybe what is in the pipeline from a risk-adjusted likelihood to win standpoint, just kind of the visibility around that?

Yes. So let me just back up a little bit. We introduced eVoS and eVerest a little more than a year ago than we came out with this NavX matching network this summer. And so between those three new platforms, we'll ship over 250 units by the end of this year, which is unprecedented from a volume standpoint. Those are going to every customer that we have. So literally, every plasma power customer we've ever sold to is sampling at least one of these technologies, if not two or three. And so what we've seen is a sense of urgency from our customer base. They need this technology to get to the next level in both logic processes and memory processes. They're tackling some really thorny technical issues and our technology is helping them get over the hump essentially. So that's what's driving the sense of urgency. And some of that's reflected in our increased R&D spending, you've seen in Q3, you'll see it again in Q4. But we're basically accelerating the builds of these systems. And so that R&D spending is going towards more units and not necessarily more people. And that's pretty good news for the company, actually.

That's helpful. And just as a follow-up, how are you thinking about -- this is maybe for Paul, but how are you thinking about free cash flow in the fourth quarter and how you'll finish up the year?

Yes. The free cash flow, I think, will be up from Q3 and Q4. We usually don't guide to that, but if you look at the factors, obviously, income is going to be higher. I think we'll have a better balance of working capital when we look at our inventory and accounts payable trends, I think those are looking positive relative to the first part of the year. And if you remember the first part of the year, we had a couple of items that impacted free cash flow in terms of timing of tax payments or annual incentives that we don't have in the fourth quarter. So I think the fourth quarter will prove to be a better quarter than Q3 for both operating cash flow and free cash flow. I guess the other aspect is if you look at CapEx, CapEx in total was down a little bit in the third quarter and as a percentage of sales was coming back a little bit. That's going to bounce around still the higher end of our range, 3% to 4% because we are making these investments in our factories. We are actually making a fair amount of CapEx investments in what I'll call R&D, which supports NPI for tooling, test fixtures and that type of activity. And we've been working on some things that help us scale the company around IT infrastructure and capability. So those investments will continue for the next year or so. So we continue to see a little bit of elevated CapEx. But again, that's not a large number in the grand scheme of thing. It's sort of that 3% to 4% of sales. So it should be better in Q4. And in general, we should track our historic levels of free cash flow conversion that we've seen in the past.

Thank you.

Our next question is from the line of Jim Ricchiuti with Needham & Company. Please proceed with your question.

Thank you. Paul, I'll just follow up on the gross margin commentary. So how do we think about the -- can you quantify the headwind from the transition from China manufacturing? And does that remain at the similar headwinds Q4 and gradually abate as we get into the first half of the year '25?

Yeah, we haven't broken that down precisely, Jim. But if you look at what we said in the past, if you recall back in the earlier part of the year, we thought that getting around $400 million would get us up 250 to 300 basis points. And then as we saw the Street sort of modulate around getting to around 37% by the end of the year, we felt that, that generally reflected these additional headwinds that we expected. So I guess you could infer from that, that that's anywhere from 50 to 100 basis points. I think those do gradually get better. They don't get better all at once. But I think over the next three quarters, you'll see those abate and that will contribute to getting the whole amount of our manufacturing cost improvements to fall through.

Got it. And Steve, maybe this is a question for you. Just on the design win activity. It sounds like you're seeing -- enjoying some nice wins. You alluded to one EVOS design win, a high-volume application. I wonder if you could elaborate on that. And then just a follow-up on the I&M design wins in the robotics and the process automation. Are these existing customers for the most part? Or are you winning some business with new customers? Thanks.

Yeah. So Jim, I can't go into much more detail on the EVOS win because of confidentiality provisions with our customers. But I can confirm it's high volume, and it will go to production next year. So I think there are a lot more of those wins in the pipeline, and we'll be able to announce more in the coming quarters. But we're very encouraged with the degree of interest and the fact that we have units not just in our customer labs, but also in their end customer fabs. And so this is a process that's well underway right now, getting these design wins confirmed. On the Industrial Medical side, it's interesting. We have design wins in a number of new areas. Every quarter seems like a new adventure for us, partly due to our website. So the website has brought in a lot of new customers. So just in Q3, we saw new customers in the metal aerospace, factory automation, test and measurement. We had new wins in automation, major wins, thin films, stage lighting, test and measurement, I can go on and on. But we're seeing customers that have high-end requirements. We're -- they have a, say, a factory production line, which needs to have high reliability and high power efficiency, they'll come to us because that's the type of product that we manufacture and design. And so there's a lot momentum, I think, in the industrial medical space and we're funding it for our website, through our sales force and through our distribution network. So we have a lot of activity going on, and we're very optimistic about growing faster than market in the coming years Industrial & Medical.

Thank you.

Our next question is from the line of Scott Graham with Seaport Research. Please proceed with your question.

Good afternoon, well done. Thanks for taking my question. I was wondering if there's a way to parse out what is the destocking impact versus just sort of I know you're saying that resales, which I assume you mean POS is better. 33% down is a big number in I&M, and I was just wondering is that essentially all destocking if you're saying that resales are improving?

Yes. I think it's -- there's a couple of things. First, I think 33% down, and I think it was a similar number last quarter, maybe even more, is pretty unprecedented in industrial and medical. And so if you step back from that, I think our view is what's driving that level of volatility is essentially the recovery from the parts and supply crisis that we went through. Along to a long time, people couldn't get parts. Industrial Medical was the last group that could get them, and that drove record numbers of revenue in 2023. So first, I think the compare is comparing probably to a higher number than is the normal market. I think the flip side is also true. Now that we are in 2024, people are digesting all the things that they got. And so you see a pretty tough comparison year-over-year. If you look at what we believe is end market demand, what our customers would actually be drawing, we think that's been relatively stable. There's been some ups and downs, but it's much more stable, and we hear that from our distributors. We kind of hear it from customers. So at least in this market, we're not seeing a big falloff in the end market. It's again some ups and downs. And when we look at the sell-through, the point of sale, we talked in our call that it's relatively solid. And if you look back over the last 8 quarters, you can see that, that number has not modulated nearly as much as what we've seen. And what I'd say when you look across industry at what our distributors and our peers have seen. That suggests this is mostly an inventory phenomenon. It's mostly a stocking issue where people took parts over the…

That's very helpful. Paul, thank you.

You bet.

I have another question on DC, data center sales. I know you have commentary here that says that, strong sales in the coming quarters. Is sort of like fourth quarter and first half of next year comment? Or do you actually have visibility based on conversations with your customers that maybe it's more like a year's worth of visibility?

Yeah. I think that's a tough question to answer. As Steve said, we have more visibility than we usually do, because there's a bit of a herd mentality in this market, and you have these periods of digestion. But I would say, based on our commentary and the products that we've seen designed in and could ramp, I think we certainly feel good about the next few quarters. Could I go out a year and say it's still going to be strong. I mean, in tech world a year is forever. So it could be different in this cycle. There's a lot of investment going into it. But I think it's hard to predict out a year at this point. But certainly, in the near-to-mid-term, it seems like there's a lot of demand for what we're doing. And we see it both terms of orders and design wins product interest on new technology.

Scott, thank you.

Thank you. At this time, we've come to the end of our question-and-answer session. I'll hand the floor back to Edwin Mok, for closing remarks.

Thank you, Rob, and thanks, everyone, for joining today's call. We look forward to seeing many of you at our 2024 Analyst Day, on November 19th. Goodbye.

Thank you. This does conclude today's teleconference. We thank you for your participation. You may now disconnect your lines at this time.