Advanced Energy Industries, Inc. (AEIS) Earnings Call Transcript & Summary

Hi, good morning, my name is Bill Peterson. I work with Harlan Sur at the semiconductor and semiconductor equipment team. We're pleased to have Paul Oldham, Advanced Energy's CFO; and Edwin Mok, the VP of Strategic Marketing and Investor Relations. I've asked the team to provide an introduction to the company for those who are less familiar with the company. I will then move to a number of questions, but we'll also bring in questions from the audience throughout the session. So if you'd like to ask a question, please click on the Q&A button. It was 1 year ago when we were supposed to have the same kind of fire chat, albeit in person, but you guys announced an acquisition on that morning. So lots of change with the company. Since I first -- I guess saw you guys 2, 3 years ago. So with that, why don't you provide a quick introduction and we move to Q&A?

Great. Thanks a lot, Bill, and thanks for having us, and good morning, everyone. We appreciate your interest in Advanced Energy. Before I begin, maybe I'll just mention that we may make forward-looking statements today, and those are subject to a number of risk factors and encourage you to have a look at our SEC filings for further discussion of those risks. Advanced Energy is a market leader in providing precision power solutions. We're a pure-play power company, and our products are basically used to convert electrical power from the grid into stable, controllable, clean, accurate, reproducible and figurable power that's used in a lot of applications globally within our various markets. If you look at the markets that we address today, we address, first, the semiconductor market. As Bill said, this has been historical root of the company. We're a market leader in this area. And our products are used, in this case, to provide the catalyzing energy that drives the chemical process for etch and dep processes. We also provide and manage the thermal energy, ion impact. We provide power that drives electronic truck for inspection, metrology in a variety of different applications. We also serve the industrial and medical market in kind of, I'll say, the precision power applications with things like medical, life sciences, equipment analytical equipment, cosmetic lasers, material processing, thermal processes, these types of applications. We also sell product into the data center and computing market where our products are found in data centers around the globe. This market is being driven now heavily by hyperscale investments, and by the need to have more power that's provided in a highly efficient and a highly dense way. And finally, we address the telecom and networking markets where our power supplies are used in base stations, remote radio heads and cellular infrastructure. This power supply is not only being very efficient and dense, but they also have to be very rugged and be able to survive all types of climates. What all of the markets we address have in common is that they serve the data economy. And as we move to a more and more interconnected society and the need for data generation, transmission, storage and use in more and more applications, drives the need to have this very clean, stable power that both, in some cases, enables the process. In other cases, powers the equipment in a very clear and clean way. We like to think of it as we power the fourth industrial revolution, and we're a critical compliant and technology provider into that market. As Bill mentioned, a year ago at this conference, that morning, we announced a very transformative acquisition, in which we acquired Artesyn Embedded Power. This acquisition, as I mentioned, was very transformative for us in a lot of ways, when it -- it doubled our addressable -- it more than quadrupled our addressable market, roughly double the revenue size of the company. It allowed us to enter the data center and net telecom and networking markets and expanded our presence in the industrial and medical markets. And it really set us up for our strategy long-term, financially, which is to accelerate earnings growth over time and as part of that, to deliver top-tier return on invested capital. We have a long-term aspiration goals: to go from about $1.2 billion to date to $1.5 billion in revenue over about the next 3 years; to increase our earnings from 2019 from $2.44 a share up to $6.50 a share; and to return -- return on invested capital of over 23%. And if you look at where we are today, 6 months into when the acquisition closed, I guess, about 8 months now from when the acquisition closed, we've made great progress. We're making excellent progress in integrating the acquisition. We had goals of within 18 to 24 months to generate $20 million of annualized synergies. To date, we've already identified and implemented about $15 million. And we targeted about $0.80 of accretion within the first 18 to 24 months. And in the first 2 quarter -- 2 full quarters, we generated close to $0.40 of accretion with the acquisition. So we feel like we're ahead of our goals. Time line-wise, we should be able to pull those in. And we're seeing a lot of progress as we integrate the teams as we move towards a combined company. So when you put that all together and you look at our recent results. Q1 was a great quarter for Advanced Energy and it illustrated a lot of the advantages of the company. I think first and foremost, our agility as a company to respond to a very challenging and fluid environment in which we had sort of rolling government-mandated closures of our factories, significant supply challenges -- with supply chain challenges with COVID-19. In that environment, we were able to exceed our revenue guidance. We improved gross margins. And for this level of revenue, I think we're performing at the high-end of our model right now. We delivered earnings that were at the high-end of an expanded range, given the uncertainty in the environment. We generated strong operating cash flow. And our actual realized return on invested capital was over 16%, which is substantially above our cost of capital, and we think already top quartile performance. Our balance sheet is strong. We have cash of $355 million. We have net cash, including the debt we issued to do the Artesyn acquisition last year. And we had $150 million unused line of credit. So we have a lot of financial flexibility, both to run our business in uncertain times as well as dry powder to continue to invest in the business and to execute our strategy. Interestingly, we were able to be a little bit opportunistic in the first quarter and then early in the second quarter. One thing we did is we converted our variable rate debt to -- effectively, fixed rate debt through an interest rate swap, where we're able to lock in 1.27% interest rate for the balance of our 4.5-year term. These are historically low rates. And again, I think just give us more financial flexibility. We also implemented an opportunistic share repurchase plan early in the quarter, which we actually stopped as the coronavirus sort of began to gain momentum throughout the world. Kind of trying to be a little bit prudent, but in the meantime, we were able to repurchase about $7.5 million worth of stock at a very attractive price of $42.59. As we look forward, while the near term is clearly being impacted by the uncertainty created by the coronavirus. Demand for our markets continues to be strong, particularly in semiconductor and in data center and computing. We believe that's because we're right in the heart of the data economy. And with this virus-induced recession, the need for work from home, the need for more data, again, transmission storage usage is not dropping off, like you might see in a traditional recession. It's actually increasing. And so we think that despite what might be some disturbances in the near term, this change may actually accelerate some of the long-term dollars in our business. But we're an innovation-based company, that's what we're focused on. And as we enable our customers' innovation, that drives growth for us. And we have a number of strategies to gain share and to increase content across our markets. And to that end, given the strength of our company, we're able to continue to invest in those critical R&D programs to help us grow faster than our markets. And the fact that we're a pure-play power company that's really focused on power technologies across a number of attractive end markets, I think, is resonating well with all of our constituents. We -- internally, we get a lot of synergy in terms of our organizations, our investments in technology and our ability to drive efficiency in our operating model. Our customers love it because they see us as a pure-play provider in technologies that are important to them, and I think investors get it. We're not a Home Depot. We're not trying to be a little bit of everything to everyone. We're able to really concentrate our investments in an area where we think there's a lot of growth opportunity. We address a large market. It's about $9 billion of addressable market today. It's pretty fragmented. And so that gives us a lot of opportunities to continue to add product and scope, both for organic and inorganic investment. And if you look at the markets we address today, we're coming from a strong position with either #1 or #2 in each of our markets. So as we look at the company, it's clearly a lot of uncertainty in the environment but we believe we have a great strategy. We've been able to execute that well. And we're nimble and agile and be able to deal with some of the challenges that could come forward from a macro perspective. So with that introduction, maybe I'll turn it back to you, Bill, for questions.

Yes. Thanks for that comprehensive introduction. Just kind of want to flesh out just a few quick near-term things before moving on to the end markets. You commented, semiconductor demand is strong. We've heard that from some of your customers and other people in the equipment space. But also, it seems that some supply chain issues in places like the Philippines held back growth for other areas like industrial. Data center is strong. We've also heard that trend more -- pretty much on every company that's presented here at our conference and through earnings. But then you mentioned telecom's muted, which -- that's been kind of mixed. Some people have talked about that accelerating and others have not. But I guess for the near-term guide, how much would you say the weakness in industrial and medical and then is -- and also telecom is related to supply-related issues on your side versus end-demand weakness? And on the flip side, I guess, do you have any potential supply constraints that could hold back your otherwise strong semiconductor or data center businesses?

Yes. It's a great question, Bill. And the performance across our markets is a little bit varied. Clearly, in semiconductor and data center markets, the demand is strong. In fact, we've commented that what's limiting our revenue right now is not demand. It's our ability to deliver to that demand, in part because of the capacity constraints and also supply chain challenges. For us, the capacity constraints right now are largely in our Philippines and Malaysia factories, where both factories are still under the government-imposed limits. They're operating, we're getting product out. We have skeleton or skeleton plus crews in each, but it's certainly not at the capacity that we would like. Our China factories, on the other hand, are pretty much back to normal, and we were able to recover those pretty quickly. So in those 2 markets, data center and semi, it's really capacity constraints that are limiting our overall revenue growth. Within Industrial & Medical, we saw a pretty substantial decline this quarter sequentially. The majority of that decline was actually driven by a single customer. That's a large customer that orders every quarter, and we saw an air pocket of demand this quarter, primarily because that customer is in the middle of a product transition to go from one generation to the next. And for a variety of reasons, they decided to accelerate that transition, which was difficult to respond to quickly. And as a result of that, we saw this sort of air pocket in demand. We expect to catch that up over the next couple of quarters or so, again, mostly driven by our ability to ramp capacity given the production constraints in the Philippines. So a large amount of that decline, I would say, was transient. It will recover. It's a single-customer issue. It's not a market issue or a share issue. It's just the timing. On the balance, there was certainly some decline in our Industrial & Medical markets. Part of that is the macroeconomic impact on our industrial markets probably has the most effect. And we are already seeing, and in some softening in those markets before coronavirus hit. But now with industries like automotive, glass manufacturing, steel, you go across the board. Investments in energy are all softer right now. And so there's some decline that's related to that. In medical, it's a mixed bag. Overall, our medical business grew in the quarter. But if you look within that things, demand for products like ventilators and life science equipment, for things like gene sequencing and other things that helped for vaccine development, those are up. At the same time, a lot of other areas, medical lasers, MRI machines, other things are down because you're seeing a shift in the medical market to -- away from nonessential services. Now that will rebound and recover over time. And I think the plus and the 1 kind of offset the minus and the other. Finally, in Telecom & Networking, it's mixed there from an industry. There's a lot of hype today around 5G investments. And certainly, on the chip side of the handset side, there's been a lot of growth. The infrastructure investment in 5G, I would say, is lagging and compounded with a strong year a year ago, a number of political factors. You had a merger between 2 large network providers this year that slowed investment. So you had a number of factors that were driving some softer investment in Telecom & Networking. And the investment in 5G has not really started yet, except for in China. And if you look at our business, we sell to all the major manufacturers of telecom base station and radio network equipment. But our China exposure is lower because the large supplier in China uses a lot of -- there's a lot of insourcing of their own power supply. So we sell to a few applications there but our share of position is not as large as it is in the other areas. So when we -- again, when we look across this portfolio overall. On balance, demand is strong. There are some puts and takes. Frankly, the diversity across the markets is something we like in the long run because these markets won't all be firing necessarily at the same time or be off at the same time. And we're seeing that now. We're able to see good, solid growth. But on balance, all of these markets being driven by the data economy, we think, are good markets to be in, and will perform over time.

Okay. Maybe sticking on, you mentioned about the political climate. There's obviously new discussions on trade, the Department of Commerce, the BIS memo on licensing requirements for equipment shipments, probably more affects your end customers. But I'd like to understand at least how you guys read the situation. Can you give us an update on any potential near-term impact of that?

Yes. It's an evolving situation, and we're studying it. Over the last year, there's been more -- between tariffs and potential restrictions, we've seen this situation evolve a lot. At the end of the day, however, as we've studied it, the impact on us, we think, is minimal for a few reasons. One is we sell very little directly into any military applications. In fact, I'd say almost 0. Second, we -- our factories are mostly in Asia. And so from a -- I'll say, a local China perspective, we're already seen as a local company and people can buy from us. And so if there's restrictions, now you come down to IP content. And at least currently, we're below any thresholds around IP content. It could affect our customers and that affect us. I think that's an open question. There's different points of view. I think if you look across the industry, some analysts who have looked at even still can view that, that could be a small -- a very small single-digit percentage impact. So at this point, at least, we don't see -- we see minimal impact, if any, on AE, but we're clearly -- we'll continue to monitor instead the situation.

Okay. Maybe just sticking with semiconductor before moving on to some of the other end markets. You obviously support a wide variety of customers. Your 2 largest customers are primarily in businesses like etch and dep, but you obviously have growing businesses and other businesses across the food chain. I guess when you think about the competitive landscape, where -- can you describe the critical areas where you're winning in these key steps? You have new product introductions recently, call it, like, called right power. Hope to get an update on your competitive -- the competitive landscape and why you guys win?

Yes. Maybe I'll ask Edwin, if you want, maybe take a cut at that and then I can add any color at the end.

Sure. So in the semiconductor space, I think there's 2 way you can look at our business. Traditionally, we are in the plasma generation power delivery system. So there will be RF and DC. In that area, we are by far the #1 player. We historically has 2x more market share than our direct competitor. And we have competitor -- we have 1 competitor in Japan, 1 in Europe, and there's also a U.S.-based competitor. All these competitors has -- shouldn't position at different customer of ours. But I think AE is in a -- we are in a much broader position in the sense that we sell to all these customer and have basically the well-established position across all the big players in the space. As you suggest though, our product in the plasma is mostly tied to etch and dep processes, right? And that's why we have been strong historically in terms of generating our revenue. That said, through a few acquisition effort into broadening beyond that, we have added a number of different products, such as high-voltage power supply and some metrology equipment, right, that allow us to broaden into other applications such as ion implant. We actually have a really large position in ion implant, high voltage, with our application like LP of e-beam thermal processes, and even e-beam inspection, we are actually pretty well-positioned around that. So as we execute this strategy, our goal is to broaden beyond our core in the plasma processes into getting a broad exposure across different type of processes in the semi space. And in general, as a result, allow us to be -- have broad exposure across NAND and DRAM and -- foundry/logics. Anything you want to add to that, Paul?

Yes. I'd just add a couple of things. So our strategy in semi is to both add content and grow share. Edwin mentioned several areas where we're adding content. Almost all the acquisitions we've done, although they've been kind of more focused at a broader set of markets, they've oftentimes brought capability that we can use in semi. And I think the most recent acquisition in Artesyn is another example of that where Artesyn products -- the Embedded Power products, are primarily auxiliary, are power supply products that provide clean, stable power to the equipment itself. We've historically not offered that type of a product in the semi market. However, now having those products in our portfolio and bringing the strong semiconductor relationships that we have, now gives us a chance to offer those products. And this is about $170 million market, which we have 0 share in. And so it's an opportunity for us. And if we could grow at 10%, 20%, 25% share over time, that's tens of millions of dollars. Interestingly enough, in this last quarter, opportunistically, we had a situation come up where one of our main customers had a vendor that couldn't deliver. And because we've made this acquisition, they reached out to us and asked, "Do you have a product that could sell into this?" And we were able to turn around very quickly, configure an existing product and opportunistically fill that demand. It was hundreds of units, not a large dollar amount, but hundreds of units. And to us, is sort of validation of the strategy and opportunity as we are, in a more focused way, looking for design and opportunities across a number of applications where the power supply is providing the auxiliary power to the equipment whereas the computer, the robot, communication devices or the machine itself. We think there's an opportunity for basically cross-selling into those markets. The second thing is from a growing share perspective and innovation perspective. You mentioned earlier our new PowerInsight product. And this is new technology that we're developing that essentially uses the data that's generated within our equipment to add more value, to either enable predictive maintenance on some of our products or even to do things like identifying opportunities for yield improvement or air control in the process itself. And we think this is very exciting. Obviously it's new. It's in kind of a pilot mode but we think this will add value to our customers and obviously to our tool. And it's a way we think we can, again, gain share and presence over time.

Yes. That was another one of my questions about the cross-selling opportunity. And that particular one was from, I'd say, parts used for other markets in the semis, but what about vice versa? I guess core AI and the other markets as well? Could you speak to the other cross-selling opportunities?

Well, I think some of those are a little longer term. But for example, we have great RF capability inside of our historical business. There's opportunities for what I'll call RF ablation applications in medical devices for a whole bunch of things. You see that starting to come. But to address those, you need sort of a lower cost embedded power product that has those RF capabilities. We think there's an opportunity to take the RF knowledge in the company historically and apply that now in a very synergistic way, with the embedded power products we've acquired and our medical position to essentially enter into some new innovative applications. Another example, we have -- given that we operate with higher power typically in AE, we have very good knowledge around thermal control and water cooling and things like that, which, again, can be applied to some of the embedded power products we've acquired for things like higher-powered, embedded power supplies that could be used for data center, telecom and networking applications. So we do see synergies, if you will, that are revenue-based, that are cross-selling-based. Because those take a little longer to either design in or develop, we haven't included any of that in our synergy model. So that's all really upside to our business over time, Bill.

Yes. Understood. Yes. And that maybe could lead into data center. I guess a lot of that, of course, was through acquired companies. But it seems like you're gaining some pretty strong share in hyperscale, especially based off the growth you guys have posted over the last few quarters. Can you speak to what's really driving the share gains? And where do you see first -- future growth from here, both from an end-market point of view as well as maybe potentially increase share or content point of view?

Yes. It's an exciting area because if we think the market trends are good, but there's also this faster investment in hyperscale. And Advanced Energy, through the Artesyn products, was kind of I'll say, a fast follower strategy in this area. And so we've been building a share position steadily over time and the investments that have made over the last 12 to 18 months are really beginning to pay off now. And maybe, Edwin, you'd like to talk a little bit about kind of what our -- what is our differentiation and what's driving our ability to grow share in hyperscale and a little bit more about our recent things.

Yes. So interesting thing about the hyperscale part of the data center market, right? So the hyperscale allow you to design and build your own equipment, right? And the whole process is actually interestingly very similar to our semiconductor customer. They have a longer design and technology cycle. It's typically 18-plus months for a project, right, in which they go for evaluation. And the same thing, if you think about your customer perspective, after spending all this time, you don't want to apply 5 vendors, 6 vendors. Ultimately, you have a 1 or 2 vendor, right, that you really work with closely. So in case of the recent quarters, the reason why we put up those really great growth just for the guys who haven't seen it, they are data center revenue. Total data center revenue grew 70%, as in 7-0 percent, sequentially from third to the fourth quarter. And in the first quarter, it grew 11%, but we said that when that the hyperscale piece actually grew over 50% sequentially. The reason why we have that is really, like Paul suggests, it was kind of a fast-forward strategy. When we acquired Artesyn, they have already been working with the second hyperscale customer on the design, and final design come to fruition and really drive revenue and, therefore, it drove that sequential growth. In terms of trends and opportunities. We have talked about 2 large hyperscalers that we have 1 design, and it drove that kind growth. We believe there's a few other ones that we can capture. There are several other hyperscaler that we're working with right now in various stages of these 18 to 24 months design cycle. So we feel pretty good that as you look forward the next, let's say, 3 years, a number of them will materialize. In terms of the overall hyperscale trend, we frankly think that the demand is there and COVID, if anything, accelerated that demand and accelerated the use of data. It's both in terms of cloud service provider, growing the capacity as well as just the general Internet use, like the web meeting that we're doing right now, right? So I think we believe that some of these are structural change, and we've definitely seen strong demand there. So we think that there will continue growth in that market.

Yes. And I guess, it sounds like with share gains and adding layering on customers, it might make it a little hard answer. But I guess, based on your visibility today, how do you see sustainability of this business as you think about in the back half of this year and into next year?

Yes. We have talked about historically that each hyperscaler could be -- spending could be lumpy, right? Historically, they might be off-cycle a little bit or it may not be all happening at the same time. That said, I think in the near term, we definitely see an acceleration. If anything, it's not really an acceleration. We see an increase in demand, right? That has drove like the strong growth going to second quarter and beyond, right? In terms of projecting second half and kind of the super near-term quality numbers, right, it's a little hard, right, frankly I mean because it's -- demand's slower than it may have been in fact, but it's -- if demand [Technical Difficulty]

Yes. It sounds like we might have lost Edwin for a moment there. But as we look at the second half, if we -- if the economy kind of holds up a little bit, then I think these trends are strong. Question is how weak will the underlying economy get and how will that drive, ultimately, demand within our markets? I think that's very hard to gauge at this point. At the end of the day, the underlying demand drivers are good. They'll continue, but we could have some ups and downs just related to the macro forces we're seeing today with COVID-19.

Yes. Understood. And telecom -- you already kind of spoke to telecom earlier and some of it may be related to who's spending now and we know China is starting to fire, maybe the U.S. has had some delays. But at least from what you're hearing from your customers, how should we think about the ramp of your business in the telecom space?

Yes. What we said in our call is we thought it would be probably another couple of quarters for Telecom & Networking to begin to recover and start to see some of these investments. We do have good exposure across all of the major suppliers, particularly in the non-China-based suppliers. So this market, and we think, will recover. It's in a little bit of a correction cycle right now, but 5G will be a faster-growing part of the investment as it goes forward, and we're well-positioned there.

And then going to your last segment, you already spoke to some of the near-term drivers in Industrial & Medical. But I guess as we just think about the long-term growth potentials in these businesses, what makes them attractive? Why are they attractive? And what are you doing to grow in these spaces?

Yes. Great, great question, and maybe I'll start with Industrial & Medical first. Obviously medical is a very stable, I'll say, growth area. And the underlying market is growing in the mid- to high single digits. And the need for smarter medical devices and that are more distributed drive -- is going to continue to drive the need for precision power in these applications. From an industrial perspective, what -- there's power and everything. And we're not focused on commodity or low-end power. We're focused in areas where we have differentiation. And that's a large market, and particularly as we've expanded our distribution channel through the Artesyn acquisition, as we have a very configurable product portfolio. We think over time, this will be a solid growth area. Obviously, the semi and semi-related technologies, I think we're all very familiar with the growth drivers there. And then, data center. We've talked quite a bit about it, and we talked about telecom.

Wrapping up with financials. You put out an EPS target of $6.50, $2.44 in 2019. How do you bridge the gap over the next few years to get to your target earnings?

Yes. It's a really good question. We do have a comprehensive strategy to bridge that gap. And of course, Artesyn is part of it, not only just the inherent profitability that comes with the business, but the synergies that we've talked about to date. We have a long-term target of $40 million in synergies. Like I said, 8 months in, we've already identified and executed $15 million of that from an annualized basis. We're well on our way from an accretion perspective there. But if you look at the rest of our markets, we have strategies around innovation, growing share, expanding our SAM through some of the strategies and things that we've talked about. Those include a number of factors. In semiconductor, we want to expand our content and grow share. We talked about gaining share in hyperscale already quite a lot in capitalizing in telecom on the 5G migration, and then broadening our footprint in Industrial & Medical. We have technology we're bringing to the table around our new RF tech capabilities, the sort of white power concepts around some really different ways to do etch and dep processes in the future. And as we continue to drive in our broader embedded power business, higher power efficiency and density, again, we think there's opportunity to gain share. And then there's cross-selling, joint development and other things. All of these things will add to our ability to grow revenues over time. We're not counting on a big market growth to drive this. I think if you look at the overall market growth we project over this period of time, it's in the very low single digits. Not because we don't think they're good markets, but because there's some cross currents, and we're not counting on that to occur. And so if you look at those pieces, we have a step-by-step plan that we think will allow us to get to that, that $1.5 billion in revenue. And then the $6.50 per share is driven by synergies, leveraging our fixed cost structure and driving efficiency throughout the business. And a key element of that is improvements in gross margins. We think we can improve gross margins by about 500 basis points from the low to mid-30s up to over 40% through a whole series of strategies around supply chain, consolidation, more volume buying, vertical integration, utilizing some of the Artesyn operational capabilities and factory consolidation. So there's a lot of elements. They're well mapped out. It's sort of up to us to execute on, but we think we're off to a good start.

Great, Paul. Everyone, thanks for joining. With that, we're out of time. Good luck in -- with this, and thanks for joining us today.

Thank you very much, and thanks, everyone. Let us know if you have any follow-up questions.

Yes.