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

All right. Good morning, everybody. My name is Amanda Scarnati. I'm one of the semiconductor analysts here at Citi. We're kicking off our semiconductor group this morning with Advanced Energy, one of the key component suppliers in the semi cap equipment space. I'm joined this morning by Yuval Wasserman, the CEO; Paul Oldham, the CFO; and Edwin Mok from Investor Relations. We're going to start off with just a quick overview from Yuval, then I'm going to dive into some prepared questions that I have. [Operator Instructions] With that, Yuval, I'll pass it off to you for a quick overview.

Thank you, Amanda. Good morning, everyone, and good to be with you. For those of you -- are not -- that are not familiar with Advanced Energy, Advanced Energy is a supplier of highly engineered, precision power conversion solutions for critical applications. We've been in business for almost 40 years, started the company as a key supplier of the semiconductor industry, providing power supplies that enable the critical processes to take place, processes like chemical vapor deposition or plasma-enhanced CVD, plasma etch, metal deposition. And over the years, we have expanded and grown to be really the market leader in power supplies for the semiconductor industry. Over the last 5 years, we have grown the company and expanded to adjacent market and new markets, both organically and inorganically. We have grown the company from $400 million in revenue about 5.5 years ago to practically a $1.3 billion revenue based in a run rate today. We are a supplier to the 4 major verticals for the data economy: semiconductor capital equipment, data center hyperscale, telecom networking and medical and industrial applications. Power electronics is becoming more and more critical for these verticals as the use of power, the cost of power and the criticality of power control continue to drive innovation and creativity and new solutions that enable all these verticals to perform very difficult tasks. As I said earlier, we are a market leader, have been the market leader, market share leader in semi for the last few decades. And we are practically either #1 or #2 in every vertical that we serve right now. And with that, I'll be happy to take any questions you have.

Great. Thank you, Yuval. Let's start off with the semiconductor side of the business since that seems to be the biggest focus area and one of the largest segments. So during the June Q earnings call, you mentioned that the demand environment was so strong, but there have been some lingering bottlenecks due to the COVID situation. How did bottlenecks on the semiconductor side cleared up? And are you seeing any changes in order behavior at your customers relative to what expectations would have been in a normal non-COVID environment?

The bottlenecks or the challenges that we have talked about are things that we said could happen as a result of the development or the evolution of COVID-19. When we exited Q2 and during the earnings report, we talked about the fact that we're back to almost 100% capacity in our factories. And we guided practically up for the company for Q3. We also said that the underlying demand for our products continues to be strong. In Q1 and Q2, we were constrained by capacity. As we move forward, we risk adjusted our forecast for Q3 based on the unknowns and things that we're not sure about relative to the impact of COVID-19 on our global factories. But again, as I said earlier, the underlying demand for our products continues to be strong.

And no change in how your customers are ordering relative to a normalized year? Are you seeing any sort of indications of pull-in driving demand higher? Or any indications of a slowdown in any of the markets you serve in semis?

Yes. I can't comment on our customers' behaviors right now, Amanda. All I can tell you that, as we exited Q2, we did not see any bizarre behavior and any behavior that indicated that our customers are stocking out inventory or behaving in a different way than they have in the past.

Great. And then what do you look -- or what do you view as sort of a normalized level of growth path for AE within the semiconductor industry?

We would like to continue to grow faster than the market, and we have demonstrated over the years our ability to grow faster than WFE market. The key reason for the fact that we have grown faster than the market are organic growth based on market share gains and increased content, the increase in importance of power and, with that, the unit content and the dollar content by chamber, additional content and product that we have introduced into the semi industry through some of the acquisitions we made. And going forward, we have new -- have served available market that we did not serve in the past, that is open to us, that will potentially accelerate our growth rate. And this is the auxiliary power part of the wafer fab equipment -- the semi equipment market that we can serve now with our embedded power products that came with the recent acquisition. And the growth right now that we see in the RPS, remote plasma source business, that for many years we could not serve due to IP limitations, that now we can serve because of some of the patents of incumbents were expired. And we are approaching this market right now and growing in adoption and market goal. So you can assume that we'll continue to grow faster than the markets we serve. Another example outside of semi is the data center hyperscale. We saw significant growth coming from the hyperscale application space, driven by the fact that we are gaining market share quickly. And coming from very little presence in a hyperscale market, this market share gain was translated to revenue growth. And just an example, in Q2, Q2 year-over-year, our growth rate in hyperscale was 500%.

Excellent. One last question on semiconductors for now. And I'd be remiss to not talk about the situation in China and increasing restrictions. And I know this just happened over the weekend, but the U.S. government is potentially adding restrictions on SMIC, the biggest foundry in China. Can you talk about any impacts that you've seen from either the earlier restrictions on military end users, the Huawei restrictions that were added in, or what these SMIC impacts could potentially have? And again, I understand it's early.

Definitely early. The decision has not been made yet. I think the news is that the U.S. is considering to implement those restrictions. Quickly about that, we are not the supplier with SMIC. SMIC is a fab. It's an end user. SMIC is an older technology user, and they rely on different type of tool sets. And right now, we're studying, waiting to see what happens. Our assumption, Amanda, is that between today until the election, we're going to see a lot of noise driven by the elections, practically. So we're -- we'll wait to see what -- if and what the decision is. Short term, we don't believe there's any impact on us. Going back to the previous decisions and decrees, the decision about Huawei or the 2 steps or escalation about Huawei, we did not see any impact on our business. We are a tiny, tiny supplier to Huawei on the telecom arena. And so that decision and the fact that Huawei right now sees more loss of business from western countries or western customers, which practically plays to our favor because Advanced Energy is a supplier in a telecom area. We're a supplier to the Ericssons and the Nokias and the Samsung. So in case, indeed, that Huawei is going to lose business, and western countries will move towards other suppliers, that will be beneficial to Advanced Energy. On the semiconductor front, we have not seen any impact on our business. And the one thing that is unique about our operation is that we are very global, and we have a business continuity strategy that relies on multiple factories in different countries with redundancy. So we have the ability to manufacture in China for Chinese customers and manufacture outside of China for non-Chinese customers if they want us to deliver from outside of China. Our redundancy allows us to decide, together with our customers, where we manufacture, where we ship to and from which country we ship to our customers. So this agility and nimbleness, the flexibility, allowed us in the past, and I believe can allow us in the future, to mitigate tariffs, trade wars and geopolitical decisions to a certain extent, more than companies that rely on one factory in one location.

Excellent. Switching gears over to the data center computing side of the business. And you touched on this a little bit on the hyperscale growth and the market share that you've been seeing there. But you've seen some meaningful year-over-year growth on the hyperscale side. Is this current revenue level sustainable? Or is this sort of a onetime expenditure that we should expect to see and sort of cyclicality within this business?

So it's a great question, Amanda. I want to make sure that everybody understands. The investments in data centers are very large capital equipment investments, not only capital equipment, capital investments. These are very large brick-and-mortar sites, sitting in locations that are close to electricity and close to water because of the need for cooling water. These are very large investments, long-term planning. And as such, they tend to be lumpy. So if you look at every hyperscaler or data center giant, their investments are lumpy. They invest in land, in buildings, in factory, in equipment. They start populating the building with equipment, digest the equipment. So per entity, it's lumpy. When you have multiple of entities investing in data centers, you see much less lumpiness, but you can still see nonlinear behavior in the market. The underlying demand for the cloud is undisputed, right? I mean we are going to continue to see more investment in the infrastructure, more investment in data centers as the world continue to accelerate the migration to everything Internet-based. From e-learning to working from home, to medical, telemedicine, AI, ML and everything is going to be accelerated even more as 5G is going to be more -- adopted faster. So we expect to see a continuing growth of the need for data centers and, with that, the need for hyperscale. Power is extremely critical for the data centers. And as data centers become more power hogs, especially as you go into artificial intelligence, edge computing, these applications consumes a lot of electric power. The power supplies that are sold into these applications become critical. Because if you have good efficiency of conversion from the grid to the actual servers, then there is less waste in dollars and less waste in cooling water. So the actual performance of the power supplies is translated to cost of ownership. And the asset owners are very highly motivated to make sure that the power supplies that they have, have high efficiency of conversion in addition to reliability and economical value. The performance becomes critical because it translates into cost of ownership. We expect to see the industry to continue to grow for the next few years. However, I don't believe that's going to be a straight-line up and to the right. I think it's going to be cyclical to a point but will continue to grow. We see this application space as a unique growth driver for us because we are kind of a late comer, a fast follower, if you may. And today, we serve in mass production only 3 out of the top 7 giant hyperscalers, and we are being evaluated. And our products have been tested and qualified by the rest of them. So as I look into the future, our goal is to be a key supplier to all the hyperscalers in the world because of our unique product advantage in power density and power conversion or power efficiency conversion. And as I said earlier, I believe that we may be -- are in the fourth inning in gaining more and more share across the hyperscale space. And for that reason, we saw this explosive growth in Q1 and Q2. And for that reason, we expect to continue to grow faster than the market. Now if the market will have a flat quarter or even a down quarter, we expect to do better than the market. And when the market grows, we expect to do better than the market.

Excellent. Switching over a little bit to the telecom and networking space. During the June quarter, you mentioned that this market has reached a bottom. What drove the sequential rebound in the quarter? And what macro drivers would bring this to year-over-year growth back to this vertical?

So we expected to see kind of a trough. And we talked about -- by the end of last year, we said we expect to see 1 or 2 quarters of a decline or bottom. And it was driven by multiple reasons: the fact that China invested locally using local suppliers, the merger of key telecom players in the U.S. that made everybody pause. We saw a significant politicization of 5G that put a lot of pressure on the market, especially when it comes to decision on which supplier is going to be the key supplier for the infrastructure. And we saw the world is changing relative to buying from Huawei or not buying from Huawei. All these forces continue to impact the market, and I think we saw a combination of inventory or investment decisions made recently that affected the market. And as I said earlier, we are in a very good position as a supplier, a key supplier to the non-Greater Chinese customers, which put us in a very competitive position. I expect the noise around 5G to continue. Again, it's highly politicized. Government decisions about Huawei impact the selection of suppliers. However, we have the products and the technology that will allow us to continue to serve the market. The important thing about 5G, 2 comments I'd like to make. The first one, we are really globally at the beginning of the investment in the 5G infrastructure. And I'm not talking about the 5G handheld devices. We benefit from the migration to the 5G handheld devices through our semiconductor vertical, right? When new device is being made that are 5G compatible, and they drive a new chipset, obviously, we benefit from that through the semiconductor chip industry. However, if you look at the infrastructure, we're just at the beginning. And we expect the investment in 5G or migration to 5G to continue for the next few years, granted 5G is not purely incremental to 4G LTE. We are going to see, in the market, a displacement. There's going to be decline on 4G investment and increase in 5G investments. We believe that net-net, the market will continue to grow. And as a key player in the market, our goal is to grow better than the market.

Great. And then I guess the last vertical really is the industrials market. And you have a wide array of markets served in this bucket, including medical, architectural glass, food manufacturing and various other industrial processes. Can you talk about which area here represents the biggest proportion of sales today? And where do you see the biggest opportunity for growth going forward? Obviously, medical would seem to be strong because of the COVID spending, but what is sort of the sustainability within these markets?

We don't delineate the actual -- as you said, Amanda, it's very fragmented. We're talking about thousands of customers, hundreds of applications, dozens of spaces. So it's very diversified, which is very good for us. And obviously, it's affected by the global economy. For example, investment in infrastructure such as real estate, buildings, et cetera, will impact applications like glass manufacturing and glass coating investment. I mean changes in the automotive industry won't impact our industrial coating business because there was a lot of automotive-related components that are coated with very unique, highly engineered thin films that are enabled by our power supplies. So we will most likely continue to fluctuate with these markets or these application spaces. However, there are areas that we believe will continue to grow and present for us a really large growth opportunity. And one of them is the medical equipment industry, both for diagnostic applications and therapeutical applications. We saw that in Spain at -- in Q1 and Q2, as our business grew dramatically because of the need for ventilators, the need for more diagnostic equipment. And also adjacent to medical is the medical research arena, where our power supplies are enabling application like gene sequencing, DNA analysis. And a lot of these products were in high demand as many of the world research institutions started to research the virus and working on vaccine. So as a result of that, we saw this dramatic increase. But regardless of COVID-19, we believe that the medical equipment industry is not only a good, attractive SAM for us, it fits some of the key attributes that allow us to be successful as a company. And the attributes in the medical equipment industry are not very different from the attributes you see in the semiconductor industry. It's highly engineered power supplies. Most of them are application-specific, required collaboration and development between suppliers and customers. And once these power supplies are getting designed in and approved by the FDA, then those copy exactly policy, they don't change the power supply. These attributes create very sticky relationship between suppliers and customers, very collaborative relationship. Customers are willing and ask to fund and develop R&D and new product development. And in general, the margins in these applications are higher than the average. So if you look at all these attributes, these are attributes that AE is thriving at. And for that reason, we believe that the medical equipment space is an attractive area for us. We are coming from a very small presence and growing, and we have seen very good growth over the last quarter as we reported. And we now invest in the resources, management and R&D investments to allow us to pursue the medical equipment vertical even faster.

Great. [Operator Instructions] All right. So kind of looking at these 4 different verticals, you've talked about growing faster than the market in semiconductors, in data centers and in telecom and networking. What do you view as sort of the biggest opportunity over the next 12 months? And are there any real sort of synergies between all of these different markets?