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

Good afternoon, and welcome to the third day of JPMorgan's 49th Annual TMC Conference. Really pleased to have the management team here from Advanced Energy. We have Steve Kelley, the CEO; Paul Oldham, the CFO; and Edwin Mok, who's in the IR, and there's a number of things there. Thanks for joining us today. I've asked you to prepare to give some introductory comments, and then we'll move on to Q&A. [Operator Instructions] Finally, there's a poll that you can see that has some questions on moving to potentially doing this [ concert ], face-to-face again, something I personally look forward to and hope to see everyone face-to-face. So if you want to click that poll, that would be great. So with that, I'm going to pass it over again. Thanks for coming, and over to you, Steve.

Thanks, Bill. Good afternoon, everyone, and thank you for your interest in Advanced Energy. Before I begin, just a reminder that any forward-looking statements that we make today are subject to risks and uncertainties. You can find a complete list of those risks and uncertainties in our SEC filings. So first, just a word on what we do. What we do is provide a highly engineered power solutions for our customers' most critical applications. So our advanced power supplies and related products convert electrical power from the grid into precision power for a variety of applications. A little bit about our markets. So within the broader power conversion market, we serve the higher-end precision power segment. That represents a combined SAM of roughly $9 billion. And many of you may know of Advanced Energy as the leader in process power for the semiconductor equipment market. That's what we've been doing for the past 40 years. Recently though, we expanded into new markets, both organically and inorganically, and we have become a leading supplier to customers who build equipment for industrial, medical, telecom, networking and data center applications. So we've broadened our market reach. So we are uniquely positioned to deliver growth and shareholder value-based upon our power-centric strategy, the growth rate of our target markets, our innovative culture and our demonstrated ability to make acquisitions, which strengthen the company. The core of our strategy is pure-play power leadership. And our expertise in power means that customers turn to Advanced Energy to solve their most challenging power delivery issues. While the markets we serve require more sophisticated power delivery systems for each succeeding generation of equipment, that's good news for Advanced Energy. In general, the customers want to improve power efficiency, increase their power density and enhance system reliability. We have a solid track record of growing faster than the growth rate of our target markets. This is partially due to increasing power content within each of the target markets, and it's partially due to market share gains of Advanced Energy. Finally, as we have demonstrated, we are accelerating revenue and earnings growth while delivering top-tier return on invested capital. We believe this represents a true value creation and return for our shareholders. Finally, a comment on recent revenue performance. 2020 was a record year for the company. We grew revenues to over $1.4 billion, and more than doubled earnings. We are off to a very good start in 2021, with strong demand across all of our markets. In the first quarter, we set another quarterly record for sales into the semiconductor market. And while we're facing some supply chain issues in the near term, we believe that the strong demand we're seeing validates our strategies and sets us up for growth in the second half of this year. So with that, we'll take some questions.

Yes. Thanks for that overview, Steve. And maybe before getting into the constraints in the various segments of the business. It's been over 2 months since you joined the team. Can you share with us what attracted you to come to Advanced Energy? And what's your impression, thus far, of the company is?

Yes. I think the first factor was looking at their position in the market. And I think Advanced Energy has a very strong position in some key markets like semiconductors, like industrial, medical, telecom, networking and data center. And so it's a good starting point. Secondly, the strategy. I think the strategy was a good one, and it's a 2-pronged strategy. First is organic growth and the second is inorganic growth. So the company is proceeding aggressively on both fronts, essentially. And third, I think, is the people. The people I met during the interview process seemed to be of like mind, so I felt comfortable joining the company. Since I joined the company, basically, it's about what I expected. I think there's definitely ways I can contribute using my experience in the semiconductor business to become more efficient from a product standpoint, product launch standpoint and basically leverage some -- some relationships I have in the semicondutor community.

Moving on to supply constraints, it's been thematic throughout our conference. It's thematic, actually, beyond some of the world of semiconductors, but your customers' customers are talking about supply constraints now moving in, in some cases, even well into 2022. Your direct customers are seeing extended lead times, maybe even beyond this year. And obviously, you talked about it as well. So a big challenge across the industry, limiting, as you mentioned, even your own ability to meet the demand. Can you give us an update on the current situation? I guess, how long should we think it's going to last for you? What actions are you taking? And I guess, has it gotten even worse since you announced earnings a few weeks back?

I think things are rolling out about how we expected when we had the earnings call a few weeks ago. We certainly have our share of challenges in the second quarter. But we've taken a number of actions, as a company, to improve our situation in the second half. So we signed a number of agreements with key integrated circuit suppliers, converting forecast into hard orders, which helps to assure supply in the second half. We have taken a look at some areas to reengineer solutions where we can't get the parts in a timely fashion. And we have weekly calls with key executives and our suppliers to continue to put forth our case, why we deserve more parts than we're getting. So I think all these issues are having some positive impact, but we anticipated most of those when we had our earnings call a few weeks ago.

Okay. And we'll get into each sort of individual market, but you talked about demand being strong across the markets. I guess at a higher level, can you provide a bit more color on the demand drivers? Again, we can go into more details. But I think one of the concerns, broadly, is are there risks for double ordering or excess ordering due to supply constraints?

Yes, we haven't seen any direct evidence of that. I think there's always a concern about double ordering these types of frothy markets, so we're definitely keeping an eye on that. I think what we've seen though, in our biggest market, which is semiconductors, there's clearly strong pull for our products. And so we don't see any double ordering there, for sure, right? I think industrial and medical, they're basically coming out of a year where things were down in 2020. And so we think the demand in industrial medical is real and getting stronger every quarter. So we're very bullish about that. I think data center computing is coming out of a digestion period, and we see extremely strong demand in the second half for data center computing. I think the only market which is not growing at the same rate would be telecom and networking. And that's largely because that market, for us, at least, is very dependent on 5G out of China -- outside of China for growth. And that's probably not going to happen in a big way until next year.

Makes sense. You did call for second half growth of around 5%, 10%, and that's being sort of paced by the supply chain. I guess, what kind of growth -- if you had unconstrained growth, what do you think you could achieve if you weren't constrained?

Yes. So the way we came up with that number, the 5% to 10% growth in the second half is we took our supply chain commitments, what we had in hand from our suppliers, and we discounted it. Because -- we discounted because of the inherent uncertainties we're seeing in the supply chain today. Every slight perturbation ends up hitting the customer. So I think if we -- if the suppliers are able to keep their commitments, we see significant upside in the second half.

I see. Okay. And of course, you're not alone in this. A lot of people have been impacted by expedited fees and other sort of costs, increased cost. Some of them will pass these on, at least in the semiconductor world, but you have these, I guess, 100 basis point impact. I guess, any more details behind this? And I guess, how long should we think about these costs incurring from here?

I can comment on that. We did guide our Q2 margins down about 100 basis points. And we said the headwind we're seeing in gross margins is more like 100 to 200 basis points. So we're partially compensating for that between volumes and good mix, and in some cases, where we're able to pass along some of these costs. It's not easy. In some cases, we're expediting and doing things to get things to customers and prioritizing timeliness over cost. We don't see these higher costs, which are primarily logistics, expediting, and in some case, some select cases, actually, higher part costs as being a structural change. It's more of a transient change. It's the environment we're in. And we think it's going to last a few quarters. I think if you look at what people said, broadly, they kind of see this lasting through the end of the year, maybe a little longer. They'll get progressively better, we think, over time. And then we should be able to recover the vast majority of that. We still feel like going into next fiscal year, we should be generally on-track to getting to our 40% margin target. That's partly because some of these costs will subside and partly because some of the other synergy things we've been working around factory consolidations will conclude by the end of the year. So going forward, we're excited about where things are going. But definitely, the near-term challenge is all about getting parts and dealing with the costs that go with that.

Sure. Let's move on to some of your business segments, starting with your largest one, semiconductors, last year, accounting for 43% -- latest quarter, actually over half your revenues. We've seen a lot -- we've seen demand get incrementally stronger even from 90 days ago from the December quarter earnings to the March quarter earnings, everybody's kind of raised their outlooks. Can you share your perspective on the demand environment for your semiconductor business as it stands now?

Yes, it's the strongest demand we've ever seen, to make a long story short. And our customers are urging us to be ready for even stronger demand in the second half and into 2022. So we're taking that seriously. And we're putting in place capacity that will handle substantial increases in production.

You mentioned the supply issues. And I know a lot of these parts are sort of single source. So if you're -- one of your key edge supplier's platform, I mean that's obviously critical for them. WFE, most people are now kind of assuming well north of 20% growth, maybe up to 30% growth or so. Can Advanced Energy grow in line with that or outperforme that relative to WFE amid this environment?

Yes. I mean, if you take a look at the history, Advanced Energy has typically growing about 1.2x WFE, and we think we can maintain that performance. Now it's going to vary from quarter-to-quarter, depending on what the equipment makers are buying or selling that particular quarter. But we think over time, that's a fair target for us is to grow at 1.2x to WFE.

Sure. And I guess maybe along those lines, I mean, everybody knows this year is strong. And I think most are assuming that next year should be pretty constructive as well. But looking ahead, what are some of the key industry inflections that can drive better demand for your own products, power products and so forth in the semiconductor space?

I think the key for us is threefold. First, we want to maintain or increase our share in conductor etch. That's our area of strength, and we want to make sure we stay ahead of our competitors through innovation. There's a couple of other areas where we can gain, I think, significant share. One is dielectric etch, where we've been a relatively minor player. We have a new product called eVoS, which is a shaped waveform technology, which we think provides our customers an edge over the conventional technology in dielectric etch. And we think over the course of the next 3 to 4 years, we could gain a significant position there with this technology. And the third is the remote plasma source, where we have been a very small player because of some intellectual property issues that we dealt with for many years. So as patents have expired, we're now able to launch a new product into the market called MAXstream, and our customers are evaluating the product, which we believe has significant differentiation and better reliability than the competitive products.

I think in addition, you mentioned the plasma source. I think there's also some ability to sell cross-selling of embedded products, RF match. Can you update us on some of the other [ area ] you have ongoing in the semi space?

Yes. So we talked on the earnings call, we talked about some small but significant design wins we've been awarded in the equipment sector. So these aren't process power, like we traditionally make for the conductor etch and dielectric etch applications, but this is more conventional power sources. And so we're leveraging our relationships with these large customers who also want to reduce their supply base. And so we're hoping to be a consolidator in some of these large semi equipment makers.

We've seen a lot of more recent, let's call, bipartisan support for the CHIPS Act. And obviously, there's still more to be done, still need to get past the finish line as the Mikrons [ that you make ]. But I guess any perspective on how such a policy would impact the industry from your vantage point? Is there any direct benefit for Advanced Energy should this get passed?

Well, there should be because, obviously, there will be a lot more fabs being built as you move to a regional strategy. So we think the fact that the U.S. is going to enhance their wafer fab infrastructure is a definite positive for us. And I think you see similar efforts in other parts of the world. And I think that all should play well for Advanced Energy.

That's very exciting times among semi. Obviously, you're hoping the team was able to meet your own supply constraints and overcome those to meet this [ strong ] and sort of everybody's seen. I wanted to move on to the Industrial & Medical. You mentioned earlier that there were some pickups last year, and we saw that too in some of the companies I cover, elective surgeries kind of went away last year to a large extent. Can you provide a general outlook for Industrial & Medical? What kind of areas you're seeing in terms of recovery? And how we should think about the segment?

Well, we like Industrial & Medical. It tends to be very sticky products, sticky customers, and the margins tend to be pretty good because we customize typically standard products or configurable products for the needs of our customers. And so we sell into markets like precision thin films, medical, horticulture and a variety of industrial markets. And so for us, it's a different type of market because it's typically a lot of small to medium-sized applications, but we're able to customize and have long life cycle products. And so we like it. It just requires a slightly different strategy from a selling standpoint. And also, I intend to move more engineering resource into Industrial & Medical, so we can broaden the opportunities we address.

I guess within the segment, broadly, and maybe more specific to industrial. What parts of the business are really showing the fastest growth? And how should we think about the growth of industrial segment, over time?

Well, we think thin films is going to continue to grow very quickly, and that leverages a lot of our process power technology. We also think medical is going to grow as well, right, as these elective surgeries come back, diagnostic applications take off. There's a variety of interesting applications for us that require precision power.

Yes. No, it makes sense. So longer term, think of this as GDP-type -- GDP plus type growth, what -- how should we think about the overall growth of the segment over the longer term?

Our objective is to grow at least twice as fast as GDP growth in the Industrial & Medical segment.

Yes. Moving on to data center computing, and this is a market where we cover very closely. Almost everybody has now said we're pretty much past the digestion phase and looking forward to growth, maybe even in the current quarter and certainly in the second half of the year. You've probably actually seen a similar digestion over the last few quarters. Can you provide an update on how you're seeing this business?

Yes. Like I said on the earnings call, we saw an uptick in orders towards the end of the quarter. And what we see right now is a lot of demand in the second half. So there's certainly more demand than we can handle, and so we're scrambling to get the supply to fulfill the demand we see in our books today. So it's a very healthy second half for data center computing.

Yes, lines up well.

Yes.

You have the 48-volt transition. And I know it's limited right now, but I assume, over time, this can be a much bigger part of your business. I guess where are we in this transition? And how should we think about this over the next few years?

Well, we think it offers us an opportunity to flex our technical muscles where we talk about our ability to hit very high efficiencies for data center. 48-volts helps us there. We have a very good power density factor. We squeeze more circuitry into the smaller space. And then the third angle for us is basically system-level solutions. So we're basically trying to operate at the upper and upper middle tiers for our hyperscale customers. So we're encouraged by the transition to 48-volt.

Yes. And you talked about that in the new Tier 1. How is the progress? And, I guess, adding further customers, what -- how should we think about that progression over time?

Yes. I think we're doing pretty well. I think we came into the year with 3 solid customers, and we talked about adding 1 to 2 more this year. So we're on track for that. I think the volume will still come from the 3 customers this year. Then what we should see is volume from the 1 to 2 additional customers starting next year.

I know you had the 48-volt transition. I guess, we think of the last several years, what are the [ long-term ] trends that you data see in center computing? And then what is unique -- something where you guys can uniquely offer value to your customers?

Again, we come back to the system-level engineering. So we think that for data center customers, in particular, the power efficiency is extremely important. And so we think we could add -- through a combination of hardware innovation and software innovation, we could add some value there to get them to peak efficiencies because it translates into much lower operating costs for our customers.

You mentioned that the telecom and networking, it's -- well, there's a lot of market dynamics and, certainly, we've seen a pause in China. Some of the companies we cover, and I specifically cover are talking about investments broadening out in places like the United States and Korea and so forth. I understand you have some designs in the 5G space. First of all, can you start -- what do you sell in this market? And I guess, when do you see a ramp-up in 5G investments, especially for you guys?

Yes. So our exposure to 5G is largely outside China. So we're selling into those markets. So we don't expect much in the way of volume increases until next year, although we are seeing some signs of life this year in the U.S. as Verizon starts to install 5G infrastructure. So there's some positive signs. But I think really next year is when that should start to take off in a big way, outside China.

I guess in the first quarter, you saw a step down in revenue due to the portfolio optimization. I guess, is the impact of telecom and networking kind of behind us at this stage? I guess, how do we think about the growth from here?

Yes, broadly speaking, we did take a number of actions to optimize the portfolio over the last year. A lot of that impact kind of got illustrated at the end of the year as customers either bought ahead under old contracts or pricing. And now we've kind of reset to a new level. So we've said that telecom and network in Q1 results reflect kind of a new baseline about the portfolio we have going forward, and that growth is 5G infrastructure. When it starts to come in, we'll see growth from there.

Yes. I guess, also just taking a step back, I mean, you now -- you've seen kind of all the businesses and some of the nuances. But I know you have the aspirational goals and the targets and so forth. Steve, have you implemented any change to the corporate strategy? Any realignment of priorities based on what you've seen? It's a very dynamic industry. There's a lot of changes even in the last few months, right? Any changes to the goals that were announced last year?

No. No, I made no changes to the strategy of the goals. Now some of the things we're doing within the businesses, we're making adjustments to try to get more efficient and to try to get new -- more new products out the door essentially. So we have some really good engineers and scientists at Advanced Energy, and we want to make sure we're making the best use of those people and their talent.

Obviously, you're amid a very strong semiconductor demand environment, and we'll see how it kind of plays out over a multiyear period. But I guess at a high level, seeing -- how you see each of the growth of the various businesses. How do you see the mix sort of changing over the next several years between the various segments?

I think semiconductor is going to stay strong for quite some time. I think it's still going to be cyclical, but I think if you look at the -- if look at the curve, over time, I think the growth rate is going to increase relative to where it was the last 5 years. So that's very positive for Advanced Energy. I think what you'll see as far as the rest of the business, you're going to see industrial medical start to grow faster as we put more resources into that business, and we like it because it tends to average up our gross margin. And I think you'll see telecom and networking grow because of largely 5G outside of China. And then finally, on data center computing, I think we'll have a variety of customers and applications that we're selling into. And we could use that business strategically. It helps to make us more efficient. It's high volume. It fills our factories and it absorbs fixed costs. In many cases, it drives technology. So that's why we're attracted to that business.

Yes, it makes sense. At the Analyst Day, the company set a new 3-year aspirational model. You obviously say that it's well aligned with your thinking to reach $1.65 billion of revenue, [$50] in non-GAAP EPS as well as a longer-term sort of 6 to 8-year vision of achieving $2.5 billion of revenue and $12 in EPS. I guess at this stage, what do you see as the biggest risks to achieving such goals as well as the long-term vision? And conversely, what could drive upside to those targets?

Yes. I mean, as I look at the company after 90 days, I think those targets are achievable. My job is to blow past the targets, essentially. That's why I was hired. And so I look at the upsides and our ability to continue to use technology across the company, right? The engineering groups across the company, whether they're in Asia or in the U.S. or in Europe, they're cooperating very well, and we're becoming more efficient, I think, every quarter as we reuse technologies from other groups. So I think that increases our power as a supplier to our customers and increase our ability to grow the company.

Just coming back to gross margins, and you spoke to it earlier. You had a higher materials cost, freight cost. Just a clarification. So does it push out the goals to sometime in 2022? Or how do you think about that exiting this year?

Yes. If you look at the goal we set originally, we talked about getting to 40%, 41% gross margin once our synergies have been fully implemented. If you look at the original plan, that's actually more than a year from now. So we've been actually able to get close to that target much earlier than expected. And at this point, our view is as we exit this year, maybe going in beginning of next year, assuming the supply chain moves to a little more normalized environment and [indiscernible] subside, and we're able to complete the factory closures that we talked about that we ought to be at or approaching that run rate. So that would put us about a year ahead of schedule, overall. So that's what we're targeting. Obviously, as you mentioned, Bill, there's ebbs and flows right now in the market. It's hard -- a little bit hard to be specific around what quarter. But that's -- broadly speaking, we think we're still on or ahead of target to achieve that 40% -- that target. And look, as we continue to grow, as we continue to execute and optimize our manufacturing activities, we think we'll continue to be able to drive some upside to that.

A question coming in, I'll try to paraphrase. But I guess, what has given the team confidence to, I guess, outgrow the market in semiconductors? And this one is actually coming back to the comment about the dielectric etch. Like what are the key sort of areas of differentiation that's giving you confidence that this could be an area of outperformance?

So dielectric etch, we have a product called eVoS. And what that is, is a shaped waveform technology. And its biggest advantage is it requires much less power. So instead of 50 kilowatts or 100 kilowatts of power, you're much better than that, right? And so it means it's scalable, and it's -- it makes more sense to future generations of equipment. So we think that's the main benefit. But also, there are ancillary benefits. When you have less power that you're injecting into the chamber, there's less chance of damaging the wafer and it also is less damage to the chamber itself. So we think the technology has got legs, and we think we have a chance of really establishing a good beachhead in that area.

We have recovery equipment guys, and they introduced new tools, but sometimes it takes 2 years before it ramps, it becomes . So what is the time frame we're talking about for some of these share gains?

I think it's over the course of the next 2 to 5 years. It doesn't happen quickly. Either share gains or share losses tend to take a long time to happen in our business.

Yes. No, I just -- it makes sense. And I'm glad you mentioned that. I think sometimes, investors are -- they hear share gains, they're looking for the next quarter. And in fact, it's something that plays out over multi-years. And oftentimes depends on who's spending and what kind of customer sets are spending and so forth. So yes, that makes more sense to me. Coming back to capital allocation, any [ room to enter ], I guess, increase the dividend or increase buybacks? And I guess, along with that, how should we think about the team's inorganic growth strategies from here? What areas are you prioritizing? Where do you see the most, I guess, M&A or, let's say, markets where you see the best M&A and so forth?

Yes. From an overall allocation perspective, no change from what we said in December. And in December, we actually increased the proportion that we targeted for growth, right, moved to 70% to 75%. And although that's not a lot. I think, directionally, it's important because it underscores the importance of inorganic growth to the strategy. And I'll let Steve comment on that directionally in a minute. As it relates to the other elements, we wanted to have a balanced strategy. So we did introduce a dividend for the first time ever in our Q1, it's $0.10 per share. We've kind of targeted roughly 10% of free cash flow, and there is room to increase that, over time. And we'll look at it as we go. But we thought it was important to have a predictable way to return capital to shareholders, and it demonstrates our confidence in the future as we look at the company. And then we have had, historically, an opportunistic share repurchase plan that's not done every quarter. We've been able to take advantage of changes in the market to be opportunistic there, and we continue to have that as part of our capital allocation. So maybe, Steve will maybe even talk a little bit about strategy and where we're focused.

Yes, I think your question, Bill, is the types of acquisitions we're looking at. I think the first criteria is we're looking at precision power companies. So people have technologies that are complementary to AE and where we can exploit some synergies between the 2 companies. So power is where we're looking. Next step is what markets are selling into? And obviously, we have a bias towards semiconductor, Industrial & Medical. So those are the first markets we'd like to bulk up. on. And thirdly, we're looking at the types of products they make. We like proprietary products. We like close customer relationships, and we like strong technical teams. And the way we go about this is we have a funnel of potential targets. They're small, medium, large companies, and we try to develop relationships with those companies well in advance. So when they choose to sell, we're viewed as a preferred buyer, essentially. And so that's the process we've used in the past. That's the process we're using today, and I think it's a good way to do it.

Yes. I had another question on semis. This is, I guess, it's a little bit longer ranging. We've seen -- well, you've seen like your customers' customers put out even like 10-year targets, 5-year targets, your -- some of your direct customers have talked about well over $100 billion in WFE in the not-too-distant future. I guess, obviously, everyone is concerned about the near-term supply constraints. But if you assume sort of $100 billion, $120 billion type of WFE numbers, do you get a capacity for that? Or I guess, how much revenue could your current capacity support?

Yes. Well, first of all, on the supply constraints, I know we spend a lot of time talking about them, but we do ultimately view those as transitory, right? I think we'll put it behind us at some point in the not-too-distant future. I think when you talk about capacity, for us, it's pretty inexpensive to add capacity. It's not like we're building a wafer fab. We're building boxes and there's some surface mount technology that we employ. But it's really pretty straightforward for us to add capacity. If I take a look at our factory footprint today, we have factories, 2 factories in the Philippines, 1 in Malaysia, 1 in China. We have plenty of room to expand in those 4 factories. And if we were in other room, we could easily add on to those factories. So for me, that's not a big concern. I think we'll have the capacity to grow with our customers.

Sure. We're just about out of time. I guess maybe passing over to you for just any sort of final closing thoughts as we end the fireside chat.

Well, Edwin or Paul, did we miss anything on the presentation today?

I think we covered all the key points. Thanks for the great questions, Bill.

Bill, I appreciate your time very much today. And to the audience, thank you for listening.

Yes. We appreciate your time, too. So thanks again for joining, and we'll look forward to catching and watching the team's -- catching up soon and watching the team's progress. Thank you.

Okay. Thank you very much, Bill. Bye-bye.

Good bye.