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

All right. Good afternoon. Thank you for joining us. My name is Ariel Granoff. I'm a Managing Director in the JPMorgan Tech Investment Banking team. And it's my pleasure to host this fireside chat today with Advanced Energy. With us today, we have Steve Kelley, President and CEO; and Paul Oldham, CFO; and Edwin Mok as well, Investor Relations. But before we begin, Paul is going to do the requisite safe harbor comment.

Yes. Thanks, Ariel. It's great to be here with everyone. Just a reminder that any statements we make today are subject to a number of risk factors, and you can read about those risk factors in our SEC statements. Also, we had our earnings release back on May 1, at which point we gave guidance, and we will not be providing any updates to guidance today.

Great. Thank you. All right. So for members in the room but also on the webcast, who may be less familiar with the Advanced Energy story, can we just start off with a quick overview of the business, your product portfolio and your customer base?

Yes. Advanced Energy is a 42-year-old company. We're located in Denver, Colorado, but we have operations around the world. Our business is supplying Advanced Power delivery systems to demanding customers. So our core business was in the semiconductor equipment area, and that's how we started the company, basically delivering pulse power to plasma chamber makers, like Applied Materials and Lam. Over time, we've made various acquisitions and built up additional businesses to our semiconductor business. The 2 biggest have been industrial and medical. We're also involved in data center computing, telecom and networking.

Just to also get recent performance out of the way, since it's on everyone's mind, can you just give us a quick update on the first quarter and how -- anything you can say on how the second quarter is tracking?

Yes, it was a solid quarter for us, Ariel. We were able to beat our guidance on both revenue and earnings. The semiconductor market was down kind of exactly like what we thought it would be. Overall, we expect that market to be down again in the second quarter, which is very consistent with what we thought back late in the calendar year last year. At the same time, our diversification strategy is working. Our Industrial & Medical products had a record quarter. So that was very good to see. And then we were kind of mixed between our Data Center and Telecom & Networking area. So all in all, it was a very solid quarter in a down market. Of course, we -- our goal this year is to perform better than we have in previous down cycles and to perform better in our markets, and I think we're right off on track to that after the first quarter.

That's great. Just on semis, I think on a lot of people's minds right now is when will the semi cycle kind of trough out. So why is it exactly maybe you expect second quarter to be your trough? And then what indicators will you be looking at to determine if we've really reached that trough? Is there anything that can tell us that we're coming out of it?

Yes. So what we said in our last earnings call was we expected Q2 to be our trough. And that's based on what we see from our customers, specifically their forecast in the second half. And so we think the second half will be roughly equivalent to the first half or better than the first half based on what we see in the backlog in our forecast. So we don't see a strong recovery, but we just see a slow recovery in the semiconductor market that should continue into 2024.

So outside of semi, you're targeting kind of stable revenue this year. So what are the -- you have these very kind of diverse end markets? What are the different puts and takes for those other end markets?

Yes. So we said, basically, if you look at our company revenue last year, roughly half the revenue was into the semiconductor equipment market and that's the part that's going down this year. The other half is in our other markets, industrial, medical, telecom, networking and data center. And we think in aggregate, those other markets, non-semiconductor markets will be roughly flat year-on-year. But there's a lot of variation from market to market. But overall, we're happy with the flat forecast. What also helps us in those other markets is we still have substantial delinquent backlog that we expect to ship in the coming months as the final parts shortages are solved. We've been dealing with part shortages now for 2 years. And I think we're at the end of the road. But we think as we get these additional scarce parts into our inventory, we'll be able to ship completed boxes to our customers very quickly.

You mentioned industrial and medical. That's an area you guys have been really interested in as a growth driver for the business. What are some kind of near- and longer-term growth drivers for that end market?

Yes. The nice thing about industrial and medical is it's a very broad market. If you look at our customer base today, it's roughly 15,000 customers. And we address some of those customers directly but many we go through distribution or through sales reps. So it's a very broad market. And we have products that satisfy the needs of very many different subsegments in that market. And so because we put focus on it, the past couple of years, we're figuring out exactly where our products fit. And so we've profiled these various applications, which range from horticulture, the test and measurement to fast charging EV applications. And where we've been successful, we profiled those successes and use those successes to help our salespeople in other regions try to replicate those successes at similar customers. And that program is working very well for us.

Okay. All right. If we can turn to some kind of hot topic issues. One of your large competitors recently had a significant cyber attack. Has that been a positive event for you? And how have you even gone about thinking about how to protect your own systems?

Yes. I think that cyber attack incident was a negative for the industry. It seems that we're recovering now from it. But it certainly shined a spotlight on our defense strategy in cyberspace. And so we spent a lot of money over the years building our defenses in that area. And obviously, we've had a lot of conversations with customers not just in the semi equipment space, but other major customers for Advanced Energy, where this has become a top 3 issue for those customers. And I think that they see our strategy as a positive for the company. So we think it helps us moving forward.

Okay. And another one that I feel like everyone is always asking about, the U.S. export controls China. Can you talk a little bit about have you been able to ship to customers in China? What has happened to orders you had to remove.

Yes. So the export controls apply to the advanced fabs in China. And so when those new rules were promulgated in October of last year, we immediately stopped shipping into plasma power customers in China. And over the last, let's say, 6 months, we think we've developed a protocol where we can be assured that when we ship our boxes into China, they end up in the appropriate fabs and not in the leading edge fabs. So we're working very closely with our customers in China to make this happen. It's important to realize, however, that China does not represent a significant part of our revenue. It's in the low single-digit percentage of our total revenue. And so we're making some incremental shipments into China. But our first priority is compliance with the export control regulations. The second priority is revenue.

On the positive side, you have U.S. and European CHIPS Act. Is it too early to kind of tell how those will impact your business? Or do you have a view?

Yes. Our view is the CHIPS Act in the U.S. and what's happening in Europe and Japan and Korea is going to be a net positive for the industry. So it's good for our customers, in particular. We don't expect to benefit directly from those subsidies and grants. But we're going to benefit indirectly because as our customers ship into these geographies, they're going to need to buy more for Advanced Energy. So that's a good thing for us.

All right. Back to first quarter, a lot of companies were obviously facing [ reductions in ] orders, backlog, et cetera. Your backlog last year ran up to $1.2 billion. It's come down a little bit over the last few quarters. Can you give us a little bit more -- just color on what drove those declines?

Sure. Typically, Ariel, we don't carry a lot of backlog in our business because our lead times are sort of in the 12- to 18-week time frame. And many of our customers actually buy off their own floor through some kind of a [indiscernible] arrangement or a hub arrangement. What we saw the last 1.5 years is with the supply shortages, we saw that really shift, a lot more direct orders, a lot more orders placed out in time because of lead times. And we expected that as supply chain improved, we'd start to see our backlog contract somewhat. And that's what's happened. About half of that backlog, contraction from its peak is us actually filling delinquent orders. And a portion of it is actually customers just moving back towards a more normalized order pattern. We peaked out about $1.1 billion in backlog. We're a little under $800 million today. And we expect that the normalized range is in the $400 million to $500 million range, and we'll probably get there in the next 2 to 3 quarters. That will continue to be a little bit of a buffer for us as that backlog comes down, we're able to fill those delinquencies. But in the long run, we think it's a more healthy range once we get to a more normalized level. I'll tell you the backlog is very healthy. Over 80% of it is our semiconductor and industrial and medical customers. It's largely shippable or with the customer request states within the next 6 months. And we haven't seen any cancellations over this period of time. It's really been more like not placing orders at the longer lead times as the backlogs come down.

Got it. So you view it as very sustainable and durable. It's not -- none of that production is really just driven by more macro trends.

I think there are the macro trends that orders -- customers are changing their order patterns. And there's certainly some lower demand. I mean semi demand is definitely down. But it's -- I think the backlog that's there is solid, and we'll continue to take advantage of that until we get to a more normalized level.

You referred to some supply chain issues. Can you talk a little bit more about how that's alleviated since the last time we were here.

Yes. So a lot's happened in the past year. I'd say, overall, the supply chain issues have ebbed to a considerable extent. However, we still have issues. And most of those issues are set up in power [ MOSFETs ], some analog ICs, particularly power analog ICs and then we still have some issues with microcontrollers. So while the list has gotten considerably shorter, those problems are still there and they're still constraining our shipments into the data center and computing market, telecom, networking, industrial, medical markets. We do think, however, given current trends, that we should see most of our supply chain issues abate by the end of this year.

So besides just general improvement in the supply chain, are you doing any more kind of alternative qualification redesign?

Yes. We did a lot of alternative qualifications redesigns over the past 2 years. And we've been fortunate that our customers have been very cooperative and worked closely with us on these qualifications. So we really appreciate that. It's really brought us closer together to our customers as we work to solve the supply chain issues. I think over the course of the last 2 years, we've also been able to clarify our supply chain strategy, become more aware of our good suppliers and our suppliers who didn't quite measure up during these periods of supply chain constraints. And so we're definitely steering more business towards the suppliers who support us well during the shortage period. So I think we'll come out of this much stronger from a supply chain standpoint.

Any other notable kind of steps you've taken to improve operations over the last couple of years?

Yes. Yes. I think the biggest move was to bring in a new supply chain and operations leader with a lot of experience in the semiconductor industry. He came to us from NXP and prior to that, TI. And he's got a strong focus on quality and a strong focus on efficiency. And those are the 2 things that matter most for Advanced Energy. We're a high-mix, low-volume type of manufacturing company. It's our ability to satisfy the needs of higher-end customers is critically important to our success. And that really helped us out last year in 2022, where we're able to, I think, outperform our competition, both on the supply chain side and the operations side. So we see it long term as a competitive differentiator in addition to our technology leadership.

One thing that we actually spoke about when we were here last year was your Shenzhen exit. How has that ultimately impacted your business?

Yes. We exited Shenzhen in December of last year, and it had 0 impact on our business. We had transferred all of that business to our Malaysia facility in Penang. And so customers didn't see any issue at all when we exited Shenzhen. Our China strategy is to basically limit our footprint in China, our factory footprint. So we announced the closure of a second factory, small factory that we inherited as part of the SL Power acquisition, and that will happen later this year. And then we'll be left with one factory, which was part of the Artesyn acquisition. We expect over the next 2 to 3 years that, that will shrink and become more of a China for China type operation. So there's a strong desire from many of our customers in U.S. and in Europe to move manufacturing outside China to limit their risks.

We actually got a question for the webcast that sort of as an output of all these different changes you're talking about, Paul, this is probably for you. Can you talk a little bit about your gross margin cadence for '23? And how quickly can you reach pre-pandemic gross margin levels?

Sure. It's a really good question. We continue to have overhang from the higher material premiums that we've been paying. That did start to abate a bit in the first quarter. We talked about that. It helped us to actually keep gross margins about flat even though volumes were down a lot. We think that will continue to improve over the course of the year, but it will be slow. Part of the reason it's slow is the premiums have to abate and then it has to roll through our inventory. So it will improve over the course of the year but slowly. Also, over the course of the year, we'll continue to make improvements in our own operations. Steve referenced the closure of another one of our sites. We're looking at our overall factory footprint and other efficiency improvements that we can make. Those will also occur over the course of this year, which should -- those 2 things principally should position us well as we go into 2024 and see some volume improvements to see a pretty good gross margin tailwind moving into 2024. So we're pretty excited about that opportunity. This year will be a transition year with the downturn in the market, it's been an opportunity for us to continue to improve our own operations, improve the efficiency and hopefully put some of these higher material costs behind us. The last thing I would mention relative to this year is that it's a great opportunity to introduce new products. And as we go into the 2024 and beyond, we should have a number of new products that will also help us over time to improve our gross margins.

It's actually good -- it's a good segue. I think a lot of people have just been taking the attitude of we kind of have to get through this year. And everything will be better in '24, but you guys have taken the opportunity to launch a number of new products. Do you mind talking about those for a moment?

Yes. I mean we see this as potentially one of the best years in our history, 2023 because, quite frankly, over the past 2 years, most of our customers in Advanced Energy, we're focused on these [ recalls ] and alternative [indiscernible] and redesigns and so forth just hustling to meet the demand that was right in front of us. This year is different. The difference is that our customers are out of that mode and they're hungry for new technology so that they could differentiate and gain share coming out of this downturn. And so we were fortunate. In that we launched 2 new platforms into the semiconductor equipment market in the first quarter. And those platforms have been extremely well received by our customers. And so we think over this year, we're going to gain quite a few new significant design wins, which sets the table for us to gain market share in Semiconductor Equipment over the coming 5 years. On the other side of the business, we're also launching a record number of new products in power, sensing and control that have been well received. And so today, we have a design win funnel that's much better than it's ever been. So we're very optimistic that 2023 is going to be a really significant year from a new product launch and a design win perspective.