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

Good afternoon, everyone. Thank you for joining us at JPMorgan's 52nd Annual Global Technology, Media and Communications Conference. My name is Sagar Kapadia, and I'm an Executive Director in JPMorgan's Technology Investment Banking team. It's my pleasure to host the fireside chat with Advanced Energy, a leading supplier of power conversion systems for semiconductors, industrial medical, data centers and telecom and networking markets. With me today are Paul Oldham, EVP and CFO; and Edwin Mok, Vice President, Strategic Marketing and Investor Relations. We'll hand over the microphone to Paul, to read out the safe harbor statement.

Okay. So let me do that. So before we begin, I'd like to remind you that any forward-looking statements that we provide today are subject to risks and uncertainties, and you can find the detail of those risks at the SEC filings. Also, we just reported our Q1 2024 result on May 1. So we are not putting any update to our guidance.

Thank you, everyone. Maybe to kick us off, there may be a few folks here who may not be fully across your story. Can you start us off by providing a high-level overview of the business.

Sure. So Advanced Energy is a $1.7 billion leader in precision power conversion and control. We basically make advanced power supplies that convert the electricity that comes from the grid into something that's usable, stable, clean for advanced high-end applications. Within the broader power market, our served addressable market is about $10.5 billion. And we started the company, it's really focused on something called semiconductor precision or process power, where we're a leader. Essentially, our products are essential to the semiconductor manufacturing process. You can't make today semiconductors without them. But since that time, we've expanded our addressable markets. We've taken our core capabilities in precision power control and conversion. And we've moved into the industrial market, medical markets into data center and into telecom and networking markets. As you look across these markets, we're focused on applications that are highly engineered for advanced applications and again, are focused on power-related technologies. Today, about 70% of the products we sell are sole-sourced applications, and they have a very long life cycle and a log tail associated with them. And so that's a rough overview of the company and who we are and what we do.

Thank you, Paul. You released your first quarter earnings early this month. Can you give us a quick rundown on the results?

Sure. So the first quarter was a bit of a tough quarter for us. In fact, we're calling it our trough quarter through this semiconductor -- through this latest cycle. In general, our semiconductor market performed a little better than expectations. It was down from Q4, but a little bit better. But across our other markets, we saw some meaningful declines. On Industrial and Medical, we saw inventory destocking at both our customers and our distributors. In our Telecom and Networking markets, we saw the same factors. We also saw weaker results out of our customers for networking and for telecom applications. And in data center, we saw a little bit of a change and timing of expectations where we saw one order that we expected in Q1 moved to the right in the year. So it was a tough quarter. Directionally, we expected to see revenues lower, but they were a bit worse than we thought.

Thank you for that. And in your earnings presentation, you spoke about rebound in Q2. Would you mind elaborating a bit on that?

Sure. So we think that the first quarter was the trough quarter for the company. And when we look across the markets, we do see signs of improvement. First, within the data center market, we're clearly seeing a recovery in that market, driven by investments for AI. Essentially, what's happening is a lot of the large investments that you've heard about from Internet companies and from enterprise companies are now starting to get into the supply chain, and we're starting to see strong demand across multiple customers for power supplies that are going into AI applications. So we expect a strong rebound in the second quarter, driven primarily by the data center market. Our other markets, we think will be about flat in the second quarter as they trade kind of sideways. And as you look through the balance of the year, we do see opportunities for those to improve over the course of the year.

And what are the early signs of improvements you are seeing in your respective markets?

So there's a variety of things. The first is in the semiconductor market, we do expect to see revenues increase in the second half versus the first half. That's driven by some investments that sort of start with high bandwidth memory and a little bit of memory investment that's coming. I think we're pretty much in line with what our customers are talking about. Overall, 2024 will still be a transition year, but we are seeing improvements in the semi market. We're also seeing a little bit of improved utilization. So we saw a quite good quarter in the first quarter for our service business, and we expect that to increase again in the second quarter. In the Industrial and Medical markets, maybe I'll first start with medical, we're beginning to see already some higher orders for medical that are starting to fill in some activity in the second half of the year. Industrial is a little less clear. They were impacted pretty significantly by the recent supply chain shortages. They were the last industry to recover from that, and they took quite a lot of product last year. Being the last to recover, they're also dealing with some pretty significant inventory destocking. And as we look at that, we think that, that largely recovers over about a 4- to 5-quarter time frame. That started late last year. And so we think by late this year, we'll start to see those inventory destocking normalize and orders start to improve. We're also seeing a number of design win opportunities, which we think have opportunity to ship in the second half of the year as well.

And maybe my natural next question is, for each of your 4 markets you just discussed, can you provide outlook for the remaining of the year?

Yes, I think I generally covered it. Semi should be up slightly first -- second half to first half. We think Industrial and Medical trades flat here for a couple of quarters, but towards the end of the year, the inventory destocking should normalize, and we should see that market pick up towards the end of the year. Medical, I think, will recover a little bit faster. I think we'll see half-on-half growth in medical based on our earlier comments. The one area we don't expect much improvement is in the Telecom and Networking area. The combination of a much softer networking and telecom environments, combined with the inventory destocking there, we think we'll sort of stay around these levels for the balance of the year, and perhaps next year we start to see things improve. I think as we look forward into 2025, however, I think we feel quite good about the status of the markets. The semiconductor market, we expect to see some recovery, driven by adoption of 2-nanometer and other next-generation technologies, some recovery in memory starting with DRAM, and continued solid spending in trailing-edge nodes. Industrial and Medical, as I mentioned, it's a matter of time. These are good markets. They're broad-based. We have a good position in the markets and those should recover. In addition, we have a number of new design wins and put a lot of effort into the channel and expansion to increase our reach. And we're seeing a good design win pipeline there, which should also help our growth. And then finally, Telecom and Networking, we don't expect much. Now data center and computing, we talked about it recovering in the second quarter. We do see broad-based orders from multiple customers and applications across both hyperscale and enterprise. And we expect that the second half will be higher than the second quarter. So while we're seeing a nice rebound in Q2, we expect that business to actually strengthen through the end of the year. And we'd expect that investment trend to historically last 4 to 5 quarters. We don't know with AI. Obviously, there's a lot of money going into it AI right now. I don't know if we'll see a sort of a super cycle relative to AI here, but we're certainly seeing stronger orders throughout the year and probably into early next year.

Let's talk about semiconductors. You did beat Q1 guidance. It was still lower than the prior quarter. Would you mind providing a little bit more context around that?

Edwin, maybe you want to talk a little bit more about the specific dynamics in semiconductor.

Sure. Yes, I can. So in semiconductor, the industry is actually going through a downturn. Now this is a mild downturn than what we have seen before, but it's going through a downturn. In the first quarter, what we have guided coming into the quarter is that we saw some of our customers seeing slightly lower demand to the trailing-edge side of the market, and that's kind of played out the way we thought it would happen in the first quarter. However, incrementally, as Paul suggested, our services actually did better than we had expected. So that provided some buffer to that weaker demand, and that's what we saw in Q1.

That's helpful. And what are your views on AE outpacing WFE in 2024?

I'll start. Maybe you can give us some more color. So I think there's a couple of things. One, we've historically outperformed WFE because where we play, which is in the chamber and with power, tends to have higher content. The investment in edge is a little bit higher, we expect that to continue. And if you look back over 10 years, we've significantly outgrown WFE. And then the last 2 or 3 years, while the market's been in a downturn, we actually declined less. So we performed actually quite well. We'd expect those trends to continue for a few reasons. One is we think we continue to play in the right spot of the market. Two, we have a significant number of new products and new platforms coming, which we think will allow us to grow share, not only in the edge market, but in some other parts of the market where we play, including the remote plasma source and high voltage. So those are the primary reasons why we think we can continue to grow faster than the market.

And are you seeing any inventory rebalancing at your semiconductor customers?

I think in semiconductor, the inventories are relatively stable. Now some customers are a little higher versus others. But I think, in general, semiconductor were the first ones to get parts coming out of the supply downturn and the inventories are largely normalized. Now for us, the inventory normalization process was pretty mild this time compared to historical levels and compared to our peers. So we actually substantially outperformed our peers last year because, for us, the inventory rebalancing was much less severe. So in general, I think the semiconductor demand is pretty well aligned to kind of the market demand.

And in your earnings call, you spoke about eVoS and eVerest design wins. Can you specify what type of applications that's related to?

Yes, this is a really exciting area for the company because I think it really lays the foundation for the next half a decade. So I'm going to ask Edwin to give a little more color on what these platforms are, and what the new design wins we've seen, not design wins yet, but the early qualification activity that we've seen.

Yes. So a little less than a year ago during SEMICON in July last year, we announced 2 new plasma generating platforms called eVoS and eVerest. These are new approach into how to deliver plasma into a plasma chamber. And we have seen very strong customer uptake for these platforms. In the recent earnings call, we actually talked about securing their initial design win for these as well as having already shipped 50 units to our customer, with the plans to ship another 150 towards the end of the year. This is a very strong level of uptake relative to historically 2 to 3x more than what we typically see for a new platform launch at this point under the platform launch cycle. So why are we seeing such strong pull from our customer? Number one, we believe we have a few technical advantage. Specifically, we have much higher efficiency. In some cases, we believe it's as -- we consume as little as 50% lower energy than the current approach. Second thing is we have the most advanced technologies needed to generate plasma processes, specifically on pulsing as well as very fast RF response time. So we believe this technical advantage allow our customers to really develop process for the next-generation 2-nanometer process or for the extremely deep NAND layer, the next-generation NAND stack or even next-generation DRAM. So our product is seeing a strong pull because we believe our customer is getting ready to target for the next [ new RAM ], which come as early as 2025. And we're seeing strong demand for that. So we feel pretty good about the progress we have made, and we feel confident that these products could enable us to gain share as we go through next technology induction in the industry.

And when you expect to generate meaningful revenues from these systems?

Yes, I think in terms of revenue, typically, from launch to actual meaningful revenue is around a 3-year cycle for us because we need to win at our OEM customer, they need to win at the fab level and the fab has decided to ramp the next technology node. So typically, that's around a 3-year time cycle. As I said, we launched our product last July. And we felt that the pull is stronger than what we had historically seen. So we still believe that by second half of '25, we will start to see revenue ramp up of these products, sending us for a very strong second half of the decade.

I think there's one other important factor at these products, which maybe is more an internal factor. Now these products are built on a standard modular platform for software and for some hardware. What that allows us to do is to modify them much more quickly than we've been able to do historically. In fact, we've said that the time to do modifications or derivatives for these products is 3 to 5x faster than it would normally take. That means we're dramatically reducing the turnaround time as our customers go through qualification changes that they have to make or adaptations they're making to their specific process. This means it's either much faster and/or we're able to deploy against many more applications simultaneously, which is one reason why I think we're seeing more pull as we're able to address a number of different applications at once because we're much more efficient in being able to tailor these products to the exact configurations or the process requirements as our customers go through these steps.

Let's move on to your second end market, Industrial and Medical. It seems that you did miss your Q1 expectations. Can you elaborate and provide a little bit more context around that?

Yes. I think the biggest factor impacting Industrial and Medical is that, as I said, it's kind of more the macro factor of this, kind of the recovery from the supply chain crisis. Historically, Industrial and Medical can have some cycles associated with them. They're much more muted because it's a broader set of customers. They're across a different set of industries, some are up a little or down a little. We don't see as wide swings maybe to 10% to 15% through a cycle. But we saw much more than that this time. And as we look back at it, what we see is that lead times for Industrial and Medical products in 2022 and 2023 were upwards of 40 weeks or longer. People had orders on the books for a long period of time. And they didn't want to take those orders off the books as we were able to actually start to fill those orders largely over 2022. It was the last market to get all those products because you can imagine if you're a relatively smaller player, you're going to get the parts we have when we have them. Unlike a semiconductor who can actually move the industry to help them get the parts they need -- they need sooner. So we saw people take product pretty well through last year. We started to see some weakness in the third quarter, and we saw that being furthered in the fourth quarter, offset by some design wins we had, and we expect it to be down in Q1. But as we exited the year, what we found is that customers kept taking all that product that they put on order and then they just had enough. And we saw a pretty big change in behavior to step back. Now at the same time, lead times went from 40 weeks to 8 weeks. So you can imagine they don't have to order stuff anymore until they actually really need it. So there's a lot more window for them to absorb this product and utilize it. So that's the biggest thing that happened. It was bigger than we thought. The biggest miss we saw in the first quarter though was in Telecom and Networking, which had the same dynamics occur with it, only with a much softer market environment as a backdrop.

And just an extension to that -- those comments, what are you seeing in terms of demand and inventory levels at OEMs and distribution?

Do you want to take a cut at that one, Edwin?

Sure. Yes, no problem at all. So in our Industrial and Medical business, we have around 45% of them sell-through distribution, 55% through direct to our customer. What we have seen, at least when we talk to our distributor, what we found is that they have obviously more inventory than they need from us. As a result, we have seen our sell-through dropping below their -- sorry, we have seen our sell-in to those distributor drop below the sell-through of those distributors. We have started to see that in the fourth quarter of last year. As Paul suggests, we are seeing an inventory reduction at the distributor as well as at the OEM level result in further reduction in inventory by taking less from us and at a level that is below the sell-through. That said, our conversation with our distributor as well as with the OEM would suggest that the demand level has not dramatically falling off the cliff. In fact, demand level is relatively stable It's more because of the inventory level that they have on hand. We are seeing similar trends in the OEM side as well. This is why we believe that it will take some time for them to work through the inventory, but given that it started as early as late Q3 into Q4, it's been already 2, 3 quarters into this process. And that give us some confidence that, that will work through the process throughout the rest of the year. And sometime in the second half, we will start to have this balance between sell-in and sell-through allow us to -- our business to start to recover.