Advanced Energy Industries, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Advanced Energy Industries Third Quarter 2020 Earnings Conference Call. At this time, our participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Mr. Edwin Mock. Vice President of Strategic Marketing and Investor Relations. Thank you. Please go ahead, sir.

Thank you, operator. Good morning, everyone. Welcome to Advanced Energy's third quarter 2020 earnings conference call. With me today are Yuval Wasserman, our President and CEO, Paul Odom, our Executive Vice President and CFO, and Brian Smith, our Director of Investor Relations. If you have not seen our earnings press release, you can find it on our website at ir.advanceenergy.com. There you'll also find a slide presentation to follow along our discussion today. Before I begin, I'd like to mention that AE will be hosting a virtual investor event on Monday, December 14th. We welcome all of you to join us at this event. In addition, we will be participating at multiple investor conferences in the coming months. As events occur, we will make the announcements. Let me remind you that today's call contains four looking statements, which are subject to risks and uncertainties that could cause actual results to differ materially and are not guaranteed for future performance. Information concerning these risks and uncertainties is found in our filing for the SEC. All forward-looking statements are based on management's estimates, projections, and assumptions as of today, November 5, 2020, and the company assumes no obligation to update them. Long-term targets presented today, which include our aspirational goals and integration targets, should not be interpreted as guidance. On today's call, our financial results will be present on a non-GAAP financial basis unless otherwise specified. An explanation of our non-GAAP financial measures, as well as reconciliations between GAAP and non-GAAP measures, can be found in today's press release. With that, let me pass the call to our CEO, Yuval Wasserman. Yuval?

Thank you, Edwin. Good morning, everyone, and thank you for joining us on this call. Overall, this was an outstanding quarter for Advanced Energy with record revenues, earnings, and operating cash flow. We delivered sequential revenue growth across all of our market's verticals and recorded new quarterly highs in semiconductor, data center computing, and service. Good operating leverage and continued execution on our synergy goals resulted in gross margins approaching 40%. and non-GAAP earnings per share, up over 3x from last year, validating our financial model and demonstrating our ability to accelerate earnings growth. Overall, demand for our products continue to be strong, driven by ongoing investment in technologies associated with the data economy. Great execution by our operations and supply chain teams enabled us to catch up on COVID-related delays and respond to the burst of demand. During the quarter, we continue to ramp our Malaysia factory, which is next to one of our leading customers. As we integrate and optimize our global operational footprint, it provides us with business continuity and resiliency in meeting our customers' demand in a dynamic operating environment. In addition, we continue to execute on our integration plans, delivering synergies and record accretion from our artisan acquisition. We expect additional synergies to be realized through 2021 as we execute structural changes in our manufacturing and supply chain. Beyond cost synergies, we have started to secure new cross-selling design wins across both semiconductor and industrial end markets, and we expect those wins to drive incremental revenues in 2021. We continue to invest aggressively in R&D, which enable us to win multiple design wins across all markets, and to launch six new products across different portfolios during the quarter. These new wins and new offerings are expected to generate continued growth for AE going forward. Turning now to our products and performance by market. As I mentioned, semi-revenue was a quarterly record, growing nearly 15% sequentially and over 70% from last year. as we continue to meaningfully outperform the market and our SEMI peers. Service revenue also reached record high, driven by improved fab utilization across multiple reasons and strong demand for upgrades and retrofits. We believe process power has become one of the fastest growing subsystem segments within the SEMI equipment supply chain. As the market leader, With the broadest product portfolio and market and customer exposure, we are gaining market share with design wins for many critical processes. The combination of strong market growth and our share gains are driving our semi-revenue to grow faster than all of our semi-peers in 2020. For example, our advanced RF matching technologies are getting adopted in multiple advanced edge and deposition process tools. resulting in revenues growing over 120% year-over-year in Q3, after doubling in Q2. Our remote plasma sources revenue grew again this quarter and is on track to double in 2020, resulting in double-digit millions of dollars of incremental revenue. In Q3, we have secured a dielectric edge design win at one of the leading OEM suppliers, and in Korea, we want several designs for memory and advanced packaging deposition applications. We believe our continuing investment in product development will enable us to capture an expanded pipeline of opportunities in new and excited areas, including additional wings in dielectric etch. Looking forward, we expect semi-regulatory Q4 to remain strong. Long term, with our design wings, growing power content, and favorable market trends, we believe we are well positioned to continue to outgrow the market. Revenue from our industrial and medical markets increased by nearly 23% sequentially, driven by increased factory output to deliver on strong backlog and general improvement in the industrial markets. For example, in industrial, demand for consumer electronics coating and motion control applications improved. Revenues from medical applications remained strong, driven by continuing demand for critical care applications. Non-critical care applications also began to improve, but remained well below pre-COVID levels. this quarter we secured multiple design rings across a wide range of medical diagnostic imaging and therapeutic applications of note we want a sole source position for a next generation diagnostic lab analyzer at one of our leading medical customers and our power solution was designed into new air filtration system for preventing the spread of covet as we look forward We expect the industrial and medical markets to continue their modest recovery with revenue around current levels in Q4. Our data center computing revenue hit another quarterly record in Q3, up 5% sequentially and 91% year-over-year. Despite industry headwinds of data center digestion and a generally weak IT spending environment, New design wins and growing share have enabled us to meaningfully outgrow the market. In hyperscale, revenue was down slightly from a record quarter in Q2, but jumped 380% from last year. Revenue from a third hyperscale customer helped to offset initial digestion from our earlier wins, and we made good progress in winning new businesses from additional hyperscalers that should contribute to revenue next year. Although revenues in this market could be lumpy quarter to quarter, we remain confident in long-term market growth and our ability to outgrow the market. Demand from enterprise OEM customers recovered in Q3, partially due to our ability to deliver to customer needs and capture market share. In addition, One of our power design lanes into high performance computing platform started to ramp. We expect HPC to be a secular driver for our business going forward, given that our industry leading product power density is the ideal solution for meeting the high power, high density requirements for those server racks. Looking forward, Our data center computing revenue is expected to remain at elevated levels and well above last year's run rate. However, we anticipate digestion in the data center market to impact our revenue in Q4. We expect growth to return later in 2021, driven by additional investment in data center with the releases of new CPUs and accelerated by our share gains. Telecom and networking revenue grew over 18% sequentially, as the market improved modestly from the trough levels in the first half of 2020. Q3 revenues also benefited from some catch-up shipment from our backlog and incremental share gains. Data center networking remains a bright spot in this market as data traffic shifts from enterprises to the cloud due to remote working trends. In addition, During the quarter, we secured a critical design win in a next-generation cloud networking platform that will support revenue growth as the industry migrates to 400-gig networks. In the telecom market, overall investment remained limited. Although our mix of products sold into 5G applications has risen considerably in 2020, large-scale infrastructure investment in 5G outside of China continued to be delayed. Looking forward, Q4 revenues are expected to come in around these levels as market signals remain mixed. Long term, our efforts in winning 5G and next generation networking designs prepare us to capture the market's recovery as global 5G infrastructure investment accelerates. In summary, our Q3 results serves as a clear validation of our strategy and our business model. These strategies enable us to deliver industry leadership, revenue growth, innovation, synergies, and earnings. I'm extremely proud of our global team who have responded to the myriad challenges this year to deliver outstanding financial and operational results while ensuring a safe environment for employees. I would also like to welcome our two new board members, Anne Del Santo and Lanisha Minix, who add complementary industrial market knowledge, experience, and capability to our board. As we continue to deliver on our strategic goals, we are realizing our vision of being a leading industrial growth company with a diversified revenue base, strong growth drivers, and top-tier financial results. As we look forward, near-term we see increased risks due to the new waves of coronavirus, but longer-term, we see 2021 setting up to be a growth year for AE. Although we see some variations quarter to quarter, we expect to continue to grow our earnings driven by our momentum in semi, share gains in hyperscale, and macro recovery in industrial markets and global 5G investments, combined with our continuing efficiency gain, portfolio optimization, and synergies. We are planning an investor briefing in December to discuss our progress to date, a deeper dive into our newer markets and an update to our aspirational goals. I'd like to thank our customers, shareholders, partners, and our valued employees for your support, especially during these challenging times. I look forward to speaking with many of you in the upcoming quarter. With that, let me turn the call over to Paul.

Thank you, Yuval, and good morning. Before I begin, Please note that all financial measures presented today will be on a non-GAAP basis unless otherwise stated. Excluded from non-GAAP results are amortization, stock compensation, integration and transition costs, unrealized foreign exchange gains and losses, and restructuring items. This quarter, we recorded $5.6 million of acquisition-related costs related to the Artisan acquisition and transition. We also recorded $3.5 million in non-cash, unrealized FX losses related to long-term lease and pension liabilities. A full reconciliation from GAAP to non-GAAP measures can be found in our press release issued earlier today. As you've all mentioned, this was an exceptional quarter as we delivered record results across a wide range of financial metrics. Strong execution by our team to meet our customer requirements and increased demand for our products enabled revenue and EPS to surpass the high end of our guidance ranges. In addition, we achieved an annualized return on invested capital of over 25% and our cash balance increased by over $48 million. Perhaps most significantly, our financial performance validates our business model and demonstrates the leverage in our operation as we execute our strategy to accelerate earnings growth. Third quarter revenue was a record $390 million, up 15% from $340 million last quarter and 122% from a year ago. We saw sequentially stronger demand across all our markets and a burst of order activity at the end of the quarter that we were able to deliver to our customers' short lead time requirements. In addition, we were able to ship backlog created during early 2020 due to capacity supply constraints. reflecting roughly half of the upside to our guidance in the quarter. On a pro forma basis, including a full quarter of artisan revenue in prior periods, Q3 revenue grew 35% year-over-year. Excluding artisan, organic revenue grew 12% sequentially and 50% year-over-year to $201 million. Turning to revenue by market, sales into semiconductor in Q3 were $167 million, up nearly 15% from a strong second quarter and up 73% year-over-year with good demand across Foundry logic and memory. Revenues were up 70% on a pro forma basis. Both semi-product and service revenues were a quarterly record. Overall, we are growing faster than our peers and the overall market with sales in both RF matches and RPS more than doubling year-over-year. Revenue from our industrial and medical markets was $87 million, up 23% sequentially as a result of modest market improvement and catch-up of backlog. On a pro forma basis, revenue declined 11% year over year as a result of ongoing general weakness in several of our industrial sectors exacerbated by the COVID-19 crisis. Data center computing revenue was $88 million, up 5% from the second quarter. On a pro forma basis, sales were up 91% year-over-year, another quarterly record for the company. Hyperscale revenues declined slightly from record levels in Q2 as cloud digestion began, but was still up almost 5x from last year. Enterprise OEM revenues grew both sequentially and year-over-year, driven by share gains and increased demand from prior design wins. Telecom and networking revenue was $48 million, up over 18% sequentially. On a pro forma basis, revenues were nearly flat year over year. Non-GAAP gross margin for the quarter increased by over 100 basis points sequentially to 39.8%. Margins benefited primarily from better fixed cost absorption on higher volume, partially offset by increased other cost of sales following a favorable quarter in Q2. Importantly, we are beginning to see the benefits of our synergy actions. including portfolio optimization and cost improvements, shine through as volumes increase, validating our business model. Although gross margin is expected to decline slightly on lower volume in the coming quarter, we continue to make great progress on our goal to improve sustainable gross margins to greater than 40% as we complete our synergy and consolidation plans over the next year. Non-GAAP operating expenses were $78.9 million. of $1.1 million from last quarter, primarily due to ongoing investment in strategic R&D programs and innovation. Expense as a percentage of sales decreased by over 250 basis points versus Q2 to just over 20% of revenue, and in the top quartile of our peers. Overall, we achieved 19.5% operating margin, reflecting 45% incremental margins or operating leverage from last quarter. As a result, non-GAAP operating income improved to $76 million, up 41% sequentially, and another record for the company. Non-GAAP other expense was $2.4 million, including $1.1 million of interest expense. We expect total other expense to be in the $1.5 to $2 million range going forward. Our non-GAAP tax expense was $9.8 million, or 13.3%, primarily as a result of favorable mix of foreign earnings. and the integration of Artisan into our tax structure on a year-to-date basis. Looking forward, we now expect the GAAP and non-GAAP tax rate to be in the 15% range. Non-GAAP earnings for the quarter were a record $1.66 per share, up 41% from $1.18 last quarter on higher revenue margins. Earnings per share was up over 200% from $0.54 one year ago, demonstrating our goal of accelerating earnings growth. The artisan acquisition contributed meaningfully to our financial results. To date, we have achieved annualized synergies of over $30 million and earnings accretion over the past four quarters of over a dollar per share. In addition to achieving our phase one synergy targets ahead of schedule, we continue to find new opportunities for efficiency improvement as we integrate into a combined functional organization. Phase two of our synergy plan is well on its way. and we remain confident in meeting or exceeding our long-term targets of over $40 million of annualized synergies and over $1.50 per share in annual EPS accretion. Turning now to the balance sheet, we ended the quarter with cash and marketable securities at $431.6 million, up $48 million from Q2. Receivables increased slightly on higher sales, The DSO improved seven days to 55 days on fairly linear shipments during the quarter. Inventory decreased by $3 million, and terms were 3.7 times. Payables were $159 million, representing 61 days of DPO. Total days of networking capital were 93, down four days from last quarter. The business continues to deliver excellent cash generation. Operating cash flow from continuing operations was $67.5 million, our highest level ever. Free cash flow from continuing operations was $56 million in Q3, and year-to-date free cash flow was $110 million. Capital expenditures for the quarter were $11.8 million, and depreciation was $7.2 million. The higher than normal capex in this quarter was due to a one-time investment in facilities to support expanded capacity in our Philippine operation. Overall, we expect capital expenditures to remain about 2% to 3% of sales, in line with historical levels for advanced energy. During the quarter, we repaid $4.4 million of principal amortization on our debt, ending with total bank debt of $326.3 million. Our trailing 12-month gross debt leverage decreased to 1.34 times, well within our target range of 1 to 2 times. During the quarter, we also repurchased approximately $4.3 million of stock at an average price of $59.70 per share. Now let me turn to guidance. Overall in the fourth quarter, we expect demand to continue to be solid across our vertical markets. We expect semiconductor revenues to remain strong, with second half of 2020 growing 15% to 20% above first half levels. Revenue for data center computing applications is expected to be lower in Q4 as we see overall market and customer-specific digestion following several strong quarters and share gains. We expect demand and revenue in industrial and medical and telecom markets to remain relatively stable. Factoring in the limited visibility and ongoing operating and macroeconomic risks related to COVID, we are guiding Q4 at $360 million, plus or minus $20 million. Based on anticipated volume, mix, and ongoing COVID-related costs, we expect non-GAAP gross margins to be in the 38% to 39% range. Operating expenses are expected to be about flat. As a result, we expect non-GAAP earnings to be $1.30 per share, plus or minus 20 cents. In summary, we expect that 2020 will be a very strong year for advanced energy, as we have grown both organically and achieved our integration and financial performance goals related to the Artisan Acquisition ahead of schedule. Based on the midpoint of our guidance, second half 2020 revenue growth would be nearly 15% over first half of 2020, and full year revenue would be up 17% from 2019 on a pro forma basis. Earnings per share would be up 42% from the first half and more than double for the full year. demonstrating our goal of accelerated earnings growth. In addition, our financial performance in the third quarter illustrates that our long-term financial targets of over 40% gross margins and over 20% operating margins are achievable. Our strategy of being a pure play power provider to industrial growth markets is enabling key competitive advantages and our continued focus on improving our operations to drive further revenue growth and profitability. Looking forward, While timing of orders and market dynamics may drive some quarter-to-quarter variation, we believe overall demand for our product remains solid and 2021 is setting up to be a good growth year for AE with multiple drivers across our vehicles. With that, let's take your questions. Operator?

At this time, as a reminder, if you would like to ask a question, press star 1 on your telephone keypad. Again, that is star and the number 1 for any questions. Your first question comes from the line of Scott Graham with Rosenblatt Securities.

Hey, good morning. Nice quarter. Thanks for taking my question. Hey, Scott.

Hi, Scott.

So I have a couple. Could you talk a little bit more about the high-performance computing and calling that a secular driver, you know, this is a ramp of a win. Even if you could just give us some type of parameter for how big that is within data center computing, I guess it's important enough where you listed it on this page. So if you can maybe give us more color on that.

So I think it's a trend right now as we see migration to high-performance computing driven by increased focus on AI, artificial intelligence, machine learning, and more focus on edge computing. These applications are requiring significant amount of power. They're power hogs. And we are well positioned, and specifically in this area, because of our high efficiency of power conversion, power density, and our solution provide a competitive advantage when it comes to the actual total cost of ownership of the asset. Now, I cannot comment on the size of the market. I'd ask maybe Edwin if you have any information about the size of this market. But it's definitely a trend that will continue to grow, and we are well positioned to benefit from this growth. Edwin?

Yeah, so this particular one, we won this design on enterprise OEM who has a high-performance computing platform that they are rolling out. But I think the whole idea is that as things move forward, there are more AI or machine learning type of applications being adopted. And you hear from multiple companies talk about high-performance computing as an area that will grow, right? And as that grows, as you all suggested, those server and those systems typically come with substantially higher power, which then higher power density becomes a more critical parameter that's important for this. And that's an area that we believe we have an advantage, and that's why we're winning this lot.

Got it. That's very helpful. Thank you. Paul, one question for you.

You talked about a sort of a one-time or expected non-recurring benefit in the third quarter, the gross margin, and you said something about, I'm sorry if I'm missing this, that half of your upside in the quarter was due to something, end-of-quarter shipment or something along those lines.

Could you clarify both the gross margin and that comment as well? Yeah, sure, Scott. So on the revenue, obviously we had an outstanding quarter, even above our guidance range that we gave before. What we said on the call is about half of that upside came from catching up backlog from earlier in the year. That essentially was a result of operational supply constraints related to COVID. So that was better than we thought we could do. So we had a really good quarter, and that's why we wanted to call that out. in particular as they catch up on that backlog. Now, if you look at our backlog numbers, they were still quite strong because we were able to fill some of that in at the very end of the quarter due to the strong demand we saw. The second comment on gross margin, what we said is the sequential improvement from last quarter was largely the result of higher volume. And what it illustrates, though, is that some of the underlying improvements we've made in portfolio rationalization, as well as cost are really shining through. As you saw this quarter on a non-GAAP basis, margins are almost 40%, which is close to our goal. Even though we haven't completed kind of our phase two structural changes for around cost of sales and supply chain and some material cost savings that we think we can achieve over the next year or so. So it wasn't really any one-time item in gross margins. It's more the benefit of volume, but we're seeing we're seeing the actions we're taking underneath that really starting to come through, which gives us a lot of confidence about our ability to get to 40% gross margins over the long run as we see good volumes in the business.

One comment about the quarter is our ability to respond very quickly to changes in volume and mix, and that allows us to deliver to customers when they need it. and address this burst in demand in Q3.

Yes, thank you. One last quick one, if you don't mind.

Could you just briefly talk about, you know, you're saying that the telecom and networking market, you're expecting that to get better. I thought you said late in 21. Is that simply a push out of your customers of their 5G spending?

Is that what that is tied to, that comment? I think we said later in 2021, not late in 2021. We're basically talking about data center computing we'll be covering late in 2021. Telecom networking, we came from a trough and we see some recovery, although because of the geopolitical situation and delay in some investments in 5G infrastructure, We see some, you know, push out into, you know, next year. However, we are very excited about 5G. And to make sure that people don't misunderstand us, 5G drives growth in all of our verticals, not only in telecom network and networking. Telecom networking, the 5G products we sell in telecom networking go to the base stations and the radio towers. However, 5G in general drives increase in semiconductor devices, which drive increase in the need for semiconductor processing tools. It accelerates the migration to industrial 4.0. that also increased the need for some of our advanced solutions for medical, for industrial, for automation, et cetera. So we are extremely excited about 5G, and we believe that the world is just the beginning of the adoption of 5G, and that will continue to drive secular growth for us, for all of our verticals, not only the power supplies that go into the infrastructure. Hey, thanks for that clarification.

I appreciate it.

The next question comes from the line of Pirtosh Mitra with Beringberg.

Great. Thank you. Good morning. What is the medical component? How much is that within the industrial and medical business? And how are you looking for growth potential for the medical part of that business? Yeah. Overall, we said last quarter that our medical is about $75 million. And it's been growing. This is an area we're excited about. If you go back three or four years ago, we had virtually no presence in this market, and we've been able to grow that both through products we've acquired and organic growth. So it's an area that we see of growth going forward.

And the growth is driven both by, you know, I would say short-term need, a burst of need for critical care applications like ventilators, and also some life science, you know, equipment that goes into a gene sequencing, vaccine development and testing. Long term, we expect to see a continuation of the growth coming from the non-critical applications. And we mentioned just a few examples when we became a sole source supplier for a blood analyzer and additional applications that go to diagnostic imaging and also therapeutic applications.

Very interesting. Thanks for that color. And then within the industrial part of that business, are there any specific end markets that you think have been a drag on growth and any thoughts on when those slower growing or not growing end markets might recover?

So the beauty about the industrial market, the non-medical part, right, the industrial market, it's highly diversified. And that's the exciting thing about it because if you look at every application in the world, they could be lumpy and they could have cycles of investment because these are capital investments. So in this specific market, we see growth coming from a consumer electronic product coating, and these are tribological coating or optical coating. We see increase in need for automation and motion control. And, again, very broad. And you should expect to see that product mix, market mix, and application mix changes dynamically. But in aggregate, we expect to see this part of our business continues to grow at GDP+.

I understood.

And maybe if I could ask this last quick one for Paul, and just on your balance sheet and capital allocation philosophy, given where you ended up at the end of this quarter, just any thoughts on how you're looking to deploy cash in the quarters ahead? Yeah, clearly our primary goal in cash deployment is to continue to grow the company. We've stated that, broadly speaking, we'd like to deploy roughly 70% of our capital to smart M&A to continue to build out our strategy as a pure play power provider. And the balance we would look at as, you know, available to return to shareholders. We've done that historically and continue to do that through an opportunistic share repurchase program. It doesn't mean we're buying every quarter, but we're looking for opportunities that make sense to be in the market. And we did buy additional shares this quarter as you saw stock dipped and we're able to pick up a few shares. I think year to date we've We've purchased something like $12 or $13 million of stock through the first three quarters of this year. And that'll vary by year. You know, that's our goal is roughly 70-30 split. Thank you. Thank you very much. Yep.

The next question comes from the line of Quinn Bolson with Needham & Company.

Hey, guys. Congratulations on the results. Wanted to just come back to the semiconductor business. and your comments about growing faster than peers. I think MKS talked about growing its power business over 100%, both in the quarter and I think year-to-date, which sounds perhaps faster than your overall semiconductor business. So wondering if you might be looking at, you know, apples and oranges here, or just could you clarify your comments about your belief you're growing faster than peers? And then I've got a couple of follow-ups. Thanks.

Sure. Thank you for the question, Quintin. I think you're not looking at apples to apples. I think you need to really take a deep dive and look at the definition of power. Now, if you look at the growth, I'm saying right now categorically, categorically, we are growing faster than MKS. Q3 year over year, year to date, second half versus first half, and year over year. And we'll be able to talk to you later if I show you some numbers. So we are growing faster than MKS in every category of growth comparison you look at. I don't know how they define power. The area where we compete with them, categorically, we're growing more than they do, and we're getting market share that drives that growth.

Okay. Thank you for that clarification. Paul, second question from you. You talked about catching up on backlog built earlier this year due to COVID supply constraints, standing for half of the upside in the third quarter. As you come into the fourth quarter, do you expect to catch up on additional demand, or do you think with the third quarter upside, you're largely back now and all of that catch-up is behind you?

I think we're largely caught up from things that were delayed due to the supplier constraints and some of our operational challenges, particularly out of the Philippines. And most of that came out of the INM and telecom side for embedded power type products. So we think we're largely caught up. Having said that, we continue to have a very strong backlog position because we continue to see good demand across our other markets. You know, we think that, you know, that helps the quarter certainly, but we wouldn't expect to see that catch up or a big backlog draw down necessarily, you know, as we look forward.

Okay, great. Thank you.

And your next question comes from . Yes.

I have a couple of follow-ups, and one as a follow-up to Quinn's question. I think it would be very helpful if you could give us an update on how you're increasing market share or presence in Japan, especially as it relates to Semicap. And I have a few follow-ups.

Well, Mehdi, obviously we need to be very careful about customer information and our business size and activities at customers' sites. We are definitely gaining share in Asia, including Japan, and the areas that we are gaining share are related to etch and deposition. We see dramatic growth in general in our RF matching technology. And as you know, RF matching is sort of the glue between the power supply and the process. And it's an area that is extremely critical, especially as multiple frequencies are being used to drive advanced processes. We are the leader in technology in RF matching. And our RF matches continue to be adopted across the board as an enabler for next-generation technology. And that's the reason, if you go back to our preparatory remarks, you can look at the growth rate we exhibit in the RF matching area, which is phenomenal. Another area that we openly talked about is key to our strategy in SEMI-FIRST. is remote plasma source technology. And our remote plasma source product line continues to grow significantly. And we expect the business to continue to generate incremental revenue for the future as we continue to gain share both in Asia and also in other locations around the world. I hope that answers your question, Mehdi.

Absolutely. Thank you. And I want to go Back to some of your targets, you have highlighted consistently your desired goal of exceeding revenue target of $1.5 billion and cash EPS of $6.50. Your Q3 results, despite the one-time adjustment to backlog from earlier this year, push you above that run rate. And as you look into the future, and I understand you're going to provide us an update on December 14, but as you look into the future, do you think that you're going to continue to exceed your targets organically, or is this going to be a mix of organic growth and selective and opportunistic acquisition?

Yeah, those long-term targets that we talk about, Mehdi, do not – do not include acquisitions. So that's our organic growth targets. To the degree we get additional acquisitions, we would see that as incremental to achieving those numbers. So obviously, we're pleased with the progress we've made today. I think we're ahead of schedule. And at the same time, there's more to do, certainly around the structural part of gross margin improvement. And we've always talked about phase two, which well underway, and we expect to make really good progress on it over the next year, which will continue to supplement our efforts to improve gross margins. But I think the encouraging thing or exciting thing for us is that with these higher volumes and the changes we've already made, you can see kind of a glimpse of the future. I mean, we're approaching those numbers even before we've completed, you know, all the opportunities to drive improvements in the business.

Right. Maybe to re-emphasize two points here. Q3 is a kind of a peek into the future. Even before we completed all these synergies that will be realized in integration of partisan and future synergies that will come after that. In addition to that, to the point that, you know, Paul made, we remain acquisitive And the plan that we basically described to you, you know, when we put together our aspirational goals, does not include acquisitions.

Yes. I just want to highlight that. Now, there's one more quick question regarding the momentum. You talked about how you see the different business units trending, but do you think you can answer qualitatively or quantitatively, but your book-to-bill above 1.0 is in Q3.

Yeah, it's a tough question to answer because, as you know, our book-to-bill, we don't really have a book since a lot of our products, especially in semi and to some degree even in embedded power, they're pulled. There's no order for them. They just get pulled from a JIT bin or from a hub. Right. But on balance, I would say we feel our outside of maybe the catch-up in backlog, certainly our book-to-bill is at least 1.0 or higher. Right. And again, and maybe – Qualitatively.

Right. And maybe, as you know, a significant portion of our business is based on long-term purchasing agreements and not purchase orders that are being placed every week or every day. So these are long-term, and it's a demand flow technology. Our customers pull our products from hubs when they need them.

Got it. Thank you, and congrats. Thank you.

Your next question is from Tom Disley with DA Davidson.

Yes. Good morning, and thanks for the question. Yuval, I was hoping you could talk a little bit more about the cross-selling opportunities. It sounds like you've had a little success now And if you could highlight where that's coming from and what the opportunity is, that would be great.

Thank you, Tom. Yes, you know, cross-selling, as we mentioned earlier in previous quarters, you know, started to realize itself faster than we, you know, predicted. And we see an increase in number of applications that we can serve with our embedded power products and and we have launched a unique product called ihp at semi-conwest that goes into multiple platforms and a semi-industry and in this case tom it's auxiliary power it's not process power now it doesn't mean that it's not important you know these power supplies if they do not operate then the whole machine doesn't move um so these are really important uh important uh power supplies with uh unique capabilities that uh that um you know serve the the global platform not only inside the fab but also outside of the fab in the uh in the back end of the of the process testing and packaging so um this is an area that um we continue to drive in semi, but we also see additional growth coming to industrial applications as we start moving products from different product lines that basically belong to either native AE or native artisan. We're now cross-selling them to different markets. So it's an area of significant potential incremental growth and drives a lot of excitement. What we bring to the table in some of these applications, our global footprint, our global manufacturing capabilities and support infrastructure around the world with our high density and high efficiency of conversion plays well into those who start looking into efficiency of power, you know, and performance locally around the world. So we're very excited about that, and we view that as one of the, you know, revenue synergies associated with the recent acquisition.

Okay, and are these situations where you have to catch the product release cycle, so it takes a few years before this gets fully integrated into the opportunity?

Well, in some of these cases, I would say yes, in similar design cycle. However, we had a few cases when we were asked to step in and help a customer to displace an incumbent that could not perform. An incumbent that could not perform either because of COVID-19 or could not perform because of issues related to their operational supply chain. At that point, our resiliency allows us to very quickly derivatize products to our customers' needs and come back with a plug-and-play solution to help our customers.

Great. Okay. And then as a follow-up, Paul, I'm wondering on the capacity side of your business, you know, with a couple of segments reaching record levels, do you have the capacity to already handle, you call it a double-digit growth in Semicap next year or? adding a couple new hyperscale customers, or would you have to add capacity?

No, it's a good question, Tom. We believe we do have capacity. The things that have constrained us this year have been, I'll say, COVID-related restraints, just the ability to get people into the factories, as well as supplier constraints. That's been the challenge. We certainly have physical capacity to continue to grow both in SEMI and data center across the board.

Yeah, it's a great question, Tom. We expect our industry to continue to grow, but we may see quota-to-quota variations driven by our customers' demand profiles. So we are designed and planned for managing bursts. And we have the capacity, we have the test equipment, we have the fixed cost in place already. And variable costs will vary with the volume. So we expect not only to be able to address the capacity increase, but also to do it in a very efficient way financially.

Great. Thanks for your time today. Thanks, Tom.

Your next question is from Pavel Molchanov with Raymond James.

Thanks for taking the question, guys. Obviously, the election results are still a little fluid, but let's assume for the sake of argument that there will be a change in administration, and in that context, a different approach to trade with China specifically. What impact, if any, would the ending of the trade war have on your business?

It's a good question, Pavel. Obviously, it's a difficult one to answer because there's a lot of dynamics. But look broadly, I think the effects of the trade and tariff wars so far have had not a lot of effect on our business directly. Because we have a global footprint, we're global customers, we haven't seen a big impact. Speculatively, you know, would a change in trade policies improve overall economic growth and trade in that regard, then I think that's probably good broadly for economies in general and for our industry probably as well.

Yeah, our global footprint, Pavel, allows us to deliver to our customers globally and manufacture close to where our customers are. So in that sense, we haven't seen dramatic impacts thus far on our business with the restrictions. And for that reason, we expect to see, unless there is an increase in geopolitical landscape that will increase GDP across the board, which will benefit us, we don't expect to see dramatic changes. Understood.

Let me turn to the service In a certain sense, you're kind of a victim of your own success. You have so much product sales now that service as a slice of the revenue mix is now less than 10%. I know you've talked in the past about kind of building up your recurring revenue stream, and in that context, Is that something that would be relevant vis-a-vis M&A, you know, acquiring any kinds of service or perhaps software businesses, if that's relevant to create more?

Yeah. So, Pavel, let me make a comment and maybe clarify something for you relative to the comment you made about our declining services as a percent of total revenue. Significant portion of our service revenue comes from our process power business, from what we call the advanced power, or native AE, if you may. And the reason for that, these are extremely sophisticated and extremely expensive products. And when they need treatment or repair or calibration, normally they're being shipped back to us through our labs around the world, and we take care of them and ship them back to our customers. because um you know the value of the asset is so high in the embedded power business that came through the acquisition many of these power supplies are not being repaired when they fail they're being replaced so it doesn't generate service revenue it generates product revenue and it's just a matter of category our native service business continues to grow with our installed base and we expect the business to continue to grow and we accelerate the growth of this business by offering uh service products like upgrades retrofits refurbishments etc so that will continue to grow but the the decline in percentage of sales total revenue is a result of the product mix now going to the other area that you asked about Software is becoming an important product for us. As we launched our Power Insight offering, we're making an investment and progress in providing software products to our customers that are adjacent to our core products and provide our customers with unique capabilities like big data analytics, predictive maintenance, and process diagnostics. That will continue, and our aim is to continue to grow this business and to offer these software products to the market, first in semi, but later in industrial and telecom networking as well.

That's very clear, and I appreciate the clarification on that point. Thank you.

And your next question is from Chris Sankar with Calvin & Company.

Yeah, hi. Thanks for squeezing me in. I had two of them. First one, Yuval, you know, when I look at your semi-cap revenues or shipments compared with your peers and contrast it to your customers like lamb, it clearly looks like your, you know, growth rate is much higher than theirs. And I understand that your customers are also building some buffer inventory because of COVID. But do you worry that at some point next year, this should normalize and your semi-cap growth rate could slow down, especially as your shipments catch up with your customers?

Yeah, answer that, Paul. So, you know, look, we anticipate, and I'm trying to be careful not to predict the market for you. I'm not trying to be a market analyst. But we are prepared and have the capability to manage and respond to changes in volume and mix. And we believe that we are going to see over the long range of the industry growth, we're not going to have every quarter up and to the right in the industry. We're prepared for that. Now, the other thing that I believe that happened, especially in Q3, We had a burst of demand. You know, it was really a demand to deliver faster and quicker. And we have the capacity, we have the operational excellence to be able to respond to these demands. Now, I'm sure that someone in your question, you're asking about inventory building in the industry. And I can tell you that there is some of that, There's some of that inventory building in the industry that some of it was driven by the, I would say, the trade war and restrictions of shipments. But it's not significant to the point that it will impact us dramatically going forward.

God, you are very helpful. This is a follow-up on the data center side of the business. You spoke a lot about the hyperscale segment and your traction there. I'm kind of curious to see on the other part of the data center, which is the enterprise spending, how do you see that business trending? Looks like IT budgets are down this year. And how do you expect enterprise to trend into next year? Thank you.

So let me address the hyperscale first. We believe that we are in the third inning of our journey in basically designing our products into the top hyperscalers, right? And if you look, you know, based on information we have shared with you earlier of the last three quarters, we have recently got set at the ramp of our product shipments into a third hyperscaler. At the same time, we're making great progress in designing our products into additional hyperscalers Now, if you look at right now where we are in the journey, we're still highly concentrated in just a few hyperscalers. Now, we believe that in the short term, we're going to see digestion in the hyperscale market as some of the hyperscalers basically use the inventory that they acquired And we look at the market and I think in our prepared remarks we said we expect to see resumptions of growth coming in 2021. We expect when the market recovers to do better than the market because we continue to gain market share. And we continue to gain market share as a fast follower because of our unique product offering with very competitive energy conversion efficiency and power density. On the enterprise area, right now we see IT spending is still slow, but high-performance computing will become a driver for the enterprise computing space. And that's why we highlighted this area. We are excited about it because we see more investment in the high-performance computing. New CPUs from Intel and AMD, we believe, will also be a catalyst to a cycle of investment in 2021. And we're looking forward to participate in this recovery.

Got you. Thank you all for the call. Very helpful.

And your final question comes from Weston Twigg with the KeyBank Capital Market.

All right. Thanks for taking my question.

I just wanted to follow up on that burst of order activity that you mentioned at the end of the quarter and just mentioned in the last comment. Why doesn't this burst in demand carry through to Q4 guidance? In other words, why is Q4 down if order activity was picking up at the end of Q3? I'm just kind of wondering if you had some color there, like which kinds of customers were doing it at why it seems sort of temporary? Yeah, it's a good question, Wes. To clarify, when we look at that surge of orders we saw, we think that was largely pre-positioning of inventory to kind of get ahead of seasonal shipment patterns and some of the geopolitical, you know, near-term geopolitical items that you've all just talked about by some customers, not all, but by a few. Overall, despite that, we expect CEMI to still stay strong. That's what we said in our comments in Q4. So that's not necessarily what's driving the more guidance. We also said that we don't expect this kind of catch-up from backlog that we saw earlier in the year to repeat in Q4. And that helped Q3 quite a bit. And then secondly, we also said the data center is going to be lower based on customer-specific and industry digestion. So those are the primary drivers. Obviously, there's risks around COVID and other environmental things that continue on. We've largely managed those. But the two big items that lead to lower guidance is just we don't expect that backlog catch-up to repeat. And we'll see lower impact, lower on data center. that that's that's the digestion in the data center market that's that's behind a lot of that okay that helps and then the other uh follow-up question i have is just gross margin the guidance is quite good 38 to 39 percent um but you talked about growth and industrial medical telecom uh over the next few years and i'm just wondering if um you know if the semi uh part of the semi-demand growth this year was inventory restocking, and you see the other segments grow nicely next year. Do you have a gross margin headwind in 2021 that might drive it below that 38%, 39% range, or could you see that maybe staying in that range or getting better through the year next year? Yeah, obviously mix can have some impact, but look, if you look at this year, semis up, but so is our embedded power products are up, and our gross margins are up in both areas. The impacts that we're making from a synergy perspective and consolidation perspective are having the desired effect. And as we look into next year, we'll see some more improvement. So, you know, on balance, I'd say the answer to your question is no. You know, we think we can continue to drive gross margins. But there could certainly be some mixed impact if you saw big swings in the relative to markets. So just to clarify, you think gross margin could trend up through the year, generally speaking, but with some mixed variation? Yes. Generally speaking, yes. Okay. Thank you.

I would now like to turn the call over to Yuval Wasserman with closing remarks.

Yuval Wasserman So thanks, everybody, for joining us today. Obviously, we're extremely excited with the progress the company is making. We're extremely excited about our future projections and the future of this company. We have four areas of excitement, SEMI, data center, medical, and 5G. And we expect those to drive continuous growth for the company in the future. We're gaining share and we are continuing to expand our presence. invest in new products that allow us to accelerate our penetration to new applications and markets. I'm looking forward to seeing many of you in December when we will provide you a deeper dive analysis of the growth trajectories, the applications, targets we serve, and update on our aspirational goals. Thank you very much.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.