Advanced Energy Industries, Inc.

Good afternoon, everyone. Welcome to Advanced Energy's second quarter 2022 earnings conference call. With me today are Steve Kelly, our President and CEO, and Paul Odom, our Executive Vice President and CFO. Before I begin, I'd like to mention that we will be participating at several investor conferences in the coming months. If you have not seen our earnings press release and presentation, you can find them on our website at ir.advancedenergy.com. Let me remind you that today's call contains forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially and are not guarantees of future performance. Information concerning these risks can be found in our SEC filings. All forward-looking statements are based on management's estimates as of today, August 3, 2022, and the company assumed no obligation to update them. Medium-term targets and long-term aspirational goals presented today should not be interpreted as guidance. On today's call, our financial results are presented on a non-GAAP financial basis unless otherwise specified. Exclued from non-GAAP results are stock compensation, amortization, acquisition-related costs, restructuring expenses, and unrealized foreign exchange gains or losses. A detailed reconciliation between GAAP and non-GAAP measures can be found in today's press release. With that, let me pass the call to our President and CEO, Steve Kelly. Thanks, Edwin.

Hello, everyone, and thanks for joining the call. Second quarter revenue and earnings per share surpassed our expectations, largely due to improved supply of key components and good execution by our operations team. While delivering record-breaking revenue, we also significantly grew our backlog, This is evidence of the strong demand across our target markets. In the near term, the primary constraint on our financial performance will continue to be the availability of scarce components, particularly integrated circuits. While the procurement of scarce ICs is key to our short-term performance, new products and technologies are key to our long-term growth. To that end, our development teams are highly focused on launching innovative products into our target markets. Within those markets, we are focusing on applications which need highly engineered solutions, allowing us to deliver more value to our customers. In addition, we are accelerating the cadence of new product introductions across a wide range of applications. In the second quarter, We expanded our reach in the medical power market by acquiring SL Power. We are now a top player in medical and aspire to become the number one player within the next five years. Customer reaction to the acquisition has been positive. They recognize that Advanced Energy's engineering capabilities, manufacturing footprint, and strong balance sheet complement the innovative strengths of SL Power. Now let me provide some further color regarding the current operating environment. As I mentioned earlier, the supply environment remains dynamic. The availability of key ICs, all of which are built on older process nodes, is the primary issue. To partially mitigate the shortages, we buy certain components through dealer and broker channels. Our customers support this effort by absorbing some of the price premiums associated with these broker buys. While there are pockets of delivery improvement, we expect that the overall procurement environment will remain challenging in the near term. We are also mitigating supply issues by working closely with customers to qualify alternative ICs. Where necessary, we have redesigned entire circuit boards to eliminate hard to find components. These alternative ICs and redesigned circuit boards contributed to our results in the second quarter and should have an even larger impact on our second half performance. We continue to maintain surge capacity throughout our factory network. This allows us to quickly take advantage of lumpy deliveries of scarce components. Now I'll provide more details for each of our target markets. In the second quarter, revenue from the semiconductor equipment market grew 30% year-on-year and 13% sequentially to nearly $230 million. This is a new quarterly record for advanced energy. We continue to expect that advanced energy's semiconductor revenue will grow faster than WFE in 2022. Our strategic development programs for dielectric etch and remote plasma source applications are progressing well, enabling us to deliver evaluation units to our key customers. In addition, we secured multiple design wins for our high voltage power conversion products, We believe that these strategic programs and products will drive long-term revenue growth and market share gains for advanced energy. In the industrial medical market, revenue grew 26% year-on-year and 27% sequentially due to improved parts availability as well as the addition of SL Power. Our industrial and medical order book increased in the second quarter. We secured major wins at multiple Tier 1 medical OEMs and won key design slots in indoor farming, factory automation, and industrial printing applications. In the second quarter, we expanded our thin-film industrial portfolio by introducing a new digitally-controlled RF generator, together with an enhanced matching network. Year to date, we have launched a variety of other new products into the industrial and medical markets, including several board-mounted power modules, a number of certified medical products, a new pyrometer for industrial temperature measurement, and a software solution for indoor farm lighting called Grow Insight. Since the acquisition of SL Power in April, we have combined the medical power development teams of SL Power, and advanced energy under a single leader. This combined team is now in a position to deliver a broader range of power delivery solutions to our medical customers. Since the acquisition, we are seeing an increase in medical power design activity, particularly in regions outside the U.S. In the data center computing, telecom, and networking markets, demand is solid. but revenue continues to be paced by the supply of critical ICs. During the quarter, we won several high-value designs in these markets. To summarize, demand for our products remains strong. Although the availability of scarce components continues to be the primary constraint, our mitigation efforts are having a positive impact. We believe that we are on track to deliver double-digit percentage revenue and earnings growth in 2022. Looking beyond this year, we are encouraged by customer acceptance of our new products and technologies, which we expect will drive improved revenue, market share, and earnings. In short, we believe that Advanced Energy is well positioned to deliver sustained, profitable growth in the coming years. Paul will now review our financial results and provide detailed guidance.

Thank you, Steve, and good afternoon, everyone. In the second quarter, we delivered record revenue of $441 million and earnings per share of $1.44, surpassing our guidance ranges. Demand for our products remained strong, and our backlog grew 15% sequentially to $1.17 billion. We believe this backlog, which is comprised of predominantly proprietary products, provides a runway to solid financial performance as we look over the next several quarters. Our operations focus remains on securing critical parts and getting products to customers as quickly as possible. Our redesign efforts, ability to move quickly to secure parts even at a premium, and other mitigating actions are having a positive impact. At the same time, the overall supply environment remains very challenging, and we continue to see higher material costs and premium recoveries As a result, we will remain prudent in our planning, but believe our second quarter results are indicative of our ability to achieve our target earnings of over $1.50 per share by the end of the year. Now let me go over our financial results. Revenue of $441 million grew 22% from last year and 11% from last quarter. Excluding the contribution of the SL Power acquisition, Organic revenue growth was 18% year-over-year and 8% sequentially. Revenue from the semiconductor market was $229 million, up 30% from last year and 13% from last quarter. Demand was strong, and our backlog grew despite the record revenues. We are working closely with our customers to prioritize critical parts and deliveries and expect our semiconductor revenue to grow sequentially again in both the third quarter and the second half. Revenue in the industrial medical market was $105 million, growing 26% from last year and 27% from last quarter. Excluding SL Power, organic growth was 12%, both year-over-year and sequentially, driven by strong market demand and improved supply of critical ICs. Revenue in both data center computing and telecom and networking continued to be meaningfully impacted by supply of critical components. As a result, Data center computing revenue was flat to last year at $69 million, but declined 9% sequentially. Telecom and networking revenue was $38 million, up 19% from last year and 8% from the first quarter. Gross margin in the second quarter was 37.1%, up 50 basis points sequentially on better mix and increased factory output. Compared to last year, Gross margins declined 90 basis points due to higher material costs. Premium recoveries, which reflect costs that we have been able to pass on to our customers but at zero margin, were similar to Q1 on a dollar basis and impacted gross margins by approximately 160 basis points. Given the dynamic supply environment, we expect that higher material costs and related premium recoveries will continue to negatively impact our gross margins in the third quarter and could extend further. Although we believe our mitigating actions should help offset some of the impact, given these challenges, we will take a more conservative approach to our cost assumptions over the next couple of quarters. Operating expenses were $94 million, up 14% from last year and 8% from last quarter. The sequential increase was largely due to the addition of SL Power and annual salary increases which occurred in the second quarter. Second quarter operating margin was 15.8%. Depreciation for the quarter was $8.5 million, and our adjusted EBITDA was $78 million, up from $62 million last year and $66 million last quarter. Non-GAAP other expense was $2.2 million, including $1.5 million of interest expense and $700,000 of foreign exchange losses. Our non-GAAP tax rate was 19.4%, slightly above our target of 19% and ahead of our historical rate of 15%. The higher rate is due primarily to the change in U.S. tax rules impacting the expensing of R&D that took effect at the beginning of the year. Second quarter earnings were $1.44 per share, up from $1.25 last year and $1.24 last quarter. Excluding the negative impact of the change in U.S. tax rules, earnings in the quarter would have been greater than $1.50 per share. Now let me comment briefly on the SL Power acquisition. In our first partial quarter, SL contributed $12.9 million in inorganic revenue and approximately 5 cents of non-GAAP earnings per share. This acquisition makes us a top player in the medical market, and we are well on our way to capture cross-selling revenue opportunities and to integrate the business. Turning now to the balance sheet and cash flow. We ended the fourth quarter with total cash, including marketable securities, of $375 million and net debt of $8 million. During the quarter, we paid approximately $145 million for SL Power, and we repurchased $17 million of common stock at $74.12 per share. Cash flow from operations was $38 million. Networking capital improved slightly to 119 days, DSO improved modestly to 55 days, and EPO declined slightly to 64 days. Inventory turns remained about flat at 2.8 times as we begin to see the impact of our actions to scale back inventories that have less critical components. In the near term, we expect inventory to remain elevated, but turns should improve as we consume inventories of less critical parts, contributing to higher cash flow over the next several quarters. During Q2, we invested $12.4 million in capital expenditures, made debt principal payments of about $5 million, and paid $3.8 million in dividends. Today we announced that our Board of Directors increased our stock repurchase authorization to $200 million in support of our long-term, opportunistic share repurchase strategy. Since our last authorization a year ago, we repurchased approximately $95 million of stock at an average price of $83.50 per share through the end of the second quarter. Now let me turn to guidance. Although we continue to see strong demand for our products, we remain in a dynamic supply environment with low visibility to the delivery of critical parts and ongoing material premiums for some components. As a result, we expect Q3 revenue to be approximately $435 million, plus or minus $25 million. Our Q3 guidance assumes semiconductor revenue will continue to grow sequentially and includes a full quarter of revenue contribution from SL Power. Q3 gross margin is expected to be about flat to Q2 levels, as higher material costs persist into the third quarter. We expect operating expenses to be in the $97 to $99 million range, primarily in a full quarter of SL power operating expenses. We expect other expenses to be approximately $2.5 million on higher interest expense, and our tax rate to continue to be approximately 19%. As a result, we expect our Q3 non-GAAP earnings per share to be $1.30 plus or minus 30 cents. Let me finish with some closing thoughts. In our second quarter, we executed well in a challenging environment. And although supply chain constraints will continue to pace our performance, our Q3 revenue guidance reflects four consecutive quarters of year-over-year revenue growth. increasing our confidence to achieve our year-end annualized earnings targets of $6 per share, despite persistently higher material costs. Looking forward, we believe that solid demand drivers in our markets, the profile of our order book, actions we are taking to mitigate supply chain challenges, and investments in new products position us well to deliver on the pent-up earnings potential for the company for many quarters to come. With that, let's take your questions. Operator?