Advanced Energy Industries, Inc.

Thank you, Operator. Good afternoon, everyone. Welcome to Advanced Energy Q1 2023 Earnings Conference Call. With me today are Steve Kelly, our President and CEO, and Paul Oldham, our Executive Vice President and CFO. Before I begin, I'd like to mention that we will be participating in 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, May 3, 2023, and the company assumes no obligation to update them. Any targets beyond the current quarter 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. Excluded from non-GAAP results are stock compensation, amortization, acquisition-related costs, facility expansion and related costs, restructuring charges, 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.

Good afternoon, everyone. Thanks for joining the call. First quarter revenue and earnings per share exceeded our guidance. Strength in the industrial medical market as well as improved component supply drove year-on-year revenue growth of 7%. Our operations team executed well, quickly turning critical components into revenue late in the quarter. Moving forward, we believe that 2023 will be a pivotal year for the company. The easing of supply chain bottlenecks means that our customers are now squarely focused on new product development and product differentiation. The timing is perfect for us, since we have recently launched a number of innovative new products with highly differentiated capabilities. We are expecting a record number of design wins in 2023, laying a strong foundation for profitable revenue growth. We believe that technology leadership, coupled with superior operational performance, is the recipe for success in our business. Over the past 18 months, we have made substantial strides towards best-in-class operational performance, particularly in the semiconductor space. We see further room for improvement and are taking advantage of the 2023 market environment to focus on operational efficiency. We are accelerating the consolidation of our factory footprint, which will improve productivity and lower fixed costs. As part of that consolidation plan, we will expand our factory in Mexicali, where we expect a quadruple output over the next two to three years. Our enhanced capabilities in North America will complement our strong factory network in Southeast Asia. Now I'd like to provide an update on the supply chain. The overall supply situation continues to improve. However, shortages of power MOSFETs and certain older node ICs continue to constrain shipments into many of our markets. We expect these constraints to be largely resolved by the end of the year. allowing us to clear most of the remaining overdue backlog. This is a high priority for the company, since resolving the remaining constraints will drive higher revenue, reduce inventory, and improve customer satisfaction. I'll now provide more detail for each of our markets. As expected, first quarter semiconductor revenue declined sequentially. Record service revenue offset some of the weakness in the broader market. On the product revenue side, there were two bright spots. The first was ion implant applications, where demand for advanced energy's high voltage systems is extremely robust. The second was ramping design wins in the etch and deposition areas. In addition, we began shipping beta units of two new plasma power products to our customers. We believe that these highly differentiated platform products offer best-in-class power control to our customers who are developing next-generation plasma etch and deposition systems. We expect to close design wins for these new products in the coming year. These wins should drive meaningful market share gains over the course of this decade. We plan to formally launch these new platform products at Semicon West, where we will provide more details on their impressive capabilities. Moving on to industrial and medical. First quarter revenue grew 48% year-on-year to $123 million, a new record for the company. The upside was driven by improved component availability and solid demand. In the industrial space, demand in thin-film manufacturing applications was very strong. In the first quarter, we also secured industrial design wins in test and measurement, manufacturing equipment, and 3D printing applications. In medical, we won designs in electrosurgery, life science, imaging, and laser applications. We are also benefiting from new cross-selling opportunities made possible by last year's acquisition of SL Power. Many SL Power customers are now evaluating and designing in medical products from other parts of our portfolio, and vice versa. We continue to invest heavily in dedicated engineering and customer-facing resources for the industrial and medical markets. We believe that advanced energy provides a unique bundle of technology, financial strength, operational expertise, staying power, and technical support, which will drive share gains in this broad market. In data center computing, first quarter revenue declined to $60 million, mainly due to component shortages. We also saw reduced demand from some hyperscale customers. Moving forward, we believe that there is upside in this market as the component shortages are resolved. In addition, we are continuing to focus our engineering team on high-value opportunities. In telecom and networking, revenue grew sequentially and year-on-year to $48 million, largely due to improved component availability. Now let me summarize the quarter and our outlook. The first quarter results validate the benefits of our diversification strategy as we performed above expectations despite the semiconductor market correction. We executed well and delivered upside to our financial targets. At the same time, we are taking actions to control our costs and accelerate the consolidation of our manufacturing footprint. For the full year, we believe that our semiconductor business will perform better than the market due to several pockets of strength. Outside of semiconductor, component shortages are still gating our revenue, but we expect that most shortages will be resolved by the end of this year. Therefore, we remain confident that our aggregate revenue in markets outside of semiconductor will be stable year on year. Looking beyond this year, we are encouraged by the strong customer interest in our new products. We believe that technology leadership, coupled with solid operational performance, will drive strong customer engagement levels with advanced energy. Ultimately, these engagements will drive long-term, profitable growth and increased value for shareholders. Paul will now provide more detailed financial information.

Thank you, Steve. Good afternoon, everyone. First quarter revenue of $425 million and EPS of $1.24 both exceeded the midpoint of our guidance, reflecting solid operational execution. Revenue grew 7% year over year and 3% organically, with record revenue in the industrial and medical market partially offsetting the anticipated weakness in semiconductor. Our backlog exiting the quarter was $756 million, down 14% from $875 million at the end of the fourth quarter. The sequential decline was driven primarily by customers reducing orders for out-quarter deliveries as we improved our lead times. As we further resolve critical part issues, we continue to expect our backlog will normalize to a level of $400 to $500 million over the next few quarters. Now let's review our financial results in more detail. Revenue in the semiconductor market was $194 million, down 4% year-over-year and 16% sequentially. The sequential decline was slightly better than our guidance, as we delivered record revenue in our service business, executed to meet higher demand for ion implant applications, and completed restocking of customer inventories back to targeted levels. Revenue in the industrial and medical market was a record $123 million, up 48% year-over-year and up 3% from last quarter. Excluding the SL power acquisition, organic revenue grew 31% from last year and 8% sequentially. We delivered a record quarter despite continued constraints of select components for this market. Data center computing revenue was down 22% year-over-year and 37% sequentially to $60 million. Although we saw lower demand from some hyperscale customers, revenue was primarily impacted by supply chain challenges, as we saw backlog actually increase in the quarter for these products. As a result, we expect revenue to increase from this trough level over the next few quarters as parts availability improves. Telecom and networking revenue was up 36% year-over-year and 8% sequentially to $48 million. It was one of the strongest quarters in recent history as we were able to secure more parts to meet demand. First quarter gross margin was 36.8%, up 20 basis points from last year and last quarter. Gross margin remained relatively flat sequentially despite the impact of lower volume as a result of modest reduction in material premiums, favorable mix, and initial actions we are taking to optimize our factory footprint and reduce costs. While we expect higher material costs to continue to negatively impact our results, we are encouraged by early signs of loosening in the supply chain. As a result, we continue to expect gradual improvement in gross margin towards the end of the year as premiums abate and historical costs flow through our inventory. Operating expenses were $99.7 million, down slightly from last quarter on reduced SG&A, partially offset by higher R&D investments driven by new product and platform launches expected this year. Operating margin for the quarter was 13.4%. Depreciation was $9.5 million, and our adjusted EBITDA was $66 million. Non-GAAP other income was a positive $500,000 due to higher net interest income partially offset by foreign exchange losses. Going forward, we expect our non-GAAP other income to be about break-even as we continue to benefit from higher interest earnings in the current environment and our low-cost debt structure. Last quarter, We initiated our 2023 restructuring plan to optimize our manufacturing operations and achieve other targeted reductions consistent with the current environment. During the first quarter, we completed the closure of our Shenzhen facility, reduced our total headcount in operations by over 800 people, announced plans to close an additional factory in China, and initiated further actions across the company. As a result, we recognized a further $1 million in restructuring costs in Q1 and expect to incur an additional $3 to $5 million over the remainder of 2023. Rounding out the P&L, our non-GAAP tax rate was 18.1%. For 2023, we are modeling our GAAP and non-GAAP tax rate to remain in the 18% to 19% range. As a result, first quarter EPS was $1.24, which was flat from last year and down from $1.70 in the previous quarter. Turning now to the balance sheet. Total cash and marketable securities at the end of the first quarter were $462 million, with net cash of $93 million. Cash flow from continuing operations was $32 million compared to $10 million last year. Inventory increased $26 million, or 7% sequentially, on higher raw materials as a result of lower revenue and increased finished goods on timing of customer shipments. We expect these finished goods to largely ship through in the second quarter. As a result, inventory days were 135 and turns decreased from 3.3 in Q4 to 2.7 in Q1. We saw a corresponding increase in DPO, which increased to 62 days. DSO was also up slightly to 62 days on timing of customer shipments late in the quarter. During the first quarter, we invested $16 million in CapEx, slightly below our expectation for 2023 of approximately 4% of sales. We also made debt principal payments of $5 million and paid $3.8 million in dividends. Turning now to our guidance. The demand environment continues to be mixed across our markets. As we noted last quarter, we expect our semiconductor revenue to decline again in the second quarter in the mid-teens sequentially. At the same time, we expect Q2 semi-revenues to be the trough for the year, with second-half revenue being flat to up versus the first half. In our other markets, we expect revenue in aggregate to grow sequentially in Q2 as we secure additional critical components. As a result, we are forecasting our second quarter revenue to be approximately $410 million, plus or minus $20 million. We expect gross margin in Q2 to be in the low 36% range on anticipated mix and lower volumes, partially offset by a modest improvement in material cost premiums. we expect gross margins to remain at or above this level in the second half of the year. As we stated last quarter, we expect Q2 operating expenses to increase $2 to $3 million sequentially due to annual salary changes, inflation, and continued R&D investment. However, we anticipate OPEX to moderate slightly in the second half of the year as we see the benefits of our actions to control spending while maintaining investment in critical R&D and growth initiatives. As a result, we expect Q2 non-GAAP earnings per share to be a dollar, plus or minus 25 cents. Before I open it up for questions, I want to highlight a few important points. First, our diversification strategy is working. Record revenue in our industrial and medical market and solid demand across most of our non-semi-markets partially offset the anticipated weakness in the semiconductor market. As a result, we were able to deliver year-on-year revenue growth for the first quarter. Second, as component availability gradually improves, we are well-positioned to improve gross margins as we exit the year, enabling more meaningful leverage in our model in 2024. Lastly, we believe our strong cadence of new products will lead to more business for advanced energy over time, enabling us to grow share and exit the downturn stronger. As a result, we continue to believe we are well-positioned to perform better than our markets this year, deliver results substantially better than in previous cycles, and to gain share and grow earnings as the markets improve. With that, let's take your questions. Operator?