Advanced Energy Industries, Inc.

Good afternoon, everyone. Welcome to Advanced Energy's second quarter 2023 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 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 estimates as of today, August 3rd, 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 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, and thanks for joining the call today.

Second quarter revenue and earnings per share exceeded guidance with another record quarter in the industrial and medical market. We continue to experience robust DesignWin activity across our product portfolio as customers shift their focus from solving supply chain issues to designing innovative new products. Over the past 12 months, We've launched multiple new differentiated platforms which will enable our customers to win in their end markets. High interest in our new products and technologies is driving a deeper level of customer engagement, particularly in the semiconductor, industrial, and medical markets. As a result, we expect to generate a record number of design wins in 2023, which we believe sets us up well for profitable revenue growth in the coming years. We are also working on a number of fronts to improve our operational efficiency. While the full benefit of these efforts will take time to be realized, we believe that our action plan will facilitate gross margin expansion as revenues grow. Moving forward, we will concentrate our production in large factories where we could leverage economies of scale and common processes. In Asia, we will continue to reduce our factory footprint in China while expanding our capabilities in Malaysia and the Philippines. In addition, we have made the decision to build a flagship factory in Thailand to accommodate future growth across our portfolio. We expect to start production at our Thailand facility in 2025. In North America, we are executing a plan to more than quadruple the output of our Mexicali factory over the next two years. Moving to the supply chain. The good news is that the availability of most critical components has improved. However, we are still experiencing shortages of selected power MOSFET, power analog, and microcontroller components. These shortages limit our ability to fully address our overdue backlog. Now I'll provide further color on each of our markets. In semiconductor, second quarter revenue was $173 million, a bit better than expected. We generated record revenue in the high voltage part of our semiconductor business, largely due to continued strong demand from ion implant OEMs. Our service business also recorded near record revenue, helped by high demand for value-added services. These pockets of strength, together with gains from recent design wins, are partially offsetting broader weakness in the semiconductor market. At Semicon West last month, we officially launched two new plasma power technologies, the Everest RF generator and the EVOS asymmetric waveform generator. These two new technology platforms offer our customers a step function improvement in plasma control with dynamic multilevel pulsing and microsecond response time. We believe that these new capabilities will enable our customers to expand process windows, improve process yield, and increase wafer throughput. Customers are enthusiastic about the new platforms, and we expect to secure multiple etch and deposition design wins over the next 18 months. Last month, we also launched our new fluoroptic thermal sensor, which features an ultra-wide temperature range. we have already secured our first design win in a cryogenic etch application. These new products and technologies are critical enablers for next-generation sub-2 nanometer processes. Also in the second quarter, we expanded our already strong position in older node processes by securing additional wins in ion implant applications. These wins were directly tied to the surge in demand for silicon carbide-based power devices. Moving to industrial and medical. Following a great first quarter, second quarter revenue grew sequentially to a record $128 million. During the quarter, we launched six new products into the industrial and medical market. We secured notable design wins in precision coating, industrial laser, and 3D printing applications. In medical, we won major designs in electrosurgery, imaging, and life science applications. Our industrial and medical design wind pipeline grew significantly in the quarter due to increased new product output, a more focused sales and applications effort, and our ability to quickly customize standard products to meet customer needs. We expect that these efforts will allow us to drive sustainable growth in industrial and medical for years to come. In data center computing, second quarter revenue was flat sequentially at $59 million. Sales to several hyperscale customers grew sequentially, fueled by demand for AI processing capability. Sales to enterprise customers declined. Telecom and networking revenue was very strong at $56 million, largely due to improved component availability. Now I'd like to offer some closing thoughts. Our second quarter results continue to validate the benefits of our diversification strategy. Our total revenue declined only 2% sequentially, despite the ongoing semiconductor market correction. We are on track to perform substantially better than in previous down cycles. Overall, 2023 is unfolding as we have projected at the start of the year. In semiconductor, we still believe that the second quarter will be our trough quarter and that the second half will be flat to up versus the first half. In our other markets, in aggregate, we now expect that full year 2023 revenue will be up slightly year on year. We believe that our diverse market exposure, our ability to work down the remaining overdue backlog in our strong design pipeline will enable us to continue to deliver solid results in a challenging market environment. Looking beyond this year, we are encouraged by the strong customer interest in our new products, as well as the continuing growth of our design wind pipeline. We believe that Advanced Energy is well positioned for profitable growth in the coming years, leveraging our technology leadership, operational excellence, and best-in-class customer service. Paul will now provide more detailed financial information.

Thank you, Steve, and good afternoon, everyone. Q2 was another quarter of solid execution, with revenue and earnings exceeding the midpoint of our guidance. Record sales in industrial and medical partially offset anticipated weakness in the semiconductor market, resulting in revenue of $416 million. Actions we took to reduce spending offset lower gross margins and enabled us to deliver earnings of $1.11 per share. Finally, Improved availability of critical components enabled us to shorten lead times to our customers and reduce backlog to $645 million. Overall, we believe the year is shaping up as expected. We are on track to perform better than the market and substantially better than previous market cycles. Now let's review our financial results in more detail. Overall revenue is $416 million. down 2% sequentially and 6% year-over-year. Backlog exiting the quarter was down over $100 million sequentially and in line with what we expected. As customers adjust their order patterns around shorter lead times, we continue to expect backlog to normalize to a level of $400 to $500 million in the next two to three quarters. Revenue in the semiconductor market was $173 million, down 11% sequentially, and 24% year-over-year. The sequential decline was better than our guidance, with strong revenue and high voltage for ion implant, initial ramp of new design wins, and near record service revenues partially offsetting weakness in the broader semiconductor market. Revenue in the industrial and medical market reached another record at $128 million, up 4% from last quarter and 22% from last year. The record quarter was driven by solid demand in several applications, such as automation, battery manufacturing, and precision coding. In addition, improved parts availability helped us address part of the overdue backlog. Data center computing revenue was flat sequentially and down 15% year over year at $59 million. Incremental demand softness in the enterprise server market was offset by higher hyperscale revenue on investments in AI applications by some customers. Supply constraints continue to prevent us from delivering our full demand. Finally, telecom and networking revenue was up 16 percent sequentially and 46 percent year-over-year to $56 million, driven by substantially improved component supply, allowing us to largely fulfill overdue backlog. Gross margin was 35.6%, approximately 50 basis points below our guidance, mainly due to unfavorable product mix. Premiums we paid for critical components improved again this quarter, but remained a meaningful headwind, as costs from prior quarters rolled through inventory to the P&L. Looking forward, we anticipate mix to normalize and premiums to continue to gradually abate resulting in gross margin recovering to the low to mid 36% range in Q3. In addition, actions we are taking to optimize our operations footprint and improve manufacturing efficiency are on track and should contribute to higher margins over the next few quarters. Finally, addition of a new manufacturing facility in Thailand in the next couple of years will position us for further growth and enable additional consolidation into larger scale, highly efficient factories. This investment and related consolidation are already contemplated within our objective of achieving gross margins of greater than 40%. Operating expenses were $98.5 million, down from last quarter. Actions we took to manage our cost structure and control discretionary spending more than offset annual salary increases which took effect during the quarter. Operating margin for the quarter was 11.9%. Depreciation was $9.4 million and our adjusted EBITDA was $59 million. Non-GAAP other income was $200,000 due to higher net interest income partially offset by foreign exchange losses. Going forward, we expect our non-GAAP other income to remain around break-even given our levels of cash and current interest rates. In the fourth quarter of 2022, we initiated a restructuring plan to optimize our manufacturing operations, consolidate some of our smaller sites into our large facilities, and achieve other targeted reductions consistent with lower volumes in 2023. We are on track to our plan and expect to see the full benefits of our actions translating to better margins over the course of 2024. Consistent with this plan, we recognized $3 million in restructuring costs in Q2 and expect to incur an additional $3 to $5 million in the second half. Our non-GAAP tax rate was 15.3% below our target of 18 to 19% due to several discrete items and favorable mix of earnings. For 2023, we are now modeling our GAAP and non-GAAP tax rate at about 17%. As a result, second quarter EPS was $1.11, ahead of guidance, but down from $1.44 a year ago and $1.24 in the previous quarter. This level of quarterly earnings is approximately two and a half times higher than trough earnings in the previous market cycle. Turning now to the balance sheet. Total cash and marketable securities at the end of the second quarter were $455 million with net cash of $92 million. Cash flow from continuing operations was $24 million, lower than last quarter primarily on timing of tax payments. Inventory decreased $9 million or 2% sequentially as we continued to rationalize our raw material inventory. As a result, Inventory days were 132 and turns remained flat at 2.7 from Q1 to Q2. Days payable decreased from 62 days in Q1 to 50 days in Q2 on timing of purchases. DSO decreased from 62 days in Q1 to 56 days in Q2. As a result, net working capital was 138 days. During the second quarter, we invested $17 million in CapEx. in line with our 2023 CAPEX plan of approximately 4% of sales. Looking forward, the majority of the spend related to the new Thailand factory is expected to occur in 2024 and to be largely funded within our CAPEX run rate of 4% of sales. As a reminder, our factories are mainly final assembly and test oriented and are not capital intensive. During the quarter, 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, with pockets of strength in some markets offsetting cyclical weakness in others. Consistent with our commentary from last quarter, we expect Q2 semiconductor revenue to be the low point for the year, with Q3 revenue up sequentially and second half revenue being flat to up versus the first half. For our non-semiconductor markets in aggregate, given our strong performance in the first half, we now project 2023 revenues to be up slightly for the year. In total, we are forecasting our third quarter revenue to be approximately flat with Q2 at $415 million, plus or minus $15 million. This outlook implies that second half total revenue will be roughly flat with first half and Q4 greater than Q3. We expect gross margin in the third quarter to improve to the low to mid 36% range on better product mix and lower component premiums quarter over quarter. We expect operating expenses to be about flat to up slightly in both Q3 and Q4 on timing of project activity related to our new product launches. As a result, we expect Q3 non-GAAP earnings per share to be $1.13 plus or minus 20 cents. Before I pass the call to the operator, let me make a few important points. Overall, 2023 is progressing as we expected coming into the year. Our diversification strategy is enabling us to deliver substantially better financial performance than in prior cycles, with a more moderated impact to revenue given our strength in industrial and medical and earnings levels substantially higher than prior troughs. We continue to be focused on improving gross margins. We believe our efforts to streamline operations, secure critical parts, reduce material premiums, and improve mix towards higher margin products will enable us to deliver on our long-term gross margin target of over 40%. Combined with actions taken to manage our cost structure, we expect to drive meaningful operating leverage in our model in 2024 as volumes recover. With that, let's take your questions. Operator?