Advanced Energy Industries, Inc.

And that's the combination of the last bit of materials rolling out, factory improvements and efficiency coming in, you know, volume recovery just back to where we've been running, not actually anywhere near previous peak levels or high levels. And so as revenues just get back to where we were, we think that's a meaningful improvement in gross margins. Now, as you look into next year, because of the things that we'll be doing, we've done already with the factory closures, we'll be doing with the other factory efficiencies this year, we think that we can get gross margins to around 40% on revenues in the mid $400 million range. And that's better than what we've been modeling up to now, where we thought we'd need to get to the mid to high $400 million range. We think there is a lot of upside in the company for gross margins. Obviously, the biggest factor impacting us now is just the revenue levels. In fact, things we've done we think are actually protecting gross margins at 35%, which is only down 70 basis points on the drop in volume we've seen. So, we think this sort of forms the foundation for, you know, a gross margin acceleration as revenues recover from this point.

Thank you, Paul. Thanks to you.

Our next question is from the line of Steve Barger with KeyBank Capital Markets. Please receive your questions.

Thanks. Steve, most industrial companies we cover are saying what you just did, which is weak first half, return to normal in back half. But can you talk more about why you think that, just where that confidence comes from? And do you expect INM can show positive growth for the year in 2024?

Yeah, so basically, Steve, I think I&M is always going to be inherently more difficult given the number of customers we're dealing with and number of different submarkets. And so we look to a couple of things. You know, one key indicator for us is distribution. So we sell about 45% of our I&M products through distributors. And, you know, we took a look at the data and, you know, a few things changed. kind of stand out. One is the resales. So resales at our top five distributors around the world have grown every quarter since Q2 of 22. So we basically exited 23 at a very high resale rate. It also shows that we have gained power share, power subsystem share at all of our major distributors over the past year. And at our top three distributors, AE is now number one in the category of power subsystems. So I think, you know, those are all positive indicators that show we have some momentum in this market and that, you know, our design wins are having some impact on our revenue already. I think the second thing that gives me confidence is that if you take a look at the industrial medical market, we were still chasing parts through the first half of last year. So there are still a fair amount of delinquencies. We closed out those delinquencies in the second half of last year. And so what's happening is the customers have different levels of inventory, you know, because, you know, there are a lot of different parts in the systems that they build. And so they're working through the inventory and doing their inventory rebalancing. The other big change our customers are dealing with is lead times. And again, the lead times have contracted significantly And that creates a bit of an air pocket. So that's why I made the statement that we believe second half, we're back to normal from a demand standpoint.

And as you think through all that, do you think that INM can show positive growth for the year versus 23?

We're not sure. We haven't gone through that model yet, but I hope so.

And one quick one for Paul, but thank you. Decremental margin in the back half averaged high 30% range. Is that how we should be thinking about 1Q and 2Q if revenue is down? Or can you do better than that?

I think when you look at going from Q, you know, Q4 to Q1, we feel pretty good about holding margins at the 35% range. We think that's going to be a floor. If revenue does tick down again, which we don't anticipate, then I think that's probably a reasonable range for decremental margins, maybe a little bit less because we'll still have some improvement on the material costs, and we continue to reduce our manufacturing footprint as we go. I think the important thing, though, as margins start to recover or revenues start to recover is that the incremental margins on the upside ought to be well north of 40%. And in some quarters could be well over 50 as we get the benefit of these various factors coming together. So we're actually pretty excited as we've continued to work this that we believe we've been able to reduce the revenue point at which we can get to 40% gross margin to this mid $400 million range per quarter. And look, if we're able to do that and we get to mid $400 million, our peak earnings, our earnings on that level will be substantially higher than our prior peak. And that's not even getting back to peak revenue levels. So, you know, we've done a lot of good work. I think we're getting the foundation in place on gross margin. Obviously, the environment the last year and a half has been challenging with parts. That's abated. We're now in a bit of a market soft point. But the underlying setup for gross margin we feel is very good as we go forward.

Appreciate that caller. But just to level set, I think you earlier said that you might exit the year at a $400 million run rate. And so what you're talking about, I mean, that would be the earliest that you're running an incremental most likely, right?

Yeah, I think over the course of the year, we'd see some pick up in volume and that would lead to some incremental. But you're right. Our projections at this point was that we would expect revenues to recover back to the $400 million level exiting this year. And at that level, we ought to be able to deliver gross margins 250 to 300 basis points higher than Q1. So that would put you in the 37.5% to 38% range on roughly $400 million. And just to calibrate that with Q4, that would be, you know, a 200 plus basis point improvement off of the Q4 levels at the same revenue level. I think that's what we're talking about is we see fundamental ability to prove gross margins and lower the revenue levels that it takes to deliver those gross margins.

Great detail. Thanks.

You bet. Our next questions are from the line of Mehdi Hassani with SIG. Please proceed with your questions.

Yes, thanks for taking my question. A couple of follow-ups from my end. For Steve and Paul, just going back to your commentary how this year is looking to be more weighted towards the second half, that's well understood, the beauty of I love spot numbers, but how should I think about second half of this year, 24 compared to the second half of 23? And I have a couple other follow ups.

Yeah, I think what we said is we're seeing early signs of, you know, improvement or that suggests there'll be improvement across most of our markets. So we do anticipate things picking up as we go through the year. And our best view is that we believe we can get back to revenues at $400 million or higher exiting the year, which would be Q4. I think that's the best visibility that we have at this point. Sure.

I guess we got the March quarter, guys. We got a feel for June flat out. We got the December at 400 plus. We just need more color on September quarter is what I was trying to figure out.

Well, there's not that many numbers in between there, Mehdi. So, you know, I don't think we have perfect visibility to what the pattern will be during the year. You know, look, semis, you know, continues to bounce around the bottom. This is a bit lower than Q1 than Q4, but we think that's going to improve. I think there's early signs of data center improving. That can be lumpy. That could come sooner, and it could come in a bump, right? I think industrial and medical will be more paced, as Steve said earlier. and telecom is going to sort of glide path down a little bit. So, you know, it's hard to say exactly how the quarters will play out. I think the near term we have pretty good visibility, and as we look out towards the end of the year, we see enough factors that give us confidence to get back to the $400 million or higher, but it's a little hard to project each quarter.

That's fair, and I appreciate all the details. One follow-up here, and I think it will be very helpful if you could, Give us some thoughts around ASP. Obviously, two years ago, industry was faced with insufficient supply and there was a significant price increase for all the semiconductor components. And I believe some of that price increase was passed on to the end customer. As we go through this inventory correction and the weaker end market demand, How are you positioning the company for pricing leverage, especially in this core semi-cap? Could your customers wait till last minute to get any kind of concession? And I'm just wondering how we should think about it.

Yeah, so let me just kind of retrace our steps over the past couple of years during the supply chain crisis. Many of our customers chose to pay premiums, so it wasn't a price increase per se, but we would – go out on the third-party market to find these scarce chips, and then they would pay the premium that we had to pay for those particular ICs or MOSFETs. And so I think as Paul explained during his presentation, most of those premiums have gone away. We had some other customers who preferred price increases. In those cases, We're working with them. You know, the first step is to get the price decreases from our IC suppliers and MOSFET suppliers. And quite frankly, that's been a bit of a challenge. So we're working hard to move our IC and MOSFET costs down. But they went up a lot faster, and they're coming down.

Okay. Thank you, Stephen. A quick follow-up for Paul. RPEX in 24, should we assume that it's kind of a flattish from here on?

I think sort of flattish, or certainly that's what we got it to for Q1. I think Q2 will be similar. And flat means it could bounce around a little bit, plus or minus. Because we get in the second half, we'll see how revenues, you know, recover. There could be a little bit of increase in the second half, more based on inflation and other factors. But in any event, you know, we don't anticipate operating expense going up. You know, we have a good cost structure. We've worked hard to get it down from where we exited a year ago. We want to sort of try to live within that cost structure. We're funding our priorities. We're making, you know, great progress on our NPI and other strategic initiatives. So I think we're going to try to stay roughly within this envelope. But I'd say, you know, maybe a little bit of increase in the second half just based on normal factors.

And, Manny, let me just complete my answer on the pricing issue. Can I just add a little more color? I think your question was more about what leverage we might have moving forward on the price. And I think it's really about new products. In Semi, in I&M, even in data center, we're bringing products to market now that offer more value to the customers and offer more profits to us. And that's how we plan to move our profitability up together with the actions we're taking in manufacturing.

Got it.

Thank you, Steve. Thank you.

The next question is from the line of Scott Graham with Seaport Research. Please proceed with your questions.

Hey, good evening. Thanks for taking my questions, guys. I wanted to maybe talk a little bit more about the gross margin. Are you guys saying that the premiums had no effect on the fourth quarter gross margin?

Yeah, no. What I said is that it did have some effect We think that's sort of in the 50 to 100 basis points. So that's continued to come down every quarter. And I think what we said as we ended the quarter, it was approaching normal levels. So I think our, you know, very end of the quarter exit rate was pretty small. But that just means those costs largely just need to roll through inventory now. So, you know, expect that same whatever 75 basis point improvement to kind of flow through. over the next quarter, quarter and a half. That's part of how we protect staying at 35. Part of setting that baseline as we go forward that those premiums are largely washed out. But there will be a little bit more in the first few months. But in terms of an ongoing activity, we think that's largely normalized.

Okay. Okay. So is there a case here, Paul, where I think you just answered it, but I'm not sure on the math. Are you saying that, like, sort of in the second half of the year, as we roll through sales and the gross margin should start to naturally move up because the sales are no longer burdened by the premiums of the gross income dollars goes up and the gross margin percent goes up with it? Is that the right way to look at it?

Yeah, it's said another way, the headwind that we've had over the last year, which has been dying down, but headwind nonetheless, that dissipates completely after, say, the first quarter or a little bit into the second. So that means that going forward, we don't have that headwind. So as volume picks up and other things improve, then we get that all the way to the bottom line. But I think the other thing is, the improvements that we're making in the factories and efficiency from a cost perspective. Um, and, and even a little bit of mixes, we're getting some, some product benefit, you know, from a sole source perspective, sole source mix, you know, towards the end of the year, all of those things really start to fall through. And that's why on similar revenue levels, you know, uh, in the fourth quarter to what we had this year in the fourth quarter, we ought to be doing, you know, roughly 200 basis points better. or as I said, 250 to 300 basis points better than where we're starting the year.

Okay. Thank you. I think we're saying the same thing. Steve, I was hoping you could tell us a little bit more about, you know, sort of this seems like another push to the right in SEMI because, you know, the numbers that we're hearing for WFE, you know, obviously they started, you know, six months, a year ago, they were, in the down twenties and then they came in from that to downs tens and fifteens. And I'm just wondering why with market conditions, you know, it's still difficult, but seemingly less difficult. Why is it kind of going the other way for you?

Yeah, Scott, I think if you take a look at the data, you know, we, we, we sell into, uh, etch and deposition applications, ion implant applications, so more conventional applications within the semiconductor process universe. We do not sell into litho. So if you extract the litho WFE, then I think you'll find that we're actually gaining share in that particular part of the market. I think what's important to realize, though, is the share gains are going to happen with the next generation processes. So that's why I spend so much time talking about Everest and Evos, because those are two new flagship technologies which have been eagerly embraced by the customers. And we think they are going to drive real share gain for the company over the next three to five years.

Okay. Last question, promise. The debt offering that you did last fall, kind of sitting and waiting for an acquisition to deploy that on. Could you just give us an idea how the funnel is looking? Is this sort of a modest setback in earnings here? Does that slow that process down, or is that still full speed ahead and you're getting closer and closer to something? Just maybe sketch out kind of where you're at.

Yeah, yeah, just let me just give you some context. You know, this this is a modest speed bump for us. It doesn't really impact any of our activities. So we're going full speed ahead on development. We're going full speed ahead on M&A. And our M&A approach hasn't changed. You know, we're basically looking at two tracks. The first track is technology tuck-ins. Those would be primarily for semiconductor applications. And the other track is, is, you know, basically larger app, uh, acquisitions. And, um, we are in, in contact with our targets and, uh, we certainly have the money, uh, to deploy, uh, when we reach agreement with one or more of these targets. Uh, but we're in no hurry. We want to make sure that the deals we engage in make a strategic sense, make financial sense with the company. And then, uh, You know, we'll basically deploy the same playbook we use with SL Power. We'll integrate quickly and maximize our synergies as fast as we can.

And I'll just remind you, Scott, also that, you know, when we did the debt offering, one of the beauties of that was that it gives us optionality as well. So we don't have to be in a hurry. We can be patient. There's other things we can do to deploy that cash that add value to the company, including arbitraging our debt next fall, if that's something that makes sense at the time. So we have a lot of options, and that, I think, gives us flexibility to be smart, to be patient, and make sure we're doing the right thing.

Okay. Thank you. As a reminder, if you'd like to ask a question today, you may press star 1 from your telephone keypad. The next questions are coming from the line of Jim Rusciutti with Needham & Company. Please receive your questions.

Hi, thanks. Most of the questions were answered. I'm just curious, though, as we think about 2024, the way you're describing the year, if that plays out that way. I'm wondering, as you layer in some of the e-commerce activity you've talked about, We're working more on the distributor front. Does any of that have the potential to add incrementally to the revenues in a meaningful way this year? Or is that more 25?

That's a good question, Jim. I think we have the ability to add incrementally to revenues this year and next year. You know, we actually launched the website in August of last year, and we saw an immediate uptick in engagement and downloads and so forth. So I think some of that work is already underway. So I'm encouraged by what I've seen so far. And that will continue throughout this year, right? So it's much easier for customers now to engage with us than it was six months ago. And as we add e-commerce, you know, to our website later this month, they'll be able to get samples of our products very quickly and make their decision more quickly. So I'm encouraged by that and also by the enthusiasm within our distributors that they're seeing how popular our products are. And they also are encouraged because they tend to make more money selling our subsystems than they do selling ICs. And so that certainly makes a difference. And we're seeing a lot more enthusiasm for both power and advanced energy through our distributor channel.

Thanks a lot. Good luck. Thanks, Jim.

Our next question is from the line of Dufan Janj with Bank of America. Please receive your question.

Hi. Yeah, thanks for taking the question. I want to go back to an earlier Semmy's question. So you said excluding LISO, potentially gaining share in some of the areas. Uh, but if we look at one of your lead edge customer, um, they've posted a strong December, uh, and even looking into March, they've had flattish outlook. Whereas I think your semis outlook is a little bit falling behind. So, uh, I just want to understand that disconnect between you and your, some of your customers.

Yeah, basically there's, there's two issues there. One is a inventory that, uh, some of our customers, are still carrying right and the second is timing because typically we'll be shipping products into a customer the quarter before they ship their products to their end customers so you know sometimes it's two quarters before and so it's very hard to correlate um our results with our customers results on a quarter by quarter basis got it got it um and then

On to gross margins. So I think exiting this year, you're targeting 57 to 57 and a half, but you still have that another two to 300 basis points in order to reach the 40% mark. So what other kind of tailwinds do you have now? You don't have that inventory normalization anymore. Potentially you have the factory optimization, but is that really enough to get you that two to 300 basis points. Thanks.

Yeah, so that's right. We would be exiting the year based on what we said in our prepared comments, somewhere between 37 and a half and 38% gross margins. As we look in then into 25, what are the other things? There are still more activities on the factory consolidation front. I think that the full benefit of that certainly bleeds into the first half of 2025 as we execute our plans over the course of the full course of 2024. I think that's another 100 basis points that could come through for sure. I think the second thing is we start to see more benefit from our shift in mix as we have more sole source products. That could add another 50 or more basis points. Over time, over a couple of years, we think that could be as much as another 150 or 200 basis points in total, but certainly I think in the In the early 25 range, I think there's easily 50 basis points and better mix and sole source products there. And the last thing is we, you know, while this year has got a bit of a front end air pocket, as Steve said, I think it exits back on a rate that's increasing. And I think generally the market views 25 as a pretty strong year, which we'll benefit from, irregardless of our new products, the channel investments and everything else. Those will be accelerators. And so that's why we look into 2025. We think that'll be a strong year. And as we said, if we can get back to $450 million, roughly mid $400 million range, that's going to yield just with the volume impact margins in the around 40%. So, you know, we feel pretty good about that when you look out in time because of the work we're doing now, the setup of things we can control in terms of managing our cost structure, getting that where we'd like it. getting the foundation for gross margin in place, the investments in new products, opportunity to gain share, the investments in channel. We think all of that positions as well to see really nice earnings growth as we go into 2025. And look, that mid $400 million, as I said earlier, isn't even peak revenue for us from the last up cycle. So if you ran that out to a peak revenue level, I think we'd be well in excess of 40% gross margins.

Thank you. Thank you. Our final question today is from the line of Mark Miller with Benchmark. Please proceed with your question.

I'm just wondering if you're seeing any impact of the slowing in EV sales, especially at second-tier foundries?

Your question, Mark, was whether we're seeing any impact in the slowing of EV sales. We really have very little direct exposure to that market. There's some indirect exposure through our work with the IC makers who are building silicon carbide chips and power MOSFETs and so forth. But at this point, we haven't seen any meaningful impact.

And what about the funding by the U.S., Europe, and Japan for internal chip production to become a driver in 2025?

I think it will, Mark. Obviously that benefits our customers, the equipment customers, and anything that benefits them ultimately benefits us. So we think building these geographical ecosystems is a good thing for the industry and will be a good thing for us.

Thank you.

Thank you. Ladies and gentlemen, this concludes our question and answer session, and I'll also conclude today's conference. You may now disconnect your lines at this time, and we thank you for your participation. Have a wonderful day.