Advanced Energy Industries Inc (AEIS) 2006 Q2 法說會逐字稿

Good afternoon. My name is Amarcus and I will be your conference operator today. At this time, I would like to welcome everyone to the Advanced Energy second quarter results conference call.

All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [OPERATOR INSTRUCTIONS] Thank you.

Miss Kawakami, you may begin your conference.

Thank you. Good afternoon, everyone, and thank you for joining us today. Hans Betz, our President and Chief Executive Officer, Steve Rhoades, our Chief Operating Officer and Mark Hartman, our Principle Financial and Accounting Officer will be today's speakers on the call.

By now, you should have received a copy of our press release that we issued about an hour ago. If you still need a copy of this release, please contact us at 970-221-4670 or you can view the release on our Web site at www.advanced-energy.com.

Before we get started this afternoon, I'd like to remind everybody that except for any historical information contained herein, the matters discussed in this conference call contain certain forward-looking statements subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements.

Such risks and uncertainties include but are not limited to the volatility and cyclicality of the industries we serve, the timing of orders received from our customers, our ability to benefit from the continued cost improvement initiatives currently underway and unanticipated changes in our effective tax rate. These and other risks are described in our Forms 10-K, 10-Q and other reports that we file with the SEC.

In addition, we assume no obligation to update the information that's provided on today's conference call.

I'll now turn the call over to Hans Betz.

Good afternoon, everyone.

I'm proud to report that the Company's operating at record levels with second quarter sales at $104.6 million. This is an 11% sequential increase driven by double-digit growth in sales to semiconductor, flat panel and architectural glass customers.

Gross margin increased to 42.8% and operating margins and net income increased 46% and 42% sequentially. The continued margin improvement was the result of ongoing product quality enhancement and our ability to continue to maximize operating efficiencies as a result of our world-class manufacturing and supply chain programs.

Our primary focus has been to improve our financial performance and expend the markets that we serve with our market leading power conversion and flow product portfolio. Our continued strong financial performance was driven by the critical initiatives that were successfully executed by our global workforce.

At a high level, these initiatives included the completion of the transition of manufacturing to our Shenzhen, China operation and the expansion of our [Teohuan] Asian-based suppliers. This infrastructure provides with us an outstanding operating model that is unique in this industry as well as improved product quality and customer responsiveness.

This improvement will be driven by new opportunities we can now pursue leveraging our world-class operations infrastructure.

Last quarter, we announced that we had joined a high tech freight alliance known as LSA and we expect to see initial benefits from this program in 2006 and further benefits in 2007. Our materials program in Shenzhen is designed to give us far greater control of our material cost and lead-times by leveraging the facilities space and the talent that already exists.

We are increasingly bringing in-house the manufacturing of more expensive, complex parts that have traditionally had longer lead-times. This program provides us additional manufacturing agility and efficiency that will gain traction over the next several quarters.

Additional cost savings are anticipated from our continuous improvement programs that are enhancing product quality and dramatically increasing our efficiency at all occasions. These programs continue to drive the reduction in non-standard material costs while eliminating process redundancies for more streamlined day-to-day operations and better management of our supply chain.

These programs give us the flexibility to further invest in opportunities that should provide us with continued margin improvement in 2007.

Our next generation product incorporate the benefit of our innovative designs, the new operating infrastructure, the lower costs, higher quality tier one supplier offerings. Once these products are shipped in volume, we will leverage the power and the efficiencies of our global capabilities.

In addition to continued progress in leveraging our global infrastructure, we continue to expand to reach of our product portfolio in our core end markets.

In semiconductor, we gained additional 300-millimeter precisions in all major application areas, CVD, PVD and Etch at a large OEM customer with our leading RF and power solutions. Flat panel strength for generation [inaudible] equipment drove sales of our Pinnacle DC power conversion product to an all-time quarterly unit record.

We also won a position at a second Korean OEM for a flat panel Etch application with our RF conversion systems. Our RF systems target CVD and Etch application in flat panel which represent a market opportunity for us that is greater than the size of the PVD business but we are currently the dominant provider of [PC] solutions.

We continue to expand the number of evolutions, evaluations, currently underway at major CVD, Etch and CVD flat panel equipment manufacturers around the world.

Generation 5 panel manufacturing has driven most of the first half unit volume growth as manufacturers take advantage of the higher yields of this panel size. We expect the third quarter to be softer than the second as the industry prepares for the transition to larger panel sizes.

Industry analysts suggest 15% growth in 2006 and 2007 for flat panel equipment market overall as demand for Generation 6 and 7 manufacturing equipment increases.

In our emerging markets, we continue to establish ourselves as a strong supplier to the solar market. Our DC and RF power systems enable the thin-film processes using manufacturing, the required codings on solar panels.

In the past three months, we announced a miter system order for our Summit DC power conversion systems from a leading European solar OEM. In March, the system order for RF and DC solutions from a well-known solar cell equipment maker and orders for our RF power conversion and matching network products from well-known OEMs.

We continue to make inroads into the solar market as investments in both wafer-based and thin-film continue to materialize, we believe our product portfolio is well suited to capitalize on the opportunities presented by this market. We expect our solar revenue to grow as we achieve design wins in this emerging market.

Since I joined as CEO last year, we have been driving our customer focus initiative throughout the organization. I have spent a significant amount of time in the field meeting with customers to better understand their needs and how we can increase our responsiveness to best anticipate those needs.

It has also helped to clarify the significant opportunities in front of us in the emerging market category and I'm confident we are doing all the right things to be successful in these new markets.

To further add to our global customer capabilities, we hired Bruno Doetsch as our VP of International Sales. This is a new position that will strengthen our focus on our international markets.

Bruno will lead AE's efforts in Europe and Asia and will drive to enhance our customer support and responsiveness. This is particularly important as we continue to pursue opportunities in the emerging non-semi markets which predominantly based in Asia and Europe.

We also look forward to welcoming Larry Firestone as our new Executive Vice President and CFO on August 8th. I've known Larry, formerly CFO for Applied Films for some time as customer of Advanced Energy and he understands the challenges of transforming a business model in a similar type of business environment.

Larry joins AE at exactly the right time. We have proven we can successfully execute to achieve our financial goals and we are now pursuing an additional set of opportunities that can deliver future growth and stronger performance as we go forward.

We continue to see an increasing pipeline of new market opportunities for which our high quality innovative product fit very well as the optimum solution for our customers. We believe we have a powerful and flexible operating and support infrastructure that provides us with a unique competitive decision to continue to win in both core and emerging markets.

I would now like to turn the call over to Mark to review the financials.

Thanks, Hans. Good afternoon, everyone. I will review the results of the second quarter of 2006 and discuss our expectations for the third quarter.

For the 2006 second quarter, sales were 104.6 million, up 11.3% compared to 94 million in the first quarter of 2006 and up 24.2% compared to 84.2 million in the second quarter of 2005. The strength of the second quarter sales was driven primarily by increased sales to semiconductor, flat panel display and architectural glass customers.

Gross profit was 44.8 million, or 42.8% of sales in the second quarter of 2006 continued improvement compared to the first quarter 2006 gross profit of 38.6 million, or 41% of sales. This compares to 30.6 million, or 36.4% of sales in the second quarter of 2005.

The gross margin improvement was the result of continued gains in overall operating efficiency and product quality driven in large part by our Shenzhen facility.

Turning to the sales by end market, sales to semiconductor capital equipment customers represented approximately 70% of total second quarter sales. Sales to flat panel display equipment customers represented approximately 11%.

Sales to the data storage industry were approximately 4%. Advanced product applications, which include sales to a variety of industrial markets such as architectural glass and emerging technology markets such as solar, represented approximately 15%.

Applied materials represented 32% of total second quarter sales, or $33.2 million, a 19% increase compared to the first quarter of 2006. OVAC, one of our major flat panel display customers, represented 10% of sales, or $10.4 million in the second quarter.

Global support represented 12.4 million, or 12% of total second quarter sales, flat compared to 12.3 million or 13% of first quarter of 2006.

Geographically, sales to all regions increased sequentially. U.S. sales represented 58% of total second quarter 2006 sales, up 10% in dollar terms compared to the first quarter of 2006.

Europe represented 8% of sales, up 16% compared to the first quarter. Asia Pacific represented 33% of sales, up 12% compared to the first quarter.

We ended the second quarter of 2006 with a total backlog of $61.1 million compared to the first quarter backlog of 57.5 million.

R&D spending was 10.8 million, or 10% of second quarter sales compared to 10.5 million, or 11% of first quarter sales and 10.2 million, or 12% of total sales in the second quarter of 2005.

SG&A was 14.2 million, or 14% of total second quarter sales compared to 14.4 million in the first quarter of 2006, or 15% of sales and 13.8 million, or 16% of second quarter 2005 sales.

Amortization of intangible assets was $453,000 in the second quarter of 2006, 477,000 in the first quarter of 2006 and 518,000 in the second quarter of 2005.

Operating income was 19.2 million, or 18% in the second quarter of 2006, a 46% increase compared to 13.2 million, or 14% of first quarter 2006 sales. Second quarter 2005 operating income was 5.1 million, or 6% of sales.

Third quarter 2006 total operating expenses will be up somewhat compared to the second quarter as we invest in strategic programs inside of sales and marketing. These programs target long-term expansion into emerging markets such as solar and other new opportunities within existing markets such as flat panel display, Etch and CVD.

Second quarter 2006 net income was 18.2 million, or $0.40 per diluted share compared to first quarter 2006 net income of 12.8 million, or $0.28 per diluted share when compared to net income of 5.9 million, or $0.18 per diluted share in the second quarter of 2005.

Our effective tax rate in the second quarter of 2006 was 10% which is lower than our previous estimate of 15. The lower tax rate was a result of higher domestic income during the quarter and our current estimated effective tax rate for the full year 2006 is 12%.

Headcount at the end of the first quarter was 1,539 compared to 1,532 employees at the end of the first quarter of 2006. 50% of our employee population is located in the Asian region with over a third of our employees are located in China.

For the first six months of 2006, sales were 198.5 million compared to 166.3 million in the first six months of 2005. Net income in the first half of 2006 was 30.9 million, or $0.69 per diluted share compared to 6.7 million, or $0.20 per diluted share in the first half of 2005.

We continue to strengthen the balance sheet. Our cash position increased 17.2 million which was in parity with earnings as we ended the quarter with 94 million in cash, cash equivalents and marketable securities. We expect to continue to generate cash throughout the remainder of the year.

Trade accounts receivable from 74.5 million in the second quarter of 2006 compared to 69.5 million in the first quarter of 2006 and 61.5 million in the second quarter of 2005.

Second quarter inventory was 59.8 million, up slightly from 55.9 million in the first quarter of 2006 and flat compared to 59 million in the second quarter of 2005.

Our capital expenditures in the second quarter of 2006 were 1.1 million compared to 730,000 in the first quarter of 2006 and 2.2 million in the second quarter of 2005. We continue to expect Cap Ex to be in the 6 million to $7 million range for the full year 2006.

Fixed asset depreciation was 3 million in the second quarter, 3.1 million in the first quarter and 3.1 million in the second quarter of 2005.

Looking ahead to the third quarter of 2006, we believe that sales will be in the 102 to $106 million range. Earnings per share will be in the range of $0.34 to $0.37 assuming a 12% effective tax rate.

That concludes our prepared remarks for today. Now Hans, Steve and I will be happy to take your questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll pause for just a moment to compile the Q&A roster. Your first question comes from Timothy Agurie with Citigroup.

Hi, guys, this is actually Brian Lee calling in for Tim. Just had a couple of things.

First, on the FPD business, can you give us an idea of what you guys are seeing in terms of demand and how we should be thinking about a rebound in this market over the next few quarters?

And then I guess a follow-up to that, whether you're still seeing any demand or what sort of demand you're seeing on Gen 5 and lower projects at this point?

What we have seen in this quarter is a very strong demand on Gen 5 and Gen 6. We see maybe some softness in Q3 because of the inventory buildup which has been publicized by LG Phillips as well as by AOU. But I think the consensus for the forecast is that '07 should be pretty strong in flat panel as well.

Okay Fair enough.

Outside of FPD, maybe staying on the demand, the demand issue, are you seeing any pushouts from some of your OEM customers like Amat or any meaningful changes in your customer's build plans at this point?

Not at this point in time.

Okay. Maybe switching gears a little bit. A couple of last things and then I'll go away.

How should we be thinking about your gross margin, how it will trend over the next few quarters? If we do see somewhat of a dip in demand in FPD and perhaps in semiconductor as well and let's say revenues dip toward the $90 million range.

Brian, this is Steve Rhoades.

We've talked about that with you in the past. The model that we're trying to operate inside of which is an incremental operating margin above $0.40, above 60 million. We've actually achieved that in this last quarter a little bit ahead of schedule and we expect to continue to operate inside of that model even with some of the investments that we're making in programs for growth for the future.

Okay.

So, as revenues incrementally dip, can we assume -- is it safe to assume that the incremental drop-off rate is equal to what we see on the drop through going as revenues go up? Essentially?

Yes. We'll continue to operate that way.

Okay.

In fact, you know, over the longer term, we actually see improvement on that. We think that there is significant gain still to be made in all of the elements of COGS for us as we look out into 2007.

Okay. And then maybe one last housekeeping question.

Can you guys break out what DSOs were in the quarter and how they broke out between COGS, R&D and SG&A?

We don't break it out to that level of extent.

Okay. Can you just give the absolute number?

For DSO?

For ESOs. For stock-based compensation.

Oh, I'm sorry. It's about 500,000.

500k. Okay. And is there any granularity you can give in terms of the breakout?

We typically don't share that.

Okay. Thanks. Thanks, guys.

Your next question comes from Stuart Muter with RBC Capital Markets.

Yes, this is Mahesh Sanganni for Stuart Muter.

Can you talk a little bit about the operating margins, operating expenses you said that are going to go up in the next and current quarter? What exactly is driving that and what kind of increase are we looking at?

Because we see very substantial opportunities in these new emerging markets, and in order to grab those opportunities, we have to make some investments in sales and marketing and in R&D. Can we break out the number of what the increase is going to be?

We haven't said but we did say that it will continue to be within the operating model that we've been.

That's in any case. So, any investment we make in these new markets, we always operate within the financial model we announce that we have been doing for the last year.

Okay. Thank you.

Your next question comes from the line of Jay Deahna with JPMorgan. [Inaudible]

I'm sorry, we're having a hard time hearing you.

This is [inaudible] calling in for Jay Deahna. I was wondering if you guys can provide us some [gross] market guidance going forward now that you have fully ramped up your China facility? Do you see further gains in gross margin going forward at this revenue level and also what would the sensitivity be to the revenue level at this point?

We do see that there are strong possibilities and we have programs in place to drive further reductions and material costs, freight costs and warranty costs on products over the next year and a half. And the gains are on the order of the gains we've made already during this year in every element of COGS.

In the near-term, you know, our models that we've talked about is that gross margin will drop by about a point per drop of 10 million in top line and the same kind of gain, if we gain 10 million in top line, we'd see another point of gain in gross margin. That'd be in the next -- in the very near-term.

But over the next 18 months we see substantial opportunities for us to continue to improve our financial performance on gross margin.

And a follow-up question on the solar market, I know in the past, you haven't commented on the potential size of this market. Do you have better visibility now to where you can give us some idea of what the potential opportunity here is?

If we look -- looking at the 2005 numbers, we had a -- I think over revenue of around 3 million. We have in the first half of this year already exceeded that value.

We will probably end up this year with a run rate of around 15 million. So that means we are somewhere around a doubling this revenue every year.

Does that mean that you continue to expect this sort of rate going, say, five years from now or --

The visibility we have is this year and the next year.

We can size it a bit for you. When we look at a production capacity on a thin-film line, which is where we're targeting, we don't have as much content on a bulk manufacturing line, bulk silicone, but if we look at thin-film solar, if there's 10-megawatts of production capacity put in, the types of products that AE sells would account for about a million, million two of hardware on that manufacturing line.

So, as we look at the types of projects that are in place, there are a number of 10 to 30-megawatt production lines going in now, lots of plans for that going forward. And that's about the content that we would see on, you know, if we win in those positions.

That's good. On the same market, are you getting the same level of gross margins on the solar market as you get with your semis and FPDs?

In general, those gross margins are not less than the semi.

Okay. Thank you.

Your next question comes from Jim Covello with Goldman Sachs.

Good afternoon, guys. Thanks so much.

Typical questions. On the operating expenses being a little bit higher as you invest in the new program, how much longer is it going to stay higher or is that kind of a permanent level for the time being?

We're going to continue to operate within the model, we have the advantage of being a little bit ahead of our projected performance. And we're staying inside of what we've said we're going to do in terms of financial performance.

I know that you just made that comment before, but if we assume a little bit of an increase this quarter, it's not like that is going to go back down in the December quarter?

No, I don't think so.

Okay. All right. More important question, and I would guess that you guys would disagree with this scenario but if you could just help us out for modeling purposes.

If your semi equipment customers are going to see a 35% decline in orders and shipments over the next couple of quarters, what kind of impact do you think that would have on your revenue?

And I know you may not agree with the scenario and it's not certainly an official guidance, but I'm just trying to get a sense for modeling purposes of given the puts and takes of inventory that you have at your SPE customers and then the other businesses that you're ramping that aren't as subject to those cyclical fluctuations, if that one, big, group of customers for you were to see a 35% decline in order and shipments, what do you think your overall decline from peak to [trough] revenues would be? Thanks.

We publish our semi is 70% of our business right now. So I guess that would be the way to go in terms of modeling.

We do see that we have opportunities in other markets and that could help us buffer some of that. But today, you know, just looking at that component of our business semi's about 70%.

Now the good news in that is lead-times have been very short, we've been very tight with the OEMs they're working on. So, I don't think we'd see a higher falloff than our customers. We don't see tremendous inventory buildups that would lead us to completely lose our business with those customers.

So, the drops in lead-times that we have to our customers and their better practice in terms of forecasting and just taking what they need would help us track with their performance.

I mean even if you don't think inventory levels are elevated, let's just say for the sake of argument that the inventory levels are normal, your inventory at the SPE/OEMs, they would presumably bring it down to below normal. Wouldn't that, I mean that's --

I just don't know how to go there. I mean you're modeling -- like you said, a scenario that's pretty far off of where we think we're operating right now.

Okay. I mean like -- final question then.

I mean, why would that be so far off? I mean it's a cyclical business. We've always seen those kind of cyclical declines.

You know, right now looking into the next quarter we still see strength coming out of the semi markets.

I'm not talking about for the quarter. I'm talking about for the cycle.

Yeah, I suppose it could happen.

All right. Thanks a lot.

Your next question comes from the line of Pasqual Sol with Lehman Brothers.

Can you talk about your current breakeven level and you said you are ahead of your plan to get to breakeven by the end of this year. Do you still think a 60 million level is true for the end of this year? Or it could be less than that.

We're operating at record levels for revenue and we've been very tight on our spending controls, our financial performance. We're actually already there.

So, we generated 43% incremental operating margin above $60 million in the second quarter of this year. And we expect to be able to operate at or above those levels for the balance of the year.

And as you look at next year, do you think that there's potential for the breakeven to be lower than what you are right now?

Those revenue levels are so far away from where we expect to operate, not so much breakeven, but what we do see is continued performance and gains and margin both at the gross margin and the operating margin level.

So we expect to improve our financial performance next year over the levels that we're at right now. We have opportunities in all elements of COGS to make improvements as we look out into next year.

Okay. And in your guidance, what kind of shipment, OEM shipments growth do you assume in for next quarter? In [inaudible] industry.

We just don't tie exactly to their shipment performance.

Yeah, but what do you think, is it going to be flatish or up slightly or up a lot?

You know, we just have to operate with what they provided to us and to you publicly that, you know, they're having flat to slightly growing shipment levels in the third quarter.

Okay. Great. Thank you.

Your next question comes from the line of Mark Fitzgerald with Banc of America Securities.

Thank you.

Could you give us some idea how much further opportunity there is for margin improvement here given that you still have quite a few things in the works here in terms of cost cutting and new design and platforms?

If you look at what we've done so far this year, we think we have about that same amount of upside at flat revenue levels looking out into the, by the end of next year. We can actually approach, we believe, the kind of peak performance that AE had in the late '90s and around 2000.

We see opportunities in all elements of COGS. There's a lot of work. We're going to have to make some investments to make that happen.

But on materials, on warranty, on freight, in efficiency gains, in labor and overhead, especially as revenue goes up above our current levels for the labor and overhead, we see a lot of opportunity for us to improve our margin and, again, kind of at the same magnitude of what we've already achieved this year.

If you looked into next year and just assumed we remained flat at this 100 to $110 million level, could we be looking at 48% gross margins, operating margins in the mid 20s, low 20s? I'm just trying to get a sense of the timing on these things.

You know, I think 3 to 4 points improvement is not unreasonable for us to expect as we look out into next year.

Okay. And then just -- any swag at the tax rate for next year?

Mark?

You know, overall, that's always difficult for us because where we have to estimate the geographic mix of revenue and where we're at and the other thing that we're always assessing is the valuation allowances that we have and, you know, when we'll be able to reverse those valuation allowances.

Going forward, depending on what we're looking at, I would say around the 20% rate but it really is going to be very dependent upon where the industries are going and what markets we find ourselves in and where the jurisdictional revenue is.

Okay. And then just one kind of macro question.

You guys and your predecessors have kind of talked about bringing up some of these new opportunities, but when we sit here, we're still looking at semiconductors, it's kind of 70% of the mix at historical levels.

When do you think given all the new efforts that are going on that you can make meaningful headway in terms of diversifying the mix here?

I think we are starting to invest heavily in the opportunities in these new markets and I think if you look at the possibilities we have, they're two-fold.

One is to gain market share, for example in flat panel and we are on the way, at least, to have some evaluation tools on the key accounts there and we are pretty confident that we have some gained shares in '07. And if you look at the new emerging markets, I think solar is probably getting strong in '07 for AE, as well.

So, that means getting into '07, getting into '08, it's probably a substantial portion of the non-semi market is a substantial portion of the revenue of the Company.

I mean are we talking 50/50 if the semiconductor industry were to hang in there for you?

I think exiting '08, it's not unreasonable to have this kind of [inaudible].

Okay. Thank you.

[OPERATOR INSTRUCTIONS] Your next question is from Brett Hodess with Merrill Lynch.

Hi. This is Kit Louden on behalf of Brett.

Could you just talk about your semi business a little bit more, just the strength in the quarter that you saw in part due to potentially share gains or just, you know, some more color on that, please?

We have some share gains in the semi business in particular on the 300-millimeter PVD and I think it's probably -- most of the time at the [aluminum] area. And we are in essence growing with the OEMs nearly the same rate.

So, going forward, your outlook is going pretty, track pretty much in line with the OEMs?

What we see in the next quarter is still some strength in the semi side and we may be flatish because of the fact that flat panel is probably in the next quarter a bit down.

Got it. Thank you.

And then also on your [tax] balance, do you see a potential for share buybacks or anything like that going forward?

No, it's not what we have in mind right now.

More so just investing in future businesses? Or in growth --

I think the better way to use the cash.

Okay, Great. Thank you.

At this time, you have no further questions.

Thank you very much, everyone, for joining us today and we look forward to speaking with you very soon.

Hello, ma'am. You just have a question that came in from Tim Summers from Stanford Medical Group. Financial Group, I'm sorry.

That's okay. Financial, Medical, whatever.

Just a couple of clarifications, Hans, did you just say that third quarter semi revenue would be up in flat panel and flat panel would be down quarter-over-quarter?

What we see is that we see from our OEMs some strength in the semis still but we see, at the same time, some softness on the flat panel side so we assume, as you see from our guidance, that we are flat or maybe a bit up.

Okay. And just a housekeeping question.

Is the earnings guidance of $0.34 to $0.37, is that GAAP earnings per share?

That's correct.

Thank you.

At this time, you have no further questions.

Great. That will conclude our call today. Thank you very much for participating.

This concludes today's conference. You may now disconnect.