Advanced Energy Industries Inc (AEIS) 2007 Q3 法說會逐字稿

Good afternoon ladies and gentlemen, and welcome to Advanced Energy's fiscal 2007 third quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) I would like to introduce Ms. Brooke Deterline, Advanced Energy Investor Relations. Ms. Deterline, you may begin your conference.

Good afternoon, thank you for joining us today for our third quarter 2007 earnings conference call. With me on today's call is Hans Betz, President and Chief Executive Officer, and Larry Firestone, Executive Vice President and Chief Financial Officer, who will both present prepared remarks. Steve Rhodes, Executive Vice President and Chief Operating Officer, will join us for questions. By now you should have received a copy of the press release that we issued approximately an hour ago. If you are in need of a copy, please visit our website at www.advanced-energy.com, or contact us at 970-407-4670.

Before we begin, I would like to let everyone that know Advanced Energy will be participating in the AEA Classic Financial Conference in Monterey, California, starting November 5th. The CFSB Conference in Scottsdale, Arizona, on November 28th at 4:00 PM, and at the Lehman Brothers Global Technology Conference in San Francisco at December 7th at 9:00 AM. I would like to remind everyone that except for historical financial 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 under way and unanticipated changes in our estimates, reserves or allowances. These and other risks are described in Form 10K and 10Q and other reports filed with the SEC. In addition we assume no obligation to update the information that we provide you during this conference call, including the fourth quarter guidance provided during the call and in our press release dated today. I will now turn the call over to Hans Betz.

Good afternoon, everyone, and thank you for joining us. Total sales decreased as expected in the third quarter, consistent with the revised guidance we issued on August 30th. We continue to experience softness in demand from semiconductor capital and equipment industry as sales declined 12% sequentially to $90.5 million. At the same time we continue to make progress in the strategic diversification of our business, notably with the recent introduction of our Solaron inverter product line which I will provide more detail on shortly. Whereas margin declined in the quarter to 40.6% due primarily to low revenues and a one-time charge related in a change in estimates of warranty expense for two products which resulted in a 2.4% reduction in gross margins. Operating margin for the quarter were 8.3%.

We generated $6.5 million in cash to end the quarter with $185 million in cash and marketable securities. [Sales] with semiconductor capital equipment industry declined 11% sequentially. At the same time we made progress penetrating key customers as our products are being designed into next generation equipment for advanced notes such as 65 nanometer. As we look at the fourth quarter we expect the weakness in the semi markets to continue. In the short term we do not anticipate the share gains will offset the effects of the industry fluctuations. However, longer term we do believe these gains will position us well for potential upside. Sales to our nonsemi market decreased 15% sequentially. This was primarily driven by the continuation of the parts in capital investment by flat-panel display manufacturers. They expected seasonal softness in data storage and a normal fluctuation in the architectural glass markets.

We saw strength in our industrial coating and inverter market segments as well as in our new Solaron inverter product line. Our sales for the flat panel display market decreased 40% as the next capital investment cycle has not yet begun. This was expected. However, the over market continued to digest current inventory displays and prices stabilized. We were encouraged to see LCD panel manufacturers return to profitability sooner than anticipated. However, as many of the flat panel manufacturers need to raise money to start the investment cycle, we do not expect this market to begin its next investment cycle under early to mid-2008, one to two quarters later than previously anticipated. Despite the current softness, we believe this segment will be a growth driver in the second half of 2008 and see longer-term opportunities developing. Faced with the data storage industry decreased 50% in the quarter as industry absorbs the current capacity for perpendicular recording installed over last year into 18 month. It is important to note that as the industry leader our sales track closely with those of the data storage markets. With industry consolidations and current hardness drive supply creating price pressure, we do expect the weakness in this tuning cycle to run through the remainder of 2007.

The optical storage market continues to hold promise with the adoption of Blu-ray and HD-DVD, expected to drive a tuning cycle in mid-to-late 2008. As these cycles are typical multi-year cycles, we remain confident that data storage will be a long-term component of revenue for our company. Sales to the architectural glass market decreased by 32% sequentially due to orders placed in China that sell beneath our target threshold and some big customers specific tuning cycles that create large quarterly fluctuations. Looking ahead, we believe the growing penetration of low e-glass in commercial and residential construction and the increased complexity on thin films on the glass will drive sales to the first half of 2008 and throughout 2009, beyond the process of building next generation products in order to capitalize on the growth of this market.

Sales to the industry coating market increased 46% sequentially, driven by the emerging demand for the use of thin film deposition and the manufacturing process for TMI shielding products. These coatings isolate the signal and ensure the integrity of radio frequency from mobile devices, such as cell phones and laptops. Manufacturers are moving away from electroplating and toward thin film deposition in order to decrease any negative environmental effects and increase product efficiency. This is a new and growing market for Advanced Energy. With over a billion cell phones shipped every year, this is yet another example for the use of thin film in manufacturing process, which has traditionally driven the growth in our market verticals. Going forward, however, we do not expect to see the same levels achieved in third quarter which were due to a few large orders. Moving on to our solar business. As a reminder, our evolving solar business now consists of both photovoltaic thin film deposition tools and our new photovoltaic inverter product line. Sales to the thin film deposition tools market were $5.6 million, which is slightly lower than the prior period but in line with our expectations of three to four times last year's revenue.

Our OEMs are reporting strong demand and we expect these backlog orders to be in production next year. Our recently launched Solaron inverter products is performing very well. We currently have a few inverters on the grid and the preliminary performance results and feedback from our customers are very positive. We are encouraged by our small but growing pipeline for this product line, as well as the faster than anticipated development of the U.S. commercial market. A number of commercial solar installations are coming on line and we believe our leadership positions in large parts supplies will afford us a significant advantage in both the thin film tools and inverter markets. We expect solar to be an exciting growth driver for Advanced Energy and we believe a significant part of the future landscape. Our service business was a solid contributor to the quarter, growing 3% due to strong growth in several of our international markets, as well as a steady increase in nonbreak fixed revenues such as upgrades.

In summary, the third quarter of 2007 was a challenging one for Advanced Energy, as we experienced cyclicality in the semiconductor markets, but made progress diversifying our business into other markets. We believe that our large power and flow expertise technology and IP, global reach, low-cost, high volume manufacturing capability, continue to create significant comparative advantages for our businesses going forward. We are exciting -- excited about our emerging market opportunities and new product introductions, both recent and expected, which we believe can leverage across multiple markets. As we were to achieve a more balanced revenue stream between our core markets and high -- higher growth emerging markets over the next few years, we believe we remain on track to grow our five years (inaudible) of 20%. We continue to enhance our AE team and strengthen our internal processes to support the strong growth ahead and profitability taking the company beyond $1 billion in revenue. I would like to thank the entire Advanced Energy team around the world for their hard work. I will now turn over the call to Larry Firestone, our CFO, who will elaborate on operating results, and final performance for the third quarter and provide guidance for the first -- for the fourth quarter.

Thank you, Hans, and good afternoon, everyone. I will review the results for the third quarter of 2007, and discuss our guidance for the fourth quarter. Sales for the third quarter of 2007 came in at the midpoint of our preannounced guidance at $90.5 million. This represented a sequential decline of 12.1% compared to $103 million for the second quarter of 2007, and 16% compared to the $107.7 million in the third quarter of 2006. Sales for the semiconductor capital equipment market decreased 18% over last year, representing approximately 67% of total sales in the quarter. Our nonsemiconductor businesses delivered 33% of total sales this quarter compared to 31% in the third quarter of 2006. Our nonsemi business -- businesses include solar, both inverter and thin film deposition tools, flat panel display, data storage, architectual glass and industrial coating and emerging markets, previously known as advanced product applications, or APA. Sales for the flat panel display industry declined to 4% of total third quarter sales versus 6% in the second quarter, as the delay in capital spending in this market continued. We expected this market -- we expect this market to begin its next capital equipment investment cycle during the early part of 2008. Data storage sales tracked the investments in the Magnetic Disk industry declining to 4% of total sales, down from 7% in the second quarter.

The Magnetic Disk industry is undergoing a period of absorption as it works through its excess capacity. We expect this trend to continue through the end of the year and into next year, as we are not seeing any significant catalyst before mid-2008, when we expect the HD-DVD and Blu-ray retooling which will drive growth in the data storage market. Sales to the architectural glass market declined at 3% of total sales to 4% in the second quarter. This market will fluctuate with the [low e-glass] market. Longer-term growth drivers for this market will be maintenance-free glass as well as sales of coated glass to the solar market. All of these markets will require thin films on the glass. Our industrial coating and emerging markets represented approximately 11% of the total third quarter sales, up from 9% in the prior quarter. These are generally sales to a collection of customers that do not fall into major market categories. Sales to the solar market in the third quarter comprised mostly of sales to OEMs of thin film deposition tools represented about 6% of total sales which is similar to last quarter. We remain on track to grow our solar business three to four times our 2006 solar revenues to the $28 million to $30 million range during 2007.

Global services, which are embedded in each of the different market segments, achieved record results at 16% of third quarter sales, up from 14% in the second quarter and up from 19% in the third quarter of 2006. These are sales of upgrades and out of warranty repairs to our growing install base. Our ending backlog for the quarter was $43.8 million, compared with ending backlog of $47.7 million exiting the second quarter. Our backlog represents orders for AE products not covered in our just-in-time agreements. Gross profit was $36.7 million or 40.6% for the third quarter of 2007. This compares to second-quarter gross profit of $45 million or 43.6%, and third quarter 2006 gross profit of $47 million or 43.7%. Gross margin was pressured by -- pressured this quarter by 240 basis-point -- 240 basis points reflected by the $2.2 million one-time charge related to the change in estimates and warranty expenses related to two products.

R&D was $12.9 million or 14.2% of third-quarter sales, similar to the second quarter, which was also $12.9 million or 12.5% of second-quarter sales, but higher than $11.3 million or 10.5% of third-quarter sales in 2006, driven by investment in new and existing products. SG&A was $15.5 million or 17.2% of third-quarter sales compared to $15.4 million or 15% of second-quarter sales, and $16.9 million or 15.7% of third-quarter 2006 sales. Amortization of intangible assets was $201,000 in the third quarter of 2007, compared to $202,000 in the second quarter of 2007, and $453,000 in the third quarter of 2006. The year-over-year reduction was the compilation of the amortization of intangible assets related to the Aera acquisition. I'm sorry, not the compilation. The completion of the amortization of intangible assets regard to go the Aera acquisition.

We recorded a restructuring charge of $556,000 in the third quarter related to the closure of our Stolberg, Germany, facility. This was consistent with our estimate discussed in prior quarters. Other income was impacted by a foreign income exchange loss of $1.4 million due to weakening of the U.S. dollar compared to the Euro and the Yen. This was the result of the U.S. dollar cash balances held at some of our foreign locates as well as intercompany payable and receivable balances in U.S. dollars between our entities. Although in many cases we have natural hedges built in between foreign currency payables and receivables, the weakening of the U.S. dollar affected our results this quarter. To mitigate this issue going forward, we're undergoing improvements such as accelerating payment dates to reduce the risk of currency fluctuation on intercompany balances. Additionally, we will evaluate our formal hedging strategy to accommodate balances without a natural hedge.

Third quarter net income from continuing operations was $5.9 million or $0.13 per diluted share, compared to $11.7 million or $0.25 per diluted share in the second quarter of 2007, and $17 million or $0.38 per diluted share in the third quarter of 2006. This was primarily due to lower revenues and the change in the effective tax rate from 12% in 2006 to 33% in 2007. Head count at the end of the third quarter was 7 -- 1,756 employees compared to 1,788 employees at the end of the second quarter of 2007. This reduction was due to normal attrition. Cash and marketable securities increased $6.5 million for the third quarter to $185 million from $178.5 million in the second quarter. DSOs were 64 days at quarter-end as trade accounts receivable were $69.7 million at the end of the third quarter of 2007, compared to $72 million at the end of the second quarter of 2007. In our inventory remains in the -- in the -- sorry, inventory turns remain in the 4.0 range consistent with the third quarter inventory which increased slightly to $57.4 million from 6 -- $56.9 million in the second quarter of 2007. Capital expenditures were $2.1 million and fixed asset depreciation was $2.7 million for the quarter.

Our guidance for the fourth quarter is as follows: given the expected softness in the semiconductor industry, our sales will be in the range of $86 million to $90 million, gross margins will remain at similar levels to the third quarter, due to product mix ,and earnings per share will be in the range of $0.12 to $0.14 per fully diluted share using a 33% effective tax rate. That concludes our prepared remarks for today, and now I'd like to open up the call for questions.

(OPERATOR INSTRUCTIONS) We will pause for just a moment to compile our Q&A roster. Our first question will come from James Covello.

Hi, this is [Kate Kotlarsky] on behalf of James Covello. I have a question regarding your gross margins. I know you said you expect gross margins to be at similar levels next quarter. Now those similar levels, is your basis for comparison the 40.6% or the sort of pro forma 43% for this quarter? And then maybe if can you give us some color as to what margins could look like in the beginning of 2008? Thank you.

Yes, it would be in the change -- probably be in the range of both the -- what was the results of the of the third quarter but also sort of in the range of that in the pro forma. And the reason for that is some product mix issues during the quarter that we expect to work them -- their way through the system, and by the time we get out into 2008, that they should normalize more in an upward direction. And along with that we still have the last quarter of the Stolberg, Germany, production shutdown that's going on.

Our next question will come from Jay Deahna.

Thanks, Jay Deahna from JPMorgan. Larry and Hans, both [Nobilis and Lamb] essentially called a cyclical turn indicating that orders will be up in the fourth quarter and shipments would start to rise in the early part of '08. If that's true, would you expect your revenues to semiconductor equipment to start come up -- to start to come up in 1Q as you fill the manufacturing pipeline there? And is there any lingering inventory that would prevent any normal early stage cyclical recovery? That is the first question. And do you believe that's likely to occur? And then the second question is, I'm going to have a follow-up on gross margins after you answer that.

Okay. Yes. We haven't guided out into the first quarter, but I would say we would probably run a little closer to the shipment schedules than the booking schedules that they talk about. So however that correlates through their business, and when you track that back to ours, you should be able to form your models around that. With respect to extraordinary inventory levels or anything that's out there in the pipeline that would create a protracted distance between us and the performance of the regular market, I would say that's -- the supply chain, including ourselves, is run pretty tight right now. So I really -- I really don't think that we see anything in the inventory range that would prevent us from performing with the overall market.

Okay. So assuming there is some sort of cyclical upswing that starts for the first quarter and I'm not saying that you are saying that, I'm saying assuming that hypothetically, and you guys start trending your revenues back up in the $100 million-plus range, what would be your expectation for some sort of a normalized gross margin, if you were to sort of steady state in let's say the $105 million to $110 million range revenues?

I think what we would be looking at is heading towards the target model, which we've got out there, and targeting -- our target model for gross margin is 47%, and I think where we left off before the market declined and happened a few quarters ago was in the 45% range. So I think as we've talked, as we've moved through the end of the December quarter, things like the Stolberg restructuring, and some of those things will be behind us, so we should be able to perform at those higher levels, moving our way to the target model.

Okay. And then the last question is, is your position as a power supplier to thin film equipment relatively equal, if you look at the two major thin film solar equipment suppliers out there applied in (arlicon)?

Is it equal between those?

Yes. In other words, like if -- if one of those companies has more rapid growth than the other because of share gain, are you pretty good either way in terms of your marketing on positioning?

Yes. We think our market share in the overall market, which includes all of the main OEMs that are supplied in the solar market, is pretty healthy. So I think we've had nice wins in all of the OEMs and certainly continued to cultivate those relationships in our design slots.

Our next question will come from Timothy Arcuri.

Hi, guys, this is actually Brian Lee calling in for Tim. I had a few things. First off, did your September quarter include any revenue from the Solaron product, or is that sort of kind of in beta stage?

It did. It included minor revenues from Solaron. But we didn't really break those out, but they're still pretty small.

Okay. Can you give us a sense for what you would expect from this new product in terms of incremental revs, looking out to '08?

Boy, we haven't guided any product, any revenues down to a product level in really any of the aspects that we have or given line of sight to anything on the inverter revenue side, yet. So it is still early, Brian, to call on that. We've got -- we've got, as Hans mentioned in his script, we have a few installed, we've sold probably in the low double-digit range of inverters that are now -- that are working their way into our backlog. So the product continues to move its way to the field and get great reviews from the field, but it's a little too early for us to start carving out and calling a trajectory, and that at this point.

Okay. Fair enough. Maybe if I can go at it another way. If I kind of look at my model and how I look at your solar business for '08, would it be reasonable to say that inverters are maybe 10% to 15% of your overall solar revs next year?

Of our solar revs?

Yes. Just the solar portion.

I mean again, we haven't really carved it out at this point in time. It is too early for us to call it at that range.

Okay. Okay. And then maybe switching gears a little bit. I know you guys have said in the past that you kind of see a $300 million, $350 million cam on the solar inverter business, kind of out -- looking out to 2010. Is there any reason that you only focus on the North American commercial market? What are kind of the barriers to making a residential product, and then beyond that maybe pushing into other regions like Europe where the transformerless designs are more common?

I think, Tim, the reason is the American market is the closest one that we had the real [luck] to team up with a nearly number one or number two player in their field. So it is very natural that you are trying to get into those markets first. And the second point is, Europe is, of course, on our list, but we have to make some changes in the voltage side. So that means this is something which we do after we have fulfilled all of the requirements in the American market. And coming back to your first question, I think, from a general point of view, if the inverter market is growing as it does, and every forecast points in the same direction, and if it turns out our inverter is performing as we have seen in the first feedback, I think that's going to be a very strong growth driver going forward for our company. No question about that.

(OPERATOR INSTRUCTIONS) We will go with our next question that comes from Brett Hodess.

Hi. Good afternoon. I'm wondering if you can talk a little bit about the flat panel side in that some companies have already started to see a pick up, like Photon Dynamics and whatnot, that is pretty substantial in their orders. So if you could maybe elaborate a little bit more on sort of what the lead time between the pickup is for your OEMs and then for yourself, perhaps, with the flat-panel market?

Yes, I would guess we're strongest in the back side PVD area, Brett, so -- and our largest customer with that is in Japan. So I would guess that a lot of what you're seeing is -- are some of the initial orders from some of the larger OEMs, the Japanese and that Korean guys that are putting their toe in the water for some of the bigger gear. I think what we're referring to is the next wave is going to come out of not only them but also the Taiwanese, and I think we all know that the Taiwanese are going to need to raise some money to make that next generation investment happen. So I think it is the beginning of the cycle. We still have a little bit of flat-panel business that is flowing through our P&L and had some last quarter as well. As far as to how we square off to Photon Dynamics and some of those things, I'm not sure I'm in a position to comment.

And the second question I had is, when you look at the solar sales when you're selling to the OEMs, before -- I think before you laid out a little bit what your sales leverage is in your power supplies relative to the size of a thin film line, I wonder if you could sort of bring us up to date on that, what your opportunity is for these particular lines that are getting announced?

Yes. For a 10 -- just call it a 10 megawatt thin film solar line, our opportunity is about $1 million to $1.5 million, in that kind of a range.

Great. Thank you very much.

Yes.

Our next question will come from Tim Summers.

Yes. Hi. Thanks for taking the questions, Hans and Larry. A couple of things. First off all, just looking at the revenue by product breakdown, it looks like when you went into the quarter, into the third quarter, it looks like you were assuming your semiconductor revenue to almost be flat from 2Q to 3Q, and it looks like it would tick down about 10% or 15% quarter-over-quarter. Is my math correct, first of all, on that assumption?

For -- from Q2 to Q3? Was that the time horizon?

Yes.

Yes, I think the semi revenues are in that range, yes.

I guess when you gave guidance on the second quarter earnings call, were you assuming that the semi revenue would be flat quarter to quarter?

To -- from Q3?

Yes.

No. It was down a little bit. I think we had it down 5% or something like that, and we ended up coming in north of that in the 10% to 12% range.

Okay. And then just a follow-up. What products had the warranty issues on them?

Yes, we don't really call out the specific products, but certainly it's in our portfolio price where we look at the return rates and the cost of the repairs, and all of those assumptions that we -- and we rerun our estimates and we found that we needed some more beef in some of our warranty estimates.

How long have these products been in the marketplace?

Probably -- well, they're coming out of warranty and we typically offer a two-year warranty. So we're starting to see the warranty performance. So in excess of two years. But a lot of what you get in the mid-course correction is after you start to see them come out of warranty.

Got it. Okay. Thanks, Larry.

Our next question will come from Timothy Arcuri.

Hi, guys. This is Brian Lee again calling in for Tim. I just had a quick follow-up. On the tax rate this quarter it looks like it was down quite a bit. Can you give us a sense for how we should be modelling that for Q4 and out into '08?

Yes. Q4 we mentioned would be a 33% tax rate, and I think that's probably fair out into 2008, as well. We do have some -- several initiatives inside the company to minimize the effective tax rate, and I think we're starting to see some of the effects of that as we go forward.

Okay. And then maybe one more quick question on the inverter opportunity. What percent of the market right now in terms of install capacity would you say is commercial versus residential? And what do you see that going to kind of longer term? Is it 50:50? And does that ratio hold, or what's kind of your outlook on that?

It is more to the 10% range.

The 10% commercial, and 90% residential?

Yes.

That is U.S., right, not global?

It is global.

Oh, global 10% commercial, 90% residential. What do you think that is maybe in 2010?

Oh, it is hard to judge, but one thing is for sure, the commercial side and even as far as the solar parts are growing faster than residential side. But that turns out in 2010 -- 2010, I don't know.

Okay. Thanks a lot, guys.

Yes.

At this time there are no further questions. Mr. Firestone.

Okay. Thank you very much for joining us today for our third quarter earnings call. We look forward to seeing you all at our upcoming investor conferences mentioned at the beginning of the call. Thank you very much.

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