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Advanced Energy Industries, Inc. (NASDAQ:AEIS)

Q2 2009 Earnings Call Transcript

July 23, 2009 5:00 pm ET

Executives

Annie Leschin – IR

Hans Betz – President and CEO

Larry Firestone – EVP and CFO

Analysts

Kate Kotlarsky – Goldman Sachs

Paul Thomas – Bank of America/Merrill Lynch

Tony Tian – Pacific Crest

Olga [ph] – Barclays Capital

Presentation

Operator

Good afternoon, ladies and gentlemen, and welcome to the Advance Energy’s Second Quarter Earnings Conference Call. All lines are placed on mute to prevent any background noise. After the speaker’s remarks, there will a question-and-answer session.

(Operator instructions) I will now turn the call over to Ms. Leschin, Investor Relations. Ms. Leschin, you may begin.

Annie Leschin

Thank you, operator, and good afternoon everyone. Thank you for joining us this afternoon for our second quarter 2009 earnings conference call. Listening on today’s call are Hans Betz, President and Chief Executive Officer; and Larry Firestone, Executive Vice President and CFO. Both of them will present prepared remarks.

By now, you should have received a copy of the press release that we issued approximately an hour ago. If you would like a copy, please visit our web site at www.advanced-energy.com or contact us at 970-407-4670.

I'd like to just take a moment to let you know that we will be participating in a number of conferences during the third quarter, including Pacific Crest on August 10 in Vail, Colorado; Citigroup on September 9 in New York; Deutsche Bank on September 16 in New York; and BofA on September 21 in Boston. As additional details become available, we will make other announcements.

Now, I would like to remind everyone that except for the historical and 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.

Statements that include the terms believes, expects, plans, objectives, estimates, anticipates, intends, targets or the like should be viewed as forward-looking and uncertain. 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 estimates, reserves or allowances. These and other risks are described in forms 10-K and 10-Q 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 third quarter guidance provided during the call and in our press release dated today. Guidance will not be updated after today's call until our next scheduled quarterly financial release.

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

Hans Betz

Good afternoon everyone and thank you for joining us. We ended the second quarter of ’09 with a particularly bleak view of the market and have since exited the quarter with signs of life returning and an improved outlook for the equipment industry. We have been encouraged to see long-awaited signs of stabilization and pockets of improvement in our markets.

Semiconductors have begun to show a moderate upturn, also reflected in our service business while solar equipment grew despite the continuing panel oversupply. Flat panel’s lack of financing shows no sign of ending before 2010. However, different avenues are opening up to address financing issues, not the least of which are the stimulus plans by various governments around the world. We remain optimistic that the effects of these programs will eventually have a positive effect on the macro economy, particularly areas such as solar and inverters. From our current vantage point, the worst of the declines in our markets appears to be behind us and the outlook is positive.

Second quarter results delivered sales of $35.6 million and a GAAP loss of $0.38 per share. We believe the careful but substantial cost-cutting measures implemented over the last several quarters were critical to weathering the storm. We continue to conserve cash as we closed the quarter with $175.3 million. A strong balance sheet is a key strategic advantage as we navigate through the cycle; but more importantly, it enables us to invest in next-generation power conversion products and technologies such as the expansion of our Solaron inverter product line. We have delivered on our commitment to accelerate technology investments and keep R&D spending steady at recent levels in an effort to roll out new products and gain market share in our markets. After a year-and-a-half of declining sales, the semiconductor market was at a particularly vulnerable point when the economic crisis hit last fall.

During the first quarter of 2009, however, capital equipment spending in the semiconductor market appears to have bottomed; and since then, the market has begun its recovery albeit slowly. Semiconductor OEMs have continued to work through their inventories and finally reached a point where the purchase of spare parts and the tear [ph] of equipment have become essential to meet current levels of demand causing our service revenue to grow as well. We are beginning to see orders from new products which reflects investment in technology to advance semiconductor equipment to the next node rather than the expansion of fab capacity.

We are also seeing certain markets such as Korea, where we have a strong market presence, emerge as strong second-tier players in the global capital equipment supply chain. Additionally, our next-generation power conversion product, Paramount, continues to gain momentum in the market. Paramount not only increases the technological capability of our customers but also lowers their cost of ownership. We are starting to see volume production orders of this product targeted at the sub-45 nanometer node.

Based on our results and customer feedback, we believe the semiconductor market will show gradual improvement throughout the rest of the year based in parts on technology investments at Intel, AMD, Samsung and TSMC. However, visibility remains limited longer term.

In our non-semiconductor markets, solar once again lead the way. Similar to most solar equipment vendors, we too are experiencing the effect of panel oversupply, both the crystal and silicon, in the form of orders push-out.

We are seeing certain geographic areas, such as Asia, buck the trend and continue to invest and expand its solar panel manufacturing capacity with the majority being (inaudible). Despite these pockets of growth, we have been skewed [ph] primarily by government funding. We anticipate investment in photovoltaic equipment will recover slowly over the next few quarters as financing becomes available. We have also begun to see significant traction in the large-scale inverter market with our 500KW Solaron inverter product announced earlier this year. We spent the last two years seeding this market with the 333KW product, establishing our product reliability at 97.5% conversion efficiency.

We recently received our first multi-megawatt order from a utility for a large ground-mount installation, thus seeing our backlog increase significantly with orders from other utilities. In total, we have sold or received orders for 42 333KW and 24 500KW inverters, three times as many 500KW inverters as we did in the first quarter. We are currently expanding our manufacturing capacity to handle growing demand. We have successfully established credibility in the large commercial market and the strength of our service business and global footprint are being recognized as a key asset to servicing the worldwide installed base of solar arrays.

We believe our technology, efficiency and AE's (inaudible) was crucial to winning these orders, as it satisfies the market need for large power conversion. Based on the feedback we have received from the market, indications are promising that our 1 Megawatt product targeted for release in the first quarter 2010 will be highly regarded as well.

The strategic decision we made a few years ago to pursue the inverter market has not only added to AE's power conversion product line but also allowed us to target a different kind of market that for the first time in the company’s history is driven not only by capacity expansion, but by the installation of solar arrays as well.

While production of solar panels have fallen off in recent quarters due to overcapacity casting a shadow on investment in capital equipment for new capacity in the near term, the return of investment for solar installation has become more attractive with lower panel prices and subsequently begun to drive demand. The result is an increased inverter sales as every solar installation requires inverters to convert DC power that the solar panels deliver into AC power for use.

Other market factors such as U.S. Economic Stimulus Package, the passage of the ITC, and associated initiatives surrounding the renewable movement will only serve to motivate solar sales, expedite the installation of solar farms, and with that improved sales of high-powered inverters.

With this as backdrop, even if solar markets' conditions remain relatively stable, inverters have the potential to grow significantly in the next year just to keep pace with installations.

The flat panel market on the other hand may take some time to recover as the declines in this market continues in the second quarter. The good news is that flat panel prices appear to have stabilized. While consumer demand for LCD panels have improved, it is not yet strong enough to require increased production capacity and the associated financing needed for production equipment.

Until this market receives financing, we do not expect to see a return of capacity growth. We believe that Taiwan and China will be the next geographical markets to move ahead with Gen-5 to Gen-7 panels; and new investment in China targeted for early 2010 should spur demand for equipment towards the year end. But the overall market will not see much of an improvement until 2010.

Looking at our service business, January appears to have been the trough in our repair activity. As I mentioned, semiconductor manufacturers have finally begun to place orders to replenish the inventory of spare parts. With fab utilization in both semiconductors and flat panel beginning to pick up, we expect this to drive service revenue. As a leading indicator, service revenue increases should come ahead of a recovery in the economy at large.

Our other business line showed mixed results this quarter, with data storage was perhaps the highlight. The demand for Blu-ray and magnetic media remained soft through year end.

In summary, with the first half of 2009 behind us, we look forward to the rest of the year with cautious optimism, with at least one of our major markets, semiconductors, beginning its recovery, the large-scale inverter market opportunity growing, we are hopeful other markets such as solar equipment for panel manufacturing will follow suit in the next few quarters. We are especially encouraged by the growing interest in our inverter products. We introduced the 500KW Solaron product at what appears to be the optimal time as the size of solar installations are increasing and the well-financed utility customers are taking advantage of our technology.

We view the downturn in the economy and our markets as a unique opportunity to review our product and technology road maps, and ensure we address our target markets in the most advantageous and strategic way possible. Our outlook, quite cautious, is much brighter than just a quarter ago. Our strategy of diversification between semi and non-semi markets, combined with our strong balance sheet and the key investments we have made including our Solaron inverter products, will continue to pay off and distinguish AE as a unique subcomponent supplier among its customer.

I would like to take a moment to thank the entire Advance Energy team worldwide for their diligent efforts and hard work. Now, I would like to turn over the call to Larry Firestone, our CFO, to provide some details on our operating results.

Larry Firestone

Thank you, Hans, and good afternoon everyone. Total revenue increased 9% to $35.6 million from $32.6 million in the prior quarter, driven primarily by growth in the semiconductor and service sales this quarter. Revenues were down 59.6% from the $88 million in the second quarter of 2008. Semiconductor capital equipment market sales increased 27.3% sequentially to $12.2 million or 34.3% of total sales in the second quarter. We believe the trough in the semiconductor capital equipment market occurred in the first quarter of 2009 and we saw the beginnings of a recovery with the second quarter orders from key OEMs to replenish their inventory as well as addressing new tool orders.

Despite being strained by the ongoing lack of financing and general economic conditions, sales to the non-semiconductor markets were 41% of total sales in the second quarter. Non-semi sales were down 5% to $14.6 million due to declines in flat panel display and architectural glass markets. Sales to the solar market were roughly flat at $6.3 million in the second quarter or 17.6% of total sales. As the industry continues to struggle with solar panel oversupply, manufacturers are focused on reducing their inventory and selling their existing capacity instead of expanding their production capacity. Funding through finance expansion is limited as a whole.

Sales to the flat panel market fell 14.3% from last quarter to $2.9 million and represented 8.2% of total sales as expansion capital remain limited in this market. Architectural glass sales were 1.5% of total sales or $526,000 compared to 5% of total sales or $1.6 million in the first quarter, due to the lumpiness of this market. Industrial coating and emerging market sales also improved this quarter with a number of small orders showing strength in Europe and North America. Sales grew 9% to $3.6 million or 10% of total sales versus $3.3 million in the prior quarter. Data storage market sales were $1.3 million or 3.6% of total sales, up $809,000 or 2.5% of total sales in the first quarter.

While the majority of data storage remained weak, we received a large upgrade order from a customer in Singapore in the magnetic storage market. Service was another highlight this quarter driven by growth in semiconductor utilization. Sales rose 14.2% from last quarter, representing 24.8% of total sales or $8.8 million with strength across geographic regions.

Our book-to-bill ratio returned positive this quarter, increasing to 1.06 to 1 from 0.87 to 1 in the first quarter of 2009 on a higher revenue base. We ended the second quarter with $26.2 million in backlog, all of which is shippable over the next 12 months, and approximately 88% of it which is shippable in the third quarter. This is compared with last quarter’s backlog of $24.4 million.

Gross profit was $7.9 million or 22.3% for the second quarter, compared to $6.4 million or 19.6% in the first quarter. This sequential increase was driven by the overall growth in sales as well as the lower freight and manufacturing expenses. Gross profit declined from the same period last year of $35.3 million or 40.1%.

R&D decreased 3.2% to $10.7 million or 30.2% of second quarter sales, down from $11.1 million or 34.0% of first quarter sales, and $13.8 million or 15.6% of sales a year ago. We continue to focus on our R&D investments and development efforts on key emerging technologies and new market opportunities.

Staying a consistent 28.6% of total sales, SG&A increased to $10.2 million from $9.4 million last quarter, and decreased from the $14 million or 15.9% in the same period last year. This sequential increase was due to a $1 million one-time reduction in depreciation associated with our building in Japan that occurred in the first quarter and $400,000 of cost in the second quarter associated with moving out of one of our facilities in Fort Collins. This space reduction will save us approximately $500,000 a year, per year going forward, and we have plans for further building consolidation.

Our income tax expense was $2.8 million due to the income in our German and Japan subsidiaries during the quarter. Going forward, we expect a similar charge on an absolute dollar basis while the U.S. tax rate will remain at zero.

GAAP net loss was $16 million or $0.38 per share compared to a net loss of $79.8 million or $1.90 per share in the first quarter, and a net income of $5.9 million or $0.14 per diluted share in the second quarter of 2008. Second quarter GAAP net loss included a $739,000 or $0.02 per share charge related to our recent restructuring efforts.

Headcount at the end of the second quarter was 1,195 employees compared to 1,251 employees at the end of the first quarter. As of June 30, cash and investments including auction rate securities were $175.3 million, an increase of $1.9 million from the $173.4 million last quarter, and down from the $180.1 million at December 31, 2008. The increase in cash was driven by strong customer collections, a gross inventory reduction of $6.2 million, and a $1.8 million tax refund. During the quarter, we repatriated approximately $46.2 million in cash from our Japanese subsidiary.

Trade accounts receivable dropped to $32.3 million at the end of the second quarter, compared to $35.6 million at the end of the first quarter. We took proactive steps to collect on outstanding accounts receivable. As a result, DSOs were 74 days compared to 109 days in the first quarter.

Total net inventory was down significantly to $39.8 million from $46 million last quarter, and inventory turns on a net basis improved slightly to 3.6 times from 3.8 times last quarter. Capital expenditures were $742,000, fixed asset depreciation was $919,000 and our intangible amortization was $120,000 for the second quarter.

Our guidance for the third quarter is as follows: We expect sales to be in the range of $40 million to $45 million. We expect our gross margins to be in the range of 23% to 27%, and we expect our GAAP loss per share to be in the range of $0.35 to $0.29, including an estimated $2 million tax expense related to earning at our regional offices in Japan and Germany.

In summary, we are cautiously optimistic about the business levels we are seeing in our key semiconductor and service markets. Coupled with proactive measures to lower our cost structure and improve operational efficiencies, our strong balance sheet has allowed us to continue to invest strategically in the key products and technologies for various markets, and position us well for market share and financial gains when the upturn in our markets occurs.

That concludes our prepared remarks for today. Operator, I would like to open up the call for questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Jim from Goldman Sachs. Your line is open.

Kate Kotlarsky – Goldman Sachs

Hi. This is Kate Kotlarsky for Jim Covello. I have a couple of questions. First, I wanted to ask about your guidance and try to get a sense of which markets you think are going to be driving most of the upside next quarter, whether you think that the semi-equipment and the semiconductor customers are going to be driving most of the upside, or whether you do expect something from some of your non-semi markets? I guess that is the first question.

Hans Betz

So, as far as the drivers for the next quarter, we see in essence three drivers. One is semi-equipment which is improving, of course. The other one is solar and within solar, mostly driven by a strong inverter business we see and of course, service. And as, maybe as the fourth driver, as we indicated in the last quarter call that the industrial coating, which probably will benefit first from the stimulus package, we see it growing strongly in the third quarter as well.

Kate Kotlarsky – Goldman Sachs

And as a follow-up on that, as it pertains to the solar business, it sounds like customers generally speaking in the solar space are still pretty cautious and it’s great that you guys are seeing good traction with the inverter product. Is some of this kind of share gain due to geographic exposure? Just want to get a sense for why you guys are a little bit more optimistic than maybe some of the other companies in the solar space.

Hans Betz

The reason is pretty simple. I think we have been in China for a long time. We have a strong position and I think we have a pretty strong position in Europe as well, and what we see is, in particular in China, the stimulus package given by the government is bearing fruits already, and our business and solar business in particular in China is pretty strong and keeps strong. So, it’s a different pattern, U.S. versus China for example.

Kate Kotlarsky – Goldman Sachs

Okay, that is very clear, thank you. And then just one question on the model for next quarter. Any change to the $60 million breakeven target that you guys had talked about before? And just wanted to get a sense for whether there is any change in the OpEx next quarter versus what we saw this quarter?

Larry Firestone

We are still in the range of $60 million breakeven, is where we are heading; and OpEx, the same.

Kate Kotlarsky – Goldman Sachs

And any charges next quarter that you guys are anticipating?

Larry Firestone

No. The only one that I mentioned was a $2 million tax expense. I made sure I modeled that in through your numbers for earnings in Japan and Germany as the U.S. tax rate will be zero.

Kate Kotlarsky – Goldman Sachs

And is that something you are anticipating in the following quarter as well or is it more of a one-quarter phenomenon as you see it now?

Larry Firestone

Yes. I would see that in the following quarter as well, Kate.

Kate Kotlarsky – Goldman Sachs

Okay, great. Thank you so much.

Operator

Your next question comes from the line of Krish from the Bank of America. Your line is open.

Paul Thomas – Bank of America/Merrill Lynch

Hi. This is Paul Thomas for Krish Sankar. Thanks for taking my question. Could you talk a little more about, I guess just beyond Q3 into Q4 – now that sales are starting to pick up, are we going to see some expenses come back in from the temporary reductions, or maybe even a little further than that?

Larry Firestone

Yes. The temporary reductions that we have in are planned in and pretty well locked in through the end of the year. We have not really laid in our plans for next year but we have a combination of more permanent reductions – I mentioned on the call that we moved out one of our facilities; that is going to save us about $500,000 a year. Beyond that, we have other facilities consolidations that we are looking at and executing, so – and beyond that, I would call it efficiencies in the business to go gain. So what our target is, at the time that we would roll out of our temporary cost reductions that we would have a permanent cost reduction to match up with that, kind of along the lines that I mentioned.

Paul Thomas – Bank of America/Merrill Lynch

Okay, thanks. And then, also on the guidance range in terms of gross margins, you talked about the revenue drivers. What is going to drive the gross margins to one end or the other of the 23% to 27% range?

Larry Firestone

It would really be product mix and also the revenue range.

Paul Thomas – Bank of America/Merrill Lynch

So is it – which is the lower gross margin driver on that, I guess, of the three drivers that you talked about, the semi and solar and service?

Larry Firestone

We wouldn’t break it down to that level of granularity.

Paul Thomas – Bank of America

Okay.

Operator

Your next question comes from the line of Weston Twigg. Your line is open.

Tony Tian – Pacific Crest

Hi. This is Tony Tian for Wes. Thanks for taking my question. I have a question regarding the inverter business. Can you tell us exactly the number of units you shipped during the quarter?

Larry Firestone

How many units we shipped during the quarter?

Tony Tian – Pacific Crest

Yes.

Larry Firestone

We shipped four units during the quarter.

Tony Tian – Pacific Crest

And another question regarding the 1000 KW inverter order, is that a modest [ph] unit order? And also, any comment on the timing of the shipment will be helpful.

Larry Firestone

On the 1 megawatt?

Hans Betz

You mean the timing of the 1 megawatt?

Tony Tian – Pacific Crest

Yes.

Hans Betz

So, I think it was in the script already that we plan to release the 1 megawatt in Q1 next year.

Tony Tian – Pacific Crest

Q1 next year?

Larry Firestone

Yes. And we didn’t say we got any orders for the 1 megawatt; that is still in development.

Tony Tian – Pacific Crest

All right. I missed seeing that part. All right, that’s very helpful.

Larry Firestone

Orders that we mentioned were really on the 500KW inverter and that was an exceptionally strong quarter.

Tony Tian – Pacific Crest

I got you. Thank you.

Operator

Your next question comes from the line of CJ from Barclays. Your line is open.

Olga – Barclays Capital

Hi. This is Olga [ph] calling in for CJ; a couple of questions. First on the solar side, given the inverter backlog they currently have and then your conversations with your traditional solar customers, I guess can you talk about how you see that business ramping into the second half given a pretty subdued first half?

Hans Betz

As far as the inverter business is concerned, I think we have seen very strong traction and all the indications are that this is going to accelerate. And that’s the reason, by the way, why we are increasing the manufacturing capability, in order to cope with the demand we expect. As far as the PV equipment is concern, I think we still kind of see flat because of the oversupply which will not go away anytime soon. I think it would probably last through Q3; maybe in Q4, it’s easing off.

Olga – Barclays Capital

When you knock that out and I guess, can you talk about some sort of range of magnitude of your solar revenue first half versus second half?

Larry Firestone

No. Not really guiding at that level, Olga.

Olga – Barclays Capital

Okay. All right. And then, on the LCD side, you guys sound pretty subdued about that. Sort of listening to the panel makers so far, there is definitely a lot of projects being outlined in Gen-7, Gen-8. I guess, can you talk about where you are seeing a discrepancy and also where your competitive positioning is at the Gen-8 level?

Hans Betz

I think as far the competition is concerned, we have a – of course, Japanese competitors. I think an indicator whether or not the flat panel display business will pick up, is in our view either the announcement of new projects and easing of the financing. So, we haven't seen that in the recent weeks or months. So therefore, we think that new capacities coming online for flat panel will probably not before 2010.

Olga – Barclays Capital

I guess, I’m just – you have seen LPO talk about an expansion for the Gen-8 fab. AUL this morning is ramping on Gen-7.5, Gen-8, restarting construction of the Gen-8. So I’m just wondering your tone versus their tone, there seems to be, I guess, a discrepancy there.

Hans Betz

I mean, if something comes up this way and if they are really placing order and building these new fabs, I think that would be – right now, it's about – in order to see a real rebound in LCD, I don’t think that’s already (inaudible).

Larry Firestone

Yes. Olga, the steady business that we do have or the business that we do see in flat panel and that we have experienced over the last several quarters has been – I think we described has been the activity out of Japan and Korea. So, with respect to your comment on LPO, that would be the kind of business that we would see on an ongoing basis. I think we all think the surge or the next real upturn is going to come out of places like Taiwan and China, as Hans mentioned to the script, and that’s going to be on the backup financing.

Olga – Barclays Capital

And then, just as a housekeeping question, the $2 million tax funds, is that something we should be thinking about the 2010 as well?

Larry Firestone

Yes, I would say so. I would say so. I would say that is a safe bet.

Olga – Barclays Capital

Okay. Got you. Thank you.

Larry Firestone

Yes.

Operator

(Operator instructions)

Larry Firestone

Okay.

Operator

Larry Firestone, you may begin.

Larry Firestone

Thank you, operator, and thank you everyone and we look forward to seeing you all at our next conference on August 10 in Vail, Colorado hosted by Pacific Crest. Thank you and bye-bye.

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