Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Advanced Energy Industries (NASDAQ:AEIS)

Q2 2012 Earnings Call

July 31, 2012 8:30 am ET

Executives

Annie Leschin

Garry W. Rogerson - Chief Executive Officer and Director

Yuval Wasserman - President of The Thin Films Business Unit

Gordon B. Tredger - President of Solar Energy Business Unit

Danny C. Herron - Chief Financial Officer and Executive Vice President

Analysts

Krish Sankar - BofA Merrill Lynch, Research Division

Edwin Mok - Needham & Company, LLC, Research Division

Colin W. Rusch - ThinkEquity LLC, Research Division

Mark W. Bachman - Avian Securities, LLC, Research Division

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Olga Levinzon - Barclays Capital, Research Division

Mark Delaney - Goldman Sachs Group Inc., Research Division

Operator

Welcome to Advanced Energy's Second Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded for replay purposes. And I would now like to turn the conference over to Annie Leschin, Investor Relations. Ms. Leschin, you may begin.

Annie Leschin

Thank you, operator, and good morning, everyone. Thank you for joining us today for our Second Quarter 2012 Earnings Conference Call. With me on today's call are Garry Rogerson, Chief Executive Officer; Danny Herron, Executive Vice President and CFO; Yuval Wasserman, President of the Thin Films Business Unit; and Gordon Tredger, President of the Solar Energy business unit.

By now, you should have received your copy of the earnings release that was issued yesterday evening. For a copy of the release, please visit our website at advanced-energy.com, or call us directly at (970) 407-4670.

This quarter, Advanced Energy will be participating in the Needham Advanced Industrial Technologies Conference on August 7 in New York, the Pacific Crest Annual Leadership Forum on August 14 in Vail, Colorado, and the City Technology Conference on September 6 in New York.

Finally, I'd like to remind everyone that except for the historical financial information contained herein, the matters discussed on this 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, objective, 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 and unanticipated changes in our estimates, reserves or allowances, as well as other factors listed in our press release.

These and other risks are described in Forms 10-Q 10-K and other reports filed with SEC. In addition, we assume no obligation to update the information that we did provide you during this call, including the third quarter guidance provided today and in our press release. Guidance will not be updated after today's call until our next scheduled quarterly financial release.

I'd now like to turn the call over to Garry Rogerson, CEO of Advanced Energy. Garry?

Garry W. Rogerson

Good morning, and thank you for joining us. I will begin today with a summary of the quarterly results and an update on the progress we've made on our strategic plan, including cost reductions and next steps to maximizing customer relationships and growing revenue.

Let me begin with Slide 4. Our second quarter performance was sound, with a 9% sequential increase in revenue to $116 million, a substantial improvement over last quarter, and profit stability of $0.18 of non-GAAP earnings per share. These results reflect our unwavering focus on lowering our cost structure and keeping those costs under control, regardless of market fluctuation. Again, we do not see these costs returning in the future.

Having lowered our quarterly breakeven to the stop of $100 million revenue level, we are now seeing the direct benefit of higher volumes equating to stronger profit. We continue to manage our working capital very well, and in the quarter, with $149 million of cash. We believe the second quarter of 2012 represented a turning point for AE, demonstrating the powerful potential of our new developing operating model.

From here, our next internal goal is to reach a $2 earnings per share target for 2014 that we laid out on our Analyst Day. The strong outlook for our Solar Energy business, combined with the return of our Thin Films market, should be sufficient to reach those levels.

We are though working, however, on a variety of ways to ensure that we achieve this internal goal, from server cost reductions to product and market expansion, either organically or inorganically, and other ways to utilize our cash.

Turning to Slide 5. Step 1 in our strategic plan was to reduce our cost structure by $16 million to $20 million annually. Having instilled a more cost-conscious culture across the organization, we have already far exceeded that, reaching upwards of $30 million in annualized cost savings, with the opportunity for more.

Now, we are moving onto step 2, finding new ways to lower our cost of manufacturing, while maintaining product quality and performance. With an experienced supply chain team in place in Shenzhen, we are just beginning to see the potential for outsourcing many of our materials and components to even lower-cost areas and utilizing modern manufacturing tools to gain greater efficiencies and lower cost.

While these savings will take longer to materialize, we believe we have the ability to save another $15 million to $20 million in manufacturing cost throughout the organization. Overall, I'm quite proud of the incredible stride the entire AE team has made in reducing our cost and achieving our 3 main goals: One, balancing the cyclicality of our business; two, reaching profitability in our Solar business; and 3, improving margins and bringing more profit to the bottom line. With our further effort, we should have the opportunity to break at -- to lower our breakeven yet further.

Turning to Slide 6. During the quarter, we generated over $33 million in cash, excluding repurchases. In addition, we completed our $75 million stock repurchase plan, buying back a total of 6.4 million shares. By lowering our cost and managing our cash more effectively, we're now looking at how best to reinvest some of those dollars, position us closer to our customers and grow our revenues.

Turning to Slide 7. What we constantly hear from our customers is how happy they are with our product, performance and service. By stating and anticipating their needs, we continue to solidify our relationships and benefit from their success as much as our own. This positions us in next generation products and allows us to enter new geographies and expand into new markets and applications.

In our Thin Films business, we won roughly 70% of the designs we targeted this quarter. Not only do we have some very significantly large wins in the semiconductor market, we are gaining a presence in areas outside of the traditional semi and non-semi market. The semiconductor wins position us for future revenue streams in 2013 and beyond.

In our Solar Energy business, we have improved our performance in each of the last 2 quarters. Currently, we have a record backlog heading into the third quarter, driven by our utility business and strong customer relationships. We've also begun to ramp shipments of our new commercial product. North America continues to be a very strong market for us, and having established our own manufacturing in Canada, we are closer than ever to our key customers in that growing region.

As we take our industry-leading products and service offerings to new territories, we are carefully selecting our partners, such as SGG, with whom we are developing low-cost inverters for the Asian market.

Finally, as we have mentioned, we are actively looking at the growing list of potential acquisitions for our business units to align with our strategy and add to our product line or geographic presence and is quickly accretive.

In summary, when you look at where we were just a few quarters ago, we have made meaningful progress in building and growing a profitable business. The last 3 quarters, we have demonstrated our ability to lower and control cost while contributing more to the bottom line. At the same time, we are expanding our reach by entering new geographies, introducing new product, and discovering new applications for our product in adjacent market. Our vision is to create a sustainable, well-balanced growth business, but even as our markets experience cyclicality, our business will remain profitable.

As you no doubt heard recently, a few of our Semicap customers lowered their outlook for the third quarter. While the semiconductor market is an important component of our business, it is no longer the majority. We have diversified into a variety of other thin film markets and built a leading Solar Energy franchise in North America, both of which should help offset some of the cyclicality we are seeing in the semiconductor market.

Today, we're a company with 2 unique business units that work separately, but in concert with one another, benefiting from each other's technology, product and manufacturing. Given our progress to date, we're on our way to achieving our 2014 internal goals of 11% cargo revenue growth, cash generation of $180 million to $200 million, and earnings per share of $1.90 to $2.10.

As we sit here today, the restructuring has exceeded our expectations. We have achieved meaningful improvement of profitability in both of our businesses, and we see plenty of opportunities to drive revenue growth across our market.

Now, let me turn the call over to Yuval. Yuval?

Yuval Wasserman

Thanks, Garry. Beginning with Slide 9, in the second quarter, we saw strong performance across most of our non-semiconductor thin-films markets, more than making up for the 5% sequential decline in our semiconductor business. While the semiconductor market wrestled with ongoing oversupply in NAND and Bergen, and slower than expected growth rate in memory content for tablets and smart phones, our non-semi business showed improvement, driven by customer wins and entry into new market in the industrial sector.

This led to a 7% sequential increase in thin-film revenues during the quarter, to $64.8 million or 56% of total sales. Operating income more than doubled over the last quarter to $8.9 million or 14% operating margin as a result of our fixed cost reductions and ongoing spending control.

Turning to Slide 10. Having realized most of our initial cost-reduction goals, we are now implementing several other programs to drive further efficiencies in our business. For example, this quarter, we began to employ new software tools to aid in our efforts to lower material cost by better managing our purchases, optimizing our inventory and improving supply cycle time. We expect further cost savings and cyclical reduction due to the broader implementation of demand flow technology and mixed lines manufacturing in our Shenzhen factory.

In keeping with our strategy to become more customer-focused, we took several steps this quarter to drive further efficiencies, localize resources closer to our customers and extend our served markets. First, we recently realigned our Thin Films organization, creating 2 different teams: One, dedicated to semiconductor, or copy exactly, Market; and another, the Thin Films industrial products and application.

While our core business in semiconductor involved a great deal of precision and design time, other markets outside of semiconductors had greater flexibility in implementing changes throughout the product life cycle. Business structure will allow us to tailor our products and services to the differing needs of these markets and address the growing demand for solutions in a variety of new applications including inductive heating, food packaging and sterilization, gas abatement and industrial coating.

Second, our strategy to position ourselves closer to our customers and collaborate earlier in their design and development processes is showing results. Our localization of engineering and a pending move of our San Jose headquarters are accelerating in a number of design wins in next-generation nodes.

During the quarter, we secured 50 wins across our semiconductor and non-semiconductor industries. The semiconductor wins position us for future revenue streams in 2013 and beyond. A spend applications ranging from PVD to S and abatement, and incorporate our recently launched Paramount and Navigator II product platforms.

In our non-semiconductor market, where designing wins can generate more near-term revenue, we achieved wins for automotive, optical and handheld device coatings, using our thin PEII Paramount Navigator, and Sekidenko product and gas abatement, using our litmus remote plasma source. These wins demonstrate the ongoing strength of our R&D, the breadth of our offerings and our ability to secure future business.

Working with our customers to meet next-generation process needs prompted 2 new product introductions this quarter. First, we launched our Ascent AMS DC Power solution at the SVC TechCon conference in early May, which incorporates our patented RF Management System to address large area sputtering in applications such as solar PV and flat-panel display.

We also introduced a Navigator II fast cat matching network at the SEMICON West trade show in July, which features the industry's fastest match solution available for sub 22 nanometers technology nodes for next-generation Thin Films plasma processing.

Turning to our outlook. We anticipate a near-term pause in the semiconductor market, demonstrated by the industry's recent announcements. As for our Thin Films market, we still anticipate a pickup in flat-panel investment later in the second half of the year and see a number of opportunities to enhance our industrial business, while the PV solar panel market remains weak.

Building on our success in reducing and controlling cost, we continue to pursue additional cost-reduction initiatives both in our operation in our global distribution network, and are proactively seeking new markets for our power conversion solutions to better offset market cyclicality. As a market leader in RF and DC power solutions, Advanced Energy is well positioned to gain share as our end markets recover.

I would now like to turn the call over to Gordon to discuss the Solar Energy business.

Gordon B. Tredger

Thank you, Yuval. Turning to Slide 12. Revenues in our Solar Energy business increased 12% sequentially to $50.8 million this quarter, or 44% of our total sales, due primarily to large-scale utility shipments in our target U.S. market. Most notably, we ended the quarter with record bookings and a strong pipeline of opportunities for the second half of this year and 2013, leaving us very optimistic about our prospects for building this business.

During the second quarter, we shipped 210 megawatts versus the 179 megawatts in the previous quarter, with commercial and utility-scale products over 250 kilowatts accounting for the majority. We generated $2.7 million in operating income this quarter versus $0.5 million in the first quarter, a direct result of our recent cost-reduction initiative.

Now turning to Slide 13. In less than a year, we have taken a number of steps to significantly improve our cost structure and lower our breakeven point. Now we're focusing on a number of longer-term cost-reduction initiatives as we turn our attention to optimizing our supply chain and effectively executing on our pipeline of R&D projects to realize our cost objectives.

First, as we have discussed, we are now manufacturing some of our sub-assembly inside of Shenzhen, and plan to increase the utilization of our Shenzhen manufacturing facility through the remainder of 2012.

Next, we're transitioning the bulk of our supply chain management to Shenzhen in the second half of this year.

We plan to automate more of these processes by utilizing new software tools to facilitate materials planning, streamline supplier selection and generate requests for quotation. We expect to recognize additional savings this year and believe that we can achieve even more savings next year. These steps should lead to greater efficiencies and further operating income improvement.

We are also making meaningful progress in growing this business on a geographic basis. First, in the U.S., we are seeing the power of the AE brand reflected in our strong backlog and order pipeline. At the recent Inter-Solar conference in San Francisco, we met with numerous customers who praised our products and service offering, and expressed their desire to explore ways for us to grow with them. In that light, we have continued to increase our bench strength by hiring additional account managers, field applications engineers and service support personnel during the quarter. We're looking forward to meeting with more customers at the Solar Power International Conference in Orlando during September.

Next, in Canada, we established our own manufacturing location as of the end of June as we become more entrenched in the market. We now have a scalable operation in Canada where we are able to control our cost and quality directly and ramp manufacturing volume with growth in demand.

With our sales applications and service support personnel operating from the same facility, we have a local presence from which we can target and serve the customer base and maintain the superior service levels for which AE is so well known. We've already won some significant orders that should benefit us in the second half of 2012, and we're seeing strong demand for our products, positioning us to be a leading player in this market.

Third, in the emerging Asia-Pacific markets, we're taking very deliberate steps to ensure that we select the appropriate market, partners and products with which to enter and succeed in these highly competitive markets, such as India. This quarter, we expanded our relationship with STEG, our Chinese partner, and plan to develop a product utilizing STEG's low-cost platform in our technology, designed for the requirements of the Asian markets. Once complete, we plan to market and sell this product to a number of Asian territories outside of China.

On a regular basis, we are being introduced to prospective projects to our customers, clearly a result of the strong relationships we have built. Japan, South Africa and South America are but a few of the opportunities where our customers have expressed their desire to work with us using the reliability of our products, our reputation for responsive service, our financial stability and our knowledge of their needs.

From initial integration and design to helping maximize energy harvest throughout the life of the project, our applications engineering and service support capabilities continue to be a differentiating factor.

As always, we will select the market opportunities where our product and service offerings fit best and that meet our financial goals. For example, the recent introduction of our 500-kilowatt mono-polar product, the AE 500 TX, is not only a good fit for the larger end commercial market, but also provides a secondary benefit as we are selling smaller scale, inverter products with approximately 1/2 of the orders for these inverters.

Though it is still early in the ramp of this product, our pipeline for the 500 mono-polar inverter remains solid, and we're enthusiastic about its prospects going forward.

Overall, we are positioned for success. We have built a strong business platform that we can leverage for sustained growth and improved operating profit over the next several quarters. While the Solar Panel market remains a bit tenuous, the demand for large-scale inverters in the U.S. is solid, even after the expiration of the 1603 cash grant program.

Utility scale projects planned over past 2 to 3 years continue to be deployed. And having won 3 significant projects that total over 200-megawatts in our utility segment last quarter, we have a record backlog and opportunities in the pipeline that should lead to healthy growth for the remainder of 2012. With Advanced Energy's products and services in high demand and several emerging markets starting to show promise for us, we believe there is a great deal of opportunity yet ahead.

I would now like to turn the call over to Danny to discuss our financial performance. Danny?

Danny C. Herron

Thank you, Gordon. During the course of my remarks, I'll refer to both GAAP and non-GAAP results. Non-GAAP measures exclude the impact of the restructuring benefits and after-tax gains on the sell of our mass flow control assets recorded in the second quarter. A reconciliation of non-GAAP income from operations and per share earnings is provided in the press release table.

Turning to the highlights of the quarter on Slide 15. Total revenues were $115.7 million, an increase of 9% sequentially and a decrease of 16% compared to the prior-year quarter. During the quarter, we completed our $75 million share repurchase program with the purchase of 35.2 million of stock. We ended the quarter with a strong balance sheet, including $149 million in cash, having generated $33.5 million in cash flow, excluding the share repurchases.

Turning to the performance of our Thin Films Business Unit on Slide 16, we'll net them in our non-semiconductor market, improved our Thin Films revenue, which increased 7% sequentially to $64.8 million in the quarter, contributing 56% to total sales.

Compared to the first quarter, we saw a 64% increase in flat panel sales to $2.2 million, a 69% increase in data storage and industrial to $9.6 million, a 14% increase in solar equipment to $3.5 million, and an 8% increase in service to $12.9 million.

These results are partially offset by the 5% decline in semiconductor sales to $36.6 million.

Turning to performance in our Solar Energy business unit, we saw a continued momentum in our inverter sales, which revenues grew both quarter-over-quarter and year-over-year. Solar Energy revenues increased 12% from last quarter to $50.8 million, driven by utility scale deployment in the U.S. market. Compared to the same quarter last year, Solar sales increased 24%.

Turning to our P&L on Slide 17. Our cost-reduction initiatives reduced operating expenses by 14% versus the same quarter last year. Sequentially, operating expenses declined $4 million, aided by lower other operating expenses, as well as a significant reduction in incentive compensation to bring year-to-date accrual in line with full-year expectation.

The pause in capital equipment spending in the semiconductor market in the second half has been partially offset by the streak in our Solar Energy business, leading us to expect that operating expenses for the balance of the year should be in line with our current year-to-date average run rate.

Currently, our P&L performance is in line with our strategic plans. Total operating expenses, excluding the restructuring to $32.6 million, a decrease of 14% versus the same period last year.

R&D expenses decreased 15% year-over-year to $14.5 million, a 13% of sales during the quarter.

SG&A decreased 16% year-over-year to $16.7 million or 14% of total sales.

I would also like to remind everyone that at the start of 2012, we began fully allocating our corporate overhead into each of our business units. This change impacts operating income for each business by approximately 3% to 5%. Nonetheless, our 9% increase in total revenues led to significantly improved operating income of $8.9 million in our Thin Film Business and $2.7 million in our Solar Energy business.

Turning to Slide 18. The cost reductions we have taken today remain intact, and we do not expect these expenses to return, even as the markets recover. Having finished the first phase of our cost-reduction plan, we are now focused on driving growth and further improving profitability. As the rest of the team mentioned, these longer-term efforts will include centralizing and automating the supply chain and inventory management and utilizing a variety of tools to improve our gross margin.

The remainder of our restructuring plan is expected to be implemented over the next 3 to 9 months as we further reduce our cost structure by consolidating certain facilities and centralizing other activities that should result in charges of about $2 million to $6 million, principally for facility consolidation, and another $2 million to $3 million for severance cost. Once complete, the restructuring plan, along with other cost-savings initiatives and margin improvements, are expected to deliver annual savings in excess of $30 million.

Turning back to the second quarter, on Slide 17, we paid taxes of approximately $4.3 million or 33% in the quarter, due to shifting of business unit profitability. Given the projected mix of our business, moving forward, our Solar Energy in the near-term, stop -- given the projected mix of our business more towards Solar Energy in the near term, which mostly occurs in the higher-taxed UL.

We have adjusted our full-year 2012 tax rate to 32%. Our tax rate assumption does not include the favorable impact of 1% to 2% if the R&D tax credit is approved prior to year end.

Income from the continuing operations was $8.8 million or $0.22 per diluted share. This compares to income from continuing operations of $0.8 million or $0.02 per diluted share in the first quarter, an income of $13.6 million or $0.31 per diluted share in the same period last year.

On a non-GAAP% basis, income from continuing operations was $7.3 million or $0.18 per share during the second quarter, excluding an after-tax gain of $1.5 million from the sell of mass flow control manufacturing assets.

Turning to our balance sheet on Slide 19. We ended the quarter with cash and investments of $149 million, a $1.7 million decrease over the first quarter. Excluding share repurchases, cash flow was $33.5 million for the quarter. Trade working capital decreased by $8.7 million during the quarter; stock option expenses, $2.2 million; and depreciation and amortization was $4.4 million for the quarter.

Finally, turning to guidance for the third quarter on Slide 20. We expect revenues to be between $116 million and $124 million and non-GAAP EPS to be between $0.17 and $0.20. The guidance reflects our view that sales to the semiconductor market will decline as the industry faces the pause. However, a pickup in our Solar Energy business should help to offset this slowdown. Obviously our margins will be lower, given the mix shift between the business units. We also expect to recognize a restructuring charge in the range of the $3 million to $4 million, mainly due to space consolidation.

This concludes our prepared remarks for today. Operator, I'd like to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is coming from the line of Krish Sankar from Bank of America Merrill Lynch.

Krish Sankar - BofA Merrill Lynch, Research Division

I have 2 of them. Garry, I just wanted to find out your view on inverter demand in the second half in the U.S., and especially what it means for Advanced Energy.

Garry W. Rogerson

Yes. I mean, we can only speak specifically of Advanced Energy. As you know, we've got record backlog and there's a hell of an activity out there in the U.S. So we're very, very comfortable. Now remember, we do pick and choose what we go for. You saw our margins improved again this quarter. So we don't go for everything. But there's a lot out there for us to go for. So we're pretty comfortable for the year. Gordon, would you like to say anything?

Gordon B. Tredger

Well, we have a strong opportunity pipeline going forward, so demand seems to be very strong from the customers that we've been engaging with at Intersolar and following up afterwards.

Garry W. Rogerson

It's important to know that space we're in. We're in utility where, as you know and we told you last time, we've got a hot product. I mean, we really do have a hot product. And we released products into the high end of the commercial. Again, now gaining traction very nicely. So we're very comfortable at the present time. Now that's not to say we can't fall off a cliff, but we are extremely comfortable, the prospect list is high, our backlog is strong and the profitability of Solar continues to improve.

Krish Sankar - BofA Merrill Lynch, Research Division

So Garry, regarding this, is it fair to say you still feel confident that your inverter revenue in 2012 would grow from 2011?

Gordon B. Tredger

Well, absolutely.

Garry W. Rogerson

I hope we sounded confident.

Gordon B. Tredger

Yes, and we've said before that we'd grow 20% year-on-year.

Danny C. Herron

Yes, and we're well on track to do that too.

Krish Sankar - BofA Merrill Lynch, Research Division

And then the final question on the guidance for September, I understand, semi is going to be sequentially down, inverters kind of grow. But I was just trying to get a sense, if we look at the whole Thin Films revenue, would that overall Thin Film revenue come down in September? Or would it be flat versus June?

Garry W. Rogerson

Just before you answer that question, Yuval, just coming back to Solar, just in case you missed it, we have absolutely a record backlog in Solar. We've got some really nice orders in-house, and the prospect list is strong for this quarter. I -- orders that we may get this quarter is strong. So at this present time, we're comfortable with our 20% growth year-on-year for this business. Obviously, if we had any doubts, we'd be telling you immediately. Yuval, on the Thin Film.

Yuval Wasserman

The question was about semiconductors, Krish?

Krish Sankar - BofA Merrill Lynch, Research Division

Yes. I was trying to get a sense of, would the Thin Film revenue, overall, into September be flat versus June, or would it be down?

Yuval Wasserman

It'll be slightly down.

Operator

Your next question is coming from the line of Edwin Mok from Needham.

Edwin Mok - Needham & Company, LLC, Research Division

Can I ask you a question about competition in solar inverter space? Have you seen your -- more competitors coming through space, and maybe a large competitor you talked about, there have actually seen some delays or some issues, the supply chain here in the U.S. Have you seen that in the marketplace?

Garry W. Rogerson

Obviously, we can't comment about other people's supply chain. We have an outstanding group of people in Shenzhen, as you know, who -- our supply chain for Solar. And that's a company-by-company issue. We're in good shape on supply-chain. And as I said, we've got strong backlog, so we've got good visibility as well. So we're in good shape.

Edwin Mok - Needham & Company, LLC, Research Division

Okay, so maybe I'll ask you differently. In terms of price competition, have you seen more price competition in the marketplace? I understand that for utility-scale project has been pretty aggressive. But on the inverter side, we've heard that price had been pretty stable. So maybe any color on that?

Garry W. Rogerson

No. I mean, firstly, we only choose to go for the business we want to go for. Secondly, we have probably, and I've used the Rolls-Royce before. I shouldn't use it, I know. But we do have an unbelievable service for our inverters, so we can command a reasonable price. We get into a situation where we win and the customer wins. And that's a situation we want to get into. We cannot -- we can't comment on competition. I mean, they do whatever they feel like doing.

Gordon B. Tredger

And from the standpoint of Advanced Energy, I mean, year-on-year, our gross margins were roughly flat. There's price competition, but we've been talking about our cost-reduction initiatives for the last couple of quarters, they're on track. And we're seeing them gaining traction. So we're pretty comfortable with where we are right now in terms of being able to compete going forward.

Yuval Wasserman

And let me point out, last year we were not fully allocating our cost. So last year in Q1, we made $500,000. With a full allocation, we would have probably lost $1 million. And this year we made $2.7 million. As Gordon said, the gross margins, while we don't disclose them, they're relatively flat year-over-year and our cost reductions have brought through profitability to the bottom line. In fact, a lot of companies still don't allocate their full cost. If we were doing it like many others in the marketplace, our margins would be 3 or 4 points better on the operating income percent of sales.

Garry W. Rogerson

Now the reason that we do that, of course, is because we want to be cost-conscious. I -- this idea of pulling out corporate cost is just like taxation without representation, really. I mean, the general managers of the business units have a problem with that, though we shove it into the business unit.

Edwin Mok - Needham & Company, LLC, Research Division

Jumping on to the Shenzhen side, I was curious, Yuval, I think I heard you talk about it's going to pick up late second half of 2012. What gives you the confidence that, that will improve?

Yuval Wasserman

We're constantly talking to both our OEM customers and also the end-users. And as you know, Samsung delayed a few times their investment in the next wave of investment. And we look at, right now, at the potential pickup in Q4 for us, driven by both growth capacity, but also technology investment.

Garry W. Rogerson

But to be fair, it doesn't matter to us, really, if it's Q4 or Q1 of next year. The key to us is that costs are coming down, our break evens are very low now, and we can get them lower. And when that peak does come again, the cash should come in or the profit should come in and the cash should follow. So, we are holding our costs down. We're waiting, of course, for that volume to come. And when it comes, we'll do well. But also, we're trying to spread our wings. Yuval has spoken about new markets we're going into to protect ourselves from these cycles. We've got some good wins outside of semiconductor at the present time, and we're really focusing on efforts in that area. So I think over time, you will see us getting out -- not getting out. We'll continue...

Gordon B. Tredger

Expanding beyond.

Garry W. Rogerson

Expanding beyond semiconductor.

Edwin Mok - Needham & Company, LLC, Research Division

And lastly, just since we brought up the topic of cost savings. So if I look at incrementally from first quarter to second quarter, that was a pretty big step-down in operating expense, right? But you guys are keeping your cost-reduction targets at exceeding $30 million, right? I was wondering if there's any incremental steps that you guys are taking that has improved your plans. As some say, it might half though. Just kind of wondering why the target are the same even though you have more -- made huge progress actually in the last quarters?

Yuval Wasserman

Well, actually, Q2 was an interesting quarter. We had really good performance, but we all also had expectation shift for the full year. So whereas at the end of Q1, we're probably expecting to be well above plan. Now, we're expecting to be on plan. So we made some adjustments to our incentives to reflect that. That's the nice thing about our new compensation plan. When you do well, we accrue at a higher rate, and when the expectations come down, we reduce the incentive compensation. So that's the biggest -- one of the largest reasons for the Q-over-Q change. But if you recall in my comment, I suggested you take the Q2 year-to-date run rate for operating expenses, and that would be good for going forward. We think we'll continue to average at that level for the remainder of the year. As Garry mentioned, our costs are out, and can tell you the culture here has changed in the last 12 months, the costs won't be coming back.

Garry W. Rogerson

Yes. Remember what we're talking about. We're taking -- it's mainly in that $30 million and above operating cost that have come out. We're now focusing on gross margin improvement. And we are seeing, as I said before, fiscally, into $20 million, we can take up. Obviously, some of that comes out in pricing as we move forward, in the Solar business perhaps. But hopefully, we can drive our breakeven down further. So if you think about cost reduction, number 1, we took operating costs out; number 2, we move -- we're moving assembly to Shenzhen; number 3, we're outsourcing from Shenzhen. And that's what we're talking about when we're talking about that $15 million to $20 million. It's really more outsourcing from Shenzhen. And number 4, which we haven't actually talked about that yet, which is probably the most exciting one, when we start taking this $45 million out, it's the design portion then. So now we're designing products, which will come out in 3 years time, probably, 2 to 3 years, I don't know, where that will reduce the cost further because we'll be designing for this new model that we have. So our target now is now $45 million in total. $45 million to $50 million.

Operator

Your next question is coming from the line of Colins Rusch from ThinkEquity.

Colin W. Rusch - ThinkEquity LLC, Research Division

Gentlemen, well done on the continued execution. Can you talk a little bit about the growth opportunities for these nonsemi interim Applications? It does seem like there's a fair amount of activity for semi-based businesses moving into industrial applications. I'd love to understand what you see as the trajectory for those opportunities that you've got in-house already.

Yuval Wasserman

Sure. Our focus is first to take the capabilities and the applications that we have developed in the semi area and extend them to adjacent market. And we have seen wins in the PVD area for special coatings applications going to the automotive industry, and that's worldwide. And recently, we've seen growth in Asia, increase in demand for application for electronic consumer products for unique coatings, both functional and decorative coatings for handheld devices. We expanded our engineering activities and application activities into the food packaging and sterilization businesses. And we have recently took our remote plasma source product line and positioned it for abatement applications for taking care, or basically disposing of, corrosive or toxic gases. And that applies to many industries as people become more green, and we expect to grow this business as well.

Colin W. Rusch - ThinkEquity LLC, Research Division

And can you give us a sense of the magnitude of the growth opportunity there?

Yuval Wasserman

We do not disclose it right now. Some of these wins are under confidentiality.

Colin W. Rusch - ThinkEquity LLC, Research Division

Right. And can you talk a little bit about the growth opportunity in Solar, just from a geographic standpoint? There's, obviously, a lot of remote sites that are now being developed in Germany. Your solution would potentially be a fit there. Can you talk about how you're approaching those opportunities, and when we might start to see some more significant growth in potentially South America, North Africa and, not least, in Southeast Asia?

Gordon B. Tredger

Yes. So we see the growth opportunities from these international markets you're talking about. We're obviously -- I think last quarter, we'd talked about the fact that we hired someone that was going to -- an experienced person that was going to be looking at these markets for us. We're going to be methodical about it. We've already announced our plans to enter India with our partners at Bergen. We spent a lot of time looking at the Indian market. But these aren't going to be quick wins for us. As we've discussed before, we're really focused on growing the business profitably. And so we'll be taking the feedback that we're gathering from these markets, coming up with the products that we know will win in those markets, finding the partners that will allow us to provide the type of service and support that AE is known for here in the U.S. And we'll keep updating you as we go forward and enter some of these new geographic regions.

Garry W. Rogerson

That's a great answer. If you think about Canada, it's taken us 3 years to develop the Canadian market. And now, we've got traction. When we went in there, we got a little bit of distribution, we tried to understand what the customers needed, we revamped our products for the Canadian market, and now, we're off to the races. That's exactly the same as in India. In India, we're in there now, we're learning about the marketplace, we are getting ready with products that we would -- still the customers would like, we'll start shipping them. It is a 3-year process to get through. I mean, India, for instance is a very, very difficult market. It's very easy to get orders in India, but it's extremely easy to get orders. It's very difficult to get paid in India. And a lot of companies outside our industry have gotten in an absolute mess doing that. We don't want to get in that mess. We want to have product designs for the Indian market, understand how they're going to pay us and do a good job. And then, we're going into others after that.

Operator

Your next question is coming from the line of Mark Bachman from Avian Securities.

Mark W. Bachman - Avian Securities, LLC, Research Division

Garry, you've used the term record backlogs several times here on the Solar business. Can you put some numbers around this in terms of how large this backlog is? And also, can you just kind of frame when the shipments or when the delivery system, sort of timeframes, on when this backlog will be delivered?

Garry W. Rogerson

We don't disclose that, but I hope you hear from our voices that we're confident in our ability to execute on what we said for solar in this year. So, we talked about a 20% average growth rate over the last 3 -- over the next 3 years, and 20% growth rate this year. We are confident that with the backlogs we have and the excitement out there at the present time, that we can get there. Obviously, if we can't get there, we would inform you as quickly as possible. Before, I said immediately. But we'll try to inform you as we always do as quickly as we can. But there's nothing to suppose, at this moment, why we won't have 20% growth this year. As I said, the backlogs are very strong, and there's decent margin backlog, as well. So we're in good shape.

Mark W. Bachman - Avian Securities, LLC, Research Division

I could hear the excitement here. How do I think about this year? Now pumping out -- you said a run rate here of $200 million this quarter. Can I think about it there's only a couple of quarters of backlog? Or can I think that, hey, we've got, at least, 4 quarters here of run rate to this record backlog that you talk about?

Garry W. Rogerson

I'm going to let Danny give you a few numbers, and maybe then I'll think of another way of answering that question.

Danny C. Herron

Mark, overall, if you look at our guidance for the quarter, 1 16 to 1 24, if you think about that, we're probably looking at a 10% to 15% decline in our Thin Film business, and probably a 25% to 30% improvement in our Solar business. As Gordon mentioned earlier, the pipeline's very strong. We certainly are coming to the end of the quarter very well positioned and certainly have the confidence that we'll achieve those numbers for the quarter. As you know, this business isn't a business where you get a contract that takes you out for several quarters. You might get 1 or 2 large contracts that do that but, mostly, you'll come into a quarter with most of your quarter covered and other stuff to ship. And then you have the long -- the big contracts. I'll refer to our previous Zachry deal. That was obviously a 12- to 18-month contract. But you don't have a whole lot of those, but you do have some. Gordon, anything to add?

Gordon B. Tredger

No, I mean, if you think about the utility segment, as Danny said, you don't get these contracts that give you that forward visibility. But you still have orders that come into play where you're working off a lead time and the deals are smaller. On the high-end commercial business, we do see situations where people expect shipments almost immediately. So when we say we've got record backlog, that tells you it's unprecedented for us, so it's giving us the confidence in the second half of the year. And when we talk about the fact that we have strong prospects, that indicates our confidence in the higher-end commercial business as well.

Mark W. Bachman - Avian Securities, LLC, Research Division

And Gordon, have you been able to win any projects larger than Zachry then?

Garry W. Rogerson

That's a very good question. We've landed some very nice, large projects. We wouldn't say whether they're larger or smaller than Zachry, but we have landed some decent business.

Mark W. Bachman - Avian Securities, LLC, Research Division

Danny, real quick, can you outline cash flow generation for us in Q2, how did it happen? Just give us a few of the components there before your cash flow statement comes out in the Q. And then how do we think about then cash flow generation in Q3 as well?

Danny C. Herron

If you think about Q2, we generated $33.5 million of cash. And that was after -- and that was before the repurchases of 35.2 million of stock. In the $33.5 million, there's probably 2 items that you could say aren't reoccurring. We've got a $5 million tax refund, and we gained about $2.5 million in cash on the sale of our flow manufacturing assets. The rest of it was a combination of $9 million reduction in trade working capital, the operating income that we produced, as well as our amortization and depreciation about $4 million a quarter. So really, if even if you back out the tax and the sale of the flow business, it was still a $27 million, $28 million cash generation. So very strong quarter. We expect Q2, we expect to continue to drive our DSO down. We came down this quarter from 101 days down to 80 days. We continue to focus on that with dedicated teams to collect money, as well as our inventory reductions have also come down. So we'll continue to focus on it. But I think this quarter, it should be -- our operating income plus the noncash items of stock compensation and amortization, and then we should see some further reduction in the trade working capital.

Garry W. Rogerson

I think the only area where I would be a little bit wary, Danny, is the growth we're experiencing in our Solar business means that inventories coming in at a faster pace. So we need to turn it quickly, so there may be a cash drain in that arena. Just -- I mean the growth is so strong in that arena. We need to balance ourselves a little bit with that.

Mark W. Bachman - Avian Securities, LLC, Research Division

Okay. On the working capital side?

Garry W. Rogerson

Yes.

Mark W. Bachman - Avian Securities, LLC, Research Division

And just last question then on this cash flow. Any plans, any ideas about putting in a new stock -- in a new stock plan here? Stock repurchase plan?

Garry W. Rogerson

Yes. I mean, utilization of cash is firstly making the organization more efficient. And you've heard some of the things we're doing to make our organization more efficient. Number 2 is acquisitions. And we really do have to acquire. We have to broaden our product line within semiconductor -- within Thin Films, sorry, within Thin Films, and dilute the semiconductor part. So there's an urgency to acquire there. Now, when I'm talking about acquisitions, we've used the word "bolt-on" or "tuck-in". Really it's the tuck-in acquisitions that we're excitedly looking for. And that lifted building, and I would think, in time, we would use cash to acquire companies or product lines or technology, just to accelerate our revenue growth. The risk to our strategic plan is not our costs. We can drive our cost down, we can improve our margins, we've got fantastic teams here now. The risk to our strategic plan is getting the growth number, getting to that $700 million. And the way we can help is through selective, accretive, quickly acquisition. Cash that's left, we will then consider using for buybacks, for stock buybacks.

Mark W. Bachman - Avian Securities, LLC, Research Division

Danny, just one housekeeping question. Can we go back to why your tax rate is coming up? Was that just solely for the U.S. exposure? And then how should we think about that tax rate for all of 2013?

Danny C. Herron

Yes. For 2012, we have a shifting of where income is being recognized. Obviously, we have a very efficient tax structure in certain countries. But with the shift in Thin Film profitability going to Solar, we have seen an increase in our tax rate. I would suggest that'll be roughly 32% for the full-year number. Now that doesn't include a retroactive reduction if the R&D tax credit is passed in the fourth quarter as most people are expecting it will. That will bring that 32% down by 1% or 2%. In 2013, given what we know today and our thought of what will happen in Thin Film, we'll probably go back to under 30% on our tax rate as we get a reshifting of the profitability by business unit.

Operator

Your next question comes from the line of Mehdi Hosseini from Susquehanna International.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Garry, in Q3 of last year, you did about $52 million of Solar revenue. In this quarter, you came almost close to that. But the margins, operating margins are very similar. So how should I think about all the cost-cutting that you have undertaken in the Solar? And when are we going to see a more meaningful margin expansion there?

Garry W. Rogerson

I think you're muddling numbers up a little bit. Probably, we're not clear. Let Danny answer that.

Danny C. Herron

Mehdi, you're referring to the Q3 of last year when the revenue was the same?

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Yes. Sort of revenue of $52 million.

Danny C. Herron

Yes. I need to go back through the Q3 numbers and see if there were any one-timers. I don't recall right now. It seems like we probably had some engineering and operating one-timers that were in there. So let me go look at that, and when we call you later this morning, I'll give you an update there. Our allocations certainly are different year-over-year. Last year, we were not allocating all of our G&A cost. So on average last year, that was about $6 million a quarter. So that means that the Solar business was probably shy $2.5 million of corporate charges that they would be getting this year. So that could be the driving force because there's no doubt, our costs are down in that business year-over-year on the controllable item. That's got to be just a timing thing.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

So let me -- looking forward and given your guidance to get to midpoint after your EPS guidance, margins are coming down because of the Solar. So -- then that's also been impacted by fewer dollars of semi-related revenue. So we got margins coming down, but your Solar business, on a relative basis, should see a margin expansion. So 2-part question: First, how should I think about margin expansion in the Solar business in the second half of this year? And number 2, how should I think about Q3 guidance? How does gross margin changes compare to operating margin?

Danny C. Herron

Well, you're absolutely right. We have a mixed shift between out business units. So the one that has the larger operating percentage income right now is declining slightly, and the other one is increasing. So just mathematically, you're going to have an overall decline on a percentage basis. But if you look at our numbers of guidance for Q3, it reflects continued improvement in our Solar business and a slight decline in our Thin Film business. And as -- I think the best way to model this is think about the operating expenses on a year-to-date basis, use the average year-to-date run rate per quarter, and go forward and think about those expenses staying flat and they'll grow whatever model assumption you have for gross margins in the Solar business and whatever gross margin assumption you have in Thin Film, and you'll get to a blended number that'll be relatively the same as what would see internally. And I think you'll see the overall business is improving. As Gordon grows volume by $320 million in a quarter, that gross margin is going to fall to the bottom because our cost is not going up. The same thing with you [indiscernible].

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

But would your 2% Solar operating margin doubles or triples by Q4?

Danny C. Herron

Well, if you run the math, if they get $20 million more revenue and say they get 25% or 35% margins, whatever your assumption is, that's another $5 million or $6 million or $7 million of operating income over what they had this quarter. So you can do the modeling and see a very profitable business. I mean -- and that brings me to a point. Garry mentioned in his remarks, we have a clear pathway to of our goal of $2 a share. If you just take where we are today and then you have Thin Film revenue coming back to where it was, and you have our Solar business growing at it -- 22% cager that we laid out for you last November, you can get to our $2 a share pretty easily by 2014 because once again, the costs are staying in check, and the costs actually are accelerating with the extra $15 million to $20 million that we think is available on our gross margin, we'll probably get there even sooner.

Garry W. Rogerson

Can I make one correction to what you're saying. Within the Solar business, we're actually adding sales people and service people at the present time because of the large prospect list. So we -- there is some increase in our selling cost at the present. And salespeople tend to take 3 to 6 months to get off to the races. So there is a cost there but, we would -- but we are -- so just so you know, I mean the growth is there and we're adding sales people, so there is a cost there.

Operator

Your next question is coming from the line of D.J. Muse from Barclays.

Olga Levinzon - Barclays Capital, Research Division

This is Olga calling in for D.J. I guess, touching on the semi side, you talked about the [indiscernible] decline being a pause. Just wondering if you currently have any facility of [indiscernible] 4Q? And if so, which end project you anticipate to drive that recovery?

Yuval Wasserman

The visibility that we have for Q4 is relying mainly on our customers' input. And right now, we see a mixed picture. And it really depends on some of the decisions that will be made regarding Q1 end-user for investment because we're usually lagging about one quarter behind in our shipment. But we continue to -- we continue to focus on preparing to next year where we believe will be an improvement next year, and we continue to win design wins in areas that will secure our future, both for 450 millimeter wafers and technology solutions for 22 nanometer nodes. So in terms of Q4, I cannot give you a clear answer regarding that. We -- what we hear from customers is that the expectation will be slightly up compared to Q3, but the information is really mixed, depends who you talk to.

Garry W. Rogerson

Yes. Again, remember what we said before, our customer is in control, they're coming down, if anything, within Thin Film. So that -- we're in effect, when that volume does come, we're in good shape, but we're also expanding into new market. Someone asked before how big are those markets that we're expanding into. They're huge, and there's lots of opportunity for us outside of Thin Film. It'll obviously take us time to get into them, but we are already, as Yuval said, starting to win some business. And we're structuring ourselves slowly to cope with this new type of business. It's very, very different in the semiconductor business. And actually, it's held us back. Semiconductor, in some ways, has held us back from this other business. And Yuval has restructured his organization so that he can now take this new business on. And it's really exciting. I mean, there's some great applications that we can get involved in.

Olga Levinzon - Barclays Capital, Research Division

And then just a follow up on your comments regarding target acquisition. How we should we think about the potential size of the deal and what level of cash you're comfortable with on the balance sheet?

Garry W. Rogerson

So, your question is how should we think about the acquisitions? We are mainly looking at small technological acquisitions that fill holes for us, that would code down our distribution channels, could be manufactured in Shenzhen. We're not thinking of having little manufacturing sites all over the place. We'll have one manufacturing site, centers of R&D excellence and our wonderful distribution channel and name. That's how we think about it. So these are more tuck-in-like acquisitions into the company. So they are going to be small. They may be small in revenues now, but our hope or our plan will be that those small revenues will grow because of our distribution and their cost would go down because of our manufacturing. So that -- you can think of smallish acquisitions accretive reasonably quickly, I don't think any -- I don't think any acquisition of this type is accretive immediately. There's always work in the first 6 months. But accretive after that, and off we go.

Gordon B. Tredger

So we're looking at targets that will be very complementary to our product portfolio and addressing areas that we believe we can buy faster than make. And also, acquisitions will take us beyond the Thin Film business into adjacent or really totally new market.

Operator

Your next question is coming from the line of James Covello from Goldman Sachs.

Mark Delaney - Goldman Sachs Group Inc., Research Division

It's Mark Delaney calling for Jim. I guess, first, there's been a lot of consolidation recently in the semi equipment industry at some of your customers and also a number of international cost restructuring along the lines that you're doing yourselves. I was wondering if you could talk about those changing customer dynamics, how that's impacting your semi equipment business?

Gordon B. Tredger

So the consolidation in the market definitely reduces the number of customers we deal with, and they become bigger and more strategic and enhance the focus on the new engagement model that we have to really get, really closer to them and engage with them in an early stage of development of their products. We have taken a few steps towards that direction with the building of the engineering center in San Jose, for example, the upcoming move of the California headquarters closer to our key customers, investment in engineering centers in Asia close to our customers. All these preparations and investments were in anticipation for a strategic relationship with the customers. That already has helped us to accelerate some of the wins we have recently won, specifically in the semi area in 22-nanometer technology and beyond and 450-millimeter wafer size investments. And what we believe is going to happen, our customers will rely on a smaller set of suppliers that are much more strategic, easy to link and they will also allow us to reduce our cost of development, the cost of R&D and will protect us in terms of our business model going forward.

Mark Delaney - Goldman Sachs Group Inc., Research Division

And then as a follow-up question, with the cost reduction efforts that you have underway and the new products that you're working on that will be rolling out in the next couple of years, do you think that total corporate average gross margin can exceed 40% by 2014?

Danny C. Herron

Well, obviously, that all depends on the mix of the Solar business and the Thin Film business. I think it'd be -- I don't see the Solar business going to 40-plus percent margins like you have in Thin Film. Well, I think the mix of the 2. What I do know is that our EPS will continue to grow. And as we mentioned, we see a very clear pathway to our $2 target that we laid out last year.

Operator

At this time, I'm showing no further questions in queue. I would like to turn the call back over to Mr. Garry Rogerson for any closing remarks.

Garry W. Rogerson

Well, thank you very much for being here today. Just a few key points that maybe we should remember. Solar is now profitable, and we're looking for growth -- continued growth in the Solar business. The backlogs are really strong. Thin Film is in a down at the present time but remains profitable. We're expecting to find new markets in Thin Film and new geographies in Solar, and we have plenty of cash. We're in absolutely great shape in relationship to our strategic plan and going forward. So thank you again for being here. See you soon. Bye-bye.

Operator

Ladies and gentleman, that concludes today's conference. We thank you for your participation. You may now disconnect. Have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Advanced Energy Industries Management Discusses Q2 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts