Advanced Energy Industries, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Financial statements are unaudited. Unless stated otherwise, amounts below are in millions of U.S. dollars.
Business context
Advanced Energy designs, manufactures, sells, and services precision power-conversion products, thermal instrumentation, and related equipment used in semiconductor and industrial manufacturing. Its solar inverter production, engineering, and sales were discontinued in 2015; remaining inverter warranty and service obligations continue to be reported as discontinued operations.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Sales | $176.6 | $126.6 | $491.8 | $348.4 |
| Gross profit | $92.2 | $66.1 | $258.2 | $181.6 |
| Gross margin | 52.2% | 52.2% | 52.5% | 52.1% |
| Operating income | $51.7 | $34.4 | $142.7 | $88.3 |
| Operating margin | 29.2% | 27.1% | 29.0% | 25.3% |
| Continuing-operations net income | $83.8 | $29.0 | $165.1 | $76.5 |
| Net income, including discontinued operations | $83.9 | $30.4 | $167.5 | $83.2 |
| Diluted EPS | $2.09 | $0.76 | $4.16 | $2.08 |
Sales rose 39.5% in Q3 and 41.2% year to date. Semiconductor sales increased 43.5% in Q3 and 47.3% year to date; industrial power sales rose 35.5% and 32.4%, respectively; global service sales rose 28.1% and 25.4%. Management attributed growth chiefly to semiconductor demand, particularly etch applications, and continued service growth. Excelsys, acquired July 3, contributed $4.0 million of Q3 sales.
Gross margin was essentially unchanged in Q3 and improved modestly year to date. Operating expenses grew in dollars but declined as a share of sales, supporting higher operating margins. Q3 continuing-operations income included a $40.2 million estimated tax benefit tied to liquidation of a U.S. solar entity; excluding that benefit, management reported effective tax rates of 15.9% for Q3 and 10.5% year to date. The reported tax benefit makes GAAP net income and EPS materially higher than underlying pre-tax operating performance alone would suggest.
Cash flow, balance sheet, and capital
- Cash flow: Nine-month cash from continuing operations was $140.3 million, versus $82.7 million a year earlier. Total operating cash flow, including discontinued operations, was $133.0 million, versus $78.1 million. Investing used $24.7 million, including $17.3 million for Excelsys and $5.6 million for property and equipment; financing used $26.9 million, including $25.0 million of share repurchases.
- Liquidity: At September 30, cash and cash equivalents from continuing operations were $366.6 million and marketable securities were $3.0 million. Management said available cash, operating cash generation, and credit availability should meet anticipated needs for the next 12 months.
- Debt and facility: The filing reports no amount drawn under the new $100 million revolving credit facility; the full $100 million was available at quarter-end. The five-year facility was entered into July 28, 2017, and its stated rate was 2.49% at quarter-end.
- Balance sheet: Total assets were $721.3 million, total liabilities $172.9 million, and stockholders’ equity $548.4 million. Inventories increased to $73.5 million from $55.8 million at year-end 2016. Goodwill and net intangible assets were $53.5 million and $34.4 million.
- Capital returns: The company repurchased 351,292 shares for $25.0 million at an average $71.16 per share. $75.0 million remained under the repurchase authorization, with no further commitment disclosed.
Changes, outlook, and notable items
- Backlog increased to $112.1 million at September 30, 2017, from $69.2 million at December 31, 2016. Management described demand as strong, particularly in semiconductor and industrial thin-film markets. The filing provides no formal revenue or earnings guidance.
- Excelsys added configurable power supplies for medical and industrial applications; the purchase consideration, net of acquired cash, was $17.3 million. Purchase accounting included $8.9 million of goodwill and $7.6 million of amortizable intangible assets.
- A $3.5 million foreign-exchange hedge for a potential offshore acquisition that was not completed contributed to the nine-month other expense. The company also reported a $3.5 million hedge loss in operating cash-flow reconciliation.
- The company had approximately $95.5 million of firm supplier purchase commitments. It disclosed ongoing legacy inverter warranty liabilities, including $24.7 million of accrued warranty liabilities in discontinued operations at quarter-end, and stated that legacy inverter claims and litigation remain a risk. No material legal-proceeding developments were reported during the nine months.
- Key disclosed risks include reliance on a small number of semiconductor customers, manufacturing concentration and delivery delays at the Littlehampton site, dependence on the Shenzhen facility, sole- or limited-source suppliers, cyclical end markets, and foreign-exchange, trade-policy, and acquisition-integration risks. The company said it had been notified that it must relocate its Shenzhen manufacturing facility by July 2020.
- Revenue standard ASC 606 was expected to become effective for the company in 2018. Management anticipated continued point-in-time recognition for most customer revenue but expected timing and balance-sheet effects for some contracts; the transition method and full impact had not been determined.
Important facts for investors to verify
- Separate the $40.2 million one-time tax benefit from recurring earnings; assess the company’s tax rate and cash-tax implications after the solar-entity liquidation.
- Track whether elevated backlog converts to shipments and cash, especially given longer delivery times for certain Littlehampton products and increased inventory.
- Assess customer concentration: Applied Materials and Lam Research represented 28.4% and 26.2% of Q3 sales, respectively; Applied Materials accounted for 43.6% of receivables at quarter-end.
- Monitor the costs, integration, and contribution of Excelsys, as well as the $95.5 million supplier commitment exposure.
- Follow legacy inverter warranty claims and litigation, the Shenzhen relocation timeline, and the eventual accounting impact of ASC 606.