Advanced Energy Industries, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Amounts are in millions except per-share data. The company designs, manufactures and supports precision power conversion and thermal instrumentation products for semiconductor, industrial and other markets, alongside a global service business. The former solar inverter manufacturing and sales business remains in discontinued operations.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Sales | $196.0 | $165.9 | $391.6 | $315.2 |
| Gross profit / margin | $101.2 / 51.6% | $87.1 / 52.5% | $204.9 / 52.3% | $166.0 / 52.7% |
| Operating income / margin | $56.0 / 28.6% | $47.8 / 28.8% | $112.1 / 28.6% | $91.0 / 28.9% |
| Continuing-operations net income | $46.4 | $45.9 | $92.8 | $81.3 |
| Diluted EPS, continuing operations | $1.17 | $1.14 | $2.33 | $2.02 |
| Operating cash flow, continuing operations | Not provided quarterly | Not provided quarterly | $87.9 | $106.6 |
- Q2 sales rose 18.2% year over year; six-month sales rose 24.2%. Industrial power grew 59.7% in Q2 and 52.9% for the half; semiconductor sales grew 8.8% and 18.8%, respectively. Global support revenue increased 18.7% and 18.8%.
- Gross margin declined year over year. Management attributed the reduction to higher freight costs, inventory reserves and lower overhead absorption. Operating expenses rose, particularly research and development spending, though operating margin was slightly lower year over year.
- Six-month total operating cash flow was $85.5 million, down from $100.2 million. Increased investment in inventory and receivables partly offset higher operating earnings. Investing cash outflow was $18.6 million; financing cash outflow was $40.6 million, including $38.1 million of share repurchases.
- At June 30, cash and cash equivalents from continuing operations were $433.0 million, with $3.1 million of marketable securities. The company reported no borrowings and had $150.0 million available on its revolving credit facility, which expires in July 2022; it was in compliance with covenants. Management said liquidity should cover anticipated needs for the next 12 months.
- Total assets were $835.1 million and total liabilities $239.5 million. Current assets were $670.8 million versus current liabilities of $132.3 million. Inventory was $109.8 million, up from $78.5 million at year-end.
Material changes and notable items
- Backlog declined to $103.9 million at June 30 from $131.3 million at December 31, 2017, primarily reflecting slower semiconductor demand. Semiconductor revenue fell 6.4% sequentially, which management linked to a pause in capital-equipment demand, especially in Korea; industrial sales offset this decline and lifted total sales 0.2% sequentially.
- The company adopted ASC 606 in Q1 2018 using the modified retrospective method; 2017 comparisons were not restated. For Q2, ASC 606 increased reported sales by $4.2 million versus the prior accounting method; for the first half, the increase was $5.6 million. This limits direct comparability of reported growth rates.
- Acquisitions included Trek, acquired in February for $11.7 million cash, and an electrostatic technology/product line acquired in May for $3.0 million. Reported Q2 and first-half sales included $10.1 million and $18.0 million, respectively, from recently acquired Trek and Excelsys businesses.
- In July 2018, the company agreed to acquire LumaSense for $85.0 million cash, subject to German competition-authority approval and customary price adjustments. LumaSense reported approximately $59.4 million in 2017 sales.
- The board increased the share-repurchase authorization by $50 million in May. The company repurchased 588,000 shares for $38.1 million in the first half; $82.0 million remained authorized at June 30. It repurchased a further $8.8 million after quarter-end.
- Tax expense increased: the effective tax rate was 16.4% in Q2 and 16.9% for the first half, compared with 3.8% and 7.3% in 2017. The filing cites the Tax Act, GILTI tax and entry into additional foreign tax jurisdictions; its Tax Act accounting remained provisional.
Outlook, risks and contingencies
- The filing provides no specific quantitative revenue, earnings or margin guidance. Management expects continued investment in research and development and believes available cash, credit and expected operating cash generation will meet anticipated needs over the next 12 months.
- Risks include semiconductor-industry cyclicality, customer order volatility, and customer concentration: Applied Materials accounted for 35.1% and Lam Research 18.5% of first-half sales. Applied Materials represented 38.4% of receivables at June 30.
- Manufacturing and supply risks are notable. Certain products have delayed shipments from the Littlehampton, UK site, with a manufacturing transition to Shenzhen potentially increasing delays and inventory. The company must relocate its Shenzhen facility by July 2020. It also disclosed $139.9 million of firm supplier purchase commitments and dependence on some sole- or limited-source suppliers.
- Potential U.S. tariffs on certain China-origin goods and semiconductor equipment or parts could raise costs, pressure margins or affect demand; the filing states that some proposed tariffs remained uncertain. Foreign-exchange movements also affect results, and no currency forward contracts were outstanding at June 30.
- Legacy inverter warranty and service obligations remain despite the discontinued business. Discontinued-operations warranty liabilities totaled approximately $18.6 million at June 30. The company also disclosed ongoing ordinary-course disputes and legal actions, with no material developments during the period.
- Other commitments include fixed annual payments to the HiTek pension plan. The company reported a $19.2 million pension liability. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- How much of reported sales growth reflects underlying demand versus ASC 606 timing effects and acquired-business contributions.
- Whether the lower backlog and sequential semiconductor slowdown persist, and how they affect future sales and margins.
- Inventory growth, cash conversion and supplier commitments, particularly if demand weakens or components become excess or obsolete.
- Execution, cost and timing of the Shenzhen relocation and Littlehampton manufacturing transition, as well as exposure to proposed tariffs.
- Completion and financing of the proposed LumaSense acquisition, including regulatory approval and final purchase-price adjustments.
- Customer concentration, legacy inverter warranty costs, and the final effect of Tax Act accounting and foreign tax rules.