Advanced Energy Industries, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Unaudited results; financial amounts below are in millions of dollars unless stated otherwise. The company designs and sells precision power, measurement and control products, and related services. In September 2019 it acquired Artesyn Embedded Power, expanding into data center, telecom, industrial and medical markets.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $175.1 | $173.1 | $450.7 | $564.7 |
| Gross profit / margin | $73.5 / 42.0% | $85.5 / 49.4% | $203.4 / 45.1% | $290.4 / 51.4% |
| Operating income | $9.4 | $39.9 | $32.2 | $152.0 |
| Continuing-operations income | $7.3 | $35.2 | $46.0 | $127.9 |
| Net income | $7.6 | $34.8 | $54.7 | $127.7 |
| Diluted EPS, continuing operations | $0.19 | $0.90 | $1.20 | $3.23 |
| Diluted EPS, total | $0.20 | $0.89 | $1.42 | $3.23 |
- Q3 sales rose 1.2%, but organic sales fell $38.9 million; Artesyn contributed $40.9 million. Nine-month sales declined 20.2%, mainly from weaker semiconductor equipment demand.
- Semiconductor equipment sales fell 19.6% in Q3 and 34.8% for the first nine months. Industrial and medical sales increased 3.9% and 7.9%, respectively, including acquired revenue. Artesyn added new telecom and data center sales.
- Lower volume and operating leverage, product mix, higher freight and customs costs, and the lower gross-margin mix of Artesyn contributed to margin declines. Operating expenses rose, including acquisition and transaction costs, higher R&D spending and amortization.
- Nine-month operating cash flow was $29.2 million, versus $113.9 million in 2018. Investing cash outflow was $382.5 million, including $365.8 million for acquisitions; financing cash inflow was $342.4 million, principally from borrowings. Cash and cash equivalents ended at $340.4 million.
Balance sheet and liquidity
- At September 30, 2019, cash, cash equivalents and marketable securities totaled $341.1 million. Total assets were $1.595 billion and stockholders’ equity was $660.2 million.
- Debt had a $345.6 million principal balance ($343.3 million net of issuance costs), including $17.5 million classified as current. The $350 million term loan and $150 million revolving facility mature in September 2024; the revolver was undrawn, leaving $150 million available. The company reported covenant compliance.
- The credit facility’s effective interest rate was 2.79% at quarter-end. Quarterly principal payments are approximately $4.4 million, with the remaining balance due at maturity.
- Operating lease liabilities totaled $112.7 million; these are separate from reported debt. Accounts receivable and inventory were $250.2 million and $240.7 million, respectively.
Material changes and unusual items
- The Artesyn acquisition’s purchase price was $367.8 million net of cash acquired; its preliminary allocation included $143.3 million of goodwill and $125.0 million of intangible assets. Artesyn contributed $40.9 million of Q3 sales and $1.2 million of net income after acquisition-related financing effects. The purchase-price allocation remained under evaluation.
- In May 2019, the company sold its central inverter service business for $1 and transferred specified warranty obligations. It recorded a $14.8 million non-cash gain in continuing-operations other income and an $8.6 million after-tax gain in discontinued operations. It also loaned the buyer $2.8 million and made up to $5.25 million of additional funding available subject to conditions.
- The company’s backlog was $300.6 million at September 30, compared with $74.7 million at December 31, 2018; management attributed much of the increase to the newly added data center and telecom markets.
- The nine-month effective tax rate was 7.7%, primarily reflecting a release of uncertain-tax-position liabilities in Q1. Q3’s 32.5% rate reflected, among other items, nondeductible Artesyn transaction costs and a change in the treatment of certain foreign earnings.
Outlook, commentary and risks
- Management said semiconductor equipment demand improved slightly in Q3 and expected further improvement in Q4, but noted limited visibility and uncertainty about when the market might return to 2017 levels. No numerical company-wide revenue or earnings guidance is provided in the supplied filing text.
- Management expected Artesyn to contribute more revenue in Q4 as it would be included for a full quarter; it also anticipated increased Q4 revenue from data center and telecom markets.
- Key risks include semiconductor-market cyclicality; successful Artesyn integration and realization of expected benefits; customer and supplier concentration; tariffs and international trade restrictions; foreign exchange exposure; and execution of manufacturing changes. The company said its Shenzhen facility must relocate by December 2021 and was investing in additional production options in Malaysia.
- Firm supplier purchase commitments were approximately $179.7 million. The filing also reports increasing claims and litigation related to the legacy inverter product line, along with ongoing warranty obligations. Management stated disclosure controls were effective at quarter-end and that no material change in internal control over financial reporting occurred during the quarter.
Investor verification points
- Track organic sales and margins separately from acquired revenue, particularly semiconductor demand and the margin mix of Artesyn.
- Review Artesyn integration progress, final purchase-price allocation, acquisition costs, and evidence of anticipated synergies.
- Assess operating cash conversion and working-capital movements against the sharp decline in year-to-date operating cash flow.
- Monitor debt repayment, covenant headroom, interest-rate exposure, and liquidity needs alongside planned capital spending or further acquisitions.
- Follow backlog conversion, customer concentration, supplier commitments, legacy inverter claims and warranty costs, and the Shenzhen relocation and Malaysia manufacturing plans.