Advanced Energy Industries, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. The company designs, manufactures and supports precision power-conversion, measurement and control products and related services for semiconductor, industrial and other markets. Financial statements are unaudited.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Sales | $173.1 million | $176.6 million | $564.7 million | $491.8 million |
| Gross profit / margin | $85.5 million / 49.4% | $92.2 million / 52.2% | $290.4 million / 51.4% | $258.2 million / 52.5% |
| Operating income | $39.9 million | $51.7 million | $152.0 million | $142.7 million |
| Income from continuing operations | $35.2 million | $83.8 million | $127.9 million | $165.1 million |
| Net income | $34.8 million | $83.9 million | $127.7 million | $167.5 million |
| Diluted EPS, continuing operations | $0.90 | $2.09 | $3.23 | $4.11 |
| Operating cash flow | Not separately presented for the quarter | $113.9 million | $133.0 million |
Balance sheet and liquidity: At September 30, cash and cash equivalents from continuing operations were $338.7 million and marketable securities were $3.1 million. Total assets were $833.6 million and total liabilities $234.1 million. The company reported no borrowings under its $150 million revolving credit facility, which was fully available; it was in compliance with covenants. The filing states that liquidity and expected cash generation should cover anticipated needs for the next 12 months.
Cash flows and capital allocation: Nine-month cash flow from continuing operations was $118.5 million. Investing used $110.5 million, including $93.8 million for acquisitions and $16.6 million for property and equipment. Financing used $71.7 million, including $69.0 million for share repurchases. Continuing-operations cash declined from $407.3 million at year-end 2017 to $338.7 million. Firm supplier purchase commitments were approximately $126.8 million.
Changes versus prior comparable periods
- Q3 sales fell 2.0% year over year, as semiconductor-market sales declined 17.3% to $96.4 million. Industrial technology sales rose 35.1% to $48.5 million, while global support sales rose 16.6% to $28.2 million.
- Nine-month sales increased 14.8%; growth included industrial technology (+45.5%), global support (+18.0%) and semiconductor (+6.4%). Acquired businesses contributed $11.3 million of Q3 sales and $21.3 million for the first nine months.
- Q3 gross margin fell 2.8 percentage points. Management attributed margin pressure to product mix, higher freight and customs costs, and lower overhead absorption amid lower volume, particularly at the Asia manufacturing facility.
- Operating expenses rose 12.6% in Q3, including higher R&D spending, acquisition-related activity and a $0.4 million restructuring charge. R&D increased to $18.5 million from $14.6 million.
- Reported earnings comparisons are affected by unusual tax items: Q3 2017 included a $40.2 million tax benefit related to the solar inverter business. Q3 2018 tax expense was $5.1 million, with a $3.4 million tax-reserve release offset in part by a $2.4 million charge associated with planned cash repatriation.
Outlook, commentary and key risks
- Management reported a pause in the semiconductor capital-equipment market during Q3 following delays in memory expansion spending. It expected further declines in semiconductor-product revenue in Q4 as equipment OEMs consume existing inventory and reduce finished goods. Backlog declined to $91.5 million from $131.3 million at December 31, 2017, primarily due to slower semiconductor demand.
- Management expected $3 million to $6 million of additional Q4 restructuring costs, associated with manufacturing-footprint optimization, operating efficiencies and acquisition synergies. R&D investment was expected to continue.
- In 2018, the company acquired Trek, an electrostatic product line from Monroe Electronics, and LumaSense. LumaSense was acquired in September for approximately $94.9 million in cash, net of working-capital adjustments. Acquisition integration, purchase accounting and realization of expected benefits remain relevant considerations.
- Customer concentration is significant: Applied Materials accounted for 35.0% of Q3 sales and 35.1% of nine-month sales; Lam Research accounted for 11.5% and 16.4%, respectively. Changes in demand from these customers could materially affect results.
- Manufacturing and supply risks include cyclic semiconductor demand, supplier commitments and potential excess inventory, reliance on limited-source suppliers, and a required relocation of the Shenzhen facility by July 2020. The filing also cites tariffs and trade restrictions, foreign-exchange exposure, and acquisition-integration risks.
- Legacy solar-inverter operations remain discontinued, but the company continues warranty and service obligations. Discontinued operations recorded a $0.4 million net loss in Q3 2018; the remaining warranty liabilities and service costs could change.
- The company withdrew its permanent-reinvestment assertion on $487.4 million of foreign earnings generated through 2017 and recorded a $2.4 million deferred tax liability; timing of any distributions was uncertain. The filing also notes that adoption of the new lease standard was expected to materially increase balance-sheet right-of-use assets and lease liabilities, primarily for facilities.
- No material developments in legal proceedings were reported for the period. Management concluded disclosure controls were effective as of September 30, 2018.
Most important facts for investors to verify
- Whether the semiconductor slowdown and Q4 revenue pressure developed as management expected, and how backlog and customer inventory levels changed.
- Whether margin pressure persisted and whether planned restructuring costs and manufacturing changes generated the anticipated savings without disrupting supply.
- Acquisition integration, final purchase-price allocations, acquired-business contributions, and any subsequent goodwill or intangible-asset impairment indicators.
- Customer concentration, the $126.8 million of supplier commitments, inventory growth, and potential exposure to excess or obsolete inventory.
- Cash generation after acquisitions and buybacks, continued availability of the undrawn credit facility, and use or timing of foreign-cash repatriation.
- Tax developments and the impact of ASC 606: 2018 revenue and earnings are not directly comparable with 2017 because the company adopted ASC 606 prospectively for comparative reporting; the filing quantifies the standard’s 2018 impact.