Good day ladies and gentlemen, and welcome to the Advanced Energy Q4 2016 Earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and instructions will be given at that time. If anyone should require operator assistance during the conference, please press star and then zero on your telephone keypad. As a reminder, today’s conference is being recorded. I would now like to turn the call over to Ms. Annie Leschin. Ma’am, you may begin.

Thank you, Operator, and good morning everyone. Welcome to Advanced Energy’s Fourth Quarter 2016 Earnings conference call. With me on today’s call are Yuval Wasserman, President and CEO, and Tom Liguori, Executive Vice President and CFO. By now you should have received a copy of the earnings release that was issued yesterday afternoon. For a copy of this release, please visit our website at advancedenergy.com. Before we begin, I would like to mention that AE will be participating in the Susquehanna Semi, Storage and Technology Summit on March 9 in New York. As other events occur, we will make additional announcements. I’d like to remind everyone that except for historical financial information contained herein, 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 believe, expect, plan, objective, estimate, anticipate, intent, target, goals, 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 markets 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 forms filed with the SEC. In addition, we assume no obligation to update the information that we have provided you during this call, including our guidance provided in yesterday’s press release. Guidance will not be updated after today’s call until our next scheduled quarterly financial release. Just as a reminder, in today’s call we will refer to both GAAP and non-GAAP results. Non-GAAP measures exclude the impact of non-cash related charges such as stock-based compensation, amortization of intangibles and restructuring costs, as well as acquisition-related costs and other non-recurring items. A reconciliation of non-GAAP income from operations and per-share earnings is provided in the press release table. We will be referring to earnings slides posted on the Investor Relations section of our website. With that, I’d like to turn the call over to Yuval Wasserman. Yuval?

Thank you, Annie. Good morning everyone and thank you for joining us for our fourth quarter earnings conference call. 2016 was a standout year for AE. Our focus on enabling breakthrough technologies with our advanced precision power products accelerated our growth and drove exceptional profitability. For the fourth year in a row, we saw sizeable double-digit increases in our revenue and significant acceleration across key financial metrics boosted by another year of record semiconductor and service revenue. This resulted in $484 million in revenue, $127 million in operating income, and $3.11 in non-GAAP EPS for the year. Our differentiated business model generated over $126 million of cash from continuing operations during the year, allowing us to continue to invest in advanced precision power solutions and explore inorganic opportunities. We extended our leadership in existing markets, expanded our distribution channels, and entered new applications. Our pursuit of operational excellence played a crucial role as our manufacturing capabilities responded to the significant increases in demand for our products. By year-end, we were within the range of our non-GAAP EPS aspirational goal of between $3.00 to $3.50 laid out last January. As a result, we recently announced a new three-year aspirational goal of greater than $800 million in revenue, greater than $4.00 of non-GAAP EPS, and greater than $350 million in cumulative cash generation. The fourth quarter capped off this exceptional year with total revenue of $135 million, non-GAAP EPS of $1.06, and strong cash generation of $44 million from continuing operations in the quarter. Semiconductor revenue led the way, aided by strong service revenue that bucked the trend of the typical fourth quarter slowdown. Industrial revenues declined as expected after large third quarter shipments. As the semiconductor wafer fab equipment industry surged in the fourth quarter and the year, AE’s semiconductor business…

Thank you, Yuval. The fourth quarter wrapped up an outstanding year for AE. Not only did we execute on our operational strategy as Yuval laid out, we exceeded our guidance on the top and bottom line and reached important financial milestones. Overall, our business fundamentals have never been stronger. Total revenue continued its upward trajectory, growing for the fourth straight quarter in a row to $135.3 million, up 6.9% sequentially. Non-GAAP operating margin rose to 30.7%, driving non-GAAP EPS of $1.06, an increase of 37.7% over the third quarter. These strong financial results validate our strategic direction and execution and provide a profitable base from which to pursue our growth plan. Let me start with fourth quarter sales by market. Semiconductor sales increased 19.3% sequentially to a record $96.8 million due to strong industry momentum and robust demand for our products. Service revenues increased 2.9%, reaching another new high of $19.5 million as more and more customers recognized the value of our service offerings to lower their total cost of ownership. This strategy has resulted in the consistent growth of our service business over the past four quarters. Industrial sales declined 28.1% sequentially to $19.1 million in the fourth quarter. The third quarter industrial revenues had a large number of major project installations and therefore we expected a decline this quarter. We expect our industrial revenue [indiscernible] in the first quarter of 2017. We continue to aggressively pursue inorganic opportunities to grow and diversify our business in order to reach our goal of one-third of total revenue from industrial. Non-GAAP operating margin exceeded our guided range for the quarter at 30.7%. Margins have expanded as we manage our cost structure in this high growth environment. At the same time, we continue to invest in R&D to keep pace with our…

[Operator instructions] Our first question comes from the line of Joe Maxa with Dougherty & Company. Your line is now open.

Well thank you, and congrats on a strong quarter and outlook.

Thank you.

Just wondering on the strength of the Q1 outlook, if you think that’s sustainable going forward. How are you looking at 2017 overall?

Joe, as we stated in the past, we expect 2017 in general to be stronger than 2016. We can’t specifically predict the profile of the quarters. All I can tell you is that we expect the Q1 revenues will grow across all product lines and service.

That’s helpful. On the industrial side, to be clear, are you looking for sequential growth? I mean, you called out sequential growth for service, but just said growth for industrial.

We expect to see a recovery in the industrial product lines in Q1 compared to Q4. Q4 was a decline coming after a very strong Q3. We expect Q1 to be a recovery and growth across all industrial applications.

That’s great. Last for me, I’ll ask on the margins. Strong margins, of course, in the guidance, but when I look at the guidance and the--

Hello?

Joe, you’ve cut out.

Hello?

Hello, can you hear me? I’m still here.

Now we can hear you. We lost you in the middle of the sentence.

Okay, I don’t know what happened. I was just thinking of the Q1 op margin guidance, given the revenue uptick sequentially, I would think it would be a little bit higher margin, but you’ve guided maybe a little bit lower, at least at the midpoint. Is there additional opex expenses you are expecting, more than normal, or do you have a product mix maybe affecting gross margin?

You know, it’s very close. It’s more product mix. We do continue to invest in R&D, and I think you’ll see that, Joe. I wouldn’t read too much into what you’re observing.

Sorry?

Mostly product mix.

All right, great. Thanks guys.

You bet.

Thank you, and our next question comes from the line of Edwin Mok with Needham & Company. Your line is now open.

Hey, thanks for taking my question. So first question on the semi side, I think you’ve already highlighted Korea being very strong this last quarter. I was wondering, is this strength just from your Korean end customers, or are you starting to see some of the Korean equipment manufacturers pick up in this quarter, and are you seeing that continue in the first quarter?

When we talk about revenue to Korea, we mean our Korean OEM customers.

So is that a sign that your business is broadening, because I think obviously the space is pretty concentrated with your big players, right? Are you seeing signs of broadening with some of the local Asian suppliers picking up share, or anything growing in good volume?

So the general answer is yes, we see increases in activity among our Korean OEMs, and usually our assumption is that it’s driven by device technology mix. In general, you can assume that a lot of the Korean OEMs benefit from investment in DRAM, and what we saw is a combination of basically memory-driven increase in demand in Q4 among our Korean customers, OEMs, equipment manufacturers.

Okay, actually that’s helpful. Then on the PECVD [indiscernible] wins, right? Just curious if you can give us some sense--I understand historically the power content in etch processes is historically highest. Are you seeing deposition processes, such as PECVD starting to catch up to etch, or are we still seeing a pretty big [indiscernible]?

No, Edwin, you can assume in general that the power supply content in PECVD is significantly lower than etch, both in terms of the number of power supplies per chamber and the sophistication and complexity of the power supplies. The other thing is--the other thing that you will usually find in a typical PECVD chamber is a power supply and matching network and a remote plasma source for cleaning. So the opportunity per chamber is much lower than etch, but at the same time as we see the introduction of new PECVD applications in the market, including for example ALD applications, you have a new growth that is driven by new applications.

Okay, that’s helpful. One last question I have, you guys have already laid out the strong aspirational goal of greater revenue and EPS. Any way you can kind of think about how you guys think about organic versus inorganic growth for you to achieve this goal? For example, you laid out over $800 million of revenue for a longer term goal. Just curious how you break that down. Any way to help us think about--just any kind of framework would be helpful.

Sure, so the inorganic growth, Edwin, is to get to industrial revenues about a third of our total, which would imply M&A of about $150 million to $200 million in additional revenue. If you go through the math on the aspirational goals, we can--if we were at $800 million, we can hit $4.00 per share at an operating margin slightly under 25%, and what that’s reflecting is that you see strong operating margins in our core business today, that will continue, or we expect it to continue. When we add acquisition, we may be looking at companies that have operating margins in the mid-teens, and that’s how you get to that blended rate. But overall, about half of that growth is inorganic growth.

Great, that’s helpful. Sorry - can I squeeze one in about cash? How much of the cash is onshore versus offshore, and any thought about buybacks?

Over two-thirds of our cash is offshore, and we look at our buyback and shareholder distributions every year, and we have $100 million authorization outstanding. I think we have about two years left on that, and our intent is to execute on that over two years.

Great, that’s all I have. Thank you.

Thank you.

Thank you.

Thank you, and our next question comes from the line of Amanda Scarnati with Citi. Your line is now open.

Hi, thanks for taking the question. Just to kind of pick up on Edwin’s last question, in terms of the $4.00 in EPS in the aspirational target, if the semiconductor market continues to grow on the memory side of the DRAM starting to pick up, and then eventually in 2018 we’re going to start to see demand from China, is there a way to kind of hit those aspirational targets outside of doing the $150 million to $200 million in revenue acquisition on the industrial side?

So good question. The aspirational goal is usually a result of our three-year strategic planning process. When we set the goal, as we said, our goal is to be greater than $4.00 per share, and it depends obviously on two things - the rate of increase in revenue in the semi industry, and you pointed to important things. One of them is China, that is anticipated to accelerate the demand, time to be determined, and obviously the inorganic contribution. Is it possible that we will accomplish the $4.00 per share bottom of the target earlier than three years? It is, depends on the market conditions.

Then the other question on the memory side, the content in DRAM versus in NAND, is there a difference in content there, a difference in ASPs in the products, or does it really matter in terms of growth whether it’s DRAM picking up or if it’s NAND really accelerating?

So I’ll answer it in two ways. The first one is the number of power supplies required per wafer pass, wafer manufacturing between planar and 3D, our assumption is that as you go from planar devices to 3D devices, our SAM rose by about 50%, so basically the serve available market grows. In addition to that, the power supplies that are used in advanced 3D devices, mainly etch, are more sophisticated, they are more what we all pulse RF advanced control systems. By default, these are more expensive and have higher ASPs.

Great, thank you.

Thank you.

Our next question comes from the line of Weston Twigg with Pacific Crest. Your line is now open.

Hi, thanks for taking my question. First question, just wondering if you could comment on the big increase in income from discontinued ops, and if there’s anything to read into that related to the old inverter business.

No, that’s just really the successful wind-down and selling off of assets, collecting receivables and doing better than we expected, Wes.

Okay. Then I was also wondering, there was a pretty big increase in services gross margin. Is that a relatively sustainable increase moving forward in terms of the gross margin on the services business?

I think what is sustainable is improving service margins. The service group has done a lot of work this year, and although it’s been a little lumpy on the margin side in service, it’s in the right direction. The revenue, we continue to take share, we continue to actually do better than expected in service revenue. Every quarter it is a record revenue in the service department. We’re very pleased with that, and as that happens, our margins have been improving. So it may not stay the margin percentage that it was in Q4, but the direction is sustainable.

Okay, and then just finally, I don’t know if you can tell us or if I missed it here, but can you tell us how much revenue you got from your two largest customers?

It’ll be in the K on February 23. Substantially, it’s consistent with prior quarters. I don’t have it exactly.

It’ll be in the K.

Got it, okay. Thanks.

Thank you.

Thank you, and our next question comes from the line of Pavel Molchanov with Raymond James. Your line is now open.

Thanks for taking the question, guys. I want to go back to the three-year targets. So based on the Q1 guidance, you’re already on the cusp of that $4.00 annualized EPS run rate with revenue on an annualized basis below $600 million, so where is the conservatism for adding $200 million of potential future revenue and have earnings be virtually unchanged?

No Wes, first of all, those goals are greater than, okay, and we did have a very good quarter and we’re very happy with that quarter. It did exceed expectations, which is very clear. So again, I’ll go back to--I think it was Edwin who asked what’s in our aspirational goals. It is having half of that revenue growth with industrial. That is based on acquisitions. We are assuming a target operating margin in the mid-teens, and that’s how you get to 800, slightly under 25% operating margin. We continue our core business margins, that’s how you get to $4.00. But yes, we’re running very well to it.

Yes, and you should look at blended operating income post-acquisition.

Okay, understood. Clearly it sounds like you’re getting kind of more enthused perhaps about getting back into M&A. You’ve historically talked about buying businesses at six to eight times EBITDA. Is that still the case, and what is the current M&A landscape looking like as you look at the range of potential targets? Is six to eight still plausible?

Yes, first of all, Pavel, we don’t focus on multiples. We focus on two hurdle rates. In the near term, it needs to be equal to or better than a buyback, and the discounted cash flow has to be above our weighted average cost of capital, risk-adjusted. That’s what we focus on, okay? I say that because there’s many targets that are low multiples but when we add them, they’re not great additions, and there’s other companies that are high multiples but when we add them, they’ve got a lot of synergies, so that’s why we tend to stay away. To your point, we just reiterated our aspirational goals, and that’s based on reviewing our targets. We have a good target list, we’re in dialogue, we’ve been in dialogue. These all have to end with two parties feeling good about the transaction. If there’s a decent price and there’s a very good return for AE shareholders, then that’s the way we look at it.

All right, appreciate it, guys.

Thank you, and our next question comes from the line of Tom Diffely with DA Davidson. Your line is now open.

Yes, good morning. First, some questions for Tom. Tom, what was the thought process behind putting the tax benefit in the pro forma results versus just taking it out?

Well, there’s new--not new, [indiscernible] never consistent with our non-GAAP results quarter to quarter. Traditionally, we have not taken out these tax benefits. These tax benefits are related to closure of audits, which is related to our ongoing business, and therefore while it may not be recurring in nature, it is reflective of the business. But to your point, everybody views it differently, so we just want to be very clear what the amount is, and that is $0.16 per share, and we leave it up to you, Tom, and others to treat as you desire.

Okay, that’s good. I just wanted to know what your thought process was. Then when you talked about the mix impact in the operating margin, is that a mix inside of semi or is that a mix of industrial versus semi?

It’s a product mix. The important thing to know is our semi and our industrial margins are very similar.

On average.

On average.

Okay, all right. Then I guess kind of stepping back, when you look at the year 2017, you’re calling for growth. I’m curious, though, a couple of the larger etch providers said that ED NAND is very big in the first half of the year, probably drops off a bit in the second half. Do you see--is it too early to figure out what your linearity is going to be for the year?

I think it’s too early to figure out the linearity, but I’d like to expand on a comment you made. 3D NAND is a really strong driver for the demand of advanced etch tools for in deposition tools. At the same time, logic devices and some of the foundry devices are using multi-patterning, and multi-patterning in itself requires a higher content of deposition etch. So the drivers are multiple, and as we go forward with more advanced logic devices, you will see an incremental increase in the need for PECVD and etch tools that are not driven only by 3D NAND memory but driven by just the next generation technology node for logic devices as well.

Okay, so look at the overall industry trends versus the current product lines.

Correct.

Okay, thank you.

Thanks Tom.

Thank you, and our next question comes from the line of Patrick Ho with Stifel. Your line is now open.

Thank you very much. Yuval, first in terms of your services growth this year, traditionally for sub-system suppliers, that’s always been a bit of a struggle competing against local vendors. I guess from a big picture standpoint, what’s been the key turnaround or some of the key catalysts that have helped you grow the services and, I guess, keep your customers on board with AE?

That’s a great question, thank you. So the first thing that as we realized that one of the drivers to accelerate revenue growth would be to regain market share from third party repair shops around the world, and what became clear to us that although repair shops were competing on price, the quality of the repair and the amount of failures that occurred shortly after the repair resulted in very high total cost of ownership to the customers. So we went back, worked with customers directly to demonstrate to them the value, long-term value of providing a repair directly by AE and not by the mom-and-pop shops. That’s one thing. The other thing is our philosophy regarding service has changed. We’re not looking at service anymore as a repair operation. We’re looking at service as an aftermarket business, and that includes upgrades, retrofits, repurposing of older equipment, extending the lifetime of equipment to next generation nodes by providing upgrade and retrofits in what we called engineered service solutions. All of that combined started to accelerate the growth, and we’ve been--I think fourth quarter in a row have record quarters every quarter coming from those, both market share gain and also the non-repair products that provide incremental value to our customers.

Great, that’s helpful. My second question is a follow-up. In terms of the working capital management, you noted on the prepared remarks that they’ve shown dramatic improvement this year. First part of this question is, can you give some of the tangible efforts on that front; and secondly, more specifically with the near-term environment, given the supply chain as a whole on the semi side of things is very strained very right now given the high demand, what efforts are you taking right now to ensure that your customers get the necessary products, particularly in this high demand environment?

Sure. You said a lot there. So first of all, we’ve made a lot of improvement in working capital. I think the important thing is we’re at where we want to be, so don’t expect more improvement, but be happy that it’s in the low 60s, it’s very, very good. You asked how is it accomplished. You know, a lot of people doing a very good job every day, both receivables, inventory, working with vendors to get their lead times down, get them to own the raw material, managing our procurement effectively. Same on the payables, right - there’s three parts to this, working with vendors, you know, somebody is willing to put their inventory on-site, we’ll pay them quicker; if they’re not, we’ll expect it longer term. So it’s day-to-day-to-day. Yes, you’re right - today, I think everybody is focused on, hey, let’s make sure we have the parts on hand, and this is something that even yesterday we talked about it in our staff. We look at that every week, our operations people are on top of it. Right now, we seem to be in good shape to meet what we need to do. But you know, I think you bring up a good point - other people could miss, which could affect everybody in the industry, right? But we look in pretty good shape.

One comment to add to that. We have a unique operation model. We rely on final assembly and test, so the number of parts that our operation assembles is very small. We rely on outsourcing of sub-components, and we’ve implemented during the last three years demand flow technology that is basically a pull bay system where our inventories continue to go down and a lot of the inventories held for us by our suppliers. So it’s a process that involves our suppliers, ourselves, our customers, and it’s been very helpful in continue to work and create working capital.

Great, thank you.

Thank you.

As a reminder, ladies and gentlemen, if you have a question at this time, please press the star and the number one key on your telephone keypad. Again, that is star, one for questions. Our next question comes from the line of Mehdi Hosseini with SIG. Your line is now open.

Yes, thanks for taking my question. A couple of follow-ups. How should we think about your revenue opportunity as a percentage of [indiscernible] spend? You have benefited tremendously from multi-patterning and 2D NAND, and that has basically helped AE to have semi revenue, or semi cab revenue that is now twice as much as the percentage of [indiscernible], like a little bit over 1% of [indiscernible] compared to, like, 0.4% of [indiscernible] back in 2010, 2011. How should we think about this migration? I know you have these opportunities with 3D NAND and multi-patterning. A lot of your OEMs are guiding to [indiscernible] at the turn of the decade, and I’m just trying to have a more simplistic way to think about your revenue opportunity. I have a couple of follow-ups.

Maybe I’m not sure if I can give you a number or a quantifiable answer. All I can tell you is that if we look at the expectations of the end markets and the wafer fab equipment market towards the migration or the completion of the migration to 3D devices, we’re not even halfway there, and what we hear is that we’re most likely 30% or 35% through the transition to 3D. That means that we’re going to see a significant continuing investment in equipment for deposition and etch that will be built to address capacity. Now on top of that, as I mentioned earlier, the migration to more advanced logic technology nodes will drive additional need for multi-patterning, and for that--for another area is something that will be an enabler for the next generation devices, ALD and ALE, new application space that we didn’t have significantly in the past, so that will be incremental. Now if you add to that the general opinion that China is going to invest significantly in new fabs as part of the government initiative to go aggressively after the semi market, we view that as another wave of accelerated investment that will benefit the equipment suppliers, and with that the critical component suppliers. We believe that the China initiative to migrate to semi will not be relying in Chinese equipment initially, and for the next significant number of years a lot of the western and Asian equipment suppliers will benefit from investment in China, which will benefit all the sub-component suppliers. It’s a long answer. I hope I gave you some color. I cannot give you a number.

Sure. As a follow-up, when you look at your backlog or expected build for this year, and I characterize it as your backlog, booking backlog or shipment backlog, you compare it to this time last year and the year before, has it changed, or is there different dynamics? I ask that in the context of your OEM customers’ ability to ship. It seems to me that your OEM customers are seeing manufacturing lead times extending, and I would think that they may be stepping up and procuring a little bit more earlier compared to previous years, and I would like to hear your views on it and tell me if I’m completely wrong with the thought process.

So Mehdi, since we operate in a demand flow technology both with our suppliers and our customers, most of the major semiconductor revenue shipments are just-in-time, and for that reason, talking about book-to-build ratios and backlogs is immaterial. We basically get a demand signal and when we get the demand signal, we ship a product.

And you’re flexible enough with internal operations to adjust if the demand exceeds your prior expectations? Is that the right way to think about it?

Yes, we are. That’s the reason we second year in a row continue to get awards from our customers on operational excellence and responsiveness. Our demand flow technology combined with our mix line configuration allows us to be very nimble, very agile, and to respond to changes in mix and volume very quickly.

Got it. Just one quick follow-up. You said earlier that industrial will be up in the March quarter, but relative to semi, I would think that semi would be up more than industrial and services. Is that a fair assumption?

We don’t guide by product lines or market segments or applications. As I mentioned earlier, we expect to see increase in our revenue coming from all our product lines.

Got it, okay. Thank you.

Thank you.

I’m showing no further questions at this time. I would now like to turn the call back to management for any closing remarks.

Thank you everybody for your attendance today and attention. Thanks for the good questions. We’re looking forward to seeing many of you during the quarter. Thank you very much.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect.