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Edited Transcript of AEIS earnings conference call or presentation 2-May-17 12:30pm GMT

Thomson Reuters StreetEvents

Q1 2017 Advanced Energy Industries Inc Earnings Call

FORT COLLINS May 3, 2017 (Thomson StreetEvents) -- Edited Transcript of Advanced Energy Industries Inc earnings conference call or presentation Tuesday, May 2, 2017 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anne M. Leschin

StreetSmart Investor Relations - Principal and Founder

* Thomas Liguori

Advanced Energy Industries, Inc. - CFO, CAO and EVP

* Yuval Wasserman

Advanced Energy Industries, Inc. - CEO, President and Director

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Conference Call Participants

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* Joseph A. Maxa

Dougherty & Company LLC, Research Division - VP and Senior Research Analyst

* Pavel S. Molchanov

Raymond James & Associates, Inc., Research Division - Energy Analyst

* Sreekrishnan Sankar

BofA Merrill Lynch, Research Division - Director

* Thomas Robert Diffely

D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst

* Yeuk-Fai Mok

Needham & Company, LLC, Research Division - Senior Analyst of Semiconductor Capital Equipment

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to the Advanced Energy First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, today's conference call is being recorded.

I would now like to introduce your first speaker for today, Annie Leschin. You have the floor.

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Anne M. Leschin, StreetSmart Investor Relations - Principal and Founder [2]

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Thank you, operator, and good morning, everyone. Welcome to Advanced Energy's First Quarter 2017 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 www.advancedenergy.com.

Before we begin, I would like to mention that AE will be participating in a few conferences this quarter, the JPMorgan Global Technology Conference on May 24 in Boston, the Stifel Technology Conference on June 5 in San Francisco and the Citi Small & Mid Cap Conference on June 8 in New York. As other events occur, we'll 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, goal 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 on 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've 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.

And just as a reminder, in today's call, we will refer both to GAAP and non-GAAP results. Non-GAAP measures exclude the impact of noncash-related charges, such as stock-based compensation, amortization of intangible assets and restructuring costs as well as acquisition-related costs and other nonrecurring 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 as well.

And with that, I'd like to turn the call over to Yuval Wasserman. Yuval?

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [3]

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Thank you, Annie. Good morning, everyone, and thank you for joining us for our first quarter earnings conference call. The first quarter of 2017 continued what has been an exciting time and an incredible run for AE in the semiconductor capital equipment industry in particular. Significant demand for our enabling power conversion technology for advanced semiconductor applications again proved to record levels.

Together with rebound in our industrial applications, total revenues increased 45% year-over-year and non-GAAP EPS grew 89%. Our ability to consistently manufacture and deliver high-quality products and device -- and services to our customers during this unprecedented ramp in demand is a testament to our organization's commitment to operational excellence.

All of this allowed us to deliver impressive results with first quarter revenues of over $149 million, non-GAAP EPS of $1.04 and nearly $43 million in cash generation.

Semiconductor revenues increased over 50% from last year to $105 million. Accelerated demand in advanced memory devices, primarily in mobile handset and solid state drives, combined with a strong performance from our Korean OEMs led to our fifth consecutive quarter of record semiconductor revenue. Together with a ramp of 1x nanometer logic, the considerable investment in 3D NAND is driving much of the growth, both in fab capacity expansion and next-generation technology development.

As they increasingly move to increasingly sophisticated 3D NAND devices with additional layers and challenging architectures, more complex deposition in etch equipment is required. Advanced Energy is playing an important role in delivering highly engineered precision power supplies for these new processing tools.

A key driver of our success comes from continuously investing in R&D and winning new designs in this fast-growing areas. This quarter, we saw a broad set of design wins in semiconductor applications for customers in Asia and the U.S. Advanced 3D memory and logic devices drove the majority of the wins. We also won designs in new plasma-enhanced atomic layer deposition applications with our new remote plasma source technology, which is being adopted for radicals-based processes.

Finally, this quarter we had an important milestone with our solid state RF matching product, which has progressed from evaluation to pilot and mass production for advanced etch applications. Solid state RF matches enable the performance of emerging short plasma processes with high speed, reliable and dynamic control.

Looking ahead, solid state drives and mobile headsets continue to generate demand, leading to 3D NAND acceleration and additional foundry and logic investment in the ramp of 10 nanometers and the development of 7 and 5 nanometers. As the semiconductor capital equipment industry strives to keep pace, some OEMs are reaching maximum for capacity and tailoring their material planning accordingly. This leads us to expect our second quarter semiconductor revenues to remain at or above the first quarter's level.

Our industrial market saw a significant rebound in the first quarter, increasing 27% from the fourth quarter. Strong growth in our thin film products came predominantly from industrial coating of advanced materials for consumer electronics. Historically, the deposition of these highly engineered materials could not be realized using standard chemical processes. Our sophisticated power supplies are enabling this highly engineered materials and coatings to have the color, composition and property desired using reactive, or pulsed sputtering processes.

Revenues from our Specialty Industrial Power business also improved significantly from the growth of our high-voltage products for the mass spectrometry market and the ramp of our thermal products through our expanding distribution channels and partnerships like Rockwell Automation.

Our continuing growth depends on our ability to design our solutions into OEMs equipment. This quarter, we had a variety of design wins across our industrial markets. In the industrial thin film space, we won designs in advanced coating applications. In China, we expanded our presence through wins in the flat panel display and the PV solar cell applications with the our new Ascent AP product.

In specialty power, we're seeing growing success in winning high-voltage designs for mass spectrometry, while actively engaging with a healthy pipeline of new opportunities, including x-ray and thermal applications in heavy industry, safety and security spaces.

We're accelerating our penetration of the mass spectrometry market due to a differentiated accuracy, stability and power density of our newly released high-voltage power supply.

This quarter, we expanded our Power Control Module market presence by winning an additional glass line project and broadening our business collaboration with Siemens to promote our power control modules in the Chinese glass industry.

Increasingly, and in line with our growth strategy, we are expanding our TAM in market share by introducing new applications for our existing products and technologies across adjacent markets. For example, we have adapted our semiconductor pyrometry technology to a broader array of industrial markets. This technology can be especially useful in materials processing due to the need for accurate, noncontact temperature measurements, such as in the production of steel, which is one of the applications where we have successfully completed a better installation. Similar examples exist in power control modules and high-voltage power supplies, which we've successfully transitioned from industrial to semiconductor applications.

For the second quarter, we expect total industrial revenues to keep pace with the first quarter run rate, growing across all segments. Thin films should account for much of the increase due to significant growth in advanced industrial coatings, solar PV, flat panel displays and architectural glass. In our specialty power business, strong performance in PCM and high-voltage products for mass spectrometry and scanning electron microscope applications should also contribute.

Our first quarter results demonstrate the success of our aftermarket strategy as we identify and pursue the opportunities to customize the value we deliver to each of our customers throughout the entire life cycle of our product.

We continue to become more intimate and knowledgeable with each customer's unique needs and direct our efforts at solving their problems. For some time now, we've been managing our service function as a growth business. As our business processes, management system and local entities continue to scale and improve and we add deeper engineering capability. We've been very pleased with the resulting accelerated growth that followed.

We look forward to continued growth in the second quarter as we hold to our simple playbook of understanding our customers' needs and delivering highly engineered solutions as quickly as possible. Recently, we celebrated the opening of a new service center in Xi'an, China in close proximity to our local semiconductor customers. This investment will allow us to provide competitive turnaround time and increase our responsiveness to the local semi players.

Entering the second quarter of 2017, we remain at historically high levels of semiconductor revenue and expect to see sequential growth as our industrial business continues to rebound and our industrial content increases. Our focus and increasing investment in innovation, leadership and technology development is helping us better serve our customers and enable their next-generation technologies for both semiconductors and industrial applications.

Continuous investment in introducing new products and transferring technology between applications is allowing us to diversify and enter new and adjacent markets and expand our TAM. With impressive results and a strong balance sheet, we continue to deliver on our strategy and pursue organic and inorganic opportunities for accelerated growth as we progress towards our aspirational goals.

I'd like to thank our customers, partners, shareholders and our valued employees for their support. Thank you for joining us. And we look forward to seeing many of you in the upcoming quarter.

I like to turn the call over to Tom. Tom?

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Thomas Liguori, Advanced Energy Industries, Inc. - CFO, CAO and EVP [4]

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Thank you, Yuval. The first quarter marked the fifth straight quarter of top line growth. Total revenue was $149.4 million, up 10.3% sequentially and 44.9% from a year ago. Non-GAAP operating margin was 31.9% compared to 30.7% in the fourth quarter and 25.3% last year.

We generated $42.7 million in cash from continuing operations. Over the past year, we have seen a nearly 50% increase in business. Our ability to quickly respond to customer demand, manage our development projects, leverage our cost and improved working capital is a testament to our highly efficient organization and commitment to customers.

Both semiconductor and service revenues reached new highs this quarter. Semiconductor sales increased 8.1% sequentially to $104.6 million due to ongoing industry-wide momentum and the critical nature of our products. Service revenue rose 5.5% sequentially, reaching $20.5 million as more and more customers recognized the competitive advantage that our service offerings provide and lower total cost of ownership.

As expected, industrial sales bounced back significantly from the fourth quarter, increasing 26.9% to $24.2 million. We continue to aggressively pursue strategic opportunities in industrial markets to expand our TAM, smooth out the cyclicality of our business and increase the quality of earnings. We would like to reach the point where 1/3 of our total revenue comes from our industrial business.

Non-GAAP operating margin for the quarter of 31.9% exceeded our guided range and is a 660 basis point improvement compared to 25.3% in the first quarter of 2016. Of this, 90 basis points came from cost of sales and 570 basis points from leveraging our operating expenses, specifically SG&A.

The benefits of the business process improvements we've made are paying off as we scale our business.

For example, we expanded the use of our ERP system around the globe, consolidated our administrative centers and utilized the shared services center in Shenzhen. This quarter, our human resource and IT teams are working to standardize our global payroll process and automate our talent acquisition. Initiatives such as these allow us to leverage our infrastructure during periods of high growth and drive more to the bottom line.

Our investment in research and development also continues to grow. First quarter research and development spending was 16.1% higher than last year. Our focus on expanding our industry-leading technology to provide next-generation solutions to our customers is a critical element of our strategy.

Other income expense this quarter of $3.2 million includes the cost of a currency option that we entered into for potential offshore acquisition that did not come to fruition. This expense is a nonrecurring M&A cost for non-GAAP EPS reported.

The tax rate for the first quarter was 11.5%. For 2017, we expect a total year tax rate of approximately 12%.

Non-GAAP EPS for the quarter was $1.04 compared to $1.06 in the fourth quarter and $0.55 in the previous year. The $1.06 in the fourth quarter included a favorable 2016 year-end tax adjustment benefit equivalent to $0.16. Compared to a year ago, first quarter non-GAAP EPS nearly doubled due to the revenue growth and cost leverage.

Turning to the balance sheet. We generated $42.7 million of cash from continuing operations, and exited the quarter with $322.7 million in cash and marketable securities. We continue to improve our working capital management. As an example, days sales outstanding is now 46 days, an 11-day year-over-year improvement, driven by process improvements made by our customer order and receivables team.

In summary, the first quarter was our fifth consecutive quarter of revenue increases. The financial results show our ability to leverage cost, invest in R&D and manage working capital in a high-growth environment. Our balance sheet remains extremely healthy. We remain committed to our capital deployment strategy as we identify organic and inorganic opportunities to grow our business.

This concludes our prepared remarks for today. Operator, I'd like to open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll be taking our first question from the line of Edwin Mok from Needham & Company.

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Yeuk-Fai Mok, Needham & Company, LLC, Research Division - Senior Analyst of Semiconductor Capital Equipment [2]

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My first question is on the semi cap side of the business, basically you guided that flat to up sequentially in the second quarter and I think Yuval -- you mentioned, it sounds like from your comments, you're seeing some supply chain challenges of your customer that's limiting the sequential growth. Can you kind of maybe give little more color around that? And is there anything you guys can do to help that and maybe -- and I have 2 follow ups?

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [3]

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Sure, Edwin. As you all know, our business is driven by our customers' shipments. And as we see continuous growth in the business, some of the OEMs, definitely not all of them, due to constraints of their own capacity or their supply chain, non-AE suppliers, caused them to basically max capacity and accordingly plan their material of critical components, such as AE, et cetera. That also was the reason why Q4 was so strong for Advanced Energy. You remember last quarter, we had a significant growth in India semi business, driven by our customers' positioning of material for early shipments in Q1 and especially compensating for Chinese New Year. So what we see in our business is a reflection of our customers' projected shipments, not revenue. Their shipment plan. So right now, we're really excited with the performance of the business and the company. If you look at the results of Q1 and the range of guidance for Q2, we are making huge progress towards our aspirational goals. And that combined with recent report from VLSI Research indicating that we have gained on average across our product lines 2.5 points of market share, it's a great position to be in as we believe that the business will continue to grow through the second half and even through next year.

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Yeuk-Fai Mok, Needham & Company, LLC, Research Division - Senior Analyst of Semiconductor Capital Equipment [4]

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Okay, great. Actually that's really good color. I have 1 follow up, on your prepared remark you talked about strong performance from Korean OEM. Are those wins that you guys have secured historically? Or you just seeing those customer basically seeing as we saw strong demand of Korea and therefore the SEM will pickup.

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [5]

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The strength in Korea is, I believe, based on recent information and what we view in the market is strongly influenced by the increase of investment in memory in Korea. And we see more business going to the direction of Korean OEMs. We are a player and a key supplier to Korean wafer fab equipment manufacturers. And as the continuous increase in investment in memory in Korea, we saw a significant growth in our revenue from Korea in the first quarter. I hope that answered the question, Edwin.

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Yeuk-Fai Mok, Needham & Company, LLC, Research Division - Senior Analyst of Semiconductor Capital Equipment [6]

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Actually, it did. It was a great answer. Last question I have is on the non-semi side. I think there you mentioned your thermal power module business has ongoing partnership with Siemens that is helping your footprint there in China. Can you maybe provide some more color in terms of how that partnership works? And -- I understand that is a small part of the industrial business right now. Do you expect that to drive greater growth, I guess, longer term?

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [7]

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Yes. But let me qualify. Our industrial business is made of multiple small components, which is a good thing. And we like it because it's very diversified and it's not very cyclical in aggregate. The power control modules that we acquired was a mainly European-centric business, and we grow it as we take these products to new world regions and drive them through our expanding and growing distribution channel. Part of our hybrid sales strategy also include partnerships with what we call channel partners. One of them is Rockwell Automation. Today, Rockwell reps and users of the Rockwell Automation systems can select AE product through the Rockwell system or website. Similarly, as we continue to expand and drive partnership with automation leaders, we have teamed up with Siemens Automation. And Siemens is expanding our presence globally, and more specifically, taken us to China glass market. Now the glass market we serve with the power control modules is not the thin film market, but rather the glass melting and float business, which is for us another layer of TAM that will continue to increase or we add more products and technologies.

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Operator [8]

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Our next question comes from the line of Joe Maxa from Dougherty & Company.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [9]

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I wanted to follow up on the semi strength, you mentioned that you expect to see the business continue to grow through the second half of next year. So I was wondering if -- I know you don't give specific color, but it sounds like you're talking the second half of '17 you think could be greater than the first half of '17? Is that how I should think of that?

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [10]

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We're not providing guidance, Joe, for the second half. But right now, reflecting the general sentiment in the market, both in the investment market, but also talking to our customers and their customers, we -- as we stated earlier, we believe that 2017 will be a better year than 2016. And we also agree with the general sentiment that the investment and growth in memory will continue through 2018. Now if you look at the -- right now based on the first half, right, our Q1 was a growth quarter, our Q2 was a growth quarter, right, projected as we guide. And again, we believe that the whole year in general will be better than 2016.

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Joseph A. Maxa, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [11]

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Okay. That's helps clear it up. I wanted to talk a little bit more about the industrial segment strength you are seeing. I understand it's very broad and you have a number of verticals, but are there a couple of keys that are really -- maybe go through that again on the keys that are really driving the strength in that business, if there are just a few?

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [12]

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Sure. I'll give you maybe 3 examples of areas that we plan, strategize and see potential growth going into the future. In the area of industrial thin films, we continued to grow and expand our industrial coating applications. We have unique technology that enable manufacturers of hard coating equipment to perform decorative films that are very unique in terms of the color, composition and structure. And this physical deposition process is enabled by our unique power supplies. A lot of these decorative or tribological coatings historically were made using chemical processes. Now the chemical processes are limited in their ability to tailor the color, composition, strength and properties of the film. Migrating into plasma processes allow the manufacturers to create very, very advanced coating that are applied not only to industrial applications but today also to consumer products. We view that as a growth area for us. Another growth area for us has been and still is, is the high-voltage product line. And within the high voltage, we focus on areas where we deliver a unique advantage. Mass spectrometry requires extremely stable and noise-free power, high-voltage power. We have a new power supply that has a very low ripple. It's a very accurate delivery of power, very stable. But the other thing, it has really high-power density, which allows our customers to have a smaller volume product. And as mass spectrometers moved from large machine in labs into almost field-deployed equipment and handheld devices for various applications, the need for high-power density is very important. So we have unique advantage there, and it's an area that we continue to pursue and gain design wins. The last example, again also for the high-voltage application space, is scanning electron microscopes. We are a critical supplier for scanning electron microscopes that are being used both in measurement and inspection in a semiconductor industry and other industries. Our unique and very advanced high-voltage power supplies enable the scanning electron microscopes to have the resolution and the capabilities required to move from one technology generation to another. I hope that answer the question, Joe.

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Operator [13]

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Our question comes from the line of Krish Sankar from Bank of America.

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Sreekrishnan Sankar, BofA Merrill Lynch, Research Division - Director [14]

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A couple of them. First one, Yuval and Tom, curious on the foreign exchange hedge. Looks like there were euro forward contracts and you guys said that there was a planned acquisition that did not come through. So curious to see is that a number one in the eurozone along the industrial vertical? And what is the reason the acquisition did not happen?

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Thomas Liguori, Advanced Energy Industries, Inc. - CFO, CAO and EVP [15]

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Sure. It was an offshore opportunity. It was priced in the foreign currency, which was volatile. We felt that was -- we wanted to lock it in first. In the end, there were some diligence items that we couldn't get comfortable with. That turned into evaluation issue. And we decided not to proceed. That said, let me give you an update on M&A. We have a series of smaller opportunities in the pipeline. They are very actionable. They're mostly private, domestic and international. And although we can't guarantee it, we do think that they will be coming to fruition in the near term.

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Sreekrishnan Sankar, BofA Merrill Lynch, Research Division - Director [16]

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Got it. And are these in the non-semi vertical?

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Thomas Liguori, Advanced Energy Industries, Inc. - CFO, CAO and EVP [17]

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Primarily, yes.

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Sreekrishnan Sankar, BofA Merrill Lynch, Research Division - Director [18]

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Got you, got you. That's very helpful. And then a follow-up, I guess, I mean I listened to your comments about how the full year is going to be stronger than last year and how things are still pretty strong. I know you guys don't give guidance on September, but just optically speaking, do you think September quarter semiconductor shipments for your guys in semi revenues would be at similar level to June or similar level to March? Or is it tough to forecast?

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Thomas Liguori, Advanced Energy Industries, Inc. - CFO, CAO and EVP [19]

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It's early to say. We feel good about our coming quarter Krish, and our revenues will follow with the industry primarily.

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [20]

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Yes, Krish, we're very excited about the year, in general. We're very excited about our progress towards our aspirational goals. We -- in fact, we're doing better than the plan we presented just six months ago. Obviously, as part of our very structured and rigorous planning process, we will now complete the strategic planning process, again, in Q3 and Q4 and update our goals if needed. But we're very excited about the progress thus far.

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Sreekrishnan Sankar, BofA Merrill Lynch, Research Division - Director [21]

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Got it. Got it. That's very helpful. And then just a final question, how much was AMAT and Lam as a percentage of sales in March?

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Thomas Liguori, Advanced Energy Industries, Inc. - CFO, CAO and EVP [22]

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I think it was 70% -- those 2 are little over 50% approximately. It will be in our...

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [23]

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It will be in the Q.

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Operator [24]

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Our next question comes from the line of Pavel Molchanov from Raymond James.

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Pavel S. Molchanov, Raymond James & Associates, Inc., Research Division - Energy Analyst [25]

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As I look at the Global Services segment, there was a time maybe 12, 18 months ago, when as a percentage of your semi cap equipment sales it was 25% to 30%, this past quarter it was less than 20% of semi cap equipment. And obviously the semi cap strength largely explains that, but as we think about the relationship between those two, is there essentially kind of a lagging effect where even if equipment slows down, global services will continue to kick up for the time being?

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [26]

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Pavel, we view service is a much more stable business and less cyclical. Obviously, with increase in fab utilization and increase in our installed base in our service offerings, we continue to see growth. And we have been growing this business quarter-over-quarter, significantly. I will not necessarily look at the relationship between the revenue of products and the revenue of service because of as you said, there is a lagging effect. Also, most of the new equipment that had been sold and shipped and installed is under warranty. And equipment under warranty does not generate revenue. So a lot of the revenue comes from equipment that is post warranty. And for that reason, if you think about it, we have a continuously growing installed base that creates a growing SAM. And with our increased development of engineered service solutions and products and gaining market share from third-party repair shops, we see this nice acceleration in growth. We also view the business as a growth business and continue to invest in engineered product and also in localized service centers. Just like the one that we celebrated about 1 week or 2 weeks ago in Xi'an, China. China see a significant growth in number of fabs, existing and new fabs and the ability to operate locally in very close proximity to our customers allow us to be very responsive and very close to our customer needs.

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Pavel S. Molchanov, Raymond James & Associates, Inc., Research Division - Energy Analyst [27]

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Okay. And just kind of a housekeeping item on the income statement. There is thoroughly meaningful amount of noncash stock comp just about every quarter, but the share count, both the basic share count and the fully diluted share count is almost identical to what it was 3 or 4 quarters ago. So what's the -- where is that variance coming from?

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Thomas Liguori, Advanced Energy Industries, Inc. - CFO, CAO and EVP [28]

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Well, the share count is -- actually from -- we see it as creeping. It is starting to creep and Pavel, the way I would look at this is that's why we stick to the capital deployment plan. We haven't done a share repurchase in four quarters. That's still on -- it's still on our [undepreciated] rate. I mean, at a minimum, we want to prevent creeping our share count. The share count itself, as you know, when you look at diluted, it's a formula, it's based -- people still have options that sometimes go back 5 or 10 years. It's based on the stock comp. It's based on a variety of factors. But in the end, equity count is starting to go up, and that is on our radar.

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Pavel S. Molchanov, Raymond James & Associates, Inc., Research Division - Energy Analyst [29]

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Okay. I was going to say, it actually looks pretty stable to me, but maybe creeping a little bit.

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Thomas Liguori, Advanced Energy Industries, Inc. - CFO, CAO and EVP [30]

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A little bit, 50,000 shares.

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Operator [31]

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Our next question comes from the line of Mehdi Hosseini from SIG. Looks like we are not getting any answer from this line.

(technical difficulty)

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Operator [32]

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(Operator Instructions) Our next question comes from the line of Tom Diffely from D.A. Davidson.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [33]

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Maybe first a clarification. It sounded like you said earlier that some of your OEMs are reaching kind of maximum capacity right now. And if that's the case, what does that mean for growth in the semiconductor market going forward for you?

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [34]

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The comment we made was some OEMs have reached maximum capacity, which means their factories are full and their ability to build, test and ship products is at max. In some cases, there -- they have max capacities driven by their supply chain. So we don't believe that, that will be a showstopper going forward. I think that without talking on behalf of other companies, I know that there are investment in increased capacity across the board both through insourcing, but also outsourcing. I view that as a temporary capacity utilization situation, but I don't see that as a long-term inhibitor for growth.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [35]

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Okay, great. And do you have -- it sounds like plenty of capacity to serve the customers’ needs?

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [36]

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That is correct. Our capacity right now, due to our unique operational model, will allow us to continue to grow through our strategic horizon without major capital investment.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [37]

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Great. Okay. And I had a question on the 3D NAND side. When the players, when the customers move from the second, third to fourth generations, does that require different etchers -- I'm sorry, power supplies for the etch? Or is it just more power supplies because there's more etch steps.

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [38]

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It's a great question. It's both. As the industry migrates to more complex architecture, it's much more challenging aspect ratios and the structure. Two things happen. Number one, some of the deposition etch processes will require more advanced power delivery systems and emerging applications that require different chemistries or different process steps will generate new sets of tools that will require either existing or new power delivery systems. So all in all, as you indicated, the growth is not purely driven by capacity, it's capacity and the migration to next-generation memory devices.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [39]

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Okay, great. Then kind of on the same lines, obviously, great market share gains over the last year. So are you seeing the same competitors? Or is that list getting smaller and smaller at the leading-edge nodes?

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [40]

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I think in general, you have the very similar group of competitors in our domain that continue to compete. There are new very small scale, mostly foreign companies that are, I call it like, operate in the fringes and trying to enter the market. The barrier for entry is very high in this industry, in general, but in this specific technology in particular. So we don't expect to see a significant change in the competitive landscape in terms of number of players. We do anticipate a healthy competition continuing between the current players.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [41]

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Okay. And then finally, Tom, when you look at obviously the revenues are at or above your target, while today, what is the -- what are the margins of today look like versus kind of what your longer-term plan is?

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Thomas Liguori, Advanced Energy Industries, Inc. - CFO, CAO and EVP [42]

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Well, the operating margins, we have leverage in them, and it's mostly SG&A. So at higher levels of revenue, yes, our operating margins can expand. On the other side, if revenues decrease, our operating margins would decrease as well. I did want to say, one interesting thing about our operating margins, the leverage is mostly on our operating expenses. If you look at our gross margin, it's been 52% for 6 to 8 quarters now. And the reason is, as we get leverage and purchase price reductions from our vendors in our cost to sales, we share that with our customers. So the operating expenses are fixed and they are leverage-able. And they will fluctuate up and down with our revenues.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - SVP and Senior Research Analyst [43]

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Okay. I guess, longer term if you do build up industrial as a percentage, does that require more expenses as far as servicing all the different end markets?

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Thomas Liguori, Advanced Energy Industries, Inc. - CFO, CAO and EVP [44]

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No, that's really good. I mean, organically, couple of things. First of all, industrial margins are comparable, if not higher, at least on the gross margin than our semi. One really good thing is, we've invested in our sales and marketing, infrastructure and industrial. That's with people, that's with filling up the channel. This is with channel management software tools. And those costs are in our P&L. So that's a positive. We made those investments going forward. So organically, our industrial margins, no, they should stay very, very healthy.

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Operator [45]

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Thank you. It's looks like we have another question from Krish Sankar. This one is from Bank of America.

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Sreekrishnan Sankar, BofA Merrill Lynch, Research Division - Director [46]

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Question for Tom. With your operating margins running at such high levels and -- I understand M&As when we focus on diversifying into industrials rather verticals, is this fair to assume any M&A at this levels is not going to be accretive necessarily for you guys?

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Thomas Liguori, Advanced Energy Industries, Inc. - CFO, CAO and EVP [47]

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Yes. On an operating margin, our M&A would be accretive dollar wise, though not on a percentage wise. When you look at our targets and when you look at what we use as a threshold generally for an operating margin, we look at something in the mid-teens like a 15%, where because they're in our core competency, we can grow it to 20%. There are some targets that are 20% above. But overall, Krish, the way to think about it is M&A is accretive earnings. It's accretive operating margin dollars. But it will be lower percentage wise.

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Operator [48]

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That's all the questions that we have in the queue at this time. So I would like to turn the call back over to management for closing comments.

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Yuval Wasserman, Advanced Energy Industries, Inc. - CEO, President and Director [49]

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Thank you, everyone, for joining us today. This is exciting time for AE. We're excited about the quarter. We're excited about the future. And we're excited about the year and next year. Looking forward to seeing you in various events in the upcoming quarter. Thanks a lot.

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Operator [50]

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Ladies and gentlemen, thank you, again for your participation in today's conference. This now concludes the program, and you may now disconnect at this time. Everyone, have a great day.