Document
Table Of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________________________
FORM 10-Q
________________________________________________
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
 
For the quarterly period ended June 30, 2017
or
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
 
For the transition period from           to           .

Commission file number: 000-26966
ADVANCED ENERGY INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
84-0846841
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
1625 Sharp Point Drive, Fort Collins, CO
 
80525
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code: (970) 221-4670

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ
 
Accelerated filer o
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of July 24, 2017 there were 39,942,723 shares of the registrant's Common Stock, par value $0.001 per share, outstanding.

 



ADVANCED ENERGY INDUSTRIES, INC.
FORM 10-Q
TABLE OF CONTENTS
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
EX-31.1
EX-31.2
EX-32.1
EX-32.2


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PART I FINANCIAL STATEMENTS
ITEM 1.
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ADVANCED ENERGY INDUSTRIES, INC.
Unaudited Condensed Consolidated Balance Sheets
(In thousands, except per share amounts)
 
 
June 30,
 
December 31,
 
 
2017
 
2016
ASSETS
 
 
 
 

Current assets:
 
 

 
 

Cash and cash equivalents
 
$
358,937

 
$
281,953

Restricted cash, related to acquisition
 
17,732

 

Marketable securities
 
4,096

 
4,737

Accounts receivable, net of allowances of $1,955 and $1,943, respectively
 
60,791

 
75,667

Inventories
 
75,557

 
55,770

Income taxes receivable
 
2,047

 
1,482

Other current assets
 
9,930

 
9,324

Current assets of discontinued operations
 
8,058

 
9,401

Total current assets
 
537,148

 
438,334

Deposits and other assets
 
2,046

 
1,835

Property and equipment, net
 
14,537

 
13,337

Goodwill
 
44,006

 
42,125

Intangible assets, net
 
27,399

 
28,071

Deferred income tax assets
 
32,328

 
32,197

Non-current assets of discontinued operations
 
15,631

 
15,630

TOTAL ASSETS
 
$
673,095

 
$
571,529

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 

 
 

Current liabilities:
 
 

 
 

Accounts payable
 
$
49,430

 
$
46,255

Income taxes payable
 
4,369

 
1,778

Accrued payroll and employee benefits
 
13,977

 
13,230

Customer deposits
 
5,916

 
5,774

Other accrued expenses
 
21,553

 
14,590

Current liabilities of discontinued operations
 
9,185

 
13,419

Total current liabilities
 
104,430

 
95,046

Deferred income tax liabilities
 
1,076

 
1,008

Uncertain tax positions
 
4,287

 
2,538

Long term deferred revenue
 
37,743

 
39,170

Other long-term liabilities
 
21,931

 
20,536

Non-current liabilities of discontinued operations
 
18,240

 
21,157

Total liabilities
 
187,707

 
179,455

Stockholders’ equity:
 
 
 
 
Preferred stock, $0.001 par value, 1,000 shares authorized, none issued and outstanding
 

 

Common stock, $0.001 par value, 70,000 shares authorized; 39,943 and 39,712
issued and outstanding, respectively
 
40

 
40

Additional paid-in capital
 
208,979

 
203,603

Retained earnings
 
278,951

 
195,364

Accumulated other comprehensive loss
 
(2,582
)
 
(6,933
)
Total stockholders’ equity
 
485,388

 
392,074

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 
$
673,095

 
$
571,529

The accompanying notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.

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Table Of Contents

ADVANCED ENERGY INDUSTRIES, INC.
Unaudited Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
 
 
 
Sales:
 
 
 
 
 
 
 
Product
$
143,288

 
$
100,752

 
$
272,115

 
$
187,045

Services
22,584

 
18,013

 
43,108

 
34,764

Total sales
165,872

 
118,765

 
315,223

 
221,809

Cost of sales:
 
 
 
 
 
 
 
Product
66,491

 
47,334

 
126,608

 
88,149

Services
12,240

 
9,385

 
22,643

 
18,154

Total cost of sales
78,731

 
56,719

 
149,251

 
106,303

Gross profit
87,141

 
62,046

 
165,972

 
115,506

Operating expenses:
 

 
 

 
 

 
 

Research and development
14,610

 
11,266

 
27,113

 
22,031

Selling, general and administrative
23,790

 
19,377

 
45,888

 
37,393

Amortization of intangible assets
974

 
1,074

 
1,936

 
2,132

Total operating expenses
39,374

 
31,717

 
74,937

 
61,556

Operating income
47,767

 
30,329

 
91,035

 
53,950

Other (expense) income, net
(83
)
 
836

 
(3,291
)
 
1,193

Income from continuing operations
47,684

 
31,165

 
87,744

 
55,143

Provision for income taxes
1,811

 
3,911

 
6,430

 
7,669

Income from continuing operations, net of income taxes
45,873

 
27,254

 
81,314

 
47,474

Income from discontinued operations, net of income taxes
179

 
3,277

 
2,273

 
5,338

Net income
$
46,052

 
$
30,531

 
$
83,587

 
$
52,812

 
 
 
 
 
 
 
 
Basic weighted-average common shares outstanding
39,849

 
39,672

 
39,793

 
39,750

Diluted weighted-average common shares outstanding
40,250

 
39,969

 
40,212

 
40,046

 
 
 
 
 
 
 
 
Earnings per share:
 

 
 

 
 

 
 

Continuing operations:
 

 
 

 
 

 
 

Basic earnings per share
$
1.15

 
$
0.69

 
$
2.04

 
$
1.19

Diluted earnings per share
$
1.14

 
$
0.68

 
$
2.02

 
$
1.19

Discontinued operations:
 
 
 
 
 
 
 
Basic earnings per share
$

 
$
0.08

 
$
0.06

 
$
0.13

Diluted earnings per share
$

 
$
0.08

 
$
0.06

 
$
0.13

Net income:
 
 
 
 
 
 
 
Basic earnings per share
$
1.16

 
$
0.77

 
$
2.10

 
$
1.33

Diluted earnings per share
$
1.14

 
$
0.76

 
$
2.08

 
$
1.32


The accompanying notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.

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ADVANCED ENERGY INDUSTRIES, INC.
Unaudited Condensed Consolidated Statements of Comprehensive Income
(In thousands)


 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
Net income
 
$
46,052

 
$
30,531

 
$
83,587

 
$
52,812

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
1,498

 
(314
)
 
4,526

 
263

Unrealized (loss) gain on marketable securities
 
(21
)
 
1

 
(21
)
 
10

Minimum benefit retirement liability
 
(138
)
 
(36
)
 
(154
)
 
(24
)
Comprehensive income
 
$
47,391

 
$
30,182

 
$
87,938

 
$
53,061


The accompanying notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.


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ADVANCED ENERGY INDUSTRIES, INC.
Unaudited Condensed Consolidated Statements of Cash Flows
(In thousands)

 
 
Six Months Ended June 30,
 
 
2017
 
2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 

 
 

Net income
 
$
83,587

 
$
52,812

Income from discontinued operations, net of income taxes
 
2,273

 
5,338

Income from continuing operations, net of income taxes
 
81,314

 
47,474

 
 
 
 
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 
Depreciation and amortization
 
4,219

 
4,045

Stock-based compensation expense
 
7,254

 
2,998

Loss on foreign exchange hedge
 
3,489

 

Net loss on disposal of assets
 
65

 
213

Changes in operating assets and liabilities, net of assets acquired:
 
 
 
 
Accounts receivable
 
16,045

 
(10,743
)
Inventories
 
(18,593
)
 
(6,632
)
Other current assets
 
(2,013
)
 
(266
)
Accounts payable
 
4,596

 
9,616

Other current liabilities and accrued expenses
 
8,183

 
(172
)
Income taxes
 
2,054

 
1,551

Net cash provided by operating activities from continuing operations
 
106,613

 
48,084

Net cash used in operating activities from discontinued operations
 
(6,396
)
 
(4,563
)
Net cash provided by operating activities
 
100,217

 
43,521

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 

 
 
Purchases of marketable securities
 
(19
)
 
(745
)
Proceeds from sale of marketable securities
 
723

 
6,921

Restricted cash, related to acquisition
 
(17,732
)
 

Purchase of foreign exchange hedge
 
(3,489
)
 

Purchases of property and equipment
 
(3,408
)
 
(2,865
)
Net cash (used in) provided by investing activities from continuing operations
 
(23,925
)
 
3,311

Net cash used in investing activities from discontinued operations
 

 

Net cash (used in) provided by investing activities
 
(23,925
)
 
3,311

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 

 
 

Net (payments) proceeds related to stock-based award activities
 
(1,877
)
 
1,621

Other financing activities
 
3

 
(2
)
Net cash (used in) provided by financing activities from continuing operations
 
(1,874
)
 
1,619

Net cash used in financing activities from discontinued operations
 

 
(24
)
Net cash (used in) provided by financing activities
 
(1,874
)
 
1,595

EFFECT OF CURRENCY TRANSLATION ON CASH
 
1,216

 
(729
)
INCREASE IN CASH AND CASH EQUIVALENTS
 
75,634

 
47,698

CASH AND CASH EQUIVALENTS, beginning of period
 
289,517

 
169,720

CASH AND CASH EQUIVALENTS, end of period
 
365,151

 
217,418

Less cash and cash equivalents from discontinued operations
 
6,214

 
8,145

CASH AND CASH EQUIVALENTS FROM CONTINUING OPERATIONS, end of period
 
$
358,937

 
$
209,273

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 

 
 

Cash paid for interest
 
$

 
$
105

Cash paid for income taxes
 
3,131

 
3,818

Cash received for refunds of income taxes
 
856

 
315

Cash held in banks outside the United States
 
228,586

 
140,556

The accompanying notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.

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ADVANCED ENERGY INDUSTRIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
NOTE 1.
BASIS OF PRESENTATION
Advanced Energy Industries, Inc., a Delaware corporation, and its wholly-owned subsidiaries ("we," "us," "our," "Advanced Energy," or the "Company") design, manufacture, sell, and support power conversion products that transform electrical power into various usable forms. Our products enable manufacturing processes that use thin films for various products, such as semiconductor devices, flat panel displays, solar cells, architectural glass, optical coating and decorative and functional coating for consumer products. We also supply thermal instrumentation products for advanced temperature control in the thin film process for these same markets. Our power control modules provide power control solutions for industrial applications where heat treatment and processing are used such as glass manufacturing, metal fabrication and treatment, and material and chemical processing. Our high voltage power supplies and modules are used in applications such as semiconductor ion implantation, scanning electron microscopy, chemical analysis such as mass spectrometry and various applications using X-ray technology and electron guns for both analytical and processing applications. Our network of global service support centers provides a recurring revenue opportunity as we offer repair services, conversions, upgrades, and refurbishments and sales of used equipment to companies using our products. As of December 31, 2015, we discontinued the production, engineering, and sales of our solar inverter product line. As such, all solar inverter revenues, costs, assets and liabilities are reported in Discontinued Operations for all periods presented herein. See Note 2. Discontinued Operations.
In the opinion of management, the accompanying Unaudited Condensed Consolidated Financial Statements contain all adjustments, consisting of normal, recurring adjustments, necessary to present fairly the financial position of the Company as of June 30, 2017, the results of our operations for the three and six months ended June 30, 2017 and 2016, and cash flows for the six months ended June 30, 2017 and 2016.
The Unaudited Condensed Consolidated Financial Statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") have been condensed or omitted pursuant to such rules and regulations. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 and other financial information filed with the SEC.
ESTIMATES AND ASSUMPTIONS
The preparation of our Unaudited Condensed Consolidated Financial Statements in conformity with U.S. GAAP requires us to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We believe that the significant estimates, assumptions, and judgments when accounting for items and matters such as allowances for doubtful accounts, excess and obsolete inventory, warranty reserves, acquisitions, asset valuations, goodwill, asset life, depreciation, amortization, recoverability of assets, impairments, deferred revenue, stock option and restricted stock grants, taxes, and other provisions are reasonable, based upon information available at the time they are made. Actual results may differ from these estimates.
CRITICAL ACCOUNTING POLICIES
Our accounting policies are described in our audited Consolidated Financial Statements and Notes contained in our Annual Report on Form 10-K for the year ended December 31, 2016.
NEW ACCOUNTING STANDARDS
From time to time, the Financial Accounting Standards Board ("FASB") or other standards setting bodies issue new accounting pronouncements. Updates to the FASB Accounting Standards Codification (“ASC”) are communicated through issuance of an Accounting Standards Update (“ASU”). Unless otherwise discussed, we believe that the impact of recently issued guidance, whether adopted or to be adopted in the future, is not expected to have a material impact on the Consolidated Financial Statements upon adoption.

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ADVANCED ENERGY INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(in thousands except per share data)


In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers" and has subsequently issued several supplemental and/or clarifying ASUs (collectively known as "ASC 606"). ASC 606 implements a five step model for how an entity should recognize revenue in order to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance will be effective for fiscal periods beginning after December 15, 2017 and for the interim periods within that year.
Advanced Energy has established a cross-functional implementation team to analyze its current portfolio of customer contracts. We have completed the disaggregation of the related sales order data and have begun testing contract elements and considering supporting software applications. The implementation team is also responsible for identifying and implementing changes to existing business processes, controls, and systems in order to support revenue recognition and disclosure under the new standard. Based on our preliminary review of our customer contracts, we expect that revenue with the majority of our customers will continue to be recognized at a point in time, generally upon shipment of products, consistent with our current revenue recognition model. Upon adoption of ASC 606, however, we also believe some of our revenue from sales of products and services to customers will be recognized over time, rather than at a point in time, due to the terms of certain customer contracts. As such, various balance sheet line items will be impacted. Advanced Energy believes the adoption of ASC606 will have an impact on both the timing of revenue recognition and various line items within the Consolidated Balance Sheet.
The standard permits the use of either the retrospective or cumulative effect transition method. Our team is continuing to evaluate the impact that the adoption will have on our Consolidated Financial Statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing reporting.
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)," to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within the year of adoption. Early adoption is permitted. Advanced Energy is currently assessing and has not yet determined the impact ASU 2016-02 may have on its Consolidated Financial Statements.
NOTE 2.
DISCONTINUED OPERATIONS
In December 2015, we completed the wind down of engineering, manufacturing and sales of our solar inverter product line (the "inverter business"). Accordingly, the results of our inverter business has been reflected as “Income from discontinued operations, net of income taxes” on our Unaudited Condensed Consolidated Statements of Operations for all periods presented herein.
The effect of extended inverter warranty sales to our customers continues to be reflected in deferred revenue in our Unaudited Condensed Consolidated Balance Sheets. Deferred revenue for extended inverter warranties and the associated costs of warranty service will be reflected in Sales and Cost of goods sold, respectively, from continuing operations in future periods in our Consolidated Statement of Operations, as the deferred revenue is earned and the associated services are rendered. Extended warranties related to the inverter product line are no longer offered.
The items included in "Income from discontinued operations, net of income taxes" are as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Sales
$

 
$

 
$

 
$

Cost of sales
(69
)
 
(1,716
)
 
(897
)
 
(2,423
)
Total operating income (including restructuring)
(26
)
 
(859
)
 
(1,146
)
 
(2,286
)
Operating income from discontinued operations
95

 
2,575

 
2,043

 
4,709

Other income (loss)
214

 
(30
)
 
377

 
339

Income from discontinued operations before income taxes
309

 
2,545

 
2,420

 
5,048

Provision (benefit) for income taxes
130

 
(732
)
 
147

 
(290
)
Income from discontinued operations, net of income taxes
$
179

 
$
3,277

 
$
2,273

 
$
5,338

    

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ADVANCED ENERGY INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(in thousands except per share data)


Assets and Liabilities of discontinued operations within the Condensed Consolidated Balance Sheets are comprised of the following:
 
 
June 30,
 
December 31,
 
 
2017
 
2016
Cash and cash equivalents
 
$
6,214

 
$
7,564

Accounts and other receivables, net
 
1,339

 
1,670

Inventories
 
505

 
167

Current assets of discontinued operations
 
$
8,058

 
$
9,401

 
 
 
 
 
Other assets
 
$
71

 
$
70

Deferred income tax assets
 
15,560

 
15,560

Non-current assets of discontinued operations
 
$
15,631

 
$
15,630

 
 
 
 
 
Accounts payable and other accrued expenses
 
$
1,186

 
$
3,684

Accrued warranty
 
7,785

 
9,254

Accrued restructuring
 
214

 
481

Current liabilities of discontinued operations
 
$
9,185

 
$
13,419

 
 
 
 
 
Accrued warranty
 
$
18,016

 
$
20,976

Other liabilities
 
224

 
181

Non-current liabilities of discontinued operations
 
$
18,240

 
$
21,157

NOTE 3.
INCOME TAXES
The following table sets out the tax expense and the effective tax rate for our income from continuing operations:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Income from continuing operations before income taxes
$
47,684

 
$
31,165

 
$
87,744

 
$
55,143

Provision for income taxes
1,811

 
3,911

 
6,430

 
7,669

Effective tax rate
3.8
%
 
12.5
%
 
7.3
%
 
13.9
%
The effective tax rates for the three and six months ended June 30, 2017 differs from the federal statutory rate of 35% primarily due to the benefit of the earnings in foreign jurisdictions which are subject to lower tax rates. Additionally, in accordance with the adoption of ASU 2016-09 “Improvements to Employee Share-Based Payment Accounting” in December 2016, the excess tax benefit attributable to stock based compensation of $3.8 million and $4.2 million, for the three and six months ended June 30, 2017, respectively, was recognized as a component of tax expense.
The effective tax rates for the three and six months ended June 30, 2016 differs from the federal statutory rate of 35% primarily due to the benefit of the earnings in foreign jurisdictions which are subject to lower tax rates.
Our policy is to classify accrued interest and penalties related to unrecognized tax benefits in our income tax provision. For the three and six months ended June 30, 2017 and 2016, the amount of interest and penalties accrued related to our unrecognized tax benefits was not significant.
NOTE 4.
EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding during the period. The computation of our diluted EPS is similar to the computation of our basic EPS except that the denominator is increased to include the number of additional common shares that would have

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ADVANCED ENERGY INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(in thousands except per share data)


been outstanding (using the if-converted and treasury stock methods), if our outstanding stock options and restricted stock units had been converted to common shares, and if such assumed conversion is dilutive.    
The following is a reconciliation of the weighted-average shares outstanding used in the calculation of basic and diluted EPS for the three and six months ended June 30, 2017 and 2016:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Income from continuing operations, net of income taxes
$
45,873

 
$
27,254

 
$
81,314

 
$
47,474

 
 
 
 
 
 
 
 
Basic weighted-average common shares outstanding
39,849

 
39,672

 
39,793

 
39,750

Assumed exercise of dilutive stock options and restricted stock units
401

 
297

 
419

 
296

Diluted weighted-average common shares outstanding
40,250

 
39,969

 
40,212

 
40,046

Continuing operations:
 

 
 

 
 
 
 
Basic earnings per share
$
1.15

 
$
0.69

 
$
2.04

 
$
1.19

Diluted earnings per share
$
1.14

 
$
0.68

 
$
2.02

 
$
1.19

The following restricted stock units were excluded in the computation of diluted earnings per share because they were anti-dilutive:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
Restricted stock units
 

 
1

 
1

 
5

Stock Buyback
In September 2015 our Board of Directors authorized a program to repurchase up to $150.0 million of our stock over a thirty-month period. As of July 24, 2017, we have $100.0 million remaining for the authorized repurchase of shares.
NOTE 5.
RESTRICED CASH
As of June 30, 2017, we had $17.7 million of cash held in restricted escrow accounts to facilitate the July 3, 2017 acquisition of Excelsys Holdings Limited ("Excelsys") (see Note 18. Subsequent Events).
NOTE 6.
MARKETABLE SECURITIES AND ASSETS MEASURED AT FAIR VALUE
Our investments with original maturities of more than three months at time of purchase and that are intended to be held for no more than 12 months, are considered marketable securities available for sale.
Our marketable securities consist of certificates of deposit. The relative cost and fair value of our marketable securities are as follows:
 
June 30, 2017
 
December 31, 2016
 
Cost
 
Fair Value
 
Cost
 
Fair Value
Total marketable securities
$
4,095

 
$
4,096

 
$
4,735

 
$
4,737

The maturities of our marketable securities available for sale as of June 30, 2017 are as follows:
 
 
Earliest
 
 
 
Latest
Certificates of deposit
 
7/28/2017

to

11/27/2017

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ADVANCED ENERGY INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(in thousands except per share data)


The value and liquidity of the marketable securities we hold are affected by market conditions, as well as the ability of the issuers of such securities to make principal and interest payments when due, and the functioning of the markets in which these securities are traded. As of June 30, 2017, we do not believe any of the underlying issuers of our marketable securities are at risk of default.
The following tables present information about the fair value hierarchy used to measure our marketable securities at fair value, on a recurring basis, as of June 30, 2017 and December 31, 2016. We did not have any financial liabilities measured at fair value, on a recurring basis, as of June 30, 2017 and December 31, 2016.
June 30, 2017
Level 1
 
Level 2
 
Level 3
 
Total
Total marketable securities
$

 
$
4,096

 
$

 
$
4,096

 
 
December 31, 2016
Level 1
 
Level 2
 
Level 3
 
Total
Total marketable securities
$

 
$
4,737

 
$

 
$
4,737

There were no transfers in or out of Level 1, 2, or 3 fair value measurements during the three and six months ended June 30, 2017.
NOTE 7.
DERIVATIVE FINANCIAL INSTRUMENTS
We are impacted by changes in foreign currency exchange rates. We attempt to mitigate these risks through the use of derivative financial instruments, primarily forward currency exchange rate contracts. During the three and six months ended June 30, 2017 and 2016, we entered into currency exchange rate forward contracts to attempt to mitigate the exchange rate risk associated with intercompany debt denominated in nonfunctional currencies. These derivative instruments are not designated as hedges for accounting purposes; however, they tend to offset the fluctuations of our intercompany debt due to foreign currency exchange rate changes. These forward contracts are typically for one month periods. We did not have any currency exchange rate contracts outstanding as of June 30, 2017 or December 31, 2016.
During the three and six months ended June 30, 2017 and 2016 the gains and losses recorded related to the foreign currency exchange contracts are as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Foreign currency (loss) gain from foreign currency exchange contracts
$
(666
)
 
$
433

 
$
(627
)
 
$
(569
)
These gains and losses were offset by corresponding gains and losses on the revaluation of the underlying intercompany debt and both are included as a component of Other (expense) income, net, in our Unaudited Condensed Consolidated Statements of Operations.
During the first quarter of 2017 we entered into a foreign currency exchange rate forward contract at a cost of $3.5 million, to mitigate the exchange rate risk associated with a planned offshore acquisition which was not consummated. This derivative instrument was designated as a hedge for accounting purposes. The hedge expired upon maturity in the first quarter of 2017. The cost of the forward contract is recorded as a component of Other (expense) income, net in our Condensed Consolidated Statement of Operations.






11

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ADVANCED ENERGY INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(in thousands except per share data)


NOTE 8.
INVENTORIES
Our inventories are valued at the lower of cost or market and computed on a first-in, first-out (FIFO) basis. Components of Inventories are as follows:
 
June 30,
 
December 31,
 
2017
 
2016
Parts and raw materials
$
52,818

 
$
43,278

Work in process
8,766

 
5,292

Finished goods
13,973

 
7,200

Inventories
$
75,557

 
$
55,770

NOTE 9.
PROPERTY AND EQUIPMENT
Property and equipment are as follows:
 
June 30,
 
December 31,
 
2017
 
2016
Buildings and land
$
1,667

 
$
1,581

Machinery and equipment
34,955

 
32,743

Computer and communication equipment
25,820

 
24,637

Furniture and fixtures
1,361

 
1,267

Vehicles
341

 
357

Leasehold improvements
16,133

 
15,546

Construction in process
482

 
644

 
80,759

 
76,775

Less: Accumulated depreciation
(66,222
)
 
(63,438
)
Property and equipment, net
$
14,537

 
$
13,337

Depreciation expense included in our income from continuing operations, is as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Depreciation expense
$
1,258

 
$
928

 
$
2,283

 
$
1,913

NOTE 10.
GOODWILL
The following summarizes the changes in goodwill during the six months ended June 30, 2017:
 
June 30, 2017
 
Effect of Changes in Exchange Rates
 
December 31, 2016
Goodwill
$
44,006

 
$
1,881

 
$
42,125









12

Table of Contents         
ADVANCED ENERGY INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(in thousands except per share data)


NOTE 11.INTANGIBLE ASSETS
Intangible assets subject to amortization consisted of the following as of June 30, 2017 and December 31, 2016:
June 30, 2017
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Technology-based
$
12,312

 
$
(4,524
)
 
$
7,788

Customer relationships
27,850

 
(9,182
)
 
18,668

Trademarks and other
2,350

 
(1,407
)
 
943

Total amortizable intangibles
$
42,512

 
$
(15,113
)
 
$
27,399

December 31, 2016
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Technology-based
$
11,643

 
$
(3,673
)
 
$
7,970

Customer relationships
26,608

 
(7,451
)
 
19,157

Trademarks and other
2,223

 
(1,279
)
 
944

Total amortizable intangibles
$
40,474

 
$
(12,403
)
 
$
28,071

    
Amortization expense for our intangible assets included in our income from continuing operations is as follows:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2017
 
2016
 
2017
 
2016
Amortization expense
 
$
974

 
$
1,074

 
$
1,936

 
$
2,132

Amortization expense related to intangible assets for each of the five years 2017 (remaining) through 2021 and thereafter is as follows:
Year Ending December 31,
 
2017 (remaining)
$
1,989

2018
3,976

2019
3,958

2020
3,297

2021
3,196

Thereafter
10,983

 
$
27,399

NOTE 12.
WARRANTIES
Provisions of our sales agreements include customary product warranties, ranging from 12 months to 24 months following shipment. The estimated cost of warranties is recorded when revenue is recognized and is based upon historical experience by product, configuration and geographic region.




13

Table of Contents         
ADVANCED ENERGY INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(in thousands except per share data)


We establish accruals for our warranty obligations that are probable to result in future costs. The warranty accrual is included in our Other accrued expenses in our balance sheet. Changes in our product warranty accrual were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Balances at beginning of period
$
4,126

 
$
1,750

 
$
2,329

 
$
1,633

Increases to accruals
208

 
541

 
2,389

 
937

Warranty expenditures
(408
)
 
(335
)
 
(797
)
 
(614
)
Effect of changes in exchange rates
7

 
(23
)
 
12

 
(23
)
Balances at end of period
$
3,933

 
$
1,933

 
$
3,933

 
$
1,933

NOTE 13.
PENSION LIABILITY
In connection with the HiTek acquisition on April 12, 2014, we acquired the HiTek Power Limited Pension Scheme ("HPLPS"). The HPLPS has been closed to new participants and additional accruals since 2006. In order to measure the expense and related benefit obligation, various assumptions are made including discount rates used to value the obligation, expected return on plan assets used to fund these expenses and estimated future inflation rates. These assumptions are based on historical experience as well as current facts and circumstances. An actuarial analysis is used to measure the expense and liability associated with pension benefits. We are committed to make annual fixed payments of $0.8 million into the HPLPS through April 30, 2024, and then $1.8 million from May 1, 2024 through November 30, 2033.
The net pension liability is included in Other long-term liabilities in our balance sheet as follows:
 
June 30,
 
December 31,
 
2017
 
2016
Pension liability
$
19,781

 
$
18,836

The components of the net periodic pension expense for the three and six months ended June 30, 2017 and 2016 were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Net periodic (benefit) expense:
 
 
 
 
 
 
 
Expected return on plan assets
$
(126
)
 
$
(132
)
 
$
(266
)
 
$
(264
)
Interest cost
236

 
256

 
500

 
512

Amortization of actuarial gains and losses
63

 
88

 
133

 
175

Net periodic expense
$
173

 
$
212

 
$
367

 
$
423

NOTE 14.
STOCK-BASED COMPENSATION
On May 4, 2017, the shareholders approved the Company's 2017 Omnibus Incentive Plan ("the 2017 Plan") and all shares that were then available for issuance under the 2008 Omnibus Incentive Plan were added to the 2017 Plan and made available for issuance thereunder. We have reserved a total of 4,977,051 shares of Advanced Energy’s common stock for issuance under the 2017 Plan. The 2017 Plan provides for the grant of stock options, stock appreciation rights, restricted stock, stock units (including deferred stock units), unrestricted stock, and dividend equivalent rights. Any of the awards issued under the 2017 Plan may be issued as performance based awards to align compensation awards to the attainment of annual or long-term performance goals. As of June 30, 2017, there were 4,190,721 shares available for grant under the 2017 Plan.
Stock option awards are granted with an exercise price equal to the market price of our stock at the date of grant and have either a time based vesting schedule of three or four years, or a performance based vesting schedule based upon achievement of

14

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ADVANCED ENERGY INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(in thousands except per share data)


organizational performance goals over a three year period, and a term of 10 years. The fair value of each award was estimated on the date of grant using the Black-Scholes-Merton option pricing model.
Restricted stock units (“RSU’s”) are granted with either a time based vesting schedule of three or four years, or a performance based vesting schedule based upon achievement of organizational performance goals over a three year period. The fair value of each RSU is determined based upon the closing fair market value of our common stock on the grant date.
We recognize stock-based compensation expense based on the fair value of the awards issued and the functional area of the employee receiving the award. Stock-based compensation for the three and six months ended June 30, 2017 and 2016 is as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Stock-based compensation expense
$
3,856

 
$
1,569

 
$
7,254

 
$
2,998

A summary of activity for stock option awards during the three and six months ended June 30, 2017 is as follows:
 
Three Months Ended June 30, 2017
 
Six Months Ended June 30, 2017
 
Number of Options
 
Weighted-Average Exercise Price per Share
 
Number of Options
 
Weighted-Average Exercise Price per Share
Options outstanding at beginning of period
454

 
$
17.63

 
474

 
$
17.47

Options granted

 
$

 

 
$

Options exercised
(79
)
 
$
16.10

 
(94
)
 
$
15.51

Options forfeited

 
$

 
(5
)
 
$
18.19

Options outstanding at end of period
375

 
$
17.95

 
375

 
$
17.95

A summary of activity for RSU awards for the three and six months ended June 30, 2017 is as follows:
 
Three Months Ended June 30, 2017
 
Six Months Ended June 30, 2017
 
Number of RSUs
 
Weighted-Average Grant Date Fair Value
 
Number of RSUs
 
Weighted- Average Grant Date Fair Value
RSUs outstanding at beginning of period
483

 
$
43.21

 
354

 
$
29.60

RSUs granted
39

 
$
74.30

 
249

 
$
63.52

RSUs vested
(110
)
 
$
30.67

 
(186
)
 
$
30.77

RSUs forfeited
(1
)
 
$
38.79

 
(6
)
 
$
31.51

RSUs outstanding at end of period
411

 
$
49.56

 
411

 
$
49.56

NOTE 15.
COMMITMENTS AND CONTINGENCIES
We have firm purchase commitments and agreements with various suppliers to ensure the availability of components. The obligation as of June 30, 2017 is approximately $97.4 million. Our policy with respect to all purchase commitments is to record losses, if any, when they are probable and reasonably estimable. We continuously monitor these commitments for exposure to potential losses and will record a provision for losses when it is deemed necessary.
We are involved in disputes and legal actions arising in the normal course of our business. There have been no material developments in legal proceedings in which we are involved during the six months ended June 30, 2017.



15

Table of Contents         
ADVANCED ENERGY INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(in thousands except per share data)


NOTE 16.
RELATED PARTY TRANSACTIONS
Members of our Board of Directors hold various executive positions and serve as directors at other companies, including companies that are our customers. Sales to our related party customers for the three and six months ended June 30, 2017 and 2016 were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Sales to related parties
$
31

 
$
109

 
$
608

 
$
223

Number of related party customers
1

 
3

 
1

 
3

Our accounts receivable balance from related party customers with outstanding balances as of June 30, 2017 and December 31, 2016 was as follows:
 
June 30,
 
December 31,
 
2017
 
2016
Accounts receivable from related parties
$
3

 
$

Number of related party customers
1

 

NOTE 17.
SIGNIFICANT CUSTOMER INFORMATION
The following table summarizes sales, and percentages of sales, by customers that individually accounted for 10% or more of sales for the three and six months ended June 30, 2017 and 2016:
 
Three Months Ended June 30,
 
2017
 
% of Total Sales
 
2016
 
% of Total Sales
Applied Materials, Inc.
$
60,163

 
36.3
%
 
$
39,032

 
32.9
%
LAM Research
34,944

 
21.1
%
 
27,237

 
22.9
%
 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
2017
 
% of Total Sales
 
2016
 
% of Total Sales
Applied Materials, Inc.
$
115,161

 
36.5
%
 
$
72,804

 
32.8
%
LAM Research
68,010

 
21.6
%
 
49,203

 
22.2
%
The following table summarizes the accounts receivable balances, and percentages of the total accounts receivables, for customers that individually accounted for 10% or more of accounts receivables as of June 30, 2017 and December 31, 2016:
 
June 30,
 
December 31,
 
2017
 
2016
Applied Materials, Inc.
$
25,800

 
42.4
%
 
$
31,078

 
41.1
%
LAM Research
1,900

 
3.1
%
 
14,317

 
18.9
%
Our sales to Applied Materials, Inc. and LAM Research include precision power products used in semiconductor processing and solar and flat panel display. No other customer accounted for 10% or more of our sales or accounts receivable balances during these periods.




16

Table of Contents         
ADVANCED ENERGY INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(in thousands except per share data)



NOTE 18.
SUBSEQUENT EVENTS

Excelsys Acquisition

On July 3, 2017, Advanced Energy acquired Excelsys, a privately held company based in Cork, Ireland. Excelsys designs and manufactures high efficiency and highly reliable power supplies for a variety of industrial markets. Its modular and user-configurable technology brings new and differentiated capabilities to Advanced Energy’s existing product portfolio. This new product line allows Advanced Energy to expand its addressable market, offering new applications and serving a larger worldwide customer base.
    
Under the agreement, Advanced Energy has acquired Excelsys for a purchase price of $17.7 million in cash. The preliminary base price is subject to a post-closing adjustment based on confirmation of the financial statements of Excelsys effective as of the closing date.

Credit Facility

On July 28, 2017, Advanced Energy Industries, Inc. (the “Company”) entered into a Loan Agreement (the “Loan Agreement”; capitalized terms used herein but not otherwise defined shall have their meanings as assigned in the Loan Agreement) with a bank which provides a revolving line of credit of up to $100.0 million subject to certain funding conditions through July 28, 2022. Amounts drawn may be used for permitted acquisitions, share repurchases, working capital and other general corporate purposes. Interest on amounts drawn shall be paid quarterly based upon the LIBOR Daily Floating Rate then in effect, plus between one and one-quarter (1.25%) and one and three-quarters (1.75%) percentage points depending on the Funded Debt to EBITDA ratio. Certain affiliates of the Company have also entered into corporate guaranties pursuant to which they have guaranteed the Company’s obligations under the Loan Agreement pursuant to the Guaranty Agreement dated July 28, 2017 by and among UltraVolt Group, Inc., UltraVolt, INC., AEI US Subsidiary, LLC, AEI Global Holdings, LLC, Sekidenko, Inc. and AE Solar Energy, Inc. in favor of the bank. The obligations under the Loan Agreement are unsecured until the Funded Debt to EBITDA ratio exceeds 2.0 to 1.0, at which time the Company and certain affiliates’ tangible and intangible personal property will be subject to a first priority, perfected lien and security interest in favor of the bank pursuant to a Security Agreement. The Company has not borrowed against this credit facility.

The Loan Agreement requires the Company to pay an unused commitment fee and certain other fees to the bank and contains various affirmative and negative covenants, which, among other things, require the Company to maintain funded debt to EBITDA ratios and, subject to various exceptions and thresholds, restrict and limit the Company’s activities in various ways, including but not limited to: (i) limiting the payment of certain dividends; (ii) limiting other debt the Company and affiliates’ incur and making certain loans; (iii) limiting the creation of liens on the Company’s and affiliates’ assets; (iv) limiting the Company’s and affiliates’ sale of certain assets; (v) limiting the type of investment the Company and affiliates can make; (vi) limiting extraordinary corporate transactions, changes in stock ownership and board membership changes that would be viewed as a change in control of the Company; (vii) limiting certain changes in the nature of the Company’s and affiliates’ business; (viii) limiting transactions with affiliates; and (ix) other restricted activities more fully set forth in the Loan Agreement.



17

Table Of Contents

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Special Note on Forward-Looking Statements
The following discussion contains, in addition to historical information, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Statements in this report that are not historical information are forward-looking statements. For example, statements relating to our beliefs, expectations and plans are forward-looking statements, as are statements that certain actions, conditions or circumstances will continue. The inclusion of words such as "anticipate," "expect," "estimate," "can," "may," "might," "continue," "enables," "plan," "intend," "should," "could," "would," "likely," "potential," or "believe," as well as statements that events or circumstances "will" occur or continue, indicate forward-looking statements. Forward-looking statements involve risks and uncertainties, which are difficult to predict and many of which are beyond our control. Therefore, actual results could differ materially and adversely from those expressed in any forward-looking statements. Neither we nor any other person assumes responsibility for the accuracy and completeness of such forward-looking statements and readers are cautioned not to place undue reliance on forward-looking statements.
For additional information regarding factors that may affect our actual financial condition, results of operations and accuracy of our forward-looking statements, see the information under the caption "Risk Factors" in Part II, Item 1A of this Quarterly Report on Form 10-Q and, in our Annual Report on Form 10-K for the year ended December 31, 2016. We undertake no obligation to revise or update any forward-looking statements for any reason.
BUSINESS OVERVIEW
We design, manufacture, sell and support precision power products that transform electrical power into various usable forms. Our power conversion products refine, modify and control the raw electrical power from a utility and convert it into power that is predictable, repeatable and customizable. Our products enable thin film manufacturing processes such as plasma enhanced chemical and physical deposition and etch for various semiconductor and industrial products, industrial thermal applications for material and chemical processes, and specialty power for critical industrial applications. We also supply thermal instrumentation products for advanced temperature control in these markets. Our network of global service support centers provides local repair and field service capability in key regions as well as provides upgrades and refurbishment services, and sales of used equipment to businesses that use our products. The markets we serve include:
Semiconductor capital equipment market - Customers in the semiconductor capital equipment market incorporate our products into equipment that make integrated circuits. Our power conversion systems provide the energy to enable thin film processes, such as deposition and etch, and high voltage applications such as ion implant, wafer inspection and metrology.
Industrial power capital market - Our industrial power capital market is comprised of products for Thin Films Industrial Power and Specialty Power applications.
Thin Films Industrial Power applications include glass coating, glass manufacturing, flat panel displays, solar cell manufacturing, and similar thin film manufacturing, including data storage, hard and optical coating.
Specialty Power applications include power control modules for metal fabrication and treatment, and material and chemical processing. Our high voltage industrial applications include scanning electron microscopy, medical equipment, and instrumentation applications such as x-ray and mass spectroscopy, as well as general electron gun sources for scientific and industrial applications.
Our thermal instrumentation products measure the temperature of the processed substrate or the process chamber. Our remote plasma sources deliver ionized gases for reactive chemical processes used in cleaning, surface treatment, and gas abatement. Precise control over the energy delivered to plasma-based processes enables the production of integrated circuits with reduced feature sizes and increased speed and performance.
The analysis presented below is organized to provide the information we believe will be helpful for understanding our historical performance and relevant trends going forward. This discussion should be read in conjunction with our Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of this report, including the notes thereto. Also included in the following analysis are measures that are not in accordance with U.S. GAAP. A reconciliation of the non-GAAP measures to U.S. GAAP is provided below.


18

Table Of Contents

Results of Continuing Operations
The following table sets forth certain data, and the percentage of sales each item reflects, derived from our Unaudited Condensed Consolidated Statements of Operations for the periods indicated:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Sales
$
165,872

 
100.0
 %
 
$
118,765

 
100.0
%
 
$
315,223

 
100.0
 %
 
$
221,809

 
100.0
%
Gross profit
87,141

 
52.5

 
62,046

 
52.2

 
165,972

 
52.7

 
115,506

 
52.1

Operating expenses
39,374

 
23.7

 
31,717

 
26.7

 
74,937

 
23.8

 
61,556

 
27.8

Operating income from continuing operations
47,767

 
28.8

 
30,329

 
25.5

 
91,035

 
28.9

 
53,950

 
24.3

Other (expense) income, net
(83
)
 
(0.1
)
 
836

 
0.7

 
(3,291
)
 
(1.0
)
 
1,193

 
0.5

Income from continuing operations before income taxes
47,684

 
28.7

 
31,165

 
26.2

 
87,744

 
27.9

 
55,143

 
24.8

Provision for income taxes
1,811

 
1.1

 
3,911

 
3.3

 
6,430

 
2.0

 
7,669

 
3.5

Income from continuing operations, net of income taxes
$
45,873

 
27.6
 %
 
$
27,254

 
22.9
%
 
$
81,314

 
25.9
 %
 
$
47,474

 
21.3
%
SALES
The following tables set forth sales, and percentage of sales, by product group for the three and six months ended June 30, 2017 and 2016:
 
Three Months Ended June 30,
 
 
 
 
 
2017
 
% of Total Sales
 
2016
 
% of Total Sales
 
Increase/ (Decrease)
 
Percent Change
 
 
 
 
 
 
 
 
 
 
 
 
Semiconductor capital equipment market
$
117,020

 
70.5
%
 
$
78,583

 
66.2
%
 
$
38,437

 
48.9
%
Industrial power capital market
26,268

 
15.8

 
22,169

 
18.7

 
4,099

 
18.5
%
Global service
22,584

 
13.7

 
18,013

 
15.1

 
4,571

 
25.4
%
Total sales
$
165,872

 
100.0
%
 
$
118,765

 
100.0
%
 
$
47,107

 
39.7
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
 
 
 
 
2017
 
% of Total Sales
 
2016
 
% of Total Sales
 
Increase/ (Decrease)
 
Percent Change
 
 
 
 
 
 
 
 
 
 
 
 
Semiconductor capital equipment market
$
221,668

 
70.3
%
 
$
148,329

 
66.9
%
 
$
73,339

 
49.4
%
Industrial power capital market
50,447

 
16.0

 
38,716

 
17.5

 
11,731

 
30.3
%
Global service
43,108

 
13.7

 
34,764

 
15.6

 
8,344

 
24.0
%
Total sales
$
315,223

 
100.0
%
 
$
221,809

 
100.0
%
 
$
93,414

 
42.1
%
Total Sales
Sales increased $47.1 million, or 39.7%, to $165.9 million for the three months ended June 30, 2017 as compared to the three months ended June 30, 2016 and increased $16.5 million, or 11.1% as compared to the three months ended March 31, 2017. Sales for the six months ended June 30, 2017 increased $93.4 million, or 42.1%, to $315.2 million from $221.8 million for the six months ended June 30, 2016. The increase in sales for both periods is primarily due to demand in the semiconductor market driven by accelerated demand and strength in etch, as well continued growth in global services.
Sales in the semiconductor market increased $38.4 million, or 48.9% for the three months ending June 30, 2017 as compared to the three months ended June 30, 2016 and increased $12.4 million, or 11.8% as compared to the three months ended

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March 31, 2017. Semiconductor market sales for the six months ended June 30, 2016 increased $73.3 million or 49.4% as compared to the same period in 2016. Our growth in the semiconductor market has been fueled by our leadership in etch applications, specifically related to advanced memory and transition to 3DNAND, along with advances in logic technology. Sales growth in each of the periods is driven primarily by recent program wins which have moved into production and delivery.
Sales in the industrial markets increased $4.1 million, or 18.5% for the three months ended June 30, 2017 as compared to the three months ended June 30, 2016 and increased $2.1 million, or 8.6% as compared to the three months ended March 31, 2017. For the six months ended June 30, 2017 sales increased $11.7 million or 30.3% as compared to the same period in 2016. The increase in sales is primarily due to the expansion in advanced coating applications. The industrial markets we serve include solar panel, flat panel display, power control modules, data storage, architectural glass, high voltage and other industrial manufacturing markets. Our customers in these markets are primarily global and regional original equipment manufacturers.
Global service sales increased $4.6 million, or 25.4%, for the three months ended June 30, 2017 as compared to the three months ended June 30, 2016 and increased $2.1 million, or 10.0% as compared to the three months ended March 31, 2017. Global service sales for the six months ending June 30, 2017 increased $8.3 million, or 24.0% as compared to the same period in 2016. The increase in global service sales in all periods is due to share gains and growth in the installed base.
Backlog
Our backlog was $106.6 million at June 30, 2017 as compared to $69.2 million at December 31, 2016. Backlog remains strong primarily due to increased demand in the semiconductor and industrial thin film markets.
GROSS PROFIT
For the three months ended June 30, 2017, gross profit was $87.1 million, or 52.5% of sales as compared to gross profit of $62.0 million, or 52.2% of sales, for the same period in 2016. Gross profit for the six months ended June 30, 2017 was $166.0 million, or 52.7% of sales, as compared to gross profit of $115.5 million, or 52.1% of sales, for the same period in 2016. The increase in gross profit is primarily attributable to increased volume in the markets we serve.
OPERATING EXPENSE
Operating expenses increased $7.7 million to $39.4 million, or 23.7% of sales, for the three months ended June 30, 2017 from $31.7 million, or 26.7% of sales for the same period in 2016. Operating expenses increased $13.4 million to $74.9 million, or 23.8% of sales for the six months ended June 30, 2017, from $61.6 million, or 27.8% of sales for the same period in 2016.
The following table summarizes our operating expenses as a percentage of sales for the periods indicated:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Research and development
$
14,610

 
8.8
%
 
$
11,266

 
9.5
%
 
$
27,113

 
8.6
%
 
$
22,031

 
9.9
%
Selling, general, and administrative
23,790

 
14.3

 
19,377

 
16.3

 
45,888

 
14.6

 
37,393

 
16.9

Amortization of intangible assets
974

 
0.6

 
1,074

 
0.9

 
1,936

 
0.6

 
2,132

 
1.0

Total operating expenses
$
39,374

 
23.7
%
 
$
31,717

 
26.7
%
 
$
74,937

 
23.8
%
 
$
61,556

 
27.8
%
Research and Development
We perform research and development of products for new or emerging applications, technological changes to provide higher performance, lower cost, or other attributes that we may expect to advance our customers’ products. We believe that continued development of technological applications, as well as enhancements to existing products to support customer requirements, are critical for us to compete in the markets we serve. Accordingly, we devote significant personnel and financial resources to the development of new products and the enhancement of existing products, and we expect these investments to continue.
Research and development expenses increased $3.3 million to $14.6 million, or 8.8% of sales, for the three months ended June 30, 2017 from $11.3 million, or 9.5% of sales, for the same period in 2016. Research and development expenses increased $5.1 million to $27.1 million, or 8.6% of sales, for the six months ended June 30, 2017 from $22.0 million, or 9.9% of sales, for the same period in 2016. The increase in research and development expense is due to our investment in new programs to maintain and increase our technological leadership to provide solutions to our customers' evolving needs.

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Selling, General and Administrative
Our selling expenses support domestic and international sales and marketing activities that include personnel, trade shows, advertising, third-party sales representative commissions, and other selling and marketing activities. Our general and administrative expenses support our worldwide corporate, legal, tax, financial, governance, administrative, information systems, and human resource functions in addition to our general management, including acquisition-related activities.
Selling, general and administrative expenses increased $4.4 million to $23.8 million, or 14.3% of sales for the three months ended June 30, 2017 from $19.4 million, or 16.3% of sales, for the same period in 2016. Selling, general and administrative expenses increased $8.5 million to $45.9 million, or 14.6% of sales, for the six months ended June 30, 2017 from $37.4 million, or 16.9% of sales for the same period in 2016. The increase is primarily driven by higher stock based compensation, performance bonus, and costs associated with business development.
Other Income (Expense), net
Other income (expense), net consists primarily of interest income and expense, foreign exchange gains and losses, gains and losses on sales of fixed assets, and other miscellaneous items. Other income (expense), net was a loss of $0.1 million for the three months ended June 30, 2017, as compared to a gain of $0.8 million for the same period in 2016. Other income (expense), net was a loss of $3.3 million for the six months ended June 30, 2017, as compared to a gain of $1.2 million for the same period in 2016. The loss for the six months ended June 30, 2017 was primarily the cost of a foreign currency exchange rate forward contract that we entered into for a potential offshore acquisition that we have decided not to consummate. See Note 7. Derivative Financial Instruments in Part I, Item 1 "Unaudited Condensed Consolidated Financial Statements" contained herein.
Provision for Income Taxes
We recorded an income tax provision for the three and six months ended June 30, 2017 of $1.8 million and $6.4 million, respectively, compared to $3.9 million and $7.7 million for the three and six months ended June 30, 2016, respectively. Effective tax rates are 3.8% and 7.3% for the three and six months ended June 30, 2017, respectively, and 12.5% and 13.9% for the three and six months ended June 30, 2016, respectively.
The effective tax rates for the three and six months ended June 30, 2017 and 2016 are lower than the federal statutory rate primarily due to the benefit of the earnings in foreign jurisdictions which are subject to lower tax rates. Additionally, the effective rates for the three and six months ended June 30, 2017 were favorably impacted by the implementation of ASU 2016- 09, Compensation - Stock Compensation: Improvements to Employee Share-Based Payments, and the related impact from the tax benefit derived from the exercise of employee equity incentive instruments.
Our future effective income tax rate depends on various factors, such as changes in tax laws, regulations, accounting principles, or interpretations thereof and the geographic composition of our pre-tax income. We carefully monitor these factors and adjust our effective income tax rate accordingly.
Results of Discontinued Operations
We completed the wind down of our inverter engineering, manufacturing and sales product line in December 2015. Accordingly, the inverter product line is presented as a discontinued operation for all periods presented herein. Extended warranties previously sold for the inverter product line are reflected in deferred revenue from continuing operations on our Unaudited Condensed Consolidated Balance Sheets and will be reflected in continuing operations in future periods as the deferred revenue is earned and the associated services are rendered.

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Income from discontinued operations, net of income taxes are as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Sales
$

 
$

 
$

 
$

Cost of sales
(69
)
 
(1,716
)
 
(897
)
 
(2,423
)
Total operating expenses
(26
)
 
(859
)
 
(1,146
)
 
(2,286
)
Operating income from discontinued operations
95

 
2,575

 
2,043

 
4,709

Other income
214

 
(30
)
 
377

 
339

Income from discontinued operations before income taxes
309

 
2,545

 
2,420

 
5,048

Provision for income taxes
130

 
(732
)
 
147

 
(290
)
Income from discontinued operations, net of income taxes
$
179

 
$
3,277

 
$
2,273

 
$
5,338

Operating income from discontinued operations for the three and six months ended June 30, 2017 and 2016 reflects the recovery of accounts receivable previously reserved for and the release of product warranty liability.
Non-GAAP Results
Management uses non-GAAP operating income and non-GAAP EPS to evaluate business performance without the impacts of certain non-cash charges and other charges which are not part of our usual operations. We use these non-GAAP measures to assess performance against business objectives, make business decisions, including developing budgets and forecasting future periods. In addition, management's incentive plans include these non-GAAP measures as criteria for achievements. These non-GAAP measures are not in accordance with U.S. GAAP and may differ from non-GAAP methods of accounting and reporting used by other companies. However, we believe these non-GAAP measures provide additional information that enables readers to evaluate our business from the perspective of management. The presentation of this additional information should not be considered a substitute for results prepared in accordance with U.S. GAAP.
The non-GAAP results presented below exclude the impact of non-cash related charges, such as the amortization of intangible assets, stock-based compensation, and restructuring charges, as well as acquisition-related costs and other nonrecurring costs, as they are not indicative of future performance. The tax effect of our non-GAAP adjustments represents the anticipated annual tax rate applied to each non-GAAP adjustment after consideration of their respective book and tax treatments.
Reconciliation of Non-GAAP measure - operating expenses and operating income from continuing operations, excluding certain items
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2016
 
2017
 
2016
Gross Profit from continuing operations, as reported
$
87,141

 
$
62,046

 
$
165,972

 
$
115,506

Operating expenses from continuing operations, as reported
39,374

 
31,717

 
74,937

 
61,556

Adjustments:
 
 
 
 
 
 
 
Stock-based compensation
(3,856
)
 
(1,569
)
 
(7,254
)
 
(2,998
)
Amortization of intangible assets
(974
)
 
(1,074
)
 
(1,936
)
 
(2,132
)
Acquisition-related costs
(150
)
 

 
(150
)
 

Non-GAAP operating expenses from continuing operations
34,394

 
29,074

 
65,597

 
56,426

Non-GAAP operating income from continuing operations
$
52,747

 
$
32,972

 
$
100,375

 
$
59,080


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Reconciliation of Non-GAAP measure - operating expenses and operating income from continuing operations, excluding certain items
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2016
 
2017
 
2016
Gross Profit from continuing operations, as reported
52.5
 %
 
52.2
 %
 
52.7
 %
 
52.1
 %
Operating expenses from continuing operations, as reported
23.7

 
26.7

 
23.8

 
27.8

Adjustments:
 
 
 
 
 
 
 
Stock-based compensation
(2.3
)
 
(1.4
)
 
(2.3
)
 
(1.3
)
Amortization of intangible assets
(0.6
)
 
(0.9
)
 
(0.6
)
 
(1.0
)
Acquisition-related costs
(0.1
)
 

 

 

Non-GAAP operating expenses from continuing operations
20.7

 
24.4

 
20.9

 
25.5

Non-GAAP operating income from continuing operations
31.8
 %
 
27.8
 %
 
31.8
 %
 
26.6
 %

Reconciliation of Non-GAAP measure - income from continuing operations, excluding certain items
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2016
 
2017
 
2016
Income from continuing operations, net of income taxes, as reported
$
45,873

 
$
27,254

 
$
81,314

 
$
47,474

Adjustments:
 
 
 
 
 
 
 
Stock-based compensation
3,856

 
1,569

 
7,254

 
2,998

Amortization of intangible assets
974

 
1,074

 
1,936

 
2,132

Loss on foreign exchange hedge

 

 
3,489

 

Acquisition-related costs
150

 

 
150

 

Tax effect of non-GAAP adjustments
(1,629
)
 
(711
)
 
(3,025
)
 
(1,366
)
Non-GAAP income from continuing operations, net of income taxes
$
49,224

 
$
29,186

 
$
91,118

 
$
51,238

Non-GAAP diluted earnings per share
$1.22
 
$0.73
 
$2.27
 
$1.28
Impact of Inflation
In recent years, inflation has not had a significant impact on our operations. However, we continuously monitor operating price increases, particularly in connection with the supply of component parts used in our manufacturing process. To the extent permitted by competition, we pass increased costs on to our customers by increasing sales prices over time. From time to time, we may also reduce prices to customers to decrease sales prices due to reductions in the cost structure of our products from cost improvement initiatives and decreases in component part prices.
Liquidity and Capital Resources
LIQUIDITY
We believe that adequate liquidity and cash generation is important to the execution of our strategic initiatives. Our ability to fund our operations, acquisitions, capital expenditures, and product development efforts may depend on our ability to generate cash from operating activities which is subject to future operating performance, as well as general economic, financial, competitive, legislative, regulatory, and other conditions, some of which may be beyond our control. Our primary sources of liquidity are our available cash, investments, cash generated from current operations as well as our credit facility noted below.
At June 30, 2017, we had $363.0 million in cash, cash equivalents, and marketable securities. We believe that our current and available cash levels, available credit facility, as well as our cash flows from future operations, will be adequate to meet anticipated working capital needs, levels of capital expenditures, and contractual obligations for the next twelve months. We may seek additional financing from time to time.

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On July 28, 2017, Advanced Energy entered into a Loan Agreement (the “Loan Agreement”) with a bank which provides a revolving line of credit of up to $100.0 million subject to certain funding conditions through July 28, 2022. The credit facility provides us with further future flexibility for execution of our strategic plans. We have not borrowed against this credit facility. For more information on the Loan Agreement, see "Note 18. Subsequent Events" as set forth in Part I Item 1 of this Form 10-Q.
In September 2015 our Board of Directors authorized a program to repurch