Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements set forth below under this caption constitute forward-looking statements. See " Special Note Regarding Forward-Looking Statements " in this Annual Report on Form 10-K for additional factors relating to such statements and see " Risk Factors " in Item 1A for a discussion of certain risks applicable to our business, financial condition, and results of operations.
This section of this Form 10-K discusses and compares the results of operations for 2020 and 2019. The discussion and analysis comparing the results of operations for 2018 to 2019 are not included in this Form 10-K and can be found within Part II, Item 7 "Management’s Discussion and Analysis for Financial Condition and Results of Operations" in our 2019 Form 10-K for the year ended December 31, 2019.
Overview
We design, manufacture, sell and support precision power products that transform, refine, and modify the raw electrical power from the utility and convert it into various types of highly-controllable, usable power that is predictable, repeatable, and customizable. Our power solutions enable innovation in complex semiconductor and thin film plasma processes such as dry etch, strip, chemical and physical deposition, high and low voltage applications such as process control, data center computing, networking, telecommunication, analytical instrumentation, medical equipment, industrial technology, and temperature-critical thermal applications such as material and chemical processing. Our network of global service support centers provides a recurring revenue opportunity as we offer repair services, conversions, upgrades, and refurbishments and used equipment to companies using our products.
Driven by continuing technology evolution and changing customer demands, the markets we serve are constantly changing in terms of advancement in applications, core technology and competitive pressures. New products we design for capital equipment manufacturers could have a lifespan of five to ten years. Our success and future growth depend on our products being designed into our customers’ new generations of equipment as they develop new technologies and applications. We work with these original equipment manufacturers early in their design cycles to modify, enhance and upgrade our products or design new products that meet the requirements of their new and future systems. The design win process is highly competitive, and we may win or lose new designs for our existing customers’ or new customers’ next generations of equipment. If existing or new customers do not choose our products as a result of the development, evaluation and qualification efforts related to the design win process, our market share may be reduced, our potential revenues related to the lifespan of our customers’ products, which can be 5-10 years, may not be realized, and our business, financial condition and results of operations may be materially and adversely impacted.
Critical Accounting Estimates
The preparation of consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires us to make judgments, assumptions, and estimates that affect the amounts reported. Note 1. Operations and Summary of Significant Accounting Policies and Estimates in Part II, Item 8 "Financial Statements and Supplementary Data" describes the significant accounting policies used in the preparation of our consolidated financial statements. The accounting positions described below are significantly affected by critical accounting estimates. Such accounting positions require significant judgments, assumptions, and estimates to be used in the preparation of the consolidated financial statements, actual results could differ materially from the amounts reported based on variability in factors affecting these statements.
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Revenue Recognition
We recognize revenue when we have satisfied our performance obligations which typically occurs when control of the products or completion of services have been transferred to our customers. The transaction price is based upon the standalone selling price. In most transactions, we have no obligations to our customers after the date products are shipped, other than pursuant to warranty obligations. Revenue is recognized net of any taxes collected from customers, which are subsequently remitted to governmental authorities. Shipping and handling fees, if any, are recognized as revenue. The related shipping and handling costs are recognized in cost of sales. Support services include warranty and non-warranty repair services, upgrades, and refurbishments on the products we sell. Repairs that are covered under our standard warranty do not generate revenue.
We maintain a credit approval process and we make significant judgments in connection with assessing our customers’ ability to pay. Despite this assessment, from time to time, our customers are unable to meet their payment obligations. We continuously monitor our customers’ credit worthiness and use our judgment in establishing a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the provisions established, a significant change in the liquidity or financial position of our customers could have a material adverse impact on the collectability of accounts receivable and our future operating results. Additionally, if our credit loss rates prove to be greater than we currently estimate, we record additional reserves for credit losses.
Business Combinations
We record the assets acquired and liabilities assumed in a business combination at their acquisition date fair values. Fair values of assets acquired, and liabilities assumed are based upon available information and may involve engaging an independent third party to perform an appraisal. Estimating fair values can be complex and subject to significant business judgment. We must also identify and include in the allocation all acquired tangible and intangible assets that meet certain criteria, including assets that were not previously recorded by the acquired entity. The estimates most commonly involve property, plant and equipment and intangible assets, including those with indefinite lives. The estimates also include the fair value of contracts including commodity purchase and sale agreements, storage contracts, and transportation contracts. The excess of the purchase price over the net fair value of acquired assets and assumed liabilities is recorded as goodwill, which is not amortized but instead is evaluated for impairment at least annually. Pursuant to GAAP, an entity is allowed a reasonable period of time (not to exceed one year) to obtain the information necessary to identify and measure the fair value of the assets acquired and liabilities assumed in a business combination.
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Income Taxes
We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We calculate tax expense consistent with intraperiod tax allocation methodology resulting in an allocation of current year tax expense/benefit between continuing operations and discontinued operations. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized.
We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. Although we believe that we have adequately reserved for our uncertain tax positions, we can provide no assurance that the final tax outcome of these matters will not be materially different. We adjust these reserves when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial condition and operating results. The provision for income taxes includes the effects of any reserves that we believe are appropriate, as well as the related net interest and penalties. For more details see Note 5. Income Taxes in Part II, Item 8 "Financial Statements and Supplementary Data."
Inventory
We value our inventory at the lower of cost (first-in, first-out method) or net realizable value. We regularly review inventory quantities on hand and record a provision to write-down excess and obsolete inventory to its estimated net realizable value, if less than cost, based primarily on our estimated forecast of product demand. Our industry is subject to technological change, new product developments, and changes in end-user demand for our products which can fluctuate significantly. Any significant changes in end-user demand, technology or new product developments could have a significant impact on the value of our inventory and our reported operating results.
Warranty Costs
We offer warranty coverage for a majority of our products for periods typically ranging from 12 to 24 months after shipment. We provided warranties on our inverter products for five to ten years and also provided the option to purchase additional warranty coverage up to 20 years. Our standard inverter product warranty expense is reported within discontinued operations. We estimate the anticipated costs of repairing our products under such warranties based on the historical costs of the repairs. The assumptions we use to estimate warranty accruals are reevaluated periodically, considering actual experience, and when appropriate, the accruals are adjusted. Should product failure rates differ from our estimates, actual costs could vary significantly from our expectations. See Note 4. Disposed and Discontinued Operations in Part II, Item 8 "Financial Statements and Supplementary Data" for more information on our discontinued operations and Note 15. Warranties in Part II, Item 8 "Financial Statements and Supplementary Data" for more information.
Goodwill, Intangible and Other Long-Lived Assets
We evaluate the carrying value of our goodwill for impairment at least annually or when an interim triggering event occurs that would indicate that impairment may have taken place. Our annual impairment test was performed as of December 31 st with no indication of impairment. We evaluate our other definite-lived intangible assets for impairment when evidence exists that certain events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Significant judgments and assumptions are required in such impairment evaluations.
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The annual impairment test of goodwill may be performed using an assessment of qualitative factors if it is considered more likely than not that goodwill is not impaired. If this qualitative assessment indicates that it is more likely than not that goodwill is impaired, then the next step of impairment testing compares the fair value of a reporting unit to its carrying value. If fair value exceeds carrying value, then we conclude no goodwill impairment has occurred. Conversely, if carrying value exceeds fair value, we recognize an impairment loss.
We evaluate definite-lived intangible assets and other long-lived assets whenever there is an indicator of impairment. When we determine that the carrying value of intangibles or other long-lived assets may not be recoverable based upon the existence of one or more indicators of impairment, we use the projected undiscounted cash flow method to determine whether an impairment exists, and then measure the impairment using discounted cash flows. If our expectations of future results and cash flows are significantly diminished, intangible assets, long-lived assets, and goodwill may be impaired and the resulting charge to operations may be material. Changes in these estimates could result in significant revisions to the carrying value of these assets and may result in material charges to our results of operations.
Defined Benefit Pension Plans
Accounting for pension plans requires that we make assumptions that involve considerable judgment which are significant inputs in the actuarial models that measure our net pension obligations and ultimately impact our earnings. These include the discount rate, long-term expected rate of return on assets, compensation trends, inflation considerations, health care cost trends and other assumptions, as well as determining the fair value of assets in our funded plans. Specifically, the discount rates, as well as the expected rates of return on assets and plan asset fair value determination, are important assumptions used in determining the plans' funded status and annual net periodic pension and benefit costs. We evaluate these critical assumptions at least annually on a plan and country-specific basis. We also, with the help of actuaries, periodically evaluate other assumptions involving demographic factors, such as retirement age, mortality and turnover, and update them to reflect our experience and expectations for the future. The Company believes the accounting estimates related to our pension plans are critical accounting estimates because they are highly susceptible to change from period to period based on the performance of plan assets, actuarial valuations, market conditions and contracted benefit changes. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our net pension and postretirement benefit obligations and related expense.
Human Capital Resources
Our corporate citizenship, social responsibility and commitment to our employees extends beyond the products we make. We recognize that our employees are our most important asset, and with approximately 10,000 employees located across the globe, we know that each person’s diverse background and unique skill set are fundamental to our success. We regularly conduct anonymous surveys to seek feedback from our employees on important topics related to confidence in company leadership, career growth opportunities, and improvements on how we can make our company a great place to work. In addition, the results of the survey are shared with our Board. To further increase our commitment to diversity and equity, in 2020, we announced the launch of our inaugural Advanced Energy STEM Diversity Scholarship, which is aimed at developing emerging talent and promoting greater ethnic, racial and gender diversity in STEM. The annual program will begin in the 2021 academic year and will accept applications from undergraduate and post-graduate students attending five leading institutions in the field of power technologies.
Total Rewards
As part of our total rewards philosophy, we believe in offering and maintaining competitive compensation and benefits programs for our employees in order to attract and retain a talented, highly engaged workforce. Our compensation programs are focused on equitable, fair pay practices including market-based base pay, an annual pay-for-performance incentive plan, and discounted Employee Stock Purchase Plan. In addition to our competitive compensation practices, we offer a strong benefits package in each of the countries in which we operate. In the majority of our non-U.S. operations, we offer additional benefits that supplement governmental statutory benefits. In the U.S., we offer a competitive benefits package that includes four different health care plan options with employee premiums lower than the market average,
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dental, vision, disability and life insurance, health savings and flexible spending accounts, paid-time off, 8-weeks of paid parental leave for both parents, company matched 401(k), flexible work schedules, expanded mental health coverage and employee assistance programs. With the challenging times created by COVID-19, we made the commitment to ensure our employees maintained financial security and provided employees the ability to work from home and paid leave time for our hourly employees who may have been impacted by temporary site closures.
Learning and Development
To support our employees in reaching their full potential and to build internal capabilities, we offer a wide range of internal and external learning and development opportunities. We have a program for education assistance reimbursement that provides financial support to employees who seek to expand their skills and abilities. We support a women’s leadership forum conducted by our employees that discusses, among other things, career development, leadership topics, and the opportunities for mentorship. We also have an internship program designed to help support a pipeline of talent for the Company. We have a robust succession planning process to develop internal leadership capabilities and technical bench strength, ensuring we have a strong workforce for the future.
Health and Safety
We are committed to providing a safe work environment for our employees. We provide regular health and safety training both on-site as needed and through our virtual training tool that assigns training requirements based on job profiles and site-specific requirements. Our Environmental, Health and Safety organization is a global team responsible for health and safety related to on-site operations including hazard and risk identification. Workplace safety is also addressed in operations meetings and monthly business reviews. We are also committed to the standards of the Responsible Business Alliance Code of Conduct which promotes labor, health and safety, environmental and ethics best practices.
Community Involvement
Our charitable contributions committee, founded in 2010, is supported and led by our employees. The committee provides financial support for 501(c)(3) corporations, non-profit institutions, and organizations that improve education, the environment, health and social services across the communities in which we operate and where our employees live. We provide financial support to workforce initiatives led by the local chamber of commerce in Northern Colorado and have partnered with a community college to provide equipment and funding to train technicians and develop skilled labor that may lead to employment opportunities with us or other local companies. We offer each employee eight hours of paid-time off to volunteer with a 501(c)(3) organization of the employee’s choosing. Our Educational Scholarship Program, available to children of AE employees, celebrates education accomplishments and facilitates career and learning goals. In 2020, we received a record number of submissions and recognized ten employees’ students across multiple countries.
Business Environment and Trends
Advanced Energy operates in a single segment structure for power electronics conversion products. The acquisition of Artesyn added additional products and market verticals to our business. Following the acquisition, we have continued to be organized on a global, functional basis to achieve the anticipated synergies associated with the acquisition. We operate in four vertical markets or applications and provide revenue information to enable tracking of market trends. Following the acquisition of Artesyn in September of 2019, we also provide information on an organic and inorganic basis to improve comparability during the periods.
The demand environment in each of our markets is impacted by various market trends, customer buying patterns, design wins, macroeconomic and other factors. During 2020 we saw strengthening demand in Semiconductor Equipment and Data Center Computing Markets and weakening demand in our general industrial markets.
In the beginning of the first quarter of 2020, we began to see an impact of COVID-19 on our operations particularly in China, which has affected both our own workforce and supply chain. This situation remains dynamic and may continue to affect our operations. See Item 1A "Risk Factors" for a discussion of certain risks related to COVID-19.
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SEMICONDUCTOR EQUIPMENT MARKET
Growth in the Semiconductor Equipment market is driven by growing integrated circuits content across many industries, increased demand for processing and storage in advanced applications such as artificial intelligence or autonomous vehicles, the rapid adoption of advanced mobile connectivity solutions such as 5G and enhancing existing and enabling new wireless applications. To address the long-term growing demand for semiconductor devices, the industry continues to invest in production capacities for advanced logic devices at the 7nm technology node and beyond, the latest memory devices including 3D-NAND, DRAM, and new emerging memories such as MRAM, and back-end test and advanced wafer-level packaging. The industry’s transition to advanced technology nodes in logic and DRAM and to increased layers in 3D memory devices is requiring an increased number of etch and deposition process tools and higher content of our advanced power solutions per tool. As etching and deposition processes become more challenging due to increasing aspect ratios in advanced 3D devices, more advanced radio frequency ("RF") and direct current ("DC") technologies are needed. We are meeting these challenges by providing a broader range of more complex RF and DC power solutions. Beyond etch and deposition processes, the growing complexity at the advanced nodes also drive a higher number of other processes across the fab, including inspection, metrology, thermal, ion implantation, and semiconductor test, where Advanced Energy is actively participating as a critical technology provider. In addition, our global support services group offers comprehensive local repair service, upgrade and retrofit offerings to extend the useable life of our customers’ capital equipment for additional technology generations. The acquisition of Artesyn in September 2019 expanded Advanced Energy’s reach within the Semiconductor Equipment market by adding a broad range of low voltage applications as well as back-end test and assembly equipment makers.
In the first half of 2019, the semiconductor industry went through a period of weakening equipment investment as a result of slowing growth in end market demand for semiconductor devices, ongoing digestion of equipment capacity, and consumption of existing inventory. Demand for semiconductor equipment has continued to grow through the fourth quarter of 2020 driven by foundry logic and certain memory investments and has returned to prior peak levels. In addition, the demand for semiconductor devices for a wide range of applications is expected to drive investment into 2021. However, due to limited visibility and uncertainty arising from COVID-19 and its impact on the global economy and supply chain, geopolitical uncertainty, overall levels of current investment by our customers, and the cyclical nature of the market it is difficult to determine the extent or duration to which the increased demand for semiconductor equipment will continue.
INDUSTRIAL AND MEDICAL MARKET
Customers in the Industrial and Medical market incorporate our advanced power, embedded power, and measurement products into a wide variety of equipment used in applications such as advanced material fabrication, medical devices, analytical instrumentation, test and measurement equipment, robotics, motor drives and connected light-emitting diodes.
OEM customers design equipment utilizing our process power technologies in a variety of industrial applications including glass coating, glass manufacturing, flat panel displays, photovoltaics solar cell manufacturing, and similar thin film manufacturing, including data storage and decorative, hard and optical coatings. These applications employ similar technologies to those used in the Semiconductor Equipment market to deposit films on non-semiconductor substrates. Our strategy around these applications is to leverage our thin film deposition technologies into an expanded set of new materials and applications in adjacent markets.
Advanced Energy serves the Industrial and Medical market with mission-critical power components that deliver high reliability, precise, low noise or differentiated power to the equipment they serve. Examples of products sold into the Industrial and Medical market includes high voltage products for analytical instrumentation, medical equipment, low voltage power supplies used in applications for medical devices, test and measurement, medical lasers, scientific instrumentation and industrial equipment, and power control modules and thermal instrumentation products for material fabrication, processing, and treatment. Our gas monitoring products serve multiple applications in the energy market, air quality monitoring and automobile emission monitoring and testing. Our strategy in the Industrial and Medical market is to grow and expand our addressable market both organically through our global distribution channels and through acquisitions of products and technologies that are complimentary and adjacent to our core power conversion applications.
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Revenue for Industrial and Medical products improved in the second half of 2020 after lower revenues in the first half of 2020 primarily due to recessionary macroeconomic conditions, and production and supply chain delays related to COVID-19 that pushed shipments into the third and fourth quarter of 2020. Additionally, we saw modest improvement in industrial markets as global economic growth resumed and our customers were able to increase capacity after governmental restrictions were relaxed during the second half of 2020.
DATA CENTER COMPUTING MARKET
Following the acquisition of Artesyn in September 2019, Advanced Energy entered the Data Center Computing market with industry-leading products and low-voltage power conversion technologies. We sell to many data center server and storage manufacturers, as well as cloud service providers and their partners. Driven by the growing adoption of cloud computing, market demand for server and storage equipment has shifted from enterprise on-premise computing to the data center. Nevertheless, with a growing presence at both cloud service providers and industry-leading data center server and storage vendors, we believe Advanced Energy is well positioned to continue to capitalize on the ongoing shift towards cloud computing. In late 2019 and through 2020, demand for our embedded power products in the data center computing market increased significantly driven by share gains and a capacity ramp at hyperscale customers. In addition, we believe as a consequence of COVID-19, hyperscale demand has risen in the near term given the increased need for cloud and network applications in the current environment. Demand for hyperscale products declined sequentially during the latter half of 2020, as a result of market digestion following a ramp of investment earlier in the year. This digestion period is expected to continue into the first part of 2021.
TELECOM AND NETWORKING MARKET
The acquisition of Artesyn in September 2019 provided Advanced Energy with a portfolio of products and technologies that are used across the Telecom and Networking market. Our customers include many leading vendors of wireless infrastructure equipment, telecommunication equipment and computer networking. The wireless telecom market continues to evolve with more advanced mobile standards. 5G wireless technology promises to drive substantial growth opportunities for the telecom industry as it enables new advanced applications such as autonomous vehicles and virtual/augmented reality. Telecom service providers have started to invest in 5G, and this trend is expected to drive demand of our products into the Telecom and Networking market. In datacom, demand is driven by networking investments by telecom service providers and enterprises upgrading of their network, as well as cloud data center networking investments for increased bandwidth. Demand in late 2019 and the first half of 2020 was lower as geopolitical issues and consolidation of wireless telecom providers drove slower global investment in cellular and network infrastructure. Revenue increased sequentially in the third and fourth quarters primarily as a result of modest improvement in market conditions and improved manufacturing capacity amid COVID-19.
Results of Continuing Operations
The analysis presented below is organized to provide the information we believe will facilitate an understanding of our historical performance and relevant trends going forward, and should be read in conjunction with our consolidated financial statements, including the notes thereto, in Item 8 "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.
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The following table sets forth certain data derived from our Consolidated Statements of Operations (in thousands):
Year Ended December 31,
2020
2019
Sales
$
1,415,826
$
788,948
Gross profit
541,869
315,652
Operating expenses
365,846
261,264
Operating income from continuing operations
176,023
54,388
Other income (expense), net
(17,876)
12,806
Income from continuing operations before income taxes
158,147
67,194
Provision for income taxes
22,996
10,699
Income from continuing operations, net of income taxes
$
135,151
$
56,495
The following table sets forth the percentage of sales represented by certain items reflected in our Consolidated Statements of Operations:
Year Ended December 31,
2020
2019
Sales
100.0
%
100.0
%
Gross profit
38.3
40.0
Operating expenses
25.8
33.1
Operating income from continuing operations
12.4
6.9
Other income (expense), net
(1.3)
1.6
Income from continuing operations before income taxes
11.2
8.5
Provision for income taxes
1.6
1.4
Income from continuing operations, net of income taxes
9.5
%
7.2
%
SALES, NET
The following tables summarize annual sales and percentages of sales, by product line (in thousands):
Year Ended December 31,
Change 2020 v. 2019
2020
2019
Dollar
Percent
Semiconductor Equipment
$
611,864
$
403,018
$
208,846
51.8
%
Industrial and Medical
313,646
245,992
67,654
27.5
Data Center Computing
322,539
91,438
231,101
252.7
Telecom and Networking
167,777
48,500
119,277
245.9
Total
$
1,415,826
$
788,948
$
626,878
79.5
%
Years Ended December 31,
2020
2019
Semiconductor Equipment
43.2
%
51.1
%
Industrial and Medical
22.1
31.2
Data Center Computing
22.8
11.6
Telecom and Networking
11.9
6.1
Total
100.0
%
100.0
%
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OPERATING EXPENSE
The following table summarizes our operating expense as a percentage of sales (in thousands):
Years Ended December 31,
2020
2019
Research and development
$
143,961
10.2
%
$
101,503
12.9
%
Selling, general, and administrative
188,590
13.3
142,555
18.1
Amortization of intangible assets
20,129
1.4
12,168
1.5
Restructuring charges
13,166
0.9
5,038
0.6
Total operating expenses
$
365,846
25.8
%
$
261,264
33.1
%
2020 Results Compared To 2019
SALES
Total sales for the year ended December 31, 2020 increased $626.9 million, or 79.5% to $1,415.8 million from $788.9 million for the year ended December 31, 2019. Revenue in 2020 benefited from $670.8 million in inorganic sales from the acquisition of Artesyn. Organic sales in 2020 increased $176.4 million primarily due to increased demand in the Semiconductor Equipment market offset by lower sales of our industrial thin film products due to a weaker overall macroeconomic environment and the impact of COVID-19. Sales in 2019 include $220.3 million in sales from our acquisition of Artesyn.
In 2020, sales to the Semiconductor Equipment market increased $208.8 million, or 51.8% to $611.9 million from $403.0 million in 2019. The increase in sales during 2020 is primarily due to an overall increase in demand for semiconductor equipment used in deposition and etch applications, increasing power content in semiconductor manufacturing tools, and market share gains in RF match and remote plasma sources.
Sales to the Industrial and Medical market increased $67.7 million, or 27.5% to $313.6 million in 2020 from $246.0 million in 2019. Our customers in this market are primarily global and regional original equipment and device manufacturers. Inorganic growth contributed $97.9 million in 2020, while organic sales in the Industrial and Medical market decreased $30.3 million, or 17.9%. The increase in inorganic sales is primarily due to inclusion of full year results for Artesyn in 2020 compared to a partial year during 2019. The decrease in organic sales was primarily due to slowing macroeconomic conditions, the impact of COVID-19 on global manufacturing, and lower demand in the consumer hard coating and flat panel display markets impacting our thin film deposition markets, partially offset by growth in medical and other embedded power products.
Sales in the Data Center Computing market were $322.5 million in 2020 and $91.4 million in 2019. The increase in Data Center Computing market sales is primarily due to inclusion of full year results for Artesyn in 2020 compared to a partial year during 2019 and revenue increases driven by growth in hyperscale customers and market share gains.
Sales in the Telecom and Networking market were $167.8 million in 2020 and $48.5 million in 2019. The increase in telecom and networking sales is due to the addition of new product verticals through inorganic growth. Since early 2019, demand for telecom and networking equipment has been impacted by reduced investment in current generation networks given geopolitical issues, consolidation of network providers, and slowing global growth. Demand in the Telecom and Networking market started to recover in the second half of 2020, and over time 5G infrastructure investments and upgrades to enterprise networks are expected to drive growth in this market.
Sales to Applied Materials, Inc. and Lam Research Corp., our two largest customers, increased $137.1 million to $390.1 million, and 27.5% of sales, in 2020 from $253.0 million, and 32.1% of sales in 2019. Our sales to Applied Materials, Inc. and Lam Research Corp. included sales in the Semiconductor Equipment market, as well as sales in the Industrial and Medical market for equipment used in flat panel displays.
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Backlog
Our backlog was $290.7 million on December 31, 2020 as compared to $258.9 million on December 31, 2019.
GROSS PROFIT
Gross profit increased $226.2 million to $541.9 million, or 38.3%, in 2020 as compared to $315.7 million, or 40.0%, in 2019. The decrease in gross profit as a percent of revenue is largely related to the mix of embedded power products acquired from Artesyn, which carry a lower gross margin, offset partially by the impact of increased volume from our organic product mix, improvements in material cost, and synergies from the combined company. Gross profit in 2020 includes $160.8 million from our acquisitions of Artesyn. Gross profit in 2019 includes $44.8 million associated with our acquisition of Artesyn.
OPERATING EXPENSE
Research and Development
We perform research and development ("R&D") of products to develop new or emerging applications, technological advances 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 and related software 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.
R&D expenses in 2020 increased $42.5 million to $144.0 million, from $101.5 million in 2019, and decreased as a percentage of total revenue to 10.2% in 2020 from 12.9% in 2019. R&D expenses in 2020 include $47.2 million from our acquisition of Artesyn. R&D expenses in 2019 include $14.2 million from our acquisition of Artesyn. R&D excluding the acquisition of Artesyn increased $9.7 million primarily due to increased payroll, consulting and material and supplies costs as we invested in new programs to maintain and increase our technological leadership and provide solutions to our customers’ evolving needs .
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 ("SG&A") expenses in 2020 increased $46.0 million to $188.6 million from $142.6 million in 2019 and decreased as a percentage of total revenue to 13.3% in 2020 from 18.1% in 2019. SG&A expenses include $57.0 million from our acquisition of Artesyn. SG&A expenses in 2019 include $19.3 million from our acquisition of Artesyn. Organic SG&A expenses increased by $8.3 million primarily due to increased incentive and stock-based compensation, offset partially by decrease in reserve for credit losses related to prior year credit exposure in the PRC as a result of deferred programs due in part to COVID-19, and lower headcount, professional services, and synergies related to the Artesyn integration.
Amortization of Intangibles
Amortization expense in 2020 increased $8.0 million to $20.1 million from $12.2 million in 2019. The increase in 2020 is primarily driven by incremental amortization of intangible assets for a full year related to our acquisition of Artesyn.
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Restructuring
Restructuring charges relate to previously announced management plans to optimize our manufacturing footprint to lower-cost regions, improvements in operating efficiencies, and synergies related to acquisitions. For the year ended December 31, 2020, we incurred $13.2 million in restructuring charges which relate to severance costs for the transition and exit of our facility in Shenzhen, PRC and actions associated with Artesyn synergies. Refer to Note 14. Restructuring Costs in Item 8. Financial Statements and Supplementary Data.
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 ($17.9) million in 2020, as compared to $12.8 million in 2019. In May 2019 we sold our central solar inverter repair and service operation and recorded a one-time gain of $14.8 million. Other income (expense) excluding the effect of the sale of the central inverter service and repair business was ($2.0) million in 2019. The increase in other income (expense) is primarily due to foreign exchange losses as our exposure to foreign currencies increased with the Artesyn acquisition and higher interest expense related to a full year of interest in 2020 compared to approximately four months interest in the second half of 2019 related to the debt issued in connection with the acquisition of Artesyn.
Provision for Income Taxes
In 2020, we recorded income tax expense for our continuing operations of $23.0 million or an effective tax rate of 14.5%. Income tax expense in 2019 was $10.7 million or an effective tax rate of 15.9%. The 2020 effective tax rate differs from the federal statutory rate of 21% primarily due to the benefit of earnings in foreign jurisdictions which are subject to lower tax rates, offset by net U.S. tax on foreign operations and withholding taxes.
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 have been reflected as "Income (loss) from discontinued operations, net of income taxes" on our Consolidated Statements of Operations for all periods presented herein.
The effect of our sales of the remaining extended inverter warranties to our customers continues to be reflected in deferred revenue in our 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 Statements 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.
In May 2019, we divested our grid-tied central solar inverter repair and service operation. In conjunction with the divesture, the initial product warranty for the previously sold grid-tied central solar inverters was transferred to the buyer. Accordingly, a gain of $8.6 million net of tax expense of $2.4 million was recognized in Other income (expense), net and Provision (benefit) for income taxes, respectively, in our discontinued operations for the year December 31, 2019. Operating income from discontinued operations for the year ended December 31, 2020 and 2019, also includes the impacts of changes in our estimated product warranty liability, the recovery of accounts receivable and foreign exchange gain or (losses).
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Income (loss) from discontinued operations, net of income taxes (in thousands):
Years Ended December 31,
2020
2019
Sales
$
—
$
—
Cost of sales
—
(901)
Total operating expense
620
1,022
Operating income (loss) from discontinued operations
(620)
(121)
Other income (expense)
65
10,895
Income (loss) from discontinued operations before income taxes
(555)
10,774
Provision (benefit) for income taxes
(134)
2,294
Income (loss) from discontinued operations, net of income taxes
$
(421)
$
8,480
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 stock-based compensation and amortization of intangible assets. In addition, they exclude discontinued operations and other non-recurring items such as acquisition-related costs and restructuring expenses, 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 and effect of adoption of the Tax Act.
Reconciliation of Non-GAAP measure - operating expenses and operating income from continuing operations, excluding certain items (in thousands)
Years Ended December 31,
2020
2019
Gross profit from continuing operations, as reported
$
541,869
$
315,652
Adjustments to gross profit:
Stock-based compensation
567
525
Facility expansion, relocation costs and other
4,349
3,891
Acquisition-related costs
5,381
8,290
Non-GAAP gross profit
552,166
328,358
Non-GAAP gross margin
39.0%
41.6%
Operating expenses from continuing operations, as reported
365,846
261,264
Adjustments:
Amortization of intangible assets
(20,129)
(12,168)
Stock-based compensation
(11,705)
(6,803)
Acquisition-related costs
(10,209)
(12,002)
Facility expansion, relocation costs and other
(2,213)
(948)
Restructuring charges
(13,166)
(5,038)
Non-GAAP operating expenses
308,424
224,305
Non-GAAP operating income
$
243,742
$
104,053
Non-GAAP operating margin
17.2%
13.2%
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Reconciliation of Non-GAAP measure – income from continuing operations, excluding certain items (in thousands)
Years Ended December 31,
2020
2019
Income from continuing operations, less non-controlling interest, net of income taxes
$
135,096
$
56,461
Adjustments:
Amortization of intangible assets
20,129
12,168
Acquisition-related costs
15,590
20,292
Facility expansion, relocation costs and other
6,562
4,838
Restructuring charges
13,166
5,038
Unrealized foreign currency (gain) loss
8,384
—
Acquisition-related and other costs included in Other income (expense), net
716
(29)
Central inverter services business sale
—
(13,737)
Tax effect of non-GAAP adjustments
(7,611)
3,206
Non-GAAP income, net of income taxes, excluding stock-based compensation
192,032
88,237
Stock-based compensation, net of taxes
9,418
5,627
Non-GAAP income, net of income taxes
$
201,450
$
93,864
Non-GAAP diluted earnings per share
$
5.23
$
2.44
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. Sales price increases, however, were not significant in any of the years presented herein.
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, and cash generated from current operations.
On December 31, 2020, we had $483.0 million in cash, cash equivalents, and marketable securities. We believe that our current cash levels and our cash flows from future operations will be adequate to meet anticipated working capital needs, anticipated levels of capital expenditures, and contractual obligations for the next twelve months.
On December 31, 2020, we had $179.6 million in cash, cash equivalents, and marketable securities held by foreign subsidiaries. As a result of the recent Tax Act, we have provided for U.S. tax on certain foreign unremitted earnings. Accordingly, cash related to these unremitted earnings could be repatriated to the U.S. with minimal additional taxes. Additional taxes would include foreign withholding taxes and U.S. state income taxes. During 2018 and 2019, the Company changed its policy regarding indefinite investment of unremitted earnings and recognized the tax expense associated with this change in election. Consistent with the Company’s capital deployment initiatives, the Company intends to utilize foreign cash to expand our operations through internal growth and strategic acquisitions, provide for service of existing debt, and opportunistically return cash to stockholders.
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Credit Facility
In connection with the acquisition of Artesyn in 2019, the Company entered into a credit agreement (“Credit Agreement") that provided aggregate financing of $500.0 million, consisting of a $350.0 million senior unsecured term loan facility (the "Term Loan Facility") and a $150.0 million senior unsecured revolving facility ("Revolving Facility"). Both the Term Loan Facility and Revolving Facility mature on September 10, 2024. On December 31, 2020, we had $150.0 million in available funding under the Revolving Facility. See Note 21. Credit Facility in Part II, Item 8 "Financial Statements and Supplemental Data" for additional information.
Dividends
We have not declared or paid any cash dividends on our capital stock in our history as a public company. However, on December 15, 2020, our Board approved the initiation of a cash dividend program under which we intend to pay a regular quarterly dividend of $0.10 per share, starting in the first quarter of 2021. On February 1, 2021, the Board declared a quarterly dividend of $0.10 per share payable to shareholders of record as of February 22, 2021. Future dividend payments are subject to approval by the Board.
Share Repurchase
On December 18, 2019, the Board authorized to remove the expiration date to the Company’s common stock share repurchase program and increase the authorized amount by $ 25.1 million, which increased the. authorization to repurchase shares up to a total of $50.0 million. As of December 31, 2020, a total of $38.4 million remained available for future share repurchases. During the year ended December 31, 2020, we repurchased 244 thousand shares for $11.6 million at an average price of $47.75 per share. There were no share repurchases during the year ended December 31, 2019.
Cash Flows
A summary of our cash from operating, investing, and financing activities is as follows (in thousands):
Years Ended December 31,
2020
2019
Net cash from operating activities from continuing operations
$
202,159
$
47,899
Net cash from operating activities from discontinued operations
(923)
493
Net cash from operating activities
201,236
48,392
Net cash from investing activities from continuing operations
(42,840)
(393,847)
Net cash from financing activities from continuing operations
(29,612)
338,840
Effect of currency translation on cash
5,143
(1,496)
Increase (decrease) in cash and cash equivalents
133,927
(8,111)
Cash and cash equivalents, beginning of period
346,441
354,552
Cash and cash equivalents, end of period
$
480,368
$
346,441
Net cash from operating activities
Net cash from operating activities in 2020 was $201.2 million, an increase of $152.8 million, or 315.7% compared to $48.4 million in 2019. The increase in net cash from operating activities was primarily due to overall increases in sales and net income.
Net cash from operating activities in the fourth quarter and full year of 2019 was impacted by net payments for acquisition related activities and assumed liabilities of approximately ($27.0) million, partially offset by receipt of approximately $10.0 million in cash related to the transfer of inventory and other current assets to Smart Global Holdings, Inc. in connection with the completion of the pre-acquisition carve-out of Artesyn’s embedded computing business.
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Net cash from investing activities
Net cash from investing activities in 2020 was ($42.8) million, compared to ($393.8) million in 2019. Net cash from investing activities in 2020 includes ($36.5) million in purchases of property and equipment as we invested in our manufacturing footprint and capacity, and ($5.5) million related to business acquisitions. Net cash from investing activities in 2019 includes ($366.1) million associated with the acquisition of Artesyn.
Net cash from financing activities
Net cash from financing activities in 2020 was ($29.6) million, which consists primarily of ($17.5) million in principal repayments on our Term Loan Facility and ($11.6) million in stock repurchases. The net cash from financing activities in 2019 was $338.8 million which included the effect of cash proceeds of $350.0 million, net of financing costs of ($2.5) million, from our Term Loan Facility, partially offset by ($8.8) million in principal repayments.
Off-Balance Sheet Arrangements
As of December 31, 2020, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.
Contractual Obligations
The following table sets forth our future payments due under contractual obligations as of December 31, 2020 (in thousands):
More
Less than
than 5
Total
1 year
1-3 years
3-5 years
years
Debt obligations (1)
$
323,750
$
17,500
$
35,000
$
271,250
$
—
Interest payments associated with debt obligations (1)
13,956
4,038
7,478
2,440
—
Operating lease obligations (2)
148,471
21,916
30,397
22,936
73,222
Purchase obligations (3)
191,765
191,205
560
—
Income tax obligations (4)
10,608
1,117
3,211
6,280
—
Pension funding commitment (5)
60,701
2,255
4,156
5,192
49,098
Total
$
749,251
$
238,031
$
80,802
$
308,098
$
122,320
(1) Our debt obligations consist of principal and interest repayments due on our Credit Facility based on current interest rates.
(2) Amounts represent the minimum contractual cash commitments, including the effects of fixed rental escalation clauses and deferred rent, exclusive of certain contingent rents that are not determinable for future periods.
(3) Our purchase obligations consist of purchase commitments with various manufacturing suppliers to ensure the availability of components.
(4) Income tax obligations are a result of the Tax Act and include a transition tax on unremitted foreign earnings and profits, of which we have elected to pay the estimated amount over an eight-year period.
(5) Our pension funding commitments represent the amounts that we are required to pay to fund our pension plan obligations.
Recent Accounting Pronouncements
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 our consolidated financial statements upon adoption.
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To understand the impact of recently issued guidance, whether adopted or to be adopted, please review the information provided in Note 1. Operations and Summary of Significant Accounting Policies and Estimates in Part II, Item 8 "Financial Statements and Supplementary Data."