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 Part I, Item 1A for a discussion of certain risks applicable to our business, financial condition, and results of operations.
The following section discusses our results of operations for 2021 and 2020 and year-to-year comparisons between those periods. Discussions of 2019 and year-to-year comparisons between 2020 and 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 2020 Form 10-K for the year ended December 31, 2020.
Overview
Advanced Energy provides highly engineered, mission-critical, precision power conversion, measurement, and control solutions to our global customers. We design, manufacture, sell, and support precision power products that transform, refine, and modify the raw electrical power coming from either the utility or the building facility and convert it into various types of highly controllable, usable power that is predictable, repeatable, and customizable to meet the necessary requirements for powering a wide range of complex equipment. Our power solutions enable innovation in complex semiconductor and thin film plasma processes such as dry etch, strip and deposition, high and low voltage applications such as semiconductor process control, data center computing, networking, telecommunication, medical equipment, life science applications, industrial technology and production, scientific instruments, clean technology production, advanced material production and temperature-critical thermal applications. We also supply related sensing, controls, and instrumentation products for advanced measurement and calibration of RF power and temperature, electrostatic instrumentation products for test and measurement applications, and gas sensing and monitoring solutions for multiple industrial markets. Our network of global service support centers provides a recurring revenue opportunity as we offer repair services, conversions, upgrades, refurbishments, and used equipment to companies using our products.
Our products are sold into the Semiconductor Equipment, Industrial and Medical, Data Center Computing, and Telecom and Networking markets, and we have provided market revenue data in this Annual Report on Form 10-K to enable tracking of trends. Advanced Energy is organized on a global, functional basis and operates in a single segment structure for power electronics conversion products.
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.
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. The estimates also include the fair value of contracts including commodity purchase and sale agreements, storage contracts, and transportation contracts. The excess
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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 U.S. 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.
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.
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. We believe 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
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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 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, we share the results of the survey 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 accepts 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, 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) contributions, flexible work schedules, expanded mental health coverage, and employee assistance programs. With the challenging times created by COVID-19, we continued our commitment to ensure our employees maintained financial security and provided certain employees the ability to work from home, paid leave time for our employees who may have been impacted by temporary site closures, and paid leave time for vaccinations.
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 also have an internship program designed to help support a talent pipeline. 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.
Diversity, Equity & Inclusion
In 2021, we relaunched our Corporate Inclusion, Diversity and Equity Steering Committee, which was tasked with researching, developing, and proposing strategies and initiatives aimed at creating and fostering engagement, awareness, respect, and inclusion for our employees, customers, vendors, and communities. This committee provides global guidance and direction while enabling local activities to develop specific, targeted initiatives as appropriate.
Health and Safety
We are committed to providing a safe work environment for our employees. We provide regular health and safety training in both on-site format 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.
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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 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 Advanced Energy employees, celebrates education accomplishments and facilitates career and learning goals.
Business Environment and Trends
Advanced Energy operates in a single segment structure for power electronics conversion products. We operate in four vertical markets or applications and provide revenue information to enable tracking of market trends.
The demand environment in each of our markets is impacted by various market trends, customer buying patterns, design wins, macroeconomic and other factors. During 2021 we saw growth in our Semiconductor Equipment and Industrial and Medical markets but weakening demand in our Data Center Computing and Telecom and Networking markets.
At the beginning of 2020 we saw the spread of COVID-19, which grew into a global pandemic. Our focus on providing a healthy and safe working environment for our employees led to intermittent shutdowns of our manufacturing facilities to implement new health and safety protocols and additional investments to comply with government guidelines. During 2020 and 2021 there were periods when some of our manufacturing facilities were not operating or were operating at reduced capacity due to government mandates to restrict travel, maintain social distancing, and implement health and safety procedures. Additionally, ongoing restrictions related to COVID-19 and disruptions in an already challenged global supply chain limited the availability of certain materials, parts, subcomponents, and subassemblies needed for production during 2021, impacting our ability to ship product to meet customer demand. The shortage of critical components was caused in part by the pandemic-driven rise in consumer demand for technology goods, increased demand for electronic components used in a wide variety of industries, logistics-related disruptions in shipping, and capacity limitations at some suppliers due to COVID-19, its variants, labor shortages, and other factors. See Part I, Item 1A "Risk Factors" for a discussion of certain risks related to COVID-19.
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, cloud computing, and autonomous vehicles, and the rapid adoption of advanced mobile connectivity solutions such as 5G, which enhances existing and enables new wireless applications. To address the long-term growing demand for semiconductor devices, the industry continues to invest in production capacities for both leading-edge and trailing-edge nodes, logic devices, 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-NAND memory devices require an increased number of plasma-based 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 RF, and 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 wafer 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
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range of low voltage applications as well as back-end test and assembly equipment makers. Our strategy in the Semiconductor Equipment market is to defend our proprietary positions in our core applications, grow our market position in applications where we have lower share, including remote plasma source and dielectric etch, and leverage our product portfolio in areas such as embedded power, high voltage power system, and critical sensing and controls to grow our share and contents at our key OEM customers.
The Semiconductor Equipment market is experiencing continued demand growth since 2019, driven by higher semiconductor contents across many industries, increased capital intensity at the leading-edge process nodes, semiconductor device makers investing in the trailing-edge nodes due to supply constraints and increased regional investments of semiconductor capacities. Advanced Energy participated in this market growth by delivering record revenue from the Semiconductor Equipment market in 2021, even with the negative impact of limited availability of critical parts due to global supply constraints. In addition, increased demand for semiconductor devices for a wide range of applications as global economies begin to recover is expected to drive investment in new capacity throughout 2022.
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, horticulture, motor drives, and connected light-emitting diodes.
OEM customers design equipment utilizing our process power technologies in a variety of industrial production 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. The acquisition of Artesyn in September 2019 substantially expanded Advanced Energy’s portfolio of products and opportunities in the Industrial and Medical market. In the first half of 2020, the COVID-19 pandemic impacted demand for our products in this market, but demand started to recover in the second half of 2020. Our strategy in the Industrial and Medical market is to expand our product offerings and channel reach, leveraging common platforms, derivatives, and customizations to further penetrate a broader set of applications, such as medical, test and measurement, horticulture, and many other industrial applications.
During 2021, we saw 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. Demand for medical products during 2020 was driven by critical care applications, offset by lower investment related to elective procedures. During 2021, demand for critical applications has declined while other demand has improved. During 2021, overall customer demand improved, but supply constraints of critical components limited our ability to ship product at the level of customer demand. However, even with the limited supply, revenue from the Industrial and Medical market grew in the year as a result of our growth strategy. We expect demand in the Industrial and Medical market to grow in 2022, but the supply constraint condition has extended into the year. It is not clear how long these supply shortages will persist or how quickly our supply will recover.
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DATA CENTER COMPUTING MARKET
Following the acquisition of Artesyn in September 2019, Advanced Energy entered the Data Center Computing market with industry leading power conversion products and technologies, which we sell to OEMs and ODMs of data center server and storage systems, 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-premises computing to the data center, driving investments in data center infrastructure. In addition, the data center industry has started to transition to 48 Volt infrastructure, where 48 Volt DC power replaces 12 Volt in server racks in order to improve overall power efficiency. Advanced Energy benefits from these trends by leading the industry in providing 48 Volt server power solutions to the data center industry. Further, demand for edge computing is growing, driven by the need for faster processing, lower latency, higher data security, and more reliability than traditional cloud computing. With a wide range of many unique configurations and requirements, edge computing creates additional opportunities for Advanced Energy. Lastly, the rapid growth and adoption of Artificial Intelligence and machine learning is driving accelerated demand for server and storage racks with increased power density and higher efficiency, which plays well to Advanced Energy’s strengths. 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. Our strategy in the Data Center and Computing market is to penetrate additional customers and applications based on our differentiated capability and competitive strengths in power density, efficiency, and controls.
In late 2019 and through 2020, demand for our embedded power products in the Data Center Computing market increased significantly driven by our 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 declined in the second half of 2020 as a result of market digestion but started to recover during 2021. However, our 2021 revenue declined due to the limited availability of parts given global supply constraints, which prevented us from producing products to meet the growing demand. We expect demand in this market to grow in 2022, but the supply constraint condition has extended into this year. It is not clear how long these supply shortages will persist or how quickly our supply will recover.
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 service providers and data centers investing in their networks for increased bandwidth. Our strategy in Telecom and Networking is to optimize our portfolio of products to more differentiated applications, and to focus on 5G infrastructure applications primarily with U.S. and European equipment providers.
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 of 2020, primarily as a result of modest improvement in market conditions and improved manufacturing capacity amid COVID-19. During 2021, revenue declined as a result of the limited availability of parts given global supply constraints and our internal decision to optimize our portfolio toward higher margin applications within the Telecom and Networking market. Going into 2022, we expect demand in this market to recover driven by increased investments in 5G infrastructure, but the supply constraint condition has extended into the year. It is not clear how long these supply shortages will persist or how quickly our supply will recover.
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Results of Continuing Operations
The analysis presented below is organized to provide the information we believe will be helpful for 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 Part II, Item 8 "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. 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.
The following table sets forth certain data derived from our Consolidated Statements of Operations (in thousands):
Year Ended December 31,
2021
2020
Sales
$
1,455,954
$
1,415,826
Gross profit
532,322
541,869
Operating expenses
380,641
365,846
Operating income from continuing operations
151,681
176,023
Other income (expense), net
(2,970)
(17,876)
Income from continuing operations before income taxes
148,711
158,147
Provision for income taxes
14,004
22,996
Income from continuing operations, net of income taxes
$
134,707
$
135,151
The following table sets forth the percentage of sales represented by certain items reflected in our Consolidated Statements of Operations:
Year Ended December 31,
2021
2020
Sales
100.0
%
100.0
%
Gross profit
36.6
38.3
Operating expenses
26.1
25.8
Operating income from continuing operations
10.4
12.4
Other income (expense), net
(0.2)
(1.3)
Income from continuing operations before income taxes
10.2
11.2
Provision for income taxes
1.0
1.6
Income from continuing operations, net of income taxes
9.3
%
9.5
%
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SALES, NET
The following tables summarize annual sales and percentages of sales by markets (in thousands):
Year Ended December 31,
Change 2021 v. 2020
2021
2020
Dollar
Percent
Semiconductor Equipment
$
710,174
$
611,864
$
98,310
16.1
%
Industrial and Medical
341,176
313,646
27,530
8.8
Data Center Computing
270,924
322,539
(51,615)
(16.0)
Telecom and Networking
133,680
167,777
(34,097)
(20.3)
Total
$
1,455,954
$
1,415,826
$
40,128
2.8
%
Years Ended December 31,
2021
2020
Semiconductor Equipment
48.8
%
43.2
%
Industrial and Medical
23.4
22.1
Data Center Computing
18.6
22.8
Telecom and Networking
9.2
11.9
Total
100.0
%
100.0
%
OPERATING EXPENSE
The following table summarizes our operating expense as a percentage of sales (in thousands):
Years Ended December 31,
2021
2020
Research and development
$
161,831
11.1
%
$
143,961
10.2
%
Selling, general, and administrative
191,998
13.2
188,590
13.3
Amortization of intangible assets
22,060
1.5
20,129
1.4
Restructuring charges
4,752
0.3
13,166
0.9
Total operating expenses
$
380,641
26.1
%
$
365,846
25.8
%
2021 Results Compared To 2020
SALES
Sales increased $40.1 million, or 2.8%, to $1,456.0 million, as compared to $1,415.8 million in the prior year. The increase in sales was primarily due to increased demand and shipments in the Semiconductor Equipment and Industrial and Medical markets, offset by lower sales from the Data Center Computing market and the Telecom and Networking market. In addition, the first half of 2020 was negatively impacted by factory shutdowns related to COVID-19. Revenues in 2021 were negatively impacted across all of our markets by supply chain shortages for certain IC’s and other components, which limited our ability to ship to our total demand.
Sales in the Semiconductor Equipment market increased $98.3 million, or 16.1%, to $710.2 million, as compared to $611.9 million in the prior year. The increase in sales during 2021 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 several areas across our portfolio.
Sales to the Industrial and Medical market increased $27.5 million, or 8.8%, to $341.2 million, as compared to $313.6 million in the prior year. Our customers in this market are primarily global and regional original equipment and device manufacturers. The increase in sales year to date was primarily due to improving macroeconomic conditions and the continued recovery from the COVID-19 pandemic driving stronger demand.
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Sales in the Data Center Computing market decreased $51.6 million, or 16.0%, to $270.9 million, as compared to $322.5 million in the prior year. The decrease in Data Center Computing market sales is due in part to digestion of equipment at key accounts following strong revenue last year and supply constraints, which limited our ability to ship sufficiently to meet customer demand.
Sales in the Telecom and Networking market decreased $34.1 million, or 20.3%, as compared to $167.8 million in the prior year. The decrease in sales was due to in part to our decision to optimize our product portfolio towards higher margin applications and production limitations due to supply constraints. Over time, we expect that 5G infrastructure investments and upgrades to enterprise networks will drive growth in this market.
Our acquisitions of TEGAM and Versatile Power contributed $12.1 million to 2021 sales. See Note 2: Acquisitions in Part II, Item 8 "Financial Statements and Supplementary Data" for details.
BACKLOG
The following table summarizes our backlog (in thousands):
December 31,
December 31,
Change
2021
2020
Dollar
Percent
Backlog
$
927,810
$
290,681
$
637,129
219.2
%
GROSS PROFIT
Gross profit decreased $9.5 million to $532.3 million, or 36.6% of revenue, as compared to $541.9 million, or 38.3%, in the prior year. The decrease in gross profit as a percent of revenue is largely related to higher material and freight costs. Additional drivers of our decrease in gross profit include productivity inefficiencies resulting from supply constraints, COVID-19 capacity restrictions, and the transition of our Shenzhen, PRC manufacturing to Penang, Malaysia. These decrease drivers were partly offset by increased volume and favorable product mix.
OPERATING EXPENSE
Research and Development
We perform R&D to develop new or emerging applications, technological advances to provide higher performance, or significant enhancements. 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 increased $17.9 million to $161.8 million, as compared to $144.0 million in the prior year. The increase in research and development expense is related to increased headcount and associated costs, outside technical services, and engineering materials as we invested in new programs to maintain and increase our technological leadership and provide solutions to our customers’ evolving needs. Our recent acquisitions of Versatile Power and TEGAM resulted in a combined increase of $2.5 million to R&D expenses. See Note 2: Acquisitions in Part II, Item 8 "Financial Statements and Supplementary Data" for additional details.
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.
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Selling, general and administrative ("SG&A") expenses increased $3.4 million to $192.0 million, as compared to $188.6 million in the prior year. The increase in SG&A is principally related to acquisition related activity partially offset by a reduction in variable compensation. See Note 2: Acquisitions in Part II, Item 8 "Financial Statements and Supplementary Data" for additional details.
Amortization of Intangibles
Amortization expense increased $1.9 million to $22.1 million, as compared to $20.1 million in the prior year. The increase in 2021 was primarily driven by incremental amortization of newly acquired intangible assets. For additional information, see Note 13. Intangible Assets in Part II, Item 8 "Financial Statements and Supplementary Data."
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 additional information, see Note 14. Restructuring Costs in Part II, 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 ($3.0) million in 2021, as compared to ($17.9) million in the prior year. The decrease between periods is primarily due to decreased interest expense related to our term note due to lower interest rates, as well as more favorable impacts from foreign exchange rate changes and gains on certain acquisition related reserves.
Provision for Income Taxes
(in thousands)
Years Ended December 31,
2021
2020
2019
Income from continuing operations, before income taxes
$
148,711
$
158,147
$
67,194
Provision for income taxes
$
14,004
$
22,996
$
10,699
Effective tax rate
9.4
%
14.5
%
15.9
Our effective tax rates differ from the U.S. federal statutory rate of 21% for the years ended December 31, 2021, 2020, and 2019, primarily due to the benefit of earnings in foreign jurisdictions which are subject to lower tax rates, as well as reductions in uncertain tax positions and tax credits, offset by net U.S. tax on foreign operations, withholding taxes, and audit settlements. The effective tax rate for 2021 was lower than the same period in 2020, primarily due to the mix of discrete events between the two periods.
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.
Non-GAAP Results
Management uses non-GAAP operating income and non-GAAP earnings per share ("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,
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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 Cuts and Jobs Act.
Reconciliation of non-GAAP measure - operating expenses and operating income from
Years Ended December 31,
continuing operations, excluding certain items (in thousands)
2021
2020
Gross profit from continuing operations, as reported
$
532,322
$
541,869
Adjustments to gross profit:
Stock-based compensation
764
567
Facility expansion, relocation costs and other
6,189
4,349
Acquisition-related costs
3,585
5,381
Non-GAAP gross profit
542,860
552,166
Non-GAAP gross margin
37.3%
39.0%
Operating expenses from continuing operations, as reported
380,641
365,846
Adjustments:
Amortization of intangible assets
(22,060)
(20,129)
Stock-based compensation
(14,975)
(11,705)
Acquisition-related costs
(6,803)
(10,209)
Facility expansion, relocation costs and other
(229)
(2,213)
Restructuring charges
(4,752)
(13,166)
Non-GAAP operating expenses
331,822
308,424
Non-GAAP operating income
$
211,038
$
243,742
Non-GAAP operating margin
14.5%
17.2%
Reconciliation of non-GAAP measure - income from continuing operations,
Year Ended December 31,
excluding certain items (in thousands, except per share amounts)
2021
2020
Income from continuing operations, less non-controlling interest, net of income taxes
$
134,663
$
135,096
Adjustments:
Amortization of intangible assets
22,060
20,129
Acquisition-related costs
10,388
15,590
Facility expansion, relocation costs, and other
6,418
6,562
Restructuring charges
4,752
13,166
Unrealized foreign currency (gain) loss
(3,543)
8,384
Acquisition-related costs and other included in other income (expense), net
(2,186)
716
Tax effect of non-GAAP adjustments
(1,346)
(7,611)
Non-GAAP income, net of income taxes, excluding stock-based compensation
171,206
192,032
Stock-based compensation, net of taxes
12,042
9,418
Non-GAAP income, net of income taxes
$
183,248
$
201,450
Non-GAAP diluted earnings per share
$
4.78
$
5.23
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Impact of Inflation
In recent years, inflation has not had a significant impact on our operations. However, more recently we are experiencing price increases in select components driven by higher global demand, supply chain disruptions, and increased freight costs. 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 based on 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, and available borrowing capacity under the Revolving Facility (defined below).
On December 31, 2021, we had $546.7 million in cash, cash equivalents, and marketable securities.
We believe the above sources of liquidity will be adequate to meet anticipated working capital needs, anticipated levels of capital expenditures, contractual obligations, debt repayment, share repurchase programs, and dividends for the next twelve months and on a long-term basis. We may, however, depending upon the number or size of additional acquisitions, seek additional financing from time to time.
Credit Facility
In September 2019, in connection with the Artesyn Acquisition Agreement, we 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 (the "Revolving Facility" and together with the Term Loan Facility, the "Credit Facility").
In April 2020, we executed interest rate swap contracts with independent financial institutions to partially reduce the variability of cash flows in LIBOR indexed debt interest payments on our Term Loan Facility (under our existing Credit Agreement dated September 10, 2019, as amended). The interest rate swap contracts fixed a portion of the outstanding principal balance on our term loan to a total interest rate of 1.271%. See Note 8. Derivative Financial Instruments in Part II, Item 8 "Financial Statements and Supplemental Data" for additional information.
In September 2021, we amended the Credit Agreement whereby we borrowed an additional $85.0 million, which increased the aggregate amount outstanding under the Term Loan Facility to $400.0 million. In addition, we increased the Revolving Facility capacity by $50.0 million to $200.0 million. Both the Term Loan Facility and Revolving Facility mature on September 9, 2026.
On December 31, 2021, we had $200.0 million in available funding under the Revolving Facility. The Term Loan Facility requires quarterly repayments of $5.0 million plus accrued interest, with the remaining balance due in September 2026. For more information on the Credit Facility, see Note 21. Credit Facility and Note 8. Derivative Financial Instruments in Part II, Item 8 "Financial Statements and Supplemental Data" for additional information.
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Dividends
In December 2020, the Board approved a dividend program under which we began paying and intend to continue to pay a quarterly cash dividend of $0.10 per share of capital stock. In March 2021, we paid the first quarterly cash dividend since our inception as a public company. During 2021, we paid cash dividends totaling $15.4 million. Future dividend payments are subject to the Board's future discretion and approval .
Share Repurchase
To execute the repurchase of shares of our common stock, we periodically enter into stock repurchase agreements. The following table summarizes these repurchases:
Years Ended December 31,
(in thousands, except per share amounts)
2021
2020
Amount paid to repurchase shares
$
78,125
$
11,630
Number of shares repurchased
901
244
Average repurchase price per share
$
86.76
$
47.75
Remaining authorized by Board of Directors for future repurchases as of period end
$
128,377
$
38,369
On July 29, 2021, the Board approved an increase to the share repurchase program, which authorized the Company to repurchase up to $200 million in shares of our common stock with no time limitation.
Cash Flows
A summary of our cash from operating, investing, and financing activities was as follows (in thousands):
Years Ended December 31,
2021
2020
Net cash from operating activities from continuing operations
$
140,914
$
202,159
Net cash from operating activities from discontinued operations
(669)
(923)
Net cash from operating activities
140,245
201,236
Net cash from investing activities from continuing operations
(47,302)
(42,840)
Net cash from financing activities from continuing operations
(25,372)
(29,612)
Effect of currency translation on cash and cash equivalents
(3,567)
5,143
Increase in cash and cash equivalents
64,004
133,927
Cash and cash equivalents, beginning of period
480,368
346,441
Cash and cash equivalents, end of period
$
544,372
$
480,368
Net Cash From Operating Activities
Net cash from operating activities was $140.9 million, a decrease of $61.3 million, compared to $202.2 million in the prior year. The decrease in net cash flows from operating activities as compared to 2020 was due to an unfavorable increase in net operating assets driven primarily by our increased investment in inventory as we attempted to mitigate supply chain constraints. This was partially offset by an increase in accounts payable.
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Net Cash From Investing Activities
Net cash from investing activities in 2021 was ($47.3) million, driven by the following:
● ($31.9) million in purchases of property and equipment as we invested in our manufacturing footprint and capacity;
● ($21.5) million for business combinations; and
● $6.1 million related to receipts on notes receivable and proceeds from sale of assets.
Net cash from investing activities in 2020 was ($42.8) million, and primarily related to investment in facilities and capacity.
Net Cash From Financing Activities
Net cash from financing activities in 2021 was ($25.4) million and included:
● $83.7 million in proceeds from borrowings, net of debt-issuance costs paid;
● ($15.4) million for dividend payments;
● ($13.8) million for repayment of long-term debt;
● ($78.1) million related to repurchases of our common stock; and
● $ (1.8) million in net payments related to stock-based award activities.
The net cash from financing activities in 2020 was ($29.6) million and included:
● ($17.5) million for repayment of long-term debt;
● ($11.6) million related to repurchases of our common stock; and ($0.5) million related to stock-based award activities.
Off-Balance Sheet Arrangements
As of December 31, 2021, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.
Contractual Obligations
In the normal course of business, we enter into contracts and commitments that obligate us to make payments in the future. Information regarding our obligations relating to income taxes, lease obligations, pension liabilities, and debt are provided in Note 5. Income Taxes , Note 16. Leases , Note 17. Pension Liability and Note 21. Credit Facility , respectively, in Part II, Item 8 "Financial Statements and Supplementary Data."
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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.
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."