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 2022 and 2021 and year-to-year comparisons between those periods. Discussions of 2020 and year-to-year comparisons between 2021 and 2020 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 Form 10-K for the year ended December 31, 2021.
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. Many of our products enable customers to reduce or optimize their energy consumption through increased power conversion efficiency, power density, power coupling, and process control across a wide range of applications .
Our plasma power solutions enable innovation in complex semiconductor and thin film plasma processes such as dry etch and deposition. Our broad portfolio of high and low voltage power products are used in a wide range of applications, such as semiconductor equipment, industrial production, medical and life science equipment, data centers computing, networking, and telecommunications. We also supply related sensing, controls, and instrumentation products primarily for advanced measurement and calibration of power and temperature for multiple industrial markets. Our network of global service support centers provides repair services, calibration, conversions, upgrades, refurbishments, and used equipment to companies using our 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. Summary of Operations and 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 intangible assets. 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 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 .
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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.”
Inventories
Inventories are valued at the lower of cost (using the first-in, first-out method) or net realizable value. General market conditions, as well as our design activities, can cause certain products to become obsolete and we adjust our inventory carrying value for estimated excess and obsolescence equal to the difference between the cost of inventory and the estimated net realizable value based on projected end-user demand, which is determined by considering historical usage, customer orders and forecast, and qualitative considerations such as market and economic conditions. The determination of projected end-user demand requires the use of estimates and assumptions related to projected unit sales for each product. Demand for our products can fluctuate significantly. A significant decrease in demand could result in an increase in the charges for excess inventory quantities on hand.
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 experience or significant changes in our assumptions may materially affect our net pension and postretirement benefit obligations and related expenses.
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Business Environment and Trends
Advanced Energy is organized on a global, functional basis and operates in the single segment for power electronics conversion products. Within this segment, our products are sold into the Semiconductor Equipment, Industrial and Medical, Data Center Computing, and Telecom and Networking markets.
In April 2022, we acquired SL Power. See Note 2. Acquisitions in Part II, Item 8 “Financial Statements and Supplementary Data.” This acquisition added complementary products to Advanced Energy’s medical power offerings and extends our presence in several advanced industrial markets.
The demand environment in each of our markets is impacted by various market trends, customer buying patterns, design wins, macroeconomic and other factors. During 2022, growth in all four of our markets was strong driven by investment in new technology, capacity, and macroeconomic recovery. However, we were limited in our ability to fulfill this demand due to supply chain shortages for critical integrated circuits, resulting in longer lead times for our products. These supply constraints have led to longer lead times in procuring materials and subcomponents and, in some cases, meaningfully higher costs for the subcomponents. We have implemented measures to improve the supply of critical materials and components and to mitigate the impact of these higher input costs, and these actions have enabled us to better meet customer demand. However, it is not clear how long global supply constraint conditions will continue, how quickly the supply chain will recover, the extent to which our mitigating actions will be successful, or to what extent we can recover our higher costs. One result of the supply chain constraints is that our backlog throughout the first three quarters of the year remained above backlog at the end of 2021. Backlog declined at the end of 2022 to $875.3 million, a decrease as compared to $1,093.0 million at the end of the third quarter of 2022, driven by approximately 40% of sequential decline from China-based semiconductor customers’ orders as a result of U.S. export controls introduced in October 2022, and the remainder from lower demand and changes in ordering patterns from our semiconductor customers as we improved our lead times. Despite the decline at the end of 2022, backlog remains high compared to previous years.
COVID related disruptions did materially impact our liquidity, ability to access capital, ability to comply with our debt covenants or the fair value of our assets in 2022.
SEMICONDUCTOR EQUIPMENT MARKET
The Semiconductor Equipment market is driven by the long-term growing need for more semiconductor production capacity and new process technologies. While the semiconductor and semiconductor equipment industries are inherently cyclical, over the long-term, integrated circuits content is growing across many industries driven by increased demand for processing, storing, and transmitting the growing amount of data. To meet the growing demand, the chip industry continues to invest in production capacity for both leading-edge and trailing-edge nodes logic devices, the latest memory devices, back-end test, and advanced wafer-level packaging. The industry’s transition to advanced technology nodes and to increased layers in 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 shrinking device geometry and increasing aspect ratios in advanced 3D devices, more advanced RF and DC plasma generation technologies are needed. We strive to provide a broad range of best-in-class, industry-leading RF and DC power solutions. Beyond etch and deposition processes, growing complexity at advanced nodes also drives a higher number of other process steps across the wafer fab, including inspection, metrology, thermal, ion implantation, and semiconductor test and assembly, 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. Our strategy in the Semiconductor Equipment market is to defend our proprietary positions in our core applications by capturing new design and product generations, growing our market position in applications where we have lower market share, such as remote plasma source and dielectric etch, and leveraging our product portfolio in areas including embedded power, high voltage power systems, and critical sensing and controls to grow our market share and content at our original OEM customers.
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The Semiconductor Equipment market continued to experience demand growth driven by investments in both leading and trailing edge semiconductor capacity throughout the first three quarters of 2022. Advanced Energy participated in the market growth while overcoming supply chain challenges and delivered record revenue from the Semiconductor Equipment market in 2022. Starting in the fourth quarter of 2022, the market entered a cyclical downturn due to changing macroeconomic conditions, overcapacity in the market for memory devices, general semiconductor inventory digestion resulting in falling fab utilization and reduced fab expansion plans, and new export restrictions to China for certain semiconductor equipment. These factors adversely impacted our demand, backlog, and revenue in the fourth quarter of 2022 and are expected to continue in 2023. We believe long-term drivers for demand growth in this market will eventually resume, due to the need to invest in new fab capacity to support growing demand for semiconductor devices in a wide range of applications, the continued transition to next generation processing nodes, increased complexity of advanced processes requiring more complex and innovative power solutions, and the regionalization of some semiconductor capacity.
INDUSTRIAL AND MEDICAL MARKET
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. Growth in the Industrial and Medical market is driven by investment in complex manufacturing processes or automation, increased adoption of smart power, sensing, and control solutions across many industrial applications, new investments in clean and sustainable technologies, and growing investment in medical devices and life science equipment. Our customers in the Industrial and Medical market are primarily global and regional original equipment manufacturers, incorporating 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, industrial production, and large-scale connected light-emitting diode applications. Examples of products sold into the Industrial and Medical market include high voltage and low voltage power supplies used in applications such as medical devices, scientific instrumentation and industrial equipment, power control modules and thermal instrumentation products for material fabrication, production process control and many precision industrial sensing applications. 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.
During 2022, we saw increased demand in the Industrial and Medical market as our customers increased investments in their production capacity and the medical technology industry recovered from the pandemic-related slowdown. Although overall customer demand increased, supply constraints of critical components limited our ability to fulfill product shipments at the level of customer demand and resulted in increased backlog. Going into 2023, we expect product delivery and revenue levels will depend on the level of customers’ demand and on resolving supply chain constraints. It is not clear how long these supply chain constraints will persist or on what timeline our supply chain will recover.
DATA CENTER COMPUTING MARKET
Advanced Energy serves the Data Center Computing market with industry leading power conversion products and technologies, which we sell to OEMs and original design manufacturers (“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 traditional enterprise on-premises computing to the data center, driving investments in data center infrastructure. Beyond the cloud, demand for edge computing is also growing, driven by the need for faster processing, lower latency, and higher data security at edge applications. In addition, the data center industry has begun transitioning from 12 Volt to 48 Volt infrastructure in data center server racks to improve overall power efficiency. Advanced Energy benefits from these trends by being an industry leader in providing high-efficiency 48 Volt server power solutions to the data center industry. Further, the rapid growth and adoption of artificial intelligence and machine learning are driving accelerated demand for server and storage racks with increased power density and higher efficiency, which complements Advanced Energy’s strengths. With a growing presence at both cloud service providers and industry-leading data center server and storage vendors, our strategy in the Data Center and Computing market is to penetrate selected customers and applications based on our differentiated capability and competitive strengths in power density, efficiency, and controls.
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Customer demand for our products rose during 2022 with continued demand for cloud and network applications. In addition, we were able to secure additional critical components compared to the prior year, allowing us to deliver higher revenue in the Data Center Computing market. Despite the improved performance, the supply of the critical components remains highly constrained, impacting our ability to fulfill product shipments at the level of customer demand. Although we expect lower overall demand in 2023 as cloud and enterprise customers slow investments to digest capacity investments, we continue to be supply constrained and our performance will be partially dependent on our ability to secure critical components and customers’ timing of new programs. It is not clear how long these supply chain constraints will persist or how quickly our supply chain will recover.
TELECOM AND NETWORKING MARKET
Our customers in the Telecom and Networking market 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 are investing in 5G infrastructure, and this trend is expected to drive demand for our products into the Telecom and Networking market. In datacom, demand is driven by networking investments by telecom service providers and enterprises upgrading their networks, as well as cloud service providers and data centers investing in their networks for increased bandwidth. Our strategy in the Telecom and Networking market is to optimize our portfolio of products to more differentiated applications, and to focus on 5G infrastructure applications.
Revenues in the Telecom and Networking market increased in 2022 compared to the same period in the prior year due to increased customer demand and our ability to secure additional critical components. We expect demand to remain stable in this market in 2023, but supply chain constraints continue to prevent us from fulfilling product shipments at the level of customer demand. It is not clear how long these supply shortages will persist or how quickly our supply chain 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.
The following table sets forth certain data derived from our Consolidated Statements of Operations (in thousands):
Year Ended December 31,
2022
2021
Sales
$
1,845,422
$
1,455,954
Gross profit
675,506
532,322
Operating expenses
442,411
380,641
Operating income from continuing operations
233,095
151,681
Other income (expense), net
8,646
(2,970)
Income from continuing operations, before income taxes
241,741
148,711
Provision for income taxes
39,850
14,004
Income from continuing operations
$
201,891
$
134,707
The following table sets forth the percentage of sales represented by certain items reflected in our Consolidated Statements of Operations:
Year Ended December 31,
2022
2021
Sales
100.0
%
100.0
%
Gross profit
36.6
36.6
Operating expenses
24.0
26.1
Operating income from continuing operations
12.6
10.4
Other income (expense), net
0.5
(0.2)
Income from continuing operations, before income taxes
13.1
10.2
Provision for income taxes
2.2
1.0
Income from continuing operations
10.9
%
9.3
%
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SALES, NET
The following tables summarize net sales and percentages of sales by markets (in thousands):
Year Ended December 31,
Change 2022 v. 2021
2022
2021
Dollar
Percent
Semiconductor Equipment
$
930,809
$
710,174
$
220,635
31.1
%
Industrial and Medical
426,763
341,176
85,587
25.1
Data Center Computing
327,466
270,924
56,542
20.9
Telecom and Networking
160,384
133,680
26,704
20.0
Total
$
1,845,422
$
1,455,954
$
389,468
26.8
%
Year Ended December 31,
2022
2021
Semiconductor Equipment
50.5
%
48.8
%
Industrial and Medical
23.1
23.4
Data Center Computing
17.7
18.6
Telecom and Networking
8.7
9.2
Total
100.0
%
100.0
%
OPERATING EXPENSE
The following table summarizes our operating expenses (in thousands) and as a percentage of sales:
Years Ended December 31,
2022
2021
Research and development
$
191,020
10.4
%
$
161,831
11.1
%
Selling, general, and administrative
218,463
11.8
191,998
13.2
Amortization of intangible assets
26,114
1.4
22,060
1.5
Restructuring charges
6,814
0.4
4,752
0.3
Total operating expenses
$
442,411
24.0
%
$
380,641
26.1
%
SALES AND BACKLOG
Sales
Sales increased $389.5 million, or 26.8%, to $1,845.4 million, as compared to $1,456.0 million in the prior year. The increase in sales was primarily due to increased demand for our products across all four of our markets and measures we took to improve material availability and capacity, which allowed us to better meet higher demand. In addition, premium recoveries, which are revenues we collected from our customers to partially reimburse us for premiums we paid to secure scarce materials, represented $68.3 million in revenue in 2022 compared to $14.3 million in 2021. The acquisition of SL Power contributed $50.3 million to our total sales in 2022. For additional information, see Note 2. Acquisitions in Part II, Item 8 “Financial Statements and Supplementary Data.”
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Backlog
The following table summarizes our backlog (in thousands):
December 31,
December 31,
Change from
Year End
2022
2021
Dollar
Percent
Backlog
$
875,346
$
927,810
$
(52,464)
(5.7)
%
Backlog represents outstanding orders for products we expect to deliver within the next 12 months. Backlog at the end of 2022 decreased from the end of 2021 primarily due to the impact of the China export controls regulation announced in October 2022 by the U.S. Commerce Department, lower demand in the Semiconductor Equipment market, and changes in order patterns for our semiconductor customers as we improved lead times, which occurred in the fourth quarter of 2022. Backlog in our other markets increased for the year.
We believe the current backlog levels provide some level of revenue protection if demand levels are reduced due to macroeconomic factors. We expect to bring our backlog back into normalized levels of $400 million to $500 million over the next several quarters as parts availability improves and lead times are reduced.
Backlog at any particular date is not necessarily indicative of actual sales which may be generated for any succeeding period. In addition, there is uncertainty of the timing of when backlog can convert into revenue due to continuing supply constraints. Because our customers generally order on a purchase order basis, they can typically cancel, change, or delay product purchase commitments with little or no notice.
Sales by Market
Sales in the Semiconductor Equipment market increased $220.6 million, or 31.1%, to $930.8 million, as compared to $710.2 million in the prior year. The increase in sales was primarily due to the growth in the Semiconductor Equipment market, particularly highlighted by the 40% increase in sales to our top two customers who are primarily in this market. In addition, we improved our ability to secure critical components and increased delivery to our customers in this market.
Sales in the Industrial and Medical market increased $85.6 million, or 25.1%, to $426.8 million, as compared to $341.2 million in the prior year. The increase in sales was primarily due to the acquisition of SL Power, which added incremental sales of $46.5 million in this market. The remainder of the increase in revenue was due to increased demand for our portfolio of products across our medical and industrial applications and improved material availability.
Sales in the Data Center Computing market increased $56.5 million, or 20.9%, to $327.5 million, as compared to $270.9 million in the prior year. The increase in Data Center Computing market sales was due to better supply availability, enabling us to partially fulfill product shipments against higher customer demand.
Sales in the Telecom and Networking market increased $26.7 million, or 20.0%, to $160.4 million as compared to $133.7 million in the prior year. The increase in sales was primarily due to improved material availability, allowing us to meet the increased demand.
GROSS PROFIT AND GROSS MARGIN
Gross profit dollars in 2022 increased by $143.2 million to $675.5 million, or 36.6% of revenue, as compared to prior year’s $532.3 million, or 36.6% of revenue, primarily driven by higher revenue.
Gross margin percentage remained flat year over year as the benefit of higher volume and favorable mix was offset primarily by higher material costs related to premiums paid to brokers for scarce parts. Premium recoveries, which represent revenue at zero gross margin, impacted gross margins by approximately 140 basis points, compared to approximately 35 basis points in the prior year. Additionally, higher material costs not recovered impacted gross margins
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by approximately 200 basis points, compared to approximately five basis points in the prior year. We expect that the amount of higher material costs and related recoveries will abate as the supply chain normalizes and scarce parts become more available from original manufacturers.
OPERATING EXPENSE
Research and Development
We perform 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 increased $29.2 million to $191.0 million, as compared to $161.8 million in the prior year. The increase in research and development expense is primarily driven by increased headcount and compensation costs of $20.4 million, as we invest 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 increased $26.5 million to $218.5 million, as compared to $192.0 million in the prior year. The increase in SG&A is primarily related to $16.9 million from increased headcount and associated costs including sales commissions and compensation driven by higher revenue and $6.0 million from the addition of SL Power. See Note 2. Acquisitions in Part II, Item 8 “Financial Statements and Supplementary Data” for additional details.
Amortization of Intangibles
Amortization expense increased $4.1 million to $26.1 million, as compared to $22.1 million in the prior year. The increase was primarily driven by incremental amortization of newly acquired intangible assets from the SL Power acquisition. For additional information, see Note 2. Acquisitions and Note 13. Intangible Assets in Part II, Item 8 “Financial Statements and Supplementary Data.”
Restructuring
In the fourth quarter of 2022, management approved a restructuring plan (the “2022 Plan”), which is expected to further improve our operating efficiencies and drive the realization of synergies from our business combinations by consolidating our operations, optimizing our factory footprint including moving certain production into our higher volume factories, and reducing redundancies. The majority of these actions impact our factory operations and should partially mitigate the impact of lower volumes on gross margins. We anticipate the 2022 Plan will be substantially completed, and associated expenses will be incurred by 2024.
In 2018, we committed to a restructuring plan (the “2018 Plan”) to optimize our manufacturing footprint and to improve our operating efficiencies and synergies related to business combinations. We incurred severance costs primarily related to the transition and exit of our facility in Shenzhen, China and actions associated with synergies related to the acquisition of Artesyn Embedded Technologies, Inc.’s embedded power business (“Artesyn”). This plan is
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substantially complete with the closure of our Shenzhen facility expected in 2023. 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 $8.6 million in 2022, as compared to ($3.0) million in the prior year. The increase in income between periods is primarily a result of higher unrealized foreign exchange gains of $4.2 million due to the strengthening U.S. dollar compared to our other foreign currencies and a one-time gain on the sale of intellectual property from a previous acquisition. This was partially offset by higher interest expenses because of increasing interest rates.
Provision for Income Taxes
(in thousands)
Years Ended December 31,
2022
2021
Income from continuing operations, before income taxes
$
241,741
$
148,711
Provision for income taxes
$
39,850
$
14,004
Effective tax rate
16.5
%
9.4
%
Our effective tax rate increased in 2022 compared to 2021, primarily driven by a change in tax law from the 2017 Tax Cuts and Jobs Act related to the capitalization of R&D expenses, as it impacts the net U.S. tax on foreign operations, that went into effect in January 2022, offset by the benefit of earnings in foreign jurisdictions which are subject to lower tax rates.
The Inflation Reduction Act (“IRA”) and CHIPS and Science Act (“CHIPS Act”) were both enacted in August 2022. The IRA introduced new provisions including a 15% corporate alternative minimum tax for certain large corporations that have at least an average of $1 billion adjusted financial statement income over a consecutive three-tax-year period and a 1% excise tax surcharge on stock repurchases. The CHIPS Act provides a variety of incentives associated with investments in domestic semiconductor manufacturing and related activities. The IRA and the CHIPS Act are applicable for tax years beginning after December 31, 2022 and had no benefit to our consolidated financial statements for any of the periods presented, and we do not expect them to have a direct material impact on our future results of operations, financial condition, or cash flows.
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, 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.
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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 2017 Tax Cuts and Jobs Act.
Reconciliation of non-GAAP measure
Operating expenses and operating income from continuing
Years Ended December 31,
operations, excluding certain items (in thousands)
2022
2021
Gross profit from continuing operations, as reported
$
675,506
$
532,322
Adjustments to gross profit:
Stock-based compensation
1,478
764
Facility expansion, relocation costs and other
5,295
6,189
Acquisition-related costs
(299)
3,585
Non-GAAP gross profit
681,980
542,860
Non-GAAP gross margin
37.0%
37.3%
Operating expenses from continuing operations, as reported
442,411
380,641
Adjustments:
Amortization of intangible assets
(26,114)
(22,060)
Stock-based compensation
(18,371)
(14,975)
Acquisition-related costs
(8,637)
(6,803)
Facility expansion, relocation costs and other
—
(229)
Restructuring
(6,814)
(4,752)
Non-GAAP operating expenses
382,475
331,822
Non-GAAP operating income
$
299,505
$
211,038
Non-GAAP operating margin
16.2%
14.5%
Reconciliation of non-GAAP measure
Income from continuing operations, excluding certain items
Years Ended December 31,
(in thousands, except per share amounts)
2022
2021
Income from continuing operations, less non-controlling interest, net of income taxes
$
201,875
$
134,663
Adjustments:
Amortization of intangible assets
26,114
22,060
Acquisition-related costs
8,338
10,388
Facility expansion, relocation costs, and other
5,295
6,418
Restructuring
6,814
4,752
Unrealized foreign currency gain
(7,645)
(3,543)
Acquisition-related costs and other included in other (income) expense, net
(8,417)
(2,186)
Tax effect of non-GAAP adjustments
(3,008)
(1,346)
Non-GAAP income, net of income taxes, excluding stock-based compensation
229,366
171,206
Stock-based compensation, net of taxes
15,444
12,042
Non-GAAP income, net of income taxes
$
244,810
$
183,248
Non-GAAP diluted earnings per share
$
6.49
$
4.78
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Impact of Inflation
In previous years, inflation did not have a material impact on our operations. However, more recently, we have experienced inflationary pressure from price increases in select components driven by factors such as higher global demand, supply chain disruptions, higher labor expenses, and increased freight costs. In this environment, we are actively working with our customers to adjust pricing that helps offset the inflationary pressure on the cost of our components. We have also been able to recover some premiums on pricing related to securing scarce materials with our customers, thus limiting the financial impact of inflationary pressures.
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).
The following table summarizes our cash, cash equivalents, and marketable securities (in thousands):
December 31, 2022
Cash and cash equivalents
$
458,818
Marketable securities
2,128
Total cash, cash equivalents, and marketable securities
$
460,946
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 12 months and on a long-term basis. In addition, we may, depending upon the number or size of additional acquisitions, seek additional debt or equity financing from time to time; however, such additional financing may not be available on acceptable terms, if at all.
Credit Facility
In September 2019, in connection with the acquisition of Artesyn, 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. 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%. For information additional information, see Note 8. Derivative Financial Instruments in Part II, Item 8 “Financial Statements and Supplementary Data.”
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.
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The following table summarizes borrowings under our Credit Facility and the associated interest rate (in thousands, except for interest rates).
December 31, 2022
Balance
Interest Rate
Unused Line Fee
Term Loan Facility subject to a fixed interest rate due to interest rate swap
$
238,219
1.271%
—
Term Loan Facility subject to a variable interest rate
136,781
5.134%
—
Revolving Facility subject to a variable interest rate
—
5.134%
0.10%
Total borrowings under the Credit Agreement
$
375,000
As of December 31, 2022, 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.
In addition to the available capacity on the Revolving Facility, prior to the maturity date of our Credit Agreement, we may also request an increase to the financing commitments in either the Term Loan Facility or Revolving Facility by an aggregate amount not to exceed $250.0 million at identical terms to our existing Credit Facility.
For additional information on our Credit Facility, see Note 21. Credit Facility in Part II, Item 8 “Financial Statements and Supplementary Data.”
Dividends
In March 2021, the Board of Directors (the “Board”) declared the first quarterly cash dividend since our inception as a public company. During 2022, we paid quarterly cash dividends of $0.10 per share, totaling $15.2 million for the full year. We currently anticipate that a cash dividend of $0.10 per share will continue to be paid on a quarterly basis, although the declaration of any future cash dividend is at the discretion of the Board and will depend on our financial condition, results of operations, capital requirements, business conditions, and other factors.
Share Repurchases
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)
2022
2021
2020
Amount paid or accrued to repurchase shares
$
26,635
$
78,125
$
11,630
Number of shares repurchased
356
901
244
Average repurchase price per share
$
74.90
$
86.76
$
47.75
In July 2022, the Board of Directors approved an increase to the share repurchase plan that increased the remaining amount authorized for future repurchases to a maximum of $200.0 million with no time limitation. At December 31, 2022, the remaining amount authorized by the Board of Directors for future share repurchases was $199.3 million.
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Cash Flows
A summary of our cash from operating, investing, and financing activities was as follows (in thousands):
Years Ended December 31,
2022
2021
Net cash from operating activities from continuing operations
$
183,731
$
140,914
Net cash from operating activities from discontinued operations
(144)
(669)
Net cash from operating activities
183,587
140,245
Net cash from investing activities
(208,272)
(47,302)
Net cash from financing activities
(61,865)
(25,372)
Effect of currency translation on cash and cash equivalents
996
(3,567)
Net change in cash and cash equivalents
(85,554)
64,004
Cash and cash equivalents, beginning of period
544,372
480,368
Cash and cash equivalents, end of period
$
458,818
$
544,372
Net Cash From Operating Activities
Net cash from operating activities from continuing operations was $183.7 million, an increase of $42.8 million, compared to $140.9 million in the prior year. The increase is primarily due to an increase in net income. This was partially offset by an unfavorable increase in net operating assets driven primarily by an increase in accounts receivable due to our strong revenue growth.
Net Cash From Investing Activities
Net cash from investing activities in 2022 was ($208.3) million, driven by the following:
● ($58.9) million in purchases of property and equipment as we invested in our manufacturing footprint and capacity; and
● ($149.4) million for business combinations.
Net cash from investing activities in 2021 was ($47.3) million, and primarily related to investment in facilities and capacity.
Net Cash From Financing Activities
Net cash from financing activities in 2022 was ($61.9) million and included:
● ($15.2) million for dividend payments;
● ($20.0) million for repayment of long-term debt; and
● ($26.6) million related to repurchases of our common stock.
The 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;
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● ($78.1) million related to repurchases of our common stock; and
● ($1.8) million related to stock-based award activities.
Off-Balance Sheet Arrangements
As of December 31, 2022, 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. Employee Retirement Plans and Postretirement Benefits, and Note 21. Credit Facility , respectively, in Part II, Item 8 “Financial Statements and Supplementary Data.”
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. Summary of Operations and Significant Accounting Policies and Estimates in Part II, Item 8 “Financial Statements and Supplementary Data.”