MKS Instruments Q2 2023 Earnings Call Transcript

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Provided by Quartr
August 3, 2023

There are 9 speakers on the call.

Operator

Good day and thank you for standing by. Welcome to the MKS Instruments Second Quarter of 2023 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, David Ryzhik, Vice President of Investor Relations.

Operator

Please go ahead.

Speaker 1

Good morning, everyone. I am David Ryzhik, Vice President of Investor Relations, and I am joined this morning by John Lee, President and Chief Executive Officer and Seth Bagshaw, Executive Vice President and Chief Financial Officer. Yesterday, after market close, we released our financial results for the Q2 of 2023, which are posted to our investor website at investor. Mks .com. As a reminder, various remarks about future expectations, plans and prospects for MKS comprise forward looking statements.

Speaker 1

Actual results may differ materially as a result of various important factors, including those discussed in yesterday's press release and in our annual report on Form 10 ks for the year ended December 31, 2022. These statements represent the company's expectations only as of today and should not be relied upon as representing the company's estimates or views As of any date subsequent to today, and the Company disclaims any obligation to update these statements. During the call, we will be discussing various financial measures. Unless otherwise noted, all references to combined company financial measures reflect the combined results of MKS and Adetec Limited, which MKS acquired on August 17, 2022. Also, unless Otherwise noted, all income statement related financial measures will be non GAAP other than revenue.

Speaker 1

Please refer to our press release and the presentation materials posted to our investor website for information regarding our combined company results, non GAAP financial results and a reconciliation of our GAAP and non GAAP financial measures. For a detailed breakout of reported and combined company revenues by end market and division, Please visit our investor website. Now, I'll turn the call over to John.

Speaker 2

Thanks, David. Good morning, everyone, and thank you

Speaker 3

for joining us today. MKS delivered strong results in the Q2, led by excellent execution in our semiconductor market and prudent cost management that is reflected in our better than expected margins. We delivered 2nd quarter revenue of $1,000,000,000 Adjusted EBITDA of $254,000,000 and net earnings per diluted share of 1.32 Revenue from our semiconductor market was above the high end of our expectations, despite the widely publicized decline in WFE spending. Our operations team executed well in shipping products on backlog, including those delayed due to the ransomware incident we experienced in the Q1. Demand for our critical vacuum subsystems for deposition and etch applications declined considerably compared to a year ago, consistent with capital equipment spending trends, particularly for memory applications.

Speaker 3

However, Photonics Solutions demand for lithography, metrology and inspection remain resilient, offsetting some of the weakness. We anticipate continued strength in these photonics applications. Design and activity remains robust, demonstrating that customers value the unique capabilities MKS offers in these areas. In fact, revenue from lithography, metrology and inspection applications in the first half of twenty twenty three grew considerably compared to the same period a year ago. Our breadth and diversity across WFE applications, Combined with our leadership position across most of the product categories we serve, reinforces our belief that we can continue to outperform industry WFE We are a critical enabler of key inflection points in semiconductors, such as atomic layer deposition, high aspect ratio etch, extreme ultraviolet lithography and advanced inspection and are well positioned for when industry capital equipment spending Looking to the Q3, we expect revenue from our semiconductor market to decline sequentially.

Speaker 3

However, after excluding the impact of the ransomware incident from the 2nd and third quarters, we expect revenue in the 3rd quarter to be consistent with 2nd quarter revenue levels. Turning to our electronics and packaging market. Revenue was softer than we expected Amid the well known weakness in demand for global electronics such as PCs and smartphones, demand for our chemistry solutions improved modestly on a sequential basis, but this was offset by continued softness in capital equipment spending, including for our laser drilling and plating equipment. Despite this cyclical weakness, we remain very excited about the long term opportunity in electronics and packaging. One of the areas of particular focus is packaged substrates, which are a critical enabler and key building block for high performance computing applications such as AI.

Speaker 3

Just to build on that last point, much like what we've Seen in the semiconductor industry over the past 60 years, the manufacturing of packaged substrates is getting harder, not easier. High performance computing applications require greater interconnect density as layer counts increase to 20 or more, while interconnect feature sizes continue to shrink. This high degree of complexity gives MKS with our unique combination, Proprietary chemistry, plating equipment and laser drilling solutions, the opportunity to expand our presence in this high growth segment of our electronics and packaging market. As a reminder, this opportunity is one of the key reasons behind our acquisition of Avatek Hence why MKS is strongly positioned for advanced packaging, which will continue to be an area of focus and investment for the company. For context, based on combined company's full year 2022 results, Advanced Packaging represents just under 1 third of Electronics and Packaging revenue.

Speaker 3

Driven by our foundational portfolio for packaged substrate applications as well as smaller revenue streams from wafer level packaging, Hybrid Bonding and other applications, we think advanced packaging solutions will be a more meaningful contributor to our revenue over the long term. Looking to the Q3, we expect revenue from our electronics and packaging market to be consistent with 2nd quarter levels. We anticipate a slight improvement in chemistry sales due to the seasonality of consumer electronics production as well as an improvement in packaged substrate demand due to high performance computing applications such as AI. These improvements are expected to be partially offset by a cyclical downturn in plating equipment sales. Turning to our Specialty Industrial market.

Speaker 3

Revenue was in line with our expectations with stable demand for our chemistry solutions for the automotive market combined with good execution covering delayed revenue due to the ransomware incident. Looking to the Q3, we expect revenue to be consistent with 2nd quarter levels. However, after excluding the impact of the ransomware incident from the 2nd 3rd quarters, we expect revenue to be slightly higher than 2nd quarter levels. In summary, I'm very pleased with our team's performance in the Q2. Despite muted demand across some of our end markets, we executed well.

Speaker 3

Thinking about our business in the second half of twenty twenty three, we continue to expect MKS' total revenue in the second half to be slightly higher than first half levels, driven by modest improvements across all three of our end markets. Longer term, we are very excited about how we are positioned to capitalize on multiple secular drivers. AI, Cloud, virtual reality and electrification are just some of the examples of what is made possible by Advanced Electronics, and we are foundational to those trends. And now, I'd like to turn the call over to Seth. Thank you, John.

Speaker 3

I'll cover our 2nd quarter results, then provide details and outlook for the Q3. Starting with the Q2, we

Speaker 4

delivered revenue of $1,000,000,000 above the midpoint of our guidance.

Speaker 3

Our strong top line results were driven by better than expected revenue from our semiconductor market, more than offsetting soft electronics and packaging revenue. Revenue from our Specialty Industrial market was in line with expectations. We estimate we recovered $120,000,000 Of the approximately $160,000,000 in revenue impacted by the ransomware incident in the Q1, we expect to recover All of the remaining revenue in the Q3. Turning to our semiconductor market, revenue was $440,000,000 in the first quarter, growing 42% sequentially and exceeding our outlook due to strong execution on shipping products from backlog, including those that are delayed by the ransomware incident in the Q1. In the Q2, we estimate we recovered $90,000,000 of the approximately $110,000,000 of revenue impacted by the ransomware incident in the Q1.

Speaker 3

As excluding the impact of ransomware incident from the first In 2nd quarters, our semiconductor revenue declined on a sequential basis, consistent with softer industry demand for semiconductor capital equipment. Turning to electronics and packaging market, revenue was $225,000,000 an increase of 1% sequentially and declined 21% year over year with Q2 2022 representing combined company results including ATOTEC for the full prior year period. Excluding the impact of foreign exchange and palladium pass through, 2nd quarter revenue declined 15% on a year over year basis. As a reminder, the ransomware incident had a minimal impact on revenue from Electronics and Packaging Market. Moving to Specialty Industrial market, revenue in the Q1 was $338,000,000 It's growing 29% sequentially, in line with our outlook due to stable demand trends across our submarkets.

Speaker 3

We estimate we recovered $30,000,000 of the approximately $45,000,000 of revenue impacted by the Ransomware incident in the Q1. As a result, after excluding the impact of ransomware incident in the 1st and second quarters, our Specialty Industrial revenue was relatively flat sequentially. Excluding the impact of the rent to our incident, foreign exchange and palladium pass through, 2nd quarter revenue declined approximately 3% year over year on a combined company basis. In the Q2, consumables and service revenue across our 3 end markets comprised 38% of our total revenue. Turning to our margins, 2nd quarter gross margin was 46.9%, sequential increase of 4 70 basis points exceeding the high end of our guidance.

Speaker 3

Higher volumes, increased factory utilization, disciplined cost management And favorable product mix contributed to the strong performance. 2nd quarter operating expenses were $243,000,000 A sequential increase of $3,000,000 but still below the low end of our guidance reflecting disciplined cost management. 2nd quarter operating margin was 22.6 percent, adjusted EBITDA margin was 25.3%, both exceeding our expectations due to strong operating leverage in the model. Our integration of ADTECH Progressing well. We made on track to achieve our cost synergy target of $55,000,000 within 18 months to 36 months post close.

Speaker 3

We exited the 2nd quarter achieving annualized cost synergies of over $30,000,000 Net interest expense for the Q2 was $79,000,000 lower than we had anticipated due primarily to favorable interest income and slightly lower interest rates relative to our forecast. Our tax rate for the 2nd quarter was 35.5 percent above our expectations due to the geographic mix of income and changes in timing of tax credits and tax planning activities. We expect our tax rate to normalize in the 3rd quarter. Net earnings for the Q2 were $88,000,000 of $1.32 per diluted share. Turning to our balance sheet and cash flow.

Speaker 3

We exited the 2nd quarter with cash and short term investments of $758,000,000 compared to $880,000,000 in the Q1. Free cash flow in the quarter was a negative $77,000,000 primarily a result of the lingering effects of the ransomware incident on working capital needs and timing of income tax payments. We expect our cash conversion cycle to improve in the 3rd quarter and free cash flow to return to more normalized levels. We maintained an undrawn revolving credit facility of $500,000,000 and exited the quarter with gross debt of $5,100,000,000 Our net leverage ratio exiting the 2nd quarter was 4.3 times based on a trailing 12 month adjusted EBITDA on a combined company basis. Consistent with prior quarter, we made a dividend payment of $15,000,000 or $0.22 per share.

Speaker 3

Before I discuss our Q3 outlook, I'd like to touch upon the non cash goodwill and intangibles impairment charges in the quarter, which totaled $1,800,000,000 associated with our Material Solutions division, which represents the former Adatech business in our Equipment Solutions business, which represents the former Electro Scientific Industries business. The current market environment, The soft demand in the PC and smartphone markets is the primary driver of both write downs with higher market interest rates playing significant role and the Additech impairment analysis as well. As John indicated in his prepared remarks, we've been very excited about the opportunity ahead of us in Advanced Packaging. In fact, since we announced our intent to acquire Adatech just over 2 years ago, the industry has increasingly recognized How much advanced packaging is critical to high performance computing applications including AI. Our leading position in deep customer relationships allows us to see inflection points earlier as we help our customers solve the greatest challenges on the horizon.

Speaker 3

That's why we assembled the broadest set of capabilities across chemistry and equipment to serve this attractive market in the growth we see ahead of us. I'll now turn to our 3rd quarter outlook. We expect 3rd quarter revenue of $930,000,000 plus or minus $50,000,000 By end market, our outlook is as follows. Revenue from our semiconductor market of approximately $370,000,000 plus or minus $20,000,000 revenue from electronics and packaging market of approximately $225,000,000 plus or minus $10,000,000 And revenue from our Specialty Industrial market were approximately $335,000,000 plus or minus $20,000,000 This outlook includes approximately $30,000,000 of revenue we expect to recover from the ransomware incident in the Q1. Therefore, we expect to essentially We caught up with the backlog of the customer deliveries by the end of this quarter.

Speaker 3

Moreover, as John mentioned, we continue We expect revenue in the second half of twenty twenty three to be slightly higher than the first half across all three end markets. Based on anticipated product mix and revenue levels, we estimate 3rd quarter gross margin of 45% plus or minus 1 percentage point. We expect operating expenses of $245,000,000 plus and last $5,000,000 consistent with 2nd quarter levels. The Q3, we estimate adjusted EBITDA of approximately $210,000,000 plus or minus $26,000,000 The Q3 net interest expense is expected to be approximately $85,000,000 reflecting projected interest rate increases. Our tax rate is expected to be approximately 26% for the 3rd quarter.

Speaker 3

And given these assumptions, we expect 3rd quarter net earnings of $0.98 per diluted In summary, MCAS has recovered well following the ransomware incident in the Q1 In spite the soft end market backdrop in the first quarter first half of twenty twenty three, delivering solid non GAAP profitability. This is a testament to our more resilient and diversified business model following the Adatech acquisition, Our ability to drive strong factory utilization and disciplined cost management in our leading portfolio of foundational solutions essential to the markets we serve. Moving forward, we are focused on maintaining the high levels of execution we delivered in Q2, return to normalized free cash flow generation and working towards further deleveraging our balance sheet. With that, I'll turn it back to the operator for Q and A.

Operator

Thank you. Please standby while we compile the Q and A roster. Our first question comes from the line of Sidney Ho of Deutsche Bank. Your line is now open.

Speaker 5

Great. Thank you. Good morning. This is Jamal Kho on for Sidney. Guys, my first question is on capacity additions, I guess, In Electronics and Packaging.

Speaker 5

And what I'm trying to gauge is when would customers return to these capacity additions, I guess. And the question is, is it fair to think about this as a typical like memory cycle, right, where you would first see utilization come back first, then it would be upgrades, I guess, benefiting your services. And then as a last step, customers would start adding capacity. Am I thinking about it the right way? And I have a follow-up.

Speaker 2

Yes. Hi, Jovai. It's John Lee. And I think your question is about the electronics and packaging market. And I think those dynamics are very similar to semi utilization rates going up and then capacity additions.

Speaker 2

So I think that is the right way to think about it. Your utilization is something that we see immediately with chemistry revenue. In terms of service, Certainly servicing our equipment would be coming next. And then of course after that is the capacity additions. And as we pointed out, There have been a little bit of weakness in Q2 on equipment the equipment part of our electronics and packaging and that's consistent with The industry trends right now.

Speaker 5

Great. Very clear, John. And I guess staying on utilization rates within Electronics and Packaging, Can you guys sort of give us a sense as to where utilization rates are right now? And based on conversations with your customers, where would you see those Trend, I guess, in the second half. And maybe just to add to that, where should investors, I guess, look to gauge how utilization rates are trending through the second half?

Speaker 5

Thanks.

Speaker 2

Yes. I think what we're seeing with our customer base certainly is that utilization rates are incrementing upwards. I think that's why our guide for the second half is slightly higher than the first half.

Speaker 4

And a lot of that

Speaker 2

is driven by the cyclicality of the consumer electronics part of our electronics of packaging chemistry revenue. And so I think that's consistent with what happens every year with the consumer product cycle. And so that's why we're guiding second half to be slightly better than first half.

Operator

Thank you. Thank you. One moment please for our next question. Our next question comes from the line of Jim Ricchiuti of Needham and Company. Your line is now open.

Speaker 6

Hi, good morning. John, you've talked about revenue synergies from Anatek and the legacy CE and P Business, with the overall market weakness, does that incremental benefit At this point, just get pushed further into 2024 or are you seeing any indications of Some momentum in that area.

Speaker 2

Yes, Jim, thanks for the question. I think we pointed out even a quarter ago They were getting some of that bluebirds coming in a little earlier than you would expect. And I think what we are seeing is that the interest In our combined solutions remains very high. We talked about our Yokohama Tech Center where we have a new plating tool, New chemistry and new laser tools, so that interest remains very high. I think the synergy in revenue will certainly come when ramps And hopefully that happens in 2024, but of course, we're prepared for whatever eventuality that is.

Speaker 2

Today, we're just focused on getting those design wins and showing our customers the benefit of having that combined solution.

Speaker 6

And a follow-up question. Seth, you may have addressed this, but with the gross margins coming in a little better than expected, Can you elaborate or a little bit more about what drove that? Was it mix? Was it just The revenues coming in a bit above target?

Speaker 3

Yes. Thanks, Jim. Yes, I mentioned in the prepared remarks, there's Combination of all those factors, mix, very strong execution in the factory utilization, cost containment, To me, it's a testament of kind of how well we execute in a really difficult environment. I think that's fundamentally why we drove the margins up the way we did. So Really happy execution, team has done a great job and I think that's really part of our DNA historically speaking.

Speaker 6

And your guidance this quarter a less favorable mix or is that I'm just trying to reconcile it just in terms of the way you're Thinking about gross margins at the midpoint?

Speaker 2

Yes, that's the way I would think about

Speaker 3

it as well. I think the mix is more normalized in the Q3 guidance, a little bit light on the revenue side, obviously, is a piece as well. But fundamentally, it's really mix In Q3, a little lower volumes and again, we can execute very well in the quarter.

Speaker 4

Thank you.

Operator

One moment please for our next question. Our next question comes from the line of Krish Sankar of TD Cowen. Your line is now open.

Speaker 4

Yes. Thanks for taking my question. First one, John, if I look at your guidance for semi ex ransomware, it looks like it's going to be flat sequentially, which kind of makes sense For the industry, yes, but also your customers are talking about drawing down their own inventory. So if I put those 2 together, is it fair to assume The semi revenues could potentially dip sequentially in the December quarter?

Speaker 2

Yes, Krish, thanks for the question. That's not what we're seeing right now, Krish. And the reason I'd say that is customers have been drawing down their inventory for a few quarters already. And so that's why we've guided kind of flat to slightly up in our semi revenue. So I understand and I've heard that some customers are drawing down have said they're drawing down their inventory, but what we've seen is that's been happening for multiple quarters already.

Speaker 4

Got it, got it. That's very helpful. And then a similar one on the Electronics Packaging side. You said Advanced Packaging is less than 1 third revenue, But it's growing, which makes a lot of sense. But if you look at the other part of the business there, even on the PCB side, it looks like that business has not inflected.

Speaker 4

So So I'm just curious like is the advanced packaging strength is kind of what informs you that your 3Q revenues could be similar to 2Q, given the other parts of the market are pretty weak?

Speaker 2

Yes. I think that's the way To think about it, Krish, advanced packaging, especially packaged substrates and packaged substrates are the latest kind of most advanced 20 plus layer type packaging of chiplets, if you will. That's the area where we think there's going to be more of an uptick driving the overall E and P segment of our business. The other parts like HDI and MLB, those areas remain kind of muted. So I think it's really about these new technologies that we think will be helping us have a slightly better second half than first half in E and P.

Speaker 4

Got it, got it. Thanks. And then a quick housekeeping for Seth. Term Loan A, is this still $900,000,000 left or is it lower than that?

Speaker 3

I'm sorry, that was the question again, Krish? I missed that.

Speaker 4

On the term loan A, is it still $900,000,000 left in term loan A or is it less than that?

Speaker 2

Yes, that's right. That's correct.

Speaker 4

Got it. Thank you very much.

Operator

Yes. Thanks, Graeme. Thank you. One moment please for our next question. Our next question comes from the line of Steve Barger of KeyBanc Capital Markets, your line is now open.

Speaker 7

Thanks. Just staying on the advanced packaging theme, I I think there's been a lot of talk about chip on wafer on substrate capacity being added. And I know you sell laser drilling packages to substrate manufacturers now, But I think that requires plating too, right? So can you talk about how ramping COWAS volume would benefit you or is some other packaging More of better for your mix?

Speaker 2

Yes, Steve, that's a great question. The short answer is yes, that will benefit us. The chip on wafer part, they were a little less exposed in terms of chemistry. But then the WASP part, if you will, the chip on substrate part, that is where we play And that's the substrate part. And so even as people package shifts onto wafers, Eventually that gets then packaged onto substrates and that's really where Atatek and our laser drilling tools are exposed.

Speaker 2

So yes, We hope Kowalz continues to ramp and we'll be a beneficiary of it.

Speaker 7

And I guess to the second part of the question, any specific packaging schemes beyond COOS which are most beneficial to you or is that all just kind of variation on a theme?

Speaker 2

It's really variation on a theme, Steve. So however you get The chip packaged eventually have to put it on a substrate. And so COWALT is one approach. There are multiple other approaches depending on the need And

Speaker 3

but they all end up going on to a substrate.

Speaker 7

Yes. And as we've gone through this downturn, have you been able Pick up any share with PCB makers or can you talk about conversations there? And are there any signs of consolidation at the lower end for Those manufacturers?

Speaker 2

Yes, I think consolidation has always been a theme in that industry. So I don't but I don't think there's anything new in terms of trends There. And it's certainly in terms of share pickup, the conversations we've had with many customers Has really been very, very good in terms of the package of solutions we're bringing to them. And so we hope that that ends up turning into market share wins and

Speaker 3

that's what we're working hard on.

Speaker 7

Got it. And can I get a quick one in for Seth? I just tried to do the math on the fly, but for the past three quarters, it looks like you've run primary working cap in the mid-thirty percent range of Trailing 12 months of revenue. Is seeing that come down to the low 30% range part of the comment about cash flow normalizing What metric would you point us to watch that?

Speaker 3

Yes, I think it's a good question, Steve. So the first half of the year obviously had a lot going on. Ransomware in the first And we covered a lot of that in the Q2 as we talked about. So the working capital metrics in those first half of this year were a little bit atypical for sure. And the reason we use free cash flow negative free cash flow in Q2 is really normalized in the working capital metrics.

Speaker 3

So on the prepared remarks we said is we think Q3 will be more normalized. I think work capital is in pretty good shape relative to our guide and midpoint on revenue. And That's why we believe the cash will be more normalized in the Q3. You can kind of go back in history and look at kind of a free cash flow metric relevant to revenue and And so that probably that low teens rate 12% or 13%, that will move around on working capital requirements. But that's kind of how I think about in the Q3.

Speaker 4

Again, we don't guide that level

Speaker 3

of detail, but it's probably a decent way of looking at it for Q3. Again, it'd be much better than Q2 for sure.

Speaker 7

Understood. Yes, thank you.

Speaker 3

Yes, you're welcome.

Operator

Thank you. One moment please for our next question. Our last question comes from the line of Joe Quatrochi of Wells Fargo. Your line is now open.

Speaker 8

Yes. Thanks for taking the question. One on the semi side. I think last quarter you talked about further clarity on the China export restrictions. And I think that's in part you shipping to your customers that they can then ship to Chinese customer their Chinese customers and then also You shipping to Chinese equipment OEMs, I was just curious how that factored into kind of the results or the upside in semi side this quarter?

Speaker 2

Yes, Joe. Thanks for the question. I think the short answer is no change In terms of how we look at the China revenue going forward, I think the last quarter we talked about more clarity In terms of what's allowed to be shipped by our customers, shipping to their Chinese customers, that hasn't really changed. We also talked a little about how we are exposed to the Chinese OEMs and the restrictions there, And that has not changed either. So even though we're guiding semi to be flat to slightly up, it's not because of any change in our view of The dynamics for what we can and can't ship to China.

Speaker 8

Got it. That's helpful. And then as a follow-up, you talked about Improving free cash flow looking into next quarter, should we think about voluntary payments on the debt as Starting to see that again next quarter?

Speaker 3

Yes. I would probably we said many times we plan on deleveraging pretty So there's no change obviously in our policy and our goals. We will when the cash levels get Back to appropriate levels such earnings free cash flow will definitely lead into that debt, but that will be a I wouldn't guide on that in the Q3 at this point.

Speaker 4

Okay. Thank you.

Speaker 2

Yes. Gerald, maybe I'll add another comment to the semi comment ahead. The guide of flat to slightly up is ex ransomware, so apples to apples in Q3, just to make sure that's understood and clear. Thanks.

Speaker 5

Yes. Thank you.

Operator

Thank you. I would now like to turn the conference back to David Bishop for closing remarks.

Speaker 1

Thank you for joining us today and for your interest in MKS. Operator, you may close the call please.

Operator

This concludes today's conference call. Thank you for participating. You may now

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