MKS Instruments Q1 2024 Earnings Call Transcript

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May 9, 2024

There are 8 speakers on the call.

Operator

Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, David Ryzhik, Vice President of Investor Relations. Please go ahead.

Speaker 1

Good morning, everyone. I am David Ryzhik, Vice President of Investor Relations, and I'm joined this morning by John Lee, President and Chief Executive Officer and Michelle McCarthy, our Vice President and Chief Accounting Officer. Yesterday, after market close, we released our financial results for the Q1 of 2024, 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, 2023. These statements represent the company's expectations only

Speaker 2

as of today and should

Speaker 1

not be relied upon as representing the company's estimates or views as of any date subsequent today, and the company disclaims any obligation to update these statements. During the call, we will be discussing various non GAAP financial measures. Unless otherwise noted, all income statement related financial measures will be non GAAP other than revenue and gross margin. Please refer to our press release and the presentation materials posted to the Investor Relations section of our website for information regarding our non GAAP financial results and a reconciliation of our GAAP and non GAAP financial measures. For a detailed breakout of revenues by end market and division, please visit our investor website.

Speaker 1

Now, I'll turn the call over to John.

Speaker 2

Thanks, David. Good morning, everyone, and thanks for joining us today. MKS delivered strong results in the Q1 despite a muted market backdrop. 1st quarter revenue of $868,000,000 exceeded the midpoint of our guidance. Adjusted EBITDA of $217,000,000 and net earnings per diluted share of $1.18 both exceeded the high end of our guidance.

Speaker 2

We're particularly pleased with our strong gross margins, which reflect the value of our proprietary offerings, disciplined cost control and operational execution. We continue to expect a recovery in our semiconductor and electronics and packaging markets to unfold slowly in the second half of twenty twenty four and are poised to capitalize on our leading positions when we enter the next upturn. In our semiconductor market, we are foundational to key suppliers of leading edge process equipment in an era where AI is beginning to have a transformative impact on compute and memory architectures. We believe that AI is a powerful secular trend that will drive growth in our industry for years to come. But it's only the latest example in the long history of powerful secular trends in this market.

Speaker 2

Personal computers, mobile devices and data centers are earlier examples of transformative use cases in their time, all a result of the miniaturization and packaging of semiconductors. Our vacuum solutions enable critical deposition and etch that are necessary in the manufacturing of high bandwidth memory as well as a broader array of DRAM, NAND and logic semiconductors. In photonics, our optical solutions help our customers solve complex challenges in lithography, metrology and inspection. In addition, our motion control solutions are used to enable precise positioning of the wafer in hybrid bonding applications. In our electronics and packaging market, our unique combination of laser and chemistry expertise positions us for attractive growth in packaged substrates, which are a key building block of advanced packaging architectures.

Speaker 2

This complements our opportunity in high density interconnect PCBs, which are required for smartphone and ARVR applications and where we also see a growing opportunity in the low earth orbit application. In our specialty industrial market, we addressed a broad array of specialized applications where we are leveraging our proprietary technology to deliver strong margins and attractive cash flows. Across all these markets, we harness a broad base of capabilities and key enabling technologies such as vacuum, photonics and materials solutions. With a leadership position in a broad array of product categories, this affords us a holistic view of the ever increasing device scaling requirements faced by our customers, enabling us to develop integrated novel solutions to address these challenges. As an example, our team in Korea was recently recognized by Samsung Electromechanics for their support in the development and trial production of new products.

Speaker 2

We were also recently recognized by STMicroelectronics receiving the Best Performance Material Supplier Award and the Innovation Value Engineering Award for our work in developing a new adhesion promoter technology that enhances automotive IC package reliability. We are proud of the deep customer relationships that we've built over the last several decades and are excited about the opportunities that lie ahead for MKS. I'll turn now to our end markets. Revenue from our semiconductor market exceeded our expectations in the Q1 as we saw slightly stronger demand and improved conversion of customer backlog. Overall demand for our vacuum solutions for deposition and etch applications remains muted, primarily due to historically low levels of NAND equipment spending.

Speaker 2

We believe broader customer inventories across our vacuum portfolio are generally in a more balanced state today compared to a few quarters ago, but we may see some additional pockets of work downs in areas tied to NAND. With our Photonics Solutions division, revenue from our optical solutions for lithography, metrology and inspection applications remained robust in the Q1. We continue to see momentum in our world class optics initiative. This is a unique offering where MKS brings optics, coatings, motion stages, optical subsystems and lasers to solve complex challenges in transistor scaling. As we look to the Q2 of 2024, we expect revenue in our semiconductor market to be slightly down sequentially from a better than expected Q1 results.

Speaker 2

Early memory market indicators, including improved pricing and increasing demand, as well as continued spending tied to AI applications are encouraging. But as the industry first brings idled capacity back online, we expect the recovery in capital equipment spending to return gradually in the second half of the year. Turning to our electronics and packaging market, revenue was in line with expectations despite the unfavorable impact of foreign currency and lower palladium prices. Sales of our chemistry solutions for PCB and packaged substrate markets were stable in this muted market for PCs, smartphones and non AI servers. Our results also reflected expected seasonal softness due to the Lunar New Year holiday.

Speaker 2

However, we did see a slight pickup in demand for our plating equipment lines for complex high density multilayer PCB production, which we believe was primarily driven by growing AI server demand. As many of you know, AI GPUs require a large amount of advanced semiconductor content, which in turn requires complex packaging schemes. Semiconductors are mounted onto a package substrate that is then mounted onto a high density PCB and afterwards is mounted onto an advanced multilayer PCB. This growing substrate and PCB content in AI architectures puts MKS in a unique position to benefit with our proprietary laser drilling, chemistry and plating equipment solutions. We also saw additional demand for laser drilling systems for the fast growing low earth orbit application within the PCB market, where we are the process tool of record.

Speaker 2

As we look to the Q2 of 2024, we expect revenue from our electronics and packaging market to be up on a sequential basis due to an increase in plating equipment revenues and a seasonal increase in chemistry revenues following typically lower first quarter utilization. Turning to our Specialty Industrial market, revenue was slightly better than expected, driven by the modest sequential improvement in our Life and Health Sciences and Research and Defense markets. Revenue from our general metal finishing business in the automotive market remained flat overall on a sequential basis. As we look to the Q2, we expect demand trends in our specialty industrial market to remain stable with revenue relatively in line with 1st quarter levels. Wrapping up, Enkei has delivered a strong profitability in the Q1 despite a continued soft end market demand environment.

Speaker 2

While we expect overall industry demand to remain muted near term, we feel very good about the positioning of our portfolio and the investments we've made to capitalize on the key secular trends driving our end markets. Turning now to the finance discussion, I'd like to introduce you to Michelle McCarthy, our Vice President and Chief Accounting Officer, who will walk through our financial results in more detail. Michelle recently joined MKS and brings a strong public company accounting background to complement our deep finance team. This team is doing an outstanding job as we conduct our search for MKS' next Chief Financial Officer and we will keep you posted on our progress. Michelle, why don't we take it from here?

Speaker 3

Thanks, John. It's a privilege to be part of the MKS team. In the Q1, we delivered revenue of $868,000,000 above the midpoint of our guidance, primarily due to better than expected revenue from our semiconductor market. 1st quarter semiconductor revenue was $351,000,000 above the high end of our guidance and declining 3% sequentially. The year over year comparison is not meaningful as it was distorted by the ransomware incident last February.

Speaker 3

Revenue performance in the quarter is led by better than expected conversion of backlog in the vacuum solutions segment as well as continued robust sales of our photonics solutions. 1st quarter electronics and packaging revenue was $208,000,000 relatively in line with the midpoint of our guidance and a decrease of 8% sequentially. Excluding the impact of foreign exchange and palladium pass through, sales of our chemistry solutions in this market grew 15% on a year over year basis as our business bounced back from industry softness a year ago. Moving to our Specialty Industrial market, revenue in the Q1 was $309,000,000 above the midpoint of our guidance and up 1% sequentially. Similar to our semiconductor business, the year over year comparison is distorted by the ransomware incident.

Speaker 3

Consumables and services revenue across our 3 end market categories comprised 42% of our total revenue. Turning to our margins. We reported 1st quarter gross margin of 47.8 percent exceeding the high end of our guidance range. The strong results were a function of better than expected volumes, favorable product mix and continued cost control. We also benefited by approximately 60 basis points from certain non recurring items.

Speaker 3

1st quarter operating expenses were 240,000,000 in line with expectations. Throughout the current cycle, MKS is focused on prudently managing our cost structure, while ensuring we invest to innovate for our customers and capitalize on the attractive opportunities we see ahead of us. Our first quarter operating margin was 20.2% and exceeded the high end of our guidance range, reflecting strong gross margin performance, coupled with the natural operating leverage in the business. It is noteworthy that our acquisition of AdoTech has been a meaningful contributor to our strong performance in both gross and operating margins. Further to that point, exiting the Q1, we exceeded our AdoTech cost synergy target of $55,000,000 and we accomplished this at the earlier end of our expected timeframe of 18 to 36 months, continuing our track record of executing well on M and A synergies.

Speaker 3

1st quarter adjusted EBITDA was $217,000,000 representing a 25% margin and exceeding the high end of our guidance range. Net interest expense for the Q1 was approximately 75,000,000 dollars slightly favorable compared to our expectations. As a reminder, in the Q1, we refinanced our term loan and completed a $50,000,000 voluntary debt prepayment. Our refinancing included the pay down of our term loan A with incremental borrowings against our term loan B and the elimination of the financial maintenance covenant that applied while our term loan A was outstanding. We expect 2nd quarter net interest expense will be approximately $79,000,000 Also in early April, we made another $50,000,000 voluntary debt prepayment.

Speaker 3

Our tax rate for the Q1 was approximately 23%, slightly favorable as compared to our expectations entering the quarter. We expect our tax rate for the 2nd quarter to be about 23% and our full year tax rate to be approximately 20%. First quarter net earnings were $79,000,000 or $1.18 per diluted share, exceeding the high end of our guidance. We exited the Q1 with more than $1,500,000,000 of liquidity, including cash and short term investments of $846,000,000 and an undrawn revolving credit facility of $675,000,000 Gross debt was $4,900,000,000 at the end of the quarter. Our net leverage ratio exiting the Q1 was 4.3 times based on trailing 12 months adjusted EBITDA of 940,000,000 dollars Free cash flow was approximately $49,000,000 and unlevered free cash flow was 108,000,000 a reminder, our Q1 free cash flow is typically lower due to timing of variable compensation payments.

Speaker 3

Consistent with prior quarters, we made a dividend payment of $15,000,000 or $0.22 per share. With that, let me turn the call back to John. John?

Speaker 2

Thank you, Michelle. Let me now turn to our 2nd quarter outlook. We expect revenue of $860,000,000 plus or minus $40,000,000 reflecting the slow path to market recovery that we've discussed on recent calls. By end market, our outlook is as follows: Revenue from our semiconductor market is expected to be $335,000,000 plus or minus $15,000,000 reflecting our view that the market continues to bounce along the bottom with a modest recovery expected in the second half of the year. Revenue from our electronics and packaging market is expected to be $220,000,000 plus or minus $10,000,000 and revenue from our special industrial market is expected to be $305,000,000 plus or minus $15,000,000 Looking ahead to the second half twenty twenty four, we expect revenue to be slightly higher than the first half, reflecting a modest improvement in our semiconductor market combined with typical seasonality in our electronics and packaging market.

Speaker 2

Our specialty industrial market is expected to remain relatively consistent, mirroring global GDP trends. Based on anticipated product mix and revenue levels, we estimate 2nd quarter gross margin of 46.5 percent, plus or minus 1 percentage point. The step down in gross margin as compared to the Q1 reflects anticipated product mix as well as certain items that we do not expect to recur in the 2nd quarter. We expect 2nd quarter operating expenses of $240,000,000 plus or minus $5,000,000 We continue to believe $240,000,000 to $250,000,000 is an appropriate run rate for the balance of 2024. We estimate adjusted EBITDA of $197,000,000 plus or minus $23,000,000 Given these assumptions, we expect 2nd quarter net earnings per diluted share of $0.93 plus or minus $0.26 We continue to execute very well in navigating the cyclical softness in our end markets.

Speaker 2

I'm very pleased with the strong profitability and margin profile of our business. This, along with our differentiated product and technology portfolio tied to key secular trends in our end markets, positions us well for the next cyclical upturn. With that operator, please open the call for Q and A.

Operator

Thank you. At this time, we will conduct a question and answer session. Our first question comes from Steve Barger from KeyBanc Capital Markets. Please go ahead.

Speaker 4

Thanks. Good morning. John, I know you expect recovery to unfold slowly in the back half, but we're hearing more commentary about 2025 being a strong year for memory and initial positioning for the 2 nanometer transition next year to start. I know you don't want to get too far ahead, but inflections can happen quickly when they come. So can you talk about customer conversations for memory and leading edge and just how you're thinking about timing and capacity to support that inflection?

Speaker 2

Yes. Hi, Steve. That's a great question. Certainly, we're very intimate with our customers and have these discussions all the time. Obviously, we need to prepare our factories to support them.

Speaker 2

I would say that we still expect a slowly unfolding second half. But to your point, there are good signs with memory pricing and utilization picking up. Logic remains strong. As you pointed out, 2 nanometer and 3 nanometer capacity is getting used up too. So I think that the discussions are all about we're on the bottom, bouncing along the bottom.

Speaker 2

And it's really about timing, Steve. And you are right, things can change very quickly. But as you know, MKS is pretty good at that. We've been at this for 60 years. We have the capacity to support obviously much higher run rate that we had already in the past few years.

Speaker 2

So we're just waiting and ready for that whenever that happens.

Speaker 4

Got it. And similar question on substrate. You talked about AI and some other opportunities like low earth orbit. Can you talk through the roadmap for more layers or tighter tolerances on those substrates and how increasing complexity will benefit you given your position in drilling, plating equipment and chemistry?

Speaker 2

Yes. See, we're really excited about things like AI driving not only the semiconductors, but the electronics and packaging. AI boards are going up to 20 layers now. And of course, the lines and spaces and the vias are also smaller. So that's all good for us.

Speaker 2

It's more chemistry, it's more difficult chemistry, it's more laser drilling, it's more difficult laser drilling, it's more difficult bonding layers between the various layers in that PCB. And so when you have the ability to toggle laser equipment, chemistry equipment and chemistry, you just have a better solution set for the customers in solving these really tough challenges. So we believe that MKS is uniquely positioned in the industry to solve these really advanced packaging problems.

Speaker 4

And just one quick follow-up. So as you've had the conversations with customers, are they telling you to prepare for a higher capital spending environment for that the drilling, plating equipment and chemistry? Well,

Speaker 2

it varies, but I think as we pointed out in earnings script, we have seen this uptick in equipment orders tied to we believe AI. This is for actually the high density multi layer board. So as we talked about in earnings calls, there's 3 different types of packages. The advanced stuff that connects the chips, then goes on to a high density board, then goes on to this very complex multilayer board. And so this is the first sign where we've seen actually CapEx increases for some part of the food chain associated with AI.

Speaker 4

Terrific. Thanks.

Speaker 2

Thanks, Steve.

Operator

Thank you. One moment for our next question. Our next question comes from Jim Ricchiuti from Needham and Company. Please go ahead.

Speaker 5

Hi, thank you. Good morning. One of your competitors in the specialty chemistry market recently, I think last month, talked about improving demand in the electronics market in a couple of the geographic regions. And I'm wondering is that consistent, John, with what you're seeing? And in general, how would you characterize also the pricing environment within the Adatech business and to the extent that might be helping your margins?

Speaker 2

Yes. I think we would agree with that, Jim. I think it's slowly improving. You saw in our commentary that year over year, our Q1 is significantly better in our electronics chemistry than it was last year to 215%. It's been gradual and improving.

Speaker 2

So that's a good sign. In terms of pricing, we talked about gross margin for the business. We talked about ADATEC gross margins, really significantly adding to the gross margin profile of MKS. I also want to point out that we saw the gross margin improvement in all three divisions, so not just Adatech. But Adatech certainly comes with, I would argue, industry leading gross margins and that's obviously indicative of the value they're bringing to those customers.

Speaker 2

So pricing has been strong. We're getting paid for the value that we bring. And then we see slight improvement and we hope that continues.

Speaker 5

Got it. On the drilling side, apart from that application that you alluded to, the lower orbit application, are you seeing any lift in the March quarter bookings that more consistent with the seasonality that we've seen occasionally in this parts of the business? Or is that still something that we're still kind of bouncing along the bottom in this part of the business?

Speaker 2

Yes. I think we can see a slight improvement, Jim. I don't look at it as any kind of trend right now. I think it's still muted, still bouncing along the bottom. But Flex laser drilling versus HDI laser drilling of course is different.

Speaker 2

So the Flex is certainly still very muted. HDI is slightly better. I would just characterize it as still bouncing along the bottom, Jim.

Speaker 5

Right. Thank you.

Speaker 2

Thanks, Jim.

Operator

Thank you. One moment for our next question. Our next question comes from Krish Sankar from TD Cowen. Please go ahead.

Speaker 6

Yes. Hi. Thanks for taking my question. I had a few of them. John, I'm just trying to reconcile your statement that second half should be slightly better than first half in terms of revenues.

Speaker 6

That would imply that calendar 'twenty four revenues for you could be down on a year over year basis or slightly down. I'm just kind of curious, is that true? If so, do you expect both semi and electronics packaging to be down or one down more than the other?

Speaker 2

Well, yes, I think there's a lot of still uncertainty with respect to revenue, but we do expect to be slightly better in the second half versus the first half. And it depends on what your assumptions are for Q3 and Q4, obviously, whether the whole year is up or down. But as was pointed out earlier, this thing they can change quickly. We're planning on a slight uptick second half, but we're also planning on being ready in case it accelerates. So I would say that's still TBD in terms of year over year comparisons for the full year.

Speaker 2

Got it. Got it.

Speaker 6

And then can you just give an estimate of what you think your advanced packaging revenues would be this year and what it was last year?

Speaker 2

Yes. I think it's we've talked about advanced packaging being a third of our business and when servers and PCs and phones were kind of more normalized, this year is probably more in that quarter percent 25%, sorry. But that can vary and of course that's you can read about the public companies who are our customers in advanced packaging and you can see that obviously their revenues are down significantly. So that's consistent with that. Got it.

Speaker 2

Got it. If I

Speaker 6

could just squeeze in one more, John. Just curious, how to think about Atrotech benefiting or the impact of AdroTek when some of your customers start moving to glass panels of advanced packaging down the road?

Speaker 2

Yes. No, glass is certainly something that the industry has talked about for a long time, obviously, and more people are talking about it now. I would just say this, Adatech is industry leader in packaging, advanced packaging and the next generation. I would characterize it as we're certainly always in those discussions, always certainly looking at what our customers' needs are and developing the necessary processes to enable what they need and glasses, one of the things that we are working on along with the rest of the industry.

Speaker 6

Thanks, John.

Speaker 2

By the way, Krish, I wanted to just clarify my statement about 25% advanced package, that's 25% of electronics and packaging, not 25% of MKS, sorry.

Speaker 6

Got it. Thank you.

Speaker 2

Thanks, Krish.

Operator

Thank you. One moment for our next question. Our next question comes from Joe Carducci from Wells Fargo. Please go ahead.

Speaker 7

Yes. Thanks for taking the question. I wanted to on the same side, As you think about just the recovery in the memory industry and you think about just what's going to be driving demand on the NAND side, it sounds like the recovery in spending is going to be more related to system upgrades or node transitions. So curious of how do you think about the revenue opportunity for MKS when maybe it

Speaker 2

sounds like the WFE is going to be a

Speaker 7

little bit more tied to migration versus net new greenfield add?

Speaker 2

Yes. Thanks, Joe. When the customers are upgrading the chambers for the next node, certain critical subsystems on there have to be upgraded, otherwise you can't do the next node. And one of those is the RF Power Decks. So as you may or may not know, there's 3 Power Decks on every chamber for VNAND Etcher and all three have to get upgraded if you are moving from one node to the other.

Speaker 2

And that is obviously the biggest part of our spend. So we don't really notice the difference when they're doing chamber upgrade versus the entire tool. Obviously, if they're doing the entire tool, we may see other parts of MKS products go in there. But the chamber upgrade really benefits us equally, I guess, from the RF power standpoint. Now having said that, we did talk about inventory burn down and there's still a little bit left in the NAND market.

Speaker 2

So but this is a good sign when some of the customers are talking about node upgrades because that will start burning off that inventory and then at some point, they'll need the new stuff from us as well.

Speaker 7

That's helpful. And as a follow-up to that, do you expect that as we kind of look into the second half of this year that that NAND inventory burn down is still to play out to some extent or is it just I guess maybe starting to play out more this quarter?

Speaker 2

Yes, I think it depends, right? It depends on how many people are changing nodes, upgrading the nodes. But I think our view now is that it's still slowly unfolding. So that's why we're saying that slowly unfolding. So I think there's still more to go.

Speaker 2

And so I think in the second half, there's still some of that NAND inventory burn down that has to happen, certainly for us. But as we talked about earlier, it can change fast, right? And that could accelerate, but and we're ready for that, whether that happens or not.

Speaker 7

Got it. And just as a follow-up question, on the services gross margin strength that you had in the quarter, was that where the one time item was or just can you help us understand what drove that?

Speaker 3

Yes, I can take that question. This is Michelle. So yes, we have favorability in the quarter as we referenced in the prepared remarks about 60 basis points. That's non recurring. It's really related to favorable material variances as well as favorability in freight and duty cost recoveries.

Speaker 3

That's really the bulk of it.

Speaker 2

Yes. So not necessarily tied to service, Joe, but you did point out our service gross margins were probably record, I guess, I would call it that. But all the divisions had improved gross margin as well. But service, we're really happy with the performance of that group with the last quarter.

Speaker 7

Is there anything to point out what drove that?

Speaker 2

There was a good product mix and certainly some pricing has rolled through and some cost pressures that have been in the past are no longer there. So kind of a mix of whole bunch of things, Joe.

Speaker 4

Thank you.

Speaker 2

Thanks, Joe.

Operator

Thank you. Next question comes from Steve Barger from KeyBanc Capital Markets. Please go ahead.

Speaker 4

Yes, thanks. Just a quick follow-up. As you've modeled out free cash flow and how EBITDA progresses, do you think net leverage can get to 4% or below by year end or is that too aggressive?

Speaker 2

Yes, Steve. Obviously, we're very aggressive in deleveraging as you saw. Q1, we added we voluntarily paid another $50,000,000 and we talked about in April, we added we voluntarily paid on yet another $50,000,000 I think our ability to delever and prepay is really going to be a function of profitability, Steve. So not news to you, I'm sure. So I think it depends on how the year unfolds.

Speaker 2

Our model still is 50% gross margin flow through, 40% operating margin flow through. But as you know, we have a lot of leverage in the model. And so when revenue does pick up, you'll see a lot of cash flow and then we'll be able to delever quicker.

Speaker 4

Great. Thanks.

Speaker 2

Thanks, Steve.

Operator

Thank you. I am showing no further questions. I would now like to turn the call over to David for closing remarks.

Speaker 1

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

Operator

Thank you. This does conclude the program. You may now disconnect.

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