MKS Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 2, 2023

Key Takeaways

  • Q3 revenue of $932 M, adjusted EBITDA of $235 M, and EPS of $1.46 with a 47.1% gross margin, all exceeding guidance despite end-market softness.
  • Semiconductor revenue of $367 M met expectations, but Q4 semiconductor revenue is expected to decline sequentially due to continued weakness in NAND spending and customer inventory workdowns.
  • Electronics and packaging revenue rose 8% sequentially to $243 M, driven by seasonality and shipments of HDI laser systems for LEO satellite communications, demonstrating technology leadership in an emerging application.
  • Generated $142 M in free cash flow and exited Q3 with $1.3 B of liquidity, prepaid $100 M of debt and repriced $3.6 B in term loans to reduce annual interest expense by about $19 M.
  • Specialty industrial revenue was slightly below expectations with modest solar and LED weakness, and Q4 specialty industrial revenue is anticipated to be slightly down.
AI Generated. May Contain Errors.
Earnings Conference Call
MKS Q3 2023
00:00 / 00:00

There are 8 speakers on the call.

Operator

Good day and thank you for standing by. Welcome to the MKS Instruments Third Quarter 2023 Earnings Conference Call. At this time, all participants are in listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded.

Operator

I would now like to hand the conference over to your first Speaker today, David Ryzhik.

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 Q3 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 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 Ottotec Limited, which MKS acquired on August 17th, 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

Speaker 2

Thanks, David. Good morning, everyone, and thank you for joining us today. Before I discuss our Q3 results and key business trends, I'd like to touch on the devastating violence that has occurred in the Middle over the past month. There's simply no words that can describe the events that have unfolded, and our primary concern is the health and safety of our employees and their families in the region. As some of you may know, MKS has 3 facilities in Israel that manufacture some of our controls, Optics and Photonics Solutions, which all remain operational.

Speaker 2

The dedication and resilience of our Israeli team is unmatched, and we hope for a return to peace quickly. Turning to our Q3 results. MKS delivered strong profitability Despite continued softness in end market demand, we reported revenue of $932,000,000 adjusted EBITDA of $235,000,000 Net earnings per diluted share of $1.46 Revenue from our semiconductor market was in line with our expectations as the cyclical downturn in industry memory spending continued. As expected, demand for our critical vacuum subsystems for deposition and etch remained muted. However, demand for our photonics solutions for lithography, metrology and inspection continues to be resilient.

Speaker 2

Looking to the Q4, we expect revenue from our semiconductor market to decline sequentially due to the continued weakness in industry memory spending, particularly for NAND, which is at a historically low level and where leading edge tools contain relatively more MKS content. We also expect continued inventory work downs at key customers as they adjust for current demand. The semi market will have its cycles, The secular growth drivers over the long term are quite clear. The connected world will need more semiconductors with enhanced capabilities, Creating the need for miniaturization and increased complexity. MKS is actively engaged with customers across a broad range of technology inflections.

Speaker 2

Examples include next generation power solutions for advanced etch applications optical subsystems for lithography, metrology and inspection and Precision Motion for advanced bonding processes that enable applications such as high bandwidth memory. We pride ourselves on investing during a downturn to position us to be even stronger in the next upturn. That is the exact playbook we have deployed over the past 60 plus years, enabling us to become a foundational supplier in the semiconductor industry with number 1 or number 2 segment share across more categories of critical subsystems than anyone else in the industry. Turning to our electronics and packaging market, revenue grew sequentially and slightly better than expected due to normal seasonality associated with consumer electronics market as well as slightly higher PCB and packaged substrate production It had the Golden Week holidays in Asia in the beginning of Q4. I'm pleased to announce that we also shipped a number of HDI laser systems to the low earth orbit or LEO Satellite Communications Space.

Speaker 2

We are the process tool record for multiple customers serving the LEO space due to the unique capabilities of our proprietary HDI Via Drilling Technology, which enables increased productivity for one of the industry's fast emerging applications. This is a validation of our technology leadership and our unique ability to solve the hardest problems, establishing us as a key supplier to the leading PCB manufacturers. In addition, we also deliver our proprietary chemistry and plating equipment to this market, which highlights opportunities for an integrated approach. Looking to the Q4, we expect revenue from our electronics and packaging market to be down sequentially, primarily due to seasonally softer chemistry utilization as well as the lumpy nature of our equipment sales. We are seeing some signs of stabilization in the PC and smartphone markets.

Speaker 2

Within the server market, there is continued strength in the packaged substrate market for AI applications, but this is more than offset by broader softness in non AI server applications. Turning to our Specialty Industrial market, revenue was slightly below our expectations. Overall, the business was stable across our markets, but we saw some modest weakness in solar and LED applications. We leverage our expertise in R and D investments in our semiconductor and electronics and packaging markets to drive opportunities in our specialty industrial market. One example is the investment we have made in laser technology for advanced micro machining applications, where we see portability into specialty industrial applications such as solar and life and health sciences.

Speaker 2

Looking to the Q4, we expect revenue from our Specialty Industrial market to be slightly down compared to 3rd quarter levels. While demand across our end markets remains cyclically muted, we are highly engaged with customers and believe we are well positioned for the upturn. I'm proud of how our team continues to execute and deliver timely solutions for our customers, while pursuing operational efficiency through tight management of discretionary costs. We have a long history of prudent cost control and financial stewardship of our business throughout various market conditions and today is no exception. Many of you on the call are familiar with the multi decade secular growth story of the semiconductor market.

Speaker 2

We have been and will continue to be foundational to that market. However, electronic devices of today and the future will need more than just semiconductor transistor scaling As we move into an era of multi chip packaging or systems scaling, MKS is uniquely positioned to enable this new era of scaling for the broadest portfolio of critical technologies across equipment, chemistry and services. And now, I'd like to turn the call over to Seth. Thank you, John. Before I cover our 3rd quarter results, provide details or outlook for the Q4, I want to echo John's comments regarding our concern for the health and welfare of our employees in Israel.

Speaker 2

We are amazed at the dedication and fortitude of our Israeli team as they operate in extremely difficult circumstances. Just as a point of reference, revenue from our manufacturing operations in Israel over the last 12 months represented approximately 7% of our total revenue. Turning to our Q3 results. We delivered revenue of $932,000,000 just above the midpoint of our guidance. As expected, we recovered substantially all the remaining revenue impacted by the ransomware incident in the Q1, which we estimate approximately $30,000,000 After excluding the impact of ransomware incident recovery from the second and third quarters, our revenue grew slightly on a sequential basis.

Speaker 2

Turning to our semiconductor market, revenue was $367,000,000 in the 3rd quarter. As assuming the impact of ransomware incident recovery from 2nd and third quarters, our semiconductor revenue was relatively flat on a sequential basis. Revenue from Electronics packaging market was $243,000,000 an increase of 8% sequentially. Excluding the impact of foreign exchange and plate and pass through, 3rd quarter revenue declined 9% on a year over year basis with Q3 2022 representing combined company results. Moving to our Specialty Industrial market, revenue in the Q3 was $322,000,000 declining 5% sequentially.

Speaker 2

However, as excluding the impact of ransomware incident in the second and third quarters, our Specialty Industrial revenue was relatively stable on a sequential basis. Within our Specialty Industrial market, sales of our general metal finishing solutions to the automotive industry were flat on a sequential basis. On a year over year basis, Specialty Industrial revenue was relatively flat, excluding the impact of the ransomware incident, foreign exchange and palladium pass through with Q3 2022 representing combined company results. In the Q3, overall consumables and services revenue was also consistent on a year over year combined company basis, excluding the impact of foreign exchange and palladium pass through and comprised 42% of our total revenue. We expect consumables and services revenue to remain a resilient source of revenue and profitability going forward.

Speaker 2

Turning to our margins. 3rd quarter gross margin was 47.1%, a sequential increase of 20 basis points, exceeding the high end of our guidance. Efficient factor utilization, disciplined cost management and favorable product mix contributed to this outperformance. 3rd quarter operating expenses were $236,000,000 sequential decrease of $7,000,000 and below the low end of our guidance, reflecting continued disciplined cost management. 3rd quarter operating margin was 21.8% Adjusted EBITDA margin was 25.2%, both exceeding our expectations, reflecting the strength in our operating model.

Speaker 2

Our integration with AdTech continues to progress very well. We remain on track to achieve our cost synergy target of $55,000,000 within 18 to 36 months post close. We exited the 3rd quarter achieving annualized synergies of nearly $45,000,000 Net interest expense for the Q3 was $84,000,000 relative in line with our expectations. Our tax rate for the Q3 was 14%, is favorable to our expectations and reflective of the success of certain tax planning initiatives following the closing of the AdTech acquisition. As a result of these efforts, we now expect full year 2023 tax rate to be 19%.

Speaker 2

Looking beyond the Q4, we believe a low 20s percent tax rate is the right way to think about it at this time. We expect to provide a more formal update to our long term tax rate in our 4th quarter earnings call. Net earnings for the 3rd quarter were $98,000,000 or or $1.46 per diluted share. Turning to the balance sheet and cash flow. We exited the 3rd quarter with more than $1,300,000,000 of liquidity, including past and short term investments of $860,000,000 and undrawn revolving credit facility of $500,000,000 The cash position represents an increase of $758,000,000 at the end of the 2nd quarter.

Speaker 2

Free cash flow in the quarter $142,000,000 primarily result of strong cash strong cost control and sequential improvement in working capital. We exited the 3rd quarter with gross debt of $5,000,000,000 In October, we had a voluntary debt prepayment of $100,000,000 which is consistent with our strategy deleveraging our balance sheet. Also in the current quarter, we successfully completed repricing by $3,600,000,000 Secure Tranche B Term Loan. The repricing reduced the spread on our term loan from SOFR plus 2 75 basis points to SOFR plus 2.50 basis points and also eliminated the credit spread adjustment with respect to our term loan, which was 10 basis points at the time of the repricing. This repricing completed despite challenging market conditions is consistent with our long term practice of proactively managing our leverage and demonstrate the confidence lenders have in our operating model.

Speaker 2

At current rates, we estimate the combination of the repricing and prepayment reduced our annualized interest expense by approximately $19,000,000 Our net leverage ratio exiting the 3rd quarter was 4.6 times based on our trailing 12 month adjusted EBITDA. Our net leverage as defined in our credit agreement includes several other adjustments and was 4.2x exiting the 3rd quarter. Consistent with the prior quarter, we made a dividend payment of $15,000,000 or $0.22 per share. I'll now turn to our 4th quarter outlook. We expect 4th quarter revenue $840,000,000 plus or minus $40,000,000 By end market, our outlook is as follows: revenue from a semiconductor market of $320,000,000 plus or minus $15,000,000 revenue from Elektron from Packaging Market of $205,000,000 plus or minus $10,000,000 We had revenue from our Specialty Industrial market of $315,000,000 plus or minus $15,000,000 Based on the midpoint of our guidance, we now expect revenue in the second half of twenty twenty three to be slightly lower than the first half compared to our prior expectation that it will be slightly higher than the first half.

Speaker 2

This is primarily due to our expectation of short term inventory work downs in our semiconductor market. Based on anticipated product mix and revenue levels, We estimate 4th quarter gross margin of 45.5 percent plus or minus 1 percentage point. We expect operating expenses $235,000,000 plus or minus $5,000,000 relatively consistent with 3rd quarter levels. For the Q4, we estimate adjusted EBITDA of $185,000,000 plus or minus $20,000,000 For the Q4, net interest expense is expected to be $80,000,000 reflecting current interest rates as well as our recent successful tranche be term loan repricing and voluntary debt prepayment. Our tax rate is expected to be 16% for the 4th quarter, consistent with the updated full year 2023 tax rate outlook of 19% that I mentioned earlier.

Speaker 2

Given these assumptions, we expect 4th quarter net earnings of $0.85 per diluted share, plus or minus $0.27 In closing, we executed very well in maintaining profitability and generating solid cash flow despite the cyclical softness in our end markets. These are things we can't control. We remain confident in long term secular growth opportunities across our portfolio. The market does sound We are well positioned to emerge from the current environment even stronger than we were going in. With that, I'll turn it back to the operator for Q and A.

Operator

Thank you. We will now conduct the question and answer session. The first question comes from Krish Sankar at TD Cowen. Krish, your line is live.

Speaker 3

Yes. Hi. Thanks for taking my question. I had 2 of them. John, on the first one, I understand your semi revenues Our WFE, which happens during a cyclical downturn, it also probably looks like a tad lower than some of your peers.

Speaker 3

So I'm curious, Is it purely because your DepEx exposure or is there something else going on the market share front? And then I had a follow-up.

Speaker 2

Yes, Krish, thanks for the question. I think it's pretty simple. We are an enabler for vertical NAND. I think we've talked about that in the past. And as I think we've heard and you've heard from many of our customers, NAND is one of the WFE segments that's really particularly down.

Speaker 2

And so our exposure there and therefore our enablement there is really what's causing us to be slightly worse than maybe some of our peers. But I want to remind everybody, we love being An enabler for V NAND in the industry with our RF Power solutions. And of course, I don't think anybody would say V NAND won't come back. It's certainly in a cyclical downturn, but when it comes back, we'll be enjoying that market leadership again.

Speaker 4

Got it, got it.

Speaker 3

Thanks. And then I just wanted to follow-up on some of the advanced packaging. I mean, you highlighted Arotech exposure there. But it looks like Adutek as a percentage of revenue has really kind of been in this low 30% range for the last couple of quarters. Are you not seeing any of the benefits from advanced packaging or is it too early for that?

Speaker 2

Yes, I think it's early days, Krish. I think one of the things we Talk about is packaged substrates. This is the advanced packaging that we've talked about. Lots of interest, lots of acceleration there, especially in high performance computing. And so we're seeing a lot of that interest, but that's still a relatively small percentage, but we expect that to grow as a percentage of Advanced Packaging and Packaging overall.

Speaker 3

Got it. Thanks, John.

Speaker 2

Thanks, Krish.

Operator

That will be appreciated. Please stand by for the next question.

Speaker 4

Yes. Thanks for taking the questions. It looks like your chemicals revenue was up nicely sequentially in the quarter. Wondering if How much of that is just normal seasonality or maybe some pass through the palladium costs?

Speaker 2

Yes, Joe. So certainly part of it was seasonality, but it was a little better than we expected, even taking into account seasonality. Now, As we've said in our prepared remarks, there was a little bit of pull in because of the holiday week in the Q1 of Q4, but it was just a little better. And so we're happy to see that.

Speaker 4

Got it. And then maybe on the semi side, one of your peers had talked about Preparing for a kind of flattish 2024 and talking to their customers, I guess. Curious how you're thinking about that and maybe In the context, you did talk about NAND being definitely weaker. How are you thinking about the setup in the next year?

Speaker 2

Yes. Obviously, we read the same things you guys do and the visibility is poor for the industry right now. I think what we're preparing for is to continue supporting our customers in R and D, so that when it comes back, We will be enjoying an even stronger position. And in the meantime, we're watching costs very closely as you can see from our numbers. I think the industry is kind of looking at first half is relatively muted kind of the same as kind of the second half of twenty twenty three.

Speaker 2

And then I think after that, I think there's varying opinions. So that's what I would say is that we're reading the same kind of things you are And it looks pretty flat for the next few quarters to us as well.

Speaker 4

Thank you.

Speaker 2

Thanks, Joe.

Operator

Please standby for the next question. The next question comes from Steve Barger at KeyBanc Capital Markets. Steve, your line is live.

Speaker 5

Thanks. John, I think we all understand this has been a really challenging cycle, but the stock is obviously acting like there are bigger risks and problems here. So Can you just discuss again why you're confident MKS is better with ATC in the portfolio? And maybe further discuss How you see this playing out in coming quarters years?

Speaker 2

Yes, Steve, thanks for the question. We've talked about advanced packaging and we've talked about how critical that's going to be to enable the next generation of electronics. So as I said in our prepared remarks, it's no longer that just the semiconductor will enable advanced electronics. I think everybody is talking about chiplete packaging or systems packaging. If we are going to continue as an industry pushing the concept, the economic concept of Moore's Law.

Speaker 2

So We love having Adatech as part of our portfolio. There's no other company that has market leadership in packaging, chemistry and the equipment, that's Adatech, As well as market leadership in a broad set of technologies in semiconductor critical subsystems, as we've talked about in the past that enables depth and etch As well as lithography, metrology and inspection. So we firmly believe that the combination of both really sets up MKS uniquely for the future.

Speaker 5

And can you just talk about what the feedback has been from customers as you go out and maybe how you see The CapEx cycle next year and what you think that can translate into for MK?

Speaker 2

Well, customers are certainly very receptive to the concept of MKS bringing more solutions to them that include lasers as well as chemistry equipment and then other Types of packaging solutions. In terms of CapEx, I think that's similar to Joe's question, it's going to be Something that seems a bit muted. For Packaging though, I think next year if things stabilize, the compares will be good. But your guess is as good as mine as to how much it comes back. But I would also comment that the packaging market for us is less Cyclical.

Speaker 2

There are cycles for sure, but the amplitude is much less than semi CapEx as you've seen in our numbers.

Speaker 5

Got it. And Seth, can I squeeze in a quick one? Sorry if I missed it. Did you talk about free cash flow in 4Q? And can we expect incremental Paydown in the remainder of this year?

Speaker 2

Yes. We didn't disclose or give guidance on free cash Flow in Q4. You saw Q3 was quite strong by the way, Steve, and that's certainly that's our goal going forward to drive that free cash flow up. So It'll depend on working capital needs, but so we didn't really give that type of guidance in the Q4. In terms of debt pay down, we have done a lot of Pulling of levers, as you saw in the prepared remarks, we did $100,000,000 in October.

Speaker 2

We plan to delever aggressively going forward and that will Roll out as the year progresses. We did the repricing that took $11,000,000 off the table. So that's again a level we pulled. With Adatech, we've driven the tax rate down long term as well. It's a big value driver.

Speaker 2

And then the cost synergies is 45 The $55,000,000 1 year end. So things we can control as in the prepared remarks, we've actually done a lot already in a short period of time with more opportunity going forward as well. And that will roll out. There's no change in our philosophy to delever, drive free cash flow, drive the integration activities, which is fine very well. Appreciate the time.

Speaker 2

Thanks. Yes. Thanks, Steve.

Operator

One moment for our next question. And the next Question comes from Jim Ricchiuti at Needham and Company. Your line is open.

Speaker 6

Thank you. I wanted to Focus on the Photonics Solutions portion of the semi business, which appears to be holding up better. And John, maybe you could talk to what your visibility, your line of site in that area of the business. Are you any more optimistic that that portion of the business is able to hold up in this cyclical downturn?

Speaker 2

Yes, Jim, I think we do believe that there is less cyclicality in The lithography metrology inspection part of the semi business and we've seen that play out over multiple quarters. We're in constant contact with those key customers, and you can see what they say publicly about their revenue over the next several quarters as well. So we believe that's really just an area of semi that's just much more consistent than certainly the debt bench part. So That's our visibility right now and that's our belief that it will continue.

Speaker 6

And on the Specialty Industrial, obviously, it's a newer area for you. And are you more concerned now about the overall macro environment potentially impacting That portion of the business as we enter 2024. In other words, are you any more Concerned about the near term outlook in that area

Speaker 2

of the business. Yes, Jim, I mean, what we've seen in the past is that the industrial part has been pretty steady, Our revenue and it's, but we're always watching some of the key markets such as automotive and that's why we made that comment about automotive in our prepared remarks. But as I said in the past too, industrials are certainly less cyclical Then the semi CapEx world. Also comment that much of our industrial revenue is utilization dependent Chemistry. So that adds a little more stability to it.

Speaker 2

But to your point, Jim, we're always watching the macro environment to see how that may or may not affect our industrial business.

Speaker 6

I'll just lob one more in. I was just wondering on GEO, you seem to be getting some traction. How should we be thinking about the potential for that to be a bigger contributor in the near term?

Speaker 2

Yes. I think what we talked about at this call was this low earth orbit application, The PCBs that are needed to support that both on the satellites as well as the ground stations. And that had a technology requirement that our tool was uniquely positioned to deliver on that. So that's just another proof point of the technology that we've developed. I think that we continue to make progress in other areas as well.

Speaker 2

And so we just wanted to point out that we continue to get signs that what we've developed and the technology there is really unique. Thank you. Thanks, Jim.

Operator

One moment for our next question. The next question comes from Sidney Ho at Deutsche Bank. Your line is open.

Speaker 7

Great. Thank you. Good morning. I'm not trying to ask for specific guidance for next year. How are you thinking about the revenue trajectory for each segment in 2024, do you think there will be another step down in the first half in any of the segments whether it's cyclically or seasonally?

Speaker 7

It sounds like you think semis will be flattish for a few quarters, but how about the other segments? And what kind of visibility do you have right now? Any color by segment or even by end market would be great.

Speaker 2

Yes. Thanks, Cindy. So, yes, I think we talked about semi and we're kind of bouncing on the bottom As we said, I would say Specialty Industrials has just held up and been very steady for this whole duration of the semi downturn. So That's kind of the expectation. Electronics and Packaging did see some cyclicality as you've seen in the quarter.

Speaker 2

There is some seasonality to it as well, but certainly less cyclical in terms of amplitude and the semi business. And it's much more utilization dependent. So I think that we watch the macro demands for PCs and servers and all that, And that drives some of that electronics and packaging business. So I think the semi recovery and electronics and packaging recovery may go hand in hand, But the amplitudes of those are much different, very different between the two markets.

Speaker 7

Okay. That's fair. Now, my second question is, you guys have a good track record of deleveraging out in the acquisition. Given the sluggish demand, What is a realistic gross leverage ratio we should be expecting by the end of calendar 'twenty four? And how should we think about the levers other than waiting for the business to recover?

Speaker 7

Thank you.

Speaker 2

Yes. Thanks, Cindy. Yes, so we kind of asked for guidance looking out in 'twenty four, so I can't give you that type of details. But Obviously, Q3 kind of gives you a snapshot at certain of those revenue levels, what type Cash flow comes off the business, so you got to have that view in mind. As John mentioned, we think semi is kind of at the trough levels or at least low levels for sure, Speaking certainly in the NAND environment.

Speaker 2

So we think that will over time be an opportunity for us. But I would say fundamentally it will be revenue driven. We will work hard on working capital efficiency. We think we have more In certain areas that we are working on pretty hard right now. But I would say it's really revenue profitability driven and then working capital management.

Speaker 2

And you saw in the Q3 results, we worked very hard to deliver really quite strong results given the environment. So I think those are things I would focus on and things we're kind of working pretty hard And that's been our playbook historically speaking.

Speaker 7

Okay. Thank you.

Speaker 2

Yes. Thanks, Cindy.

Operator

I am showing no further questions at this time. So this concludes the question and answer session. I would now like to turn it back to David Ryzic with closing remarks.

Speaker 1

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

Operator

Thank you for your participation in today's conference. This does conclude the program and you may now disconnect.

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