MKS Instruments, Inc. (NASDAQ:MKSI) Q1 2024 Earnings Call Transcript May 9, 2024
MKS Instruments, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Welcome to the MKS Instruments’ First Quarter 2024 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. [Operator Instructions] 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.
David Ryzhik: 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 first quarter 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. 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-K for the year ended December 31st, 2023.
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 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.
Now, I’ll turn the call over to John.
John Lee: Thanks David. Good morning everyone and thanks for joining us today. MKS delivered strong results in the first quarter despite a muted market backdrop. First quarter revenue of $868 million exceeded the midpoint of our guidance. Adjusted EBITDA of $217 million and net earnings per diluted share of $1.18 both exceeded the high end of our guidance. 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 2024 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. 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 processes 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 and 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. This complements our opportunity in high-density interconnect PCBs, which were required for smartphone and AR/VR 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 Electro-Mechanics for their support in the development and trial production of new products. We were also recently recognized by ST Microelectronics receiving the best Performance Material Supplier Award and the Innovation Value Engineering Award for our work in developing a new adhesive 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 first quarter. 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. 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 first quarter.
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 second quarter of 2024, we expect revenue in our semiconductor market to be slightly down sequentially from a better-than-expected first quarter results. 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 idle 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 package 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 Luna New Year holiday. 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 on to a high-density PCB and afterwards is mounted on to an advanced multilayer PCB.
This growing substrate and PCB content and 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. As we look to the second quarter of 2024, we expect revenue from our electronics and packaging market to be up on a sequential basis due to an increase in planting 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 second quarter, we expect demand trends in our specialty industrial market to remain stable with revenue relatively in line with first quarter levels. Wrapping up, MKS delivered a strong profitability in the first quarter, despite a continued soft end market demand environment. 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 continue to post it on our progress. Michelle, why don’t you take it from here?
Michelle McCarthy: Thanks John. It’s a privilege to be part of the MKS team. In the first quarter, we delivered revenue of $868 million above the midpoint of our guidance, primarily due to better-than-expected revenue from our semiconductor market. First quarter semiconductor revenue was $351 million 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. Revenue performance in the quarter was led by better-than-expected conversion of backlog in the Vacuum Solutions segment, as well as continued robust sales of our Photonics Solutions. First quarter electronics and packaging revenue was $208 million, 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 first quarter was $309 million, 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. Consumables and services revenue across our three end market categories comprised 42% of our total revenue. Turning to our margins. We reported first quarter gross margin of 47.8%, 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 nonrecurring items. First quarter operating expenses were $240 million 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 Atotech has been a meaningful contributor to our strong performance in both gross and operating margins. Further to that point, exiting the first quarter we exceeded our Atotech cost synergy target of $55 million and we accomplished this at the earlier end of our expected time frame of 18 to 36 months, continuing our track record of executing well on M&A synergies.
First quarter adjusted EBITDA was $217 million, representing a 25% margin and exceeding the high end of our guidance range. Net interest expense for the first quarter was approximately $75 million, slightly favorable compared to our expectations. As a reminder, in the first quarter, we refinanced our term loan and completed a $50 million voluntary debt prepayment. Our refinancing included the paydown of our term loan A, with incremental borrowings against our term loan B and the elimination of the financial maintenance covenants that applied, while our term loan A was outstanding. We expect second quarter net interest expense will be approximately $79 million. Also in early April, we made another $50 million voluntary debt prepayment. Our tax rate for the first quarter was approximately 23%, slightly favorable as compared to our expectations entering the quarter.
We expect our tax rate for the second quarter to be about 23% and our full year tax rate to be approximately 20%. First quarter net earnings were $79 million or $1.18 per diluted share exceeding the high end of our guidance. We exited the first quarter, with more than $1.5 billion of liquidity including cash and short-term investments of $846 million, and an undrawn revolving credit facility of $675 million. Gross debt was $4.9 billion at the end of the quarter. Our net leverage ratio exiting the first quarter was 4.3times, based on trailing 12 months adjusted EBITDA of $940 million. Free cash flow was approximately $49 million and unlevered free cash flow was $108 million. As a reminder, our first quarter free cash flow is typically lower due to timing of variable compensation payments.
Consistent with prior quarters, we made a dividend payment of $15 million or $0.22 per share. With that, let me turn the call back to John. John?
John Lee: Thank you, Michelle. Let me now turn to our second quarter outlook. We expect revenue of $860 million plus or minus $40 million reflecting the slow path to market recovery that we have discussed on recent calls. By end market, our outlook is as follows: revenue from our semiconductor market is expected to be $335 million plus or minus $15 million, 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 million plus or minus $10 million, and revenue from our Specialty Industrial market is expected to be $305 million plus or minus $15 million. Looking ahead to the second half of 2024, 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.
Our Specialty Industrial market is expected to remain relatively consistent mirroring global GDP trends. Based on anticipated product mix and revenue levels, we estimate second quarter gross margin of 46.5% plus or minus one percentage point. The step down in gross margin as compared to the first quarter reflects anticipated product mix as well as certain items that we do not expect to recur in the second quarter. We expect second quarter operating expenses of $240 million plus or minus $5 million. We continue to believe $240 million to $250 million is an appropriate run rate for the balance of 2024. We estimate adjusted EBITDA of $197 million plus or minus $23 million. Given these assumptions we expect second 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. 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&A.
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