Q1 2020 Earnings Call

Ladies and gentlemen, thank you for standing by welcome to todays program entitled MKS instruments first quarter of 2020 conference call.

At this time all participants are in listen only mode. After the speakers presentation. There will be a question and answer session to ask a question during the session you'll need to press star one on your telephone.

I'd now like to reduce your host for today's program.

David Ryzhik, Vice President of Investor Relations. Please go ahead Sir.

Good morning, everyone I'm, David Ryzhik, Vice President of Investor Relations and I'm joined this morning by John Lee, Our President and Chief Executive Officer, and Seth Bagshaw, Our senior Vice President and Chief Financial Officer.

Thank you for joining our earnings conference call yesterday after market close we released our financial results for the first quarter of 2020, which are posted to our website www dot MKS I N S. T Dot com as a reminder, various remarks about future expectations plans and prospects for MK.

It was comprised of 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 the most recent annual report on form 10-K for the company.

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 day subsequent to today and the company disclaims any obligation to update these statements.

During the call we will be discussing non-GAAP financial measures. Please refer to our press release for information regarding our non-GAAP financial results and a reconciliation of our GAAP and non-GAAP financial measures now I'll turn the call over to John.

Thanks, David Good morning, everyone. Thank you for joining us today.

In the last 90 days I cannot be more proud of the dedication resilience and hard work of the MKS team during such a challenging time.

Well to share a few thoughts on the coven 19 crisis and how MKS responded.

Our first and foremost objective has been it continues to be the safety and well being of our global workforce.

Consists of more than 5000 employees with offices in factories in 18 countries.

Our second critical objective has been ensuring the continuity of our operations by swiftly responding to disruptions at our factories and supply chain partners.

This included securing supplies of critical components dressing rapid changes in workforce availability and harnessing our global service footprint to respond to the repair and maintenance needs of our customers.

I'm proud to report we delivered quarterly revenue at the high end of our guidance range.

Even though our guidance had not factored in any impact from the cover 19 pandemic.

I'd also like I mentioned that several of our products are being used to support the fight against Cobot 19.

We've often talked about how MKS provides critical enabling technologies for dance processes.

Our valves and pressure measurement solutions are used in the sterilization of personal protective equipment.

Our optical filters are deployed in diagnostic systems for Kobin 19.

And our ratings are incorporated in blood analyzers.

Finally, something that gives me the greatest pride is how we engage with our communities and just kind of need.

In addition to donating masks and other personal protective equipment to hospitals, we establish an employee matching program with the United way to help local communities in which our employees live.

And as a credit to the innovation and ingenuity of our workforce some of our U.S. in Mexico employees took it upon themselves to use threed printing to fabricate relief straps, we're facing fields.

We indoors and applaud these initiatives.

We will continue to find ways to support our communities in the car. This healthcare workers on the front lines of this global pandemic.

Now I'd like to turn to discuss our first quarter results in more detail.

We delivered first quarter revenue of $536 million.

At the high end of our guidance range.

Non-GAAP net earnings for the first quarter were $85 million or dollar 54 per diluted share, which was above the high end of our guidance range.

Sales to our semiconductor market further strengthened in the first quarter driven by broad based demand from our OEM equipment and end user customers.

Despite factory in supply chain disruptions throughout the quarter, we continue to meet our customers' needs.

We continue to see strong order rates in the second quarter, However, Shelton place directives and effect around the world are impacting some of our facilities as well as those in our supply chain to varying degrees.

We saw strong demand for our power solutions portfolio, driven by multiple customers across both conductor and the electorate etch applications.

Our power solutions business remains one of our key growth drivers within our semiconductor end market and we will continue to take advantage of new opportunities, where we can serve as a critical technology enabler.

We continue to see increase adoption of our ozone solutions for atomic layer deposition.

Serving both logic and memory manufacturing.

We believe our ozone systems or the preferred solution, leading edge foundry applications.

Our market, leading remote plasma source portfolio had another solid quarter, securing several wins in advanced deposition processes.

And our advanced markets, we are encouraged with the stability in our first quarter revenue, even amid the global disruptions.

In fact, we anticipate revenue from our advanced markets to remain stable in the second quarter.

We were pleased with the solid demand in our industrial markets led by electronic thin film and PCB drilling applications.

We also secured several design wins for our lasers and advanced electronics manufacturer, which is a key growth driver for our dance markets.

Excluding our research market, which was negatively impacted by University and research lab closures caused by cold in 19.

Our advanced markets revenue would have grown on a sequential basis.

Revenue from our equipment and solutions division exceeded our expectations driven by strong demand for a flex PCB be drilling solutions.

We remain very positive about the long term opportunity in flex PCB as we expect it's increasing usage in electronic devices to accelerate t. secular trends, such as Fiveg and internet of things.

In addition to serving the capacity needs of our PC because customers.

We also a key technology enabler for complex transitions to denser Pcbs using smaller ideas as well this material.

We're also excited about the opportunity that our new high density interconnect drilling solution presents which boasts an attractive cost of ownership advantage comprised of industry, leading throughput and significant weight and footprint savings.

Interest in our HD I tool continues to grow we continue working with our beta customers qualifying our solution.

We recognize there is significant market uncertainty as well the economy absorbs the impact of the cobot 19 pandemic.

However, as I look out beyond the near term uncertainty I remain very optimistic about three important secular trends driving long term growth in our semiconductor and advanced markets.

First the rise of the date economy increases demand for advanced memory and logic chips, that's driving long term growth and semiconductor manufacturing capacity.

Second increasing complexity of technology transitions in semiconductor manufacturing offers continue opportunities for share gain that favorite companies with a broad portfolio of critical technology solutions.

Third the accelerating need for laser based decision manufacturing requires a complementary offerings lasers optics motion and optical sub systems and MTS is uniquely positioned to provide integrated solutions.

Oh abroad, and differentiated portfolio relentless focus on innovation and customer experience and world class operational execution.

Positions us as a key beneficiary of those secular trends.

And drive continued outperformance in the markets we serve.

Now I'll turn the call over to set.

Thank you John I'll first cover our Q1 results and provide additional detail our second quarter guidance.

Sales for the first quarter of $536 million up 7% sequentially in $16 million above the midpoint of our guidance.

Several factors sales through and $13 million up 15% sequentially, reflecting strong industry fundamentals as our end customers increased equipment spending.

Sales to our dance markets, which wouldn't $23 million, a slight decrease of 2% sequentially.

We're pleased with the results within our dance market given the unforeseen headwinds we saw in the first quarter caused by the coated 19 pandemic.

Within our dance markets revenue from industrial life, and health Science in defense market collectively grew on a sequential basis.

However, our research market was definitely impacted by the widespread University in research lab shutdowns due to the pandemic, which led to the overall sequential decrease in revenue within our advanced market.

For the quarter revenue split between our semiconductor and at the end markets was 58% in 42% respectively.

First quarter gross margin was 44.7%.

The sequential increase of 140 basis points in 70 basis points above the midpoint of our guidance range.

Gross margin the quarter benefit from higher sales volume in product mix.

Non-GAAP operating expenses were $130 million also favorable to the midpoint of our guidance range, reflecting our continued focus on cost control, even given higher revenue volumes.

First quarter non-GAAP operating margin was 20.5% a sequential increase of 2010 basis points.

190 basis points favorable to the midpoint of our guidance.

Which highlights our core competency in managing our business first sustainable and profitable growth, while driving strong operating leverage in our financial model.

Non-GAAP net interest expense for the first quarter was $7.3 million.

And our non-GAAP tax rate was 17%.

Non-GAAP net earnings for the first quarter $85 million or $1.54 cents per diluted share.

In the first quarter revenue from equipment solutions Division was $51 million you sequential increase of 80% sure my strong demand from our flex PCB via drilling solutions.

We're also pleased the increase in I could've been solutions gross margin, which grew to 45.6% in the first quarter driven by product mix and higher volume.

The integration of the ESI acquisition substantially complete.

And this quarter. We're also pleased to announce we reached our previously announced annualized cost synergies target of $15 million achieving this goal within 14 months of the acquisition well ahead of our original time estimate of 18 to 36 months post acquisition.

We continue to seek additional opportunity to drive profit improvements across the entire company on a continual basis.

Now turning to the balance sheet.

Actually in the first quarter, we maintained a strong balance sheet liquidity with cash and short term investments of $500 million to $3 million in $100 million incremental borrowing capacity on an asset base line of credit subject to certain borrowing base requirements.

During the quarter completely 50 million dollar voluntary principal prepayment in the balance of our term loan was $840 million at the end of the quarter.

Our net leverage ratio further decrease in the quarter was 0.8 times, highlighting our ability to generate strong cash flow.

[noise] scheduled term loan payments go next 12 months totaled $9 million and our term loan Detroit in February of 2026 does not contain financial maintenance covenants.

Also in the first quarter, we made a dividend payment of $11 million or 20 cents per share.

In terms of working capital days sales outstanding was 65 days at the end of the first quarter compared to 62 days the end of the fourth quarter.

And the inventory turns were 2.5 times, which was consistent with the fourth quarter.

Free cash flow for the quarter was $65 million included $10 million of capital expenditures.

Now I'll turn to our second quarter outlook.

Order rates remain strong through my semiconductor market.

Over the manufacturing service keep capacity of certain of our facilities in supply chain partners remains constrained to the Shelton placed directives around the world.

Although we incorporate our best assessments in the financial impact of these factors. The time extends to these widespread Shelton placed directives will depend on a number of factors in government actions.

As result of these factors, we estimate that our sales in the second quarter could range from $450 million to $520 million.

Based upon current business levels absent cobot 19 constraint, we estimate our second quarter revenue would likely be at least consistent with first quarter levels.

We estimate our non-GAAP gross margin could range from 42.5% to 44.5%.

Reflecting anticipated product mix in global global shelter in place directives impacting capacity.

Second quarter, non-GAAP op expenses could range from $124 million $232 million.

R&D expenses could range from $41.5 million to $44.5 million.

In FCC expenses could range from $82.5 million to $87.5 million.

While we are estimating sequential decline in revenue our order rates remain healthy and as such we do not expect you said that reduction in operating expenses in the second quarter.

Non-GAAP net loss expense expect to be approximately $6.7 million in our non-GAAP tax rate expect to be approximately 17%.

Given these assumptions first quarter non-GAAP net earnings could range from $50 million to $77 million were 90 cents to $1.38 cents per diluted share.

I'd like to now turn the call back the operator for QNX.

[noise] certainly ladies and gentlemen, if you have a question at this time. Please press Star then one on your Touchtone telephone. If your question has been answered and you'd like to remove yourself from the Q. Please press the pound key.

Our first question comes from the line of Krish Shankar from Cowen and company. Your question. Please.

Hi, Thanks for taking my question I had a couple of them first one John said.

Thanks for giving the call it looks like a 50 million reduction at the midpoint in revenue you said that as all due to call that a in Q2 was this Q1 and it seems like it's all coming in the semiconductor side. It what doesn't mean difference in the supply chain between Siamese in advance markets that semi is what impact of an advance markets.

Yeah, Chris I think a harsh portion of the 50 is still in advance markets and the biggest driver there.

Is the closures of universities are non essential kind of businesses for us to ship or material to our products too. So there's still a portion of that of the 50 million is driven by advanced markets and that's driven by these closures.

In semi I think it's really about regional shelter in place directors and the uncertainty of when and how much of those Shelton place directors will mitigate over time.

And just like with everybody else in this in the semiconductor market, we have suppliers in countries like Malaysia and Singapore.

As well as you'll Mexico and so those are the main countries right now that we're most concerned but.

Things can change rapidly and that's why we're offering this kind of guidance going forward.

Got it probably John and then two other quick questions and I'm.

[laughter] you know the demand has been pretty strong and you're more supply constraint kinda it seems.

In sync with what you a custom when they glam also said last week.

But those agendas view that the downstream demand might slow down into second half of the you see that doesn't happen, but it looks like in Q2, you an under shipping demand. So is it fair does it mean, if don't seem demand faults in Q3.

The catch up supply would make it not that bad for you folks in Q3.

Oh that can be a case krish, but we certainly don't have great visibility like everybody else in terms of any kind of demand disruption. We know now that said we have strong order rates in Q1 in Q2.

And we have licensed rates, we will try very hard obviously as we've demonstrated Q1 two.

To deliver so everything that our customers needs and that's why the range is a little wider and we have.

Every day, so you know solving supply constraints everyday new supply constraints come up.

So we expect to to do the for 85, but theres lot of uncertainty there and you will always try to overachieve.

Got it no final question John is on the light and motion I guess, the legacy Newport business.

We've been pretty cool, but it does not expected to reap on any time until later this year do you think that recovery has been pushed out due to cold it or it doesn't really change because that has been running at a pretty pretty load run rate.

Yeah, no it's hard pressed to tell us its cobot related right now it seems to be very consistent to what we saw in the most of 2019.

Where a lot of it was a tariff and trade.

Ward issues. So right now I think it's really still similar kinds of behavior and drivers.

Thanks, John.

Thanks, Craig.

Thank you. Our next question comes to mind that Patrick Ho from Stifel. Your question. Please.

Thank you very much in Oh, Paul as well and congrats on the really nice quarter, John maybe first off in terms of the variables.

You've talked about the supply constraints affecting revenues for the June quarter from a margin perspective, you have issues like the supply chain manufacturing utilization and even logistics can you give a little bit of color.

How that affects margins both near term and when you believe you could start mitigating some of those issues.

From a bigger.

Bigger picture perspective.

Yes, that's just a said I'll take that question. So you're right in the first quarter, we had margin of 44.7%, which.

It's about what to expect to these volumes, maybe a little favorable product mix. You mentioned you use I had a strong quarters well the margin snack.

Cost of 46% 45.6.

So we gave the guidance or the second quarter at a 45 midpoint.

Real Delta between Q1 in Q2 is well have lower production volumes and I believe that really drives fundamentally about a point differential.

In the guidance gross margin rate.

So you get back up to the 535 rate I think that will normalize pretty quickly that's the only real delta between Q1 in Q2 in the margins.

Great that's really helpful.

And maybe as my follow up question in terms of the aside business you talked about the PCB. The flex PCB business picking up can you give us an update a bumpy your H.T.I. efforts and what you're seeing there in terms of some of the evaluations that you've talked about in the past and when you could start recognize.

Adding some more meaningful revenues.

Yeah, Patrick as John So we continue to have further increases in a number of photos and beta sites.

It's really the goal this year is to obtain a design wins all the fire tool various processes east with our customers. So that's what we're really focused on and so I think it's really from a substantial revenue standpoint, it's really a 2021 story.

Great. Thank you very much.

Thanks, Patrick.

Thank you. Our next question comes from the line the Tom Diffely from D.A. Davidson Your question. Please.

Yes. Good morning, So John when you talked about to supply constraints. So just curious is the bigger impact on new supply for your products, creating your products or is it the supply constraints your OEM customers have in their channels.

Well I can't comment on you know what our OEM customers constraints are I can certainly say that in Q1 as you can tell from our numbers and case was not a constraint for any of our customers we believe that.

And as you know our customers are not shy about telling us. If we are so I'd say, if they have supply constraints or some of the our OEM customers have said.

Perhaps it's in other parts of their supply chain.

Oh right now I was just wondering if the timing of what your customers are asking for has been a bigger had an even bigger impact versus your ability to supply them with what they needed.

No I think our customers have ordered a strong order rates as a as we talked about.

And bill and able to meet those those demands in the first quarter. I think we will also be able to meet them in the second quarter or it's just that we have some supply constraints and so we worked very closely with our customers to make sure that so we keep them hole.

And prioritize.

There are their shipments as well.

So I don't believe will have any kind of constraints to our customers in Q2.

Given the given the volume of a material that we can get through our factories.

Okay.

And then when you look at the aside business you talked about the flex getting stronger is that driven by capacity needs has the market adoption over basically absorbed all the capacity put in place couple of years go or is this driven by technology purchases for Fiveg and the rollout later this year.

A this is really a bit of both a there's capacity additions for sure and that's why.

The numbers or or as well as good as they are.

Some of it is of it is used for fiveg, but so we really can't differentiate sometimes how much of it is used for fiveg versus you know, making the regular non fiveg phones.

Okay. Thank you.

Thanks, Tom.

Thank you. Our next question comes from a line of Sidney Ho from Deutsche Bank. Your question. Please.

Great. Thanks for taking my question.

Couple of them first one is once these guidance last quarter, you had expected no impact from the Cohen of ours.

Yet you a semi business seems to have done extremely well, even what that what the shutdowns and travel restrictions and supply constraints and whatnot. How would you describe this upside in Q1 was that driven by a certain customers regions. Do you think is some sort of pull into fall demand from Q2.

Oh, because of whatever's going on with the virus in once the logistics, even an issue at all in the quarter.

Yeah, I would say the city that the order rates for strong in the beginning of the quarter. They were already increasing in Q4. So I don't think it was any kind of different behavior from our customers in terms of a strong order rate I think we did deliver to the high end of a non corona virus you know affected.

Items range and that doesn't mean, we didnt have challenges as we talked about we had lots of challenges as you know we have factories in China, we have factories in Singapore, we have factories in Europe.

Factories in Mexico factors in United States, many of them and all of them almost all of them had some kind of impact and then of course, our suppliers that are all in those regions. I think it's just a testament to our operational capability in our supply chain management to.

The weather all those challenges happened in February in China. As says you know and then it spread to Europe and other countries in March.

So I think we just delivered a lot better and execute a lot better than maybe some of our peers.

Okay. That's helpful. I I know, you're not ready to guide for second half yet given the supply supply chain uncertainties, but if those issues somehow resolved, let's say, but again this quarter, how you're thinking about the full year Wi Fi market given the order book seems to be quite healthy and do you feel comfortable that you still outgrow.

With that that market this year, whatever debt WFP ends up to be.

Oh, Yes city. So you know obviously, we have no crystal ball in terms of second half I think it will really deter you determined by the bit Big Chip manufacturers and then there will be determined by kind of what the consumer demand is an industry demand is so I don't I don't think we can really comment on what the second half will be.

Oh, we know is that our order rates are strong in Q1 in Q2 remains strong and we'll make sure that we a.

Deliberate to those order order rates.

Okay, maybe maybe on the advanced market, if I back out the U.S. high side, obviously does pretty good.

Revenue from the non U.S. high area, it's about a quarter lower than what it was two years ago is that it sounds like you guys feel pretty comfortable that that it's a it's just going to be consistent in Q2 is that the right level for which we should start thinking about that business I'm, calling out that the more normalized rate.

From probably aren't out.

Yeah, I think a that is probably the right way to think about Sydney given that you know I don't see any changes in you know kind of the constraints that happened before and some of those constraints were.

Trade war or issues, a those seem to still be there.

And then research of course is is going to continue we believe to be limited in terms of when they can open some of the universities and research labs. They can open they can't take product from us lasers and other components, if they're not open grad students on ordering online or optical components.

So from our website ceteris. So there is still a significant no noticeable component that's at the Krish, they'll probably 20% of 50 million.

Lower revenue in Q2 is probably because of research.

Okay. That's fair, maybe one last one I will go away.

Actually use of cash a you know the history of purely pay down debt and maybe negotiating for low interest rate and given the uncertainty we facing what what is your priority of cash right now and operationally are you building inventory 40 anticipated increase in demand in second.

Yes, so I'll take that Sydney, so yeah, obviously long term.

Cap allocation of acquisitions dividends, putting as well and then paying down debt I think had pretty effective job negotiating new rates as the market allows us. So I think in the intermediate term your next quarter, two or our view the Andy.

Marshall cash on the balance sheet, just given uncertainty in the marketplace.

If things change I think we'll get back to looking at paying down debt future.

Thanks, only right now through Q2, our goal of you kind of Martian cash balance sheet.

Okay, great. Thanks.

Thank you. Our next question comes the line of Amanda Scarnati from Citi. Your question. Please.

Hi, Good morning, the first question of more on the advanced market side of the business.

There's expectations at smartphones could be down about 10% to 20%. This year can you just talk about how that would impact your bags markets business or is this more about 21 story for you. So what happens in 20 isn't necessarily think of an impact on you just talk about what that looks like.

Yeah, I mean, it's John so it's a it's a little difficult because even if smartphones does go down as you say by 10%, there's a whole supply chain of customers that we have that are supply those phones and you know just depending on their capacity who wins the it goes on track it could be ordering.

Lasers to build more tools or they can be ordering more years side PCB drilling tools. So it's actually a little hard for us to quantify how much of a downtick it might or might affect MKS generally overall on average obviously you know capacity.

We will be could well be lower.

Really capacity would be lower but in terms of how it affects us will really depend on which one of our customers wins and which ones don't.

Great.

And then this is a a little bit new but I know that the U.S. The commerce. The U.S. Commerce Department came out with a new rules on Monday, we require licenses to ship anything to China. Starting at the end of June can you just talk about you know what impact that could have on cash or any information that you might have in terms of what those licenses might look like.

Okay.

Yeah I mean, it's good question, yes, it did come out like yesterday I guess.

So we're evaluating now.

And it's probably a little too early to tell how much of an impact if any will have on and yes, I would like to point out though that we already do this process. We already have products that have to go through export control and we know the path. We know the government agencies that are regulated and so really a question now is so how many.

The other customers because we'll be on that list and we have to have export control. So I think we're still in the evaluation stage still early days there Amanda.

Great. Thank you.

Thank you I mean.

Thank you aren't next question comes from line of Mark Miller from Benchmark. Your question. Please.

Thank you for the question I was just noted the smartphones are supposed to be week.

Reimbursed, but at the same time in terms of memory and logic chip to man.

This is being more than offset by data center growth. Some of that's due to more you know at home work and schooling.

But then tell a cast some concerns during their conference call, whether they were saying that that's been very strong.

And expected to be strong this quarter, but there could be some slowing in data center demand.

Later this year.

Just wondering what are your feelings about that and also in terms of the Fiveg ramp you really see that covering one very strong into second here for the year.

Hi, Mark as John well I think we certainly have long term views of datacenter and data economy driven.

Demands for Sunoco to chips as well as Fiveg.

Driven demand for not just the chips, but also believes in manufacturing processes. So I think I would say that long term is still very very bullish on data.

The economy and the need for Fiveg.

I think we certainly don't have a crystal ball in terms of what might happen or.

Might or might not happen in the second half with respect to those of you know I don't think we have any more visibility and Intel does or at Samsung for Apple, So, but I think longer term, but those are the messages I like to emphasize those are great long term drivers for us.

Oh, so separately on in terms of laser domain lasers, typically thrive or dive on a global doctoral output and I'm. Just wondering what your thoughts are there, especially with you know concerns about a contraction of the global economy.

Yeah, Mark I think that's generally true I think when you're lasers are focused on industrial manufacturing, but some of which as we've talked about are asked our lasers are really focused on new processes, new enabling processes and new types of products and so I think it's a little decouple from just general industries.

GDP and that's what we've seen in the past and we hope to see in the future.

That's probably a just a housekeeping issue could you you supply the revenue breakout for light and motion and vacuum analysis.

Yeah, So for Q1, the news and $20 million 320.

Motion 165 million quarter.

And even asked was 51 million.

Thank you.

Thanks Mark.

Thank you once again, if you will be question at this time. Please press Star then one.

And this does conclude be question and answer session of today's program I'd like to hand, the program back to John Lee for any further remarks.

Thank you.

I'm extremely proud of the dedication and resilience our employees around the world you have overcome an unprecedented number of challenges never before seen our lifetimes in order to deliver on our commitments, while keeping each other say, helping our communities.

As I write that after implementing the required social dispensing practices, we have become even closer as members of the global team.

Thank you for joining us today and for your interest of them yes.

Thank you ladies and gentlemen few participation in today's conference. This does conclude the program you may now disconnect good deck.

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