MKS Inc. (MKSI) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to MKS Instruments' First Quarter 2018 Earnings and Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be provided at that time. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to turn the conference over to MKS' Chief Financial Officer, Seth Bagshaw. Sir?

Thank you. Good morning, everyone. I am Seth Bagshaw, Chief Financial Officer and I'm joined this morning by Jerry Colella, our Chief Executive Officer and President; and John Lee, our Chief Operating Officer. Thank you for joining our earnings conference call. Yesterday after market closed, we released our financial results for the first quarter of 2018, as well as our April 2018 operating model. We reclassified certain historical data for our service revenue to conform to typical industry practices. Beginning in 2018, we'll now include revenue from the aftermarket sale of spare parts and service revenue which has previously been recorded as product revenue. Our financial schedules, schedules of reclassified service revenue and revenue by end market in the April 2018 operating model had been posted to our website www.mksinst.com. As a reminder, the various remarks that we make 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 31, 2017, which is on file with SEC. These statements represent the Company's expectations only as of today, and should not be relied upon as representing the company's estimates or views as of any date subsequent to today, and the Company disclaims any obligation to update these statements. Today's call also includes non-GAAP adjusted financial measures. Reconciliations to GAAP measures are contained in yesterday's earnings release. Now, I'll turn the call over to Jerry.

Thanks, Seth. Good morning, everyone, and thank you for joining us today. I'll start with our results for the first quarter of 2018, followed by several business highlights, then I'll turn the call over to John Lee who will share additional details in our customer's end markets. Seth will then provide further information on our financial results, our second quarter 2018 guidance and our updated operating model before we open the call for your questions. First quarter revenue was $554 million, above the high end of our guidance and an increase of 27% from the year ago. This marks the seventh consecutive quarterly record for revenue. We also set a new quarterly record for non-GAAP net earnings totaling $114 million or $2.07 per share. We achieved record revenue in the first quarter for both our semiconductor and advanced market segments. Revenue for the semiconductor market was $313 million; revenue for sales markets was $241 million and is now approaching a $1 billion annualized run rate. Furthermore, we have evolved our business model over the last five years, achieving a more balanced revenue split between semiconductor and advanced markets which is now 57% and 43% respectively, even with the significant expansion of our semiconductor business. Our growing exposure to these exciting and advanced markets presents a unique opportunity for MKS as well as diversifying our customer base. As we study these broad market trends, it is clear that innovation in photonics and laser processing will lead to new markets and opportunities that can only be imagined today. As we did in the semiconductor market for over the last 50 years, we will drive that same innovation with our Light & Motion division. This is a tremendous strategic opportunity to create value and accelerate growth. We've made substantial improvements in terms of integrating legacy with Newport [ph] businesses. Historically, each business unit operated independently and did not leverage at the investments across the combined company. Over the past two years, we have addressed this fundamental issue by bringing the business units together with a keen focus on identifying customer opportunities that could be served across multiple product categories. We've also integrated the sales team. We then unified approach to customer to helping them better utilize the entire breadth of capabilities and advantages of our integrated portfolio. As we move into 2018, we'll explore additional sales channel strategies to operate more efficiently and drive growth. It is very clear that after owning Newport for less than two years, this is a great asset that has benefited from the influence of the MKS business processes, our Light & Motion division continues to perform extremely well, driven by growth in our industrial market segment, as well as building OEM businesses with our semiconductor customers. Turning now to market outlook, we expect to see double digit growth in WFE, the semiconductor business for 2018, which are the more positive outlook from our last earnings call. Given opposition in the market today, we anticipate we will outpace WFE growth with sustained strength driven by robust demand for data storage and data processing applications. We also anticipate significant growth in advanced markets, especially those segments driven by increasing applications and laser manufacturing. I am extremely pleased with our first quarter performance and confident our strategic strategies have positioned us for market outperformance of 2018 and beyond. Now, I'll turn the call over to John.

Thanks, Jerry. As we have discussed in the past, our power solutions business continues to be a highlights, enabling us to deliver unparalleled technical capabilities to customers. The increasingly complex challenges for etching and deposition processes are driven by the requirements for advanced logic in DRAM and the challenging vertical structures for V-NAND [ph]. Our strategy is to invest early in key technologies and product platforms that we believe will be transformative, knowing that design wins will lead to longer term revenue. The strategic investments we made in bioelectric etch beginning three years ago have led to key design wins which are now paying off with significant orders. More recently, investments in conductor etch in deposition are starting to generate design wins, which we expect to fuel future revenue growth and continued share gain. In the first quarter, we had design wins in both conductor etch and deposition applications for V-NAND for the large North American OEM. First quarter revenue for our power solutions business was the highest ever, of 17% from an already strong fourth quarter. We are pleased to report that according to industry analysts, our power solution's market share has increased 230 basis points in 2017. Turning now to our advanced markets. As we've discussed in the past, the need for faster, more precise manufacturing techniques requires unprecedented innovations in laser-processing capabilities. Demanding applications such as cutting, scribing and marketing are enabled not only by ultra-fast pulse lasers, but also by the ability to control the laser beam through a precise beam profiling and power measurement. MKS' capabilities in ultra-fast lasers, laser power management, laser beam profiling, motion control and beam delivery optics uniquely positions us to provide comprehensive solutions that surround the work piece. This is analogous to how our vacuum instruments and controllers surround the process chamber. We are the industry leaders in laser beam profiling and power measurement and our first quarter revenue grew 23% sequentially. We received orders from laser beam profiling systems in Germany. The first order was for an automotive transmission laser welding application. The second order was for the additive manufacturing of complex metal components. The customer chose our new beam watch system which is the industry's first non-content [ph] monitoring system that shows the changes in size, location and energy distribution of the laser beam in real time. Finally, our core laser business had another strong quarter. In Japan, we won an order for our wafer dicing application using our new picosecond laser. We also won orders for film scribing, glass drilling and dye-attached [ph] film cutting applications using our ultraviolet nanosecond lasers. In 2017, our laser business grew 23% and this growth has accelerated in the first quarter of 2018 where revenue is 62% higher than a year ago. We project that the opportunities for laser materials processing will approach $4.5 billion for the year 2022, offering another large and growing market that diversifies MKS' revenue profile. At this point, I would like to turn the call over to Seth.

Thanks, John. I will cover the first quarter financial results, our Q2 2018 guidance and then our updated April 2018 operating model. Revenue for the quarter was $554 million, increase of 8% sequentially and an increase of 27% compared to the first quarter of 2017. The increase in revenue with broad-base particularly strong into the latter part of the quarter. Sales to semiconductor market remained very strong and we achieved a new record of $313 million in the first quarter. Sales to our advanced markets which comprised 43% of our total revenue increased 6% sequentially and also achieved a new record of $241 million. The Light & Motion division achieved a new quarterly record for both revenue and non-GAAP operating income which were $206 million and $54 million respectively. During the quarter which we acquired Newport in 2016, the pro forma revenue in operating income were $151 million and $16 million respectively. In the past seven quarters, quarterly revenue has increased over 35% and non-GAAP operating income has increased by almost 240%. As a result, we more than double the operating margin of the Light & Motion division from 10.6% in the second quarter of 2016 to 26.2% in the first quarter of 2018. As Jerry has mentioned, this acquisition has also substantially increased our percentage of revenue from advanced markets in that time frame, providing additional growth opportunities. GAAP and non-GAAP gross margin were 47.4% and non-GAAP operating expenses were $117.8 million for the quarter. Due to strong financial performance levels, we expect variable incentive compensation expense to be higher than expected. In the first quarter, higher incentive compensation had a 30 basis point impact on gross margin and approximately $5 million increase in operating expenses. Non-GAAP operating margin was 26.2% which was then our expected operating model range with a higher incentive compensation expense. GAAP and non-GAAP interest expense was $5.4 million and $3.6 million respectively and interest income was $1.1 million for the quarter. The non-GAAP tax rate was 19.5% and the GAAP tax rate was 17%, largely due to the benefit of tax reductions related to stock compensation. During the quarter, we incurred structuring charges of $1.2 million, primarily related to further streamlining consolidation of certain administrative functions. GAAP net income was $105 million or $1.90 per share and non-GAAP net earnings were $114 million or $2.07 per share. At the end of the first quarter, we had cash and short term investments of $542 million, which approximately 40% was in the U.S. and 60% in our international operations. During the quarter, we made another voluntary pre-payment on our term loan that have now completed over $430 million in payments in the last 24 months since loan origination. As of March 31, our term loan balance was $348 million; our net cash position increased $44 million, we ended the quarter with a net cash of over $195 million. Furthermore on April 11, we completed the fourth repricing of our term loan which reduced the interest rates spread by an additional 25 basis points to a LIBOR plus 175 basis points, which equates to a non-GAAP interest rate of 3.25%. The impact of these recent actions will reduce our non-GAAP interest cost by almost $3 million per year. The cumulative effect of all the voluntary debt pre-payments in four interest rate repricings have reduced our annualized non-GAAP interest cost by more than 70% in the last 24 months. Free cash flow for the quarter was $63 million. In terms of working capital, and day sales outstanding increased slightly to 56 days at the end of the first quarter compared to 53 days at the end of the fourth quarter due primarily at the timing of revenue in the quarter. Inventory turned were consistent with the fourth quarter and with 3.2, continue to provide the balance approach to capital deployment and during the quarter we paid a cash debt of $9.8 million or $0.18 per share. Turning to Q2 2018 guidance; we continue to see strong growth in our end markets. We estimate that our sales in the second quarter could range from $550 million to $590 million and gross margin could range from 47% to 48% reflecting expected product mix. Non-GAAP operating expenses could range from $113 million to $119 million, R&D expenses could range with $36 million to $38 million and SG&A expenses could range from $77 million to $81 million. Non-GAAP interest expense is estimated to be approximately $3 million and a non-GAAP tax rate could be approximately 19.5%. Given these assumptions, second quarter non-GAAP net earnings could arrange from $116 million to $131 million or $2.09 to $2.36 per share. In the second quarter, amortization and tangible assets expect to be approximately $11 million; GAAP interest expense estimated to be approximately $3.4 million and GAAP net income expected to range from $106 million to $121 million or $1.91 to $2.18 per share on approximately 55.4 million share outstanding. Finally, yesterday we published an April 2018 operating model which is an update to our January model reflecting higher illustrative annualized revenue levels in the impact of our fourth term loan repricing and voluntary debt pre-payment in the quarter. In an illustrated level of $2.3 billion, we estimate that non-GAAP gross margin could be 48% and non-GAAP operating margin could be 28%. Projected non-GAAP tax of 19% [indiscernible] model shows potential non-GAAP EPS of $9.31. This represents an additional 9% accretion from our January 2018 model published last quarter and an improvement of over 60% from the published model a year ago. Lastly as a reminder, our operating expense in the first half of this year are higher than anticipated due to variable compensation. The April operating model reflects more normalized incentive compensation. This concludes our prepared remarks and we'll now open the call for questions.

Thank you. [Operator Instructions] Our first question comes from Sidney Ho with Deutsche Bank. Your line is now open.

Thanks and congratulations on a great quarter and guide. For the second quarter revenue guidance, maybe start off with that. Can you talk about what is your expectations between -- the growth between semis and the advanced markets?

I think we expect to see a slight improvement in both. Pretty consistent and solid revenue for both of those markets. I think the mid-point is somewhere around 3% high or so than what we just achieved so we see this consistent with both markets.

Okay, that's great. I understand you guide one quarter at a time, but I'm curious how do you think about your semiconductor business in the second half of the year versus the first half. There obviously have been a lot of fears that the market has peaked this year and maybe even more specifically the first half of this year. Just want to hear your view on that.

Well, I'll go back to the same question that was asked last year and the same thing was supposed above the second half of '17 and that didn't turn out to be the case. And I've been in the industry long enough to know that the forecast has run over, it got fast, that's what we tell our operations team. But we see WFE as being strong in terms of somewhere 6% to 12% up, the fundamentals are intact and as far as storage, computing and networking, strong D-NAND [ph] and DRAM. We have multiple OEMs, the mix of this changes, demand can vary quarter-to-quarter. Our Korean [ph] business appears to be still very strong. We read all of the commentary about the end customers like SK Hynix investing at DRAM and 3D, Micron within Singapore, Fab spending at CMC [ph] and Samsung. So it appears to be positive, but I'm from Missouri. I certainly make sure we operate the company with a foot on the brake and a foot on the gas. But from what we see, it still appears to be pretty consistent business, but we'll see. Like I said, last year was projected to turn over and it didn't and we'll see what happens, but so far we're still pretty comfortable to where we are and we also feel very comfortable about the external demand, the chips which drive the demand for the equipment.

Got you. Maybe last question for me. For the advanced market as a group, obviously has done really well -- you have said in the past that you think you can grow that business at least twice the rate of GDP growth. Clearly you done better than that with year-over-year growth accelerating to nearly 30% in Q1. How do you see the seasonality of that business and do sales in that area tend to be more lumpy going forward?

Well, the research market segment of that business, if you look at it, if you pilot in with non-semi has the same intensity be it seasonal. We typically don't really see a lot of seasonality in that business. I think Newport used to say their first quarter used to be a difficult one for them although they did very well. I don't know if John, you have said any other comments over, but we don't really know any seasonality of the business.

Yes. And I think, Sidney, some of the areas of the advanced market where we're resourced and focused on are the industrial applications. That is what is driving a large part of the growth.

Okay, thank you very much.

Thank you. Our next question comes from Patrick Ho with Stifel. Your line is now open.

Thank you very much and congrats also on the quarter and outlook. Jerry, maybe first one on the semiconductor end. Obviously your core vacuum and analysis business continues to outperform overall industry growth rates. Can you give a little color on the semi business or at maybe what the catalyst there for the changes in the growth profile in that segment?

Patrick, could you repeat the question because it kind of got muted towards the second half of what you're saying.

I apologize. Is this better?

Yes. It was fine. It was like a couple second period where I couldn't quite hear what you said.

Got you. Basically I was just wondering for your Newport semiconductor business that you acquired, what has been the catalyst that has helped you drive above average growth since you've acquired that business?

Sure. I'll turn that one over to John.

Yes. Patrick, the Newport business brought in for semi, they will target the inspection, larger OEMs and they've grown just similarly as you would expect as the vacuum's type OEMs. The design wins that were awarded years ago or a couple of years ago and continue design wins on what's driving the Newport side are the semi growth, if that's your question.

Great. As a follow question, you gave a little bit of color on your laser business with some of the applications there, the cutting, the welding -- are there any additional industrial applications that is hard-giving with the laser market or do you see a lot of the growth over the next couple of years in these type of I guess, heavy industrial marketplaces that you described in your prepared remarks?

I think Patrick, the only other color I'd add to that is that the laser manufacturing processes are not just the heavy industry type of applications like welding and cutting of metal, but also in some of the finer types of precision laser manufacturing and that's where we have a strength in terms of pulse lasers. So that's even more exciting to us in those applications. PCB A drilling, fine metal cutting and those kinds of applications.

Yes. We've put in the category of microelectronics and certainly at our Analyst Day in June, we're going to amplify our position in those markets. We're going to highlight our power business and we're also going to highlight our laser business and give a deeper explanation of why we win and where we think those markets are going. But I agree with John, it's not just the heavy industrial side, it's actually more applications in mobile device manufacturing or other types of displays.

Great. And maybe a final question for Seth in terms of the gross margin line. You've been at these higher levels relative to the past. Is product mix the biggest variable for your gross margin line right now? Or are there kind of market mixes that could also impact on a quarter-to-quarter basis?

Yes. I think, Pat, the bigger driver is actually volume. If you look at the Light & Motion product portfolio, you're on the pretty good margin -- a little bit above the corporate average, the V&A [ph] side is again close to that range as well. What I find, I think, the volume is a bigger driver quarter-over-quarter. That's what I would say and then we'll get a 50% variable gross margin in our model for quite a long period in time. That's pretty applicable going forward as well. Volume is number one. Mix, I think you'll see as we grow, the other advanced markets, we'll do get a little better margin there over time as well.

Great. Thank you.

Okay. Thank you, Patrick.

Yes. Thanks, Patrick.

Thank you. Our next question comes from Amanda Scarnati with Citi. Your line is now open.

Hi, good morning. Just a quick follow up on seasonality that was touched upon and then on semi business. Are you not seeing seasonality in that business because you're attacking that market differently in how you approach sales? Or do you think that there's something fundamentally different with the macro environment today than it was two years of going Newport with standalone business?

Hey, Amanda. It's John. I'll take that one. We're not seeing seasonality in the advanced markets because the markets we are attacking there are really high-growth markets -- these applications in laser micro processing. And those are really driven by demand and higher manufacturing capacity for things like iPhone. That's a much larger growth rate than what might be seasonal in a research environment.

Okay. And then on the power side. Not to front-run what you're going to say at your Analyst Day in two months, but you saw significant growth. I think you said it was about 230 bips in market share in 2017. Can that growth continue with just the dialog to business that you have or do you need that addition of the conductor X wins in order to really grow that business on the power side?

Yes. I think we could still go a lot more market share just by winning more dielectric. We certainly don't have all of it for sure and things like V-NAND and DRAM use a lot more dielectric etch than they might have in the past. So I think just dielectric at itself and our position in it and our continued winning of design ones there should also grow that.

And then just last question, just confirming. Do you have any revenue at all in the conductor etch right now or is it all just in dielectric?

Most of the conductor etch we've talked about is design ones.

Okay, thank you.

Thanks, Amanda.

Thank you. [Operator Instructions] Our next question comes from Tom Diffely with D.A. Davidson. Your line is now open.

Yes. Good morning. I was hoping to get a little bit more in what you've seen in terms of inventory levels in the channel, in particularly the OEM customers?

We really don't have a lot of insight into the particular OEM, their inventory levels. We just worry about our own for the most part. But the commentary has been consistent. I can't see that it's either grown or shrunk. It has been consistent from what we see.

Okay. And have you seen the OEM customers start to further consolidate their supplier base? Some of the share gains you're getting right now based on the fact that they want fewer, more well-capitalized players?

Yes. I think that has always been the last few years, kind of the strategy of the customers to deal with a larger, more global, more technically confident suppliers -- so that's us. We benefit from that. As far as actively seeing them participating in that, know it's more about just commentary, 'Look to your left, look to your right, that guy might not be there next year.' One of those types of things I've heard for 30 years. But I think we are winning because of the capability we have around the world, the deep technology we have and the type of support we provide our customers. What's the strategy now were gaining share because they believe we can support their business.

Okay. And what have you seen in terms of China as far as new OEM potential customers who are servicing the new ranking fabs there?

John and I will tag-team on that one.

Yes. I think the OEMs in China are still the same ones. I think we don't know who they are and I think they are still in the design phase and piloting, putting their tools into pilot lines. So we've seen some growth in LED type of OEMs, MOCVD types, but for semi, it hasn't really changed from historic levels, but certainly a lot more activity.

Yes. We have a very good relationship. We have a concentrated strategy like we did in Korea and you can note the success we've had there. Another great quarter in Korea again. Same approach to China that we want our share, we wanted to make sure that we have full support for those customers no matter how small they are or how fudging [ph] they may be and we certainly have a lot of contest on the tools than when this picks up, we will benefit greatly from it.

Okay. In China, is it the situation where it helps to have local company or local representatives there? Or can you service that market directly?

Well, first of all, we manufacture in China. We have a large operation in Tian Shan [ph]. We also have been on the ground in China for probably 15 or more years, well before the semiconductor market ever really thought about forming there, where SMAIC was the really only customer we had. So we had a strong presence in China for a very long time and that's back when we acquired Newport. We put more people on the ground in China because we thought that was fertile ground for the laser and optics, of photonics business. We have the resource on the ground to support that and we are rating Chinese citizen by having a large volume presence in Tian Shan.

Okay, great.

As well as service, sales and everything else.

Yes, okay. And Seth, when you look at the balance sheet, obviously you've done a really good job of pre-paying the debt and building that net cash position, is there a certain level of debt that you are comfortable with? Or is this just a goal to get rid of all of it for the next nearly couple of years?

Yes. Good question, Tom. We keep driving the rate down. A 3.25% is a pretty low cost debt and a very flexible debt instrument. There is really no covenant to speak of and we can let this thing go for a while. I think you'll see us -- we're 3.48% right now at the end of the last quarter. We made you a little more, but kind of in the right zip code right now for the capital structure and the EBITDA ratios and the leverage ratios are very, very modest. We might do a little more, we might hang here for a bit. I wouldn't see substantial moving from here, quite honestly.

Okay, great. I appreciate your time this morning.

Okay. Thanks, Tom.

Thanks, Tom.

Thank you. As I'm showing no further questions in the queue, I'd like to turn the conference back over to Mr. Colella for closing remarks.

Thank you. We're very pleased with the strong stop in 2018 and are excited about how well MKS is positioned for the bounce of the year in both semiconductor and advanced markets as we remain on our path of sustainable and profitable growth. Thank you for joining us on the call today and for your interest in MKS. We look forward to updating you on our progress when we report our second quarter financial results and hope to see many of you at our upcoming Analyst Day at the NASDAQ market site in New York on June 19. Thank you.

Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you very much for your participation. You may all disconnect. Have a wonderful day.