MKS Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the MKS Instruments third quarter 2020 conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star 1 on your telephone. Please be advised that today's conference may be recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, David Ridgick, Vice President, Investor Relations.

Please go ahead, sir. Thank you. Good morning, everyone. I'm David Rizek, Vice President of Investor Relations, and I'm joined this morning by John Lee, President and Chief Executive Officer, and Seth Bagshaw, Senior Vice President and Chief Financial Officer. Yesterday, after market closed, we released our financial results for the third quarter of 2020, which are posted to our website, mksinst.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 the most recent annual report on Form 10-K and any subsequent quarterly reports on Form 10-Q 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 date 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 GAAP. 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, and thank you for joining us today. In the third quarter, we delivered record revenue of $590 million, which is above the high end of our guidance range. Non-GAAP net earnings were $107 million, or $1.93 per diluted share, which is at the high end of our guidance range. Before I discuss our results and market trends in more detail, I want to take a moment to acknowledge the tireless efforts and dedication of MKS employees around the world who achieved these record results, especially in such a challenging environment. Our employees continue to display amazing resilience in dealing with the extraordinary circumstances resulting from the global COVID-19 pandemic. Yet, this did not impact their focus on serving customers, maintaining productivity, executing on our innovation playbook, and most importantly, showing compassion and caring towards each other. One of our strongest guiding principles at MCAS is to win as a team, and that's what we did. Now let me discuss our third quarter results in more detail. Sales to our semiconductor market grew 12% sequentially as we experienced strong demand across our portfolio of critical subsystems, most notably in our power solutions business, where we achieved another record revenue quarter. We are extremely pleased with our sales and technology execution in power, delivering over 110% year-over-year growth for the first three quarters of 2020. Demand for our market-leading plasma and reactive gas solutions continues to be strong, especially in semiconductor deposition applications. The reliability, compact footprint, and cost of ownership advantages of our remote plasma sources have led to several large orders in the quarter, in atomic layer deposition and plasma-enhanced CVD applications. Our dry ozone systems continue to gain traction in advanced deposition processes, and our dissolved ozone and dissolved ammonia systems are seeing strong demand for wet-clean applications at leading edge foundry nodes. Our broad portfolio and unique capability to solve the most critical challenges around the vacuum chamber have set us apart from our peers. However, our semiconductor growth strategy goes beyond the vacuum chamber, and we continue to expand into lithography, metrology, and inspection applications, where we are leveraging our broad optics, motion, and photonics expertise. In the third quarter, we secured several additional design wins through our world-class optics initiative, and we continue to engage with key OEMs to help solve their toughest problems. As we look into the fourth quarter, we expect demand in our semiconductor market to remain strong. We are pleased with our results in our advanced markets, which grew 4% sequentially, better than we anticipated. We saw a seasonal decline in PCB drilling applications as expected. However, this was offset by stronger demand in our research and life and health sciences markets. During the past few earnings calls, we've talked about the long-term opportunity we see in precision laser processing. particularly for advanced electronics manufacturing. I would like to highlight three key drivers that underpin our excitement around this opportunity. First is the expansion of devices that require precision laser processing. Five years ago, precision lasers were used mainly for smartphone electronics and solar panel manufacturing. Now we are seeing precision laser processing expand to wearables, tablets, autonomous vehicles, and many other electronic devices. Second is the significant increase in the number of electronic components per device. Five years ago, we were dealing with hundreds of components in a smartphone. Today, we are dealing with many thousands. Third is the continued expansion in the types of laser-based processes being deployed for precision manufacturing. Our customers are finding new ways to use lasers, for example, in laser doping, surface functionalization, and micro-welding. We believe the confluence of these drivers offers an attractive growth opportunity where we are uniquely positioned with our Surround the Workpiece portfolio of lasers, optics, photonics, motion, and laser drilling systems. We are particularly excited to have announced our first multi-unit order for our new high-density interconnect PCB via drilling tool. Our customers are installing our tools for volume production. This is an important milestone for MCAS as we enter into this $500 million market with a strongly differentiated tool. We are happy with the sequential revenue growth in our advanced markets in the third quarter, and we anticipate demand trends in the fourth quarter to remain consistent. Before I turn the call over to Seth, please note that MCAS will be holding a virtual investor day on Thursday, December 10th. We plan on providing more insight into our growth opportunities, strategy, and long-term financial model. Stay tuned for more information in the coming weeks. And now I'd like to turn the call over to Seth. Thank you, John. I'll cover our third quarter results and provide additional detail on our fourth quarter guidance. Sales of third quarter were a record $590 million, up 8 percent sequentially, and up 28 percent year-over-year, and above the high end of our guidance range. This strong performance reflects continued strength in our semiconductor market, as well as sequential growth in our advanced markets. The third quarter semiconductor sales were a record $359 million, up 12% sequentially, and up 61% year-over-year, reflecting strong industry fundamentals. We saw strength across our product portfolio, but in particular, our power solutions business posted another record quarter, which marks the second consecutive quarter of triple-digit year-over-year growth in this business. Sales to advanced markets were $231 million, up 4% sequentially, driven by improvements in research and defense in life and health science markets, which more than offset the expected seasonal decline of FlexPCB products. In our second quarter earnings call, we know that our research market, been impacted by COVID-19-related university and research lab closures, had stabilized relative to the first quarter. We are pleased to announce that in the third quarter, revenue from our research market grew over 30% sequentially, led by university reopenings, and has now returned to pre-pandemic levels. As John mentioned earlier, we received a multi-unit order for our geode HDI system earlier in the third quarter. And following successful installation and customer acceptance, we recognized revenue in the first unit in the third quarter. For the quarter, the revenue split between our semiconductor and advanced markets was 61% and 39%, respectively. Third quarter non-GAAP gross margin was 45.1 percent, which is slightly below the midpoint of our guidance, primarily due to product mix and inventory charges for certain discontinued products within our light and motion division. We also incurred high variable compensation costs due to our strong financial results. We expect these items to return to more normalized levels in the fourth quarter. Non-GAAP operating expenses for the third quarter were $129 million, flat to the second quarter, reflecting a continued focus on cost control, even with high anticipated revenue volumes and variable compensation. Third quarter, non-GAAP operating margin was 23.1%, a sequential increase of 150 basis points, reflecting strong financial leverage in our operating model. We continued to generate additional cost synergies from the ESI acquisition, We are pleased to announce that exiting this quarter, we have further increased these savings and have now realized a total of $18 million of annualized cost synergies. This amount is above our original target and remains well ahead of schedule. Non-GAAP net interest expense in the third quarter was $6.3 million, and a non-GAAP tax rate deflected a favorable geographic mix of taxable income was 17%. Non-GAAP net earnings for the third quarter were $107 million and $1.93 per diluted share. Now, turn to the balance sheet. Exiting the third quarter, we maintained a strong balance sheet liquidity with cash and short-term investments of $716 million in $100 million of incremental borrowing capacity under an asset-based line of credit subject to certain borrowing-based requirements. our net leverage ratio further decreased, highlighting our ability to generate strong EBITDA and cash flow. Since the closing of the ESI acquisition in February of 2019, our net leverage ratio has decreased from one times to 0.2 times exiting the third quarter, and we anticipate continued reduction in our net leverage ratio exiting the fourth quarter. Consistent with prior quarters, we made a dividend payment of $11 million, or 20 cents per share, In terms of working capital, day sales outstanding were 56 days at the end of the third quarter compared to 64 days at the end of the second quarter. Inventory turns were 2.6 times compared to 2.4 times in the second quarter. We remain focused on improving our cash conversion cycle and following a record second quarter, third quarter operating cash flow and free cash flow again set new records at $152 million and $123 million, respectively. Free cash flow was 21 percent of revenue for the quarter. I'll now turn to our fourth quarter outlook. Based on current business levels, we estimate that our fourth quarter revenue of $600 million, plus or minus $25 million. Based on anticipated product mix in revenue levels, we estimate fourth quarter non-GAAP gross margin of 45.5 percent, plus or minus one percentage point, and non-GAAP operating expenses of $133 million, plus or minus $4 million. For the fourth quarter, non-GAAP net interest expense is expected to be approximately $6 million, and a non-GAAP tax rate expected to be approximately 17 percent reflect anticipated geographic mix of taxable income. Given these assumptions, we expect fourth quarter non-GAAP net earnings of $2 per diluted share, plus or minus 20 cents. I'd like to now turn the call back to the operator for Q&A.