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MKS Instruments Inc (NASDAQ:MKSI)
Q3 2019 Earnings Call
Oct 24, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the MKS Instruments Third Quarter 2019 Earnings Conference Call. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Mr. David Ryzhik, Vice President of Investor Relations. Please go ahead, sir.

David Ryzhik -- Vice President of Investor Relations

Thank you. Good morning, everyone. I am David Ryzhik, Vice President of Investor Relations, and I'm joined this morning by Jerry Colella, our Chief Executive Officer; John Lee, our President 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 third quarter of 2019. Our financial results and a schedule of revenue by market have been posted to our website www.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 for the Company and any subsequent quarterly reports on Form 10-Q. 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 Gerry.

Gerald G. Colella -- Chief Executive Officer

Thanks, David. Good morning, everyone, and thank you for joining us today. I'll start with our results for the third quarter of 2019, followed by several business and market highlights. Then, I'll turn the call over to John, who'll share additional details on our strategy, customers and markets. Seth will then provide additional information on our financial results and fourth quarter 2019 guidance. Lastly, I'll provide some remarks before we open the call for your questions.

This quarter revenue was $462 million, which is at the high end of our guidance range. Non-GAAP net earnings for the third quarter was $62 million or $1.12 per diluted share, which was above our guidance range. This outperformance was driven by stronger demand within our semiconductor market, as well as continued operational and financial execution.

While timing of a full market recovery remains uncertain, we are seeing improving conditions complemented by stronger execution and product differentiation as evidenced by recent design wins. Our Advanced Markets remain impacted by macroeconomic headwinds, widely as a result of trade uncertainty, export restrictions and softening in consumer electronics demand. While we expect these headwinds remain an overhang in the fourth quarter, we are excited about the long-term opportunity for Advanced Markets and we believe our broad portfolio positions us well to benefit from key secular trends such as 5G.

While trade macro-economics and the semiconductor cycle may be top of mind for many of us, we remain firmly committed to investing in growth and positioning MKS, not just for a cyclical recovery in our markets, but more importantly, for the vast growth opportunity we see ahead. Key catalysts are expected to underpin MKS's growth in the long-term include, explosion in data growth, which drives demand for memory and foundry capacity, we are the key solution provider. Complex technology transitions across memory and foundry, which can drive higher content for MKS, given our market-leading differentiation and product expertise.

The impact of 5G on the commercial sector, which is expected to stimulate growth even further, as on premise, edge and off-premise IT environments grapple with the growth in data they need to store and process it. The impact of 5G on the consumer sector and the ensuing impact on flex PCB where MKS is a key beneficiary with a market-leading portfolio, as well as other advanced markets including solar, life science [Phonetic], research, defense and additive manufacturing, where MKS is well positioned to drive secular adoption of lasers, after components and laser-based systems. In this content, we remain confident that MKS is positioned to continue to outperform the long term semiconductor and Advanced Market growth rates.

Turning to our Q4 revenue and earnings guidance, we estimate that sales in fourth quarter could range from $445 million to $495 million. Fourth quarter non-GAAP net earnings per share will range from $0.85 to $1.19 per share. Seth will provide the balance of our fourth quarter guidance in his remarks. And at this point, I'd like to turn the call over to John.

John T.C. Lee -- President

Thanks, Jerry. MKS remains well positioned to benefit from the secular trends across our semiconductor and Advanced Markets given our broadening product portfolio, our uncompromising focus on innovation, our strong customer relationships, and disciplined operational and financial execution.

The explosion of data and its impact on memory and larger chip demand combined with the increasing complexity of technology transitions, places MKS in an attractive position as a key solutions provider in the semiconductor manufacturing ecosystem. Moreover, 5G is expected to catalyze data growth even further, driving additional demand for semiconductor manufacturing capacity.

In the third quarter, we benefited from orders arising from our previously announced conductor etch design wins in our power solutions business for 13.56 megahertz RF generators and custom matching networks. In fact, we extended our momentum by displacing a competitor with yet another 13.56 megahertz RF power design win, this time for dielectric etch applications.

We also secured a number of design wins for our dissolved ozone systems. As we mentioned last quarter, ozone has proven to be an excellent green alternative to chemicals that are used for cleaning in semiconductor and display manufacturing. MKS has been a leader in this area and our dissolved ozone systems continue to gain traction with key customers.

As Jerry mentioned, demand from our Advanced Markets remains constrained due to macroeconomic and trade uncertainty, but we were pleased to secure a series of meaningful laser orders for PCB production, as well as across additive manufacturing, solar, OLED applications. In addition, our newest diffraction grating product completed qualification at a large analytical instrument customer and we received multiple orders from other life and health sciences customers. Diffraction gratings are used to precisely separate light into distinct wavelengths and are commonly used in many optical instruments.

We remain bullish about the opportunity that lies ahead for laser based microprocessing applications and are particularly excited about the impact of 5G on flexible PCB high density interconnect PCBs production, where we expect our optics, photonics, lasers and laser systems to be key beneficiaries. We continue to make excellent progress with our integration of the ESI, and in the third quarter, saw continued market acceptance of our flexible PCB laser drilling system.

On our prior earnings calls, we highlighted the shipment of beta systems for our new high-density interconnect via drilling solution to our regional application centers in Taiwan, Japan and China. The HDI opportunity represent a significant expansion and addressable market for us and we cannot be more pleased to announce today that we have received our first HDI purchase order. In addition, we have already shipped beta systems to two other customers. Market interest in our offering continues to grow and we remain excited about the long-term growth opportunities for both the flexible and HDI PCB markets.

Before I turn the call over to Seth, I wanted to take a moment to thank Jerry on behalf of everyone at MKS. Jerry, the list of accomplishments while you have been at MKS is impressive to say the least. And I'm fortunate to have been able to serve under your leadership and direction for almost 10 years. I'm honored to have been chosen to assume the role of CEO, starting January 1. You'll be missed by everyone here at MKS, but luckily you are not going too far and we are excited to work with you in your new role as Chairman.

At this point, I'd like to turn the call over to Seth.

Seth H. Bagshaw -- Senior Vice President, Chief Financial Officer and Treasurer

Thank you, John. I'll cover our Q3 2019 financial results and discuss our Q4 2019 guidance. Sales of third quarter $462 million, at the high end of the guidance range, and a decrease of 2% sequentially compared to the second quarter. Sales to semi-conductor customers were $223 million, a increase of 4% sequentially as we continue to see positive signs in the semi market.

Sales to Advanced Markets were $239 million, a decrease of 8% sequentially, and were impacted by the general slowdown in industrial markets, as well as uncertainty caused by global trade tensions. Sales to life and health sciences and research and defense markets remained steady in the third quarter. 52% of our sales were to customers in our Advanced Markets, while 48% were to customers in the semiconductor market, consistent with our long-term goal of achieving a balanced market mix.

GAAP and non-GAAP gross margin of 44.3% was within our expectations at this revenue volume. Non-GAAP operating expenses were $124 million, which were favorable to the midpoint of our guidance due to continuing focus on managing our cost structure. Non-GAAP operating margin was 17.6%, which is almost 200 basis points favorable to midpoint of our guidance range.

This continued strong financial performance reflects our ability to effectively manage the Company through all phases of the operating cycle. GAAP operating expenses were $138 million and include $17 million in amortization of tangible assets, $2.1 million in acquisition and integration costs, $1.5 million in restructuring costs and $600,000 of transaction fees associated with the repricing of our term loan. In addition, we recorded a $6.8 million gain from the sale of certain real estate holdings as we continue to streamline our geographic footprint.

GAAP net interest expense was $13.5 million and non-GAAP net interest expense was $10.5 million. Our GAAP tax rate was 14.4% and our non-GAAP tax rate was 15.6%. Tax rates were below their expectations due to mix of geographical income and we expect these rates to return to more normalized levels in the fourth quarter.

GAAP net income was $47 million or $0.80 per diluted share and non-GAAP net earnings were $62 million or $1.12 per diluted share. The integration of the ESI acquisition continues to proceed very well and exiting the third quarter, we achieved $12 million annualized cost synergies. We are on schedule to realize the $15 million announced total annualized cost synergies within the next 12 months to 18 months. In the third quarter, revenue for the equipment and solutions division was $49 million, which was also within our expectations.

Now turning to the balance sheet, in September, we successfully repriced our [Technical Issues] fifth repricing of our term loan, which reduced the interest rate spread on the two existing tranches from LIBOR plus 2% and LIBOR plus 2.5%, respectively, to LIBOR plus 1.75% and combined the two tranches into one tranche maturing date in February of 2026.

In addition, we made a $50 million voluntary prepayment of principal on our term loan at September 30 on outstanding balance of $395 million. The most recent voluntary prepayment is our 10th since loan origination in April 2016.

The repricing and voluntary prepayment reduces our annualized non-GAAP interest costs by almost $6 million based on current interest rates. Exiting the quarter we maintained a strong balance sheet liquidity with $475 million of cash and investments, $100 million of incremental borrowing capacity under an asset-based line of credit and a modest 12-month net leverage ratio of under 1 time.

Free cash flow for the quarter was $44 million. We continue to demonstrate a balanced approach to capital deployment, and in the quarter, we paid a cash dividend of $10.9 million, or $0.20 per share. In terms of working capital, days sales outstanding were 65 days at the end of the third quarter compared to 60 days at the end of the second quarter. Inventory turns were 2.2 times and were consistent with the second quarter.

Finally, I'll discuss our Q4 2019 guidance. Based upon current business levels, we estimate that our sales in the fourth quarter could range from $445 million to $495 million, and our non-GAAP gross margin could range from 42.5% to 44.5%. We expect the gross margin to slightly lower in the fourth quarter due to both seasonally lower volumes and product mix of the equipment solutions division. We expect our gross margin to return to normalized levels by the first quarter of next year.

Q4 non-GAAP operating expenses could range from $121 million to $129 million, R&D expenses could range from $40.5 million to $43.5 million and SG&A expenses could range from $80.5 million to $85.5 million. Non-GAAP interest expense is expected to be approximately $8.9 million and our non-GAAP tax rate is expected to be approximately 21%.

Given these assumptions, fourth quarter non-GAAP net earnings could range from $47 million to $66 million, or $0.85 to $1.19 per diluted share. In the fourth quarter, amortization of tangible assets is expect to be approximately $17.1 million. Integration-related costs are expected to be approximately $1.9 million. Interest income is expected to be approximately $1 million. And GAAP interest expense is estimated be approximately $9.1 million.

GAAP net income is expected to range from $32 million to $50 million, or $0.58 and $0.91 per diluted share on approximately 55.3 million shares outstanding.

Let me now turn the call back to Jerry for his final thoughts before we move to Q&A.

Gerald G. Colella -- Chief Executive Officer

Thank you. Seth. Before I turn the call over to Q&A, I wanted to share some final thoughts as this will be my last earnings call before I step down from the CEO role effective January 1, 2020, and then assuming the role of Chairman of the Board in May of 2020. As you all know, John will be replacing me as CEO, and I could have not asked for more qualified leader to succeed me. John has been with MKS for over 10 years and has played a significant role in our success. Needless to say, I am very excited about MKS's future.

The Company's accomplishment over the past six years has been astounding, and I'm honored to have had the opportunity to lead such an extraordinary team through this transformation. Over this time, we've tripled our revenue and market cap, delivered a greater than 700% increase in non-GAAP EPS, raised our dividend multiple times, doubled our workforce and acquired four companies while aggressively delevering our balance sheet following each major acquisition.

If that's not enough, for the third year in a row, MKS was named one of Fortune Magazine's 100 fastest growing companies. I'm also proud to announce that two of the three winners of the 2019 Nobel Prize in Physics use our proprietary gratings to discover the first planet orbiting a star [Indecipherable]. This gives new meaning to the term reach for the stars and I cannot wait to see John take this Company to new heights.

This concludes our prepared remarks. We'd like to turn the call back to the operator for Q&A.

Questions and Answers:

Operator

[Operator Instructions] And our first question is coming from the line of Sidney Ho from Deutsche Bank. Your line is open.

Sidney Ho -- Deutsche Bank -- Analyst

Great. Thanks. Jerry, it's been very nice working with you, so you definitely will be missed. My first question is, if I look at the 4Q guide, what is the relative growth rate by segment baked in your guidance? I think I can guess directionally, but just want to get a sense about the magnitude and whether there is more downside in the Advanced Markets?

John T.C. Lee -- President

Yes. Sidney, it's John. So we are looking at high-single digits quarter-to-quarter growth in semi market. I think that's consistent with probably what you've heard on with other customers and it could be higher than that, but that's what we see right now. And actually, for Advanced Markets, it is down about $10 million, but all of that is due to the seasonality of the E&S division. So, their Q4 is usually the seasonal low because of the cyclicality of that market, but the other part of this is, the light and motion business of the Advanced Markets is actually steady quarter-over-quarter. And we're actually pretty happy with that given all the uncertainty in the -- the tariff wars and the macro economic kind of issues. So hopefully that gives you a little bit more color on how we look at the Advanced Markets, ex ESI, with ESI and semi.

Sidney Ho -- Deutsche Bank -- Analyst

That's good. That's great. My follow-up question is, I think, last quarter you guys had alluded to some positive discussions with your semi customers, which seems to have materialized. Can you give us a little sense about when did you started to seeing that kind of inflection of demand, how broad based that demand uptick was? And then finally it's, I guess when revenue started coming down a few quarters ago, you were negatively impacted by your customers cutting inventory. Do you expect them to start building inventory again as the business starts coming back?

John T.C. Lee -- President

Yes. So it's John again. I think, certainly, when our customers see a ramp, they will start building inventory. That's normal, that's the part of the nature of the semi industry. We started seeing the uptick in orders probably in the middle of the quarter, middle of Q3, but a lot of it -- and we thought a lot of it was driven by foundry and logic and I think that we're still consistent with that thinking. I think what we're seeing now is a little bit more additional upside now with little bit of VNAND as well. So that's what we're seeing today.

Gerald G. Colella -- Chief Executive Officer

This is Jerry. I'd like to also go back to amplify the commentary about the Advanced Markets, so I can bring people back to our historical performance, which to me is an indication of the future. So for about a 13-year of plus period, we had 8% compounded annual growth rate on the Advanced Markets. In '17 and '18, we saw about a 14% growth rate. So we still abide by our model of 2 times the growth rate of those markets and we believe that some part of this issue is also reflected in the China trade issue. We have customers coming to us saying, it's not a matter of if, it's a matter of when. Perhaps some of the orders are a bit muted compared to what they normally would be approaching us with orders. So besides sort of seasonality, we do think there is some impact, and with a good news coming out, hopefully, this geopolitical issue will abate over time and we expect to see our growth rate to go back to normalized numbers. So, that's just for a little context on Advanced Markets so as we don't put a pall over that business.

Sidney Ho -- Deutsche Bank -- Analyst

Wonderful. Last question if I could. Seth, you guided to gross margin being 42.5% to 44.5% in Q4, and you said things will kind of get back to normal levels in Q1. If I look at 2020, how should we think about the gross margin progression?

Seth H. Bagshaw -- Senior Vice President, Chief Financial Officer and Treasurer

Yeah. So, Sidney, what I'll say is, again, if you take the midpoint of the guidance in the fourth quarter of $170 million [Phonetic] revenue, again, I think normalized that will be at least a point north of what we're currently at midpoint. So I think that's a good jumping-off point. And then, what I would say is, our model again has been the 50% [Phonetic] variable gross margin on revenue increase, that's still the assumption going forward. I think that's what we use internally, obviously.

And the other wild card, which would be, it's hard to quantify, but it's actually helpful on the upside is, right now, all our factories are running at relatively lower levels based on historical activity. So what happens when business comes back and you start generating more throughput to the factories, the absorption gets better as well. That would be additive to some level to what I just gave you for a model. That's my expectations going forward.

Gerald G. Colella -- Chief Executive Officer

And then, on top of that, as you know, six years ago, we started a team called profit and cash recovery team, which has led to the increase in the EPS that we talked about earlier. Those teams still exist. They meet every month. They jointly brief them. There is more work that they continue to do to pursue a higher profitability for the Company. There is also still a large segment of our business that we are moving to a low-cost region, which over time, will improve the profitability of the business. So we haven't taken foot off the pedal of improving the profitability of the Company going forward. And John Lee has been leading that charge and he will continue to push forward on things like low-cost country migration, supply chain maximization. All of the things we've done in the last six years, that will continue.

Sidney Ho -- Deutsche Bank -- Analyst

Great. Thank you very much.

Operator

And our next question coming from the line of Amanda Scarnati with Citi. Your line is open.

Amanda Scarnati -- Citi -- Analyst

Thanks. Good morning. The first question is on the ESI side of the business. Can you talk a little bit about what normalized revenues look like in this business, now they've come down a little bit? And how much of the revenue today are you seeing already from 5G? I mean how should that track going forward?

John T.C. Lee -- President

Yeah. Amanda, it's John. So ESI will probably end the year pro forma around the $200 million. And as I think we've talked about in the past, 2019 was a low year because of the overcapacity over by two of the primary markets, meaning flex and MLCCs in 2018. So going forward, I think, we would expect that to be a bit higher. It all depends on, I think, a little bit about how much more inventory burn off there is in flex, but we're excited about the fact that our new flex tool CapStone continuous to receive very favorable results from our customers. Our HDI business we -- as I've mentioned on the call, we have some very positive results today and we expect that to be additive, since we have no market share in that business.

With respect to your question on 5G, I think, some of the phone makers that are making 5G phones, obviously, have their subcontractors using our tools to make flexible PCBs for 5G. I think, as 5G continues to grow in market share, we know that the content of flex PCBs and MLCCs in 5G is significantly higher. And so we expect that to continue to grow. I think there is a tailwind. I think everybody is a bit surprised that 5G looks like it's going to be adopted at a faster pace in 2020 for sure than industry had thought maybe even just 90 days ago. So I think that's a nice tailwind for us. So going forward, we expect that to continue to be more adopted by our customers of ESI.

Amanda Scarnati -- Citi -- Analyst

Great. And then on the semiconductor side of the business, can you just remind us what your percentage is of revenue to the memory side of the business, NAND and DRAM, versus logic and foundry if you've broken that out in the past? And just what you were seeing in terms of orders this quarter. You saw some nice revenue in the semiconductor business and was that mostly tied to that foundry CapEx boost that we saw over at [Indecipherable]?

John T.C. Lee -- President

Yeah. Amanda, it's John, again. I think, for sure, we thought that the Q3 bump that we started seeing the pickup that was pretty much tied to the logic, foundry picking up their CapEx spend and then that flowing through the OEMs. It's been difficult for us to figure out how much is memory, how much is logic, since we're sending tens of thousands of all kinds of parts to the OEMs and then they put all kinds of tools going forward. But I think from a macro-economic standpoint we could see that the pick up in Q3 was foundry driven. And we are guiding to be a little higher, obviously, in Q4 because foundry will continue to be strong, but we also, as I said, see that VNAND -- at least, some initial buys of VNAND could also be -- will be an upside to the CapEx spend.

Gerald G. Colella -- Chief Executive Officer

I think I'd add a little additional color to that too is, one of our largest customers surged with us over the last several years, and they are very well positioned on the memory side of the business. With them surging into the number two, then in number one spot, would give you a good indication of the position MKS has in memory when NAND comes back. So expect to see acceleration through the foundry work and then once memory continues to accelerate that should be good positive effect for MKS over time.

Amanda Scarnati -- Citi -- Analyst

Great. I just want to clarify, John, one thing that you said that NAND could be upside in December quarter. So you're not sort of building that into expectations at this point that any sort of [Indecipherable] is coming back?

John T.C. Lee -- President

No, we have built it in. So we already have built in the upside on NAND. Yes.

Amanda Scarnati -- Citi -- Analyst

Okay. Thank you.

John T.C. Lee -- President

You welcome.

Operator

And our next question is coming from the line of Patrick Ho with Stifel. Your line is open.

Patrick Ho -- Stifel -- Analyst

Thank you very much. And first off, I want to just take a moment also to congratulate you Jerry for the work at MKS for many years, but particularly the last five plus years as CEO. I think the Company has really transformed itself and obviously as the leader of the Company, you should get a lot of credit for that.

Gerald G. Colella -- Chief Executive Officer

Thank you. I have a great team by the way just to let you know. Same people will be here after I am gone. But thank you, Patrick. I appreciate that.

Patrick Ho -- Stifel -- Analyst

Just like the Patriots, I assume, right?

Gerald G. Colella -- Chief Executive Officer

Yeah. It's Belichick and Brady, not just Belichick, just to let you know. Everybody has to do their job.

Patrick Ho -- Stifel -- Analyst

Let me start off first on the semi side of things. Some of the share gains that you talked about on the call, particularly in the power solutions, but other areas. I think I've seen in press release is in the mass flow controller side of things. Are these applicable to tools that are being delivered in volume today for this upcoming upcycle or are these more on future nodes, where you'll see the higher volume adoption?

John T.C. Lee -- President

Patrick, it's John. So let me just speak to our power part. We've talked about several design wins over the last few quarters on conductor etch, and what we said today was that, some of those initial design wins are now turning into volume orders, and some other design wins have not yet, and so it's a mix. But this is the first, hopefully, ramp where some of our conductor etch design wins that we've talked about over the last six quarters are turning into volume. And we expect that the other design wins that have not turned to volume will eventually perhaps in next cycle or this cycle. But this is the first quarter we're seeing those volume orders for conductor etch design wins in the past.

Patrick Ho -- Stifel -- Analyst

Great. That's helpful. And maybe, following up on the light and motion business that you mentioned that was holding steady. Can you just remind us about some of the differentiations in that business and the markets you serve relative to the broader industrial market where there is clearly weakness, say, in the fiber laser market in terms of the industrial segment. Can you just again remind investors about I guess the diversification and some of the different marketplaces your types of laser serve?

John T.C. Lee -- President

Yeah. Sure, Patrick. So we've talked about in the past, when we talk about industrial lasers, we talk about microprocessing. So the powers are lower. This is in contrast of macroprocessing, where the laser powers in the tens of kilowatts. But just because the power is lower doesn't mean it's easier to do. It's actually more difficult because we're actually pulsing. And so this is the kind of finesse manufacturing that's allowing people to, for instance, make next generation of flexible PCBs for iPhones or to use these lasers to get another 1% efficiency in solar cells or to cut OLED displays. And so this is the kind of broad based industrial laser microprocessing market that we address. And so, the other part of it was the high power macroprocessing market and we do participate in that with power meters and diagnostics, but we do not make those lasers.

Gerald G. Colella -- Chief Executive Officer

Patrick, also, I think the other thing I'd like to add to that is more of the thesis and strategy between a Newport Light and Motion and ESI is that we are excited about the technical collaboration between some of the best laser development minds and people who use them in the system side of the business. And the fact that we can understand the applications in the systems side with ESI and we can develop lasers that will help them, differentiate themselves, as well as they can provide technical feedback back to the Light and Motion laser equipment group and the people that develop those lasers to create more technical operation differentiation to the other providers of lasers.

So beyond just the current set of business that we see, we're excited about the collaboration and the opportunity to continue to differentiate both companies with collaboration on the design and application of lasers. I don't want that to get lost. That's a key point of that both of those companies.

Patrick Ho -- Stifel -- Analyst

Great. That's helpful. And maybe as a final follow-up question for John, I know, earlier this year at Photonics West you talked about some of the introduction of new complementary products, especially for the Light and Motion business, and how you were going to Surround the Workpiece. One, can you give us an update on the traction of some of those products as well as some of the maybe qualitatively what else you're working on that you plan to introduce to further Surround the Workpiece?

John T.C. Lee -- President

Yeah. I think one of the biggest guess we had in completing Surround the Workpiece strategy was our laser portfolio. So while we've seen a lot of success in our laser group, we still did not address the picosecond segment of lasers. And so we've talked about two releases of the picosecond lasers this year, one is 25 watts and one is 50 watts . And so those are gaining good traction right now and so that's another area that we'll probably be able to talk about more going forward, especially as Photonics West rolls around again.

Patrick Ho -- Stifel -- Analyst

Great. Thank you again.

Gerald G. Colella -- Chief Executive Officer

Thank you, Patrick.

Operator

[Operator Instructions] And our next question is coming from the line of Krish Sankar with Cowen & Company. Your line is open.

Krish Sankar -- Cowen & Company -- Analyst

Yeah. Hi. Thanks for taking my question and Jerry congrats on a terrific career. As everybody else mentioned, you'll definitely be missed.

Gerald G. Colella -- Chief Executive Officer

Thank you.

Krish Sankar -- Cowen & Company -- Analyst

I had three questions all three on market share, either for Jerry or John. You guys spoke about how December quarter semis is going to be up sequentially like high-single digits. How much of that is driven by the conductor etch market share? Is there a way to segment it by saying we thought that when you'd be flat or down, is there any color on that?

John T.C. Lee -- President

Krish, it's John. No, I don't think we'd say that conductor etch market share win is driving all that. I think it's really the broader based semiconductor industry moving up, because as you know, we have the broadest portfolio of products. So pressure is going up, flow is going up, valves is going up, plasma is going up and power is going up. So it's not driven all by one particular segment.

Krish Sankar -- Cowen & Company -- Analyst

Got it. And then [Indecipherable] your customers drew down their own inventory over the recent down cycle. Do you expect they are going to start building up inventory and if is so, is that imminent, do you think it's a Q4, Q1 event or you think you are going to be more cautious in your approach building up inventory as the cycle approaches?

John T.C. Lee -- President

Yeah. Well, history says, Krish, that [Indecipherable] build up inventory fast and to your point, we believe that will happen in Q4 and Q1 because of some of the end user announcements of what they expect to spend in CapEx. And that's pretty much all the visibility we can have. Now, of course, some folks think that first half will continue into the second half, but as you know predicting semi CapEx is a [Indecipherable]. So will just be fast, but we do expect that there will be a buildup of inventory to support shipments in Q4 for our OEM customers and shipments in Q1 for our OEM customers.

Gerald G. Colella -- Chief Executive Officer

And customers have signaled that to us already.

Krish Sankar -- Cowen & Company -- Analyst

Got it. Just two quick questions, one on ESI, the HDI PCB spoke about a new order. If I remember right when ESI was stand-alone their HDI market share was under like 2% or 3%. Is that still the case and where do you think your HDI market share for PCBs would be exiting a year from now? And then a quick follow-up.

John T.C. Lee -- President

Yes. Krish. So it was probably under 2%, how is that for market share of HDI. So we kind of look at it as zero, because they had an older tool addressing HDI that's been obsoleted a while ago, many years ago. So it's really a legacy stuff. This is a new tool addressing the $500 million HDI market. So we today have zero market share and that new first order, by the way, was with a customer that didn't even a beta site. Usually you take a beta site, you try it for a while, then you pay for it and you order more. And we have two of those customers. So there's two separate individual customers in Asia that we have already shipped beta tools to. So they will be trying out their fabs for the next three to six months.

By the way we also have a line of sight to a few more of this quarter beta shipments and we'll update you on that at next quarter's call. But this other customer quite unique. I'll give you a little more color. So they give us PL, we'll be shipping them the tool soon, but they're are materials developer, meaning they're developing materials or next-generation HDI PCB. And for us, that's very strategic because if and when they are successful, when other customer say, OK, let's use your material, they are going to ask how do you process it, how do you drill holes in. Obviously, they will have a recipe and proof with our tool at that point.

Krish Sankar -- Cowen & Company -- Analyst

Got it. That's very helpful, John. And then just a final question on the Newport industry laser business. Is that recovery in the business going to be driven primarily by macro China recovery or are there any market share related headwinds or competitive challenges we need to worry about?

John T.C. Lee -- President

Well, there is always competitors, Krish, but we've actually been taking share over the last couple of years in our lasers for that microprocessing industrial. So I think our view is that it's mostly constrained by the geopolitical issues and the trade war.

Krish Sankar -- Cowen & Company -- Analyst

Got it. Thanks, John and congrats again, Jerry.

Gerald G. Colella -- Chief Executive Officer

Thank you.

John T.C. Lee -- President

Thanks, Krish.

Operator

Our next question is coming from the line of Tom Diffely with D.A. Davidson. Your line is open.

Tom Diffely -- D.A. Davidson -- Analyst

Yes. Good morning. And Jerry it's been a pleasure working with you, and good luck in your next role as Chairman. But I guessing it is not going to be a hands off role.

Gerald G. Colella -- Chief Executive Officer

Well, if you ask this team. That's why when John said, I'll be missed, I said, yeah, probably by some people, but not by lot of others. You'll see.

Tom Diffely -- D.A. Davidson -- Analyst

Yeah. John. I wanted to ask one more question on HDI. It seems like a really big opportunity here. What drove your win and what do you think is going to drive your wins going forward? Is it speed, accuracy, what does your tool have?

John T.C. Lee -- President

Yeah. Tom, I think what we had designed the tool for was a 20% and 30% increase in productivity, so speed at the same accuracy relative to what was already out there. And so I think that's why we're seeing this initial strong interest for it. Additionally, though, as you get into developing recipes, we're starting to see there could be other advantages to how we drill the hole. But the primary differentiator is 20% to 30% improvement in throughput. So that's a huge cost of ownership for our customers. And then over time it seems like we'll be developing new recipes with the flexibility that we have in how we design the laser and that should allow us perhaps other advantages going forward.

And as you can imagine, we're not stopping there. There are other ideas and things being tried already in our development labs to move the HDI process forward for even faster or to smaller dimensions or more accuracy than what's already out there today.

Unidentified Speaker

I have a point to add to that too, Tom. Our competing tool on HDI is about 80% lighter from the competing tool and about third less area square foot in the factory environment. So, as John mentioned, it's also faster and lower cost of ownership. It's actually small and lighter and just helpful as well.

Gerald G. Colella -- Chief Executive Officer

Yeah, when people ask what's weight got to do with it, we have got a large operations in China and you don't really get to expand horizontally. You have to expand vertically and having a tool that's significantly lighter in weight means that you don't have to have just go on the first floor, install, you know I'm talking about second and third floor of manufacturing operations, which is believe or not a big deal in terms of the square footage that's allowed in China.

Tom Diffely -- D.A. Davidson -- Analyst

Okay. And what are the buying cycles like in that space? I mean, do you have to wait capacity needs to open up or is it technology driven? When do your customers become right for you to have an insertion point?

John T.C. Lee -- President

Hey, Tom. I think it's a similar bycycle as Flex PCB, because you can imagine a lot of consumer products use both, right. And so we look at it as the first half of the year is usually when the end users, the iPhone maker, the other smartphone makers start awarding contracts to the sub-cons and that's when the sub-cons know how much capacity they are going to need and that's when they start ordering. So usually we see orders kind of end of Q1 and through Q2. And then, there is certainly some follow on in Q3 for any extra capacity and that's the kind of cyclicality. And Q4, as we talked about, it is a PCB cyclical low and that's why we talked about that earlier.

Tom Diffely -- D.A. Davidson -- Analyst

Okay. And one more question on the flex side. We heard from other suppliers that there's two big drivers. There is, moving to the most advanced technologies, which increases complexity, but it's also the kind of a tail of the older phones moving to the more advanced phones, that upgrade cycle, even though they're not new technologies, it's the higher use of the technologies and so that's also a pretty good driver. I'm curious on your flex side over the next couple of years do you see that second point as been a nice driver of capacity for you?

John T.C. Lee -- President

It could be, but probably in a secondary fashion. So a secondary supplier of PCBs may be using some of the older tools that they had been using for advanced smartphones, for instance, now. Maybe two or three years from now, they'll be using it for the older phones and then that does open up capacity for more advanced flex PCBs for the newest phones. So we haven't really thought about that as precisely as you thought about, Tom. So that could be a tailwind, but we haven't analyzed that quantitatively yet.

Tom Diffely -- D.A. Davidson -- Analyst

Okay. And then Seth, finally, just on the R&D side, guys going forward is the gap in R&D based on something like beta sites or tools going out the door, what's the $3 million difference there?

Seth H. Bagshaw -- Senior Vice President, Chief Financial Officer and Treasurer

It could be just normal fluctuations in R&D spending, Tom. It's nothing that's uniquely tied to any particular product or R&D effort. And it can bounce around a little bit as a fair amount of the R&D spend is in material base which kind of comes in lumpy fashion so that's probably what's driving that quite honestly.

John T.C. Lee -- President

Sometimes Tom we will be building a lot of new units, say for our power. There would be materials charged R&D. You ship it and then of course it kind of rolls into costs and that can be very lumpy.

Tom Diffely -- D.A. Davidson -- Analyst

Okay. That makes sense. All right. Well, thanks for your time and congratulations, Jerry.

Gerald G. Colella -- Chief Executive Officer

Thank you, Tom.

John T.C. Lee -- President

Thank you.

Operator

And I'm not showing any further questions. I would now like to call back over to [Technical Issues].

Gerald G. Colella -- Chief Executive Officer

Well, thank you. We are pleased with our results for the third quarter of 2019. We had a another quarter of strong operational and financial execution, which drove our top and bottom line outperformance. And we are confident that our exposure to diverse end markets and strategy we have put in place will position us for long-term success.

Lastly, I want to thank you for joining us on the call today and for your interest in MKS. I have enjoyed working with many of you as CEO. I look forward to watching the Company reached new heights as Chairman. We look forward to updating you on our progress when we report our fourth quarter 2019 financial results. Thank you.

Operator

[Operator Closing Remarks]

Duration: 46 minutes

Call participants:

David Ryzhik -- Vice President of Investor Relations

Gerald G. Colella -- Chief Executive Officer

John T.C. Lee -- President

Seth H. Bagshaw -- Senior Vice President, Chief Financial Officer and Treasurer

Unidentified Speaker

Sidney Ho -- Deutsche Bank -- Analyst

Amanda Scarnati -- Citi -- Analyst

Patrick Ho -- Stifel -- Analyst

Krish Sankar -- Cowen & Company -- Analyst

Tom Diffely -- D.A. Davidson -- Analyst

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