MKS Inc.

Good day, and thank you for standing by, and welcome to MKS Instruments' second quarter 2022 conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 11 on your telephone. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, David Rizek, Vice President of Investor Relations. Please go ahead.

Thank you. Good morning, everyone. I am David Rizek, Vice President of Investor Relations, and I am 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 second quarter of 2022, which are posted to our website, which we recently changed to mks.com. As a reminder, various remarks about future expectations, plans, and prospects for MKS comprise forward-looking statements. Actual results may differ materially as a result of various important factors, including those discussed in yesterday's press release and in our most recent annual report on Form 10-K 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. During the call, we will be discussing various financial measures. Unless otherwise noted, all forward-looking financial measures exclude any contribution from Adatech Limited, the acquisition of which is still pending. Also, unless otherwise noted, all income statement related financial measures will be non-GAAP other than revenue. Please refer to our press release and the presentation materials posted to our website for information regarding our non-GAAP financial results and the reconciliation of our GAAP and non-GAAP financial measures. Now, I'll turn the call over to John.

Thank you, David. Good morning, everyone, and thank you for joining us today. We delivered exceptional results in the second quarter with record revenue of $765 million. and strong profitability, with net earnings per diluted share of $2.59. Both metrics exceeded the high end of our guidance range as we managed through continued supply chain constraints and inflationary pressures. These results are a testament to our ability to execute by managing costs and factory efficiency while continuing to invest in our ambitious R&D plans for the future. This performance is also the result of the hard work, dedication, and ingenuity of our employees as well as the collaboration with our valued supply chain partners and customers who continue to place their trust in MKS. Now I'd like to provide more detail on our second quarter results and my thoughts on current demand trends. We delivered record revenue from our semiconductor market in the second quarter, increasing 6% sequentially and exceeding our expectations. While there's clearly a lot of focus on the current macro environment, our business levels remain strong in the second quarter. Our operations and engineering teams executed extremely well, navigating industry-wide supply chain constraints to deliver to our customers. Availability of certain components somewhat improved in the second quarter, but we continue to remain supply constrained in our ability to fully meet customer demand. Our strong performance in the semiconductor market was the result of broad-based success across our portfolio, with record semiconductor revenue for both our vacuum and photonics solutions divisions. These results highlight the value of our deep customer relationships and the engineering and development investments we've made to help solve their most complex problems at the most advanced technology nodes. A good example of the return on our R&D investments is the strong demand for our market-leading RF power supplies, which is a critical enabler of vertical scaling in the semiconductor industry. Our market share gain has been primarily driven by dielectric edge applications for 3D NAND. We are also continuing to gain traction in conductor edge solutions, where we see an attractive market share gain opportunity. In addition, we see increasing opportunities in advanced deposition applications. For example, we displaced the incumbent for a leading edge foundry deposition process because of our dual-level pulsing capabilities. As reported by Tech Insights, we have taken market share leadership in our power supplies over the past year. We continue to see an attractive opportunity for further growth given the continued trend of vertical scaling in semiconductor structures. We also saw strong demand across our market-leading plasma and reactive gas portfolio, where we delivered record revenue in the quarter. We received significant follow-on orders for our dissolved ozone solutions from a large foundry for wet-clean applications. Our customers are increasing their use of our dissolved ozone solutions as an environmentally sustainable alternative to traditional wet clean chemistries. While traditional solutions use toxic chemicals that require careful disposal, our ozone solutions naturally break down to oxygen and water after the cleaning process. We believe we are well positioned to benefit not only from leading edge foundry fab expansions, but also from the semiconductor industry's growing need for green solutions. We also delivered record revenue from the pressure, valves, and analytical control products in our vacuum portfolio, which is yet another proof point of our leadership in critical vacuum subsystems over an unmatched breadth of solutions. Our solutions play a critical enabling role in the products that our customers provide to the marketplace. Take, for example, our flagship pressure measurement solutions. We were able to measure gas pressure in the chamber with extreme precision which is critical to quality and yield across deposition and etch applications. Our market-leading baritron capacitance manometer enables unprecedented sensitivity and accuracy, akin to detecting a millimeter of movement from more than one kilometer away. It's important to underscore that our strategy as a technology enabler in the semiconductor market extends beyond the vacuum chamber, and I'm pleased with the growing traction of our photonics solutions division in lithography, metrology, and inspection applications. In the second quarter, our photonics solutions revenue to the semiconductor market reached another record, growing considerably on a year-over-year basis. We saw particular strength in our optical solutions and motion products. Our precision motion solutions are worth highlighting, as we have seen an acceleration in business levels and design wind activity from our semiconductor customers over the past few quarters. In advanced packaging, metrology, and inspection applications, Customs are using our motion solutions to enable rapid movement and precise placement of the wafer to within the accuracy of a few atoms, which is critical to process performance and throughput. As we look to the third quarter, demand trends in our semiconductor market remain strong across our vacuum and photonics portfolios that serve deposition, etch, lithography, metrology, inspection, and wet clean applications. While our demand outlook is healthy, We've remained impacted by supply chain constraints, and as such, we expect revenues to be consistent with second quarter levels. In short, we are executing well across our semiconductor business as a leading critical subsystem technology provider. We believe that nearly every chip manufactured in the world today is made using MKS technology, and we are well positioned to capitalize on the long-term secular growth in the semiconductor market. We have the number one or number two position in nearly all of our major product categories in the semiconductor market. We intend to grow even further and extend our lead in this space, as we have done for more than 50 years. Moving to our advanced electronics market, revenue in the second quarter declined 6% sequentially. Consistent with our expectations and as discussed in our Q1 earnings call, industry demand for flexible PCB via drilling has continued to soften as customers have temporarily slowed capacity expansions due in part to softness in smartphone demand. In addition to the flexible PCB market, we've also seen softness in other applications tied to consumer electronics. While our advanced electronics market is soft right now, we believe this is transitory, and we remain very excited about the long-term secular opportunity for laser-based manufacturing in electronics applications. The same trends that drive our semiconductor business, miniaturization and complexity, are key drivers for advanced electronics, as customers demand more processing power, more features, and new form factors for their devices. We believe our flexible PCB, HDI PCB, and IC substrate via drilling solutions are all well positioned for the years ahead. In the third quarter, we expect PCB industry demand to remain muted. As such, we expect revenue from our advanced electronics market to remain consistent with second quarter levels. Turning to our specialty industrial market, revenue grew 1% sequentially, consistent with our expectations. We saw steady demand across industrial, life and health sciences, and research and defense applications. As a reminder, our specialty industrial market provides a more stable revenue stream comprised of a broad array of applications with good margins and cash flow. For the third quarter, we expect revenue from our specialty industrial market to remain consistent with second quarter levels. Moving to our pending acquisition of Adatech, we remain very excited and look forward to combining our capabilities in lasers, optics, motion, and process chemistry to drive faster solutions and new innovations for our customers. We expect that our adjacent expertise will uniquely position MKS to optimize the interconnect which is a significant enabling point of next-generation advanced electronics. As for the status of the transaction, I'm pleased to announce that today we received unconditional merger approval from China's State Administration for Market Regulation. The acquisition is anticipated to close on August 17th, subject to obtaining the required sanction by the Royal Court of Jersey and the satisfaction of customary closing conditions. As many of you know, MKS has a longstanding track record of technology leadership and operational excellence, and we continue to execute well in today's challenging environment, as clearly demonstrated in our second quarter results. While we are closely monitoring the macroeconomic landscape and supply chain impacts on our business, our overall demand environment is healthy, and we are in an outstanding position to continue delivering for our customers. With that, I'd like to turn the call over to Seth. Thank you, John. I will cover second quarter results, then provide additional detail and guidance for the third quarter. Revenue for the second quarter reached a record $765 million, up 3% sequentially, and exceeding the high end of our guidance range. Revenue from the semiconductor market reached a record at $515 million, up 6% sequentially, and up 19% year-over-year, reflecting broad-based demand for our vacuum and photonic solutions. Power Solutions delivered another strong quarter, and our plasma reactive gas, pressure, valves, and liquid control product groups, as well as our photonic solutions division, each delivered record revenue in the semiconductor market. This is a strong validation of our consistent strategy of cultivating a broad and complementary portfolio, both organically and through acquisitions, that provides the fundamental building blocks essential for semiconductor manufacturing. 7-0 customers are increasingly relying on MKS to enable the multi-year product development roadmaps. Moving to our advanced electronics market, revenue in the second quarter was $77 million, a decline of 6% sequentially and 44% year-over-year. As expected, we saw continued subs in industry demand for flexible PCB via drilling equipment. We believe the long-term secular trends in the flexible PCB industry remain intact, given its growing importance in enabling new form factors and more features in next generation electronic devices. Therefore, we believe the current softness we are seeing is transitory. We continue to work closely with current and potential customers to drive growth in our HDI PCB via drilling platform. One of our initial high volume manufacturing customers has continued to add capacity, while another customer that previously qualified our platform has deployed additional units across other global sites. Our HDI solution remains a strategic opportunity for MKS. We're excited about the potential cross-selling opportunities the pending acquisition of Adatech brings us as a leading provider of electroplating in the HDI industry. As we said before, defining trends of miniaturization complexity that have dominated the semiconductor market for decades are becoming increasingly critical to advanced electronics. We're using the same strategic playbook that made us successful in the semiconductor market, become a foundational solution provider in advanced electronics. We were delivering the key building blocks, the next generation technologies. We look forward to closing that tech acquisition to flex a transformational step in a longstanding strategy. Turning now to a specialty industrial market, revenue was $173 million in the second quarter, growing 1% sequentially. but declining 5% year-over-year. We saw steady sequential demand across a wide array of applications. Our strategy, especially industrial, is quite simple. We're able to leverage our innovative vacuum and photonics technology designed for semiconductor and advanced electronics applications by applying that technology to a broad array of applications across industrial, life and health sciences, and research and defense. In the second quarter, I am pleased to say we also delivered record revenue in our services business, growing 8% sequentially and 9% over year to surpass a $100 million level for the first time. This success resulted in a strategic decision years ago to operate our worldwide services business as a distinct business unit with a dedicated leadership team and a customer-centric focus. With an increasing install base and further opportunities to drive new value-added customer solutions, We are well positioned to continue to drive growth in the years ahead. Our second quarter gross margin was 44.2%, exceeding the midpoint of our guidance by 70 basis points. Given well-known inflationary pressures, we are very pleased with how we executed in the quarter. Second quarter operating expenses, which included annual compensation increases, were $154 million, $2 million favorable midpoint of our guidance. We continue to prudently manage our cost structure while investing in a number of attractive organic growth opportunities. Second quarter operating margin was 24.1%, exceeding the height of our guidance range by 70 basis points, reflecting strong execution and challenging macroeconomic environment and strong operating leverage in our financial model. Second quarter adjusted EBITDA was $208 million, The adjusted EBITDA margin was 27.2%. Net interest expense for the second quarter was $6 million, and our tax rate is approximately 18%. Net earnings for the second quarter were $145 million, with $2.59 per diluted share. Exiting the second quarter, we maintained a strong balance sheet and liquidity position, with cash and short-term investments at a record of over $1 billion, which positioned us well ahead, well, for the pending ad tech acquisition. Our term loan principal balance was $820 million at the end of the second quarter, and we exited the quarter with $246 million net cash balance. In terms of working capital, days outstanding were 54 days at the end of the second quarter compared to 59 days at the end of the first quarter. Inventory returns were 2.5 times at the end of the second quarter, compared to 2.6 times at the end of the first quarter. For the second quarter, operating cash flow was $105 million, and free cash flow was $41 million. Our capital expenditures in the quarter included an approximately $40 million investment to acquire and expand a facility in South Korea. We have a long-standing strategy to provide sales, service, and technical support to the South Korean consent sector industry which has significantly increased our direct sales to these local customers. This investment will allow us to expand our capabilities and support our future growth objectives in this region. Consistent with prior quarters, we made a dividend payment of $12 million, or 22 cents per share. I'll now turn to our third quarter outlook. With business levels remaining robust, we continue to face supply chain constraints. As such, we expect third quarter revenue of $770 million plus or minus $30 million. Based on anticipated product mix and revenue levels, we estimate third quarter gross margin of 44.5%, plus or minus one percentage point. And we continue to take necessary steps to counteract inflationary impacts on our business. We expect operating expenses of $155 million, plus or minus $4 million. In the third quarter, Net interest expense is expected to be approximately $6 million, and our tax rate is expected to be approximately 18%. Given these assumptions, we expect third quarter net earnings of $2.66 per diluted share, plus or minus 25 cents. In summary, we're actually well delivering growth and profitability across a number of attractive market opportunities. Despite macroeconomic inflationary headwinds, our financial performance is very strong, and we believe that pending acquisition of Adatek provide long-term value creation for our employees, customers, and shareholders. I'd like to now turn the call back to the operator for Q&A.