MKS Inc.

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the MKS Instruments third quarter 2022 earnings conference call. At this time, all participants are on 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 will need to press star 1-1 on your telephone keypad. At this time, I would like to turn the conference over to Mr. David Rizek. Mr. Rizek, you may begin, sir.

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 the market closed, we released our financial results for the third quarter of 2022, which are posted to our website. 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 current report on form 8k filed with sec on august 17 2022 and any subsequent quarterly reports on form 10q 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 references to pro forma financial measures reflect MCAS and Adatech Limited, which MCAS acquired on August 17, 2022, are on a U.S. GAAP basis and include adjustments to conform to accounting policies of MKS. Also, unless otherwise noted, all income statement related financial measures will be non-GAAP other than revenue. For a detailed breakout of reported revenues by end market, as well as out of tech and combined company revenues by end market, please visit the investor relations section of our website. Please refer to our press release and the presentation materials posted to our website for information regarding our non-GAAP financial measures and 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. The third quarter marked a major advancement in MCAS's long-term strategy as we completed the acquisition of Adatech Limited. Adatech further broadens MCAS's capabilities by bringing leadership in critical chemistry solutions for advanced electronics and specialty industrial applications. and we are pleased to welcome the talented global team of over 4,000 new employees to the MKS family. We delivered strong results in the third quarter with record revenue and strong profitability. On a pro forma basis for the third quarter, we delivered revenue of $1.1 billion, of which over $360 million was from Adatech. Excluding the partial quarter contribution from Adatech, our revenue exceeded the midpoint of our guidance range and was another quarterly record. We continue to execute in a challenging environment of supply chain constraints and inflationary pressures. While we have overcome numerous constraints throughout the quarter, we are still facing shortages of a small number of components that are impacting shipments of some high-value solutions. We are also operating in an environment of increasing macroeconomic uncertainty and an anticipated decline in wafer fabrication equipment spending. And I'll provide our perspective on these factors shortly. Next, I wanted to share an update on our organizational structure and divisional reporting following the closing of our acquisition of Adatech. In the third quarter, our equipment solutions division was consolidated into our photonics solutions division. This consolidation aligns with our broader portfolio of photonics solutions and further enhances synergies between our critical photonics subsystems and our laser systems. As a result, going forward and in our third quarter 10Q, The financial results of the Equipment Solutions Division will be combined with the Photonics Solutions Division. And the Adatech business operates as a separate division, which we refer to as the Materials Solutions Division. As a reminder, earlier this year, we introduced our three end market categories, Semiconductor, Advanced Electronics, and Specialty Industrial. These market categories will remain the focus of our external reporting. Now I'd like to provide more detail on our third quarter results and my thoughts as we look into the fourth quarter. Semisensor market revenue reached another record in the third quarter. We saw broad-based demand across our portfolio. Our market leadership and RF power for dielectric etch continues to be a significant driver. And we delivered another record quarter, benefiting from investments into leading edge 3D NAND. We also continue to gain traction in RF power for conductor etch, where we see an attractive market penetration opportunity. Demand for our remote plasma sources remain very strong, driven by both on wafer and chamber clean applications. We also had a record quarter in our analytical and control solutions, led by growth in physical vapor deposition chambers as interconnect density increases for logic devices. Photonics solutions revenue for the semiconductor market reached another record, as we continue to gain traction in our optical solutions and motion businesses for advanced lithography, metrology, and inspection applications. We continue to gain significant design wins, and our engagement with key customers in this important market segment continues to strengthen. In fact, when excluding the inorganic contribution from the photon control acquisition, we deliver more than 35% year-over-year organic growth in our photonics solutions for the semiconductor market. Overall, our semiconductor market results in the third quarter were exception, even as we continue to face supply chain constraints in the quarter. Given nearly every semiconductor chip manufactured in the world today is made possible by MKS's technology, I'm excited about how well positioned we are to continue to leverage the attractive long-term secular opportunities in this market. While these long-term secular trends remain unchanged, recently issued U.S. Export restrictions on advanced semiconductor equipment sales to China are immediately impacting our direct customers who rely on our subsystems. In addition, as I mentioned earlier, we continue to see shortages of components needed for certain high-value products. As a result, we expect revenue from our semiconductor market to decline sequentially by approximately 20% in the fourth quarter compared to pro-former revenue for the third quarter. We have also seen a moderation in order rates in the fourth quarter. and we expect wafer fabrication equipment spending to decline in 2023 as the industry scales back investments to restore supply-demand balance. Turning to our advanced electronics market, revenue from our flexible PCB via drilling systems remain muted in the quarter, as expected. Demand for our chemistry solutions moderated in the quarter due to weakening end-market demand for electronics, such as smartphones and PCs. However, we saw strong demand for our plating equipment in the quarter. And overall, pro forma advanced electronics revenue grew slightly on a year-over-year basis when excluding the impact of foreign exchange and palladium pricing. Since the closing of the Adatek acquisition, our teams have been in active discussions with customers, outlining the unique value proposition behind our combined laser drilling and chemistry expertise to optimize the interconnect. We believe this is an increasingly critical focal point in enabling the integration of advanced electronic devices. In addition to our HDI market, our capabilities are focused increasingly on package substrates, which is the fastest growing segment of the advanced PCD market. Package substrates have become a critical building block of heterogeneous computing architectures, such as chipless, as well as other advanced computing applications. Today, we occupy a uniquely differentiated position by virtue of our market leadership in chemistry solutions, along with the laser drilling capabilities of our GEO platform. Our positive engagements with customers thus far confirm the strong value proposition of our combined laser drilling and chemistry solutions as a path to enhancing yield and reducing time to market. In the immediate term, we expect that macroeconomic headwinds in electronics and markets will negatively impact our performance. with revenue from our advanced electronics market expected to decline sequentially in the fourth quarter compared to pro forma results for the third quarter. It is worth noting that the fourth quarter is typically seasonally lower than the third quarter. Moving to our specialty industrial market, we saw relatively stable demand across our industrial, life and health sciences, and research and defense applications. Within the specialty industrial market, our general metal finishing business continued to be impacted by supply chain constraints in the automotive market. Nonetheless, demand was steady in the third quarter, and we expect GMF to benefit once supply chain constraints ease, though growth will ultimately be anchored by end demand. For the fourth quarter, we expect revenue from our specialty industrial market to remain consistent, pro forma results for the third quarter. In short, I'm very pleased with how MCAS executed in the third quarter. While the macroeconomic backdrop is a factor we are closely watching, I'm very excited about our long-term positioning for the numerous secular trends supporting MCAS's business opportunities. Finally, we will host an analyst day on December 14th, where we will provide updates on our strategy, market opportunities, and long-term financial model for the new combined company. With that, I'd like to turn the call over to Seth. Thank you, John. I'll cover third quarter results and provide additional detail and guidance for the fourth quarter. In the third quarter, we delivered revenue of $954 million in net earnings per share of $2.74, which includes a partial quarter contribution from Adatech following the closing of the acquisition. Following the Adatech acquisition, we delivered record revenue in the third quarter and exceeded the midpoint of our guidance range, led by record revenue from our semiconductor market. On a pro forma basis for third quarter, we delivered a revenue of $1.1 billion. In an adjusted pro forma basis, we delivered just the EBITDA of $327 million. Furthermore, even though we delivered strong financial results, recent foreign exchange volatility resulted in approximate mid-single-digit headwind to overall year-over-year revenue growth on a pro forma basis. Following the acquisition, our revenue mix is more balanced by end market. On a pro forma basis for the third quarter, revenue from our semiconductor market was 48%. It was 26% each from our advanced electronics and specialty industrial markets. In addition, we now possess a higher mix of more consistent consumables and service revenue, which made up about 37% of overall pro forma revenue for the third quarter. Now, trying to end market results, I'll be commenting on pro forma revenue and change from prior periods on a pro forma basis. We delivered record pro forma revenue from our semiconductor market in the third quarter, increasing 4% sequentially to $552 million and growing 9% year over year. We saw broad-based strength from across our vacuum portfolio, while growth in our photon solutions products continues to be strong outpacing overall industry growth. As John mentioned, recent U.S. export control restrictions on products sold for advanced semiconductor applications are impacting our sales to certain China customers. Based upon our preliminary assessment of sales through our direct sales channel and through our OEMs, we estimate the overall annualized impact could be in the range of $250 million to $350 million. That amounts to approximately 6% to 8% of our projected pro forma revenue for 2022, assuming the midpoint of our guidance for the fourth quarter. Moving to our advanced electronics market, pro forma revenue in the third quarter was $296 million, growing 1% sequentially and declining 9% year over year. As you may be aware, the cost of palladium makes up a significant portion of overall cost of goods sold for Adatex chemistry business. In order to insulate itself from typical market-based price fluctuations in palladium, AdTech has implemented an effective pass-through pricing mechanism to customers. In this context, assuming the effects of palladium pricing pass-through revenue, as well as foreign exchange headwinds, pro forma advanced platronics revenue was up 1% on a year-over-year basis. In a specially industrial market, we delivered pro forma revenue of $292 million in the third quarter, declining 1% sequentially, and flat on a year-over-year basis. Excluding the effects of palladium pricing pass-through in foreign exchange headwinds, pro forma special industrial revenue grew 7% year-over-year. On a standalone basis for MKS, excluding the partial quarter contribution for the ad tech acquisition, we executed very well. Revenue and operating margin exceeded the midpoint of our guidance, with operating expenses favorable to the midpoint of our guidance, reflecting strong cost controls. Turning to our margins, we reported third quarter gross margin 44.9%. Given well-known supply chain inflationary pressures, we are pleased with how we exited in the quarter and continue to work hard in addressing these macroeconomic factors. Third quarter operating expenses were $189 million, up $35 million sequentially, primarily due to the partial quarter contribution from Adatech. Third quarter operating margin was 25.1%, up 100 basis points sequentially. We continue to prudently manage our cost structure while maintaining our commitment to investing in organic growth opportunities that we believe can deliver attractive long-term returns. In addition, our integration of Adatech is progressing very well. We are on track to achieve our cost-saving target of $55 million within 18 to 36 months post-close. We recently marked the one-year anniversary of the acquisition of Photon Control. We delivered synergies in profitability improvements ahead of our own internal expectations, exemplifying our strong track record of M&A integration. Third quarter adjusted EBITDA was $268 million, and adjusted EBITDA margin was 28%. Net interest expense for the third quarter was $36 million. A sequential increase of $30 million reflecting the incremental debt associated with the ad-tech acquisition. In the quarter, we implemented interest rate hedges such that approximately 50% of our total debt outstanding is at a fixed rate. Our tax rate for the third quarter was approximately 18%, which benefited from transaction-related expenses. Net earnings for the third quarter were $167 million, or $2.74 per diluted share. Exiting the third quarter, we maintained strong liquidity with cash and short-term investments of $885 million and revolving credit facility of $500 million. We exited the quarter with gross debt of $5.2 billion, and our net leverage ratio, which we calculated on a combined company basis, was 3.3 times. The third quarter, operating cash flow was $199 million, and free cash flow was $173 million, Each inclusive of $36 million in acquisition, integration, and restructuring costs. Our capital expenditures in the third quarter were $26 million. Consistent with prior quarters, we had a dividend payment of $12 million, or 22 cents per share. I'll now turn to our fourth quarter outlook for the combined company. On a pro forma basis, we expect revenue from our semiconductor and advanced electronics markets to decline sequentially. while revenue from our specialty industrial market is expected to remain consistent with third quarter levels. Overall, we expect fourth quarter revenue of $1 billion, plus or minus $50 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 $240 million, plus or minus $6 million. For the fourth quarter, we estimate adjusted EBITDA of approximately $240 million, plus or minus $27 million. The sequential decline in adjusted EBITDA in a pro forma basis is a function of lower projected revenues, as well as a $20 million foreign exchange gain recorded by Adatech in the pro forma third quarter period, which is not expected to repeat in the fourth quarter. For the fourth quarter, net interest expense is expected to be approximately $81 million, reflecting a full quarter of net interest expense associated with the ad tech acquisition. As we've stated, our primary focus is to deliver our balance sheet, which we have demonstrated a strong track record of doing so following our last two debt finance acquisitions, Newport in 2016 and ESI in 2019. Our tax rate is expected to be approximately 27% for the fourth quarter, This increase is due primarily to the mix of geographical income associated with the ad tech acquisition for the full quarter. Given these assumptions, we expect fourth quarter net earnings of $1.34 per diluted share, plus or minus 27 cents. In closing, we are very excited to close the ad tech acquisition. It provides us with critical chemistry solutions for advanced electronics and especially industrial markets. Today, we are a more scaled company with a higher proportion of more consistent consumables in service revenues. Our integration activities are well underway, and we are well positioned to adapt to changing market conditions and to execute on a long-standing strategy of sustainable long-term growth and profitability. I'd like to now turn the call back to the operator for Q&A.