MKS Inc.

Good day, and thank you for standing by. Welcome to the MKS Instruments fourth quarter and full year 2022 earnings conference call. At this time, all participants are in the listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during that session, you will need to press star 11 on your phone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded, and I would now like to hand the conference over to your speaker today, Mr. David Rizek. Mr. Rizek, please go ahead.

Good morning, everyone. I am David Rizek, Vice President of Investor Relations, and I'm joined this morning by John Lee, President and Chief Executive Officer, and Seth Backshaw, Executive Vice President and Chief Financial Officer. Yesterday, after market close, we released our financial results for the fourth quarter and full year 2022, which are posted to our investor website at investor.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 quarterly report on Form 10-Q for the quarter ended September 30th, 2022. 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 combined company financial measures reflect the combined results of MCAS and Out-of-Tech Limited, which MCAS acquired on August 17, 2022. 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 the Investor Relations section of our website for information regarding our combined company results non-GAAP financial results, and a reconciliation of our GAAP and non-GAAP financial measures. As a reminder, in the fourth quarter, MCAS updated its end-market classifications, including replacing advanced electronics with electronics and packaging, reclassifying products and services supporting light-emitting diode, laser diode, and solar markets from electronics and packaging to specialty industrial, and reclassifying material solutions division products and services supporting wafer-level packaging from semiconductor to electronics and packaging. 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. Now, I'll turn the call over to John.

Thanks, David. Good morning, everyone, and thanks for joining us today. We ended 2022 on a strong note, with revenue and EPS exceeding the high end of our guidance range. Of course, the first quarter did not begin the way we expected. On February 3rd, we identified that NCATS had been a victim of a ransomware incident. We took immediate action to contain the incident, which has materially impacted our business systems as well as the operations of our Photonics Solutions Division and Vacuum Solutions Division. including our ability to process orders, ship products, and provide service to customers. The operations of our material solutions division were not impacted. Today, we're well into the recovery phase, and we've begun starting up the effective manufacturing and service operations, and we expect these operations will be restored over the coming weeks. We plan to provide a more complete picture of the costs and related impacts of the incident on our first quarter earnings call but we do expect there will be a material impact on our first quarter performance. Our main focus today, of course, is on ramping up our production and service operations to meet the needs of our customers. I do want to take a moment to reflect on how enormously grateful I am for the efforts of the entire NKS team, from leadership to all key functional departments, in responding to and managing this situation. You always hear that the best prove the metal in the toughest moments, but you often don't get to see that. I'm extremely proud of the unprecedented responsiveness, stamina, innovation, and resiliency demonstrated by our teams. I also want to thank our customers, suppliers, and other business partners for their understanding, patience, and support through this difficult period. We're working hard to be fully back up soon, and I look forward to delivering on our commitments to all of you. Now, on to the business. I start by reflecting on the major milestone of 2022, which of course is the addition of Adatech to the NKS portfolio. Adatech's critical process chemistry and equipment solutions across our electronics and packaging and especially industrial markets further strengthen our position as a foundational technology solutions provider. We hit the ground running with Adatech. Our integration efforts have been progressing extremely well. And our initial engagements with major PCB manufacturing customers have been very positive. We look forward to demonstrating the value of our company's broader and unique capabilities to all of our stakeholders. 2022 also marked another record year for our semiconductor business, highlighted by strong demand across our vacuum and photonics portfolios. Our customers count on our broad domain and process expertise to solve their most complex challenges. We are uniquely positioned in the semiconductor capital equipment industry as MCAS solutions are used in over 85% of the steps needed to manufacture a semiconductor chip. Operationally during 2022, our global team navigated well through continued supply chain constraints and significant inflationary pressures. I'm proud of how we executed to meet those challenges while remaining focused on innovating across our portfolio to solve the industry's critical technology challenges. While we believe macroeconomic challenges along with expected pressures in WSE investment will persist this year, our 2022 achievements, combined with our leadership across a broad array of end markets, should significantly enhance our long-term potential to deliver sustainable and profitable growth within an estimated $25 billion addressable market. Now let me discuss our results in more detail. We delivered fourth quarter revenue of $1.09 billion, adjusted EBITDA of $282 million, and net earnings per diluted share of $2. Sales to our semiconductor market exceeded our expectations as we executed well in responding to supply chain constraints and delivered on shipments better than anticipated. Our photonic solutions revenue set another record, reflecting continued customer traction and market penetration in advanced lithography, metrology, and inspection applications. We were pleased to see our optical solutions business continue to gain traction across the EUV ecosystem for both lithography and inspection applications. Lithography, metrology, and inspection applications continue to grow as a percentage of our overall semiconductor revenue. And for 2022, our revenue from these applications grew almost 30%, outpacing estimated industry growth rates. We expect this will remain an area of growth and investment for MKS. Now moving to our electronics and packaging market, revenue was in line with our expectations of a sequential decline when compared to combined company results for the third quarter. As anticipated, softening in global electronics demand impacted sales of our chemistry solutions for advanced PCBs and packaged substrate applications. Sales of our flexible PCB laser drilling equipment remained muted in the quarter, as expected as customers continue to digest the strong growth and flex capacity added in 2020 and 2021. However, we saw encouraging signs of customer activity in our HDI PCB via drilling business. In the fourth quarter, we received a meaningful order for our geode HDI tool, and we are starting off the year well with a multi-unit order in the first quarter from a long-time Adatech customer. This is the first example highlighting the potential cross-selling synergies as we further integrate our businesses. For the full year, sales to our electronics and packaging market from the Adatek business grew by 3% when excluding the impact of foreign exchange and palladium pass-through. Overall, we're very pleased with Adatek's performance in a difficult near-term electronic device market. Turning to our specialty industrial market, revenue was also consistent with our expectations and flat sequentially compared to combined company results for the third quarter. Our general metal finishing business continued to be impacted by lower automobile production volumes due to lingering supply chain constraints. In addition, some of our GMF customers were negatively impacted by disruptions associated with COVID-19 in China in the fourth quarter. That said, when excluding the impact of foreign exchange and palladium pass-through, Adatech's GMF business grew 2% year over year in the fourth quarter and 4% for the full year. Looking ahead to the first quarter of 2023, because of the impact of the ransomware incident, we're not able to provide our usual guidance at this time, but Seth will provide some color shortly. In summary, our fourth quarter results highlight our solid execution in a challenging environment. 2023 kicked off with its own challenges that the ransomware incident has demonstrated. It also presents opportunity. As we execute on our recovery efforts, we will remain focused on our growth strategy across our end markets, which includes attractive revenue synergy opportunities. These markets feature powerful secular growth drivers. And as near-term industry headwinds abate, we look forward to capturing the valuable opportunities that lie ahead. Now I'd like to turn the call over to Seth. Thank you, John. I'll cover our fourth quarter and full year results and provide some thoughts for our first quarter of 2023, including the preliminary impact of the ransomware incident. Starting with the fourth quarter, we delivered revenue of $1.09 billion above the high end of our guidance range. Revenue was down 5% sequentially and down 6% year-over-year, each compared to combined company results of the previous period. This is due to the impact of foreign exchange fluctuation in plate and pass-through, Fourth quarter revenue grew 1% on a year-over-year basis compared to combined company results. Turning to our end market results, fourth quarter semiconductor revenue was $503 million, declining 6% sequentially and growing 2% year-over-year. Each compared to combined company results for the previous period, which was better than our expectations. Despite headwind from Patina supply chain constraints, as well as newly enacted U.S. export restrictions in the fourth quarter, our team executed very well in delivering to our customers. Fourth quarter revenue from electronics and packaging market was $266 million, a decrease of 8% sequentially and 19% year-over-year, each compared to combined company results for the previous period. Excluding the impact of foreign exchange and palladium pass-through, Fourth quarter revenue declined 11% on a year-over-year basis compared to combined company results. On a sequential basis, this decrease in revenue is primarily a function of lower chemistry revenue resulting from the softer global electronics demand. Electronics and packaging revenue may have 25% of overall revenue in the fourth quarter. As we mentioned in our recent analyst day, we have a unique opportunity to combine our capabilities to optimize the interconnect as packaged substrates and advanced PCBs require greater integration due to the trends of miniaturization and complexity. We are very pleased with the initial reaction in the marketplace of our combined laser drilling and chemistry capabilities. That reaffirms our belief that we can deliver meaningful revenue synergies from the combination of our two companies as customers begin to focus on next generation device design cycles. Moving to our specialty industrial market, revenue in the fourth quarter was $316 million, flat sequentially and declining 4% year-over-year, each compared to combined company results in the previous period. Including the impact of foreign exchange and palladium pass-through, fourth quarter revenue grew 3% year-over-year on a combined company basis. In the quarter, the specialty industrial market made up 29% of total revenue. As a reminder, our specialty industrial market utilizes our proprietary technologies in vacuum, photonics, and materials to serve a broad array of applications. This share of expertise allows us to tap into some attractive secular growth opportunities, diversifies our revenue, and comes with healthy margins in cash flow. In the fourth quarter, consumables and service revenue across the three end market categories comprise 37% of our total revenue, up 3% year-over-year on a combined company basis, including the impact of foreign exchange and palladium pass-through. Looking forward, we expect this revenue stream to provide greater resilience in our financial model as we enter a period of cyclical and macroeconomic softness. Our services revenue, in particular, showed strong momentum led by our semiconductor market. These results are a byproduct of the actions we took several years ago strategically reorganizing services to drive a more market-centric growth and profitability strategy. Turning to our margins, we reported a fourth quarter growth margin of 45.9% exceeding the height of our guidance range. We executed well in addressing continued supply chain constraints and inflationary pressures and also benefited from a more favorable product mix. Fourth quarter operating expenses were $242 million, up slightly from the midpoint of our guidance to the higher revenue volume. Fourth quarter operating margin was 23.6%, significantly above the height of our guidance range, due to strong operating leverage in our financial model, along with favorable product mix. Our integration of AdTech is progressing well, and we are on track to achieve our cost-to-energy target of $55 million within 18 to 36 months post-close. Fourth quarter adjusted EBITDA was $282 million, also above our guidance range. Adjusted EBITDA margin was 26%. Net interest expense for the fourth quarter was $75 million. This was slightly lower than we anticipated with variable timing of Fed rate increases relative to interest reset dates of our term loans as well as higher interest income. Our tax rate for the fourth quarter was 20%, better than expected, due primarily to refinement of acquisition-related valuations estimates in a favorable geographical mix of income. Net earnings for the fourth quarter were $133 million, or $2 per diluted share. Turning to our balance sheet and cash flow, consistent with our track record of due leveraging, we made a voluntary principal payment of $100 million in the fourth quarter. Exiting the quarter, we maintained strong liquidity with cash and short-term investments of $910 million and a revolving credit facility of $500 million. We exited the quarter with gross debt of $5.1 billion, which included a voluntary debt prepayment partially offset by revaluation of Euro denominated debt to a strong Euro in the quarter. Our net leverage ratio exiting the fourth quarter, which we calculated on a combined company basis, was 3.4 times, based on trailing 12-month adjusted EPTA. For the fourth quarter, operating cash flow was $184 million, and free cash flow was $130 million, Our capital expenditures in the fourth quarter were $54 million, an increase of $28 million compared to the third quarter, reflecting a full quarter contribution from Adatech. Consistent with prior quarters, we had a dividend payment of $15 million, so 22 cents per share. Moving to full-year 2022 results, revenue was a record $3.5 billion, up 20% year-over-year, so $2.9 billion reported in 2021. On a combined company basis with Adatech, revenue was consistent year-over-year. However, through the impact of foreign exchange and palladium pass-through, 2022 revenue grew 5% for the combined company. Semiconductor revenue set another record in 2022, totaling $2.04 billion, growing 12% year-over-year. For the impact of foreign exchange, semiconductor revenue grew 16% year-over-year. We've delivered strong growth across our portfolio of vacuum and photon solutions, reflecting our unique breadth in technology leadership. Electronics and packaging revenue was $1.1 billion in 2022 on a combined company basis. For the impact of foreign exchange, plug-in pass-through, combined company sales declined 8% on a year-over-year basis. Adtech's business performed well in the electronics and packaging market, growing 3% year-over-year, including foreign exchange and plating and pass-through. Specialty industrial revenue was $1.3 billion in 2022 on a combined company basis, excluding the impact of foreign exchange and plating and pass-through. Combined company sales grew 4% on a year-over-year basis. In 2022, on a combined company basis, the revenue split between our semiconductor and Latron's packaging, especially industrial markets, was 46%, 25%, and 29% respectively. Total consumables and service revenue amounted to $1.7 billion in 2022 on a combined company basis, up 5% year-over-year, with the effect of foreign exchange and palladium pass-through. In 2022, on a reported basis, operating cash flow was $529 million, and free cash flow was $365 million. I'll now turn to our first quarter outlook. To address the current status of our recovery from the ransomware incident, given that our effective operations are just starting to return to production and are focused on serving our customers, we're not able to provide a useful guidance for the first quarter. In addition, as you may have seen yesterday, we filed a notification with the SEC of an extension to file our 10-K. Even though we are in the process of restoring our systems, we require additional time to complete our annual report. As John noted, the incident has materially impacted our operations for our vacuum and photon solutions divisions. The operations of our material solutions division were not impacted. MSD revenues are spread across electronics and packaging in especially industrial markets. What we can share is that prior to the ransomware event, we were planning to guide total MCAS revenue for the first quarter to be approximately $1 billion. This reflected widely publicized circular softness in the semiconductor industry, offset somewhat by a strong backlog coming into the quarter, continued weakening in global electronics spending, impacted our electronics and packaging market, and a modest sequential decline in revenue, especially in the industrial market. We estimate the ransomware incident will impact our first quarter revenue by at least $200 million. However, we expect to substantially recover this revenue by the end of the second quarter. Prior to the incident, we're also expecting gross margins of 44.5% down from the fourth quarter levels due to lower volume and mix. In terms of operating expenses, we're also expecting approximately $260 million in the first quarter up from fourth quarter levels primarily due to seasonal increase in compensation and fringe expenses, as well as continued investment into product development and customer-facing sales and marketing expenses. Our ability to continue to invest in critical initiatives has been a key strategic driver behind our long-standing ability to exit cycles in a stronger market position to continue to accelerate our customers' product roadmaps. We plan to maintain these investments. We're also keeping a close eye on macroeconomic industry trends and a proven playbook for managing costs through cycles will allow us to adjust spending levels when and if needed. As an example, we've already executed approximately one-third of our $55 million ad tech cost energy target within just a short period of time. Just to run out of expectations prior to the incident, for the first quarter, we expect our tax rate to be 27%. We currently expect our net interest expense to be $78 million. With that, I'll turn it back to John to wrap up. Thanks, Seth. While the events of the last month have been an unpleasant distraction, they do not change the MCAS story. Following an important 2022 in which we closed our strategic acquisition of Adatech and delivered strong financial performance, MCAS is even better positioned for the future. We now address all of the core building blocks of advanced electronic devices, from the semiconductor chip to wafer-level packaging to the package substrate to the PCB, with enabling technologies that solve for miniaturization, complexity, and novel chemistry. And we do so with an enhanced business profile featuring the most comprehensive technology portfolio in the industry, spanning vacuum, photonics, and chemistry. market leadership in 20 critical product categories across a balanced end market profile, a resilient business model with a significant mix of consumable and services revenue, and a larger addressable market. For all of these reasons, we are confident that we are ready to capture a broader set of exciting market opportunities. Now I'd like to turn the call back to the operator for Q&A.