MKS Inc.

Good day and thank you for standing by. Welcome to the MKS Instruments first quarter 2023 earnings conference call. At this time, all participants are in a listen only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during this session, you'll need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your speaker today, David Ruchek, Vice President of Investor Relations. Please go ahead.

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 Backshaw, Executive Vice President and Chief Financial Officer. Yesterday, after market close, we released our financial results for the first quarter of 2023, which are posted to our investor website at investor.mks.com. As a reminder, various remarks about future expectations, plans, and prospects for MCAS-comprised 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 annual report on Form 10-K for the year ended December 31, 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 Auditech 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 our investor website for information regarding our combined company results, non-GAAP financial results, and a reconciliation of our GAAP and non-GAAP financial measures. 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 our investor website. Now, I'll turn the call over to John.

Thanks David. Good morning everyone and thank you for joining us today. I'm very pleased to report that we have restored our global operations following the ransomware incident we identified in early February. We are on track to meet our commitment to substantially recover revenue by the end of the second quarter. I can't say enough about how proud I am of the entire MKS family. Thanks to the dedication, hard work, and ingenuity of our 10,000 plus employees, we are a stronger and more resilient company today than we have ever been. I also want to take a moment to thank our customers and suppliers for their support and cooperation throughout this process so that we continue to deliver as a critical enabler to the industries we serve. With that, I'll review our operating environment, including our first quarter results and the trends we are seeing in the second quarter. We delivered first quarter revenue of $794 million, adjusted EBITDA of $142 million, and net earnings per diluted share of 48 cents. We estimate the ransomware incident had a negative impact on revenue of approximately $160 million for the quarter. As Seth will detail, revenue for the quarter excluding the impact of the ransomware incident was a little lower than we anticipated. The difference reflected softer demand that developed in the latter part of the quarter, which was relatively more pronounced in our electronics and packaging market. In our semiconductor market, business levels continue to soften in the first quarter, consistent with a well-publicized decline in industry-wide WFE spending in 2023. We remain very engaged with our customers across a spectrum of opportunities in deposition, etch, lithography, metrology, and inspection. And our ability to invest through the cycles has been a key reason we have outperformed WFE and the critical subsystems market over the long term. In fact, as reported by Tech Insights, our share of the overall critical subsystems market grew in 2022 on top of the gains we made in 2021. Our performance in 2022 exemplified our technical leadership and the breadth of our Surround the Wafer portfolio, where we gained share in a number of categories, including remote plasma sources, microwave power, liquid ozone, FTIR gas analysis, linear motion subsystems, and optical fiber thermometry. Our broad portfolio positions us well for when WFE spending recovers. Now more than ever, we are reminded of how important semiconductors are to our daily lives, and we firmly believe they will become even more important over time. This reliance on semiconductors will require not just more equipment, but also solutions addressing increased miniaturization and complexity in semiconductor design and manufacturing. And MKS is uniquely positioned as the broadest critical subsystem solutions provider in the industry, enabling more process steps in the fab than anyone else in the world today. As we look into the second quarter, we anticipate demand for semiconductor capital equipment to remain muted, consistent with expectations for a decline in WFE spending in 2023. Turning to our electronics and packaging market, revenue was below our expectations but consistent with softness and demand for global electronics, such as PCs, servers, and smartphones. Customers scaled back production, which impacted our chemistry sales, as well as delayed delivery of plating equipment for PCB and substrate applications. That said, we expect demand to improve sequentially in the second quarter due to additional working days in the quarter and delivery of equipment pushed from the first quarter. We are pleased with the progress of the integration of Adatech, both from a cost perspective and in establishing the value proposition of our combined proprietary chemistry and laser drilling solutions, which positions us at the forefront of what we call optimize the interconnect. This is the next frontier in the integration of SEMI and PCB design for advanced electronics. On our last earnings call, I noted that we had received our first HDI laser drilling order from a longtime Adatech customer. Since then, we received our second HDI order from another Adatech customer. These wins were a result of the combination of Adatech's longstanding relationships in the HDI market and the reference wins that our geo laser drilling tool had already achieved in an emerging market application. It's early in the game, but we are very pleased with customer interest in our combined capabilities as it provides initial validation of the potential for revenue synergy. At our analyst day in December, we discussed how packaged substrates are a critical building block for electronic devices, and in particular, high-performance computing architectures. I'm pleased to announce that we recently held an expansion ceremony at our Yokohama Tech Center in Japan, which included the introduction of two new significant products. The first is an extension of our ESI geodrilling platform, which is geared towards next-generation packaged substrate applications such as ABF build-up laminate processing. Our proprietary VIA drilling technology enables the highest throughput and lowest cost per part for advanced flip chip ball grid array packaging, which is critical for high performance computing applications. The second new product is our Adatek G-Plate vertical desmear and electrolysis copper plating tool for next generation package substrates. This new tool will support customers in their yield optimization and next-generation process development for advanced packaging applications with lines and spaces below 5 microns. These product announcements further extend our capabilities as a foundational solutions provider for advanced PCB and substrate applications, as we are the industry's only integrated provider of advanced laser drilling, proprietary chemistry, and horizontal and vertical plating solutions. As the defining trends of miniaturization and complexity dominate advanced PCB and substrate manufacturing the way they did in the semi-industry, we are well positioned to become the industry's go-to technology enabler. Turning to our specialty industrial market, business levels softened slightly on a sequential basis in the quarter. However, our GMF business held up well. Looking out to the second quarter, we expect demand to remain fairly steady. In summary, While the year got off to an unexpected start, we have rebounded well operationally and are delivering effective shipments to customers. We're also building early momentum with customers for our optimized the interconnect offering. Overall business levels have softened entering the second quarter, but we remain optimistic about the quarters to come. We expect NCAS's total revenue in the second half of 2023 to be slightly higher than the first half levels. driven by a modest improvement across each of our three end markets. We will continue to keep a close eye on near-term macro and industry-specific conditions. Longer term, we are as bullish as ever on the secular tailwinds and attractive growth opportunities across our markets, and we intend to seize them. Now, I'd like to turn the call over to Seth. Thank you, John. I will cover our first quarter results and provide details and outlook for the second quarter of 2023. Starting with the first quarter, we delivered revenue of $794 million. As John mentioned, our global team executed well during a challenging period for the company as we worked to restore operations following the ransomware incident. We estimate the negative impact to revenue was approximately $160 million for the quarter, and our team worked diligently to restore production relative to our initial expectations of at least $200 million impact when we reported our fourth quarter results. While recovery has gone well, we've seen a softening of business levels relative to our prior outlook, mainly in the electronics and packaging market. As a result, we're excluding the impact of the ransomware incident. We estimate first quarter revenue would have been lower than our original expectations. As our outlook indicates, we expect softness in overall business levels will continue in the second quarter. However, we see a slight improvement in the second half of the year. Turning to our end markets for the first quarter, As a reminder, the ransomware incident only impacted our vacuum photonics solutions divisions. Therefore, we mostly felt an impact on our semiconductor and specialty industrial markets, and to a lesser extent, electronics and packaging market. We expect to recover approximately 95% of this revenue, remaining 5% largely tied to our transactional catalog business in our specialty industrial market. With that as a backdrop, Semiconductor revenue was $309 million in the first quarter, declining 38% sequentially and 37% year-over-year, primarily due to the negative impact of the ransomware incident, as well as lower industry demand for semiconductor capital equipment. We estimate the ransomware incident impacted our semiconductor revenue by approximately $110 million in the first quarter. Given the impact of the ransomware incident, we estimate semiconductor revenue was down approximately 17% sequentially and 14% year-over-year. We expect to make up approximately 75% of that delayed revenue in the second quarter, with virtually all the remaining balance made up in the third quarter. While the first quarter was challenging, we have deep relationships with our customers and work closely with them to restore shipments as quickly as possible. Turning to electronics and packaging market, revenue was $222 million, a decrease of 17% sequentially and 24% year-over-year, with Q1 2022 representing combined company results. Assuming the impact of foreign exchange and palladium pass-through, first quarter revenue declined 20% on a year-over-year basis compared to combined company results. We estimate the ransomware incident has only nominally impacted our electronics and packaging revenue, We expect this to be substantially recovered in the second quarter. As John mentioned, our chemistry and plating equipment sales were negatively impacted by the industry's slowdown in global electronics demand. Our chemistry revenue declined 13% year-over-year, with the impact of foreign exchange and plating pass-through, reflecting the widely publicized slowdown in unit production volumes across PC, smartphone, and server applications. To add some context, according to Gardner, overall PC shipments declined 30% year-over-year in the first quarter. According to Canalys, smartphone shipments declined 12% year-over-year. Because there are more factory working days in the second quarter due to the Chinese New Year holiday in the first quarter, we expect electronics and packaging revenue to improve sequentially in the second quarter. In addition, we expect revenue to grow in the second half compared to first half levels. Moving to our specialty industrial market, revenue in the first quarter was $263 million, declining 17% sequentially and 18% year-over-year, with Q1 2022 representing combined company results. We estimate the ransomware incident impacted our specialty industrial revenue by approximately $45 million in the first quarter, which we expect to recover approximately $20 million in the second quarter and most of the remainder in the second half of the year. Excluding the impact of the ransomware incident in foreign exchange and plaguing pass-through, first quarter revenue declined approximately 2% year-over-year on a combined company basis. We do not expect to recover a nominal amount of revenue in this part of our business due to the transactional book-and-turn nature of orders that we generate through our catalog business. In the first quarter, consumables and service revenue across our three end markets comprise 43% of our total revenue. Turning to our margins, we reported first quarter gross margin of 42.2%, a sequential decline of 370 basis points, primarily due to the underutilization of a factory associated with a ransomware incident. First quarter operating expenses were $240 million, a sequential decline of $2 million due to lower variable compensation associated with the reduced revenue levels in the first quarter, as well as prudent cost control. First quarter operating margin was 12.1%. Adjusted EBITDA margin was 17.8%, both negatively impacted by lower revenue volumes as well as factory underutilization associated with the ransomware incident. Our integration of ad tech is progressing well. We're made on track to achieve our cost synergy target of $55 million within 18 to 36 months post-close. We exited the first quarter achieving annualized synergies of $25 million. Net interest expense for the first quarter was $76 million, slightly lower than we had anticipated due to favorable interest income. Our tax rate for the first quarter was a benefit of 47% driven by the geographic mix of earnings in the quarter. Net earnings for the first quarter were $32 million, or 48 cents per diluted share. Turning to our balance sheet and cash flow, despite the unusual challenges we faced, we exited the quarter maintaining strong liquidity with cash and short-term investments of $880 million and revolving credit facility of $500 million. We exited the quarter with gross debt of $5.1 billion. Our net leverage ratio exiting the first quarter, which is calculated on a combined company basis, was 4.0 times based on trailing 12-month adjusted EBITDA. For the first quarter, operating cash flow was $37 million, and free cash flow was $20 million, both negatively impacted by the ransomware incident. Insisting with prior quarters made dividend payments of $15 million, or 22 cents per share. I'll now turn to our second quarter outlook. We expect second quarter revenue of $980 million, plus or minus $50 million. While we normally do not provide specific guidance by end market, given the different moving pieces, such as recovery of ransomware revenue and underlying business levels, we believe a little more granularity would be helpful. With that, in the second quarter, we expect revenue from a semiconductor market to be approximately $400 million, plus or minus $20 million, revenue from electronics and packaging market to be approximately $240 million, plus or minus $10 million, and revenue from a special industrial market to be approximately $340 million, plus or minus $20 million. To the impact of the rent incident from the first and second quarters, we estimate second quarter revenue of approximately $870 million, which would represent a sequential decline from the first quarter. We expect this to be primarily a result of softer revenue from a semiconductor market, reflecting declines in wafer fab equipment spending, partially offset by lost improvements in revenue electronics and packaging, and especially industrial markets. Based on anticipated product mix and revenue levels, we estimate second quarter gross margin of 45%, plus or minus one percentage point. We expect operating expenses of $255 million, plus or minus $6 million. The sequential increase in the first quarter levels is due to higher revenue volumes, timing of annual merit increases, variable compensation, and normalization of product spending following a ransomware incident. For the second quarter, we estimated adjusted EBITDA approximately $223 million, plus or minus $27 million. For the second quarter, net incident expense expected to be approximately $82 million, reflecting slightly higher interest rates compared to the first quarter. And our tax rate expected to be approximately 27% for the second quarter. Given the tax benefit record in the first quarter, along with our guidance for the second quarter, we expect our tax rate to be higher in the second half to arrive at an estimated full year rate of 27% within our long-term model range. Given these assumptions, we expect second quarter net earnings of $1.13 per diluted share, plus or minus 29 cents. In summary, despite unusual challenges, we executed well on driving profitability in the first quarter. Moving forward, we are focused on resuming strong free cash flow generation, realizing acquisition synergies, and executing our discipline strategy to leveraging our balance sheet.