MKS Inc.

Good day and thank you for standing by. Welcome to the MKS Instruments second quarter of 2023 earnings 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 will need to press star 11 on your telephone. 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. I would now like to hand the conference over to your speaker today, David Rizek, 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 Bagshaw, Executive Vice President and Chief Financial Officer. Yesterday, after market close, we released our financial results for the second 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 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 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 MKS and Adatek Limited, which MKS 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 and combined company revenues by end market and division, 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. MKS delivered strong results in the second quarter, led by excellent execution in our semiconductor market and prudent cost management that is reflected in our better than expected margins. We delivered second quarter revenue of $1 billion, adjusted EBITDA of $254 million, and net earnings per diluted share of $1.32. Revenue from our semiconductor market was above the high end of our expectations, despite the widely publicized decline in WFE spending. Our operations team executed well in shipping products from backlog, including those delayed due to the ransomware incident we experienced in the first quarter. Demand for our critical vacuum subsystems for deposition and etch applications declined considerably compared to a year ago, consistent with capital equipment spending trends, particularly for memory applications. However, photonic solutions demand for lithography, metrology, and inspection remain resilient, offsetting some of the weakness. We anticipate continued strength in these photonics applications. Design and activity remains robust, demonstrating that customers value the unique capabilities MKS offers in these areas. In fact, revenue from lithography, metrology, and inspection applications in the first half of 2023 grew considerably compared to the same period a year ago. Our breadth and diversity across WFE applications, combined with our leadership position across most of the product categories we serve, reinforces our belief that we can continue to outperform industry WFE spending over the long term. We are a critical enabler of key inflection points and semiconductors, such as atomic layer deposition, high aspect ratio etch, extreme ultraviolet lithography, and advanced inspections. and are well positioned for when industry capital equipment spending recovers. Looking to the third quarter, we expect revenue from our semiconductor market to decline sequentially. However, after excluding the impact of the ransomware incident from the second and third quarters, we expect revenue in the third quarter to be consistent with second quarter revenue levels. Turning to our electronics and packaging market, revenue was softer than we expected amid the well-known weakness and demand for global electronics, such as PCs and smartphones. Demand for our chemistry solutions improved modestly on a sequential basis, but this was offset by continued softness in capital equipment spending, including for our laser drilling and plating equipment. Despite this cyclical weakness, we remain very excited about the long-term opportunity in electronics and packaging. One of the areas of particular focus is packaged substrates, which are a critical enabler and key building block for high-performance computing applications such as AI. Just to build on that last point, much like what we've seen in the semiconductor industry over the past 60 years, the manufacturing of packaged substrates is getting harder, not easier. High-performance computing applications require greater interconnect density, as layer counts increase to 20 or more, while interconnect feature sizes continue to shrink. This high degree of complexity gives MKS, with our unique combination of proprietary chemistry, plating equipment, and laser drilling solutions, the opportunity to expand our presence in this high-growth segment of our electronics and packaging market. As a reminder, this opportunity is one of the key reasons behind our acquisition of Adatech and is why MCAS is strongly positioned for advanced packaging, which will continue to be an area of focus and investment for the company. For context, based on combined company full-year 2022 results, advanced packaging represents just under one-third of electronics and packaging revenue. Driven by our foundational portfolio for package substrate applications, as well as smaller revenue streams from wafer-level packaging, hybrid bonding, and other applications, we think advanced packaging solutions will be a more meaningful contributor to our revenue over the long term. Looking to the third quarter, we expect revenue from our electronics and packaging market to be consistent with second quarter levels. We anticipate a slight improvement in chemistry sales due to the seasonality of consumer electronics production, as well as an improvement in package substrate demand due to high-performance computing applications such as AI. These improvements are expected to be partially offset by a cyclical downturn in plating equipment sales. Turning to our specialty industrial market, revenue was in line with our expectations with stable demand for our chemistry solutions for the automotive market combined with good execution and recovering delayed revenue due to the ransomware incident. Looking to the third quarter, we expect revenue to be consistent with second quarter levels. However, after excluding the impact of the ransomware incident from the second and third quarters, we expect revenue to be slightly higher than second quarter levels. In summary, I'm very pleased with our team's performance in the second quarter. Despite muted demand across some of our end markets, we executed well. Thinking about our business in the second half of 2023, we continue to expect MCAS's total revenue in the second half to be slightly higher than first half levels driven by modest improvements across all three of our end markets. Longer term, we are very excited about how we are positioned to capitalize on multiple secular drivers. AI, cloud, virtual reality, and electrification are just some of the examples of what is made possible by advanced electronics. And we are foundational to those trends. And now, I'd like to turn the call over to Seth. Thank you, John. I'll cover our second quarter results, then provide details and outlook for the third quarter. Starting with the second quarter, we delivered a revenue of $1 billion above the midpoint of our guidance. Our strong top line results were driven by better than expected revenue from our semiconductor market, more than offsetting soft electronics and packaging revenue. Revenue from our specialty industrial market was in line with expectations. We estimate we recovered $120 million of the approximately $160 million in revenue impacted by the ransomware incident in the first quarter, we expect to recover substantially all of the remaining revenue in the third quarter. Turning to our semiconductor market, revenue was $440 million in the first quarter, growing 42% sequentially, and exceeding our outlook to a strong execution on shipping products from backlog, including those that delayed by the ransomware incident in the first quarter. In the second quarter, we estimate we recovered $90 million of the approximately $110 million of revenue impacted by the ransomware incident in the first quarter. After excluding the impact of ransomware incident from the first and second quarters, our semiconductor revenue declined on a sequential basis, consistent with softer industry demand for semiconductor capital equipment. Turning to electronics and packaging market, revenue was $225 million, an increase of 1% sequentially, in decline of 21% year-over-year, with Q2 2022 representing combined company results, including ad attack for the full prior year period. Excluding the impact of foreign exchange and platinum pass-through, second quarter revenue declined 15% on a year-over-year basis. As a reminder, the ransomware incident had a minimal impact on revenue from electronics and packaging market. Moving to a specially industrial market, revenue in the first quarter was $338 million, growing 29% sequentially, in line with our outlook due to stable demand trends across our sub-markets. We estimate we recovered $30 million of the approximately $45 million of revenue impacted by the ransomware incident in the first quarter. As a result, after excluding the impact of ransomware incident in the first and second quarters, especially industrial revenue was relatively flat sequentially. Excluding the impact of the rent-to-rent incident, bond exchange, and play-in pass-through, second quarter revenue declined approximately 3% year-over-year on a combined company basis. In the second quarter, consumables and service revenue across our three end markets comprised 38% of our total revenue. Turning to our margins, second quarter gross margin was 46.9%, a sequential increase of 470 basis points, exceeding the high end of our guidance. Higher volumes, increased factory utilization, disciplined cost management, and favorable product mix contributed to the strong performance. Second quarter operating expenses were $243 million, a sequential increase of $3 million, but still below the low end of our guidance, reflecting disciplined cost management. Second quarter operating margin was 22.6%. Adjusted EBITDA margin was 25.3%. both exceeding our expectations due to strong operating leverage in the model. Our integration of ad tech is progressing well. We remain on track to achieve our cost-energy target of $55 million within 18 to 36 months post-close. We exit the second quarter achieving annualized cost synergies of over $30 million. Net interest expense for the second quarter was $79 million, lower than we had anticipated, due primarily to favorable interest income and slightly lower interest rates relative to our forecast. Our tax rate for the second quarter was 35.5% above our expectations due to the geographic mix of income and changes in timing of tax credits and tax planning activities. We expect our tax rate to normalize in the third quarter. Net earnings for the second quarter were $88 million, or $1.32 per diluted share. Turning to our balance sheet and cash flow, we exited the second quarter with cash and short-term investments of $758 million compared to $880 million in the first quarter. Free cash flow in the quarter was a negative $77 million, primarily a result of the lingering effects of the ransomware incident on working capital needs and timing of income tax payments. We expect our cash conversion cycle to improve in the third quarter in free cash flow to return to more normalized levels. We maintain an undrawn revolving credit facility of $500 million and exit the quarter with gross debt of $5.1 billion. Our net leverage ratio exiting the second quarter was 4.3 times based on a trailing 12-month adjusted EBITDA on a combined company basis. Existing with prior quarter, we made a dividend payment of $15 million, or 22 cents per share. Before I discuss our third quarter outlook, I'd like to touch upon the non-cash goodwill and intangibles impairment charges in the quarter, which total $1.8 billion, associated with our material solutions division, which represents the former Adatech business, and our equipment solutions business, which represents the former Electro-Scientific Industries business. The current market environment, particularly the software demand in the PC and smartphone markets, is the primary driver of both write-downs, with higher market interest rates playing a significant role in the Adatech impairment analysis as well. As John indicated in his prepared remarks, we are very excited about the opportunity ahead of us in advanced packaging. In fact, since we announced our intent to acquire Adatech just over two years ago, the industry has increasingly recognized how much advanced packaging is critical to high-performance computing applications, including AI. Our leading position in deep customer relationships allows us to see inflection points earlier as we help our customers solve the greatest challenges on the horizon. That's why we assemble the broadest set of capabilities across chemistry and equipment that serve this attractive market in the growth we see ahead of us. I'll now turn to our third quarter outlook. We expect third quarter revenue of $930 million, plus or minus $50 million. By end market, our outlook is as follows. Revenue from a semiconductor market of approximately $370 million, plus or minus $20 million. Revenue from electronics and packaging market of approximately $225 million, plus or minus $10 million. And revenue from a specially industrial market of approximately $335 million, plus or minus $20 million. This outlook includes approximately $30 million of revenue we expect to recover from the ransomware incident in the first quarter. Therefore, we expect to essentially be caught up with the backlog of investment deliveries by the end of this quarter. Moreover, as John mentioned, we continue to expect revenue in the second half of 2023 to be slightly higher than the first half across all three end markets. Based on anticipated product mix and revenue levels, we estimate a third quarter gross margin of 45%, plus or minus one percentage point. We expect operating expenses of $245 million, plus or minus $5 million, consistent with second quarter levels. The third quarter, we estimate adjusted EBITDA of approximately $210 million, plus or minus $26 million. The third quarter net interest expense expected to be approximately $85 million, reflecting projected interest rate increases. Our tax rate expected to be approximately 26% for the third quarter. And given these assumptions, we expect third quarter net earnings of 98 cents per diluted share, plus or minus 29 cents. In summary, MCAS has recovered well following the ransomware incident in the first quarter, and despite the soft end market backdrop in the first half of 2023, delivering solid, non-gap profitability. This is a testament to our more resilient and diversified business model following the AdTech acquisition, our ability to drive strong factory utilization and disciplined cost management, and our leading portfolio of foundational solutions essential to the markets we serve. Moving forward, we are focused on maintaining the high levels of execution we delivered in Q2, returning to normalized free cash flow generation, and working towards further deleveraging our balance sheet.