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Operator
Good day, and thank you for standing by. Welcome to the NKS Instruments fourth quarter and full year 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 1 1 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 Risick, Vice President of Investor Relations.
David Risick
Please go ahead. Good morning, everyone.
spk05
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 fourth quarter and full year 2023, which are posted to our investor website at investor.mks.com. As a reminder, various remarks about future expectations, plans, and prospects are for MCAS 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 2022 combined results of MCAS and Adatech 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. 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.
David Rizek
Good morning, everyone, and thank you for joining us today. MCAS delivered solid results in 2023 against a challenging market backdrop. For the full year, we delivered revenue of $3.6 billion, adjusted EBITDA of $863 million, and net earnings per diluted share of $4.43. Our performance highlighted the resilience of our business. We faced headwinds from a softer demand environment in our semiconductor and electronics and packaging markets, but we generated solid profitability due to a combination of of prudent cost controls, and the underlying strength of our broad portfolio of proprietary solutions. We appreciate the continued support of our customers who rely on MKS to solve their toughest challenges and on our employees who work relentlessly to deliver on the MKS promise. Our results also reflect our first full year operating with Adatech as a combined, capable global company. The addition of Adatek's industry-leading chemistry and plating equipment solutions have expanded our broad range of capabilities and provided us with a higher mix of consumables and services revenue. We are on track to achieve our targeted cost synergies from the Adatek acquisition. I'm also encouraged with the progress we made in 2023 in positioning for future revenue opportunities as our electronics and packaging teams are actively engaged with key customers on their next generation designs for advanced packaged substrates, a critical enabler for new applications such as artificial intelligence. Most industry observers expect the recovery in our end markets to slowly unfold in the second half of this year. We have established ourselves as a critical enabler of advanced electronics with our foundational solutions for the semiconductor and electronics and packaging markets. By staying focused on our innovation roadmaps, controlling costs, managing our balance sheet, and driving design wins with key customers, we are positioning MKS to generate attractive growth and value creation in the years ahead. Now let me discuss our fourth quarter results in more detail. We delivered revenue of $893 million, adjusted EBITDA of $218 million, and net earnings per due share of $1.17, all above the high end of our guidance range. Revenue from our semiconductor market exceeded our expectations, as we saw better-than-expected demand in certain product categories, such as plasma and reactive gas and analytical controls solutions. That offset a continued muted demand environment for our vacuum solutions for deposition and etch applications due to the industry downturn in NAND equipment spending, which remains at historically low levels. Demand for our photonic solutions for lithography, metrology, and inspection applications remained robust. In 2023, this business grew on a year-over-year basis and exited the year at more than 20% of our overall semiconductor revenue. Photonic solutions remain an important area of investment for MCAS. We expect it to be one of the key growth drivers for our semiconductor market in the years to come. As we look to the first quarter of 2024, We expect revenue in our semifinal market to be down sequentially from our better than expected fourth quarter as overall demand remains muted. While customer inventory levels of some of our product categories have eased, we expect continued drawdown in categories tied to memory spending. Turning to our electronics and packaging market, revenue is slightly better than expected due to the lumpiness of certain laser drilling equipment sales. Overall demand remains stable but muted. consistent with PC, smartphone, and server production volumes. That said, the long-term growth drivers for our electronics and packaging market remain as strong as ever. We frequently discuss how the trends of miniaturization and complexity are moving from semiconductors to other critical components of advanced electronic devices, including packaged substrates, which are a key building block of advanced packaging architectures. There are many packaging architectures enabling today's cutting-edge applications, of which TSMC's chip-on-wafer-on-substrate architecture, or COAS, is one. Let me walk you through how MKS is a foundational enabler to that architecture. For the COW, which represents the chip-on-wafer, we have a leading portfolio of critical subsystems across deposition, etch, lithography, metrology, and inspection applications that are integral to the manufacturing of individual semiconductors, as well as bonding these individual semiconductor chips to each other. We also have a small but growing chemistry business for this application. These stacks of chips are then packaged on top of silicon interposer, which is the W, or wafer, which is then integrated on a package substrate. This last step represents the O and the S in COAS. MKS has leading expertise in laser drilling chemistry, and plating equipment that addresses more than 70% of the critical process steps to manufacture these package substrates. Similar to transistor scaling for semiconductors, the lines, the spaces, and the interconnecting vias of a package substrate are getting smaller. The size of the substrate is getting larger. The number of layers in each package continue to increase. All of this creates more complexity and miniaturization And MKS is uniquely positioned with the broadest portfolio to help our packaged substrate manufacturing customers meet these challenges. As we look to the first quarter of 2024, we expect revenue from our electronics and packaging market to be down slightly on a sequential basis, primarily due to typical seasonality associated with the Chinese New Year. Turning to our specialty industrial market, revenue was slightly weaker than expected, primarily due to modest softness and demand for research and defense applications. As we look to the first quarter, we expect demand trends in our specialty industrial market to remain stable, with revenue to be relatively in line with fourth quarter levels. As a reminder, we leverage our R&D investments in our semiconductor and electronics and packaging markets to drive incremental revenue opportunities in our specialty industrial market, which is a more stable business with good margins and cash flow. Wrapping up, I want to thank the entire MKS team for their passion, dedication, and resilience this past year. In addition to weathering a softer end market backdrop, the MKS team worked tirelessly to resume normal production and deliver for our customers as we recovered from the ransomware event in the first quarter of 2023. The strength of our team, and our culture is reflected in the industry accolades we receive during the year, including being named to U.S. News & World Report's inaugural Best Companies to Work For in the Industrials and Business Services Industry list, as well as being named by Newsweek and Statista as one of America's most responsible companies for 2024. Finally, before I hand the call over to Seth, I want to thank him for his dedication and service to MCAS and to congratulate him on his upcoming retirement. Throughout Seth's long and distinguished career at MCAS, he has been instrumental to our growth and transformation. Seth's foresight, financial stewardship, and ability to navigate complex financial landscapes have earned him the admiration and respect of all who have had the privilege of working alongside him. Our search for his replacement is well underway. We look forward to updating you when we have named our next Chief Financial Officer. And now, I'd like to turn the call over to Seth. Thank you, John. Before we discuss our results and outlook, I just want to say a heartfelt thank you to the entire MKS team, as well as our shareholders for your support and partnership in the past 18 years. It's been a privilege to serve as Chief Financial Officer of MKS. I am proud to have been a part of the company's substantial growth and transformation over that period. MKS' strong operating model and unique position to capitalize across a number of attractive secular growth opportunities leaves me very excited about the company's future I look forward to following MCAS's continued success. Let me now cover our fourth quarter and full year results and provide some thoughts on our first quarter of 2024. Starting with the fourth quarter, we delivered revenue of $893 million above the high end of our guidance range, primarily due to better than expected revenue from the semiconductor and electronics and packaging markets. Revenue was down 4% sequentially and down 18% year-over-year. Turning to our end market results, Fourth quarter semiconductor revenue was $362 million, declining 1% sequentially and 28% year-over-year. Fourth quarter electronics and packaging revenue was $226 million, a decrease of 7% sequentially and 15% year-over-year. Due to the impact of foreign exchange and palladium pass-through, fourth quarter revenue declined 9% on a year-over-year basis. Moving to our specialty industrial market, revenue in the fourth quarter was $305 million, down 5% sequentially and down 3% year-over-year. Considering the impact of foreign exchange and palladium pass-through, fourth quarter revenue declined 3% year-over-year. In the fourth quarter, consumable services revenue across our three end market categories comprised 41% of our total revenue. Turning to our margins, we reported fourth quarter gross margin of 46% exceeding the midpoint of our guidance range. The more favorable gross margins were a function of unexpected volumes as well as favorable product mix. Our healthy gross margins reflect the value of our technological capabilities in the complex problems we solve for our customers. Fourth quarter operating expenses were $229 million below the low end of our guidance range. due to strong cost control, even though we had better than expected revenue. Fourth quarter operating margin was 20.3%, well above the height of our guidance range, due to higher revenue, favorable mix, and prudent cost control, resulting in robust operating leverage. We continued to work toward our cost energy targets with Adatech. We exited the fourth quarter delivering almost $50 million of annualized run rate cost synergies, on track to achieve our cost energy target of $55 million, actually in the second quarter of 2024. Fourth quarter, just the EBITDA was $218 million, also above our guidance range. Just the EBITDA margin was 24%. Net interest expense for the fourth quarter was $76 million, lower than we anticipated due to more favorable interest rates relative to our expectations. Our tax rate for the fourth quarter was 16%. Net earnings for the fourth quarter was $78 million, or $1.17 per diluted share. Turning to our balance sheet and cash flow, we exited the fourth quarter with more than $1.3 billion in liquidity, including cash and short-term investments of $875 million and an undrawn revolving credit facility of $500 million. We exited the quarter with gross debt of $5 billion. And last month, we successfully completed the refinancing of our $744 million secured tranche A term loans by raising incremental secured U.S. dollar and euro tranche B term loans. As a result of the refinancing, we extended maturity of the refinance debt to 2029, consistent with our existing tranche B term loans, and eliminated the financial maintenance covenant that applied while our tranche A term loan was outstanding. Based on current interest rates, we also expect the refinancing to result in modest interest savings. In addition, we made a voluntary debt prepayment of $50 million earlier this month, following the $100 million voluntary debt prepayment we made in the fourth quarter. We continue to prioritize deleveraging our balance sheet while managing the cash and investment needs of the business. In this context, it's worth noting that the first quarter typically has lower free cash flow due to timing of variable compensation payments. Our net leverage ratio exiting the fourth quarter was 4.7 times, based on trailing 12-month adjusted EBITDA of $863 million. For the fourth quarter, free cash flow was $146 million, and unlevered free cash flow was $194 million. Consistent with prior quarters, we made a dividend payment of $15 million, or 22 cents per share. Moving to full-year 2023 results, revenue was $3.6 billion, down 19% year-over-year on a combined company basis. Semiconductor revenue, total $1.48 billion, declined 28% year-over-year due to the decline in global semiconductor capital equipment spending. The largest driver of that decrease with significant decline in NAND spending, where we are a key enabler with certain subsystems, such as RF power generators for high aspect ratio etching. Electronics and packaging revenue was $916 million in 2023, down 19% year-over-year compared to combined company results in 2022. Including the impact of foreign exchange and palladium pass-through, electronics and packaging revenue declined 13% on a year-over-year basis. With an electronics and packaging market, total chemistry sales declined 10% year-over-year on a combined company basis, excluding the impact of foreign exchange and palladium pass-through. Specialty industrial revenue was $1.23 billion in 2023, down 4% year-over-year on a combined company basis, excluding the impact of foreign exchange and palladium pass-through. Sales declined 2% year-over-year. In 2023, the revenue split between our semiconductor, electronics, and packaging, especially industrial markets, was 41%, 25%, and 34%, respectively. For the full year, gross margin was approximately 46%, and operating margin was approximately 20%. Again, that performance is a reflection of the value of our proprietary and differentiated technology, as well as disciplined cost management. We are pleased with execution on margins given a lower level of revenue due to broader industry softness. Turning to cash flow, we generate operating cash flow of $319 million and free cash flow of $232 million. Furthermore, we generate unlevered free cash flow of $473 million for 13% of total revenue. We are pleased with the strength of the underlying cash generation in our business despite a challenging demand environment in our end markets. as well as a ransomware event in the first quarter of 2023. As our end markets recover, we expect cash generation to improve, which will enable us to accelerate our debt pay down. Now let me turn to our first quarter outlook. We expect first quarter revenue of $840 million, plus or minus $40 million. By end market, our outlook is as follows. Revenue from our semiconductor market of $330 million, plus or minus $15 million, revenue from electronics and packaging market of $210 million, plus or minus $10 million, and revenue from a specialty industrial market of $300 million, plus or minus $15 million. Based on anticipated product mix and revenue levels, we estimated first quarter gross margin of 45.5%, plus or minus 1%. For the first quarter, we expect operating expenses of $240 million, plus or minus $5 million. Sequential increases due to typical increase in fringe expenses will continue investments into the business. While operating expenses can fluctuate due to underlying business levels, we believe a $240 million to $250 million quarterly run rate is a reasonable estimate to think about OpEx for the balance of 2024. We'll also continue to manage our cost structure carefully. For the first quarter, we estimate adjusted EBITDA of $182 million, plus or minus $22 million. For the first quarter, net interest expense is expected to be $78 million, reflecting current interest rates, our recent refinancing, and the $50 million voluntary prepayment we made earlier this month. For the first quarter, we expect our tax rate to be approximately 24%. However, for the full year, we expect our tax rate to be approximately 20%. We are very pleased with execution optimizing our tax rate following the closing of the ATT&CK acquisition in August of 2022. In fact, absent any change in tax legislation, we now expect our long-term tax rate to be approximately 19% to 21% compared to the tax rate of 25% to 27% that we presented in our long-term financial model at our 2022 analyst day. Given these assumptions, we expect first quarter net earnings of $0.72 per diluted share, plus or minus $0.25. In closing, we performed well navigating through cyclosoftness in our end markets by focusing on what we can control. We maintained strong gross and operating margins. We prudently managed our cost structure while remaining aggressive in product innovation. We significantly lowered our tax rate through a series of tax planning initiatives, We optimized our balance sheet by extending certain debt maturities and simplified our debt structure by eliminating the financial maintenance coverage that applied to our existing debt. We reduced our cost of debt through repricing our USD term loan B. We maintained strong liquidity as we managed through a cyclical slowdown. And finally, we deployed more than 80% of free cash flow to debt paydowns. All of these actions have made MCAS a stronger company. We're well-positioned to capture long-term secular growth opportunities we see across our portfolio and translate that into attractive value creation for our shareholders. With that, operator, you can now open up for Q&A.
Operator
As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again.
David Risick
Please stand by while we compile the Q&A roster. Our first question comes from Joe Quattrochi with Wells Fargo.
Operator
Your line is now open.
Joe
Joe Quattrochi Yeah, thanks for taking the questions. Maybe first just to start as we kind of think about, you know, total revenue and your guidance for the first quarter and think about the seasonality for some of the businesses or in markets. How should we think about, I guess, the rest of the year? Do you view the March quarter as kind of the low point of revenue for the year?
David Rizek
Hi, Joe. It's John. I'll take that. You know, as you know, we only guide one quarter out. Visibility is limited as usual. But we certainly read the same things you do, and we're certainly in constant contact with our customers. And I think our view is consistent with the industry, meaning the first half is kind of consistent with current levels, kind of with our guidance. And then certainly the industry feels that the second half can be a little better. And our focus is really to continue to do the R&D for the future projects with our customers. And so, as you know, MKS has always been very lean and able to react very quickly to any changes in those assumptions. So, we are looking at a first half that's kind of consistent with what we just talked about and guided for Q1. Got it.
Joe
That's helpful. And then just as a follow-up, I think in the past you guys have talked about, you know, the number of MKS plus Addertech opportunities in your pipeline and I think a lot of them have still been kind of driven by Adotech. But just kind of curious, just as we turn over the new calendar year, if there's any update there on the number of opportunities there, and then maybe any color on just the number that are being driven by MKS.
David Rizek
Yeah, sure, Joe. So we've kind of alluded to double-digit numbers of customer opportunities with different customers, double-digit. And that remains the same. As you know, the development and work with the customers takes time because we're working on the next generation package substrates with these customers. As you know, Adatech has leading industry market share in that space, and the top 30 customers are their customers. So the majority of it is the synergy of Adatech and those relationships bringing over the laser groups. But our laser group also has had market share leadership in flex drilling, And there are examples there as well, customers there, where the laser group is bringing the Adatech opportunity into that customer.
David Risick
Perfect. Thank you. Thanks, Joe. Thank you. And one moment for our next question. Our next question comes from Krish Sankar with TD Cohen.
Operator
Your line's now open.
CapEx
Hi, thanks for taking my question, and Seth, thanks for all your help through the years. You'll definitely be missed. John, my first question is, last year your semi-business underperformed WFC. This year, arguably, WFC is expected to be flat, although the second half bias. Kind of curious how to think about your business because historically, you know, it seems like in the years when WFE improves, you should outperform WFE. But how to think about your business in a year when WFE is actually flat?
David Rizek
Yeah, that's a good question, Krish. Certainly, we look at our performance relative to WFE over the long term because, as you know, during the cycles, it varies when you're going up or going down. You know, many industry analysts are thinking of 2024 being flat, as you said, for WFE. I think the only characteristic I'd say that's a little different is when it's flat that long, the inventory burndown eventually finishes. And so even if it's flat, because there's just less inventory burndown, it should be beneficial to those of us in that part of the supply chain. And in our prepared remarks, we did call out that there have been many product categories where inventory burndown has completed, and we're kind of seeing a balance between what our customers are shipping versus what we're shipping to them. But it's not done yet, and we called out that memory, specifically product categories tied to memory, there's still, we believe, some inventory burndown that has to happen. And that is certainly going to be a function of how fast that part of the semi-market turns up.
CapEx
Got it, got it, got it. And then, you know, on the AdvoTech side, I guess I should say the PCB part of your business, is it fair to assume that the material side, which is your legacy AdvoTech business, that is really going to be driven by smartphone volumes? And on the PCB drilling side, one of the questions I get is, you know, even if smartphone units grow this year, they're still below the peak pandemic levels. So there is really no need to buy PCB drilling equipment. So I'm just kind of curious, can you help answer those two parts of the PCB question?
David Rizek
Yeah, I think there's no real change. The dynamics are very much determined by utilization versus capacity expansion. So no change there. And to your point, as utilization rates increase, we'll see that in the consumables part immediately and first. And just like in semi, once the utilization rates hit a certain level, our customers would then be making plans for capacity additions. And the CapEx then would follow, not just in laser drilling, but also equipment for chemistry plating. So what we're focused on now is making sure that we're designed in so that when those volumes of CapEx occur, we're going to see that volume. But the characteristics of the consumable part of our business versus the CapEx part haven't really changed.
CapEx
Got it. Thanks a lot, John. Thanks, Chris.
David Risick
Thank you. And one moment for our next question. Our next question comes from Jim Rashudi with Needham & Company.
Operator
Your line is now open.
Jim
All right. Thank you. Good morning. I wanted to go back to the comment about the E&P business and what you described as lumpiness in the laser systems business. So in other words, where did you see some strength? Was it in that legacy flex drilling, or did you see some momentum in the HDI laser systems business in the G02?
David Rizek
Yeah, Jim. Yeah, we can give you a little color on that. CapEx for lasers is a little lumpy in the packaging business. And the better than expected result in Q4 was really driven by laser drilling for the flex market.
Jim
Okay. And John, how would you characterize what you're seeing for the HDI portion of that business?
David Rizek
Yeah, I think it's still muted, Jim. I think, you know, you can see the utilization rates of many of our customers. And as you know, that's driven a lot by smartphones, PCs, and servers. And so, you know, some of our substrate customers publicly, you know, public companies have been, you know, down 30% year over year. So when those utilization rates pick up, then as, you know, my answer to Chris's question, we'll see that chemistry go up and then
Jim
that continues we'll see that capex investment happening but right now hdi capex seems still a little muted got it um just a follow-up question um on the uh the photonics solutions division the psd um you know we saw some a little bit more of a sequential decline in q4 I'm trying to understand that a little better. Is that the semi portion of that business maybe catching up with some of the weakness you've seen in other areas in semi business? Or is it just possibly a case of weakness in some of the other markets that's overall impacted the photonics, the PSD revenue?
David Rizek
Yeah, that's a good question. The PSD division, the semi-part of PSD, that has continued to be strong, as we mentioned in the remarks. And that's, as we said, going to be one of the bigger long-term drivers of our outgrowth in market share in WFE because of the exposure to lithography, metrology, and inspection. And so the slight downtick in PSD was really some muted demand in research and defense. relative to what our expectations were.
Jim
But that's not suggestive of any maybe change in the market in that non-semi portion of the business where you think it's, is it more of a timing issue, Joe? Are you seeing any change in dynamics in the market?
David Rizek
No, in fact, you know, The specialty industrials is made up of many markets, and some can be a little lumpy up and down, but in general, it's been a pretty steady business. Some of the industrials, for instance, like automotive, have actually been very, very steady. This particular quarter, we're just calling out a little bit of research and defense that was a little lower than our expectations, but the rest of the specialty industrial markets were very steady, actually.
Jim
Yeah, that just actually segues to the last question about automotive. Are you seeing any impact from all of the headlines we're seeing in automotive as it relates to the out-of-tech business?
David Rizek
Yeah, we see the same things you see a lot of the chip companies, right? They're just playing automotive, guiding down. But we really haven't seen that, Jim. It's been a very steady, steady business throughout the year, and kind of our expectation leads in Q1 as well.
David Risick
Okay, thank you. Thanks, Jim. Thank you. One moment for our next question.
Operator
And our next question comes from Steve Barger with KeyBank Capital Markets. Your line is now open.
Steve Barger
Hey, good morning. My first question is related to the cycle. In the past, you've talked about how SEMI and E&P are likely to recover in a similar timeframe but at different magnitudes. Do you still expect a more or less simultaneous recovery, or is there any scenario why one segment or the other would lag or not participate as the market recovers?
David Rizek
Yeah, thanks, Steve. It's a good question. I think, you know, in general, they are correlated because, you know, if you're making more chips, you're going to have to package them. I think our view is that they are going to continue to be correlated. The difference for MKIS is that our exposure is to semi is really about CapEx and our exposure, most of our exposure to E&P is consumable. So as we talked about earlier in the earlier question, we'll see that sooner E&P just because of the consumable nature of the business. And then CapEx there would follow as well.
Steve Barger
Right. Got it. And free cash flow has been in the $140 million range the last couple of quarters. Do you feel like that's stabilizing to the point where it could be more predictable around these levels as you go through the year and think about working cap and inventory?
David Rizek
Yeah, Steve, this is Seth. I'll take that question, obviously. So I think it's hard to get cash flow in any one quarter, but the inventory levels, as we talked before, has been really sticky because of the supply chain constraints. We're starting to see the inventory level sort of peak in the last quarter. That will be helpful going forward as well. But fundamentally, as you outlined here, at certain revenue levels, which we're hitting right now, the cash flow becomes quite robust. Q1 is a little more working capital requirements because of variable compensation payments. But Q4, we're very pleased with cash flow, very strong execution on margins and on OPEX. They'll continue through 2024 as well. So it's hard to predict exactly cash flow each quarter, but I would expect cash flow to be more robust going forward as a revenues pickup.
Steve Barger
Got it. Thank you.
Operator
Thank you. I'm showing no further questions at this time. I would now like to turn it back to David Rizek for closing remarks.
David Rizek
Yes, I'd like to thank everyone for joining the call. And operator, you can close the call.
David Risick
This concludes today's conference call.
Operator
Thank you for participating. You may now disconnect.
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