Q3 2022 MKS Instruments Inc Earnings Call

November 3, 2022

Okay.

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 in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question. During this session you will need to press star one one on your telephone keypad at this time I would like to turn the conference over to Mr. David <unk>. Mr. <unk> you may begin sir.

Good morning, everyone I am David <unk>, Vice President of Investor Relations and I'm 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 close 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 8-K filed with the SEC on August 17, 2022, and any subsequent quarterly reports on Form 10-Q.

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 MKS and <unk> limited, which MKS acquired on August 17th 2022, or on a U S GAAP basis GAAP basis.

And include adjustments.

Second form 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 <unk> 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 a reconciliation of our GAAP and non-GAAP financial measures now I'll turn the call over to John .

Thanks, David and good morning, everyone and thank you for joining US today, the third quarter marked a major advancement in <unk> long term strategy as we completed the acquisition of <unk> limited.

<unk> further broadens mks's capabilities by bringing leadership in critical chemistry solutions for advanced electronics and specialty industrial applications.

We are pleased to welcome the talented global team of over 4000, new employees to the <unk> 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.

Of which over 360 million was from Alphatec.

Excluding the partial quarter contribution from AMETEK, our revenue exceeded the midpoint of our guidance range and was another quarterly record.

We continue to execute in a challenging environment, the supply chain constraints and inflationary pressures.

Well, 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 will 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 that attack.

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.

Further enhance the synergies between our critical photonics sub systems and our laser systems.

As a result going forward and in our third quarter 10-Q, the financial results of the equipment solutions Division will be combined with the Photonics solutions Division.

And the AMETEK business operates as a separate division.

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 a focus of our external reporting.

Now I'd like to provide more detail on our third quarter results and my thoughts as we move as we look into the fourth quarter.

Semiconductor market revenue reached another record in the third quarter, we saw broad based demand across our portfolio.

Our market leadership in RF power for dielectric etch continues to be a significant driver.

And we delivered another record quarter.

Benefiting from investments into leading edge <unk> NAND.

Also continued to gain traction in our 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 cleaning applications.

We also had a record quarter in our analytical and control solutions.

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.

For the third quarter.

We have also seen in moderation and order rates in the fourth quarter, and we expect wafer fabrication equipment spending to decline in 2023 is the industry scaled back investments to restore supply demand balance.

Turning to our advanced electronics market revenue from our flexible Pcbs via drilling systems remain muted in the quarter as expected.

Demand for our chemistry solutions moderated and a quarter due to weakening and market demand for electronics, such as smartphones and <unk>.

However, we saw strong demand for our planning 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 acquisition our teams have been an active discussions with customers outlining the unique value proposition behind our combined laser drilling and chemistry expertise optimize the interconnect.

We believe this is an increasingly critical focal point and 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 P. C D market.

Packet substrates of becoming critical building block of heterogeneous computing architectures, such as Chiklis as well as other advanced computing applications.

Today, we occupy a uniquely differentiated position by virtue of our market leadership in chemistry solutions.

With a laser drilling capabilities of our geode platform.

Are 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 signs of market.

And the media turn.

Term, we expect that macro economic 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 lifestyle 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, the man was steady in the third quarter, and we expect G. M. F. Two benefit once supply chain constraints, he's still growth will ultimately be anchored by and 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 without mk's execute in the third quarter.

While the macroeconomic backdrop as a factor we are closely watching I'm very excited about our long term positioning for the numerous secular trends supporting encases 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 he'll cover a third quarter results and provide additional detailed guidance for the fourth quarter.

In the third quarter, we delivered revenue of $954 million and net earnings per share of $2.74.

Which include the partial quarter contribution from added tax following the closing of the acquisition.

This was in the attic acquisition, we delivered record revenue in the third quarter and exceeded the midpoint of our guidance range led by record revenue from a semiconductor market.

On a pro forma basis with third quarter, we live in revenue of $1.1 billion.

And adjusted pro forma basis, we live in just to EBITDA of $327 million.

Furthermore, even though we delivered strong financial results recent foreign exchange volatility resultant approximate mid single digit headwind to overall year over year revenue growth on a pro forma basis.

Followed the addict acquisition, our revenue mix is more balanced by and market on a pro forma basis for the third quarter revenue from a semiconductor market was 48%. It was 26% each from our advanced electronics and specialty industrial markets.

In addition, we now possess a higher mix it more consistent consumables and service revenue.

Which made up about 37% of overall pro forma revenue for the third quarter.

Now I'm trying to end market results will be commenting on pro forma revenue in changed from prior periods on a pro forma basis.

We delivered record pro forma revenue from a semiconductor market in the third quarter, increasing 4% sequentially to 552 million and growing 9% year over year.

We saw a broad base strength from across our vacuum portfolio, while growth in our photonics 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 it through our own.

MS. We estimate the overall inlaws 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.

Which were advanced electronics market pro forma revenue third quarter was $296 million growing 1% sequentially and declining 9% year over year.

As you may be aware the cost of palladium mix. It takes different portion of overall cost of goods sold for <unk> chemistry business.

In order to insulate itself typical market based price fluctuations in palladium Adtec is implemented and effective pass through pricing mechanism to customers.

In this context, when the effects of palladium pricing pass through revenue as.

As well as foreign exchange headwinds pro forma advanced lit trucks revenue was up 1% on a year over year basis.

And especially industrial market, we delivered pro forma revenue towards $92 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 specialty industrial revenue grew 7% year over year.

On a standalone basis for MKS Sunni partial quarter contribution from the Attic acquisition, we ask you to 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 report third quarter gross margin $44, 9%.

Well known supply chain inflationary pressures.

We are pleased with how we exited in the quarter continue to work hard and dressed in these macroeconomic factors.

Third quarter operating expenses were $189 million up 35 million sequentially, primarily due to the partial quarter contribution from Adtec.

Third quarter operating margin was 25.1% up 100 basis points sequentially.

We can do currently manage our cost structure, while maintaining our commitment to invest the organic growth opportunities that we believe and drove attractive longterm returns.

In addition, our integration of ethic progressing very well we're on track to achieve our cost safety target of $55 million within 18 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 a strong track record of M&A integration.

Third quarter, adjusted EBITDA was $268 million adjusted EBITDA margin was 28%.

Net is expense of the third quarter with $36 million <unk>.

Sequential increase of $30 million, reflecting the incremental debt associated with the <unk> acquisition.

In the quarter, we have made a interest rate hedges since that approximately 50% of our total debt outstanding is that a fixed rate.

Our tax rates, the third quarter was approximately 18% which benefit from transaction related expenses.

Net earnings for the third quarter $167 million or $2.74 per diluted share.

Excellent third quarter maintain strong liquidity and kept with cash and short term investments that $885 million and revolving credit facility of $500 million.

We exit the quarter with gross debt of $5.2 billion in.

And our net leverage ratio.

On a combined company basis with 3.3 times.

The third quarter operating cash flow was hundred $99 million in free cash flow of $173 million.

Each inclusive of $36 million acquisition integration and restructuring costs.

A capital expenditures in the third quarter with $26 million.

Consistent with prior quarter's me a dividend payment of $12 million or 22 per share.

I will now turn into a fourth quarter outlook for the combined company.

On a pro forma basis, we expect revenue from a semiconductor in advance of trucks markets to declines sequentially.

While revenue from especially industrial market goes back to me inconsistent 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 continue to take necessary steps to contract 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, approximately $240 million plus or minus $27 million.

The sequential the client adjusted EBITDA pro forma basis, as a function of lower projected revenues as well as a $20 billion foreign exchange gains recorded by <unk> and the pro forma third quarter period, which is an aspect to repeat in the fourth quarter.

The fourth quarter net is expense expect to be approximately $81 million, reflecting a full quarter of net it's expense associate with the Adtec acquisition.

As we've stated a primary folks delever a balance sheet, which we have demonstrated strong track record of doing so formula last two that science acquisitions.

Newport in 2016 and ESI in 2019.

Our tax rate expect to be approximately 27% for the fourth quarter.

This increase is due primarily to expect to the nicks of geographical <unk> associated with the <unk> acquisition for the fourth quarter.

Giving your assumptions, we expect fourth quarter net earnings of $1.34 per diluted share plus or minus 27.

In closing we are very excited to close the <unk> acquisition provides us with critical chemistry solutions for advanced electronics and specialty industrial markets.

Today, we are more scale company with a higher proportion of more consistent consumables and service revenues.

[noise] integration activities are well underway.

And we are well positioned to adapt to changing market conditions.

Excellent no long term long sitting strategy, a sustainable longterm growth and profitability.

But the now turn the call back the operator for Q&A.

Ladies and gentlemen, if you have a question or comment at this time. Please press star one one on your telephone keypad again, if you have a question or comment at this time. Please press star one one on your telephone keypad and.

In an effort to facilitate as many participants questions as possible. We ask that you. Please limit yourself to one question and one follow up if you have additional questions you are invited to rejoin the queue.

Please stand by while we compiled Q&A roster.

Our first question or comment comes from the line of City Hall from Deutsche Bank. Your line is open.

[noise] great. Thank you very much my first question is on semiconductors.

UN guiding queue for Sammy's revenue down, 20%, but when I look at you and largest customer the guiding roughly flat quarter of a quarter clinic for Q4, and then even if you're back how's it deferred revenue, they're not down nearly as much can you help us reconcile the difference and to the extent that you think the delta is driven by inventory adjustments.

At the customers do you think that will complete by the end of the quarter and maybe you can start shifting to the advanced starting in Q1.

Yeah. Thanks for the question of.

Fundamentally there are two drivers.

For the guide down for semi in queue for most of it is still driven by supply chain constraints. So it's not nothing to do with demand.

As I mentioned before the number of components that are constrained as fewer are fewer however components. We're seeing constrain are tied to some of our high value products and so that's the majority of it there's a little bit from China export restrictions, but mostly it's still a supply chain construe.

An issue.

Okay, maybe a follow up question I Wanna talk about gross margin.

Two guidance gross margin down for at 244.5%. So down 50 basis points can you walk us through some of the puts and takes that's impacting Q4 and more importantly, as we look beyond Q for not asking for specific guidance are there any one time charges that would come out in the first quarter or should we think about using incremental margins of 50.

Percent with the four Q at the base.

Going forward that test of like what are you thinking about it. Thank you yet.

This is Seth I'll take that question. So yeah. So on the on the Guy for the fourth quarter.

You, probably well know added tax margins are above are typical margins. So that's helpful. In the quarter it'd be helpful going forward for sure.

Really the primarily change in the margins are combined company basis is just lower volumes and the legacy Mkf's business. So that's really to drive or they are quite honestly is the biggest factor.

You know going forward in terms of guiding for margins will be announced a you know in December 14th what kind of walk through that little more detail by growth by markets and gross margins.

And on a combined company basis will be able to articulate kind of hard to look at the growth from the margins and operating margins going forward.

So I kind of wait for that so that he'll say to kind of play out that model in more detail.

Okay great.

Sorry city so.

For first quarter.

We will have normal innovation of.

<unk> accounting costs and cost of goods sold but we'll non-GAAP those items out otherwise really nothing.

Wherever unusual the first quarter.

Thanks.

Yep. Thanks it.

Thank you next question or comment comes from the line of Jim Richard Judy from Needleman Company Mister <unk>. Your line is open.

Hi, Thank you. Good morning, so yeah, we don't have a lot of history about how the attic Tech business performed during.

Periods of economic weakness, yeah, I guess with maybe the.

Exception of 2020, but I wonder if you can give us a little color on how you're thinking about the the electronics and the G M X business.

Yeah, potentially a recessionary cycle, including that consumers consumer loans business that gives you that I guess some support.

Hi, John Yeah. That's a great question. So we have some history, when we look back and added sack.

During any kinds of recessionary timeframes.

Because they have so much more of their revenue being consumables that they do not see the levels of decline that we typically see in the capex environment.

And so I think that's really going to help support.

The entire company.

Or any kind of recessionary downturns or even semi cyclical downturns.

As I think we all know the automotive market has been constrained as well and I think as those constraints ease that should also be helpful for that side of the editing business as well.

And China, if I follow up question just on supply chain, particularly in the in the semi business.

It's still a headwind, but what are your expectations as you as you look out over the next one to two quarter is that gonna be.

Largely behind you and then you're just dealing with these other factors, including the weaker WSB I think the export controls.

Did you ever think it's my expectation is that we were in first still a couple more quarters at least of constraints, but it has been getting better.

Even in our prepared remarks that did mentioned that it's a fewer number of components actually they were chasing so that's helpful.

And we just happened to be in a particular quarter, where some of those components are tied to some of our high value products. Obviously, we're working very hard to to.

Overcome those obstacles.

We are able to do that within the quarter of course, that's that's upside, but our guidance is basically based on what we see today.

Thank you.

Thanks, Jim.

Thank you. Our next question or comment comes from the line of Chris shrank car from Cowen and company standby.

Hi, Thanks for taking my question I had a couple of them first one I just wanted to double check.

You know, maybe my master strong women.

You guys are re segment of the divisions, but is your vacuum physicians, which I believe is primarily the semiconductor business.

Under the ruling of outgoing Wtt appear.

I think you're asking about 20 twenty-two crash yeah.

Yeah, I think it's slightly under growing WMC and I think as you know when when we were in.

Upcycle, we tend to outgrow it flattens out then we are kind of flattish then when there's a downturn of course, we underperform, but you know as we look at.

The long term performance of our semiconductor business with respect to WC. We plotted five years 10 years 15 years, we're still above 200 basis points higher than double USC over the long term.

The.

I mean, John just out of curiosity, but undergoing WC. This year. They may you've spoken about market share Vincent power supply.

Are you seeing any.

Shed lawsuits in other parts of <unk> business like vacuum components, so no problems and things like that.

Yeah, Chris, though we're not facts.

As you mentioned are power supplies shipments in Q3 were a record for that division again.

And you know when you look at the market share data from third parties, we either have held our own or gained and many of the categories that we have for vacuum. So right now we're pretty pretty happy with how each of the product groups of performing.

Got it got it and then a quick question for said just for modeling purposes.

In 2022, all should we think about interest expense tax rates.

Opex, if you had a zooming similar revenue living since December quota.

Yeah. So.

Tax rate on again will outline is more in the Annals day in a couple of months, but I'll give you some high level thoughts on NASA tax rate should be in that kind of mid 20% range made up of 20% range. You know going forward, that's kind of our goal there as well I think he has an interest rates I mean right now we're.

Looking at the queue for like a little over 6% were damaged right on our debt, we'd hedge half of that as we mentioned in the prepared remarks. So.

Look at the rate curves going out in the future, but they'll give you a sense of how best to to kind of model that and then again Opex I would say that will always be prudent managing our cost structure you saw in the third quarter were favorable legacy Mtf's side.

So is John Nan Shan was seeing something.

Potential slowdown in the semi cap space next year, so will respond to that as we've always done many times before.

But I think if you were to say you know steady state run rate business you know.

You'd probably see some inflationary impact on Opex, we take the cue for an annualized that usually first half of the year, we have wage increases however.

However, we've got a long standing policy and program to reduce and be more efficient in our cost structure. So that'll kind of dry those costs down on a steady state business. So I think he can rely on us to be pretty prudent our cost structure going forward.

But there's nothing icy out there right now in the queue for run rates that would drive that up substantially issue or even a steady state business.

Thanks, a lot Sir thanks, John Yep. Thanks, Thanks, Chris.

Thank you. Our next question or comment comes from the line of Joe <unk> from Wells Fargo Mister <unk> to your line is open.

Yeah. Thanks for taking the question.

The acquisition, how how should we think about the right level of cash that you need on the balance sheet you run the day to day operations and I guess, how do you think about balancing that with debt reduction during a cyclical downturn.

Yeah, Joe So I'll take it I'll take that question, though we modeled as we said before [noise].

The acquisition of $800 million of cash on the balance sheet and was that revolver $500 million on top of that so.

We thought very thoughtful.

Doing a number of modeling back we announced transaction the summer of 21, obviously again when the rates were higher in the Ah March April timeframe. So we feel very comfortable.

That quantum of cash can take us through any cycle and so that's kind of how we look at it we can certainly run the company a little later than that but our viewers to be again pretty you know very high bill liquidity on the balance sheet.

So what kind of maintain that level of cash going forward.

Then give it to our goal going forward and we have the same play, but we ran many times before with other debt financed transactions to delever pretty rapidly and again, that's our goal going forward as well that's always been our view.

With the rates being higher for sure that just doubles down in our strategy as well. So so I think to kind of wrap it up we were well tuned of the right environment. We do want to Delever very aggressively that is our goal and always has been and the amount of liquidity. We have on the cash on the balance sheet is pretty pretty substantial Frankie.

Whether to any potential.

Slowdown in the business and we look at that on a quarterly basis, and we put the high beams on we're always kind of reassessing that physician as well.

Got it and then maybe as a quick follow up and you talked about 40 per cent of the combined company now you know having a revenue basis somewhat recurring I guess is that the right way so to think about it and then.

Maybe it is there any way you can help us kind of understand how does that translate into maybe like EBITDAR or free cash flow.

Yeah sure I think that is the right way to think about it so the 37% 40% of Ah <unk>.

Quarter's revenue was rich.

Recurring are resilient if you will.

Service revenue and chemistry consumables.

And as Seth mentioned, the gross margins, Florida, the appetite business.

Actually higher than legacy in cash business.

The operating margins of the <unk> service business, which republish is actually very high as well.

So not only are those resilient revenues, but the profitability that comes off of them.

Is marginally higher than the rest.

And just add to that it's those rather than not tied to the sending cap cycle. So if you'll look forward and you have a view on semi cab softening.

Could actually increase its own company that's.

That's part of the theme on kind of the acquisition as well we've thought about about that recurring revenue is very important to us going forward.

Got it thank you.

Thank you. Our next question or comment comes from the line of Mark Miller from Benchmark Company Mister Miller Your line is open.

Alright, I just wanted to clarify you weren't talking about for 2023 in terms of semi.

<unk> pay around $250 million to $350 million from swimming is that correct.

Mark that's just what we view as the impact from.

The potential sanctions.

Line of business. So that includes both our direct business as well as any impacts from our indirect cut of indirectly through our OEM customers.

Interest expense for the December quarters that around $80 million.

81 male incorrect give or take yep.

In terms of these impacts.

What percent of the total.

In terms of semi spending what what percent of your semi spending the impact will be coming from the restrictions versus just general slowly.

Mainly driven by the impact the restrictions.

Yeah, well if you take the mid point of that range of 253 5300 call it or semi revenue in 2022.

It was on that order of $2 billion. So we're talking about 10% to 20% in 2015%.

Thank you.

Thanks Mark.

Thank you. This concludes our Q&A session I would like to turn the conference back over to Mister David risk for any closing comments.

Uh-huh.

Thank you for joining us today and for your interest in Mkf's Operator, you may close the call. Please.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program you may now disconnect everyone have a wonderful day.

The conference will begin shortly.

To raise your hand during <unk> you can dial star one one.

[music].

Uh-huh.

[music].

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 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 one one on your telephone keypad at this time I would like to turn the conference over to Mr. David Ryzik. Mr. Ritchie you may begin sir.

Yesterday after the market close 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.

During the call we will be discussing various financial measures unless otherwise noted all references to pro forma financial measures reflect MKS and AD Tech limited, which MKS acquired on August 17th 2022, or on a U S GAAP basis GAAP basis.

No.

And include adjustments adjustment.

Yeah.

To conform to accounting policies of MKS.

Also unless otherwise noted all income statement related financial measures will be non-GAAP other than revenue.

A detailed breakout of reported revenues by end market as well as <unk> 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.

A reconciliation of our GAAP and non-GAAP financial measures now I'll turn it over the call over to John .

Thanks, David and good morning, everyone and thank you for joining us today.

Third quarter marked a major advancement in <unk> long term strategy as we completed the acquisition of <unk> limited.

<unk> further broadens mks's capabilities by bringing leadership in critical chemistry solutions for advanced electronics and specialty industrial applications.

We are pleased to welcome the talented global team of over 4000, 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 <unk>.

Excluding the partial quarter contribution from <unk>, our revenue exceeded the midpoint of our guidance range and was another quarterly record.

We continue to execute in a challenging environment, the 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.

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 <unk>.

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 enhance the synergies between our critical photonics sub systems and our laser systems.

As a result going forward and in our third quarter 10-Q financial results of the equipment solutions Division will be combined with the Photonics solutions Division.

And the Alphatec 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 a focus of our external reporting.

Now I'd like to provide more detail on our third quarter results and my thoughts as we move as we look into the fourth quarter.

Semiconductor market revenue reached another record in the third quarter, we saw broad based demand across our portfolio our.

Our market leadership in RF power for dielectric etch continues to be a significant driver and.

And we delivered another record quarter.

Benefiting from investments into leading edge <unk> NAND we.

We also continue to gain traction in our 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 cleaning 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.

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 delivered more than 35% year over year organic growth in our photonics solutions for the semiconductor market.

Overall, our 700 market results in the third quarter were exception, even as we continue to face supply chain constraints in the quarter.

Given the nearly every semiconductor chip manufacturer in the world today is made possible by Encases 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 in 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 forma 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 scaled back investments to restore supply demand balance.

Turning to our advanced electronics market revenue from our flexible PCB via drilling systems remained 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 plant and 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 <unk> 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 and enabling the integration of advanced electronic devices.

In addition to our HDI market our capabilities are focused increasingly on packaging substrates, which is the fastest growing segment of the advanced PCB market.

Packaged substrates have become a critical building block of heterogeneous computing architectures, such as shippers as well as other advanced computing applications today.

Today, we occupy a uniquely differentiated position by virtue of our market leadership and chemistry solutions.

Along with our laser drilling capabilities of our <unk> platform.

Our positive engagements with customers, thus far confirmed 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.

Term, we expect that macroeconomic headwinds in electronics end 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 gms to benefit once supply chain constraints ease fill growth will ultimately be anchored by end demand for.

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 MKS executed in the third quarter, while the macroeconomic backdrop as a factor we are closely watching I am very excited about our long term positioning for the numerous secular trends supporting <unk> business opportunities.

Finally, we will host an analyst day on December 14th we will provide updates on our strategy market opportunities and long term financial model for the new combined company.

I'd like to turn the call over to Seth.

Thank you John I'll cover third quarter results and provide additional detail on guidance for the fourth quarter.

In the third quarter, we delivered revenue of $954 million and net earnings per share of $2 74.

Which includes a partial quarter contribution from <unk> following the closing of the acquisition.

Excluding the <unk> 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 revenue of $1 1 billion.

And on an adjusted pro forma basis, we delivered adjusted EBITDA of $327 million.

Furthermore, even though we delivered strong financial results recent foreign exchange volatility, resulting approximately 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 turning to end market results well be commenting on pro forma revenue in 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.

Per year.

We saw broad based strength from across our vacuum portfolio, while growth in our photonic 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.

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 advanced electronics market pro forma revenue in third quarter was $296 million growing 1% sequentially and declined 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 <unk> chemistry business.

In order to insulate itself in typical market based price fluctuations in Palladium AD Tech has implemented an effective pass through pricing mechanism to customers.

In this context, excluding the effects of palladium pricing pass through revenue as well as foreign exchange headwinds pro forma advanced electronics revenue was up 1% on a year over year basis.

And especially 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 and foreign exchange headwinds pro forma, especially industrial revenue grew 7% year over year.

On a standalone basis for MKS, excluding the partial quarter contribution from the <unk> 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 reported third quarter gross margin of 44, 9%.

Given well known supply chain inflationary pressures.

We are pleased with how we exited in the quarter continue to work hard to address these macroeconomic factors.

Third quarter operating expenses were $189 million up $35 million sequentially, primarily due to the partial quarter contribution from AD Tech.

Third quarter operating margin was 25, 1% up 100 basis points sequentially.

We can 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 ASIC progressing very well we are on track to achieve our cost synergy target of $55 million within 18 to 36 months post close.

Third quarter, adjusted EBITDA was $268 million and adjusted EBITDA margin was 28%.

Net <unk> expense for the third quarter was $36 million.

The sequential increase of $30 million, reflecting the incremental debt associated with the <unk> acquisition.

In the quarter, we estimated 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 were $2 74 per diluted share.

Exiting third quarter maintain 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.

On a combined company basis was three three times.

The third quarter operating cash flow was $199 million and free cash flow was $173 million.

<unk> closer to the $36 million in acquisition integration and restructuring costs.

Our capital expenditures in the third quarter with $26 million.

Consistent with prior quarters, we had dividend payment of 12 million or <unk> 22 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 prospect to make consistent with third quarter levels.

Overall, we expect fourth quarter revenue of $1 billion plus.

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 on a pro forma basis as a function of lower projected revenues as well as a $20 million foreign exchange gains recorded by AD Tech and the pro forma third quarter periods do not expect to repeat in the fourth quarter.

The fourth quarter net expense expected to be approximately $81 million, reflecting a full quarter of net <unk> expense associate with the <unk> acquisition.

As we've stated our primary focus delever, our balance sheet, which we have demonstrated strong track record of doing so following the last two that science acquisitions.

<unk> 2016, and ESI in 2019.

Our tax rate expected to be approximately 27% for the fourth quarter.

This increase is due primarily to the expect to the mix of geographical income associated with the <unk> acquisition for the full quarter.

Given your assumptions, we expect fourth quarter net earnings of $1 34 per diluted share plus or minus <unk> 27.

In closing we are very excited to close the <unk> acquisition provides us with critical chemistry solutions for advanced electronics and specialty industrial markets.

Today, we have more scale company with a higher proportion of more consistent consumables and service revenues.

Our integration activities are well underway and we are well positioned to adapt to changing market conditions and to execute on our long term long, saying strategy of sustainable long term growth and profitability.

Let's now turn the call back to the operator for Q&A.

Please standby, while we compile the Q&A roster.

Our first question or comment comes from the line of Sidney Ho from Deutsche Bank. Your line is open.

Great. Thank you very much.

My first question is on semiconductors.

You're guiding Q4, <unk> revenue down 20%, but when I look at your largest customer they are guiding roughly flat quarter over quarter for Q4, and maybe even if you back out the deferred revenue they are not down nearly as much can.

Can you help us reconcile the difference and to the extent that you think the delta is driven by inventory adjustments at the customers do you think that will complete by the end of the quarter and maybe you can start shifting to demand starting in Q1.

Yes, thanks for the question.

Fundamentally there are two drivers.

For the guide down for semi in Q4, most of it is still driven by supply chain constraints. So it has nothing to do with demand.

As I mentioned before the number of components that are constrained as fewer or fewer.

However, the components that we're seeing constrain are tied to some of our high value products and so that's the majority of it there's a little bit from the China export restrictions, but mostly it is still a supply chain constraint issue.

Okay.

Okay, maybe a follow up question I wanted to talk about gross margin.

<unk> guided gross margin down for at 244, 5% down 50 basis points can you walk us through some of the puts and takes that's impacting Q4 and more importantly, as we look beyond Q4, not asking for specific guidance are there any one time charges that would come out in the first quarter or should we think about using incremental margins of 50.

<unk> with the <unk> asset base.

Going forward that that's the right way of thinking about it. Thank you.

Yes. This is Seth I'll take that question. So yes, so on the on the guide for the fourth quarter.

You, probably well know <unk> margins are above our typical margins. So that's helpful. In the quarter would be helpful going forward for sure, but really that primarily change in the margins on a combined company basis is just lower volumes in the legacy MKS business. So that's really the driver. They are quite honestly is the biggest factor.

<unk>.

Going forward in terms of guiding for margins, while the analyst day in December 14th will kind of walk through that a little more detail by growth by markets and gross margins.

On a combined company basis, we'll be able to articulate kind of how to look at the growth and the margins and operating margins going forward.

So I kind of wait for that for that analyst day to kind of play out that model in more detail.

Okay, great. Thank you.

Sorry, Sandeep so.

For first quarter.

We will have normal amortization of <unk>.

Purchase accounting costs and cost of goods sold but we will non-GAAP those items out otherwise really nothing that we're aware of unusual in the first quarter.

Thanks, Ed.

Thank you. Our next question or comment comes from the line of Jim Ricchiuti from Needham <unk> Company. Mr. <unk>. Your line is open.

Hi, Thank you good.

Yeah.

So yeah, we don't have a lot of history.

How about how the analytics business performs during.

Periods of economic weakness I guess with the exception of 2020, but I Wonder if you can give us a little color on how you're thinking about.

Electronics and the GM business.

During a potentially recessionary cycle, including.

Consumers consumables business that gives you at I guess some support.

Hey, Jim its John Yes, that's great question so.

We have some history when we look back on that attack the dura.

Any kind of recessionary timeframes.

Because they have so much more of their revenue being consumables that they do not see the levels of decline that we typically see in a capex environment.

And so I think thats really going to help support.

The entire company.

During any kind of recessionary downturns or even semi cyclical downturns.

<unk>.

I think we all know the automotive market has been constrained as well.

And I think as those constraints ease that should also be helpful for that side of the aerotech business as well.

And John if I follow up question just on supply chain.

In the semi business.

It's still a headwind but.

What are your expectations as you as you look out over the next one to two quarters is that going to be.

Largely behind you and you are just dealing with these other factors, including the weaker WMC I think the export controls.

Yeah, Jim I think it's.

My expectation is that we're in for still a couple of more quarters at least of constraints.

But it has been getting better.

Even in our prepared remarks, I did mention that it's a fewer number of components actually that we're chasing so that's helpful.

And we just happen to be in a particular quarter, where some of those components are tied to some of our high value products. Obviously, we're working very hard to.

<unk>.

Overcome those obstacles.

And then we are able to do that within the quarter of course, that's that's upside, but our guidance is basically based on what we see today.

Thank you.

Thanks, Jim.

Thank you. Our next question or comment comes from the line of Krish Shankar from Cowen and company standby.

Hi, Thanks for taking my question I had a couple of them first one I just wanted to double check.

And then maybe my math is strong given.

You guys are re segmented.

Divisions, but.

<unk> vacuums positions, which I believe is primarily the semiconductor business.

On the drilling of outgoing WC this year.

I think youre asking about 2022 Krish, yes.

Yes, I think it's slightly under growing WMC and I think as you know when when we were in.

Upcycle, we tend to outgrow as it flattens out and we are kind of <unk>.

Flattish and then when there's a downturn of course, we underperformed, but you know as we look at the.

The long term performance of our semiconductor business with respect to WC. We plotted five years 10 years 15 years, we're still above 200 basis points higher than <unk> over the long term.

Got it.

John just out of curiosity undergoing WP this year I know you've spoken about.

Market share gains and power supply.

Are you seeing any share losses in other parts of your semi business like vacuum components.

And things like that.

Yes, Chris we're not facts.

As you mentioned RF power supplies shipments in Q3 were a record for that division again.

And when you look at the <unk>.

Market share data from third parties.

Either have held our own or gained in many of the categories that we have for vacuum. So right now we're pretty pretty happy with how each of the product groups are performing.

Got it got it and then a quick question as we've said just for modeling purposes.

In 2022, how should we think about interest expense tax rate and also opex.

Assuming similar revenue levels in the December quarter.

Yeah. So.

Tax rate again will outline this more on the analyst day in a couple of months, but I gave you some high level thoughts on NASA tax rate should be in that kind of mid 20% range mid to upper 20% range going forward.

That's kind of our goal there as well I think he asked on interest rates I mean right now we're looking at for Q4 like little over 6% weighted average rate on our debt we would.

Hedged half of that as we mentioned in the prepared remarks. So you kind of look at the rate curves going out in the future, but that gives you a sense of how best to kind of model that and then again opex I would say that.

We'll always be prudent in managing our cost structure you saw in the third quarter, we were favorable on the legacy MKS side.

So as John mentioned, we're seeing some.

Potential slowdown in the semi cap space next year. So we'll respond to that as we've always done many times before.

But I think if you were to say steady state run rate business.

You'd probably see some inflationary impact on Opex, if you take the Q4 and annualize that usually first half of the year, we have wage increases however.

However, we've got a long standing policy and program to reduce and be more efficient in our cost structure. So that will kind of drive those costs down on a steady state business. So I think he can rely on us to be pretty prudent on our cost structure going forward.

But there's nothing I see out there right now in the Q4 run rates that would drive that up substantially issue or even on a steady state business.

Thanks, a lot thanks, John Yes.

Thanks, Rich thanks Krish.

Thank you. Our next question or comment comes from the line of Joe <unk> from Wells Fargo. Mr. <unk>. Your line is open.

Yes, thanks for taking the question.

Post the acquisition, how should we think about the right level of cash that you need on the balance sheet to run the day to day operations and I guess, how do you think about balancing that with debt reduction during a cyclical downturn.

Yes, Joe So I'll take I'll take that question. So we modeled as we said before.

The acquisition $800 million of cash on the balance sheet, and we've got revolver $500 million on top of that so.

We thought very thoughtful.

Doing a number of modeling that we announced transaction in the summer of 'twenty. One obviously again when the rates were higher in the March April timeframe. So we feel very comfortable.

That quantum of cash can take us through any cycle and so that's kind of how we look at it we can certainly run the company a little leaner than that but our view is that would be again pretty very high build liquidity on the balance sheet.

So what kind of maintain that level of cash going forward.

And then kind of pivot to our goal going forward and we had the same playbook. We ran many times before with other debt finance transactions to Delever pretty rapidly and again, that's our goal going forward as well.

That's always been our view.

With the rates being higher for sure that just doubled down on our strategy as well. So so I think to kind of wrap it up we were well tuned up that rate environment.

We do want to Delever very aggressively and that is our goal and it always has been and the amount of liquidity, we have and the cash on the balance sheet is pretty pretty substantial franking to weather through any potential.

Slowdown in the business and but we look at that on a quarterly basis, and we put the high beams on we're always kind of reassessing that position as well.

Got it and then maybe as a quick follow up you talked about 40% of the combined company now having a revenue basis somewhat recurring I guess is that the right way so to think about it and then maybe is there any way you can help us kind of understand how does that translate into maybe like EBITDA or.

Free cash flow.

Yes, Joe I think that is the right way to think about it so the 37% 40% of.

The quarter's revenue was recurring or resilient if you will.

Service revenue and chemistry consumables.

And as Seth mentioned, the gross margins for the <unk> business is actually higher than legacy MKS business.

The operating margins of the MKS service business, which we publish is actually very high as well.

And so not only are those resilient revenues, but the profitability that comes off of them.

Is marginally higher than the rest.

And just to add to that it's those rather than not tied to the semi cap cycle. So if you look forward do you have a view on semi cap softening that percentage could actually increase in total company. That's that's part of the theme on kind of the acquisition as well.

We've thought about talked about that recurring revenue is very important to us going forward.

Got it thank you.

Thank you. Our next question or comment comes from the line of Mark Miller from Benchmark Company. Mr. Miller. Your line is open.

I just wanted to clarify you are talking about for 2023 in terms of SME.

Sales impact will be around $250 million to $350 million from slowing is that correct.

Mark that's just what.

What we view as the impact from.

The potential sanctions.

Business. So that includes both our direct business as well as any impacts from our indirect cuts of indirectly through our OEM customers.

Interest expense for the December quarter is that around $80 million.

81 million correct give or take yes.

And in terms of these impacts.

What percent of the total.

In terms of SME spending.

What percent of your semi spending the impact will be coming from the restrictions versus just general slowing.

It will be mainly driven by the impact of the restrictions.

Yes, well if you take the midpoint of that range of $2 $53 5300 call. It.

Semi revenue in 2022.

Is on that order of $2 billion. So we're talking about 10% to 20% in 2015%.

Thank you.

Thanks Mark.

Thank you. This concludes our Q&A session I would like to turn the conference back over to Mr. David <unk> for any closing comments.

Okay.

Thank you for joining us today and for your interest in MKS Operator, you may close the call. Please.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program you may now disconnect everyone have a wonderful day.

Q3 2022 MKS Instruments Inc Earnings Call

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