Good day, and thank you for standing by. Welcome to the MKS Instruments First Quarter 2023 Earnings Conference Call. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your speaker today, David Ryzhik, Vice President of Investor Relations. Please go ahead.

Good morning, everyone. I am David Ryzhik, Vice President of Investor Relations, and I'm 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 first quarter of 2023, which are posted to our Investor 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 annual report on Form 10-K for the year ended December 31, 2022. These statements represent the company's expectations only as of today and should not be relied upon as representing the company's estimates or views as of any date subsequent to today, and the company disclaims any obligation to update these statements. During the call, we will be discussing various financial measures. Unless otherwise noted, all references to combined company financial measures reflect the combined results of MKS and Atotech Ltd., which MKS acquired on August 17, 2022. Also, unless otherwise noted, all income statement-related financial measures will be non-GAAP other than revenue. Please refer to our press release and the presentation materials posted to our Investor website for information regarding our combined company results, non-GAAP financial results and a reconciliation of our GAAP and non-GAAP financial measures. For a detailed breakout of reported revenues by end market as well as Atotech and combined company revenues by end market, please visit our Investor website. Now I'll turn the call over to John.

Thanks, David. Good morning, everyone, and thank you for joining us today. I'm very pleased to report that we have restored our global operations following the ransomware incident we identified in early February. We are on track to meet our commitment to substantially recover revenue by the end of the second quarter. I can't say enough about how proud I am of the entire MKS family. Thanks to the dedication, hard work, and ingenuity of our 10,000-plus employees, we are a stronger and more resilient company today than we have ever been. I also want to take a moment to thank our customers and suppliers for their support and cooperation throughout this process so that we continue to deliver as a critical enabler to the industries we serve. With that, I'll review our operating environment, including our first quarter results and the trends we are seeing in the second quarter. We delivered first quarter revenue of $794 million, adjusted EBITDA of $142 million, and net earnings per diluted share of $0.48. We estimate the ransomware incident had a negative impact on revenue of approximately $160 million for the quarter. As Seth will detail, revenue for the quarter, excluding the impact of the ransomware incident, was a little lower than we anticipated. The difference reflected softer demand that developed in the latter part of the quarter, which was relatively more pronounced in our electronics and packaging market. In our semiconductor market, business levels continued to soften in the first quarter, consistent with the well-publicized decline in industry-wide WFE spending in 2023. We remain very engaged with our customers across a spectrum of opportunities in deposition, etch, lithography, metrology, and inspection. Our ability to invest through the cycles has been a key reason we have outperformed WFE and the critical subsystems market over the long term. In fact, as reported by TechInsights, our share of the overall critical subsystems market grew in 2022 on top of the gains we made in 2021. Our performance in 2022 exemplified our technical leadership and the breadth of our surround the Wayfair portfolio, where we gained share in a number of categories, including remote plasma sources, microwave power, liquid ozone, FTIR gas analysis, linear motion subsystems, and optical fiber thermometry. Our broad portfolio positions us well for when WFE spending recovers. Now more than ever, we are reminded of how important semiconductors are to our daily lives, and we firmly believe they will become even more important over time. This reliance on semiconductors will require not just more equipment, but also solutions addressing increased miniaturization and complexity in semiconductor design and manufacturing, and MKS is uniquely positioned as the broadest critical subsystem solutions provider in the industry, enabling more process steps in the fab than anyone else in the world today. As we look into the second quarter, we anticipate demand for semiconductor capital equipment to remain muted, consistent with expectations for a decline in WFE spending in 2023. Turning to our electronics and packaging market. Revenue was below our expectations, but consistent with softness in demand for global electronics, such as PCs, servers, and smartphones. Customers scaled back production, which impacted our chemistry sales as well as delayed delivery of plating equipment for PCB and substrate applications. That said, we expect demand to improve sequentially in the second quarter due to additional working days in the quarter and delivery of equipment pushed from the first quarter. We are pleased with the progress of the integration of Atotech both from a cost perspective and in establishing the value proposition of our combined proprietary chemistry and laser drilling solutions, which positions us at the forefront of what we call optimized the interconnect. This is the next frontier in the integration of semi and PCB design for advanced electronics. On our last earnings call, I noted that we had received our first HDI laser-driven order from a long-time Atotech customer. Since then, we received our second HDI order from another Atotech customer. These wins were a result of the combination of Atotech's long-standing relationships in the HDI market and the reference wins that our GEO laser drilling tool had already achieved in an emerging market application. It's early in the game, but we are very pleased with customer interest in our combined capabilities as it provides initial validation of the potential for revenue synergy. At our Analyst Day in December, we discussed how package substrates are a critical building block for electronic devices and in particular, high-performance computing architectures. I'm pleased to announce that we recently held an expansion ceremony at our Yokohama Tech Center in Japan, which included the introduction of two new significant products. The first is an extension of our ESI Geode drilling platform, which is geared towards next-generation package substrate applications such as ABF buildup laminate processing. Our proprietary via drilling technology enables the highest throughput and lowest cost per part for advanced flip chip ball grid array packaging, which is critical for high-performance computing applications. The second new product is our Atotech G-Plate vertical desmear and electroless copper plating tool for next-generation package substrates. This new tool will support customers in their yield optimization and next-generation process development for advanced packaging applications with lines of space below 5 microns. These product announcements further extend our capabilities as a foundational solutions provider for advanced PCB and substrate applications as we are the industry's only integrated provider of advanced laser drilling, proprietary chemistry, and horizontal and vertical plating solutions. As the defining trends of miniaturization and complexity dominate advanced PCB and substrate manufacturing as they did in the semi industry, we are well positioned to become the industry's go-to technology enabler. Turning to our specialty industrial market. Business levels softened slightly on a sequential basis in the quarter. However, our GMF business held up well. Looking out to the second quarter, we expect demand to remain fairly steady. In summary, while the year got off to an unexpected start, we have rebounded well operationally and are delivering affected shipments to customers. We're also building early momentum with customers for our optimized the interconnect offering. Overall business levels have softened entering the second quarter, but we remain optimistic about the quarters to come. We expect MKS's total revenue in the second half of 2023 to be slightly higher than the first half levels, driven by a modest improvement across each of our three end markets. We will continue to keep a close eye on near-term macro and industry-specific conditions. Longer term, we are as bullish as ever on the secular tailwinds and attractive growth opportunities across our markets, and we intend to seize them. Now I'd like to turn the call over to Seth.

Thank you, John. I will cover our first quarter results and provide details on our outlook for the second quarter of 2023. Starting with the first quarter, our revenue was $794 million. As John mentioned, our global team executed well during a challenging period for the company as we worked through store operations following the ransomware incident. We estimate the negative impact to revenue was approximately $160 million for the quarter, and our team worked diligently to restore production relative to our initial expectations of at least a $200 million impact when we reported our fourth quarter results. While recovery has gone well, we've seen a softening of business levels relative to our prior outlook, mainly in the electronics and packaging market. As a result, and excluding the impact of the ransomware incident, we estimate first quarter revenue would have been lower than our original expectations. Our outlook indicates we expect softness in overall business levels to continue in the second quarter. However, we see a slight improvement in the second half of the year. Turning to our end markets for the first quarter. As a reminder, the ransomware incident only impacted our Vacuum Photonics Solutions divisions. Therefore, we mostly felt an impact in our semiconductor and specialty industrial markets and to a lesser extent to the electronics and packaging market. We expect to recover approximately 95% of this revenue, with the remaining 5% largely tied to a transactional catalog business in our specialty industrial market. Against this backdrop, semiconductor revenue was $309 million in the first quarter, declining 38% sequentially and 37% year-over-year, primarily due to the negative impact of the ransomware incident as well as lower industry demand for semiconductor capital equipment. We estimate the ransomware incident impacted our semiconductor revenue by approximately $110 million in the first quarter. Excluding the impact of the ransomware incident, we estimate semiconductor revenue was down approximately 17% sequentially and 14% year-over-year. We expect to make up approximately 75% of that delayed revenue in the second quarter and virtually all the remaining balance by the third quarter. While the first quarter was challenging, we have deep relationships with our customers and work closely with them to restore shipments as quickly as possible. Turning to the electronics and packaging market, revenue was $222 million, a decrease of 17% sequentially and 24% year-over-year, with Q1 2022 representing combined company results. Excluding the impact of foreign exchange and palladium pass-through, first quarter revenue declined 20% year-over-year on a combined company basis. We estimate the ransomware incident has only nominally impacted our electronics and packaging revenue. We expect this to be substantially recovered in the second quarter. As John mentioned, our chemistry and plating equipment sales were negatively impacted by the industry slowdown in global electronics demand. Our chemistry revenue declined 13% year-over-year, excluding the impact of foreign exchange and palladium pass-through, reflecting the widely publicized slowdown in unit production volumes across PC, smartphone, and server applications. To add some context, according to Gartner, overall PC shipments declined 30% year-over-year in the first quarter, and smartphone shipments declined 12% year-over-year. Because there are more factory working days in the second quarter due to the Chinese New Year holiday in the first quarter, we expect electronics and packaging revenue to improve sequentially in the second quarter. In addition, we expect revenue to grow in the second half compared to first half levels. Moving to our specialty industrial market, revenue in the first quarter was $263 million, declining 17% sequentially and 18% year-over-year, with Q1 2022 representing combined company results. We estimate the ransomware incident impacted specialty industrial revenue by approximately $45 million in the first quarter, which we expect to recover approximately $20 million in the second quarter and mostly the remainder in the second half of the year. Excluding the impact of the ransomware incident, foreign exchange, and palladium pass-through, first quarter revenue declined approximately 2% year-over-year on a combined company basis. We do not expect to recover a nominal amount of revenue in this part of our business due to the transactional book and turn nature of orders that we generate through our catalog business. In the first quarter, consumables and service revenue across our three end markets comprised 43% of our total revenue. Turning to our margins, we reported first quarter gross margin of 42.2%. The sequential decline of 370 basis points was primarily due to the underutilization of our factory associated with the ransomware incident. First quarter operating expenses were $240 million, a sequential decline of $2 million due to lower variable compensation associated with the reduced revenue levels in the first quarter, as well as prudent cost control. The first quarter operating margin was 12.1%. Adjusted EBITDA margin was 17.8%, both negatively impacted by lower revenue volumes as well as factory underutilization associated with the ransomware incident. Our integration of Atotech is progressing well and remains on track to achieve our cost synergy target of $55 million within 18 to 36 months post-close. We exited the first quarter achieving annualized synergies of $25 million. Net interest expense in the first quarter was $76 million, slightly lower than we anticipated due to favorable interest income. Our tax rate for the first quarter was a benefit of 47%, driven by a geographic mix of earnings in the quarter. Net earnings for the first quarter were $32 million or $0.48 per diluted share. Turning to our balance sheet and cash flow. Despite the usual challenges we faced, we exited the quarter maintaining strong liquidity with cash and short-term investments of $880 million and a revolving credit facility of $500 million. We exited the quarter with gross debt of $5.1 billion. Our net leverage ratio exiting the first quarter, which is calculated on a combined company basis, was 4.0x based on trailing 12-month adjusted EBITDA. For the first quarter, operating cash flow was $37 million, and free cash flow was $20 million but negatively impacted by the ransomware incident. Consistent with prior quarters, we had dividend payments of $15 million or $0.22 per share. I'll now turn to our second quarter outlook. We expect second quarter revenue of $980 million, plus or minus $50 million. While we normally do not provide specific guidance by end market, given the different moving pieces such as recovery of ransomware revenue and underlying business levels, we believe a little more granularity would be helpful. With that, in the second quarter, we expect revenue from the semiconductor market to be approximately $400 million, plus or minus $20 million; revenue from electronics and packaging market to be approximately $240 million, plus or minus $10 million; and specialty industrial market to be approximately $340 million, plus or minus $20 million. Excluding the impact of the ransomware incident for the first and second quarters, we estimate second quarter revenue of approximately $870 million, which represents a sequential decline from the first quarter. We expect this to be primarily a result of softer revenue from the semiconductor market, reflecting declines in wafer fab equipment spending, partially offset by improvements in revenue from electronics and packaging and specialty industrial markets. Based on anticipated product mix and revenue levels, we estimate second quarter gross margin of 45%, plus or minus 1 percentage point. We expect operating expenses of $255 million, plus or minus $6 million. The sequential increase from the first quarter level is due to higher revenue volumes, timing of annual merit increases, variable compensation, and normalization of product spending following the ransomware incident. For the second quarter, we estimate adjusted EBITDA of approximately $223 million, plus or minus $27 million. For the second quarter, net interest expense is expected to be approximately $82 million, reflecting slightly higher interest rates compared to the first quarter, and our tax rate is expected to be approximately 27% for the second quarter. Given the tax benefit we recorded in the first quarter, along with our guidance for the second quarter, we expect our tax rate to be higher in the second half to arrive at an estimated full-year rate of 27%, which is within our long-term model range. Given these assumptions, we expect second quarter net earnings of $1.13 per diluted share, plus or minus $0.29. In summary, despite unusual challenges, we executed well on driving profitability in the first quarter. Moving forward, we are focused on resuming strong free cash flow generation, realizing acquisition synergies, and executing our disciplined strategy of deleveraging our balance sheet. With that, I'll turn it back to the operator for Q&A.

Our first question comes from the line of Steve Barger of KeyBanc Capital Markets.

Great to hear about that second system order from an Atotech customer. Are you surprised by the timing of that given how tough the cycle has been? And can you talk about customer engagement around the combined advanced packaging applications versus what you expected given current conditions?

Steve, it's John. Thanks for the question. As I said last quarter, it's a bit of a bluebird a little sooner than we'd expect for these, but I think it does validate the thesis for the acquisition, the synergy, and combined capabilities of Atotech chemistry solutions and chemistry equipment as well as laser drilling. You're right. The industry is a little more muted at this point, but during these times, design wins continue and design work continues, and that kind of interaction we have with our customers continues to be very strong. As we mentioned in the prepared remarks, we had a ceremony at the Yokohama Tech Center, and many customers were invited, and we had great participation. We got to give them a tour of two brand new capital equipment, a laser tool and Vitrocoat tool, a vertical Vitrocoat tool. So that engagement remains very strong, and we're really happy to see that.

And for the electronics chemistries and plating business, can you remind us, is it basically a one-to-one relationship between volume and fab utilization rates, meaning as the cycle turns, do you see an immediate increase in volume?

I think that's how we look at it, especially the chemistry part. Obviously, that is very much utilization dependent. So I think that's the latter half of Q1 we started seeing some of that slowing down, and that's what caused the slight drop in Q1. As we talk to customers, as we talk to and read about the industry and plans by our customers, that's why we think that number one, Q2 will be a little better, more working days, mostly. That is the assumption. And then the second half, we think, will be slightly better because we see the markets improving slightly in terms of utilization rates.

Our next question comes from the line of Krish Sankar with TD Cowen.

I have two of them. The first one, John, if I look at your commentary on slicing revenues slightly above, it does imply that September quarter revenue will be sequentially down from June of $980 million, but I understand June had some impact from the ransomware. So if I strip that out, it seems September could be up from June, excluding ransomware. Is that the way to think about it?

Krish, I think that is the way to think about it. So I think your question is, excluding ransomware, is Q2 kind of a trough quarter. I think that's the way to look at it. And so the second half is going up slightly in all three markets. And so that's how we are seeing the market at this point.

Just to add to that, too, Krish, the second half obviously will include revenue that we didn't ship in the first quarter that will roll into the second half of the year. When we say slightly higher, that's above kind of those rollover revenue numbers. So it's actually increasing in the markets.

Got it. And then just out of curiosity, this is my follow-up, regarding Q2 being the trough in semi revenues. I understand some of your customers have also spoken about running at these Q2 revenue levels into Q3 and Q4. But historically, during downturns, you tend to lag your customers because of the inventory usage, but that doesn't seem to be happening based on what some of the other subsystem folks have mentioned. I'm kind of curious why you think that's going on where your bottom is in tandem with your customers versus lagging them?

Well, I think we tend to precede our customers, obviously, our semi equipment customers. I think that's what we're seeing right now. I think the backlog was strong coming into Q1. A lot of that may add a little more confusion to the normal cycles. But I think what we see right now is a lot of inventory burn off in the market. We can see from the plans of our customers that it should be slightly up.

Our next question comes from the line of Joe Quatrochi of Wells Fargo.

A question on the materials solutions business, the improvement that you're expecting in the second half of the year. How much should we think about that being maybe more seasonally driven versus kind of a bottoming in Q2 of demand?

Joe, it's John. I think maybe I'll address Q2 first. As I said earlier, Q2 is really about more working days relative to Q1, as Seth said in his prepared remarks. I think to your question in the second half, there can be and it's usually some seasonality, especially with the consumer products part of the portfolio. But remember that the chemistry business for Atotech addresses not just the consumer products but also servers and industrials and all that. So it's a little broader. When you look at all the markets and all the data we're getting from all the customers, that's how we kind of come up with a slightly better second half versus first half. So it's not just the consumer markets only.

Got it. That's helpful. And then just as a follow-up, for Seth, how do we think about the cadence of voluntary debt paydown now that we kind of have the ransomware attack behind us? Should we expect that to start to pick back up this quarter?

Yes. There's been no change in our approach. We are actively looking to deleverage the balance sheet. We have done a $100 million voluntary payment back in the fourth quarter. That's kind of our lean going forward. We haven't given a bright line of that curve. That is certainly our policy and our desire and our goals. In Q2, because of the lower revenue we booked in the first quarter, will catch up in Q2. That might need a little more working capital required on the receivable side in Q2, so I wanted to give you full transparency there. Again, we think the back half of the year will be a little bit stronger, slightly up a bit, getting back to that free cash flow generation. So once that cash is generated, that's what we're going to put back to work to take off the term loan A off the balance sheet.

Our next question comes from the line of Sidney Ho of Deutsche Bank.

Great. I guess, if you strip out the impact of the ransomware, how do you think your semiconductor revenue for the full year versus what you thought two months ago? I know there's a lot of moving parts with more production cuts in memory and foundry. But your customers also talk about being able to ship more to China, and maybe lagging edge foundry and logic is a little bit stronger than they thought. Just wanted to get your thoughts on that.

Yes, Sidney, it's John. So you're asking me to predict semi again. I would say we came into the year certainly expecting the well-publicized downturn in memory CapEx. I think that's not a surprise. We've been monitoring foundry, and that's been operating kind of as we expected at the beginning of the year. But to your point, lagging edge does seem to be a little stronger, probably more than we expected, and the industry probably expected. As you've seen, obviously, China is now more clear on what we can ship to China, what our customers can ship to China. I think we have said that the impact of the October 7th restrictions on our revenue in China was a range of $250 million to $350 million at kind of 2022 run rates. I would say our view now is that's probably towards the lower end of that range is our view today.

Okay. That's great and helpful. I have a second question regarding the gross margin. I understand you projected the second quarter to be at 45%. Should we anticipate that to reach the usual fully normalized number and begin to rise as revenue increases in the second half of the year? Or are there lingering effects from the underutilization due to the ransomware incidents?

Yes, this is Seth. Yes. So the volume is the biggest driver for sure. So if you model revenue up, that would lead to an uptick on the overall margins as well, because the variable margin is higher than 45%. We talked earlier about inflationary pressures that everyone is facing. We take action to mitigate those going forward as well. Our goal is to drive gross margin improvement through those actions and product development, high-value offerings for our customers. That will continue to be our view on margins going forward. For short-term modeling, I think the way you want to look at it is the volume is the biggest driver.

Our next question comes from the line of Jim Ricchiuti of Needham & Company.

So specialty industrial ex the ransomware was down about 2% sequentially. Is that what you said?

Yes, Jim, I think what we said is we had about a $45 million impact from ransomware in Q1. I believe that number is correct, but we'll triple check that for you.

Yes, John, I want to mention that we lack extensive experience with the GMF segment of the business. We're noticing signs of a slowdown in various markets, particularly industrial ones. I am curious about your perspective on that segment as we approach the second half of the year. I'm not asking for specific guidance, but have there been any changes in demand trends? You mentioned that it is holding up relatively well.

Yes, that's right. And Jim, just to answer your first question, that 2% is year-over-year for the specialty industrial. As I said in the prepared remarks, as we look at all the specialty industrial markets, we do expect that market also to be slightly better in the second half than our first half. What has stayed pretty much stable in the first half ex ransomware, we see that it will also likely improve slightly in the second half. That's made up of many different markets, as you can imagine. That's what we're seeing today. I think it's a great stabilizing part of our revenue stream for the company now.

Got it. Seth, you mentioned synergies in Q1. Was that in line with your expectations going back to the December quarter? Or did things change just given what happened with the ransomware and the changing macro environment? I'm curious if that's been consistent. And how do we think about synergies on a go-forward basis?

Yes, the $25 million we realized annualized for the first quarter is probably better than we expected, I would say, six months ago. The team has done a really good job getting engaged and obviously finding opportunities. The MSD business was not impacted by ransomware. They had been operating as usual for the quarter. The takeaway is, we feel very good about the $55 million in 18 to 36 months; we're obviously trying to pull that low as best as we can. The $25 million, I think, is a little bit above our expectations. The teams have been really engaged in working on the right opportunities, and we think there's more opportunities moving forward as well.

Our next question comes from the line of Steve Barger of KeyBanc Capital Markets.

Seth, you mentioned getting back to better free cash flow generation in the back half. Can you estimate what free cash flow could look like this year? And more broadly, where do you expect free cash flow margin will run as your operations in the cycle normalize?

Yes. So thanks for the question, Steve. Obviously, I’m not giving guidance for the full year, but if we go back to the typical volume that we had pre-ransomware, we look at the cash flow off those quarters for a good indication of what we expect going forward. There's really nothing unique looking forward in Q3 and Q4 based on working capital requirements or profitability and our expectations for sure, that has any different impact on free cash flow. You saw kind of pre-ransomware. So I think if you look at those back quarters, you get a good sense of the free cash flow generation. There are always things we can do better. We will always challenge ourselves to drive more efficiency in working capital and profitability. So consider those things always front and center in how we're going to run the business. But that’s kind of how I look at our historical pre-ransomware metrics, giving you a good sense of the free cash flow generation we can pull off.

Got it. And this has been a tough cycle even before the ransomware attack. Does anything you've seen from the cycle, from the integration, change how you think about the level of the 2027 revenue and EPS targets, whatever the timing may be?

No, not at all. I mean, obviously, there's always cycles in any business, certainly in the semiconductor space, and we're well tuned to that. Everything we talked about at the Analyst Day, and what we're seeing today is entirely intact. We are well positioned across the markets we operate in. We gained share this past year in '22 in a very challenging environment on top of a very substantial share gain in '21. We're doubling down on that. The engagement with customers is really strong, and the interactions are very good. The R&D teams are fully engaged. So there's really no change in the fundamental piece of the business and how we grow long-term shareholder value. As John mentioned in the prepared remarks, the team has done a fantastic job navigating a very difficult supply chain environment in a ransomware incident, and we did better than we expected coming into this quarter. So no, no changes in our view. Looking out five years, you'll have these fluctuations for sure, but we can manage these pretty well.

I'd now like to turn the call back to David for closing remarks.

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

Thank you, and thank you for your participation in today's conference. This does conclude the program, and you may now disconnect.