Good day and thank you for standing by. Welcome to the MKS Instruments' Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would 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 second quarter of 2023, which are posted to our investor website at investor.mks.com. As a reminder, various remarks about future expectations, plans, and prospects for the webcast 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 and combined company revenues by end market and division, please visit our investor website. Now I'll turn the call over to John.

Thanks, David. Good morning, everyone. And thank you for joining us today. MKS delivered strong results in the second quarter, led by excellent execution in our semiconductor market, and strong cost management, as reflected in our better than expected margins. We delivered second quarter revenue of $1 billion, adjusted EBITDA of $254 million and net earnings per diluted share of $1.32. Revenue from our semiconductor market was above the high end of our expectations despite the widely publicized decline in wafer fabrication equipment spending. Our operations team executed well in shipping products from backlog, including those delayed due to the ransomware incident we experienced in the first quarter. Demand for our critical vacuum subsystems for deposition and etch applications declined considerably compared to a year ago, consistent with capital equipment spending trends, particularly for memory applications. However, demand for our Photonics solutions in lithography, metrology, and inspection remains resilient, offsetting some of the weakness. We anticipate continued strength in these Photonics applications. Design and activity remain robust, demonstrating that customers value the unique capabilities MKS offers in these areas. In fact, revenue from lithography, metrology, and inspection applications in the first half of 2023 grew considerably compared to the same period a year ago. Our breadth and diversity across wafer fabrication equipment applications combined with our leadership position across most of the product categories we serve reinforces our belief that we can continue to outperform industry wafer fabrication equipment spending over the long-term. We are a critical enabler of key inflection points in semiconductors, such as atomic layer deposition, high aspect ratio etch, extreme ultraviolet lithography, and advanced inspection and are well positioned for when industry capital equipment spending recovers. Looking to the third quarter, we expect revenue from our semiconductor market to decline sequentially. However, excluding the impact of the ransomware incident from the second and third quarters, we expect revenue in the third quarter to be consistent with second quarter revenue levels. Turning to our Electronics and Packaging market, revenue was softer than we expected amid the well-known weakness in demand for global electronics, such as PCs and smartphones. Demand for our chemistry solutions improved modestly on a sequential basis, but this was offset by continued softness in capital equipment spending, including for our laser drilling and plating equipment. Despite the cyclical weakness, we remain very excited about the long-term opportunity in Electronics and Packaging. One of the areas of particular focus is packaged substrates, which are a critical enabler and key building block for high-performance computing applications such as AI. Just to build on that last point, much like what we've seen in the semiconductor industry over the past 60 years, the manufacturing of package substrates is getting harder, not easier. High-performance computing applications require greater interconnect density as layer counts increase to 20 or more, while interconnect feature sizes continue to shrink. This high degree of complexity gives MKS, with our unique combination of proprietary chemistry, plating equipment, and laser drilling solutions, the opportunity to expand our presence in this high-growth segment of our Electronics and Packaging market. As a reminder, this opportunity is one of the key reasons behind our acquisition of Atotech, which is why MKS is strongly positioned for advanced packaging, an area we will continue to focus on and invest in. For context, based on combined company full year 2022 results, advanced packaging represents just under a third of Electronics and Packaging revenue. Driven by our foundational portfolio for package substrate applications as well as smaller revenue streams from wafer-level packaging, hybrid bonding, and other applications, we think advanced packaging solutions will be a more meaningful contributor to our revenue over the long-term. Looking to the third quarter, we expect revenue from our Electronics and Packaging market to be consistent with second quarter levels. We anticipate a slight improvement in chemistry sales due to the seasonality of consumer electronics production as well as an improvement in package substrate demand due to high-performance computing applications such as AI. These improvements are expected to be partially offset by a cyclical downturn in plating equipment sales. Turning to our specialty industrial market, revenue was in line with our expectations with stable demand for our chemistry solutions for the automotive market, combined with good execution and recovering delayed revenue due to the ransomware incident. Looking to the third quarter, we expect revenue to be consistent with second quarter levels. However, after excluding the impact of the ransomware incident from the second and third quarters, we expect revenue to be slightly higher than second quarter levels. In summary, I'm very pleased with our performance in the second quarter. Despite muted demand across some of our end markets, we executed well. Thinking about our business in the second half of 2023, we continue to expect MKS' total revenue in the second half to be slightly higher than first half levels, driven by modest improvements across all three of our end markets. Longer term, we are very excited about how we are positioned to capitalize on multiple secular drivers, such as AI, cloud, virtual reality, and electrification, which are just some of the examples of what is made possible by advanced electronics, and we are foundational to those trends.

Thank you, John. I'll cover our second quarter results, then provide details and outlook for the third quarter. Starting with the second quarter, we delivered revenue of $1 billion, above the midpoint of our guidance. Our strong top-line results are driven by better-than-expected revenue from our semiconductor market, more than offsetting softer Electronics and Packaging revenue. Revenue from our Specialty Industrial market was in line with expectations. We estimate we recovered $120 million of the approximate $160 million of revenue impacted by the ransomware incident in the first quarter. We expect to recover substantially all of the remaining revenue in the third quarter. Turning to our semiconductor market, revenue was $440 million in the first quarter, growing 42% sequentially and exceeding our outlook due to strong execution on shipping products from backlog, including those delayed by the ransomware incident in the first quarter. In the second quarter, we estimate we recovered $90 million of the approximately $110 million of revenue impacted by the ransomware incident in the first quarter. After excluding the impact of the ransomware incident from the first and second quarter, our semiconductor revenue declined on a sequential basis consistent with softer industry demand for semiconductor capital equipment. Turning to Electronics and Packaging market. Revenue was $225 million, an increase of 1% sequentially and a decline of 21% year-over-year, with Q2 2022 representing combined company results, including Atotech for the full prior year period. Excluding the impact of foreign exchange and platinum pass-through, second quarter revenue declined 15% on a year-over-year basis. As a reminder, the ransomware incident had a minimal impact on revenue from the Electronics and Packaging market. Moving to the Specialty Industrial market, revenue in the first quarter was $338 million, growing 29% sequentially, in line with our outlook due to stable demand trends across our submarkets. We estimate we recovered $30 million of the approximately $45 million of revenue impacted by the ransomware incident in the first quarter. As a result, after excluding the impact of the ransomware incident in the first and second quarters, our Specialty Industrial revenue was relatively flat sequentially. Excluding the impact of the ransomware incident, foreign exchange and platinum pass-through, second quarter revenue declined approximately 3% year-over-year on a combined company basis. In the second quarter, consumables and service revenue across our three end markets comprised 38% of our total revenue. Turning to our margins, second quarter gross margin was 46.9%, a sequential increase of 470 basis points, exceeding the high end of our guidance. Higher volumes, increased factory utilization, disciplined cost management, and favorable product mix contributed to the strong performance. Second quarter operating expenses were $243 million, a sequential increase of $3 million, but still below the low-end of our guidance, reflecting disciplined cost management. Second quarter operating margin was 22.6%. Adjusted EBITDA margin was 25.3%, both exceeding our expectations due to strong operating leverage in the model. Our integration of Atotech is progressing well. We remain on track to achieve our cost synergy target of $55 million within 18 to 36 months post-close. We exited the second quarter achieving annualized cost synergies of over $30 million. Net interest expense for the second quarter was $79 million, lower than we anticipated due primarily to favorable interest income and slightly lower interest rates relative to our forecast. Our tax rate for the second quarter was 35.5%, above our expectations due to the geographic mix of income and changes in timing of tax credits and tax planning activities. We expect our tax rate to normalize in the third quarter. Net earnings for the second quarter were $88 million or $1.32 per diluted share. Turning to our balance sheet and cash flow, we exited the second quarter with cash and short-term investments of $758 million compared to $880 million in the first quarter. Free cash flow in the quarter was a negative $77 million, primarily a result of the lingering effects of the ransomware incident on working capital needs and timing of income tax payments. We expect our cash conversion cycle to improve in the third quarter and free cash flow to return to more normalized levels. We maintain an undrawn revolving credit facility of $500 million and exited the quarter with gross debt of $5.1 billion. Our net leverage ratio exiting the second quarter was 4.3 times, based on a trailing 12-month adjusted EBITDA on a combined company basis. Existing with the prior quarter, we made a dividend payment of $15 million or $0.22 per share. Before I discuss our third quarter outlook, I'd like to touch upon the non-cash goodwill and intangibles impairment charges in the quarter, which totaled $1.8 billion associated with our Materials Solutions division, which represents the former Atotech business, and our Equipment Solutions business, which represents the former Electro-Scientific Industries business. The current market environment, particularly the softer demand in the PC and smartphone markets, is the primary driver of both write-downs, with higher market interest rates playing a significant role in the Atotech impairment analysis as well. As John indicated in his prepared remarks, we are very excited about the opportunity ahead of us in Advanced Packaging. In fact, since we announced our intent to acquire Atotech just over two years ago, it has increasingly been recognized how much Advanced Packaging is critical to high-performance computing applications, including AI. Our leading position in deep customer relationships allows us to see inflection points earlier as we help our customers solve the greatest challenges on the horizon. That's why we assembled a broader set of capabilities across chemistry and equipment that serve as an attractive market in the growth we see ahead of us. I'll now turn to our third quarter outlook. We expect third quarter revenue of $930 million, plus or minus $50 million. By end market, our outlook is as follows: Revenue from our semiconductor market of approximately $370 million, plus or minus $20 million. Revenue from Electronics and Packaging market of approximately $225 million, plus or minus $10 million, and revenue from our Specialty Industrial market of approximately $335 million, plus or minus $20 million. This outlook includes approximately $30 million of revenue we expect to recover from the ransomware incident in the first quarter, therefore, we expect to essentially be caught up with the backlog of customer deliveries by the end of this quarter. Moreover, as John mentioned, we continue to expect revenue in the second half of 2023 to be slightly higher than the first half across all three end markets. Based on anticipated product mix and revenue levels, we estimate third quarter gross margin of 45%, plus or minus 1 percentage point. We expect operating expenses of $245 million, plus or minus $5 million, consistent with second quarter levels. For the third quarter, we estimate adjusted EBITDA of approximately $210 million, plus or minus $26 million. For the third quarter, net interest expense is expected to be approximately $85 million, reflecting projected interest rate increases. Our tax rate is expected to be approximately 26% for the third quarter. And given these assumptions, we expect third quarter net earnings of $0.98 per diluted share, plus or minus $0.29. In summary, MKS recovered well from the ransomware incident in the first quarter despite the soft end market backdrop in the first half of 2023, delivering solid non-GAAP profitability. This is a testament to our more resilient and diversified business model following the Atotech acquisition. Our ability to drive strong factory utilization and disciplined cost management and our leading portfolio of foundational solutions essential to the markets we serve. Moving forward, we are focused on maintaining the high level of execution we delivered in Q2, returning to normalized free cash flow generation and working towards further deleveraging our balance sheet.

Thank you. Our first question comes from Sidney Ho of Deutsche Bank. Your line is now open.

Good morning. This is Joe Mark on for Sidney. Guys, my first question is on capacity additions, I guess, in Electronics and Packaging. And what I'm trying to gauge is when would customers return to these capacity additions? I guess the question is, is it fair to think about this as a call like the memory cycle, right, where you would first see utilization come back first then would be upgrades, I guess benefiting your services? And then as a last step, customers would start adding capacity. Am I thinking about it the right way? And I have a follow-up.

It's John Lee. I think your question is about the Electronics and Packaging market. And I think those dynamics are very similar to semiconductor utilization rates going up and then capacity additions. So I think that is the right way to think about it. Utilization is something that we see immediately with chemistry revenue. In terms of services, certainly servicing our equipment would be coming next. And then, of course, after that are capacity additions. As we pointed out, there has been a little bit of weakness in Q2 on the equipment part of our Electronics and Packaging, and that's consistent with the industry trends right now.

Great. Very clear, John. And I guess staying on utilization rates within Electronics and Packaging. Can you guys sort of give us a sense as to where utilization rates are right now? And based on conversations with your customers, where would you see those trend, I guess, in the second half? And maybe just to add to that, where should investors, I guess, look to gauge how utilization rates are trending through the second half.

Yeah. I think what we're seeing with our customer base certainly is that utilization rates are incrementally increasing. I think that's why our guidance for the second half is slightly higher than the first half. A lot of that is driven by the cyclicality of the consumer electronics part of our Electronics and Packaging chemistry revenue. So I think that's consistent with what happens every year with the consumer product cycle. And so that's why we're guiding for the second half to be slightly better than the first half.

Thank you. One moment please for our next question. Our next question comes from the line of James Ricchiuti of Needham & Company. Your line is now open.

Hi, good morning. John, you've talked about revenue synergies from Atotech and the legacy Electronics and Packaging business. With the overall market weakness, does that incremental benefit at this point just get pushed further into 2024? Or are you seeing any indications of some momentum in that area?

Thanks for the question. I think we pointed out even a quarter ago that we're getting some of those bluebirds coming in a little earlier than you would expect. I think what we are seeing is that the interest in our combined solutions remains very high. We talked about our Yokohama TechCenter, where we have a new plating tool, new chemistry, and new laser tools. So that interest remains very high. I think the synergy and revenue will certainly come when ramps occur, and hopefully, that happens in 2024. But of course, we're prepared for whatever eventuality that is. Today, we're just focused on getting those design wins and showing our customers the benefit of having that combined solution.

And a follow-up question. Seth, you may have addressed this. But with the gross margins coming in a little better than expected, can you elaborate a little bit more about what drove that? Was it mix? Was it just the revenues coming in a bit above target?

Yeah James. I mentioned in my prepared remarks that there is a combination of all those factors: mix, very strong execution, factory utilization, cost containment. To me, it's a testament to how well we execute in a really challenging environment. I think that's fundamentally why we drove the margins up the way we did. So really happy with our execution. The team has done a great job, and I think that's really part of our DNA historically speaking.

Is your guidance this quarter reflecting a less favorable mix, or how are you approaching gross margins at the midpoint?

Yeah. That's the way I would think about it as well. I think the mix is more normalized in Q3 guidance, a little bit light on the revenue side, obviously, is a piece as well. But fundamentally, it's really mix in Q3, a little lower volumes. And again, we continue to execute very well in the quarter.

Our next question comes from the line of Krish Sankar of Cowen. Your line is now open.

Yeah, hi. Thanks for taking my question. First one, John, if I look at your guidance for semi ex-ransomware, it looks like it's going to be flat sequentially, which kind of makes sense where the industry is, but also your customers are talking about drawing down their own inventory. So if I put those two together, is it fair to assume your semi revenues could potentially dip sequentially in the December quarter?

Thanks, Krish. That's not what we're seeing right now. The reason I'd say that is customers have been drawing down their inventory for a few quarters already. That's why we've guided for flat to slightly up in our semi revenue. I understand and I've heard that some customers are drawing down and have said they're drawing down the inventory. But what we've seen is that's been happening for multiple quarters already.

Got it. Got it. That's very helpful. And then a similar question on the Electronics Packaging side. You said advanced packaging is less than one third revenue, but it's growing, which makes a lot of sense. But if you look at the other part of the business there, even on the PCB side, it looks like that business has not inflected. So I'm just curious, is the advanced packaging strength kind of what informs you that your Q3 revenues could be similar to Q2, given the other parts of the market are pretty weak?

Yeah. I think that's the way to think about it, Krish. Advanced packaging, especially package substrates and package substrates are the latest kind of most advanced 20-plus layer type packaging of chiplets, if you will. That's the area where we think there's going to be more of an uptick driving the overall Electronics and Packaging segment of our business. The other parts like HDI and MLB, those areas remain kind of muted. So I think it's really about these new technologies that we think will help us have a slightly better second half than first half in Electronics and Packaging.

Thank you. One moment please for our next question. Our next question comes from the line of Steve Barger of Keybanc Capital Markets. Your line is now open.

Thanks. Just staying on the advanced packaging theme. I think there's been a lot of talk about chip on wafer on substrate capacity being added, and I know you sell laser drilling packages to substrate manufacturers now. But I think that requires plating too, right? So can you talk about how ramping co-op volume would benefit you? Or is some other packaging scheme more beneficial for your mix?

Yeah, Steve. That's a great question. The short answer is yes, that will benefit us. The chip on wafer part, they were a little less exposed in terms of chemistry. But then the last part, if you will, the chip on substrate part, that is where we play, and that's the substrate part. Even as people package chips onto wafers, eventually that gets then packaged onto substrates. That's where Atotech and our laser drilling tools are exposed. So yes, we hope co-ops continues to ramp, and we will be a beneficiary of it.

And I guess, to the second part of the question, any specific packaging schemes beyond co-op which are most beneficial to you? Or is that all just kind of a variation on a theme?

It's really a variation on a theme, Steve. So however you get the chip packaged, eventually it has to go on a substrate. Co-ops are one approach. There are multiple other approaches depending on the need. But they all end up going on to a substrate.

And as we've gone through this downturn, have you been able to pick up any share with PCB makers? Or can you talk about conversations there? And are there any signs of consolidation at the lower end for those manufacturers?

Yes, I think that consolidation has always been a theme in that industry. But I don't think there's anything new in terms of trends there. In terms of share pickup, the conversations we've had with many customers have been very good in terms of the package of solutions we're bringing to them. We hope that ends up turning into market share wins. That's what we're working hard on.

Thank you. One moment please for our next question. Our last question comes from the line of Joseph Quatrochi of Wells Fargo. Your line is now open.

Yeah, thanks for taking the question. One on the semi side. I think last quarter, we talked about further clarity on the China export restrictions. I think that's in part you shipping to your customers that they can then ship to their Chinese customers, and also you shipping to Chinese equipment OEMs. I was just curious how that factored into the results or the upside in the semiconductor side this quarter.

Joe, thanks for the question. The short answer is no change in terms of how we look at the China revenue going forward. I think the last quarter we talked about more clarity in terms of what's allowed to be shipped by our customers, shipping to their Chinese customers. That hasn't really changed. We also talked a lot about how we are exposed to the Chinese OEMs and the restrictions there. That has not changed either. Even though we're guiding semiconductor revenue to be flat to slightly up, it's not because of any change in our view of the dynamics for what we can and can't ship to China.

Got it. That's helpful. And then as a sort of a follow up, you talked about improving free cash flow looking into next quarter. Should we think about voluntary payments on the debt starting to see that again next quarter?.

We have consistently stated our intention to deleverage aggressively, and there is no change in our policy or objectives. Once our cash levels return to appropriate levels, the generation of free cash flow will contribute significantly to reducing our debt. However, we will not provide guidance on this for the third quarter at this time.

Yeah, hey, Joe. Maybe I'll add a comment to the semiconductor comment. The guide of flat to slightly up is ex-ransomware. So apples to apples in Q3. Just to make sure that's understood and clear. Thanks.

Yeah. Thank you.

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

This concludes today's conference call. Thank you for participating. You may now disconnect.