Good day and thank you for standing by. Welcome to the MKS Instruments' Third 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 first speaker today. David Ryzhik.

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 third quarter of 2023, which are posted to our investor website at investor.mks.com. As a reminder, various remarks about future expectations, plans, and prospects for MKS comprise forward-looking statements. Actual results may differ materially as a result of various important factors, including those discussed in yesterday's press release and in our Annual Report on Form 10-K for the year-ended December 31, 2022. These statements represent the company's expectations only as of today and should not be relied upon as representing the company's estimates or views as of any date subsequent to today. And the company disclaims any obligation to update these statements. During the call, we will be discussing various financial measures. Unless otherwise noted, all references to combined company financial measures reflect the combined results of MKS and 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. Before I discuss our third quarter results and key business trends, I'd like to touch on the devastating violence that has occurred in the Middle East over the past month. There are simply no words that can describe the events that have unfolded, and our primary concern is the health and safety of our employees and their families in the region. As some of you may know, MKS has three facilities in Israel that manufacture some of our controls, optics, and photonics solutions, which all remain operational. The dedication and resilience of our Israeli team is unmatched, and we hope for a return to peace quickly. Turning to our third quarter results, MKS delivered strong profitability despite continued softness in end market demand. We reported revenue of $932 million, adjusted EBITDA of $235 million, and net earnings per diluted share of $1.46. Revenue from our semiconductor market was in line with our expectations as the cyclical downturn in industry memory spending continued. As expected, demand for our critical vacuum subsystems for deposition and etch remained muted. However, demand for our photonic solutions for lithography, metrology, and inspection continues to be resilient. Looking to the fourth quarter, we expect revenue from our semiconductor market to decline sequentially due to the continued weakness in industry memory spending, particularly for NAND, which is at a historically low level, and where leading-edge tools contain relatively more MKS content. We also expect continued inventory workdowns at key customers as they adjust for current demand. The semiconductor market will have its cycles, but the secular growth drivers over the long term are quite clear. The connected world will need more semiconductors with enhanced capabilities, creating the need for miniaturization and increased complexity. MKS is actively engaged with customers across a broad range of technology inflections. Examples include next-generation power solutions for advanced etch applications, optical subsystems for lithography, metrology and inspection, and precision motion for advanced bonding processes that enable applications such as high bandwidth memory. We pride ourselves on investing during a downturn to position us to be even stronger in the next upturn. That is the exact playbook we have deployed over the past 60-plus years, enabling us to become a foundational supplier to the semiconductor industry with number one or number two segment share across more categories of critical subsystems than anyone else in the industry. Turning to our Electronics & Packaging market, revenue grew sequentially and slightly better than expected due to normal seasonality associated with the consumer electronics market, as well as slightly higher PCB and Packaged Substrate production ahead of the Golden Week holidays in Asia at the beginning of the fourth quarter. I'm pleased to announce that we also shipped a number of HDI laser systems to low-earth orbit or LEO satellite communications space. We are the process tool record from multiple customers serving the LEO space due to the unique capabilities of our proprietary HDI via drilling technology, which enables increased productivity for one of the industry's fast emerging applications. This is a validation of our technology leadership and our unique ability to solve the hardest problems, establishing us as a key supplier to the leading PCB manufacturers. In addition, we also deliver our proprietary chemistry and plating equipment to this market, which highlights opportunities for an integrated approach. Looking to the fourth quarter, we expect revenue from our Electronics & Packaging market to be down sequentially, primarily due to seasonally softer chemistry utilization as well as the lumpy nature of our equipment sales. We are seeing some signs of stabilization in the PC and smartphone markets. Within the server market, there is continued strength in the Package Substrate market for AI applications, but this is more than offset by broader softness in non-AI server applications. Turning to our Specialty Industrial market, revenue was slightly below our expectations. Overall, the business was stable across our markets, but we saw some modest weakness in solar and LED applications. We leveraged our expertise in R&D investments in our Semiconductor and Electronics & Packaging markets to drive opportunities in our Specialty Industrial market. One example is the investment we have made in laser technology for advanced micromachining applications, where we see portability into Specialty Industrial applications such as solar and life and health sciences. Looking to the fourth quarter, we expect revenue from our Specialty Industrial market to be slightly down compared to third quarter levels, while demand across our end markets remains cyclically muted. We are highly engaged with customers and believe we are well positioned for the upturn. I'm proud of how our team continues to execute and deliver timely solutions for our customers while pursuing operational efficiency through tight management of discretionary costs. We have a long history of prudent cost control and financial stewardship of our business throughout various market conditions, and today is no exception. Many of you on the call are familiar with the multi-decade secular growth story of the semiconductor market. We have been and will continue to be foundational to that market. However, electronic devices of today and the future will need more than just semiconductor transistor scaling. As we move into an era of multi-chip packaging or systems scaling, MKS is uniquely positioned to enable this new era of scaling with the broadest portfolio of critical technologies across equipment, chemistry, and services. And now I'd like to turn the call over to Seth.

Thank you, John. Before I cover our third quarter results and provide details regarding our outlook for the fourth quarter, I want to echo John's comments regarding our concern for the health and welfare of our employees in Israel. We are amazed at the dedication and fortitude of our Israeli team as they operate in extremely difficult circumstances. This is a point of reference. Revenue from our manufacturing operations in Israel in the last 12 months represented approximately 7% of our total revenue. Turning to our third quarter results, we delivered revenue of $932 million, just above the midpoint of our guidance. As expected, we recovered substantially all the remaining revenue impacted by the ransomware incident in the first quarter, which was estimated at approximately $30 million. After excluding the impact of the ransomware incident recovery from the second and third quarters, our revenue grew slightly on a sequential basis. Turning to our semiconductor market, revenue was $367 million in the third quarter. After seeing the impact of the ransomware incident recovery from the second and third quarters, our semiconductor revenue was relatively flat on a sequential basis. Revenue for the Electronics & Packaging market was $243 million, an increase of 8% sequentially. Excluding the impact of foreign exchange and palladium pass-through, third-quarter revenue declined 9% on a year-over-year basis with Q3 2022 representing combined company results. Moving to our Specialty Industrial market, revenue in the third quarter was $322 million declining 5% sequentially. However, after excluding the impact of the ransomware incident in the second and third quarters, our Specialty Industrial revenue was relatively stable on a sequential basis. Within our Specialty Industrial market, sales of our general metal finishing solutions to the automotive industry were flat on a sequential basis. On a year-over-year basis, Specialty Industrial revenue was relatively flat excluding the impact of the ransomware incident, foreign exchange, and palladium pass-through with Q3 2022 representing combined company results. In the third quarter, overall consumables and services revenue was also consistent on a year-over-year combined company basis, excluding the impact of foreign exchange and palladium pass-through and comprised 42% of our total revenue. We expect consumables and services revenue to remain a resilient source of revenue and profitability going forward. Turning to our margins. Third-quarter gross margin was 47.1%, a sequential increase of 20 basis points exceeding the high end of our guidance. Efficient factory utilization, disciplined cost management, and favorable product mix contributed to this outperformance. Third-quarter operating expenses were $236 million, a sequential decrease of $7 million and below the low end of our guidance reflecting continued disciplined cost management. Third-quarter operating margin was 21.8% and adjusted EBITDA margin was 25.2%, both exceeding our expectations and reflecting the strength in our operating model. Our integration of Atotech continues to progress very well. We remain on track to achieve our cost synergy target of $55 million within 18 to 36 months post close. We exited the third quarter achieving annualized synergies of nearly $45 million. Net interest expense for the third quarter was $84 million, relative in line with our expectations. Our tax rate for the third quarter was 14%, favorable to our expectations and reflective of the success of certain tax planning initiatives following the closing of the Atotech acquisition. As a result of these efforts, we now expect the full year 2023 tax rate to be 19%. Looking beyond the fourth quarter, we believe the low 20% tax rate is the right way to think about it at this time; we expect to provide a more formal update to our long-term tax rate in our fourth-quarter earnings call. Net earnings for the third quarter were $98 million or $1.46 per diluted share. Turning to the balance sheet and cash flow, we exited the third quarter with more than $1.3 billion of liquidity, including cash and short-term investments of $860 million and an undrawn revolving credit facility of $500 million. The cash position represents an increase from $758 million at the end of the second quarter. Free cash flow in the quarter was $142 million primarily resulting from strong cost control and sequential improvement in working capital. We exited the third quarter with gross debt of $5 billion. In October, we had a voluntary debt prepayment of $100 million, which is consistent with our strategy of deleveraging our balance sheet. Also in the current quarter, we successfully completed a repricing of a $3.6 billion secured tranche B term loan. The repricing reduced the spread on our term loan from SOFR plus 275 basis points to SOFR plus 250 basis points, and also eliminated the credit spread adjustment related to our term loan, which was 10 basis points at the time of the repricing. This repricing, completed despite challenging market conditions, is consistent with our long-term practice of proactively managing our leverage and demonstrates the confidence lenders have in our operating model. At current rates, we estimate the combination of the repricing and prepayment will reduce our annualized interest expense by approximately $19 million. Our net leverage ratio exiting the third quarter was 4.6 times based on trailing 12-month adjusted EBITDA. Our net leverage, as defined in our credit agreement, includes several other adjustments and was 4.2 times exiting the third quarter. Consistent with the prior quarter, we made a dividend payment of $15 million, or $0.22 per share. I'll now turn to our fourth-quarter outlook. We expect fourth-quarter revenue of $840 million plus or minus $40 million. Our end market outlook is as follows: revenue from the semiconductor market of $320 million plus or minus $15 million; revenue from the Electronics & Packaging market of $205 million plus or minus $10 million; and revenue from the Specialty Industrial market of $315 million plus or minus $15 million. Based on the midpoint of our guidance, we now expect revenue in the second half of 2023 to be slightly lower than the first half, compared to our prior expectation that it would be slightly higher than the first half. This is primarily due to our expectation of short-term customer inventory workdowns in our semiconductor market. Based on anticipated product mix and revenue levels, we estimate fourth-quarter gross margin of 45.5% plus or minus one percentage point. We expect operating expenses of $235 million plus or minus $5 million, relatively consistent with third quarter levels. For the fourth quarter, we estimate adjusted EBITDA of $185 million plus or minus $20 million. For the fourth quarter, our net interest expense is expected to be $80 million, reflecting current interest rates, as well as our recent successful tranche B term loan repricing and voluntary debt prepayment. Our tax rate is expected to be 16% for the fourth quarter, consistent with the updated full-year 2023 tax rate outlook of 19% that I mentioned earlier. Given these assumptions, we expect fourth-quarter net earnings at $0.85 per diluted share plus or minus $0.27. In closing, we executed very well in maintaining profitability and generating solid cash flow despite cyclical softness in our end markets. These are things we cannot control. We remain confident in long-term secular growth opportunities across our portfolio. When the market does bounce back, we are well positioned to emerge from the current environment even stronger than we were going in. With that, I'll turn it back to the operator for Q&A.

Thank you. The first question comes from Krish Sankar at TD Cowen. Krish, your line is live.

Yes, hi. Thanks for taking my question. I had two of them. John, on the first one. I understand your semiconductor revenues are worse than WFE, which happens during a cyclical downturn. It also probably looks like a tad lower than some of your peers. So I’m curious if that’s purely because your debt has exposure, or is there something else going on in the market share front? And then I had a follow-up.

Yes, Krish, thanks for the question. I think it’s pretty simple. We are an enabler for vertical NAND. I think we’ve talked about that in the past. And as I think we’ve heard and you’ve heard from many of our customers, NAND is one of the WFE segments that’s particularly down. So our exposure there, and therefore our enablement there is really what’s causing us to be slightly worse than maybe some of our peers. As I want to remind everybody, we love being an enabler for VNAND in the industry with our RF power solutions. And of course, I don’t think anybody would say VNAND won’t come back. It’s certainly in a cyclical downturn. But when it comes back, we’ll be enjoying that market leadership again.

Got it. Thanks. And then I just wanted to follow up on some of the advanced packaging. I mean you highlighted Atotech's exposure there, but it looks like Atotech as a percentage of revenue has really kind of been in this low 30% range for the last couple of quarters. Are you not seeing any of the benefits from advanced packaging? Or is it too early for that?

Yes, I think it’s early days, Krish. I think one of the things we talk about is packaged substrates. This is the advanced packaging that we’ve talked about. Lots of interest, lots of acceleration there, especially in high-performance computing. So we’re seeing a lot of that interest. But that’s still a relatively small percentage. But we expect that to grow as a percentage of advanced packaging and packaging overall.

Got it. Thanks, John.

Thanks, Krish.

Next question comes from Joe Quatrochi at Wells Fargo. Joe, your line is open.

Yes, thanks for taking the questions. It looks like your chemicals revenue was up nicely sequentially in the quarter. Wondering if how much of that was just normal seasonality or maybe some pass-through of the palladium costs?

Yes, Joe, certainly part of it was seasonality, but it was a little better than we expected, even taking into account seasonality. Now, as we said in our prepared remarks, there was a little bit of pull-in because of the holiday week in the first quarter of Q4, but it was just a little better. And so we’re happy to see that.

Got it. And then maybe on the semi side, one of your peers had talked about preparing for a kind of flattish 2024. I guess curious how you’re thinking about that, and maybe in the context you did talk about NAND being definitely weaker. How are you thinking about the setup into next year?

Yes, obviously we read the same things you guys do, and the visibility is poor for the industry right now. I think what we’re preparing for is to continue supporting our customers in R&D so that when it comes back, we will be enjoying an even stronger position. In the meantime, we’re watching costs very closely, as you can see from our numbers. I think the industry is kind of looking at the first half to be relatively muted, kind of the same as the second half of 2023, and then I think after that there are varying opinions. So that’s what I would say is that we’re reading the same kind of things you are, and it looks pretty flat for the next few quarters to us as well.

Thank you.

Thanks, Joe.

Please stand by for the next question. The next question comes from Steve Barger at Keybanc Capital Markets. Steve, your line is live.

Thanks. John, I think we all understand this has been a really challenging cycle, but the stock is obviously acting like there are bigger risks and problems here. So can you just discuss again why you’re confident MKS is better with ATC in the portfolio and maybe further discuss just how you see this playing out in coming quarters and years?

Yes, Steve, thanks for the question. So, we’ve talked about advanced packaging and we’ve talked about how critical that’s going to be to enable the next generation of electronics. So as I said in our prepared remarks, it’s no longer just that a semiconductor will enable advanced electronics. I think everybody’s talking about chiplet packaging or systems packaging if we are going to continue as an industry pushing the concept, the economic concept of Moore’s Law. So we love having Atotech as part of our portfolio. There’s no other company that has market leadership in packaging, chemistry, and the equipment that’s Atotech has, as well as market leadership in the broad set of technologies in semiconductor critical subsystems, as we’ve talked about in the past, that enable deposition and etch as well as lithography, metrology, and inspection. So we firmly believe that the combination of both really sets up MKS uniquely for the future.

And can you just talk about what the feedback has been from customers as you go out and maybe how you see the CapEx cycle next year and what you think that can translate into for MKS?

Well, customers are certainly very receptive to the concept of MKS bringing more solutions to them that include lasers as well as chemistry equipment and then other types of packaging solutions. In terms of CapEx, I think that’s similar to Joe’s question. It’s going to be something that seems a bit muted for packaging though. I think next year if things stabilize, the compares will be good, but your guess is as good as mine as to how much it comes back. But I would also comment that the packaging market for us is less cyclical. There are cycles for sure, but the amplitude is much less than semiconductor CapEx, as you’ve seen in our numbers.

Got it. And Seth, can I squeeze in a quick one? Sorry if I missed it. Did you talk about free cash flow in Q4, and can we expect incremental debt pay down in the remainder of this year?

Yes, we didn’t disclose or give guidance on free cash flow in Q4. You saw Q3 was quite strong. By the way, Steve, it's certainly our goal going forward to drive that free cash flow up. So it’ll depend on working capital needs. But we didn’t really give that type of guidance for the fourth quarter. In terms of debt pay down, we have done a lot of pulling of levers, as you saw in the prepared remarks. We did $100 million in October, and our plans do leverage aggressively going forward now, and roll out as the year progresses. We did the repricing that took $11 million off the table. So that’s, again a lever we pulled with Atotech we’ve driven the tax rate down long-term as well. That’s a big value driver. And then the cost synergies are $45 million to $55 million one year in. So, things we can control as mentioned in the prepared remarks. We’ve actually done a lot already in a short period of time. There’s more opportunity going forward as well. And that’ll roll out, and there’s no change in our philosophy to deleverage, drive free cash flow, and drive the integration activities, which have gone very well.

Appreciate the time. Thanks.

Yep. Thanks, Steve.

One moment for our next question. The next question comes from James Ricchiuti at Needham & Company. Your line is open.

Thank you. I wanted to focus on the photonics solutions portion of the semiconductor business, which appears to be holding up better. And, John, maybe you could talk to your visibility, your line of sight in that area of the business? Are you any more optimistic that that portion of the business is able to hold up in this cyclical downturn?

Yes, Jim, I think we do believe that there is less cyclicality in the lithography, metrology, and inspection part of the semiconductor business, and we’ve seen that play out over multiple quarters. We’re in constant contact with those key customers, and you can see what they say publicly about their revenue over the next several quarters as well. So, we believe that’s really just an area of semi that’s much more consistent than certainly the deposition and etch part. So that’s our visibility right now, and that’s our belief that it will continue.

And on the Specialty Industrial, obviously, it’s a newer area for you. And are you more concerned now about the overall macro environment potentially impacting that portion of the business as we enter 2024? In other words, are you any more concerned about the near-term outlook in that area of the business?

Yes, Jim, I mean, what we’ve seen in the past is that the industrial part has been pretty steady, our revenue in it, but we’re always watching some of the key markets, such as automotive, and that’s why we made the comment about automotive in our prepared remarks. But as I said in the past, two industrials are certainly less cyclical than the semiconductor CapEx world. Also, comment that much of our industrial revenue is utilization-dependent chemistry. So that adds a little more stability to it. But to your point, Jim, we’re always watching the macro environment to see how that may or may not affect our industrial business.

I’ll just lob one more in. I was just wondering, on geo, you seem to be getting some traction. How should we be thinking about the potential for that to be a bigger contributor in the near term?

Yes, I think what we talked about at this call was this low-earth orbit application, the PCBs that are needed to support that both on the satellites as well as the ground stations. And that had a technology requirement that our tool was uniquely positioned to deliver on that. So that’s just another proof point of the technology that we’ve developed. I think that we continue to make progress in other areas as well. And so we just wanted to point out that we continue to get signs that what we’ve developed and the technology there is really unique.

Thank you.

Thanks, Jim.

One moment for our next question. The next question comes from Sidney Ho at Deutsche Bank. Your line is open.

Great, thank you. Good morning. I’m not trying to ask for specific guidance for next year. How are you thinking about the revenue trajectory for each segment in 2024? Do you think there will be another step down in the first half in any of the segments, whether it’s cyclically or seasonally? It sounds like you think semiconductors will be flattish for a few quarters, but how about the other segments and what kind of visibility do you have right now? Any color by segment or even by end market would be great.

Yes. Thanks, Sidney. Yes, I think we talked about semiconductors, and we’re kind of bouncing on the bottom, as we said. I would say Specialty Industrial has just held up and been very steady for this whole duration of the semiconductor downturn. So that’s kind of the expectation. Electronics & Packaging did see some cyclicality, as you’ve seen in the quarter. There is some seasonality to it as well, but certainly less cyclical in terms of amplitude than the semiconductor business. And it’s much more utilization-dependent. So I think that we watch the macro demands for PCs and servers and all that, and that drives some of that Electronics & Packaging business. So, I think the semiconductor recovery and the Electronics & Packaging recovery may go hand in hand, but the amplitudes of those are much different, very different between the two markets.

Okay, that’s fair. Now, my second question is you guys have a good track record of deleveraging post-acquisition. Given the sluggish demand, what is a realistic gross leverage ratio we should be expecting by the end of calendar 2024, and how should we think about the levers other than waiting for the business to recover? Thank you.

Yes, thanks. And so we kind of asked for guidance looking out in 2024. So probably can’t give you that type of details. But obviously the Q3 kind of gives you a snapshot at certain those revenue levels, what type of cash flow comes off the business. So you got to have that view in mind. As John mentioned, we think semiconductors are kind of at the trough levels, or at least low levels for sure, historically speaking, certainly in the NAND environment. So we think that’ll over time be an opportunity for us. But I would say fundamentally it’ll be revenue driven. We will work hard on working capital efficiency. We think we have more opportunity in certain areas that we’re working on pretty hard right now. But I would say it’s really revenue-driven, profitability-driven, and then working capital management. You saw in the Q3 results we work very hard to deliver really quite strong results given the environment. So, I think those are the things I would focus on, the things we’re working pretty hard on, and that’s been our playbook historically speaking.

Okay, thank you.

Yep. Thanks, Sidney.

I am showing no further questions at this time. So this concludes the question-and-answer session. I would now like to turn it back to David Ryzhik with closing remarks.

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

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