Good day, ladies and gentlemen, and welcome to the MKS Instruments First Quarter 2019 Earnings Conference Call. [Operator Instructions]. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Seth Bagshaw, Chief Financial Officer. Please go ahead, sir.

Thank you. Good morning, everyone. I'm Seth Bagshaw, Senior Vice President and Chief Financial Officer. And I'm joined this morning by Jerry Colella, our Chief Executive Officer; and John Lee, our President and Chief Operating Officer. Thank you for joining our earnings conference call. Yesterday, after market closed, we released our financial results for first quarter of 2019. Our financial results as scheduled pro forma revenue by market have been posted to our website, www.mksinst.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 the most recent end report on Form 10-K for the company. 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. Today's call also includes non-GAAP adjusted financial measures. Reconciliations to GAAP measures contained in yesterday's earnings release. In addition, we refer to certain pro forma measures with the acquisition of Electro Scientific Industries Inc, or ESI, which closed on February 1, 2019, had occurred at the beginning of the first quarter of 2018. Now I'll turn the call over to Jerry.

Thanks, Seth. Good morning, everyone, and thank you for joining us today. I'll start with the results for the first quarter 2019 followed by several business and market highlights. Then I'll turn the call over to John who'll share additional details on our strategy, customers and markets, supplemented by additional information on our financial results and second quarter 2019 guidance, before we open the call for questions. On a reported basis, overall first quarter revenue was $464 million, which included 2 months of ESI results. On a standalone basis, MKS delivered first quarter revenue of $428 million, which was above the midpoint of our guidance range. On a reported basis, overall non-GAAP net earnings were $61.3 million or $1.12 per share, which included 2 months of ESI results. On a standalone basis, MKS first quarter non-GAAP net earnings were $64 million or $1.17 per share. This bottom line outperformance was driven primarily by another strong quarter for Advanced Market business, and our long-standing commitment to mention the cost through the semiconductor market cycles. For the first quarter, we continued to see strength in our Advanced Markets, and in particular, on Surround the Workpiece offerings. The laser business is the cornerstone of this strategy from which we deliver leading products and services to the laser, photonics and optic markets, and in turn, grow our share. We also had a strong quarter in China, in both the semiconductor and solar markets. Due to the dynamic macroeconomic environment in China, we remained focused on positioning ourself to take advantage of growth opportunities. Our long-term strategies around technical localization and broadening our exposure to new customers and markets has positioned us well in China, much as we did in Korea over the past 6 years with the annual revenues at more than triple. John…

Thanks, Jerry. We are very pleased with our progress on integrating ESI into our business. It has a very strong cultural fit and both companies share similar core values, which will help us rotate a smooth, ongoing integration. As we have done with other acquisitions, we are applying the MKS business process, have begun to find areas for collaboration and leverage. For example, we are collaborating on a recently released, flexible Printed Circuit Board laser drilling solution, which incorporates our spectra-physics nanosecond pulse laser. We have already received significant quarters in Asia and Europe for this solution. We provide unmatched productivity improvements that further solidifies our market leadership in the flexible PCB market. In the first quarter, Career Technologies Corporation, one of the world's leading manufacturers of flexible PCBs, honored ESI with its Principal Partner Award in recognition of the outstanding operational support for Career's business ramp in 2018. Also the ESI high density, interconnect driven solution was awarded the Printed Circuit Design in Fab magazines 2018, new product award for rigid printed circuit board fabrication. As we've discussed during our last call, the ESI acquisition further broadens our Surround the Workpiece offerings by adding Advanced systems expertise and deep technical understanding of laser materials interactions. We expect ESI leadership and complex printed circuit board processing systems to provide MKS the opportunity to accelerate the roadmaps and performance of our laser, motion and photonics portfolios. While we manage through the cycles of the semiconductor market, we continue to emphasize the importance of design wins through uninterrupted support of our customers' development roadmaps. In the first quarter, we had noteworthy wins in our power solutions business. We continue to take share in our power from memory applications, most recently, in conductor etch with our next generation 13.56 megahertz generator. We also…

Thank you, John. I'll cover our Q1 2019 financial results then discuss our Q2 2019 guidance. The GAAP and non-GAAP results for the first quarter include the combined results of the recent acquisition of ESI, which closed on February 1. Turning to Q1, pro forma sales for the quarter were $471 million, a decrease of 11% sequentially. Pro forma sales for semiconductor market were $221 million and pro forma sales for our Advanced Markets were $250 million, both decreased by 11% sequentially. The decrease in pro forma sales were primarily driven by the moderation sale for semiconductor industry as well as the flexible PCB market as ESI's customers absorbed capacity additions over the last 18 months. On a pro forma basis, approximately 47% of our sales were the semiconductor market and 53% to customers in the other Advanced Markets we serve. Now moving to GAAP and non-GAAP results for the quarter. Reported revenue for the quarter was $464 million and non-GAAP gross margin was 43.8%. Non-GAAP operating expenses and non-GAAP operating margin were $121 million and 18%, respectively. GAAP gross margin was 42.7%, included the impact of $5 million of inventory purchase accounting charges. GAAP operating expenses were $175 million, included $16 million in amortization of intangible assets, $30 million in acquisition integration cost, $1.7 million in expenses related to fulfilling a customer obligation and $6 million in transaction fees associated with the issuance of term loan debt to finance the acquisition of ESI. GAAP net interest expense was $7.4 million, and non-GAAP net interest expense was $6.8 million. Our GAAP tax rate was 18.8%, and our non-GAAP tax rate was 18%. GAAP net income was $12.5 million or $0.23 per share and non-GAAP net earnings was $61.3 million or $1.12 per share. Respect to MKS standalone results, excluding the…

[Operator Instructions]. And our first question comes from the line of Patrick Ho with Stifel.

Congrats on a nice quarter and closing the ESI acquisition. Jerry, in your prepared remarks, you said you believe that the semi business is stabilizing. Maybe on a qualitative basis, can you give a little more color on, one, why you believe it's starting to stabilize and maybe two, do you believe that the March quarter represents -- the March or June quarter represents a bottom for MKS' semi business?

Yes. Thanks, Patrick, for the call -- for the question. No, the reason why I made a comment about stabilizing is because we don't report on orders. We report on revenue. But what I look at is -- I look on [indiscernible] and everyday, I've done it, everyday, it felt like 36 years probably. And the semi orders have really stabilized nicely, and the Advanced Markets orders look very strong. So maybe -- no, we don't comment about order rate in terms of specifics. But I look at those things, I see that there's real good stability and the only rate that we've seen. We've had positive -- more positive commentary of what customers about, what towards the end of the year looks like and they are preparing themselves, hopefully, for -- maybe things coming back and to reflect a strong 2020. But you have to back off at the '19 for our quarter rates, which backs it further into us. The other thing I do want to mention though is there's always doom and gloom of the semi industry, and even if we stay flat this year in semi, it'll be the third highest revenue year in the company's history. So we've been supplying the semiconductor industry well over 40 years and this is to be the third highest year, and the run rate will be close to $900 million. People are sad about that. And on Advanced Markets, it's close to $1 billion. So I'm not feeling bad about running a business that's close to $2 billion just because it looks a little down right now. And we've adjusted our cost structure, we are continuing to look at costs for efficiency and productivity. But I feel very good about what our business prospect looks like even if we were flat because I've been through some pretty horrific downturns in the past, and this feels, not that I'm happy about it, but it feels more consistent. And like I said, I think the order rates have stabilized, and as you know, Patrick, those things can churn on a $0.10. If I was most [indiscernible], I'd give you great predictions. But I feel that generally, it seems to be coming together. People talk a little more about DRAM and maybe memory inventory side to stabilize a bit. But I look internally at the order rates, and they appear to be pretty healthy at this point. Hope that answer the question.

No, that was helpful. May be as my follow-up question, John, when you described the Advanced Markets and some of the opportunities and some of the design wins that you got there in the quarter, particularly in China, I think you mentioned glass cutting, scribing, markets like that. Can you detail maybe some of the other applications that are driving, and now they project a year in your Advanced Markets business?

Sure, Patrick. Yes. So a lot of the solar market applications are what was referred to in the prepared remarks, and so that's the scribing et cetera. But if you look at ESI, that brings in a whole another level of different kinds of laser applications such as the flexible PCB, which is certainly different than solar. And that's also strong in China as well as other Asian countries.

Great. And final question from me for Seth. In terms of the gross margin outlook, ESI, historically, has had a volatile gross margin profile driven primarily by product mix. How much of that is an influence, I guess, in the June quarter. And how do you look at that variable as we go into the second half of 2019?

Yes. Patrick. So in Q2, again, the $485 million midpoint of guidance, you'd kind of assume that there's still -- MKS businesses is pretty consistent on the revenue side. And so you get to ESI's kind of the difference in that $5 million I think for the quarter, give or take a little bit. And at those volumes, the gross margin is in the mid-40 range, so even at a relatively modest flex spending environment, the -- in the mix we're seeing it right now, it's a pretty strong operating model. And then going forward, what's interesting is ESI on a standalone basis and MKS on a consolidated basis, they have variable gross margins still in that 50% range and variable operating margin at a 40% to 45% range. So it was interesting as ESI with a robust model kind of is right in line with the MKS long-term operating model in terms of profitability, based on flow through additional revenue. So that's kind of how we're looking at the model going forward. Right, mix could have an impact obviously, but based on our projections in the second quarter, yes, that's what we're seeing for the gross margins, again, a pretty healthy level. So we're pretty happy about that going on.

And our next question comes from the line of Sidney Ho with the Deutsche Bank.

I think you guys just talked about the ESI as the difference and for the given guidance that the MKS itself is kind of consistent. Can you talk about the splits or helps to chose between the semi side the first, Advanced Markets side outside of ESI? What's taken into your guidance?

Yes. Patrick, this is John. So I was saying that for semi, it's consistent, the MKS business, if that's what your question is. For the Advanced Markets, it's a little lumpy, but it's been steady. And so still a lot of it is still driven by lasers in the Surround the Workpiece portfolio. So we're pretty happy with the growth base there. In our Advanced Markets, we still -- probably said, and we're still very confident and growing at twice the rate of those Advanced Markets growth rates. And so that's what we're continuing to see.

Okay. That's fair. That's -- kind of my next question is. I think Q1 to be look at on an organic basis, I think the advanced market may be a little lighter than you guys have expected. Just wondering what is driving the mix? Is that a -- is there some lumpiness, and are you still expecting the 8% and 10% growth you're looking for this year?

Yes. I know, Phil -- Sidney, that Advanced Markets business has always been a lumpy business. Some of it is project based and that's been the calling cards for MKS forever, frankly. So I guess that I saw the order rates in -- coming in last quarter we're strong for the Advanced Markets. So do you ever look at over the long run, over a years time rather than quarter-to-quarter, this can move up and down a little bit. I remember back in the days when solar was hot and LED was hot, and we'd get huge orders and that would be for a contract. And then they back off a bit. Then you get a -- 6 months later, another huge order. So that's kind of a way that, that business moves around. But we expect that to remain relatively strong and consistent.

Okay. Maybe -- my last question is on the ESI. Clearly, things are little tough there in the first half of the year. How should we think about the growth projection over the next few quarters, especially, related to PCB business, which I believe is down maybe by one customer? And also just to finish up all the closing parts, you previously talked about the -- you expect the deals to be accretive during your first 12 months post-closing. Are you expecting that to happen give where revenue was at calendar Q1? And what kind of quality revenue do you expect ESI to be accretive to EPS? And what margins level would you expect that to happen?

Yes. So this is Seth. I'll take the accretive question first. So in the Q2 guidance, it actually is accretive. I know I said that it's just a $5 million revenue give or take, plus or minus, 10%. That midpoint operating profit on a non-GAAP basis is kind of high single digits. And that'd be accretive for the quarter. So again, in that -- and again, and in Q2, we only have about $1 million of cost synergies in those numbers, and we get more opportunity going forward as well. So we're pretty fit right out of shoe, which is great.

Yes. And then, Sydney, for your other question about how to look at the business. I'm assuming flex PCB's where we want to secure our #1 market position and that was the release that the [indiscernible], which is what I referred to in the prepared remarks. And those are ones that have been released, and we're already getting a few orders. And so we're really happy about and confident that we'll maintain our #1 in flexible PCB via drilling. And then as we talked about, we were getting ready to start delivering the [indiscernible] tool, which I -- in my prepared remarks, I said got the magazine's Best Product for 2018 Award. And so as those beta sites go out in the Q2, Q3 time frame that's kind of the next real market segment by which we don't participate today. And we hope to participate just as we do with flex PCB; going forward. So that's what you should look for going forward.

Yes. I mean, we're really excited about the HDI opportunity. When we looked at the company, we looked at what they were doing in that business in the past. Virtually, there was really no business there at all. We looked at the prospect of market share, they looked [indiscernible]. It appeared to be quite reasonable to us. And now we're looking at the solution that they provided and seeing the facts that they've been awarded an award with that design gives us great confidence that, that pickup in their business in the future on HDI is on top of already the share they have in flex PCB, along with just the organic growth of the market. So we think that's going to be very positive for the company over the next several years for sure, thinking to the 5G.

And our next question comes from the line of Krish Sankar with Cowen and Company.

Yes. Thanks for taking my question. I just have a few of them. Jerry or John, I'm just trying to figure out on the core of the legacy MKS side business. Is It fair to assume that semiconductor revenues are down Q-over-Q in June versus March?

Yes, Krish. So I think June versus March is flat. March was just slightly down, maybe about 5% from a pretty high Q4 where we saw some pull ins into Q4. So that's why we think it's -- that we characterized it as stable and flat.

Got it. That's very helpful, John. And then how do you see your customers inventory, like where do you think they are in that inventory stabilization or rationalizing the inventory process today on the semiconductor side?

Yes. I think it's a mixed bag, Krish. Unfortunately, I wish people weren't as irrational about what they thought this would be, and they bought a little more than they needed to. But it does appear as though it leaned off a good segment of that inventory. And I think we're in a pretty decent place now, compared to last 6 to 7 months that we saw. So I think it's -- no I think that's what we said that this is just flat at this point. And so I thought that the order rates have stabilized, which meant I didn't see another debt degradation in the orders, which is good, which would mean to me that the inventory is stabilized. Because the order rate really is a reflection about the position they have on the inventory. And when I look at that, it appears as though we were in pretty good stead at this point. And my team needs to tell me that they pretty much consumed a large bulk hit that we [indiscernible] with this little more -- had to eat up and for the most part, it appears to be pretty consistent and stable right now, Krish. We feel pretty good about that.

Got it. And I think just to follow up on the point, does that mean, in theory, if your customers -- your semicap customers are an inflection in the business upwards, your shipment should follow in tandem without any kind of a quarter or 2 lag? Is that fair?

There's no question. Yes. This is an example, one of the things I mentioned was -- in my remarks, we're actually putting capacity in. We have one business unit, I'm putting in $15 million worth of capital in anticipation of the next so that they can pick up. But albeit times are very, very short, Krish. We're on a lot of JT product for the customer, so we would see an immediate pickup. It's not a quarter lag. You'd probably see us -- our revenue pick up before you would see the OEMs revenue pickup. We're that fast.

Got it. Thanks, Jerry, very helpful. And a follow-up question on ESI. My understanding was that on the flexible PCB side, ESI had almost 75% market share versus maybe under 5% or low single digits on the HDI PCB: a, is that correct; and b, if so, is there any kind of cross-selling opportunities within flexible and HDI, or are they all completely different customer base?

Krish, this is John. Yes. So those numbers are right. But I would say the HDI number was even lower for the older tools. So we're starting at a low base. There are many of our customers -- PCB customers who do both flex and HDI, some who only do flex and some who only do HDI. So there are cross-selling opportunities because you're already in the factory with flex. And then of course, you know the relationship, and you can leverage that.

But there are other opportunities within semi of discussions that we could have, I think, with end users about some potential to the ESI longer term, and we're already in those conversations. The minute we bought ESI, there were end-users talking to us about, okay, we need that roadmap meetings now. Then you come over, and we've already had those. Very similar to what happened with Q4. Very similar.

[Operator Instructions]. Our next question come from the line of Tom Diffely with D.A. Davidson.

First question on ESI. The roughly $35 million for the quarter, which is 2 of the 3 months. Is that reflective of the business trends there? Or was it just somehow skewed because Chinese New Year was essentially when you assumed control?

Yes. Tom, it's Seth. Yes, $35 million got a couple of things. One, you're right, it's a partial quarter, so obviously, it's only 2 months. And the next, they also have some purchasing accounting revenue adjustments, which bring that revenue down. So I would say this that if ESI was a standalone company, the revenue would be more like the high $40 million range, trending up obviously is Q2. You have a whole comp -- that's kind of a better metric.

Okay, good. And then, Seth, you talked about creating a new category of equipment and solutions. What else is in there besides ESI, going forward?

It's just ESI. It'll just be that division at this point.

Yes. We're going to have three divisions going forward. Vacuum analysis was with the standalone MKS business. Light and Motion that was Newport. And equipment and solutions, which was with ESI, Tom.

Okay, great. And then Jerry, obviously, we've been ready to ESI appear for a long time, and they've got a very deep bench of just core technology. How long do you think it'll be before you can utilize some of that technology in your other products?

Well, I mean, we've already had a lot of collaboration between Newport and ESI over the last year or two and actually had displaced an incumbent on the latest flex tool that we released. We came in with better technology, more capable. And we have a technology conference we're holding in the next few weeks. There will be a lot of opportunity for people from all the divisions to talk about a collaboration. We also have the office of the CTO. So we're already engaged in that already. My expectation is, we'll see how that comes out. You see total designs like those over a year or two. Although, in some cases, you can probably already displace a competitor because you don't have to copy exactly in the other Advanced Markets like you do in semi. So the opportunity to take more share or utilize our technology within our own systems is a little easier on -- in the Advanced Markets then it is on the semi side. So John, do you want to add anything?

Yes. Tom, I had to add that we had many, many dual tool roadmap meetings between the Light and Motion group and the ESI group. And I think the capability on both sides was a little surprising to each side, though some of the modeling capability and the assistance capability to ESI was unknown to the Light and Motion side. Some of the laser capability and motion capability was unappreciated -- underappreciated by the ESI folks. So there's been a lot of really good ideas. And going forward, they just held a joint TRM together in Asia at the request of that customer, as Jerry had mentioned. And so when you can come to a customer and show the whole portfolio of Newport and the whole portfolio of ESI, no one else can do that. And so that was really a great event for our customers as well.

And, Tom, I know this is going to sound like self-promotion, obviously, but as the CEO, I should, but I sit in -- I sat in in on these map -- the monthly business reviews for the last number of decades. And I am incredibly impressed with the amount of technical horsepower this company now has. It is absolutely incredible. What was more incredible to me is see people from multiple divisions that all understand each other's technology. And the fact that they talked about how they can be engaged in developing more capable technology and integrated systems and helping each other solve their -- the solutions and their problems. And I was just blown away by [indiscernible] and how much technical firepower this company now has. And I'm just glad that John is a PhD from MIT because he can help me understand what I don't understand. So that's really incredibly impressive.

Yes. Okay, great. Seth, one more question on the guidance. The EPS range is little wider than it has been recently. Is that strictly because of the volatility of the ESI business or is there something else behind that?

No. Tom, we have our own range as for MKS. And then we have talked to the ESI team, and said, if you were standalone, what would you range your revenue? And he was like, probably $5 million on both sides at midpoint. And we just add their range to our range. It was simple math like that. That was how we got it.

And then, finally, John. When -- you talked about the 5G rollout as being the big driver. And I assume that you're more leveraged to the handset part versus the base station. And it seems like handset's more of a 2020, 2021 episode. So just, kind of -- if you could just kind of go through what you think the opportunity is on a near-term basis versus what it could be in a couple of years that'd be great.

Yes. Sure, Tom. So on a near-term basis, base stations that's driving a lot of the new chip technology. So that's what would affect our core MKS business. And then going forward though, the headsets, that's where new materials are being adopted for enabling those handsets. And that's when you start seeing the capabilities of ESI starting to help that kind of a market. So near-term is more of the VNA side and then longer-term is more of the ENS side.

Okay. But is it fair to say that the longer term, the handset roll out is going to be a much bigger opportunity for you?

Yes. Because that has both the VNA side as well as the flexible PCB side.

Thank you. And that does conclude today's question-and-answer session. I would now like to turn the call back to Jerry Colella, Chief Executive Officer, for any further remarks.

We are pleased with our results for the first quarter of 2019. We expect that our exposure to diverse end markets, a global leadership position in the semiconductor market, and our focus on financial and operational excellence will continue to drive sustainable and profitable growth. I am more confident than ever that the strategy we put in place has positioned us for long-term outperformance within the markets that we serve. Thanks for joining us on the call today. And if you're interested in MKS, we look forward to updating you on our progress when we report our second quarter 2019 financial results. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.