Good day, and thank you for standing by. Welcome to the MKS Instruments First Quarter 2022 Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference may be recorded. [Operator Instructions] I would now like to hand the conference over to your host 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, Senior Vice President and Chief Financial Officer. Yesterday, after market closed, we released our financial results for the first quarter of 2022, which are posted to our website, 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 our most recent annual report on Form 10-K and any subsequent quarterly reports on Form 10-Q. These statements represent the company’s expectations only as of today and should not be relied upon as representing the company’s estimates or views as of any date subsequent to today. And the company disclaims any obligation to update these statements. During the call, we will be discussing various financial measures. Unless otherwise noted, all forward-looking financial measures excluding any contribution from Atotech Limited, the acquisition of which is still pending. 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 website for information regarding our non-GAAP financial results, a reconciliation of our GAAP and non-GAAP financial measures and certain pro forma financial information. 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 with our Q1 results, especially given the significant industry supply chain challenges. First quarter revenue of $742 million was within 1% of the midpoint of our guidance range. Profitability was strong with net earnings per diluted share of $2.71, exceeding the midpoint of our guidance range and an increase of 6% year-over-year. We credit this profitability to excellent execution in our factories and an emphasis on cost control while continuing to make targeted R&D investments across our portfolio. We believe our performance highlights prudent management of our expenses while still investing in the long-term growth of our business. While underlying demand trends remain very healthy, industry supply chain constraints are limiting growth, which is particularly true in our Semiconductor business. Before I review the key trends across our end markets, I want to explain the change in how we will present our revenue. Beginning with this quarter, we have divided what we previously referred to as our Advanced Markets into two separate end markets: Advanced Electronics, Specialty Industrial. We believe this change better represents the end markets we serve and will enable you to better understand the key drivers of our business. There will be no change to our Semiconductor Market, which includes deposition, etch, lithography, metrology, inspection, wet clean and packaging applications. In the first quarter, revenue from our Semiconductor Market comprised 66% of overall revenue. Advanced Electronics represents revenue from advanced printed circuit board, solar, display and electronic component applications. We view our Advanced Electronics Market as a close cousin to the Semiconductor Market, each of which benefits from the same defining trends of miniaturization and complexity. We believe packaging technologies will become increasingly critical to enabling better performance, design and cost of…

Thank you, John. I will first provide additional detail and updated end market classification then cover our first quarter 2022 results followed by guidance for the second quarter. Let’s start with Advanced Electronics, which is a key enabler of laser-based manufacturing solutions for cutting-edge electronics applications. This market includes flexible and HDI PCB via drilling, laser and vacuum processing solutions for solar and display applications and a number of other precision manufacturing applications for electronic devices. We believe our unique Surround the Workpiece portfolio of lasers, motion, optics and other photonic solutions combined with our applications expertise from our Equipment Solutions Division provide us with a unique opportunity to be the go-to enabler of advanced electronics manufacturing. These applications offer attractive secular growth or maybe some level of cyclicality, given this market is tied to capital equipment spending. Looking ahead, our pending acquisition of Atotech would add critical electroplating solutions for advanced interconnects. With these solutions, one of the laser drilling systems, we believe we’re well positioned to optimize the interconnect and accelerate customer road maps, next-generation electronic devices. We also believe Atotech’s electronics business will add a large base of stable recurring revenue with a strong margin profile. For 2021, revenues from Advanced Electronics Market comprised 15% of MKS’ total revenue and on a pro forma basis with Atotech’s 2021 reported financial results would have comprised 32% of overall revenue. Our Specialty Industrial Market represents a broad array of leading technologies across industrial, life and health sciences, research and defense markets. Examples of applications include vacuum solutions for synthetic diamond manufacturing, lasers for ophthalmic surgery, vibration isolation for advanced research and infrared zoom lenses for both commercial and defense application. This market provides more stable revenues and strong margins and cash flow. In this market, we leverage product and…

Thank you. [Operator Instructions] Our first question comes from the line of Patrick Ho with Stifel. Your line is open. Please go ahead.

Thank you very much. John, maybe first off, I know there are a lot of moving parts on the whole supply chain and COVID-related issues. But can you give a little bit of color for the June quarter, what the bigger impacts are? Is it the ability to procure certain components or the Shenzhen lockdowns and the after effects still impacting your ability to ramp up the facility there? And maybe as a follow-up to that, what’s been the ability on your end to flex some of that capacity to – because you have a large footprint. What’s the ability to flex some of that capacity to, I guess open capacity?

Yes. Thanks, Patrick for the question. I think I’ll take the Shenzhen one. So our factory was closed for about a week or so because of the COVID-19 restriction. So we did recover after about a week, and so that’s factored into our Q2 guidance. But I would comment that the supply chain constraints are not getting better. Electronic components remain a big part of it, but also it broadened to other types of materials, resins, specialty metals. And so we’re factoring that into our Q2 guidance as well. In terms of moving capacity between factories, there are a few factories where we can do that. But mostly, our factories are still running pretty well in terms of utilization because they’re still constrained by supply.

Great. That’s helpful. And maybe as my follow-up question for Seth, in terms of gross margins, you guys performed really well despite the shortfall in revenues and the supply chain constraints. Can you just give some of the levers that are keeping gross margins at still pretty high levels, given the current environment?

Yes. Thank you, Patrick. Yes, I would say that the – obviously, what we do is provide to our customers high-value applications. So I think what you’re seeing is a reflection in our margin, reflects frankly that value to our customers in the overall markets we serve. Kind of on the tactical level to your question, we have a number of levers. We’ve got a world-class operations team. We’re really working to qualify potential other sources to mitigate some inflationary pressure. We do have some pricing ability. We’ve talked about that in the past that we’ve definitely leaned into, and there’s more opportunity there as well in the future. And we’ve broad-based portfolio across a number of different markets, I think, kind of mitigate some of the things that John talked about in some of the markets we serve. So it’s a wide range of opportunities. It’s a wide range of different levers we pull. I think fundamentally, you’ll see our margins go back up over time to historical levels. That’s our goal, for sure.

Great. Thank you again.

Thanks, Patrick.

Thank you. And our next question comes from the line of Jim Ricchiuti with Needham & Company. Your line is open. Please go ahead.

Hi, thank you. So if I look at the Vacuum Solutions business being down sequentially, guys, that was mainly supply chain and the COVID disruption, and that’s, I assume, the area of the semiconductor business that you’re a little bit more cautious about continuing supply chain issues in the June quarter?

Jim, it’s John. That’s right. Give or take, it was about down 1% in our semi business, and that is where the majority of the supply chain constraints are hitting our business.

Okay. And if we look at the photonic solutions portion of the business and look at the way you’re now characterizing that business, what I’m wondering is if you could provide some color on the nonsemi photonics business, how that’s performing. For instance, are you seeing any signs of changing demand in the European part of that business just in light of the geopolitical situation that we’re experiencing there?

Yes, Jim, thanks for the question. No, we’ve actually seen that part of the business of the photonic solutions division to be pretty stable. We don’t have a lot of exposure of business to Russia, if you will, and no supply chain. And so the business has been actually pretty stable in the – as we talked about life and health sciences, research and defense so – and other industrials.

Okay. Thanks a lot.

Thanks, Jim.

Thank you. And our next question comes from the line of Scott Graham with Loop Capital Markets. Your line is open. Please go ahead.

Yes, hi. Good morning. Thanks for taking the question John, Seth and David. So I’m just looking at the weakness in the PCB business, and you’re alluding to your sort of the OEs CapEx weakening there. That’s does seem to be a pivot versus where we were understanding, of course, that this is a lumpy business. How will we read that across – we’re gearing up for an acquisition. I just – we’re much more than doubling down in PCB, we’re kind of 5x-ing it, right? So I’m just wondering how – why should we be comfortable over the next couple of quarters with the PCB business weakness, and you’re about to significantly increase the size of a business where the customers’ capital spending is weak?

Yes, Scott, that’s a fair question. I would always pivot to the fact that our strategies are always long term. And when we look at advanced packaging and package substrates, we see that as a really attractive long-term opportunity for MKS. And that’s why we are trying to acquire Atotech. When you look at our flex business, it is lumpy. And I think it’s well known that smartphone and consumer demands and some of the uncertainties have made our customers cautious in terms of adding capacity for flex. But we also know that we are the leader in Flex PCB via drilling. There’s been no loss of market share as far as we know. So we always look at the long term, and flex business will come back. HDI business will grow. And if Atotech is part of the family, their business for electronics plating will also grow. So we’re really looking at the long-term play with respect to advanced packaging.

Understood. Thank you. So I appreciate that, John. It was good. I suspect the same. The other question I had was about sort of price cost, and some companies look at price cost as pricing versus materials. Some look it as pricing versus company-wide deflation. However you look at it, it does look like the second quarter is going to be behind that curve. And so I know you mentioned that there’s some opportunity for you in pricing. Kind of why does the gross margin sink that much? How – why are we not increasing prices maybe a little bit faster, right, to buffer that second quarter gross margin? Maybe just talk about price cost in the context of your second quarter guide.

Yes, Scott. I think the inflationary costs have hit us pretty hard, as I said, everybody pretty hard. We have been leaning into price increases, but that does take some time to recover. And so the pace of which inflationary costs have hit us and the pace of our levers in terms of price increases, there’s a bit of a gap, I guess. And I think you’re seeing that in our guidance in Q2. But as I’ve said, we expect that to recover over the next outer quarters as well. And we have a lot of backlog. And so backlog is commitments at previous prices. And so it’s a bit of a constraint in terms of how fast we can change prices versus, for instance, a consumable company where you can just change prices immediately or a chip company, for that matter. And so we do have a little bit of a lag there, but be rest assured that we expect to recover that gross margin in the outer quarters.

And I appreciate that, John. Thank you and I guess it will be like a two quarter event. But just to tuck-in sort of question 2a here, is there any reason why with demand strong because it doesn’t sound to me like semi is weaker, and that’s where the supply chain is kind of hitting you the hardest. It sounds to me like the end demand is pretty strong. Is there any reason why we can’t reprice the backlog?

It’s always an option that we’ve looked at. And we have to balance that with partnerships and relationships with key customers. And so we look at that as well. But we also try to make sure that we’re partnering in a long-term sense with our key customers. That’s really important to us that we maintain those long-term partnerships. And I think we get rewarded for that by our biggest customers.

Just to add what John said is the market share gains we generated back in 2021 is kind of extension what John mentioned. Obviously, technology, seeing the right inflection points, investing ahead of that curve is a big driver for share gains. But the fact that our customers trust us to work with us, I think, is pretty important as well. So I would say it’s a big picture view is how we look at it.

Guys, thanks a lot for taking my questions.

Yes, thanks Scott.

Thank you. And our next question comes from the line of Joe Quatrochi with Wells Fargo. Your line is open. Please go ahead.

Yes. Thanks. Thanks for taking the question. Maybe one on the semi side. I’m just curious, several of your customers are talking about diversifying the supply chains or qualifying additional critical sub components. Have you guys benefited from any of that type of practice in terms of being able to maybe gain some share and some critical applications that maybe you previously weren’t?

Joe, it’s John. Actually, we have. We have actually been the beneficiary of some of that behavior from our customers. And going back to Scott’s earlier question, that’s because our customers trust us, and we partner with them. And so when they have constraints in their supply chain, MKS is one of the first companies they always come to and say, "Can you deliver these other new products or more of the ones that are designed in?" And so we actually have been the beneficiary of that. So we’re working hard in our operations team to continue to deliver and overcome the supply chain constraints. But in this kind of environment, the operations team is going to be responsible for share gains actually. Usually, we get share gains from technology, new innovations, et cetera, and that’s normal. But in this kind of constrained environment, our ability to gain market share because of our operational team’s excellence and performance is really a great – another lever for us.

That’s helpful. And then just as a follow-up on the flex side, how would you characterize the industries or your customers’ discipline relative to maybe the last down cycle? Have you seen them maybe pull back on the CapEx somewhat quicker or faster than the past cycle in terms of just kind of hoping to see a less of a peak to trough?

Yes. No, I think this one is a little different than the last cycle, Joe. I think this one was – started off the year with kind of uncertainty. What – people weren’t sure or customers weren’t sure their capacity needs because there was uncertainty by their customers in terms of the signals from them. And then as the quarter progressed, I think those uncertainties became realized. And that – the inflationary expectations and expect on consumer demand, the geopolitics of Eastern Europe didn’t help. And so those uncertainties became realized into kind of a risk-off approach. And that’s what we’re seeing right now in our flex market.

Very helpful. Thank you.

Thanks, Joe.

Thank you. [Operator Instructions] Our next question comes from the line of Krish Sankar with Cowen and Company. Your line is open. Please go ahead.

Hi, good morning. This is Steven calling on behalf of Krish. Thanks for taking my question. I guess the first one is just a little bit more of a high level if you could talk a little bit about the linearity across the three businesses throughout the quarter. I guess just looking at the higher DSOs in the quarter, I’m kind of wondering whether it was the semis business that saw some of the orders sort of frozen there, closer to the end of the quarter due to the Shenzhen production impact or if there are other interesting characteristics of the orders and sales across the other segments during the quarter.

Yes, Steve, this is Seth. I’ll take that question. Yes, I said in the prepared remarks, the DSO’s a little bit higher this quarter versus prior quarters because the linearity of revenue in the – during the quarter. Usually, we have a little more of a hockey stick at the back end, which is more a photonics piece of the business. But I think what you’re seeing, we saw in Q1 is the supply chain constraints; it was sort of a linear impact there as well. So I wouldn’t say it’s a timing of orders per se. I think it’s more of how we get the parts into the operations and how we shipped out products. That was more of the linear impact, I think, on the quarter. And that drove up DSO. I mean, the aging is in good shape, everything else. It’s really just the timing of revenue during the quarter. It’s more operational-driven than order-driven.

Got it. Thank you for the answer. And also one more for you as well on the gross margin side. So just in terms of the sequential decline in gross margins, can you provide more color on what is the incremental change that’s driving that? Is it partly mix? Or is it more the inflationary costs becoming a higher burden in the June quarter? And any additional color around that would be great.

Yes. Yes, exactly. I’ll take that one as well, Steve. So yes, you’re right. So we’re down about 1.5 points sequentially, and it’s virtually all inflationary pressure. That’s a little bit of mix too because we mentioned the flex, the PCB drilling revenue in Q2 be relatively muted. It’s a little bit of mix there, but the lion’s share of the sequential decrease is inflationary pressure. And we know where it’s coming from. As John mentioned, we have actions in place. We’re very committed to kind of get back to historical levels, and that’s certainly all hands on deck work on that right now. But that’s what’s driving at least in the short term the impact on Q2.

I think the magnitude of it, is it the higher cost? Is it affecting the semi business more than the other two segments?

Yes, correct. Yes. So you’ll see it in the back of the analysis division is the biggest impact is. It’s affecting every division, but the vast majority is the semi piece of our business.

Great. Thanks Seth.

Yes. Thank you.

Thank you. And our next question comes from the line of Paretosh Misra with Berenberg. Your line is open. Please go ahead.

Thank you. Good morning. Your photonics business is holding up better sequentially and was up a lot on a year-over-year basis. So what are you seeing there? Has it been impacted less by these supply chain issues? Or it’s just better demand which is driving that?

Yes. Paretosh, we strategically made some decisions early on when we bought Newport, which was to take the photonics technologies that we had and try to leverage that into some of the semi markets where Newport was relatively less levered. And that, again, like RF Power was a multiyear strategic decision. And we’ve been making progress with design wins over the last several years that we’ve talked about on these calls. And you’re starting to see that. You’re starting to see that a big part of the Photonic Solutions division growth is coming from the semi market. You see the Specialty Industrial being relatively stable, and you see the Advanced Electronics for the Photonics division also relatively stable. But the growth, a lot of that growth is driven by strategic decisions we made to put that technology for the semiconductor market.

Got it. And then as a follow-up, in this Specialty Industrial segment or market, how should we think about the growth potential in that business? Is it similar to Advanced Electronics? Or could it be lower than the electronics over the long run?

Yes. No, that’s – Specialty Industrial, we kind of look at it as a GDP plus kind of business. So that is lower than what we expect for the Advanced Electronics. And so – but that’s stable, much more stable, you can see in our guidance as well. It levers the research that we put into Semiconductors and Advanced Electronics. And we only play in certain niches where we have value and where we can have that steady gross margin and cash flow from it.

Got it. Thanks, John.

Thanks, Paretosh.

Thank you. And our next question comes from the line of Hans Chung with D.A. Davidson. Your line is open. Please go ahead.

Thank you for taking my question. So first, is it possible to quantify like the impact from the supply chain constraint to our second quarter outlook? Like how much of amount like for example, like without supply chain constraint and what we can do in terms of top line? And then what’s the backlog exiting the March quarter versus three quarters ago?

Hans, it’s John. It’s difficult to quantify exactly what the supply chain constraints are on the top line. I think that’s your question. Suffice it to say, though, that our backlog is continuing to increase. We don’t publish that backlog. Bookings also continue to increase. So it’s not a demand problem. It’s not a backlog problem. It’s a supply chain constraint problem. And so we’re working real hard to try to increase our output every quarter. But as I said before, the supply chain constraints seem – they’re not getting better. And they continue to surprise. We continue to react. We react better. We have better partnerships with our customers and our suppliers, but they continue to surprise. And I think we’re also contemplating or including in our guidance the fact that there are COVID shutdowns now. We were affected by Shenzhen in Q1. As you know, there are potential effects of shutdowns in Shanghai and now Beijing. And we don’t have factories there, but we have offices, and certainly maybe third-tier suppliers have factories there. And so we’re taking all that into account as we guide the revenue going forward.

Got it. Okay. And then next question is regarding your RF Power, the business. So you have gained market share for the past couple of years, I would say. And just kind of how much room for you guys to continue to gain share, particularly in the contact edge side of business?

Yes. No. As you know, we’ve been talking about design wins and incremental share gains for many years. And I think many of our long-term investors have stayed with us, and they’ve benefited from that. Many other investors didn’t know who to believe. So they might have bailed out. Too bad for them. But we were consistent, we were determined. And you can see that this is something that doesn’t happen very often in the semiconductor equipment market because of Copy Exact! For us to be a distant number two in RF Power six years ago to being number one in RF Power. My career, that has happened maybe two or three times in the entire industry. So that’s a really significant change. And to your question, going forward, we see that continuing to grow. All that share gain that we talked about in terms of making us distant number two to number one was almost all driven by dielectric etch. We haven’t even tapped into conductor etch, where we have some design wins, and we expect to continue to have more design wins. And so we think that RF Power will continue to grow and extend its lead in market share.

Thank you.

Thank you. And this does conclude today’s question-and-answer session. And I would like to turn the conference back over to David Ryzhik for any further remarks.

Thank you, Michelle, and thank you all 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. Everyone, have a great day.