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

Good morning, everyone. I am David Ryzhik, Vice President of Investor Relations, and I'm joined this morning by John Lee, President and Chief Executive Officer; and Seth Bagshaw, Executive Vice President and Chief Financial Officer. Yesterday, after market close, we released our financial results for the first quarter of 2023, which are posted to our Investor website 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 revenues by end market as well as Atotech and combined company revenues by end market, please visit our Investor website. Now I'll turn the call over to John.

Thanks, David. Good morning, everyone, and thank you for joining us today. I'm very pleased to report that we have restored our global operations following the ransomware incident we identified in early February. We are on track to meet our commitment to substantially recover revenue by the end of the second quarter. I can't say enough about how proud I am with the entire MKS family. Thanks to their dedication, hard work and ingenuity of our 10,000-plus employees, we are a stronger and more resilient company today than we have ever been. I also want to take a moment to thank our customers and suppliers for their support and cooperation throughout this process so that we continue to deliver as a critical enabler to the industries we serve. With that, I'll review our operating environment, including our first quarter results and the trends we are seeing in the second quarter. We delivered first quarter revenue of $794 million, adjusted EBITDA of $142 million and net earnings per diluted share of $0.48. We estimate the ransomware incident had a negative impact on revenue of approximately $160 million for the quarter. As Seth will detail, revenue for the quarter, excluding the impact of the ransomware incident was a little lower than we anticipated. The difference reflected softer demand that developed in the latter part of the quarter, which was relatively more pronounced in our electronics and packaging market. In our semiconductor market, business levels continued to soften in the first quarter, consistent with the well-publicized decline in industry-wide WFE spending in 2023. We remain very engaged with our customers across a spectrum of opportunities in deposition, etch, lithography, metrology and inspection. And our ability to invest through the cycles has been a key reason we have outperformed WFE and the critical subsystems…

Thank you, John. I will cover our first quarter results and provide details on our outlook for the second quarter of 2023. Starting with the first quarter to the revenue of $794 million. As John mentioned, our global team executed well during a challenging period for the company as we work through store operations following the ransomware incident. We estimate the negative impact to revenue was approximately $160 million for the quarter, and our team worked diligently to restore production relative to our initial expectations of at least $200 million impact when we report our fourth quarter results. While recovery has gone well, we've seen a softening of business levels relative to our prior outlook, mainly in electronics and packaging market. As a result, and excluding the impact of ransomware incident, we estimate first quarter revenue would have been lower than our original expectations. As our outlook indicates, we expect softness in overall business levels will continue in the second quarter. However, we see a slight improvement in the second half of the year. Turning to our end markets for the first quarter. As a reminder, the ransomware incident only impacted our Vacuum Photonics Solutions divisions. And therefore, we mostly felt an impact in our semiconductor and specialty industrial markets and to a lesser extent, to electronics and packaging market. We expect to recover approximately 95% of this revenue, remaining 5% largely tied to a transactional catalog business in our specialty industrial market. With as a backdrop, semiconductor revenue was $309 million in the first quarter, declining 38% sequentially and 37% year-over-year primarily due to negative impact of the ransomware incident as well as lower industry demand for semiconductor capital equipment. We estimate the ransomware incident impacted our semiconductor revenue by approximately $110 million in the first quarter. Excluding the…

[Operator Instructions]. Our first question comes from the line of Steve Barger of KeyBanc Capital Markets.

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

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

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

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

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

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

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

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

Got it. Got it. And then just out of curious this is my follow-up, argument that Q2 is the trough in semi revenues. I understand some of your customers have also spoken about kind of running at these Q2 revenue levels into Q3 and Q4. But historically, like as the use of the inventory, and it seems like coming out of a downturn or getting into the first part of the down cycle, you should lag your customers because of the use of the inventory, but that doesn't seem to be happening based on what and some of the other subsystem folks have mentioned, I'm kind of curious why do you think that's going on where your bottom is kind of in tandem with your customers versus lagging them?

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

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

A question on the materials solutions business, the improvement that you're expecting in the second half of the year. How much should we think about that being maybe more seasonally driven versus kind of a bottoming in 2Q of kind of in demand?

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

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

Yes. There's been no change in our approach. You delever the balance sheet pretty aggressively. And we'll lead to the term loan A, by the way. We've done that $100 million voluntary payment back in the fourth quarter. And so that's kind of we're lean in going forward. We haven't kind of given a bright line of that curve. That's certainly our policy and our desire and our goals. So it's kind of leading to that, for sure. I think Q2, because of the lower revenue we booked in the first quarter will catch up in Q2. That might be a little more working capital required on the receivable side in Q2. So that kind of give you full transparency there. But again, we think the back half of the year will be a little bit stronger, slightly up a little bit, get back to that free cash flow generation. So once that cash is generated, that's what we're going to put back to work to take off the term loan A off the balance sheet.

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

Great. I guess, if you strip out the impact of the ransomware, how do you think your semis revenue for the full year versus what you thought 2 months ago? I know there's a lot of moving parts with more production cuts in memory and foundry. But your customers also talk about able to ship more to China and maybe lagging edge foundry and logic is a little bit stronger than they thought. Just wanted to get your thoughts on that.

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

Okay. That's great. That's helpful. Maybe a second question on the gross margin. I think you guys guided the second quarter to be 45%. Should we expect that to be at the normal -- fully normalized number and to start going up as revenue goes up in the second half of the year? Or there is some lingering impact from the underutilization coming from this the ransomware events?

Yes, this is Seth. Yes. So the volume is the biggest driver for sure. So if you model revenue up, that would be the uptick on the overall margins as well because the variable margin is higher than 45%. And then we talked before, in the longer term, we have inflationary pressures every else is faced. Do we take the action to kind of mitigate that going forward as well. So our goal always kind of drive gross margin improvement to those actions and product development, high-value offerings for our customers and so forth. So that will be obviously continued our view on margins going forward. But for kind of short-term modeling, I think the way you want to look at it is the volume is the biggest driver.

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

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

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

Yes. And I guess, John, where I'm going with this is we don't have a lot of experience with the GMF portion of the business. And obviously, we're seeing signs of slowing in different markets, different industrial markets. And I'm wondering how you guys are thinking about that part of the business as we look out to the second half of the year? Not looking for guidance, but just maybe in terms of has there -- have there been some changes at all in the demand trends? You alluded to the fact that it's holding up relatively well.

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

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

Yes. The $25 million we realized annualized for the first quarter is probably better than we expected, I would say, 6 months ago. The team has done a really good job getting engaged and obviously finding opportunities. And obviously, the MSD [indiscernible] was not impacted by ransomware. So they had been as usual for the quarter. So I would say the takeaway is, we feel very good about the $55 million in 18 to 36 months obviously trying to pull that low as best as we possibly can. The $25 million, I think, is a little bit above our expectations. And again, the teams have been really engaged in working on the right opportunities, and we think there's more opportunity going forward as well.

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

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

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

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

No, not at all. I mean, obviously, there's always cycles in any business, certainly in the semi space, we're well tuned to that. But everything we talked about at the Analyst Day, and we're seeing today is exactly intact. We are well positioned across the markets we play in. We gained share this past year in '22 in a very challenging environment on top of a very substantial share gain in '21. So we're kind of doubling down on that. The engage with customers is really strong, and the interactions are very good. The R&D teams are fully engaged. So there's really no change in the fundamental piece of the business and how we grow long-term shareholder value. As John mentioned in the prepared remarks, the team has done a fantastic job navigating a very, very difficult supply chain environment in a ransomware incident, and we did better than we expected coming into this quarter. So no, no change in our view. Looking out 5 years, you'll have these fluctuations for sure, but we can manage these pretty well, we think.

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

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

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