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's 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 NaN, 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 semi 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…

Thank you, John. Before I cover our third quarter results provide details 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 the last 12 months represented approximately 7% of our total revenue. Turning to our third quarter results. We delivered a 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 estimated approximately $30 million. After excluding the impact of 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 third quarter. After seeing the impact of ransomware incident recovery from the second and third quarters, our semiconductor revenue was relatively flat on a sequential basis. Revenue for Electronics & Packaging market was $243 million, an increase of 8% sequentially. Excluding the impact of foreign exchange 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 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,…

Thank you. [Operator Instructions] 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 semi revenues are worse than WFE, which happens during a cyclical downturn. It also probably looks like a tad [ph] lower than some of your peers. So I’m curious is that purely because your debt as exposure, or is there something else going on the market share front? And then I had a follow up.

Yes, Krish, thanks for the question. I think it’s a 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 really particularly down. And 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 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. And 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.

[Operator Instructions] 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 just normal seasonality or maybe some pass through 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 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 and talking to their customers, I guess curious how you’re thinking about that. And maybe in the context you did talk about NaN being definitely weaker, how you’re thinking about the set up 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 and 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 first half is relatively muted, kind of the same as kind of the second half of 2023, and then I think after that I think there’s 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 that just 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 as well as market leadership in the broad set of technologies in semiconductor critical subsystems, as we’ve talked about in the past, that enables dep 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 MK?

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 semi 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 4Q, 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, is it certainly that’s our goal going forward to drive that free cash flow up. So it’ll depend on working capital needs. But so we didn’t really give that type of guidance in the fourth quarter. In terms of debt pay down, we have done a lot of pulling of levers, as you saw in prepared remarks. We did $100 million in October, and our players do lever aggressively going forward now, and roll out as the year progresses. Did the repricing that took $11 million off the table. So that’s, again a level 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 is $45 million to $55 million one year in. So things we can control as in 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, there’s no change in our philosophy to delever drive free cash flow, drive the integration activities, which gone very well.

Appreciate the time. Thanks.

Yep. Thanks, Steve.

One moment for our next question. And 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 semi business, which appears to be holding up better. And, John, maybe you could talk to what 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 inspection part of the semi 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 just much more consistent than certainly the dep 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 semi 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 semis 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 will be great.

Yes. Thanks, Sidney. Yes, I think we talked about semi 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 semi 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 semi 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 semi 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 [indiscernible] 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 semi is 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 know 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 profitability driven and then working capital management. And you saw in the Q3 results we work very hard to deliver really quite strong results given the environment. So, I think those are things I would focus on, the things we’re kind of working pretty hard 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.