Welcome to the MKS Instruments First Quarter 2024 Earnings Conference Call. [Operator Instructions] 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, 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 Michelle McCarthy, our Vice President and Chief Accounting Officer. Yesterday after market close, we released our financial results for the first quarter of 2024, 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, 2023. 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 today, and the company disclaims any obligation to update these statements. During the call, we will be discussing various non-GAAP financial measures. Unless otherwise noted, all income statement-related financial measures will be non-GAAP other than revenue and gross margin. Please refer to our press release and the presentation materials posted to the Investor Relations section of our website for information regarding our non-GAAP financial results and a reconciliation of our GAAP and non-GAAP financial measures. For a detailed breakout of 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 thanks for joining us today. MKS delivered strong results in the first quarter despite a muted market backdrop. First quarter revenue of $868 million exceeded the midpoint of our guidance. Adjusted EBITDA of $217 million and net earnings per diluted share of $1.18 both exceeded the high end of our guidance. We're particularly pleased with our strong gross margins, which reflect the value of our proprietary offerings, disciplined cost control and operational execution. We continue to expect a recovery in our semiconductor and electronics and packaging markets to unfold slowly in the second half of 2024 and are poised to capitalize on our leading positions when we enter the next upturn. In our semiconductor market, we are foundational to key suppliers of leading-edge process equipment in an era where AI is beginning to have a transformative impact on compute and memory architectures. We believe that AI is a powerful secular trend that will drive growth in our industry for years to come. But it's only the latest example in the long history of powerful secular trends in this market. Personal computers, mobile devices and data centers are earlier examples of transformative use cases in their time, all a result of the miniaturization and packaging of semiconductors. Our Vacuum Solutions enable critical deposition and etch processes that are necessary in the manufacturing of high-bandwidth memory as well as a broader array of DRAM, NAND and logic semiconductors. In Photonics, our optical solutions help our customers solve complex challenges in lithography, metrology and inspection. In addition, our motion control solutions are used to enable precise positioning of the wafer and hybrid bonding applications. In our electronics and packaging market, our unique combination of laser and chemistry expertise positions us for attractive growth in packaged substrates, which…

Thanks, John. It's a privilege to be part of the MKS team. In the first quarter, we delivered revenue of $868 million, above the midpoint of our guidance, primarily due to better-than-expected revenue from our semiconductor market. First quarter semiconductor revenue was $351 million, above the high end of our guidance and declining 3% sequentially. The year-over-year comparison is not meaningful as it was distorted by the ransomware incident last February. Revenue performance in the quarter was led by better-than-expected conversion of backlog in the Vacuum Solutions segment as well as continued robust sales of our Photonics Solutions. First quarter electronics and packaging revenue was $208 million, relatively in line with the midpoint of our guidance and a decrease of 8% sequentially. Excluding the impact of foreign exchange and palladium pass-through, sales of our chemistry solutions in this market grew 15% on a year-over-year basis, as our business bounced back from industry softness a year ago. Moving to our specialty industrial market. Revenue in the first quarter was $309 million, above the midpoint of our guidance and up 1% sequentially. Similar to our semiconductor business, the year-over-year comparison is distorted by the ransomware incident. Consumables and services revenue across our 3 end market categories comprised 42% of our total revenue. Turning to our margins. We reported first quarter gross margin of 47.8%, exceeding the high end of our guidance range. The strong results were a function of better-than-expected volumes, favorable product mix and continued cost control. We also benefited by approximately 60 basis points from certain nonrecurring items. First quarter operating expenses were $240 million in line with expectations. Throughout the current cycle, MKS is focused on prudently managing our cost structure while ensuring we invest to innovate for our customers and capitalize on the attractive opportunities we see ahead…

Thank you, Michelle. Let me now turn to our second quarter outlook. We expect revenue of $860 million, plus or minus $40 million, reflecting the slow path to market recovery that we have discussed on recent calls. By end market, our outlook is as follows: revenue from our semiconductor market is expected to be $335 million, plus or minus $15 million, reflecting our view that the market continues to bounce along the bottom with a modest recovery expected in the second half of the year. Revenue from our electronics and packaging market is expected to be $220 million, plus or minus $10 million and revenue from our Specialty Industrial market is expected to be $305 million, plus or minus $15 million. Looking ahead to the second half of 2024, we expect revenue to be slightly higher than the first half reflecting a modest improvement in our semiconductor market, combined with typical seasonality in our electronics and packaging market. Our Specialty Industrial market is expected to remain relatively consistent, mirroring global GDP trends. Based on anticipated product mix and revenue levels, we estimate second quarter gross margin of 46.5%, plus or minus 1 percentage point. The step down in gross margin as compared to the first quarter reflects anticipated product mix as well as certain items that we do not expect to recur in the second quarter. We expect second quarter operating expenses of $240 million, plus or minus $5 million. We continue to believe $240 million to $250 million is an appropriate run rate for the balance of 2024. We estimate adjusted EBITDA of $197 million, plus or minus $23 million. Given these assumptions, we expect second quarter net earnings per diluted share of $0.93, plus or minus $0.26. We continue to execute very well in navigating the cyclical softness in our end markets. I'm very pleased with the strong profitability and margin profile of our business. This, along with our differentiated product and technology portfolio tied to key secular trends in our end markets positions us well for the next cyclical upturn. With that, operator, please open the call for Q&A.

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

John, I know you expect recovery to unfold slowly in the back half, but we're hearing more commentary about 2025 being a strong year for memory and initial positioning for the 2-nanometer transition next year to start. I know you don't want to get too far ahead, but inflections can happen quickly when they come. So can you talk about customer conversations for memory and leading edge and just how you're thinking about timing and capacity to support that inflection?

Yes, Steve, great question. Certainly, we're very intimate with our customers and have these discussions all the time. Obviously, we need to prepare our factories to support them. I would say that we still expect a slowly unfolding second half. But to your point, there are good signs with memory pricing and utilization picking up. Logic remains strong, as you pointed out, 2-nanometer and 3-nanometer capacity is getting used up too. So I think that the discussions are all about -- we're on the bottom, bouncing along the bottom. And it's really about timing, Steve. And you are right, things can change very quickly. But as you know, MKS is pretty good at that. We've been at this for 60 years. We have the capacity to support, obviously, much higher run rate that we had already in the past few years. So we're just waiting and ready for that whenever that happens.

Got it. And similar question on substrate. You talked about AI and some other opportunities like low earth orbit. Can you talk through the road map for more layers or tighter tolerances on those substrates and how increasing complexity will benefit you given your position in drilling, plating equipment and chemistry.

Yes. So, we're really excited about things like AI driving not only the semiconductors, but the electronics and packaging. AI boards are going up to 20 layers now. And of course, the lines and spaces in the VS are also smaller. So that's all good for us. It's more chemistry, it's more difficult chemistry. It's more laser drilling, it's more difficult laser drilling. It's more difficult bonding layers between the various layers in that PCB. And so when you have the ability to toggle, laser equipment, chemistry equipment and chemistry, you just have a better solution set for the customers and solving these really tough challenges. So we believe that MKS is uniquely positioned in the industry to solve these really advanced packaging problems.

And just one quick follow-up. So as you've had the conversations with customers, are they telling you to prepare for a higher capital spending environment for that -- the drilling and plating equipment in chemistry?

Well, it varies. But I think as we pointed out in the earnings script, we have seen this uptick in equipment orders tied to, we believe, AI. This is for actually the high-density multilayer board. So as we talked about in the earnings calls, there's 3 different types of packages: The advanced stuff that connects the chips and goes on to a high-density board then goes on to this very complex multilayer board. And so this is the first sign where we've seen actually CapEx increases for some part of the food chain associated with AI.

Our next question comes from Jim Ricchiuti from Needham & Company.

One of your competitors in the specialty chemistry market recently, I think, last month. talked about improving demand in the electronics market and a couple of the geographic regions. I'm wondering, is that consistent John, with what you're seeing -- in general, how would you characterize also the pricing environment within the Atotech business? And to the extent that might be helping your margins?

Yes, I think we would agree with that, Jim. I think it's slowly improving. You saw in our commentary that year-over-year, our Q1 is significantly better in our electronics chemistry than it was last year to the tune of 15%. It's been gradual and improving. So that's a good sign. In terms of pricing, we talked about gross margin for the business. we talked about Atotech gross margins really significantly adding to the gross margin profile of MKS. I also want to point out that we saw the gross margin improvement in all 3 divisions, so not just Atotech but Atotech certainly comes with, I would argue, industry-leading gross margins and that's obviously indicative of the value they're bringing to those customers. So pricing has been strong. We're getting paid for the value that we bring. And then we see a slight improvement, and we hope that continues.

Got it. On the drilling side, apart from that application that you alluded to, the lower orbit application, are you seeing any lift in the March quarter bookings that more consistent with the seasonality that we've seen occasionally in those parts of the business? Or is that still something that we're still kind of bouncing along the bottom in this part of the business.

Yes. I think we can see a slight improvement, Jim, but I don't look at it as any kind of trend right now. I think it's still muted, still bouncing along the bottom. But flex laser drilling versus HDI laser drilling, of course, is different. So the flex is certainly still very muted. HDI is slightly better. I would just characterize it as still bouncing along the bottom, Jim.

Our next question comes from Krish Sankar from TD Cowen.

I have a few of them. John, I'm just rig to reconcile your statement that second half should be slightly better than first half in terms of revenues. That would imply that calendar '24 revenues for you could be down on a year-over-year basis. or slightly down. Just kind of curious is that true? If so, do you expect both semi and electronic packaging to be down or one down more than the other?

Well, yes, I think there's a lot of still uncertainty with respect to revenue, but we do expect to be slightly better in the second half versus the first half. And it depends on what your assumptions are for Q3 and Q4, obviously, whether the whole year is up or down. But as was pointed out earlier, these things -- they can change quickly. We're planning on a slight uptick in second half, but we're also planning on being ready in case it accelerates. So I would say that's still TBD in terms of year-over-year comparison for the full year.

Got it. Got it. And then can you just give an estimate of what you think our advanced packaging learnings would be this year and what it was last year?

Yes. I think it's -- we've talked about advanced packaging being 1/3 of our business. And when servers and PCs and phones were kind of more normalized. This year is probably more in that 25% -- 25%, sorry. But that can vary. And of course, that's -- you can read about the public companies who are our customers in advanced packaging. And you can see that obviously, the revenues are down significantly. So that's consistent with that.

Got it. Got it. If I could just squeeze one more, John. Just curious how do you think about Atotech benefiting or the impact of Atotech when some of your customers start moving to glass panels or advanced packaging down the road?

Yes. No, glass is certainly something that the industry has talked about for a long time, obviously, and more people are talking about it now. I would just say this, Atotech is an industry leader in packaging, advanced packaging and the next generation. I would characterize it as we're certainly always in those discussions, always certainly looking at what our customers' needs are, and developing the necessary processes to enable what they need and glass is 1 of the things that we are working on along with the rest of the industry. By the way, Chris, I wanted to just clarify my statement about 25% advanced package, that's 25% of electronics and packaging, not 25% of MKS. Sorry.

Our next question comes from Joe Quatrochi from Wells Fargo.

I wanted to -- on the NAND side, as you think about just the recovery in the memory industry, and you think about just what's going to be driving demand on the NAND side? It sounds like the recovery in spending is going to be more related to system upgrades or node transitions. So curious of how do you think about the revenue opportunity for MKS when maybe it sounds like the WAP is going to be a little bit more tied to migration versus net new greenfield ad?

Yes. Thanks, Joe. The -- when the customers are upgrading the chambers for the next node, certain critical subsystems on there have to be upgraded, otherwise, you can't do the next node. And 1 of those is the RF power decks. So as you may or may not know, there's 3 power decks on every chamber for VNAND etcher. And all 3 have to get upgraded if you're moving from one node to the other. And that is obviously the biggest part of our spend. So we don't really notice the difference but when they're doing chamber upgrade versus the entire tool, obviously, when they're doing the entire tools, we may see other parts of MKS products go in there. But the chamber upgrade really benefits us equally, I guess, from the RF-power standpoint. Now having said that, we did talk about inventory burn down and there's still a little bit left in the NAND market. So -- but this is a good sign when some of the customers are talking about node upgrades because that will start burning off that inventory and then at some point, they'll need the new stuff from us as well.

That's helpful. And as a follow-up to that, do you expect that as we kind of look into the second half of this year that NAND inventory burn down is still to play out to some extent? Or is it just, I guess, maybe starting to play out more this quarter?

Yes. I think it depends, right? It depends on how many people are changing nodes, upgrading the nodes. But I think our view now is that it's still slowly unfolding. So that's why we're saying that, slowly unfolding. So I think there's still more to go. And so I think in the second half, there's still some of that NAND inventory burn down that has to happen, it's only for us. But as we talked about earlier, it can change fast, right? And that could accelerate, but -- and we're ready for that, whether that happens or not.

Got it. And just as a follow-up question. On the services gross margin strength that you had in the quarter, was that where the onetime item was? Or just can you help us understand what drove that?

Yes, I can take that question. This is Michelle. So yes, we have favorability in the quarter, as we referenced in the prepared remarks, about 60 basis points. That's nonrecurring. It's really related to favorable material variances as well as favorability in freight and duty cost recoveries. That's really the bulk of it.

Yes. So not necessarily tied to service, Joe. But you did point out our service gross margins were probably a record, I guess, I would call it that. But all the divisions had improved gross margin as well. But service, we're really happy with the performance of that group with the last quarter.

Is there anything to point out what drove that?

There was a good product mix. And certainly, some pricing has rolled through and some cost pressures that have been in the past are no longer there. So kind of a mix of whole bunch of things, Joe.

[Operator Instructions] Our next question comes from Steve Barger from KeyBanc Capital Markets.

Yes. Just a quick follow-up. As you've modeled out free cash flow and how EBITDA progresses, do you think net leverage can get to 4 or below by year-end? Or is that too aggressive?

Yes, Steve, obviously, we were very aggressive in deleveraging. As you saw Q1, we added -- we voluntarily paid another $50 million, and we talked about -- in April, we added -- we voluntarily paid down yet another $50 million. I think our ability to delever and prepay is really going to be a function of profitability, Steve. So not news to you, I'm sure. So I think it depends on how the year unfolds. And our model still is 50% gross margin flow through, 40% operating margin flow-through. But as you know, we have a lot of leverage in the model. And so when revenue does pick up, you'll see a lot of cash flow and then we'll be able to delever quicker.

I am showing no further questions. I would now like to turn the call over to David for closing remarks.

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

Thank you. This does conclude the program. You may now disconnect.