Welcome to the MKS Instruments' Second Quarter 2024 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the call over to Paretosh Misra, Vice President of Investor Relations. Please go ahead.

Good morning, everyone. I am Paretosh Misra, Vice President of Investor Relations, and I'm joined this morning by John Lee, President and Chief Executive Officer; and Michelle McCarthy, Vice President and Chief Accounting Officer. Yesterday, after market close, we released our financial results for the second quarter of 2024, which are posted to our investor Web site 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 31st, 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 to 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 Web site 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 Web site. Now, I'll turn the call over to John.

Thanks, Paretosh, and good morning everyone. Let me start by welcoming Paretosh to MKS as our new Vice President of Investor Relations. Paretosh brings strong experience in both investor relations and sell-side research, where we covered MKS earlier in his career. I assume a number of you may already know Paretosh. We're glad to have him onboard. You'll be hearing from him soon. In addition, we are making very good progress on our search for MKS' next CFO. I hope to have news to share in the not too distant future. MKS delivered a strong second quarter, with revenue of $887 million, at the high end of our guidance, and EPS of $1.53, exceeding the high end of our guidance. Our EPS included approximately $0.14 of interest expense benefit from our recent convertible note offering and term loan B paydown. But even without this tailwind, we still exceeded the high end of our guidance. Our results reflect the continued excellent financial execution which positions the company well for the eventual end market recovery. In addition to our revenue and earnings performance, we maintained strong gross margins above 47%, reflecting the value of our proprietary and differentiated solutions, as well as our consistent focus on cost control. Our operating expenses were better than guided as a result of lower than expected compensation and benefit costs primarily related to the timing of new hires and prudent management of third-party spend. Our solid execution extended to the balance sheet where we continued our long-standing track record of proactively managing our leverage. During the quarter, we closed an upsized $1.4 billion convertible note offering at a fixed coupon rate of 1.25%. We used approximately $1.2 billion of the net proceeds to pay down our term loan B, which significantly reduced our cash interest expense.…

Thank you, John, and good morning, everyone. For the second quarter, MKS reported revenue of $887 million, up 2% sequentially and at the high end of our guidance range, driven by better than expected Semiconductor and Electronics & Packaging revenue. Second Semiconductor revenue was $369 million. Up 5% sequentially and well ahead of our expectations, primarily driven by stronger than expected in-quarter demand conversion. As John mentioned, a year-over-year comparison for semiconductors is not meaningful given our second quarter 2023 results include recovery from the ransomware incident in the first quarter of 2023. Year-over-year comparisons should be largely normalized starting with the third quarter. Second quarter Electronics & Packaging revenue was $229 million, an increase of 10% quarter-over-quarter and 2% year-over-year. This result was led by seasonal strength in chemistry and higher equipment sales. Excluding the impact of foreign currency and palladium pass-through, chemistry sales grew 19% year-over-year, as we are seeing some recovery from industry-wide softness in the second quarter of 2023. In our specialty industrial market, second quarter revenue is $289 million, a decline of 7% sequentially and just below our guidance expectations. Revenue can fluctuate from quarter-to-quarter as a result of trends within the multiple end markets served, but overall has been generally stable over the last four quarters. Similar to our semiconductor market, the year-over-year comparison is distorted as a result of recovery from the ransomware incident. Turning to margins, we reported second quarter gross margin of 47.3%, representing the high end of our guidance. Gross margin was down sequentially as expected due to favorability from the non-recurring items in the first quarter, as well as product mix, including the impact of startup costs related to the world-class optics win in our Photonic Solutions division, as John discussed. Our margins continue to reflect the strength of…

Thank you, Michelle. Let me now turn to our third quarter outlook. We expect revenue of $870 million, plus or minus $40 million, reflecting the better-than-expected second quarter and a continued slow path to market recovery as we continue to bounce along the bottom of this industry cycle. We now expect second-half revenue to be relatively in line with first-half levels. By end market, our third quarter outlook is as follows. Revenue from our semiconductor market is expected to be $360 million, plus or minus $15 million. Revenue from our Electronics & Packaging market is expected to be $220 million, plus or minus $10 million. And revenue from our specialty industrial market is expected to be $290 million, plus or minus $15 million. Based on anticipated revenue levels and product mix, we expect third quarter gross margin of 46.5%, plus or minus 100 basis points. We expect third quarter operating expenses of $235 million, plus or minus $5 million. As we continue to manage expenses, we believe $235 million is an appropriate run rate for the fourth quarter as well. We estimate adjusted EBITDA of $206 million, plus or minus $23 million. As Michelle mentioned, the recent convertible note offering and term loan B paydown is expected to be accretive by roughly $0.27 per share in the third quarter. We expect a tax rate of approximately 16.5% in the third quarter, and we expect to remain on track to achieve a tax rate of 20% for the full fiscal year. Given these assumptions, we expect third quarter net earnings per diluted share of $1.43, plus or minus $0.28. I'm proud of how our team has navigated the cyclical softness in our end markets while delivering for our customers and our shareholders. 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.

Thank you. At this time, we will conduct the question-and-answer session. [Operator Instructions] Our first question comes from Joseph Moore of Morgan Stanley. Your line is now open.

Great. Thank you. It looks like those margins in the quarter were stronger than we expected, and your Q3 guidance was pretty good. Can you talk about the puts and takes, and what's driving that gross margin improvement?

Yes, good morning, Joe. I think the gross margin is reflective of the proprietary nature of our products. I think, there was a good product mix again, mainly MSD, chemistry revenue, remained a good proportion of the revenue, but also gross margin was improving as well in VSD as well as service. And we did note a little bit of gross margin headwind in PSD. So, that kind of range of 46 to, give or take, 100 basis points, 46.5, that's really the right way to think about our gross margin with the current mix that we have today.

Great. Thank you. And as a follow-up, separately, can I ask about on the semi side, are you seeing any indications of NAND spending picking up, either second-half this year or early next year?

Yes, I think, it's hard to predict that, but I think we read the same things you guys read. And I think NAND does seem to be pushing out a little bit relative to maybe the industry view early in the year. So, I think we're still bouncing along the very bottom for NAND. And as you know, we have some great set of proprietary solutions there. So, when that market picks up we'll certainly enjoy that pickup. But right now, Joe, I think we're a little more bouncing along the bottom a little longer, and I think that's consistent with the industry view.

Great, thank you.

Thanks, Joe.

Thank you. [Operator Instructions] Our next question comes from Vivek Arya of Bank of America Securities. Your line is now open.

Hi. This is Michael Mani on for Vivek Arya. Thank you for taking a few of our questions. First off, I think some of your major customers in the semi market reported so far indicated relatively strong sequential growth into the second-half. So, I guess, how can we reconcile this with some of the more muted trends you're seeing in Q3? And what sign should we look for as these customers prefer a more sustained can occur is it largely a function of utilization or are there other signs we should monitor? Thank you.

Yes, Michael, I think one of the things that's happening now in the industry and with MKS is that our lead times have been pulled in, which is good. They've pulled in to kind of the normal historic lead times, which are pretty short. And that does limit our visibility a little bit. And as we noted in the call this time, as well last quarter, there is a lot more of the unexpected, if you will, in-quarter conversions because our lead times are shorter. And so, I agree that some of our customers have indicated that there may be some -- better second-half. And then, we'll see if that happens to us -- for us. But certainly if they do, and they need our equipment, we'll see that. But right now the best we can see is that the second-half first-half is relatively consistent. And I would note, as we said in the prepared remarks, that Q2 was much higher than we had expected coming into Q2.

Got it, thank you. And next, could you share any more color on the strategic photonics win in the quarter? Once this fully ramps over the coming quarters, how much could this potentially contribute to growth next year? And is there any way to frame the long-term opportunities of optic photonics market for MKS? Thank you.

Yes, I think this is just the latest example of a multiyear strategy we've had of investing in world-class optics. We believe that we have a unique capability in the industry because of our broad product portfolio, and we can integrate many things together that no one else can. And so, this is a big win, and we're happy to have gotten it. There is always the historic costs, cycle time is longer in the beginning, and manufacturing efficiency is a little less efficient in the beginning until you start making more units. As you order more parts, obviously pricing of the supply, the parts goes down. So, we do have a little headwind on that in the beginning, but that's kind of normalized. So, I think it's just part of our bigger effort in world-class optics, which I think we'd point out our revenue in lithography, metrology and inspection has continued to grow, even during this current down cycle, and that's part of the reason why we continue to believe we can outperform WFE growth.

Thank you.

Thanks.

[Operator Instructions] Our next question comes from Melissa Weathers of DB. Your line is now open.

Hi there. Thank you for letting me ask a question. I wanted to talk about the specialty industrial business. Can you summarize where you think we are cyclically in that business? Think it came in a little bit lighter than what I thought in the recent quarter. So, how do we think about that business cyclically? I know there are a bunch of different moving parts within it.

Yes, thanks for the question, Melissa. I think we look at it as not cyclical. It's made up of a bunch of different markets that tend to sum up to something pretty stable. And we've seen that over the past several quarters. It can be lumpy. And this quarter was down a little more than we had expected, as we said. I would look at this -- I would look at the longer-term revenue for specialty industrials, that's why we look at a year at a time. And when you look at it in that perspective, it is still very stable. So, it can be lumpy depending on some sub-segments of the markets.

Got it. And then, on E&P side, I think last quarter you talked about an uptick in demand for high-density multilayer PCBs related to AI servers. How is that business trending, are you still seeing momentum from AI?

Yes, I think we do. Many of those customers that are more levered to AI are our customers. And we see that momentum. And many of them are public companies because -- so, you can see what they're saying. And the good thing is that the proportion of the PCB market that is driven by AI is increasing. But as we noted before, it's still relatively a small proportion of the PCB markets. PCs, and smartphones, and non-AI servers are still the largest part of it. And as you know there's still a little bit of muted demand in PCs and smartphones.

Got it, thank you.

Thank you.

Thank you. Our next question comes from Jim Ricchiuti of Needham & Company. Your line is now open.

Hi, and thanks. Good morning. Hey, John, wanted to go back to the E&P performance in Q2, which was a little better than expected. It sounds like it was both equipment and chemistry related. I wonder if you can give a little bit more color on which was the bigger driver to that outperformance. And then, I have a follow-up question on E&P.

And good morning, Jim, you're right, Q2, the uptick in E&P was driven by both equipment and chemistry, but chemistry is by far the bigger driver, Jim. And as you know, our guidance in Q3 is slightly down, but the -- just to give everybody a little more color, it's really because of the equipment that's slightly down. The chemistry is still, as we expect, Q3 being a little higher than Q2. So, I just want to give everybody a little color that that's consistent probably with what the industry is seeing.

Got it, that's helpful. And yes, there are expectations, as you know, that we could see a better refresh cycle with smartphones next year. And I'm not going to ask you if you agree with that unless you want to offer some perspective. But if that's accurate, and I'm curious, which parts of the business is going to lead that recovery from a bookings standpoint? Is it going to be the PCB drilling business followed by the chemistry or is chemistry more -- it sounds like that's more book-and-ship, and when could you see a possible uptick in orders if we're in that kind of a scenario?

Yes, it's a great question, Jim. If there was just steady business and people weren't adding CapEx, obviously the chemistry utilization and the chemistry bookings, which happen right when we ship, by the way, so there's really not a lag, would be the first indicator. But you raise a good point, if there was a big up-cycle, if you will, in CapEx investments, we would have to see those bookings with the lead times that we have on laser systems. And we don't report bookings. So, I think -- but to your point, you're right. If there is a buildup that requires new CapEx, we should see that in equipment sooner than just utilization rate.

Okay. Thanks a lot.

Thanks, Jim.

Thank you. The next question comes from Krish Sankar of TD Cowen. Your line is now open.

Yes, hi, thanks for taking my question. I think, one, John, your outlook on September quarter, it jives with what your customers have said also. But I'm curious, the biggest delta between them and now is the fact that Intel-type CapEx. And I'm just wondering how much of that has had any important, if any, in the second-half of this year and, more realistically, in calendar '25?

Yes, I think you're right; Intel did have their call, and did guide CapEx down a little bit in 2024. I'm not sure that really impacted our view of the guidance. And our view, obviously, is made up of all the customers in the industry. But I think the -- when you think about the industry, everybody is kind of thinking 2025 is going to be good. But the time in which it does turn up is pushed out a little bit. And I think that's what we're seeing. And that's why we're looking at second-half being very similar to first-half. I think coming into the year, Krish, we're all hopeful, we didn't know that there might be a stronger hock stick towards the end of the year. And as the year progressed, I think that has gradually come down. And I think, right now, our best view is that second-half roughly the same as the first-half.

Got it. I mean maybe let me ask the question a different way, John. Intel also gave a calendar '25 CapEx number which is down 17% year-over-year. Baking that in, are you still in the camp that WFE will be a strong growth year next year?

Well, I think that is certainly a headwind to all WFE, but as you know, if someone's not spending on WFE, as long as the chip revenues are needed and the capacity is needed, someone else will be spending the CapEx as well. So, I still think that 2025 will be better. And we don't really predict WFE going forward. It's very hard to do. And thankfully you guys have to and we don't. But I still think 2025 will be better. But in terms of an impact on my specific customer, I don't think I could really predict what that will be on 2025.

Got it. And then, a quick follow-up on the Atotech side, obviously the Atotech business does have some exposure to Intel, but you also have some exposure to some of these AI chips, which has seen some delays with cobalt, I'm kind of curious, has that really changed your perspective on Atotech's advanced packaging opportunity into next year?

Yes, no, I think the next generation PCBs and substrate work that we're doing with our most advanced customers, that's still a couple years out anyway. And your commentary is really about utilization rates today and any impacts from any kind of specific customer commentary. But as we said in the answer to an earlier call, a question, we still see that AI-driven chemistry business is good. It's just that we have to put that in perspective in terms of the proportion of AI chemistry relative to the chemistry for the entire PCB market.

Got it, got it. Thank you, Joe.

Thanks, Krish.

Thank you. Our next question comes from Joe Quatrochi of Wells Fargo. Your line is now open.

Yes, thanks for taking the question. I just wanted to kind of understand the second-half versus first-half now, expecting flat. I think as I think about like the beat, the magnitude of the beat in T&Q, and then kind of where the street producer was modeling kind of a low single-digit increase half on half for second-half, it seems like the flat half on half is a bigger change in the magnitude of the Beat in 2Q. So, I'm just kind of trying to understand is there anything else that changed aside from the upside that you put up in 2Q, particularly in Semi?

Yes, Joe, I don't think there was a big change. We kind of looked at every quarter through the year as kind of bouncing along the bottom. As I said earlier, coming into the year, we kind of expected with the industry that there would be more of an uptick in the second-half, but slight, as we said. And now I think most of the industries have said that there is a bit of a push out. And so, whatever the consensus had for us and for the industry in Q3 and Q4 is probably more muted, that's for sure. And this is our best view right now. So, I think not much change. I think we're just bouncing along the bottom. I think the only change is we're probably bouncing along the bottom a little longer than we thought we might at the beginning of the year.

Got it. And as a follow-up, can you talk a little bit about the early synergistic plating and chemistry design win that you saw in the quarter. Was that -- and does that include MKS, like laser drilling as well, or is it just on the Atotech side?

Yes, we've talked in the past about laser drilling wins synergistic. The ones we mentioned this time were Atotech wins synergistically. And as we've said before, if Atotech and MKS were already in that customer and we both won, we don't count that as synergy. It's really the case where either the legacy MKS laser guides were in and Atotech wasn't. And if Atotech wins, then we count that as a synergy. And that's really what we're talking about with these two wins we called out.

That's helpful. Just to be clear, is that one of the first kind of MKS-led wins then?

It is, it is. The other ones we've talked about in the past were the Atotech bringing in the laser group. So, these are the first two. Now remember, it wouldn't take a while, right, because you're qualifying, you're testing, etc. So, we have been working at this for multiple quarters and we have other things we're working on right now that hopefully in the future will turn into wins as well. So, yes, these are the first two Atotech chemistry wins because of the laser group.

Helpful. Thank you.

Thanks, Joe.

Thank you. [Operator Instructions] Our next question comes from Steve Barger of KeyBanc Capital Markets. Your line is now open.

Thanks. I know there is a lot of variables to this question. But in general, if you sell a new plating system and it gets to full run rate, how can we think about what that adds to consumables in terms of percentage to the base chemistry business, or maybe you can talk about it in terms of dollars per system? I am just trying to understand the relationship between new equipment installs and consumable uptake.

Yes, Steve. Thanks for calling. I know you are probably on an airplane there somewhere. But, I would say this, the ASPs of the equipments, the CapEx depends on how big it is, number one. But if you take one -- maybe one of our biggest exciting tools. And, we are talking about electronics versus GMF, it could be couple of million dollars or so. Now, the chemistry is, I would say, think of it an order of magnitude less per month. And so, this chemistry in all these tanks, but that chemistry last forever. So, that's kind of way we think about it. We can give you a little more color on that going forward. So, I just don't have it off the top of my head because it does vary by the chemistry -- by how much the chemistry we have. And then, of course, the gross margins could vary slightly depending on the chemistry. So, I think when we get the CapEx in, we are just really happy about the longer term prospects of that chemistry. And, that could be 30 years of chemistry revenue.

Right. Yes, great. That's good start. And a lot of industrial end markets are soft right now. But, are you seeing opportunities outside of automotive in the other established end markets in specialties that could you a little revenue leverage to the cycle when it does improve?

Yes, I think it is not the end. I would say you are right. Some of the industrial -- industrial customers outside of automotive seem to be a little more hesitant if you will, but I would say in one of the specialty industrial markets that seems to have been doing a little better was defense. And we probably mentioned that a couple of times over the last couple quarters. But, as I said that's a small percentage of our business. But, it has been doing well in the last couple of quarters. So, that's one I would call out. But as again, it's really made of multiple, multiple markets of our specialty industrials revenue.

Understood. Thanks.

Thanks, Steve.

Thank you. [Operator Instructions] This concludes question-and-answer session. I would now like to turn it back to Paretosh Misra 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 for your participation in today's conference. This does conclude the program. You may now disconnect.