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Operator
Welcome to the MKS Instruments First Quarter 2024 earnings conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star 1-1 on your telephone and wait for your name to be announced. You will then hear an automated message, advising your hand is raised. To withdraw your question, please press star 1-1 again. 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 Rizik, Vice President of Investor Relations. Please go ahead.
David Rizik
Good morning everyone. I am David Rizik, Vice President of Investor Relations. And I am joined this morning by John Lee, President and Chief Executive Officer, and Michelle McCarthy, our Vice President and Chief Accounting Officer. Yesterday, after market closed, we released our financial results for the first quarter of 2024, which are posted to our investor website at .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 sections 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.
John Lee
Now,
David Rizik
I'll turn the call over to John.
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. A gestated 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 edge processes that are necessary in the manufacturing of high bandwidth memory, as well as a broader array of DRAM,
David
NAND,
John
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 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 are a key building block of advanced packaging architectures. This complements our opportunity in high density interconnect PCBs, which are required for smartphone and AR VR applications, and where we also see a growing opportunity in the low bandwidth orbit application. In our specialty industrial market, we address a broad array of specialized applications where we are leveraging our proprietary technology to deliver strong margins and attractive cash flows. Across all these markets, we harness a broad base of capabilities and key enabling technologies such as vacuum, photonics, and materials solutions. With a leadership position in a broad array of product categories, this affords us a holistic overview of the ever increasing device scaling requirements faced by our customers, enabling us to develop integrated, novel solutions to address these challenges. As an example, our team in Korea was recently recognized by Samsung Electromechanics for their support in the development and trial production of new products. We were also recently recognized by STMicroelectronics receiving the Best Performance Material Supplier Award and the Innovation Value Engineering Award for our work in developing a new adhesion promoter technology that enhances automotive IC package reliability. We are proud of the deep customer relationships that we've built over the last several decades and are excited about the opportunities that lie ahead for MKS. I'll turn now to our end markets. Revenue from our semiconductor market exceeded our expectations in the first quarter as we slightly stronger demand and improved conversion of customer backlog. Overall demand for our vacuum solutions for deposition and edge applications remains muted, primarily due to historically low levels of NAND equipment spending. We believe broader customer inventories across our vacuum portfolio are generally in a more balanced state today compared to a few quarters ago, but we may see some additional pockets of work downs in areas tied to NAND. With our Photonics Solutions Division, revenue from our optical solutions for lithography, neutrology, and inspection applications remained robust in the first quarter. We continue to see momentum in our world-class optics initiative. This is a unique offering where MKS brings optics, coatings, motion stages, optical subsystems, and lasers to solve complex challenges in transistor scaling. As we look to the second quarter of 2024, we expect revenue in our semiconductor market to be slightly down sequentially from a better than expected first quarter results. Early memory market indicators, including improved pricing and increasing demand, as well as continued spending tied to AI applications are encouraging. But as the industry first brings idle capacity back online, we expect the recovery and capital equipment spending to return gradually in the second half of the year. Turning to our electronics and packaging market, revenue was in line with expectations, despite the unfavorable impact of foreign currency and lower palladium prices. Sales of our chemistry solutions for PCB and packet substrate markets were stable amidst a muted market for PCs, smartphones, and non-AI servers. Our results also reflected expected seasonal softness due to the Lunar New Year holiday. However, we did see a slight pick-up in demand for our plating equipment lines for complex, high-density, multi-layer PCB production, which we believe was primarily driven by growing AI server demand. As many of you know, AI GPUs require a large amount of advanced semiconductor content, which in turn requires complex packaging schemes. Semiconductors are mounted onto a packaged substrate that is then mounted onto a high-density PCB and afterwards is mounted onto an advanced multi-layer PCB. This growing substrate and PCB content in AI architectures puts MKS in a unique position to benefit with our proprietary laser drilling, chemistry, and plating equipment solutions. We also saw additional demand for laser drilling systems for the fast-growing, low-Earth orbit application within the PCB market, where we are the process tool of record. As we look to the second quarter of 2024, we expect revenue from our electronics and manufacturing marketing market to be up on a sequential basis due to an increase in plating equipment revenues and a seasonal increase in chemistry revenues following typically lower first quarter utilization. Turning to our specialty industrial market, revenue was slightly better than expected, driven by the modest sequential improvement in our life and health sciences and research and defense markets. Revenue from our general metal finishing business in the automotive market remained flat overall on a sequential basis. As we look to the second quarter, we expect demand trends in our specialty industrial market to remain stable, with revenue relatively in line with first quarter levels. Wrapping up, MKS delivered a strong profitability in the first quarter, despite a continued soft end-market demand environment. While we expect overall industry demand to remain muted near term, we feel very good about the positioning of our portfolio and the investments we've made to capitalize on the key secular trends driving our end markets. Turning now to the finance discussion, I'd like to introduce you to Michelle McCarthy, our Vice President and Chief Accounting Officer, who will walk through our financial results in more detail. Michelle recently joined MKS and brings a strong public company accounting background to complement our deep finance team. This team is doing an outstanding job as we conduct our search for MKS's next Chief Financial Officer, and we will keep you posted on our progress. Michelle, why don't we take it from here?
Michelle McCarthy
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 -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 solution segment, as well as continued robust sales of our photonic 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 -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 -over-year comparison is distorted by the ransomware incident. Consumables and services revenue across our three 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 non-recurring items. First quarter operating expenses were $240 million, in line with expectations. Throughout the current cycle, MKS has 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 of us. Our first quarter operating margin was 20.2%, and exceeded the high end of our guidance range, reflecting strong gross margin performance, coupled with the natural operating leverage in the business. It is noteworthy that our acquisition of AdoTech has been a meaningful contributor to our strong performance in both gross and operating margins. Further to that point, exiting the first quarter, we exceeded our AdoTech cost synergy target of $55 million, and we accomplished this at the earlier end of our expected timeframe of 18 to 36 months, continuing our track record of executing well on M&A synergies. First quarter adjusted EBITDA was $217 million, representing a 25% margin, and exceeding the high end of our guidance range. Net interest expense for the first quarter was approximately $75 million, slightly favorable compared to our expectations. As a reminder, in the first quarter, we refinanced our term loan and completed a $50 million voluntary debt prepayment. Our refinancing included the paydown of our term loan A, with incremental borrowing, against our term loan B, and the elimination of the financial maintenance covenant that applied while our term loan A was outstanding. We expect second quarter net interest expense will be approximately $79 million. Also, in early April, we made another $50 million voluntary debt prepayment. Our tax rate for the first quarter was approximately 23%, slightly favorable as compared to our expectations entering the quarter. We expect our tax rate for the second quarter to be about 23%, and our full year tax rate to be approximately 20%. First quarter net earnings were $79 million, or $1.18 per diluted share, exceeding the high end of our guidance. We exited the first quarter with more than $1.5 billion of liquidity, including cash and short investments of $846 million and an undrawn revolving credit facility of $675 million. Gross debt was $4.9 billion at the end of the quarter. Our net leverage ratio exiting the first quarter was 4.3 times, based on trailing 12 months adjusted EBITDA of $940 million. Free cash flow was approximately $49 million, and unlevered free cash flow was $108 million. As a reminder, our first quarter free cash flow is typically lower due to timing of variable compensation payments. Consistent with prior quarters, we made a dividend payment of $15 million, or $0.22 per share. With that, let me turn the call back to John. John?
John
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've 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 special 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 .5% plus or minus one 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 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
Thank you. At this time, we will conduct a question and answer session. As a reminder, to ask a question, you will need to press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. We ask that you please limit your questions to one question and one follow-up. Please stand by while I compile the Q&A roster. Our first question comes from Steve Barger from KeyBank Capital Markets. Please go ahead.
Steve Barger
Thanks. Good morning. 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 two 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. 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?
John
Yeah, Steve, that's a 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, two nanometer and three nanometer capacity is getting used up too. I think that the discussions are all about we're on the bottom, bouncing along the bottom, and it's really about timing, Steve. You are right. Things can change very quickly, but as you know, MKCIS 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. We're just waiting and ready for that whenever that happens.
Steve Barger
Got
John
it.
Steve Barger
Similar question on substrate. You talked about AI and some other opportunities like low Earth orbit. Can you talk through the roadmap 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?
John
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. Of course, the lines and spaces in the vias are also smaller. 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 bonding layers between the various layers in that PCB. When you have the ability to toggle laser equipment, chemistry equipment, and chemistry, you just have a better solution set for the customers in solving these really tough challenges. We believe that MKCIS is uniquely positioned in the industry to solve these really advanced packaging problems.
Steve Barger
And just one quick follow-up. As you've had the conversations with customers, are they telling you to prepare for a higher capital spending environment for the drilling, plating equipment, and chemistry?
John
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 multi-layer boards. As we talked about in the earnings call, there's three different types of packages. They've advanced stuff that connects the chips, then goes onto a high-density board, then goes onto this very complex multi-layer board. This is the first sign where we've seen actually capex increases for some part of the food chain associated with AI.
Steve
Terrific. Thanks. Thanks, Steve.
Operator
Thank you. One moment for our next question. Our next question comes from Jim Rekuti from Needham & Company. Please go ahead.
Jim Rekuti
Hi. Thank you. Good morning. One of your competitors in the specialty chemistry market recently, I think last month, talked about improving demand in the electronics market in 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 -of-tech business? To the extent that might be helping your margins?
John
Yeah, 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 a 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 -of-tech gross margins really significantly adding to the gross margin profile of MCAS. I also want to point out that we saw the gross margin improvement in all three divisions, not just -of-tech. -of-tech certainly comes with, I would argue, industry-leading gross margins. That's obviously indicative of the value they're bringing to those customers. Pricing has been strong. We're getting paid for the value that we bring. Then we see slight improvement, and we hope that continues.
Jim Rekuti
Got it. On the drilling side, apart from that application that you alluded to, are you seeing any lift in the March quarter bookings that are more consistent with the seasonality that we've seen occasionally in these parts of the business, or is that still something that we're still bouncing along the bottom in this part of the business?
John
Yeah, I think we can see a slight improvement, Jim. I don't look at it as any kind of trend right now. I think it's still muted, still bouncing along the bottom. Flex, laser drilling versus HDI, laser drilling, of course, is different. The Flex is certainly still very muted. HDI is slightly better. I would just characterize it as still bouncing along the bottom,
Jim Rekuti
Jim. All right. Thank you.
John
Thanks, Jim.
Operator
Thank you. One moment for our next question. Our next question comes from Krish Sankar from TD Cowan. Please go ahead.
Sankar
Yeah. Hi. Thanks for taking my question. Out of a few of them, John, I'm just trying 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 -over-year basis or slightly down. I'm just trying to keep is that a true, if so, they expect both electronics packaging to be down or one down more than the other?
John
Well, yeah, 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. 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, they can change quickly. We're planning on a slight uptick second half, but we're also planning on being ready in case it accelerates. I would say that's still TBD in terms of -over-year comparison for the full year.
Sankar
Got it. Can you just give an estimate of what you think of advanced packaging revenues would be this year and what it was last year?
John
Yeah, I think we've talked about advanced packaging being a third of our business when servers and PCs and phones were more normalized. This year is probably more on that quarter percent, 25 percent, sorry. But that can vary, and of course, you can read about the public companies who are our customers in advanced packaging, and you can see that obviously their revenues are down significantly. So that's consistent with that.
Sankar
Got it. If we could just squeeze in 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 for advanced packaging down the road?
John
Yeah, 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 one of the things that we are working on along with the rest of the industry.
Glass
Thanks, John.
John
By the way, Chris, I wanted to just clarify my statement about 25% of advanced packaging. That's 25% of electronics and packaging, not 25% of MKS.
Glass
Sorry.
Operator
Got it.
Glass
Thank
Operator
you.
Jim
Thanks, Chris. Thank you. One moment for our next question. Our next question comes from Joe Quadrochi from
Operator
Wells Fargo. Please go ahead.
spk04
Yeah, thanks for taking the question. I wanted to come to the same side. As you think about just the recovery in the memory industry and you think about just what's driving demand on the NAND side, it sounds like the recovery and spending is going to be more related to system upgrades or node transitions. I'm curious, how do you think about the revenue opportunity for MKS when maybe it sounds like the WIP is going to be a little bit more tied to migration versus net new greenfield ads?
John
Yeah, thanks, Joe. 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. One of those is the RF power decks. As you may or may not know, there's three power decks on every chamber for VNAN Etcher. All three have to get upgraded if you're moving from one node to the other. That is obviously the biggest part of our spend. We don't really notice the difference between when they're doing chamber upgrade versus the entire tool. Obviously, if they're doing the entire tool, we may see other parts of MKS products go in there. The chamber upgrade really benefits us equally from the RF power standpoint. Having said that, we did talk about inventory burn down and there's still a little bit left in the NAND market. This is a good sign when some of the customers are talking about node upgrades because we'll start burning off that inventory and then at some point, they'll need the new stuff from us as well.
VNAN Etcher
That's helpful. As a follow-up to that, do you expect that as
spk04
we look into the second half of this year, that NAND inventory burn down is still to play out to some extent or is it maybe starting to play out more this quarter?
John
Yeah, I think it depends. It depends on how many people are changing nodes or upgrading the nodes. Our view now is that it's still slowly unfolding. That's why we're saying that, slowly unfolding. I think there's still more to go. I think in the second half, there's still some of that NAND inventory burn down that has to happen, certainly for us. As we talked about earlier, it can change fast and that could accelerate. We're ready for that, whether that happens or not.
spk04
Got it. Just as a follow-up question, on the services gross margin strength that you had in the first quarter, what drove that?
Michelle McCarthy
I can take that question. This is Michelle. We have favorability in the quarter as we referenced in the prepared remarks, about 60 basis points. That's non-recurring. It's really related to favorable material variances as well as favorability and freight and duty cost recoveries. That's really the bulk of it.
John
Not necessarily tied to service, Joe, but you did point out our service gross margins were probably record, I guess, would call it that. All the divisions had improved gross margin as well, but service were really happy with the performance of that group with the last quarter.
Joe
Is there anything to
John
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. It makes a whole bunch of things,
Joe
Joe. Thank you.
John
Thanks, Joe.
Operator
Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. One moment for our next question. Our next question comes from Steve Barger from KeyBank Capital Markets. Please go ahead.
Steve Barger
Yeah, thanks. Just a quick follow-up. As you've modeled out free cash flow and how EBIT progress, do you think net leverage can get to four or below by year end or is that too aggressive?
John
Yes, Steve. Obviously, we're very aggressive in deleveraging. As you saw, Q1, we voluntarily paid another $50 million and we talked about in April, we voluntarily paid 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. I think it depends on how the year unfolds. 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. When revenue does pick up, you'll see a lot of cash flow and then we'll be able to deliver quicker.
Steve
Great. Thanks. Thanks, Steve.
Operator
Thank you. I am showing no further questions. I would now like to call over to David for closing remarks.
David Rizik
Thank you all for joining us today and for your interest in MKS. Operator, you may close the call,
Operator
please. Thank you.
Jim
This does conclude the program. You may now disconnect.
Operator
Welcome to the MKS Instruments First Quarter 2024 earnings conference call. At this time, all participants are in listen only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star 1-1 on your telephone and wait for your name to be announced. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. 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 Rizik, Vice President of Investor Relations. Please go ahead.
David Rizik
Good morning, everyone. I am David Rizik, Vice President of Investor Relations and I am joined this morning by John Lee, President and Chief Executive Officer, and Michelle McCarthy, our Vice President and Chief Accounting Officer. Yesterday, after market closed, we released our financial results for the first quarter of 2024, which are posted to our investor website at .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's 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 sections 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 market and division, please visit our Investor website.
John Lee
Now,
David Rizik
I'll turn the call over to John.
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. A gested 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 strong gross margins which reflect the value of our proprietary offerings, discipline cost control, and operational execution. We continue to expect a recovery in our semiconductor and electronics 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 the results of the miniaturization and packaging of semiconductors. Our vacuum solutions enable critical deposition and edge processes that are necessary in the manufacturing of high bandwidth memory as well as a broader array of DRAM,
David
NAND,
John
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 in hybrid bonding applications. In our electronics and packaging market, our unique combination of laser and chemistry expertise positions us for attractive growth in package substrates, which are a key building block of advanced packaging architectures. This complements our opportunity in high density interconnect PCBs, which are required for smartphone and AR VR applications, and where we also see a growing opportunity in the low earth orbit application. In our specialty industrial market, we address a broad array of specialized applications where we are leveraging our proprietary technology to deliver strong margins and attractive cash flows. Across all these markets, we harness a broad base capabilities and key enabling technologies such as vacuum, photonics, and materials solutions. With a leadership position in a broad array of product categories, this affords us a holistic view of the ever increasing device scaling requirements faced by our customers, enabling us to develop integrated novel solutions to address these challenges. As an example, our team in Korea was recently recognized by Samsung Electromechanics for their support in the development and trial production of new products. We were also recently recognized by ST Microelectronics, receiving the Best Performance Material Supplier Award and the Innovation Value Engineering Award for our work in developing a new adhesion promoter technology that enhances automotive IC package reliability. We are proud of the deep customer relationships that we've built over the last several decades and are excited about the opportunities that lie ahead for MKS. I'll turn now to our end markets. Revenue from our semiconductor market exceeded our expectations in the first quarter as we saw slightly stronger demand and improved conversion of customer backlog. Overall, demand for our vacuum solutions for deposition and edge applications remains muted, primarily due to historically low levels of NAND equipment spending. We believe broader customer inventories across our vacuum portfolio are generally in a more balanced state today compared to a few quarters ago, but we may see some additional pockets of workdowns in areas tied to NAND. With our Photonic Solutions Division, revenue from our optical solutions for lithography, metrology and inspection applications remain robust in the first quarter. We continue to see momentum in our world-class optics initiative. This is a unique offering where MKS brings optics, coatings, motion stages, optical subsystems and lasers to solve complex challenges in transistor scaling. As we look to the second quarter of 2024, we expect revenue in our semiconductor market to be slightly down sequentially from a better than expected first quarter results. Early memory market indicators including improved pricing and increasing demand as well as continued spending tied to AI applications are encouraging, but as the industry first brings idle capacity back online, we expect the recovery and capital equipment spending to return gradually in the second half of the year. Turning to our electronics and packaging market, revenue was in line with expectations despite the unfavorable impact of foreign currency and lower palladium prices. Fails of our chemistry solutions for PCB and substrate markets were stable in this immuted market for PCs, smartphones and non-AI servers. Our results also reflected expected seasonal softness due to the Lunar New Year holiday. However, we did see a slight take up in demand for our plating equipment lines for complex high-density multi-layer PCB production, which we believe was primarily driven by growing AI server demand. As many of you know, AI GPUs require a large amount of advanced semiconductor content, which in turn requires complex packaging schemes. Semiconnectors are mounted onto a packaged substrate that is then mounted onto a high-density PCB and afterwards is mounted onto an advanced multi-layer PCB. This growing substrate and PCB content in AI architectures puts MKS in a unique position to benefit with our proprietary laser drilling, chemistry and plating equipment solutions. We also saw additional demand for laser drilling systems for the fast-growing low-Earth orbit application within the PCB market, where we are the process tool of record. As we look to the second quarter of 2024, we expect revenue from our electronics and packaging market to be up on a sequential basis due to an increase in plating equipment revenues and a seasonal increase in chemistry revenues following typically lower first quarter utilization. Turning to our specialty industrial market, revenue was slightly better than expected, driven by the modest sequential improvement in our life and health sciences and research and defense markets. Revenue from our general metal finishing business in the automotive market remained flat overall on a sequential basis. As we look to the second quarter, we expect demand trends in our specialty industrial market to remain stable, with revenue relatively in line with first quarter levels. Wrapping up, MKS delivered a strong profitability in the first quarter, despite a continued soft end market demand environment. While we expect overall industry demand to remain muted near term, we feel very good about the positioning of our portfolio and the investments we've made to capitalize on the key secular trends driving our end markets. Turning now to the finance discussion, I'd like to introduce you to Michelle McCarthy, our Vice President and Chief Accounting Officer, who will walk through our financial results in more detail. Michelle recently joined MKS and brings a strong public company accounting background to complement our deep finance team. This team is doing an outstanding job as we conduct our search for MKS's next Chief Financial Officer and we will keep you posted on our progress. Michelle, why don't we take it from here.
Michelle McCarthy
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 -over-year comparison is meaningful as it was distorted by the ransomware incident last February. Revenue performance in the quarter is led by better than expected conversion of backlog in the vacuum solution segment, as well as continued robust sales of our photonic 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 -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 last quarter, we were down by the ransomware incident. Consumables and services revenue across our three 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 has 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 of us. Our first quarter operating margin was .2% and exceeded high end of our guidance range, reflecting strong gross margin performance, coupled with the natural operating leverage in the business. It is noteworthy that our acquisition of Adotech has been a meaningful contributor to our strong performance in both gross and operating margins. Further to that point, exiting the first quarter, we exceeded our Adotech cost energy target of $55 million, and we accomplished this at the earlier end of our expected timeframe of 18 to 36 months. Continuing our track record of executing well on M&A synergies. First quarter adjusted EBITDA was $217 million, representing a 25% margin and exceeding the high end of our guidance range. Net interest expense for the first quarter was approximately $75 million, slightly favorable compared to our expectations. As a reminder, in the first quarter, we refinanced our term loan and completed a $50 million voluntary debt prepayment. Our refinancing included the pay down of our term loan A with incremental borrowings against our term loan B and the elimination of the financial maintenance covenant that applied while our term loan A was outstanding. We expect second quarter net interest expense will be approximately $79 million. Also, in early April, we made another $50 million voluntary debt prepayment. Our tax rate for the first quarter was approximately 23%, slightly favorable as compared to our expectations entering the quarter. We expect our tax rate for the second quarter to be about 23% and our full year tax rate to be approximately 20%. First quarter net earnings were $79 million or $1.18 per diluted share, exceeding the high end of our guidance. We exited the first quarter with more than $1.5 billion of liquidity, including cash and short-term investments of $846 million and an undrawn revolving credit facility of $675 million. Gross debt was $4.9 billion at the end of the quarter. Our net leverage ratio exiting the first quarter was 4.3 times based on trailing 12 months adjusted EBITDA of $940 million. Free cash flow was approximately $49 million and unlevered free cash flow was $108 million. As a reminder, our first quarter free cash flow is significantly lower due to timing of variable compensation payments. Consistent with prior quarters, we made a dividend payment of $15 million or $0.22 per share. With that, let me turn the call back to John. John?
John
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 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 special 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 .5% plus or minus one 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 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 93 cents plus or minus 26 cents. 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 of return. 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
Thank you. At this time, we will conduct a question and answer session. As a reminder, to ask a question, you will need to press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. We ask that you please limit your questions to one question and one follow-up. Please stand by while I compile the Q&A roster. Our first question comes from Steve Barger from Key Bank Capital Markets. Please go ahead.
Steve Barger
Thanks. Good morning. 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 two-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. 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?
John
Yeah, Steve, that's a 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, two-nanometer and three-nanometer capacity is getting used up too. I think that the discussions are all about we're on the bottom, bouncing along the bottom. It's really about timing, Steve, and you are right. Things can change very quickly, but as you know, MKCIS 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. We're just waiting and ready for that whenever that happens.
Steve Barger
Got it. Similar question on substrate. You talked about AI and some other opportunities like low Earth orbit. Can you talk through the roadmap for more layers or tighter tolerances on those traits and how increasing complexity will benefit you given your position in drilling, plating equipment, and chemistry?
John
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. Of course, the lines and spaces in the vias are also smaller. 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. When you have the ability to toggle laser equipment, chemistry equipment, and chemistry, you just have a better solution set for the customers in solving these really tough challenges. We believe that MKCIS is uniquely positioned in the industry to solve these really advanced packaging problems.
Steve Barger
Just one quick follow-up. As you've had the conversations with customers, are they telling you to prepare for a higher capital spending environment for the drilling, plating equipment, and chemistry?
John
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 the high-density multi-layer board. As we talked about in the earnings call, there's three different types of packages. They advance stuff that connects the chips, then goes onto a high-density board, then goes onto this very complex multi-layer board. This is the first sign where we've seen CAPEX increases for some part of the food chain associated with AI.
Steve
Terrific. Thanks. Thanks, Steve.
Operator
Thank you. One moment for our next question. Our next question comes from Jim Rekuti from Needham & Company. Please go ahead.
Jim Rekuti
Hi. Thank you. Good morning. 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 -of-tech business? To the extent that might be helping your margins?
John
Yeah, 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 a 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 -of-tech gross margins really significantly adding to the gross margin profile of MCAS. I also want to point out that we saw the gross margin improvement in all three divisions, not just -of-tech. -of-tech certainly comes with, I would argue, industry-leading gross margins, and that's obviously indicative of the value they're bringing to those customers. Pricing has been strong. We're getting paid for the value that we bring. Then we see slight improvement, and we hope that continues.
Jim Rekuti
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 these 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?
John
Yeah, 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. The flex is certainly still very muted. HDI is slightly better. I would just characterize it as still bouncing along the bottom,
Jim Rekuti
Jim. All right. Thank you.
Jim
Thanks,
John
Jim.
Operator
Thank you. One moment for our next question. Our next question comes from Krish Sankar from TD Cowan. Please go ahead.
Sankar
Yeah. Hi. Thanks for taking my question. Out of the field then, John, I'm just trying to reconcile your statement that second half should be slightly better than first half in terms of revenue. That would imply that calendar 24 revenues for you could be down on a -over-year basis or slightly down. This kind of case, is that A, true? If so, they expect both Semi and E, electronic packaging to be down or one down more than the other?
John
Well, yeah, 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. 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, this can change quickly. We're planning on a slight uptick 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 -over-year comparison for the full year.
Sankar
Got it. Got it. And then can you just give an estimate of what you think of advanced packaging learnings would be this year and what it was last year?
John
Yeah, I think we've talked about advanced packaging being a third of our business. When servers and PCs and phones were kind of more normalized, this year is probably more on that quarter percent, 25 percent, sorry. But that can vary. And of course, you can read about the public companies who are our customers in advanced packaging, and you can see that obviously their revenues are down significantly. So that's consistent with that.
Sankar
Got it. Got it. If we could just squeeze in one more, John, just curious, how do you think about ad to take benefiting or the impact of ad to take when some of your customers start moving to Glass panels for advanced packaging down the road?
John
Yeah, no, Glass is certainly something that the industry's talked about for a long time, obviously, and more people are talking about it now. I would just say this, ad to take is 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 one of the things that we are working on along with the rest of the industry.
Glass
Thanks, John.
John
By the way, Chris, I wanted to just clarify my statement about 25 percent advanced packaging, 25 percent of electronics and packaging, not 25 percent of MKS. Sorry. No,
Glass
it's not. Thank you.
John
Thanks, Chris.
Jim
Thank you. One moment for our next question. Our next question comes from Joe Cardoche
Operator
from Wells Fargo. Please, please go ahead.
spk04
Yeah, thanks for taking the question. I wanted to come to the same side. You know, as you think about just the recovery in the memory industry and you think about just, you know, what's going to be driving demand on the NAND side, it sounds like, you know, the recovery and 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 WIP is going to be a little bit more tied to, you know, migration versus net new greenfield ads?
John
Yeah, thanks, Joe. 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 one of those is the RF power decks. So as you may or may not know, there's three power decks on every chamber for a VNAND etcher, and all three 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, you know, notice the difference between when they're doing chamber upgrade versus the entire tool. Obviously, if they're doing the entire tool, 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, you know, they'll need the new stuff from us as well.
VNAN Etcher
That's helpful. And as a follow up to that, do you expect that as we
spk04
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, I guess, maybe starting to play out more this quarter?
John
Yeah, I think, you know, 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, certainly 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.
spk04
Got it. And just as a follow up question, on the services gross margin strength you had in the quarter, was that where the one time item was? Or just can you help us understand what drove that?
Michelle McCarthy
Yeah, I can, I can take that question. This is Michelle. So yeah, we have favorability in the quarter, as we referenced in the prepared remarks, about 60 basis points. That's not recurring. It's really related to favorable material variances, as well as favorability and freight and duty cost recovery. That's really the bulk of it.
John
Yeah, so not necessarily tied to service, Joe. But you did point out our service rev, our service had improved gross margin as well. But service were really happy with the performance of that group with the last quarter.
Joe
Is there anything that
John
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 a whole bunch of things,
Joe
Joe. Thank you.
John
Thanks, Joe.
Operator
Thank you. As a reminder, to ask a question, please press star one one on your telephone, and wait for your name to be announced. One moment for our next question. Our next question comes from Steve Barger from KeyBank Capital Markets. Please go ahead.
Steve Barger
Yeah, thanks. Just a quick follow up. As you've modeled out free cash flow and how EBIT.progresses, do you think net leverage can get to four or below by year end? Or is that too aggressive?
John
Yes, Steve. Obviously, we're 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 out yet another 50 million. Yeah, 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. In 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 leverage quicker.
Steve
Great, thanks. Thanks, Steve.
Operator
Thank you. I am showing no further questions. I would now like to turn the call over to David for closing remarks.
David Rizik
Thank you all for joining us today and for your interest in MKS. Operator, you may close the call,
Operator
please. Thank you. This does conclude the program. You may now disconnect.
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