Good day, and thank you for standing by. Welcome to the MKS Instruments First Quarter 2022 Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference may be recorded. [Operator Instructions] I would now like to hand the conference over to your host today, David Ryzhik, Vice President of Investor Relations.

Please go ahead..

Good morning, everyone. I am David Ryzhik, Vice President of Investor Relations, and I’m joined this morning by John Lee, President and Chief Executive Officer; and Seth Bagshaw, Senior Vice President and Chief Financial Officer.

Yesterday, after market closed, we released our financial results for the first quarter of 2022, which are posted to our website, mksinst.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 most recent annual report on Form 10-K and any subsequent quarterly reports on Form 10-Q.

These statements represent the company’s expectations only as of today and should not be relied upon as representing the company’s estimates or views as of any date subsequent to today. And the company disclaims any obligation to update these statements. During the call, we will be discussing various financial measures.

Unless otherwise noted, all forward-looking financial measures excluding any contribution from Atotech Limited, the acquisition of which is still pending. Also, unless otherwise noted, all income statement-related financial measures will be non-GAAP other than revenue.

Please refer to our press release and the presentation materials posted to our website for information regarding our non-GAAP financial results, a reconciliation of our GAAP and non-GAAP financial measures and certain pro forma financial information. Now, I’ll turn the call over to John..

Advanced Electronics, Specialty Industrial. We believe this change better represents the end markets we serve and will enable you to better understand the key drivers of our business. There will be no change to our Semiconductor Market, which includes deposition, etch, lithography, metrology, inspection, wet clean and packaging applications.

In the first quarter, revenue from our Semiconductor Market comprised 66% of overall revenue. Advanced Electronics represents revenue from advanced printed circuit board, solar, display and electronic component applications.

We view our Advanced Electronics Market as a close cousin to the Semiconductor Market, each of which benefits from the same defining trends of miniaturization and complexity.

We believe packaging technologies will become increasingly critical to enabling better performance, design and cost of electronic devices from high-end smartphones to electric vehicles to high-performance microprocessors for data centers and artificial intelligence.

And advanced PCBs and package substrates are the next key drivers of these trends, underscoring the strategic rationale of our pending acquisition of Atotech, where we plan on leveraging Atotech’s electroplating solutions and our advanced laser drilling solutions to accelerate our customers’ road maps.

In the first quarter, revenue from our Advanced Electronics Market comprised 11% of overall revenue. Our Specialty Industrial Market represents a broad array of industrial, life sciences, research and defense applications. These are businesses that leverage our domain expertise in Semiconductor and Advanced Electronics.

They represent a collection of proprietary technologies with strong margins. In the first quarter, revenue from our Specialty Industrial Market comprised 23% of overall revenue. Now, I’d like to provide more detail on our first quarter results and my thoughts on second quarter demand trends.

Sales to our Semiconductor Market declined 1% sequentially in the first quarter, in line with our expectations, reflecting continued supply chain constraints, as well as a temporary shutdown at our Shenzhen facility due to local government COVID-19 measures.

Our operations and engineering teams continue to respond to these challenges with agility, flexibility and determination in partnership with our customers and suppliers. Overall, semiconductor demand trends remained robust in the first quarter with broad-based strength across our vacuum and photonics portfolio.

We continue to see strong demand for our RF Power solutions for dielectric etch applications as well as for our dissolved ozone solutions for advanced foundry applications, especially in new fab expansions. I’m also pleased to announce that we commenced shipment of our new clean line solution in the first quarter.

This innovative system is a compact remote plasma source used to reduce buildup of byproducts that arise from vacuum processing, which improves fab yields and lowers preventative maintenance costs.

It is a direct result of our Surround the Chamber strategy as it leverages our expertise across our RF Power, remote plasma, valve and integrated process solutions teams to deliver a unique solution, which again demonstrates the strength of MKS’ innovation engine. We are seeing very positive interest from multiple customers.

We also continue to see strong demand for our photonics solutions with particular strength in our precision motion subsystems, securing design wins across multiple back-end applications, including annealing and advanced packaging lithography. As we look to the second quarter, demand trends in our Semiconductor Market remain very strong.

However, we expect supply chain constraints to remain a factor. Accordingly, we expect revenue from our Semiconductor Market to be consistent to slightly down as compared to first quarter levels.

Before I discuss our Advanced Electronics and Specialty Industrial Markets, I want to share my thoughts on 2021 critical subsystem market share data published earlier this month by the independent market research firm, TechInsights, formerly VLSI.

The report validated that MKS has continued to take share in the overall critical subsystem category in 2021. In fact, the research shows MKS is now the market leader in RF Power Supplies. This achievement was a culmination of many years of targeted investments, innovation, execution and close collaboration with our customers.

I’m extremely proud of the MKS team for achieving this milestone, which took hard work, dedication and expertise. And we see additional opportunities on the horizon for RF Power, fueled by continued industry investments into vertical scaling.

TechInsights also highlighted our share gains across other critical subsystem categories such as RF matching networks, remote plasma sources, pressure sensing, residual gas analyzers and linear motion subsystems.

As a critical subsystem leader with the broadest set of capabilities in the industry, we are well positioned to capitalize on many opportunities that lie ahead in the Semiconductor Market. Moving to our Advanced Electronics Market. Revenue in the first quarter declined 15% sequentially and 29% year-over-year.

Declines were primarily a result of softer industry demand for flexible PCB via drilling equipment.

We believe our customers have taken a risk-averse approach to expanding Flex PCB capacity at this time, given the growing uncertainty resulting from factors such as supply chain constraints, geopolitical tensions, inflation risk and its impact on consumer and demand.

As we look to the second quarter, we expect revenue from Advanced Electronics to be down sequentially led by continued softness flexible PCB equipment spending. Excluding flexible PCB via drilling, our Advanced Electronics revenue is expected to be consistent with first quarter levels.

Revenue from our Specialty Industrial Market declined 1% sequentially, but grew 2% year-over-year. We saw good sequential and year-over-year growth in life sciences applications, offsetting seasonal softness in research spending.

For the second quarter, we expect revenue from our Specialty Industrial Market to remain consistent with first quarter levels. Before I hand the call over to Seth, I want to share a few thoughts regarding our pending acquisition of Atotech.

As you may have seen, on April 1, we announced an extension of the date for completing the acquisition to September 30, 2022. The strategic benefits of acquiring Atotech have become increasingly compelling as the trends towards advanced packaging continue to accelerate.

We believe the unique combination of MKS’ laser drilling and Atotech’s advanced electroplating solutions will allow MKS to become a foundational enabler of electronic devices.

Spanning from the transistors on a chip to the interconnects in an advanced PCB, the defining trends of miniaturization and complexity that have driven continuous innovation in the semiconductor industry for decades are rapidly disrupting the PCB and package substrate landscape.

Just like what we did in semi more than two decades ago, we are positioning ourselves to be at the forefront of these trends.

We believe Atotech’s General Metal Finishing business will fit nicely within our Specialty Industrials business, sharing the common thread of leveraging core domain expertise to address a wide variety of specialty industrial applications.

We continue to work with China’s state administration for market regulation to obtain regulatory clearance, which is the remaining jurisdiction for which approval is a condition to closing. And we’re looking forward to closing the transaction and welcoming the talented Atotech team to MKS. With that, I’d like to turn the call over to Seth..

Thank you, John. I will first provide additional detail and updated end market classification then cover our first quarter 2022 results followed by guidance for the second quarter. Let’s start with Advanced Electronics, which is a key enabler of laser-based manufacturing solutions for cutting-edge electronics applications.

This market includes flexible and HDI PCB via drilling, laser and vacuum processing solutions for solar and display applications and a number of other precision manufacturing applications for electronic devices.

We believe our unique Surround the Workpiece portfolio of lasers, motion, optics and other photonic solutions combined with our applications expertise from our Equipment Solutions Division provide us with a unique opportunity to be the go-to enabler of advanced electronics manufacturing.

These applications offer attractive secular growth or maybe some level of cyclicality, given this market is tied to capital equipment spending. Looking ahead, our pending acquisition of Atotech would add critical electroplating solutions for advanced interconnects.

With these solutions, one of the laser drilling systems, we believe we’re well positioned to optimize the interconnect and accelerate customer road maps, next-generation electronic devices. We also believe Atotech’s electronics business will add a large base of stable recurring revenue with a strong margin profile.

For 2021, revenues from Advanced Electronics Market comprised 15% of MKS’ total revenue and on a pro forma basis with Atotech’s 2021 reported financial results would have comprised 32% of overall revenue.

Our Specialty Industrial Market represents a broad array of leading technologies across industrial, life and health sciences, research and defense markets.

Examples of applications include vacuum solutions for synthetic diamond manufacturing, lasers for ophthalmic surgery, vibration isolation for advanced research and infrared zoom lenses for both commercial and defense application. This market provides more stable revenues and strong margins and cash flow.

In this market, we leverage product and technology capabilities that we developed from our investments in the Semiconductor and Advanced Electronics Markets. Atotech’s General Metal Finishing business would fall into our Specialty Industrial Market.

Similar to our existing Specialty Industrial applications, this important domain expertise in chemistry is leveraged across a wide array of applications such as surface finishing, in functional coatings for electric vehicles, renewable energy and a host of other industrial and commercial applications.

In 2021, revenues from our Specialty Industrial Market comprised 23% of MKS’ total revenue. On a pro forma basis, Atotech’s 2021 reported financial results would have comprised about 27% of overall revenue. In addition to dividing our Advanced Market to two separate markets, we also modified the names of three divisions.

Our Vacuum and Analysis Division is now our Vacuum Solutions Division. Our Light and Motion Division is now our Photonic Solutions Division and our Equipment and Solutions Division is now our Equipment Solutions Division.

A historical snapshot of our results broken down by our divisions in new markets for the prior three years is available in the Investor Relations section of our website. With that, let’s now discuss our first quarter results and outlook for the second quarter.

Sales for the first quarter was $742 million and declined 3% sequentially but up 7% year-over-year.

While overall revenue was below the midpoint of our guidance, we are very pleased with how we executed in the quarter, given ongoing global supply chain constraints as well as temporary shutdown of our Shenzhen facility due to local COVID-19 restrictions.

In the first quarter, Semiconductor sales were $488 million, down 1% sequentially but up 19% year-over-year, reflecting broad-based demand from our vacuum and photonic solutions. While supply chain constraints draw most attention these days, our relentless focus on innovation is the strongest ever.

The market share gains we delivered in 2021 are a clear reflection of our ability to accelerate our customer road maps. We are innovating areas key to Advanced Electronic -- advanced semiconductor manufacturing, including vertical scaling, atomic layer processing, advanced lithography, metrology and inspection as well as wet clean applications.

We have significant domain expertise across each of these areas and in many cases where we combine our broad expertise to introduce new solutions that create new market applications such as our clean line solution that John discussed. We have a long track record of gaining market share. We continue to leverage new opportunities.

Moving to Advanced Electronics Market. Revenue in the first quarter was $82 million, a decline of 15% sequentially and 29% year-over-year. The primary driver behind the decline was soft industry demand for flexible PCB via drilling equipment.

As a result of the factors John highlighted, we expect demand for our flexible PCB equipment to remain relatively muted in the second quarter. This market continues to be a long-term secular grower, but given our exposure to the capital equipment spending in this industry, our quarterly revenue remains lumpy.

For context, between 2019 to 2021, flexible PCB equipment revenue grew at a 40% compounded annual growth rate. We continue to work closely with the HDI PCB via drilling beta customers to drive further qualifications while continuing to generate interest from new customers.

We have dozens of tools in high-volume manufacturing running 24/7, which is a clear validation of our technology. One of the attractions of this market is that it’s sticky once you get designed in. We would have liked to have made faster progress gaining share, we are encouraged by the customer conversations and the performance of our offering.

Moreover, we’re excited about the growing attention on advanced HDI PCBs in package substrates and the role this play in authorizing performance, cost and designs of Advanced Electronic devices.

We expect this to become more critical to enabling high-end smartphone applications, those high-performance servers, wearables, electric vehicles and other electronic devices. Importantly, these increasing market requirements align very well with MKS and Atotech’s capabilities.

And we believe our combined capabilities will allow us to optimize the interconnect and drive better and faster solutions for our customers. Turning now to Specialty Industrial Market. Revenue was $172 million in the first quarter, declining 1% sequentially, but growing 2% year-over-year.

On a sequential basis, we saw growth in life and health sciences and defense applications, offset by seasonal softness in the research market. Our first quarter gross margin was 45%, which at the midpoint of our guidance.

As expected, we were negatively impacted by higher inflation, but we’re pleased how we execute our gross margin despite revenue being below the midpoint.

While first quarter research and development expenses remained flat sequentially, reflecting continued investment in product development, first quarter operating expenses were down $3 million sequentially to $144 million and below our guidance range as a result of strong cost controls as well as the timing of certain equity compensation expenses, which will be reflected in the second quarter.

First quarter operating margin was 25.6%, 100 basis points above the midpoint of our guidance to near the high end of our guidance range. Operating income was $190 million, up $11 million year-over-year. First quarter adjusted EBITDA was $211 million. Adjusted EBITDA margin was 28.4%.

Net interest expense for the first quarter was $6 million, and our tax rate was approximately 18%. Net earnings for the first quarter were $151 million or $2.71 per diluted share.

Exiting the first quarter, maintained a strong balance sheet and liquidity position with cash and short-term investments at a record $1 billion, which well positions us to have the pending Atotech acquisition. Our term loan principal balance was $822 million at the end of the first quarter.

We exited the first quarter with $231 million net cash balance. In terms of working capital, day sales outstanding were 59 days at the end of the first quarter compared to 53 days at the end of the fourth quarter, reflecting the timing of revenue during the quarter.

Inventory turns were 2.6 times at the end of the first quarter compared to 2.8 times at the end of the fourth quarter, which was impacted by supply chain constraints. These metrics combined with the annual bonus payment resulted in first quarter operating cash flow of $41 million and free cash flow of $22 million.

Consistent with prior quarters, we had a dividend payment of $12 million or $0.22 per share. I’ll now turn to our second quarter outlook. Even though business levels remain robust, we expect second quarter revenue of $730 million, plus or minus $30 million, primarily due to continued supply chain constraints.

Based on anticipated product mix and revenue levels, we estimate second quarter gross margin of 43.5%, plus or minus one percentage point. Like many other companies, we’re not immune to exceptional macroeconomic inflationary challenges impacting our markets.

However, we have a strong track record of driving continuous improvement in our operating model. We will continue to take all necessary steps to counteract these inflationary impacts over time. We expect operating expenses of $156 million, plus or minus $4 million. The sequential increase is largely due to timing of annual compensation increases.

For the second quarter, net interest expense is expected to be approximately $6 million, and our tax rate expected to be approximately 18%. Given these assumptions, we expect second quarter net earnings of $2.28 per diluted share, plus or minus $0.24.

Before I turn the call back to the operator, I’d like to share a few thoughts on our pending acquisition of Atotech. I am pleased to announce we successfully resyndicated our debt financing earlier this month following the expiration of the previous syndication.

Our updated financing includes a term loan B with a USD 3.6 billion tranche and a EUR 600 million tranche, both of which were substantially oversubscribed. We also diversified our lending base with a $1 billion term loan A. Funding will coincide with the close of the pending acquisition of Atotech.

Given the current debt market environment, the price was understandably somewhat higher this time around. However, we are very pleased with the final terms and the mix of debt capital we achieved. We believe the successful pricing demonstrates lenders’ belief in the strong credit profile of the combined company.

We are confident that cash flow generation of the combined company will position us to aggressively delever the balance sheet, consistent with prior acquisitions. We’re also pleased with Atotech’s business performance as evidenced by their full year 2021 results released on April 4.

In fact, on a pro forma basis, 2021 adjusted EBITDA for the combined company would have amounted to $1.3 billion. Atotech has also performed slightly better than we expected when we performed our initial due diligence. Furthermore, we originally announced the acquisition, we said that we expected net leverage at closing to be slightly below 3.5 times.

Given the extension of the timing of the transaction, anticipated cash flow generation for both MKS and Atotech, we now anticipate a more favorable net leverage ratio at closing. MKS is in a strong position to drive shareholder value creation by capitalizing on a number of attractive secular trends.

And we believe Atotech would further enhance those efforts. I’d like to now turn the call back to the operator for Q&A..

Thank you. [Operator Instructions] Our first question comes from the line of Patrick Ho with Stifel. Your line is open. Please go ahead..

Thank you very much. John, maybe first off, I know there are a lot of moving parts on the whole supply chain and COVID-related issues.

But can you give a little bit of color for the June quarter, what the bigger impacts are? Is it the ability to procure certain components or the Shenzhen lockdowns and the after effects still impacting your ability to ramp up the facility there? And maybe as a follow-up to that, what’s been the ability on your end to flex some of that capacity to – because you have a large footprint.

What’s the ability to flex some of that capacity to, I guess open capacity?.

Yes. Thanks, Patrick for the question. I think I’ll take the Shenzhen one. So our factory was closed for about a week or so because of the COVID-19 restriction. So we did recover after about a week, and so that’s factored into our Q2 guidance. But I would comment that the supply chain constraints are not getting better.

Electronic components remain a big part of it, but also it broadened to other types of materials, resins, specialty metals. And so we’re factoring that into our Q2 guidance as well. In terms of moving capacity between factories, there are a few factories where we can do that.

But mostly, our factories are still running pretty well in terms of utilization because they’re still constrained by supply..

Great. That’s helpful. And maybe as my follow-up question for Seth, in terms of gross margins, you guys performed really well despite the shortfall in revenues and the supply chain constraints.

Can you just give some of the levers that are keeping gross margins at still pretty high levels, given the current environment?.

Yes. Thank you, Patrick. Yes, I would say that the – obviously, what we do is provide to our customers high-value applications. So I think what you’re seeing is a reflection in our margin, reflects frankly that value to our customers in the overall markets we serve. Kind of on the tactical level to your question, we have a number of levers.

We’ve got a world-class operations team. We’re really working to qualify potential other sources to mitigate some inflationary pressure. We do have some pricing ability. We’ve talked about that in the past that we’ve definitely leaned into, and there’s more opportunity there as well in the future.

And we’ve broad-based portfolio across a number of different markets, I think, kind of mitigate some of the things that John talked about in some of the markets we serve. So it’s a wide range of opportunities. It’s a wide range of different levers we pull. I think fundamentally, you’ll see our margins go back up over time to historical levels.

That’s our goal, for sure..

Great. Thank you again..

Thanks, Patrick..

Thank you. And our next question comes from the line of Jim Ricchiuti with Needham & Company. Your line is open. Please go ahead..

Hi, thank you.

So if I look at the Vacuum Solutions business being down sequentially, guys, that was mainly supply chain and the COVID disruption, and that’s, I assume, the area of the semiconductor business that you’re a little bit more cautious about continuing supply chain issues in the June quarter?.

Jim, it’s John. That’s right. Give or take, it was about down 1% in our semi business, and that is where the majority of the supply chain constraints are hitting our business..

Okay. And if we look at the photonic solutions portion of the business and look at the way you’re now characterizing that business, what I’m wondering is if you could provide some color on the nonsemi photonics business, how that’s performing.

For instance, are you seeing any signs of changing demand in the European part of that business just in light of the geopolitical situation that we’re experiencing there?.

Yes, Jim, thanks for the question. No, we’ve actually seen that part of the business of the photonic solutions division to be pretty stable. We don’t have a lot of exposure of business to Russia, if you will, and no supply chain.

And so the business has been actually pretty stable in the – as we talked about life and health sciences, research and defense so – and other industrials..

Okay. Thanks a lot..

Thanks, Jim..

Thank you. And our next question comes from the line of Scott Graham with Loop Capital Markets. Your line is open. Please go ahead..

Yes, hi. Good morning. Thanks for taking the question John, Seth and David. So I’m just looking at the weakness in the PCB business, and you’re alluding to your sort of the OEs CapEx weakening there. That’s does seem to be a pivot versus where we were understanding, of course, that this is a lumpy business.

How will we read that across – we’re gearing up for an acquisition.

I just – we’re much more than doubling down in PCB, we’re kind of 5x-ing it, right? So I’m just wondering how – why should we be comfortable over the next couple of quarters with the PCB business weakness, and you’re about to significantly increase the size of a business where the customers’ capital spending is weak?.

Yes, Scott, that’s a fair question. I would always pivot to the fact that our strategies are always long term. And when we look at advanced packaging and package substrates, we see that as a really attractive long-term opportunity for MKS. And that’s why we are trying to acquire Atotech. When you look at our flex business, it is lumpy.

And I think it’s well known that smartphone and consumer demands and some of the uncertainties have made our customers cautious in terms of adding capacity for flex. But we also know that we are the leader in Flex PCB via drilling. There’s been no loss of market share as far as we know.

So we always look at the long term, and flex business will come back. HDI business will grow. And if Atotech is part of the family, their business for electronics plating will also grow. So we’re really looking at the long-term play with respect to advanced packaging..

Understood. Thank you. So I appreciate that, John. It was good. I suspect the same. The other question I had was about sort of price cost, and some companies look at price cost as pricing versus materials. Some look it as pricing versus company-wide deflation. However you look at it, it does look like the second quarter is going to be behind that curve.

And so I know you mentioned that there’s some opportunity for you in pricing. Kind of why does the gross margin sink that much? How – why are we not increasing prices maybe a little bit faster, right, to buffer that second quarter gross margin? Maybe just talk about price cost in the context of your second quarter guide..

Yes, Scott. I think the inflationary costs have hit us pretty hard, as I said, everybody pretty hard. We have been leaning into price increases, but that does take some time to recover. And so the pace of which inflationary costs have hit us and the pace of our levers in terms of price increases, there’s a bit of a gap, I guess.

And I think you’re seeing that in our guidance in Q2. But as I’ve said, we expect that to recover over the next outer quarters as well. And we have a lot of backlog. And so backlog is commitments at previous prices.

And so it’s a bit of a constraint in terms of how fast we can change prices versus, for instance, a consumable company where you can just change prices immediately or a chip company, for that matter. And so we do have a little bit of a lag there, but be rest assured that we expect to recover that gross margin in the outer quarters..

And I appreciate that, John. Thank you and I guess it will be like a two quarter event. But just to tuck-in sort of question 2a here, is there any reason why with demand strong because it doesn’t sound to me like semi is weaker, and that’s where the supply chain is kind of hitting you the hardest. It sounds to me like the end demand is pretty strong.

Is there any reason why we can’t reprice the backlog?.

It’s always an option that we’ve looked at. And we have to balance that with partnerships and relationships with key customers. And so we look at that as well. But we also try to make sure that we’re partnering in a long-term sense with our key customers. That’s really important to us that we maintain those long-term partnerships.

And I think we get rewarded for that by our biggest customers..

Just to add what John said is the market share gains we generated back in 2021 is kind of extension what John mentioned. Obviously, technology, seeing the right inflection points, investing ahead of that curve is a big driver for share gains. But the fact that our customers trust us to work with us, I think, is pretty important as well.

So I would say it’s a big picture view is how we look at it..

Guys, thanks a lot for taking my questions..

Yes, thanks Scott..

Thank you. And our next question comes from the line of Joe Quatrochi with Wells Fargo. Your line is open. Please go ahead..

Yes. Thanks. Thanks for taking the question. Maybe one on the semi side. I’m just curious, several of your customers are talking about diversifying the supply chains or qualifying additional critical sub components.

Have you guys benefited from any of that type of practice in terms of being able to maybe gain some share and some critical applications that maybe you previously weren’t?.

Joe, it’s John. Actually, we have. We have actually been the beneficiary of some of that behavior from our customers. And going back to Scott’s earlier question, that’s because our customers trust us, and we partner with them.

And so when they have constraints in their supply chain, MKS is one of the first companies they always come to and say, "Can you deliver these other new products or more of the ones that are designed in?" And so we actually have been the beneficiary of that.

So we’re working hard in our operations team to continue to deliver and overcome the supply chain constraints. But in this kind of environment, the operations team is going to be responsible for share gains actually. Usually, we get share gains from technology, new innovations, et cetera, and that’s normal.

But in this kind of constrained environment, our ability to gain market share because of our operational team’s excellence and performance is really a great – another lever for us..

That’s helpful.

And then just as a follow-up on the flex side, how would you characterize the industries or your customers’ discipline relative to maybe the last down cycle? Have you seen them maybe pull back on the CapEx somewhat quicker or faster than the past cycle in terms of just kind of hoping to see a less of a peak to trough?.

Yes. No, I think this one is a little different than the last cycle, Joe. I think this one was – started off the year with kind of uncertainty. What – people weren’t sure or customers weren’t sure their capacity needs because there was uncertainty by their customers in terms of the signals from them.

And then as the quarter progressed, I think those uncertainties became realized. And that – the inflationary expectations and expect on consumer demand, the geopolitics of Eastern Europe didn’t help. And so those uncertainties became realized into kind of a risk-off approach. And that’s what we’re seeing right now in our flex market..

Very helpful. Thank you..

Thanks, Joe..

Thank you. [Operator Instructions] Our next question comes from the line of Krish Sankar with Cowen and Company. Your line is open. Please go ahead..

Hi, good morning. This is Steven calling on behalf of Krish. Thanks for taking my question. I guess the first one is just a little bit more of a high level if you could talk a little bit about the linearity across the three businesses throughout the quarter.

I guess just looking at the higher DSOs in the quarter, I’m kind of wondering whether it was the semis business that saw some of the orders sort of frozen there, closer to the end of the quarter due to the Shenzhen production impact or if there are other interesting characteristics of the orders and sales across the other segments during the quarter..

Yes, Steve, this is Seth. I’ll take that question. Yes, I said in the prepared remarks, the DSO’s a little bit higher this quarter versus prior quarters because the linearity of revenue in the – during the quarter. Usually, we have a little more of a hockey stick at the back end, which is more a photonics piece of the business.

But I think what you’re seeing, we saw in Q1 is the supply chain constraints; it was sort of a linear impact there as well. So I wouldn’t say it’s a timing of orders per se. I think it’s more of how we get the parts into the operations and how we shipped out products. That was more of the linear impact, I think, on the quarter. And that drove up DSO.

I mean, the aging is in good shape, everything else. It’s really just the timing of revenue during the quarter. It’s more operational-driven than order-driven..

Got it. Thank you for the answer. And also one more for you as well on the gross margin side.

So just in terms of the sequential decline in gross margins, can you provide more color on what is the incremental change that’s driving that? Is it partly mix? Or is it more the inflationary costs becoming a higher burden in the June quarter? And any additional color around that would be great..

Yes. Yes, exactly. I’ll take that one as well, Steve. So yes, you’re right. So we’re down about 1.5 points sequentially, and it’s virtually all inflationary pressure. That’s a little bit of mix too because we mentioned the flex, the PCB drilling revenue in Q2 be relatively muted.

It’s a little bit of mix there, but the lion’s share of the sequential decrease is inflationary pressure. And we know where it’s coming from. As John mentioned, we have actions in place. We’re very committed to kind of get back to historical levels, and that’s certainly all hands on deck work on that right now.

But that’s what’s driving at least in the short term the impact on Q2..

I think the magnitude of it, is it the higher cost? Is it affecting the semi business more than the other two segments?.

Yes, correct. Yes. So you’ll see it in the back of the analysis division is the biggest impact is. It’s affecting every division, but the vast majority is the semi piece of our business..

Great. Thanks Seth..

Yes. Thank you..

Thank you. And our next question comes from the line of Paretosh Misra with Berenberg. Your line is open. Please go ahead..

Thank you. Good morning. Your photonics business is holding up better sequentially and was up a lot on a year-over-year basis.

So what are you seeing there? Has it been impacted less by these supply chain issues? Or it’s just better demand which is driving that?.

Yes. Paretosh, we strategically made some decisions early on when we bought Newport, which was to take the photonics technologies that we had and try to leverage that into some of the semi markets where Newport was relatively less levered. And that, again, like RF Power was a multiyear strategic decision.

And we’ve been making progress with design wins over the last several years that we’ve talked about on these calls. And you’re starting to see that. You’re starting to see that a big part of the Photonic Solutions division growth is coming from the semi market.

You see the Specialty Industrial being relatively stable, and you see the Advanced Electronics for the Photonics division also relatively stable. But the growth, a lot of that growth is driven by strategic decisions we made to put that technology for the semiconductor market..

Got it.

And then as a follow-up, in this Specialty Industrial segment or market, how should we think about the growth potential in that business? Is it similar to Advanced Electronics? Or could it be lower than the electronics over the long run?.

Yes. No, that’s – Specialty Industrial, we kind of look at it as a GDP plus kind of business. So that is lower than what we expect for the Advanced Electronics. And so – but that’s stable, much more stable, you can see in our guidance as well. It levers the research that we put into Semiconductors and Advanced Electronics.

And we only play in certain niches where we have value and where we can have that steady gross margin and cash flow from it..

Got it. Thanks, John..

Thanks, Paretosh..

Thank you. And our next question comes from the line of Hans Chung with D.A. Davidson. Your line is open. Please go ahead..

Thank you for taking my question.

So first, is it possible to quantify like the impact from the supply chain constraint to our second quarter outlook? Like how much of amount like for example, like without supply chain constraint and what we can do in terms of top line? And then what’s the backlog exiting the March quarter versus three quarters ago?.

Hans, it’s John. It’s difficult to quantify exactly what the supply chain constraints are on the top line. I think that’s your question. Suffice it to say, though, that our backlog is continuing to increase. We don’t publish that backlog. Bookings also continue to increase. So it’s not a demand problem. It’s not a backlog problem.

It’s a supply chain constraint problem. And so we’re working real hard to try to increase our output every quarter. But as I said before, the supply chain constraints seem – they’re not getting better. And they continue to surprise. We continue to react. We react better.

We have better partnerships with our customers and our suppliers, but they continue to surprise. And I think we’re also contemplating or including in our guidance the fact that there are COVID shutdowns now. We were affected by Shenzhen in Q1. As you know, there are potential effects of shutdowns in Shanghai and now Beijing.

And we don’t have factories there, but we have offices, and certainly maybe third-tier suppliers have factories there. And so we’re taking all that into account as we guide the revenue going forward..

Got it. Okay. And then next question is regarding your RF Power, the business. So you have gained market share for the past couple of years, I would say.

And just kind of how much room for you guys to continue to gain share, particularly in the contact edge side of business?.

Yes. No. As you know, we’ve been talking about design wins and incremental share gains for many years. And I think many of our long-term investors have stayed with us, and they’ve benefited from that. Many other investors didn’t know who to believe. So they might have bailed out. Too bad for them. But we were consistent, we were determined.

And you can see that this is something that doesn’t happen very often in the semiconductor equipment market because of Copy Exact! For us to be a distant number two in RF Power six years ago to being number one in RF Power. My career, that has happened maybe two or three times in the entire industry. So that’s a really significant change.

And to your question, going forward, we see that continuing to grow. All that share gain that we talked about in terms of making us distant number two to number one was almost all driven by dielectric etch. We haven’t even tapped into conductor etch, where we have some design wins, and we expect to continue to have more design wins.

And so we think that RF Power will continue to grow and extend its lead in market share..

Thank you..

Thank you. And this does conclude today’s question-and-answer session. And I would like to turn the conference back over to David Ryzhik for any further remarks..

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

This concludes today’s conference call. Thank you for participating. You may now disconnect. Everyone, have a great day..