Let's get started. Good morning. Welcome back to the session. I'm Vivek Arya. I cover semiconductor, semiconductor equipment at BofA Securities . I'm really delighted to have the team from MKS join us this morning: Dr. John Lee, President and CEO, and David Ryzhik, Head of Investor Relations. I'll go through my questions, but please feel free to raise your hand if you would like to bring up something on your side. So maybe, John, you know, for those who are.
I'd like to let David say some things first.
Okay. Oh, yes, please. Exciting part of the.
That's what I'm best for. Any forward-looking statements that we may make today are subject to risk factors in our SEC filings. You can find the GAAP reconciliations, any non-GAAP numbers that we may talk about on our IR page of our website. Vivek, I'll pass it back to you.
Thank you so much. So maybe, John, for those who are unfamiliar, maybe walk us through kind of the broad MKS story. You know, M&A has been part of the strategy for you, but just how do you look at the company holistically across the three segments of semiconductors, right? Electronics and packaging, and especially industrial.
Yeah, maybe I'll step back a little bit for some of those new to MKS stories. So MKS was founded in 1961 with one product, and this was a pressure sensor that measured pressure inside a vacuum chamber. That was a critical chamber. It was the etch and dep chambers for semiconductor. Today, that pressure sensor is still over 80% market share. But with that one product, we were able to build on it to make other organic development of other product lines, as well as inorganic acquisitions. Over the next 20 years, we did that and became the broadest critical subsystem supplier for semiconductor capital equipment for vacuum chambers, which is about 60% of WFE. In 2016, we made a big pivot. We acquired a company called Newport Corporation. That did two things.
One, it brought us to new markets and new technologies: lasers, optics, photonics, and different kinds of markets. But it also made us stronger in semi because what it brought to us was lithography, metrology, and inspection customers. So today, when you add up the big five capital equipment makers in semiconductor, in the semiconductor capital equipment world, it's Applied and Lam, Tokyo Electron, ASML, and KLA. Those are all our customers, and we have multiple critical subsystems in each one of their tools. So every fab in the world today, 85% of the equipment in every fab in the world today has multiple MKS subsystems in it. So every chip in the world is made with a lot of MKS content.
But the other part of Newport was not just diversifying to other markets, but it brought us to one particular market that we saw quite interesting, and that was packaging, packaging of chips, because our lasers are being sold to people using it to make small features for packaging. And we're like, okay, what's about, what is it about this market? That led us to acquire a laser systems company, Electro Scientific Industries, for advanced packaging. That also then told us and allowed us to see a trend that was happening multiple years ago. And that trend was the need for packaging to enable the more-than-Moore's law. And because of that, we acquired Atotech. Atotech is a leader in enabling advanced packaging with their chemistry and chemistry equipment. So today, we're foundational to the more-than-Moore's law. Moore's law was an observation, an economic observation, and it was about horizontal shrink.
Everything was twice as good every two years. That was absolutely true for about 40 of those 60 years that semis been around. But then it started asymptotic, started going off the curve. As a result of that, people said, let's put maybe two CPUs together to make that computer twice as good every two years. We did that, and that extended Moore's law for a little bit. Then that started running out of steam. People said, let's put GPUs and high bandwidth memory together and package it all together so that electronic device is twice as good every two years. That's what we kind of call more-than-Moore's law. That requires not just the semiconductors, but the packaging as well. You have to have both in order to maintain this more-than-Moore's law.
MKS is the only company in the world that addresses foundational technologies to all of those enabling things that allow More-than-Moore's Law. Our semiconductor business is about 40% of our revenue. Our electronics and packaging business is about 25% of our revenue. Then we have specialty industrials. This is a group of different markets where we're leveraging the technology we developed for semiconductors and for electronics and packaging and using it in other markets and applications. That's 33% of our company. That has been a very stable GDV plus segment that allows us to have a much stronger financial foundation from which we can use to continue to invest in the semiconductor and the electronics and packaging.
So John, as you look at the second half, you've called for some half-and-half growth. What are the kind of leading indicators of that? And how much of that is market growth? How much of that is kind of unique to your product cycles?
Yeah, I would say we've said that the second half of 2024, we believe will be slightly better than the first half in both the semiconductor market and the electronics and packaging market. The semiconductor market is really driven by the fact that a lot of the inventory burndown has occurred. We've seen our customers drop in orders now. So green shoots where we're shipping to their demand and what they're shipping. And that's really a great way to, a good sign that the inventory burndown is mostly done, with the exception of NAND-based inventory that still has some ways to go in terms of burning down. And then, of course, in electronics and packaging, we do have a consumer products component to electronics and packaging. Think about smartphones and PCs. And in the packaging business, the PCB business, if you will, there is this cyclicality.
Not all of our revenue is from consumer products, but a lot of it is. Q1 is the lowest point. Q2 increases. Q3 is the peak. Q4 depends. It depends on how well phones are selling and consumer demand. When you add that up, the second half of electronics and packaging is always slightly better than the first half, given everything else is the same. That's what we guide. We are seeing green shoots and certainly DRAM pricing, NAND pricing, utilization rates, certainly at DRAM factories, even NAND factories. Logic and foundry seems to be staying also very stable. We have a little optimism that the second half will be a little better than the first half.
Got it. Historically, what's been your correlation to just wafer fab equipment trends? Because, you know, this year, for example, we are seeing WFE kind of in the low single-digit type of range. So if that's all you knew, how would it help you forecast your semiconductor business?
Yeah, maybe I'll step back a little bit. So we, you know, it's hard to forecast quarter-over-quarter because things change so much. There's inventory that have to burn or not. So the way we look at how we do, how we measure ourselves relative to wafer fab equipment is longer term. And when you look at WFE growth rates, it's whatever it is, 5%, 6% over the long term. We've consistently been able to outperform WFE by 200 basis points over the last 10 years. That's just data. Now, we expect to continue doing that. And you can ask why. Well, there are a lot of growth areas that change. So we believe in only doing critical subsystems, things that are hard to do. But while everything is critical, you don't know which one's going to be more critical at that next inflection. The best example is NAND.
BNAN happened. You know, that was kind of a new thing, very new. The inflection there was that our power was going to be much more important and much more needed. Because we had our power, we can double down on that. That allows us to outgrow the market. So that's an example of a broader idea, which is that having a broad portfolio does that allow you to do that. But it also allows you to bring a more comprehensive solution. You're more important to the customers because you're bringing in multiple solutions all the time. We're leveraging that beyond WFE. But in general, we tend to outperform WFE on an upturn, underperform in the downturn, but overall, on average, 200 basis points better than WFE over the last 10 years. That's our model.
Got it. We had Applied Materials present earlier today, Lam Research two days ago. So they outlined a very strong growth in their gate all-around business, right? So I think Applied has had almost $2.5 billion this year. Lam had said over $1 billion. How does the move towards this new transistor structure benefit MKS, right? And how would you kind of contrast it, John, given your experience in the industry versus the move we saw from planar to FinFET?
Yeah, I think it's similar. You know, when we moved to different architectures like FinFET or gate-all-around or even backside power for that matter, a lot of that is driven by deposition and etch. And of course, Lam and Applied are leaders there. They are our two biggest customers. Certainly in upturn, we derive their revenues over 10% each. So we've had a long history in partnership with both of them. We're designed into many of their tools. And so if they're shipping more tools for whatever process there is in gate-all-around, we're likely going to benefit from it. And I think that's kind of the same trend. There's a bunch of different steps that Applied supplies tools to and Lam. And we're all over those tools.
Okay. On the NAND side, have you seen any signs of recovery yet? Like, would you be early to see that, or would you start to see that in phase two that you first need to see better utilization of what these companies already have?
Well, I think we would certainly see it before our customers had to ship for sure, right? So we precede our customers. But in terms of, we haven't seen that yet. I think as an industry, we're all pretty consistent with that. But we have, as an industry, seen green shoots. The pricing, of course, has gotten better, positive. That's always good to make some money on it. Utilization rates have improved. And I think we've heard of Samsung saying, "We're going to convert to V9. We're going to go to V9." That's their terminology for the next node of NAND, right? So those are all green shoots and good. You know, we haven't seen a lot of folks saying NAND is going to inflect in a particular quarter or whatnot. I think in general, we think DRAM will inflect sooner.
A lot of that's because of the uniqueness of HBM driving a lot of capacity. You need more NAND capacity as well for AI servers. But HBM DRAM is a little more inefficient to make, which is good for us equipment makers. But NAND, I think we'll catch up eventually as well. It's a little delayed relative to DRAM.
I see. As we look into next year, so not a forecast, obviously, it's early. How would you kind of stack rank where you see the best growth opportunities?
Yeah, you know, I think a lot of folks are hoping that 2025 is a great year. I think Foundry Logic seems to be strong and continue to stay strong. That's the assumption. And that's driven by going to three nanometer in volume and working on two nanometer. And the other assumption is that China stays roughly the same. And then DRAM, DRAM picking up. I think DRAM picking up would certainly drive WFE in 2025 and beyond to be certainly materially better than 2024. And I think that's where a lot of the forecasts are coming from. You have some other forecasts that are even more aggressive. And that would require kind of NAND. And it depends on when that turns up. But if NAND turns up, DRAM turns up, and Logic and Foundry stay consistent, we could have a very good next couple of years.
You know, when we talk with a number of the end customers who are developing GPUs or ASICs, and they ask, "Where are the biggest supply constraints?" They always point to advanced packaging. So what is your kind of exposure to the need for advanced packaging? And how correlated is that business to just the growth in overall AI and cloud deployments?
Yeah, that's great. I'll take CoWoS as an example of an advanced packaging scheme. That's the TSMC approach. But there's EMIB. Everybody has their own version of it. But the idea is that there's two parts to packaging. There's the silicon to silicon, chip to chip, chip to silicon interposer. After that, you have to put it on a PCB. That PCB we call package substrate, the most advanced PCB. That is something, that's where we play. That's the S. So we're the S. We do have chemistry in the chip on wafer. But that chemistry is very small relative to the chemistry and the chemistry equipment and lasers that are needed for the S. And just as an example, so that S, it used to be for the most advanced servers, maybe 15 layers, maybe 12. And now it's pushing 20, 22 layers for the same server.
So for us, each layer is made one at a time. For us, it's square inches. And if you have more layers, your SAM just increased by that much. The second thing that's happening is that we're shrinking lines and spaces and interconnect holes between them because you're trying to get density. You're trying to get more interconnects because you're connecting bigger chips that have to talk to each other or more chips that have to talk to each other. So let's shrink lines and spaces. That's harder to do. That favors people who have the technology and who can invest in that technology. And then I talked about layers. And then the other thing is let's make that board bigger because I got more chips. And so all that is about technology inflection as well as area.
And that chemistry that's needed to fill all those holes with copper and make all those lines and spaces, Atotech is market share leader. That's why we bought Atotech. We saw this trend happen. We saw more layers happen. We saw small lines and spaces happening. We saw bigger boards happening. And we saw more chips had to be packaged together to continue to extend Moore's Law.
How big of exposure is this within your E&P segment? Where do you see it going?
Yeah, so our electronics and packaging business is about a third of our company. That was 2022. 2023 is a little lower, 25%. The package, that's mostly packaging. The advanced packaging is about a quarter of that. That's the fastest growing. That's the high single-digit part of the electronics and packaging business. That's the battleground right now. So that's the opportunity for MKS, especially when we are already the market leader supplying the chemistry. There's no other competitor that supplies chemistry, chemistry equipment, and laser equipment. No one does all three. We think that's a huge differentiator for us because if we can come with all three to solve a customer's problem faster because we have all three, they get to market faster. Therefore, should reward us for giving them those solutions faster.
Got it. Does it make a difference, John, if somebody's using a chiplet approach versus multiple reticle size chips fused together? Does that make a difference on the packaging side?
Yeah, stitching reticles together, making bigger chips. I don't think so because if you made a bigger chip by stitching, that chip still got to communicate. And so that communication bandwidth, if you will, is really that's what drives how many layers of interconnects you have, how small the lines and spaces are, how big the entire board is. Stitching is difficult. And that's really why people have gone to packaging chips by themselves of the same size reticle, if you will, or small. So I don't think it would really matter for us. What really matters is how many interconnects you need to have on that package substrate.
One other thing that I noticed is this opportunity within E&P for laser drilling for low earth orbit applications. Yeah, that seems to be like a very interesting and unique aspect of, right, not something we hear normally in semiconductors.
Yeah, that was kind of a niche application. It's not a big number for us, but it shows you that, shows us that our laser tool is quite differentiated because in order to make those types of PCBs for low earth orbit applications, our tool is much faster than the competition. And if you think about low earth orbit, so there's tens of thousands of satellites rolling around the world. And they're not in geosynchronous orbit, meaning the same satellite is not looking at the same antenna. They're actually, they have to chase each other, right? And because of that, you need a lot of antennas on the ground level. Those antennas are basically, you know, if you see some of them, they are kind of, they look like one big PCB, kind of 12 inches by 15 inches. That entire PCB is the antenna. And that's what we're making.
It's kind of a proof point that our laser drilling tool is quite unique.
Maybe help us unpack the specialty industrial business. What is in that segment? What are kind of the growth drivers?
Yeah, so specialty industrials, as I said before, leverages the R&D we've already invested into the semi market and the electronics and packaging market. So for instance, we've had different types of products being used in industrial and diamond manufacturing. So there's an industrial segment to that specialty industrials. Industrial. We've had lasers being used for eye surgery. So there's a life and health sciences component to it. We've had vibration isolation tables used in microscopes. So there's an R&D part of it. There's thermal lenses that we make that's also part of the D, the defense industry. So it's life and health sciences, research and defense, and industrials. And each one of these are niche applications for us. But it's great gross margins, great cash flow. And we're not doing much R&D at all. We're leveraging it. And that's a third of our business now.
That third is really giving us a lot more stability as we go through these cycles in the semiconductor and the electronics and packaging markets.
On Atotech, you hit your cost synergy targets already. How much more is left? Are there more operating synergies that are left?
Yeah, I think it's part of the DNA of MKS. We're always looking at how to be more efficient. I would say this. We hit the $55 million of synergy in 20 months. So on the earlier end of our 18-36 month target. Probably not a surprise to those who know us well. I would say this. Even today, we're still finding ways to be more efficient with some of the legacy, legacy MKS business, the vacuum side. You saw their gross margins starting to continue to uptick over the years. We've been scrubbing that group for 60 years. Newport, you saw some of their margins improving a little bit too. We've bought Newport for eight years. We've been scrubbing them for eight years. We won't stop. Atotech, we've been scrubbing for two years. So we'll stop talking about it as a synergy target from the M&A.
But rest assured, we will continue looking at opportunities.
Then, John, maybe moving on to the financial model. I think you've given a 2027 revenue target of $5.6 billion. So that's sort of a mid-teens or so sales figure from 2023 levels. Maybe give us a view of how much progress you're making there. Is that a conservative target? Is that an easy target?
Yeah, so when we developed the 2027 target and we showed that at the analyst day in 2022, five-year model, we looked at it. We built in cycles as well. But we kind of looked at, well, you know, how fast is chip revenue going? What do we think is the range of CapEx intensity? So therefore, what is WFE? And then 200 basis points above that. So that's part of the model. 40% of our company is WFE plus 200 basis points. And what do you want WFE to be in 2030, let's say, if the semiconductor market is $1 trillion, you know, pick your favorite CapEx intensity, 15%, it's $150 billion WFE. We back that out to 2027. So that's one part of our market. The other part is electronics and packaging. And there you have three segments to it.
You have the GDP part, which is kind of multilayer boards. You know, the kind of old stuff, older stuff. It's great business for Atotech. You have the middle stuff, which is high-density interconnects, think smartphones. So big market too, growing at mid-single digit. And then you have the fastest growing, the top third. This is the package substrate we just talked about for AI. And that's growing in high single digits. And when we put it all together, we think that we should be able to grow E&P at 300 basis points above GDP, right? Obviously, much faster in the higher end and less in the lower end. And then specialty industrials, the other third of our company, is really GDP plus. And that's how we get to that $5.6 billion. And we had some other numbers there, right? 47% plus for gross margin.
Majority exceeded.
We exceeded in Q1, but we guided a little lower for Q2 to be, you know, but we're happy with that progress for sure.
Is there more leverage to the gross margins?
We're not ready to say that there's a different model than what we've said publicly. Our model is that we have a 50% drop through to gross margin for incremental dollars of revenue. And 40% incremental margins. So we're really happy with where we've gotten there. And then, you know, EPS is in that $13 range. You know, and certainly, you know, we're happy with the progress so far. And we're not guiding a five-year model every quarter, obviously. But remember, we got to 47% gross margin at $3.6 billion versus $5.6 billion. And so I think there's just, you know, hats off to our team for really working hard on optimizing the company and operating it and managing it really efficiently in a downturn.
Is it a services component to your business also that is perhaps a little more predictable and resilient to a downturn?
Yeah, there is. About 15% of our overall total MKS is service. And this is service of hardware equipment. And so, you know, all the fabs that have all of our critical subsystems, you know, things can break, things can wear out. Some things are kind of consumable in a longer time frame. So that's 15% of the revenue. That's fairly stable because it's utilization dependent, fab utilization dependent. Doesn't mean it can't go down, but certainly fab utilization dependent, spare parts, things like that. And so that's a very stable part of our revenue. But the other part of our revenue that's very stable is the chemistry. Chemistry is consumable, right? And that's utilization dependent too. So when you add chemistry and you add services, hardware services, 40% of MKS revenue is that bucket of relatively more stable revenue.
That's also another foundation, if you will, in terms of financial foundation in times cycles.
On the capital structure side, you refinance your term loan. You know, you have been prepaying debt. How should we think about delevering the balance sheet?
Yeah. Well, over the next 18-24 months, that is priority number one. You know, M&A is really still going to be important to us, but probably in the longer term view right now because we want to get that leverage down. Our long-term model for leverage goal is 2.0 gross leverage. And you're right. You know, we had unfortunate timing when we closed Atotech. Interest rates had gone up 12 months in a row. Both markets turned south. So kind of poor timing. But we've got the operating margins back to 20% even in trough quarters. We were able to pay off $200 million prepay in the last six months. We were able to get our tax rates down from 28% to 20%. Got the term loan A's off the books because there were some covenants there.
We weren't really worried about it, but you know, you always get that question. And we did a little repricing as well. And we will continue to do repricing when that makes sense. And of course, two weeks ago, we did a convertible. That convertible probably went as well as it could have. Our banking partners did a great job. We had a $1 billion with a 15% green shoe that went to $1.2 billion with a $200 million green shoe, way oversubscribed. Stock price reaction, the first day, you know, of course, there's a big dip. But the next day, when the hedge funds get allocated, because they're the ones that have to hedge, they probably had less. And so the stock recovered and it's pretty much recovered now. But what that convert did is it took out $75 million of interest costs per year.
We were paying incremental interest costs on the term loan B of 7.5%. The convert is 1.25%. We also tried to make the convert much more bond-like, if you will, by purchasing capped calls so that shareholders are not diluted until 100% of the share price when we launched.
Long term, John, if you look at, let's say, the next three to five years, is there an ideal mix that you would like to see within the company? And you know, are there M&A opportunities you think that will help you drive towards that ideal mix? And how does one come up with the ideal mix?
Yeah, yeah, no, it's a good question. I think really we have all the major components that we want for our goal of being foundational to More-than-Moore's Law. No one else has this, right? A lot of people talk about packaging now. We actually did something about it three years ago, right? So with the acquisition of Atotech. And so we have the major pieces. Yes, you're right. There's always tuck-ins, right? There's probably more opportunities in tuck-ins in the photonic space and maybe the chemistry space than the vacuum space because, you know, we were the consolidator there, if you will. We don't really have a bias as to, you know, more consumable, more chemistry, more lasers, more optics. I think it's whatever makes sense, whatever is actionable. We don't have a lot of gaps right now. There always are, right?
But we're really happy with the portfolio now. And you know, if something's come up, we're always debating whether we can do it cheaper organically or inorganically. In the past, we've always done a lot of inorganic. But more recently, in the last 10 years, I'd say we've actually had many more single doubles and home runs organically. And I think scale helps. So when you have scale, you can actually make big bets organically. Our power for VNET was one, big bet organically. Because you don't get paid for two or three years because you got to hire the engineers, you got to develop it, you got to partner with your OEM customers, they got to win, and the chip fab's got to go build. So it's a three to five year time frame before you win, but you get paid. We're willing to do those kinds of bets.
We're courageous enough and we're capable enough. And that really is a differentiator for us longer term. So in terms of product mix, we like all our children, if you will. But they're all critical subsystems.
Must have some favorites.
Well, you know the Baratron, as I said, it is still a market share leader. Competitors have been trying to take that share for 65 years. And we have some secret sauce there, if you will, that has allowed us to maintain that very high market share. Our power, more recent story, we were number two in market share for 30 years trying to prove. And now, you know, in 2022, we took number one market share. Our investments in world-class optics over the last four years has shown, has resulted already, you can see it in the numbers, our lithography, metrology, and inspection numbers have been consistently growing even during a semi-downturn. Because those customers have long lead times and their suppliers have long lead times. Plus we're taking share because we invested more capability.
And then, of course, you know, the Atotech acquisition, we just believe that packaging and package substrates are going to be the next battle for shrinking and complexity and requiring companies who can provide R&D scale.
On that positive note, thank you, John. Really appreciate your time.
Great. Thanks for backing us.