Hi.
Good morning. I'm Shane Brett, Semiconductor Equipment Analyst in Morgan Stanley, New York. We have today John Lee, CEO of MKSI, and Ram Mayampurath, CFO of MKSI. Firstly, I know you guys have been on the road for the last week and a half or so. Could you kind of walk us through where do you think the sort of MKSI story may be underappreciated?
Yeah, maybe I'll start, Shane. So I think one of the areas that we've been a little surprised at with respect to investors understanding the MKS story is people don't appreciate, I think, how embedded in the ecosystem we are. And that ecosystem is about making advanced electronics. So when you think about making advanced electronics advanced, there's two components to it now. In the past, it used to be just about semiconductor chips. Make semiconductor chips better, and your advanced electronics got better. And four years ago, we saw that that was changing, that semiconductors were necessary but no longer sufficient. You needed to package these things together. And so in the era of AI and heterogeneous packaging, we saw that four years ago. We did something about it. We bought Atotech.
And now, together with legacy MKS and Newport and ESI and Atotech, we address 85% of all WFE. So 85% of that sea of equipment in every fab in the world has multiple MKS subsystems in it. No one else can say that. Secondly, in packaging, making the package substrates that put all those chips together, we address 70% of all the steps to make that package substrate. And no one else is close to that. And so that's how embedded we are in the ecosystem. We're talking to our customers and their customers. And that allows us to see inflections very fast, very quickly, because we're everywhere, if you will. That gives us two things. One, we can actually move to where potentially growth is or outsized growth is in a new critical subsystem or a new process step.
It also allows us to understand the relative strengths of the ecosystem. Not everybody is going to win, right? Our customers all are good customers and trying to win. But sometimes one wins, and sometimes one loses. So having that visibility also gives us an advantage in terms of where to place our bets. So I think that's an area of underappreciation, I think, with our investors, is how embedded MKS is in the entire ecosystem for making advanced electronics.
Then maybe we can start off with advanced packaging. So last earnings, it really felt like your strategy of optimizing interconnect was really just starting to bear fruit, caught me off guard a little bit. Could you kind of tell us about the synergies you're really seeing between Atotech's chemistry offering and maybe some of the existing offerings prior to Atotech, and how you're kind of tackling the issues that advanced packaging may be facing in the industry right now?
Yeah, so advanced packaging, of course, is all the rage and now people talking about it. Maybe just to step back a little bit and define what we mean by advanced packaging. So let's take TSMC's CoWoS as an example. A lot of people have heard about CoWoS, C-O-W-O-S, so chip on wafer on substrate. And chip on wafer is about chips on top of each other, HBM, DRAM on top of each other. But everything then is put onto S. S is a substrate. S is what we're talking about, the chemistry and the laser drilling for S. There are 20-25 layers of a package substrate as part of the S underneath all those chips. And then there might be 40 more layers of multi-layer board PCBs underneath that.
Think about 40-60 layers, all made one layer at a time, holes drilled one at a time, chemistry plated one at a time, 60 times on every AI server board. That's really what we're talking about in advanced packaging. What we assembled, to your question, is not just the chemistry provider. The number one leading market share is Atotech, now MKS, in chemistry for plating, but also the number one plating equipment provider for that, which came from Atotech. Then the laser drilling equipment that goes with it, where we're not number one yet, and we aspire to be, and the investment in tech centers around the world. We have 16 tech centers around the world.
What we mean by a tech center is a large site where we have plating tools, laser tools, chemistry, and engineers to support the customers in that region. No one else has that footprint as well, and in those tech centers is where we see a lot of the synergy. Customers come in. They can now run their boards with our laser tool and our chemistry and our chemistry equipment all in one. And that helps them develop the next generation technology for their customers as well.
At these tech centers, does your engagement go to just your Shinko's and Ibiden's, your customers, or do they go all the way up to sort of the TSMCs and Samsungs in the world where you're really sort of intertwining semiconductor all the way to the advanced packaging portion?
Yeah, it's really at the Shinko, Ibiden, UMTC level. These are our customers. They're the package substrate makers. They make these and then send them to OSATs or TSMC, possibly, where the chips have been put on. And so that's really where we are in that food chain. Now, of course, we're always talking to our customers' customers in the food chain, understanding where their roadmaps are going as well. But in these tech centers, it's really about these direct customers that are making the package substrates.
Got it. And just moving on to semiconductor. So we have GAA, 4F squared for DRAM. How is sort of MKSI positioned for these tech inflections? And could you just kind of remind us where your sort of semiconductor business is exposed by end market as well?
Yeah, so our semiconductor business, as I said, we're exposed to 85% of WFE. In 2022, when Logic Foundry was good, DRAM was good, NAND was good, we were about 55% memory, DRAM and NAND. In 2023, obviously, Logic Foundry was much stronger. We were like 2/3 Logic Foundry. So we really kind of follow the market with a little bit of indexing in NAND because of our market share position and RF power. But generally, we look at WFE as we're everywhere. So if GAA, Gate-All-Around, requires 15% more steps, well, that's good for us. That's 15% more equipment, right? Same with backside power. And those are vacuum equipment, deposition equipment. And in general, too, there's always lithography and inspection. So I think when there are more steps and more capital intensity with more complex nodes, that's always good for MKS.
As one of the kind of major players within semiconductor subcomponents, where would you think kind of from a subcomponents perspective, the biggest challenges for semiconductors going forward? And how do you think MKSI is positioned, or what are you doing to sort of combat those challenges?
Yeah, so I mean, the challenge is there's lots of challenges, lots of opportunities. And we look at them as opportunities, actually. So when you think about the architectural changes in chips, it's going more vertical. In fact, it's even going to chips, wafers bonding to each other. And so that's a change that allows more deposition-etch processes, more material science. And that's an opportunity for our broad portfolio of vacuum-based equipment. And then, of course, there's always the continuous shrink of features. And that requires more litho and more inspection of that. And that gives us the opportunity in our world-class optics portfolio. So I think when you look at the set of challenges, more verticality is a trend now that's driving a lot of new vacuum and materials processing steps.
But litho is always going to be there, always going to be a challenge that requires new problems to be solved.
Back in the 2010s, it was vertical NAND and RF power that really drove your growth at that time. Is there any sort of inflection over the next three years, whether it be litho, inspection, etch or deposition, something that really kind of could possibly push MKSI to really outperform WFE over the next two to three years?
Yeah, well, I think we're investing in litho, metrology, inspection because we've been under-indexed there. So that's not dependent on litho and metrology and inspection growing necessarily. It's just about our share gain there. But then if you think about RF power and the things that go around making things more vertical, RF power was the reason why we can make VNAND 200 layers, 400 layers thick. And so anything that goes vertical requires more RF power. And the deposition and etching steps that go with it is going to be good for MKS. So VNAND has more legs to go. People are talking about 1,000 layers, right? 3D DRAM is something people are working on. Remains to be seen when it hits volume production, but if and when. That's going to be exciting for a deep-etch company and therefore for MKS as well.
Even 4F squared kind of DRAM, it's about putting chips together, wafers together. That also gives us not just the verticality of things, but precision motion. So when you're bonding wafers together, you have to bond them very precisely. And motion is one of the key subsystems necessary for that. So lots of opportunities. I think it goes back to the broader strategy of MKS. Why have all these product categories versus being good at one thing? And as long as we can manage multiple product categories and be number one or two in multiple product categories, we have a better chance of outgrowing the market because you don't really know what's going to be the new critical subsystem that's more critical and drives the new generation of opportunity.
But if you're in every one of them or most of them, you can actually pivot very quickly, like RF power and perhaps world-class optics or motion.
On litho, metrology, and inspection, could you give us a background on how that sort of your share at those customers or how your share at those product lines kind of started to get going and where you kind of envision it going forward?
Yeah, so this was litho, metrology inspection was a market brought to us through the acquisition of Newport Corporation because they're an optics, lasers, motion kind of company. And those customers were one of many good customers that they had, but they weren't their largest subsegment. And I think that was a strategy. They didn't want to be over-indexed to one particular market segment. We, of course, were already in semi. We were semi guys. And we said, you know what? Those customers, there are a couple of them only, right? And they are market leaders. We don't have the market share there that we already have with the traditional equipment companies that made vacuum tools. And so we decided let's invest in that. And that means more capital equipment, more process engineering capability.
The kind of things we do there are shaping optics, putting coatings on optics, integrating the optics with precision motion or lasers and/or lasers, and building subsystems, more complex subsystems to do really hard things in those tools. Our revenue before we started that, maybe four or five years ago, was the $100 million-$150 million range, given the cycles. Now it's over $300 million. Remember, the first two or three years of that four or five-year range was zero because you're investing, and then you're getting design wins, and then you get in that ramp, right? This is an area where I think we will certainly continue to invest and outgrow the market. We have outgrown that subsegment of WFE.
Got it. And just before I move on to some NAND questions, I know it's top of mind for the audience, but just China exposure, could you kind of remind us where is the China exposure across your entire business and maybe some semiconductor specific etch?
Yeah, maybe we'll Ram do that one.
Sure. So that's an area we focus on, keep a very close eye on. The direct exposure to China has already happened. And we have lost about $200-$250 million of very profitable business back when the regulations changed a few years back. There is still some direct sales left, but much smaller. Most of our sales are indirect through some of our larger OEMs. And we are waiting to see the impact of that. And it's probably going to be if their exposure is 40% to China, then that'll be roughly the impact we'll take. But more to come on that. We don't know. The direct exposure has already been taken. We don't expect any more hit there.
OK, so the direct exposure to the China equipment makers would be pretty much.
That's correct.
Got it. Thank you. Then just on NAND, so industry is probably just going to have upgrades next year. Could you remind us how MKSI is positioned for those upgrades and whether you kind of see more kind of benefits from a greenfield or a brownfield or how those upgrades may shape your business next year?
Yeah, yeah, you're right. A lot of people talk about upgrades mostly in NAND in 2025. And I think it really depends on the scale of the upgrade. So if you have an etcher that does 100-layer VNAND hole etch and you want to upgrade it to 128, maybe you don't need a lot of RF power, if you will. You might be able to get it done with cryo etch or new chemistries and some other things. But if you're going from 100 to 150 or that kind of scale, I don't see how you can do that without some new RF power. Remember that in each of these chambers, there's three different power sources, RF power. Each has different power. Each has different frequencies. They do different things that enable that VNAND hole etch.
So I think it will depend on what those end customers want to do and how much of the upgrade jump they make. And that will certainly help burn the inventory that we have in RF power. And then, of course, that will lead to new orders.
Got it, got it. And just last question before I move on is obviously with semiconductor advanced etchers getting so much more complex. How early do customers like AMAT and Lam possibly engage MKSI? And does your sort of engagement go all the way up to sort of the TSMCs and Samsungs levels?
Yeah, so we've had long, decades-long relationships with all these customers. So we're continuously having discussions about the next problem. And as you know, the amount of time it takes to solve these problems continues to extend as the problems get more difficult. So EUV is the biggest example. That took 20 years to figure out, right? But so you're talking multiple years for sure in some of these harder problems. They have a new problem. They're going to need something new. What do you have? It takes multiple years of concerted effort to do that because gone are the days where you can just throw something on and have a new solution. You're inventing new critical subsystems as well as new systems in order to address these problems. So it's multiple-year kind of engagements. And that's true of litho, dep, and etch and all the equipment there.
Got it, got it. And before I move on to the financials, I wanted to ask broad markets. So could you kind of give the audience a reminder what the kind of broad markets business is and sort of how it plays into the MKSI story?
Yeah, specialty industrials kind of markets, yeah. So a third of our business is what we categorize as specialty industrials. It's made up of many different markets: life and health sciences, defense, research, and industrial. And that's been a very steady third of our business, highly profitable and steady. And that gives us a lot of flexibility in terms of ability to pay down debt faster, ability to continue to invest during cyclical downturns in our semi and E&P markets. And that's really critical because our customers need us to continue investing during down cycles. And I think if you can't, you're not going to be on their ABL. So that's just a new requirement that plays to scale. If you have scale and you can invest in that downturn, I think you're going to be a much stronger supplier.
Having a third of your business, our business, being specialty industrials where there's much less R&D because we're leveraging the R&D from semi and E&P, that gives us a lot more flexibility.
Got it, and I think there's a good way, good segue to leverage to repeat, which is the MKSI story, so could you kind of remind us of what's the balance sheet situation right now? What's the priorities? And possibly what the kind of next two to three years may look like for the balance sheet?
Yeah, certainly. So strengthening the balance sheet is our key focus, which is mostly managing our debt. So I'll start with capital allocation. Capital allocation priorities are investing for business continuity and growth, which is CapEx of 3%-5%, closer to 4% maybe. We continue to pay our dividend. And everything else goes towards debt management. And it starts from the gross margin, actually. We've had a lot of focus on driving our margin and profitability. If you look at the last two years, 2023 to 2024, about same levels of sales, we have made meaningful improvement in our gross margin. We finished at 48%, the lower 48% in Q3. So that's a combination of both commercial actions and also operational excellence programs. And we have more to do there. Mix certainly helped. And mix is a factor. We're driving quarterly changes maybe.
But a lot of work has gone into maintaining that gross margin. And we'll go into maintaining it in that range. And then a clear bridge from there to cash generation, which leads to the capital allocation strategy.
So I know you guys had a minimum requirement on debt pay down this year, but you guys have kind of gone way beyond that.
We did.
Could you kind of remind us on what was that minimum payment, where you guys have came in, and where this sort of strong free cash flow generation comes from?
So the minimum, thanks for asking that. So minimum payment was $50 million. And we've paid $426 million on top of that. So we've paid down close to $500 million this year. And the margin improvement and profitability is the key driver of generating that cash flow. And what's important to point out is that once that cost line has been corrected, as the sales comes back, you're going to see a lot more drop to the bottom line and additional possibilities of debt management and cash generation.
I know you guys have spoken about being ready for a much bigger WFE market than some may envision. I know capital intensity should be kind of within the 3%-5% range next few years.
That's correct. Closer to 4% probably for next year.
And I just have one more question on the September quarter. One kind of thing that caught everyone off guard was just how strong the gross margin was. If there's sort of any one-time factors that you'd like to remind people or how we should think about maybe gross margin next year, that would be helpful.
So the one-time factors will be mixed. And we hinted to that in our earnings call and guidance. So we are forecasting 47% for Q4. And that's mostly because of the mix of the business. But that's the range we want to maintain. And the big step change from there will come from volume coming in as the plants get loaded, as our procurement gets more opportunity to drive product costs down and so on.
Just last question on the financials. You guys have your midterm targets. In terms of the margin, it just seems to be tracking a lot stronger. How should we think about, let's say, margins when we do hit the revenue goals, the medium-term revenue goals that you have laid out?
Yeah, I think we talked about the 2027 model in 2022 of over 47% gross margin, which we were there at $5.5 billion revenue, and we're at $3.5 billion, so we're very happy with that. As Ram said, if we were at $5.5 billion today, I think just by volume, that 47% would be higher. So we don't update it today for sure, but certainly, if we can continue doing that, we'll be happy with that. I think adding Atotech to the mix and improving gross margin in all three divisions, actually, not just Atotech, has helped improve the gross margin for the entire company. And mix does matter, right? So the vacuum solutions division has the lowest gross margin relative to corporate, but it has the highest operating margin flow through as well. So if VSD were to double because semi doubled, the gross margin would go down mathematically.
But the operating margin would jump a lot better. So I think we look at gross margin as gradual improvements over time for all divisions. And then, of course, operating margin is certainly what we look at as well, controlling the OpEx, EPS for sure, paying down the debt, lowering interest payments. And then tax rates, something we haven't talked about too much. Tax rates kind of going from 28% to 16% this year. That's not sustainable long term. There are some one-time events. But 20%, 18%, that's kind of sustainable now.
Got it. With that, I'd like to pause if there's any questions from the audience.
Pricing power? You said some part of your margin was coming through commercial actions. I guess that's pricing.
Pricing, yeah, that's right.
So I'll just repeat the question for the audience. So the question was on pricing power and how that may impact margins going forward.
Yeah, so part of the improvement in gross margin was partly pricing getting paid fairly for what we offer. Our strategy in price and in which products we want to stay in is we want to do things that are differentiating. If things become commoditized and you can't get that pricing power, we'll maybe milk it for a while, but then eventually leave. We've been fortunate. Our customers recognize what we bring. You can see the gross margins of Atotech at 55%, PSD at kind of corporate average, and even VSD going up in the mid-40s range. Those are always difficult discussions. Our customers recognize that we certainly bring a lot to the table. The second thing is our customer base is more diversified. We're not just semi vacuum anymore. We are semi in addition to packaging.
And so there's just a lot more opportunities now for us to go after segments or subsegments or product lines where that gross margin is something that is supported by the industry, where they will pay you for that. We're not limited anymore by taking business that we might not have been so happy with in the past.
I just wanted to ask about the opportunities in advanced packaging, and you've got a slide on package substrates and then the different types like CoWoS and EMIB and things like that. Is the opportunity for you primarily inside the PCB or the substrate in terms of drilling and plating and not on the interconnects? Because the interconnect density is going down a lot, isn't it, I think, in some places? And then the way those packages are linked, be it different types of balls or hybrid bonding or whether you're using parts of TCB and all that kind of interconnect density changes, do you benefit from that as well? Or is your opportunity more in the sophistication of what's going on inside the substrates and PCBs?
Yeah, so the chip-on-wafer part with the hybrid bonding and pillars and all that, we benefit from that because there's chemistry there for sure. So we participate there. But it's an order of magnitude or more chemistry because of the substrate, the PCB part. When you see that cross-section, you can just look at it and realize how much more chemistry there is in the S. And remember, that S is growing. It's going from just a package substrate goes from 15 to 20 to 25 layers. The MLB went from whatever, 20 to now it's 40 layers. Hybrid bonding is going up too. It's going from 8 to 12, maybe 16. But it's not going from X to 5X or 10X in some of these cases. And two other things are happening. It's the same story we saw in semi.
So not only are there more layers, the features in them are smaller. So it's harder to do. And the size of the boards are bigger, right? So bigger wafers is the analogy. Small lines and spaces is the analogy. More layers is the same analogy that we saw in semi. It's the same driver. I need more density. I need more interconnection. And I've got to communicate. I get to get the chip to communicate to the outside world. And to do that, I need all these package innovations. So that is the opportunity for us. That is why we did our transformational acquisition of Atotech. And it's good to have the number one chemistry provider of not just chemistry, but the equipment in that space.
Any other questions? Then just on sort of the chemistry and the equipment, how do you think the sort of Atotech's business has allowed you to sort of expand your customer base in advanced packaging?
Yeah. So Atotech has had very long relationships with these top 30 customers of theirs, the PCB makers, as well as the other 100 smaller customers. And remember, when we sell an Atotech tool, it's 100 meters long. And if you buy three of them, you've got a factory, right? You build a factory around those lines. And then we provide the chemistry. And so when Atotech gets that trust from our customer, it's the CEO decision. It's a CEO decision. And so when they come in to visit or the next thing, CEOs come out. And COOs come out to meet them. And that has been a huge benefit for us because when we were trying to sell laser tools to those systems, you get the laser tool engineer and department head choosing the laser tool.
But now we're getting the entire head of the company or that fab talking to us about the lasers now, as well as the Atotech tools. So I think the relationships that Atotech has had, it's so integral to these customers. They've earned that trust over decades. The tools are so large and so critical to yield of those factories. The chemistry is so important to the yield. The support when things go south. We have tech centers locally, analytical labs that can measure everything, contamination, cross-sections. That kind of support and then the roadmap that Atotech provides them with 100 PhD chemists in Berlin looking at the next generation, that's really the trust that they're buying.
Really, a semiconductor strategy over the last decade translating into optimizing the interconnect this decade.
Same movie. Same movie. We're in an auditorium. It's like we could just show this movie 10 years from now. And it's just so analogous, so analogous. I think the other thing that's analogous is in the 1990s, there were 30 chip companies. There are about 30 big PCB manufacturers today. As problems get harder, there will be some consolidation. But we're a market leader supplying to all of them. As problems get harder, you're going to have stronger customers. And we want to be partners to all of them.
And with sort of the consolidation in your customer end, they would be looking out for a player that can probably spend a bit more in R&D against MKS.
Right, scale. Scale is going to matter because they're going to have harder problems to solve that will take multiple years, right? They've got to have someone that can work with them for multiple years. Glass substrates is a favorite example. We've been working with many of our customers for 10 years on that. Now people are talking about it, right? But it's not a last year everybody started working on it, right? It's been 10 years.
Got it. So a few seconds left. Any last comments from you guys?
No, I think 2024 was a tough year, bouncing on the bottom. I think a lot of the things we did are appreciated by the street. The gross margin, as Ram talked about, the OpEx control, the tax rate. So this is in a very muted market, end market for our business. And I really look forward to showing the street what we look like when the end markets are all up, right? The gross margins will benefit from volume. We'll try to hold OpEx. And then as we pay down more debt too, it's an accretive option to EPS.
Got it. That's all we have today. Thanks very much for.
Thank you.
Yeah, thanks, Ram.