Let's get started. Hello, everybody. Thanks for joining our 53rd Annual TMT Conference. My name is Peter Peng, Small- and Mid-Cap Semiconductor Analyst for the firm. I'm pleased to have John Lee, President and CEO, and Ram Mayampurath, CFO at MKS, here with us today. Gentlemen, if you can just start off with an overview of MKS Instruments and then a summary of the March quarter and June quarter outlook, and then we can kick off the Q&A.
Yeah, so thanks, Peter. Thanks for having us. Some of you know MKS, but for those of you who don't, MKS is almost a 65-year-old company. We started in just a semi market, and we were making instruments at the time. That's the name MKS Instruments. These instruments would control things around a vacuum chamber. When we moved into semi, of course, vacuum chambers became quite important in the semiconductor equipment industry. That is how we became a market leader in surrounding the chamber was our motto. Anything that surrounded a vacuum chamber that was critical, controlling pressure, controlling flow, measuring things, we thought was part of a portfolio that made strategic sense for us.
We were private until 2000, and then at that point, we went public, did a series of acquisitions, probably 10 or 15, just in the vacuum space for semiconductor equipment. In 2015, we did one of our biggest acquisitions that moved the company from just a semiconductor equipment company only to something much broader in terms of foundational technology. That was the acquisition of Newport Corporation. Newport had also done a lot of consolidation in their market, photonics, optics, lasers. Together, we became the broadest portfolio of foundational technologies that addressed not just the vacuum equipment part of semiconductors, but also lithography, metrology, and inspection. The combination of those customers allows us to say that we are in 85% at every piece of equipment at every fab in the world with multiple subsystems.
Because you just add up Applied Materials, LAM, Tokyo Electron, ASML, and KLA's market share, and you get 85%. We're on every one of their tools with multiple subsystems. We did a couple more acquisitions later as we saw this change in Moore's Law. Moore's Law was running out of gas, and people were dividing cores up to get another 10 years, and then that started running out of steam. They started putting chips together. When you put multiple chips together, you still want them to act like they're one big chip. Otherwise, you don't really get that performance boost. This led to the era of heterogeneous integration. This is where we are. This is what enables AI. It's what NVIDIA shows. Every time they talk about all their AI chips, they hold up a board, right?
They do not hold up a chip. They hold up a board with lots of chips on it. That interconnection, those boards, that is very, very complex. It can be 20-40 layers of different interconnecting layers with copper, small lines and spaces. When we did the acquisition of Electro Scientific Industries, this is laser drilling of those PCBAs, making those holes. We did the acquisition of Atotech in 2022, our biggest acquisition to date. That was adding the chemistry capability and the chemistry equipment capability to make those heterogeneous PCBs. Today, we are foundational to Moore's Law and more than Moore's Law, because everything now that drives that is no longer just semi. It is the packaging of the semi. I think we were early. We said that when we did the acquisition. No one really kind of understood that. They get it now.
We address 70% of all those steps for making that dense interconnect. 85% of all chips have multiple MKS equipment on it. 70% of all steps in making that interconnection is addressed by MKS equipment, laser equipment, as well as chemistry. That is where we are today. Q1. Yeah, recap of Q1. Q1 was strong. We exceeded guidance in all metrics, top line, bottom line. We were really proud of the fact that the gross margin held up in a quarter where there was a lot more equipment revenue. Usually, equipment is a little lower gross margin than chemistry revenue. I think it is the fifth quarter in a row, Ram has pointed out, where gross margin is now over 47%.
A few years ago, we did our five-year model at Analyst Day, and the long-term model in five years at $5.6 billion in revenue was 47% gross margin. We're already there at $3.6 billion. A lot of work on pricing, a lot of work on efficiency of factories. We have made some good progress there, even though the top line has not helped us. I think also EPS was a good story for us, exceeded the guidance, exceeded the high end of the guidance, actually. We have worked hard on things like tax rates, as well as, of course, the OpEx. Q1 was a strong quarter. We guided relatively flat, I would call it, in terms of top line. We do have a little bit of impact from tariffs. We will probably talk a little bit about that, and we called that out during the call.
Otherwise, pretty steady right now for our markets as of today.
Okay. Why do not we just kind of start off with the near-term stuff on the tariffs, because that has been very topical and top of investors' mind. Liberation Day was just a month ago, and your customers are facing numerous uncertainties. Some of them are spending and strategic spends that are less likely to get cut back, such as node migrations, AI accelerated compute. There are other segments like industrial, automotive, and the consumer-focused smartphone and PC that could likely get impacted by tariffs. I think you have a very unique vantage point, given that you have three different business segments. What have you kind of observed over the last several weeks in terms of your customer discussions? Any notable discrepancy among your customers in your different end markets?
Yeah, I have to say it's been pretty consistent. When I think about the semi market and the packaging market that goes with semi, that's been pretty consistent. It hasn't really changed because of the tariffs. Certainly, that's what we said in the earnings call for our Q2 guide. A lot of those investments are strategic, as you know. Node migration from one xx NAND to two xx NAND, going from three nanometer to two nanometer to even beyond that. That really has no--we haven't seen any changes there. Where we have seen some effects that are macro-related, some of it caused by tariffs, some of it not, is in some of our industrial segment. Just normal industrial markets, as well as automotive. Automotive, of course, is impacted by tariffs.
We have seen those two markets be a little weak, and that affects our specialty industrials market segment of MKS. The semi part and the packaging, electronics and packaging have been pretty steady, and really no changes to really call out at this point.
Just on the direct tariff costs, your gross margin guidance includes 100 basis points of gross margin impact, and it is primarily impacting your vacuum business. If you can just kind of elaborate on what the assumptions are you are making, and then some of the near and longer-term mitigation strategies. I think earlier one of your peers also talked about, because of the recent trade easing, that this could be a worst-case scenario in terms of that. Are you seeing that as well?
Yeah. Like you said, Peter, we have baked in up to 100 basis points in our gross margin for tariffs. Our goal is to mitigate the tariffs as much as possible and then get into any commercial actions if needed. It is a broad area of things we are working on. We also have a global footprint, and if we know for sure these are the rules and these are here to stay, we can make the changes in the supply chain and rewire our supply chain to make sure that the tariffs are mitigated. That comes with some costs. We want to make sure that we have definite clarity before we get into those steps.
For now, we are doing all we can to mitigate the short-term impact of tariffs, and our actions will also include some commercial actions as needed selectively to pass those through. We are confident that we can come up with mitigation plans to overcome the tariffs impact and keep in close touch with the developing rules as they come along. In the long term, we are committed to a 47%+ gross margin with or without tariffs.
The announcement Monday is certainly helpful for the quarter, right? As you said, that can change tomorrow. Who knows?
Okay. Starting with your semiconductor business, your large customers have largely reiterated their view of a mid-single-digit percentage WFE revenue outlook for 2025, kind of highlighting the strength in leading-edge foundry and logic, NAND technology upgrades, and strong spending in advanced DRAM HBM. Just kind of you historically highlighted a 200 basis points premium to WFE. Kind of based on your visibility and discussion with customers, how are you assessing your relative performance against this mid-single-digit WFE outlook?
Yeah, so some facts, of course. If you take our Q1 semi result and our midpoint of our Q1 semi guide, half over half, first half 2025 versus first half 2024, we'd be up 15%, okay, just in semi. Now, two factors there. One is, let's say WFE is up 5%, give or take. That's kind of a consensus number. We would enjoy that because of our position in semi. Also, as you recall, we were still getting our inventory being burned down at our customers in 2024. When you compare ourselves to ourselves, it's going to be better than just the market at 5%. That's typical. That is what happens on the downturn. Our inventory burns, and we underperform. On the upturn, we overperform as they restock and prepare for the ramp.
We're still committed, and we think we have avenues for that 200 basis points outperformance of WFE. There has been a huge headwind, right? We are down about $250 million out of our $2 billion peak semi revenue because of the restrictions to China. We can't sell to certain companies there that our competitors that are not U.S.-based can and are selling. That's just headwind for us. That's why we've got to look at other ways to grow, like lithography, metrology, inspection, going after more RF power in different segments, going after different regions where we're not as strong. We've got a little more headwind now, but I think the strength of MKS's portfolio, we think we can still do that.
On the NAND technology upgrade, your customers are starting to upgrade from 100-plus layers to 200-plus layers, eventually 400 layers, right? We're starting to see this drive in inflection in NAND WFE. How do you anticipate the trajectory of these upgrades, right? You have a pretty strong market leadership in RF power. Maybe if you can just give us insight on how you're thinking about the technology upgrade through the year.
Yeah, I think even 90 days ago today, the change is actually in the NAND part of the market for us. Nine days ago, we were hoping upgrades would happen. We were sure that our inventory was burning off, but we were not sure if it was going to be burned off to the point where our customer would need to pull more inventory. 90 days later, those have happened. Upgrades are happening. Our inventory has normalized, so they are pulling. We are benefiting from that. You can see in our numbers in Q1. I think going forward, obviously, any upgrades do benefit MKS because when you upgrade, you have to upgrade with something that is already there. The only installed base is from LAM, and RF power is us, right? That is helpful when these upgrades occur. There has also been a greenfield as well.
Some of the end users are talking about future greenfields. The benefit for us is RF power is the biggest part of the bomb for us. Greenfield's even better because then we have the surrounding chamber portfolio also benefiting because it's a brand new tool versus just an upgrade of the RF power. I think depending on the future of decisions by all the NAND makers, that will determine whether the NAND upgrades continue at pace, accelerate, or decelerate. We just do not really know that because I do not think anybody knows that until those companies decide.
One of your lead customers just recently talked about for the two-thirds of the installed base that's still in the 100 layers to convert into 200 layers, that would drive a $40 billion of spending just to convert. Maybe you can just give us some qualitative or quantitative thoughts on how that would translate into MKSI.
Yeah. Typically, in general, our vacuum portfolio is anywhere from 1.5% - 2.5% of the BOM of our customers. It depends on our market share and the particular components. That gives you a range. We're not going to call out exactly RF power. You can kind of do that math, and that's market share leadership. If one of our customers is seeing $40 billion for themselves, then if we're seeing, take it 1.5%-2.5%, that's the opportunity for us if they see $40 billion.
Okay. Just relatedly, we get asked this question quite a bit. On the opportunities between just the upgrade and greenfield, how would you kind of compare the revenue opportunities between these two opportunity sets?
Yeah. Yeah. As I said, the RF power is the biggest part of the BOM for us. In an upgrade, that's usually the main thing that's being upgraded from the MKS portfolio. In a greenfield, they need everything else: the pressure measurement, valves, flow delivery. We just get another enhancement from that. We're not going to break out how much is RF power versus that. It depends on the chamber sometimes, by the way, and depends on our market share. Greenfield is certainly better.
Perfect. Let me just pause here to see if there's any questions.
Yeah. If I look at the trend of some of your customers: Applied Materials, KLA, LAM, Tokyo Electron, they all seem to be focused on moving towards these more integrated systems, right? Applied calls their system like integrated material systems where they're integrating multiple chambers, the position, etch, and so on. In addition to that, they've got all this integrated metrology. I would think that that would be a pretty big benefit for the MKSI team because you've got so much more vacuum requirements, you've got so much more RF requirements, you've got so much more metrology requirements, and all being sort of optimized and integrated into this single system. Do you view that as sort of a content gain opportunity as you look at some of these next-generation opportunities?
Yeah, I think that's right. It's a good observation . I think the bigger way we view it is that as things get more difficult, there's a need for more critical subsystems, critical subsystems that measure things more precisely, deliver things more precisely, et cetera. When you're integrating things together, the idea is you're not breaking vacuum because when you break vacuum, oxygen gets on the wafer, stuff happens, and that's not good. That's just one of the indicators of complexity and making things more difficult to do. In that, there's a lot more precision and control, moving things around. Those are opportunities. Things like our optical thermometry, measuring the temperature of the wafer. We bought that company a few years ago. In the past, it was like some chambers needed it. Now it's like most etch chambers need that.
I think the same, I'll take the opportunity to talk about, the same trend is happening in electroplating of PCBs. One of the tools, pieces of equipment that Atotech makes, MKS now, that no one else makes as well, is something called a horizontal plating tool. It's 50 meters- 100 meters long. Why is it that long? It's because the panel that's being plated is continuously submerged through different process steps for 50 meters or 100 meters. It never breaks the surface of water or liquid. That is a huge advantage. Many other tools, you do one step, you got to take it out. Now things have happened. Then you put it back in. The interface of these connections of copper to copper is just not as good. That's exactly why Applied is doing the PVD tool that has everything connected together.
The same trend is actually happening, is already happening in electroplating for advanced PCBs.
Thank you.
Historically, you've been very strong in the dielectric etch market. I think in your last analysis today, you kind of discussed some penetration opportunities in the conductor etch market. Maybe you can just share your progress in this area.
Yeah. Yeah, you're right. We were distant number two in RF power seven or eight years ago. We had low share in conductor etch and dielectric etch. We made a lot of progress in dielectric etch driven by V-NAND. And so in 2022, we're number one in RF power because NAND was a great year. In conductor etch, we have a couple of design wins we talked about in the past. There's still much smaller revenue streams than our dielectric etch, RF power and dielectric etch. We haven't made the same progress we made, frankly, because there's just a lot more to do in dielectric etch, and we were really focused on that. I think I look at it as an opportunity. Things are changing. Those are areas for opportunity.
For instance, a lot of people have talked about something called pulse DC power instead of RF power. It's just two different ways of delivering power to an etch chamber. Pulse DC is changing and being used in conductor etch now. That's an area where it's an opportunity for us as well as everybody else because something's changing, right? It's not just a CIP of what's already out there. We think that conductor etch can be a future good opportunity for us. Remains to be seen. These things take multiple years. You design in. The toolmaker has to get their tool designed in. The end user, chip maker, has to go build a fab from it.
I think the progress has mostly been dielectric etch the last eight, nine years, a little bit of conductor etch, but that's where the opportunity is for us.
One area that you've been gaining a lot of traction is in the process control and lithography application, right? Revenue has been growing at a 20% CAGR, and it's almost a $300 million revenue run rate business. Maybe just discuss some of the design win pipeline and share your perspective on how large this business can eventually get over time.
Yeah. So when we acquired Newport Corporation, they were in lithography, metrology, inspection, but it was just one of many markets that they were in. We, being a semi company, said, "That's an opportunity for us because the two big customers there, they do not have a lot of competition, right? If you get designed in there, you're likely going to win." That is why we invested in that. To do that, you have to invest. You have to invest in equipment, CapEx. You have to invest in process engineers to develop coating recipes for the optics. You have to invest in a lot of optical design engineers, right? These pieces of equipment were very complex, and those customers want to certainly outsource subsegments, subsystems. Basically, you have to have your own kind of optical engineering team with coating machines and capability.
We did that investment. That's why we drove it from $150 million to $300 million over the last five years. I would characterize it as still early earnings. You can just look at $300 million for LMI, lithography, metrology, inspection. The vacuum side is anywhere from $1 billion-$2 billion, depending on the cycle, for us. When you look at WFE, how much is vacuum-based tools and how much is lithography? It's probably 60% vacuum-based and 40% LMI, right? It does not mean we're going to get the same percentage in each of our customers, but that is the opportunity.
Got it. Okay. That's great. Your mix of business has shifted over time. It was very memory-centric. Over time, I think given the kind of weaker spending trends and some of the progress that you're making in the foundry and logic space, it's becoming more balanced. I think in the longer term, how do you think your mix is going to look like if memory WFE do rebound? Do you think it's more balanced over time, or is it going to go back to historic?
Historically, it was balanced. This is going back 10, 15 years because we did not really care it was a vacuum-based chamber. You are right, over the last eight years or so, five years, more and more memory. We were more memory-centric because of our success in V-NAND with RF power. That was a big driver of it. Our relative lack of success in lithography, metrology, inspection. Now that has shifted. NAND is going to be probably a little less than the peak NAND spends in 2022. DRAM looks like it is still going well, especially with HBM driven by AI. Our efforts in lithography, metrology, inspection, that is mostly foundry-weighted. Right now, I think in last year, we were actually 60% foundry logic, whereas in the past, it had not flipped. In the past, we have called out 55% was memory, NAND and DRAM.
That had been true for several years. Now it's shifted a little bit just because NAND and DRAM were lower. I think going forward, it feels like 50/50. It really does. That's okay. That's not a bad thing, right? I think the idea of being 85% levered to semi is we don't care if one decade etch and depth are outgrown because of multiple patterning, because EUV isn't ready. We kind of won't care now in the future when EUV is ready and people are spending more on lithometrology inspection, which was the last five years, right? If you look at the next five years, it's like, "Oh, maybe it's gate all around. Maybe it's backside power, more depth and etch." Okay. We're exposed to 85% WFE, and I think that's a healthy approach to the industry.
We care if WFE goes up. If it goes up, if we can outgrow it, then that's the strategy for us.
Maybe switching to the electronic and packaging business, right? There's a lot of exciting growth in this area. We highlighted back-end high bandwidth memory, AI compute servers, edge devices, the low Earth orbit satellite applications. Maybe you could just rank order the top three or four applications that you feel most excited and how material are those to your overall business?
Yeah. For our electronics and packaging market, a lot of it is really driven. The acceleration is driven by the high-end packaging part of the PCB industry. The PCB industry has three segments, we like to characterize it. Multi-layer boards, that is kind of the old, if you will, PCBs. Think refrigerators and washing machines. That is a third of the market. The middle third is something we call HDI, high-density interconnect. PCB is the same thing. Think of smartphones. Smaller features, more layers. The higher end is what we call package substrate. Again, organic PCBs. That is for servers, advanced PCs, and now AI servers. That is growing at high single-digit to maybe even double-digit CAGR now. HDI is kind of growing mid-single-digit CAGR. MLB is GDP.
The only exception now that's happening is, and so that's the biggest driver for us, I think, is AI and the packaging. AI, for sure, we knew was driving the most advanced PCBs, but we've talked about several quarters now of equipment orders, chemistry equipment orders for MLB and HDI. At first, we were puzzled. We're not making more refrigerators, as far as I can tell, right? AI boards on package substrates need to be then connected to the rest of the world via HDI boards and MLB boards. That is where we're seeing three quarters now of strong bookings for that equipment, which comes with our chemistry. A lot of these customers either already have the capacity and need more or want to get into that AI stream. MLB people who have always been in MLB now can actually play in AI, right?
Some of them are making those bets. I think low Earth orbit is a nice niche kind of play. Although every month we hear someone else ready to start a company to launch thousands of satellites into space. We are the laser drilling tool record for making those PCBs. When you think about 5,000 satellites with the PCBs, that's not what we're talking about. We're talking about the hundreds of thousands of dishes that are one big PCB, very complex, that are looking at all those satellites. That's what's driving the volume right now. As more and more companies look at low Earth orbit, I think that's a nice, relatively small part of our business now, but growing rapidly as well. AI and package substrates, that's the biggest driver today.
Maybe just following up on the three consecutive quarters is just positive booking trends in your chemistry equipment sales. You have a pretty high attach rate with the chemistry sales. Maybe you can just provide some insights into your customer buying patterns and what that might mean for your chemistry sales over the next several quarters.
Yeah. Our strategy always with our equipment is it comes 100% with our chemistry. That is true. Five years later, there's a little degradation, but we hold about 85% for the chemistry for the duration of that tool. That's good for future chemistry revenue when we're shipping our tools out. As you pointed out, we've had three good quarters of chemistry equipment bookings. The last two quarters, you've seen the revenue come in. As I said, these tools are unique in that only we're making them. They're complex. They do things that our competitors cannot. I think maybe another thing to point out is you can buy someone else's equipment, and sometimes that happens. We lose the equipment. Oftentimes, we still win the chemistry because they're trying to win advanced packaging for AI, right?
If you want to compromise on the equipment, you really need good chemistry now. If you really want high yield and high throughput, why not take the equipment and the chemistry that's already been optimized together? The equipment's better than any piece of equipment out there right now. I would say right now, we're really happy with the chemistry market share for these advanced applications. Extremely happy. Equipment, we're also very happy, but the market share is not 100% there.
Moving on to the last business, the specialty industrial, which doesn't really get too much attention, right? It's a pretty well-diversified business encompassing defense, healthcare, automotive, and just broader industrial markets. It's free cash flow generative. You talked about kind of the macro impact impacting some of the softness in the industrial and auto. What signs or metrics are you need to see before you can kind of call a bottom and a recovery in this business?
Yeah. Maybe I'll let Ram answaer that.
Yeah, sure. Like I said, Peter, first of all, let's clarify that it is not a commodity business at all. It is a high-margin business. It helps with our cash flow. It also helps share some of the R&D cost because most of our R&D goes to the semiconductor and electronics and packaging businesses, and specialty benefits from that investment. There are a number of segments that go into that particular market. There is healthcare. There are lasers that go into various applications. There are general industrial segments, and there is auto. Auto and general industrial being the two biggest within the specialty industrial business. As you know, both of those have been not doing well for several quarters now. PMI is a good index to look at. Just the auto production is also a good index to look at.
We hope we are at the bottom of that trend, but we have not really seen any huge recovery there at all. Like I said, we are happy to keep that business, although we do not see much growth because it is very profitable and it also generates cash. As the top line comes back to more normal levels, you are going to see that multiplied effect of the bottom line.
Okay. So on the financial side, there's some OpEx step up in 2025, but you kind of focus on some of these longer-term growth initiatives. Maybe if you can just elaborate on some of these longer-term projects and what you're targeting or specific applications.
Yeah. If we take a step back and if you think about the last two years, 2023- 2024, our gross margin grew by 190 basis points and our operating income grew by 180 basis points. It is a combination of both commercial actions. It is a testament for the value we bring to our customers, our pricing stability, and the design and the differentiation that our R&D team brings. Also, manufacturing excellence operations, that continuous improvement actions that go on both in manufacturing and procurement and some design. We are very confident of our gross margin improvements. OpEx, on the other hand, has stayed flat. There has been no increase in OpEx between 2023 and 2024. To Peter's point, we are investing a little bit in OpEx. We have given a range of $250 million-$260 million for a quarter for this year.
That is in anticipation of some of our conversations with our key customers and the growth we are seeing ahead of time. Most of that investment goes towards some basic infrastructure improvements and also in people. In Q1, we finished in the middle, $254 million. In Q2, we are guiding to the lower end of that range. We are laser-focused on the spending there. We first look for reallocation of resources before we look for new dollars, for sure. It is mostly to prepare that platform for the growth that we see that is coming, especially because we have been invested in the last couple of years.
Yeah. In general, there's so many opportunities for us to invest in. They're in lithography, metrology, inspection. They're in power still in the vacuum section. They're in chemistry, chemistry equipment. Having this broad portfolio targeted to very fast-moving markets, it's good to have the scale we have and the profitability and financial model we have because we can actually really target tens of engineers into a different area right away. Many of our competitors can't do that, right? We have multiple of those opportunities all the time. It's just good to have that broad portfolio, but still focused on semi and electronics and packaging and having the size to be able to invest in that.
You guys have done a pretty good job of deleveraging and actively repaying debt, refinancing your term loan. Just given the uncertainty in the macro environment, how are you thinking about debt paydown? Is that 2.0 net leverage ratio something that's still achievable over the next several years?
Certainly. Just following through the P&L conversation, we are very happy to see that clean bridge from P&L to cash flow. Our cash generation has been very strong. It is a combination of operational performance improvements and working capital management. In 2024, we paid down $426 million on top of the $50 million mandatory payments towards our debt. In Q1, our cash generation was 13%, 100% of net earnings converted to cash is about 13% of revenue. In addition to paying down $100 million towards the debt in January, we also repurchased some stock because it was a very strong quarter of cash. The stock repurchase was accretive, and it helped offset the dilution for the year. We are committed to making another payment towards our debt in this quarter so that pattern that we had last year will continue.
Debt repayment and strengthening the balance sheet remains our focus. Going back to what I said before, the cost correction that we have done, as the top line comes back to more normal levels, you are going to see that cash flow generation multiply, and we are able to accelerate our debt repayment when we get there.
Perfect. We're out of time, and that wraps up the session. Thank you, gentlemen, for participating.
Thank you. Okay. Thanks.