Thank you for standing by. My name is May. I will be your conference operator today. At this time, I would like to welcome everyone to MKS's third quarter 2026 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. To ask questions, please press star one. To withdraw your question, please press star one again. Thank you.
Good morning, everyone. I am Paretosh Misra, Vice President of Investor Relations, and I am joined this morning by John Lee, President and Chief Executive Officer, and Ram Mayampurath, Executive Vice President and Chief Financial Officer. Yesterday, after market close, we released our financial results for the third quarter of 2026, which are posted to our investor website at investor.mks.com. As a reminder, various remarks about future expectations, plans, and prospects for MKS comprise forward-looking statements. Actual results may differ materially as a result of various important factors, including those discussed in yesterday's press release and in our 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 non-GAAP financial measures. Unless otherwise noted, all income statement-related financial measures will be non-GAAP, other than revenue and gross margin. Please refer to our press release and the presentation materials posted to the investor relations section of our website for information regarding our non-GAAP financial results and a reconciliation to our GAAP measures. Our investor website also provides a detailed breakout of revenues by end market and division. Now, I will turn the call over to John.
Thanks, Paretosh, and good morning, everyone. MKS's strong business momentum continued in the third quarter, driving revenue and EPS above the high end of our guidance. We also expanded operating margins by approximately 700 basis points year-over-year, demonstrating the leverage in our business as revenue scaled. Each of our end markets performed at or above the high end of our guidance, and we continue to see strong order flow, providing us greater visibility into future demand. Our guidance today points to a very strong finish to the year, with continued robust year-over-year revenue growth driven by unprecedented demand across our key end markets. As AI-related investments accelerate across semiconductor manufacturing and electronics and packaging, we are capitalizing on our broad capabilities, long-term relationships with customers, and our ability to develop solutions that address the fundamental trends of scaling, stacking, and new materials.
These same trends are driving complex requirements for memory and logic devices, as well as the advanced circuit boards and substrates that integrate them. We are uniquely foundational to enabling customer roadmaps across both markets. This position is also translating into new design wins that create opportunities to gain share and further expand our visibility into the AI super cycle. At our upcoming investor day in December, we look forward to sharing more about how and where we innovate and win. I will turn now to our Q3 end market performance and Q4 outlook. Starting with our semiconductor market, revenue was at the high end of our guidance range, up 15% sequentially and 54% year-over-year. Growth was broad-based across our vacuum and photonic solutions, including power, pressure, microwave, and plasma and reactive gas solutions.
We also secured a major customer win with a leading foundry, selecting our dissolved gas solutions for advanced logic. NAND upgrades continued at a healthy pace, and with greenfield capacity planned for 2028, our RF power outlook is robust. Design win activity remains solid, including an important pulsed DC power win for a significant conductor etch application. Overall, order activity remains very strong, providing rapid revenue growth and excellent visibility well into the new year. Our semi outlook for Q4 points to accelerating year-over-year growth, with continued strength across our product portfolio. Customer conversations we are having give us confidence in our ability to continue outgrowing WFE during this period of elevated investment. Against this backdrop, some customers have noted certain constraints elsewhere in their supply chain. We plan several years ahead so that we and our suppliers are positioned to meet customer demand.
From a manufacturing perspective, we are preparing for WFE approaching $300 billion in 2028. Our Malaysia super center will ramp over the coming quarters, with room for further expansion. We also plan to expand super center capacity in other key regions, such as North America and Europe. MKS has the depth, scale, and financial strength to expand capacity across our own operations and supply chain while maintaining CapEx intensity within our targeted 3%-5% range. Turning now to electronics and packaging. The business continues to deliver outstanding growth. Revenue was well above our guidance range, increasing 9% sequentially on top of a strong Q2 and up 43% year-over-year. Our chemistry equipment business continued to see record order volumes as customers expand capacity, largely to support AI-related applications.
Chemistry revenues grew 26% year-over-year, excluding the impact of FX and palladium pass-through, the strongest growth in the history of the company. That performance reflects strong AI-driven demand, as well as increasing consumables revenue as the equipment we have installed over the past several quarters is qualified and moves into production. As a reminder, our proprietary chemistries have an attach rate of greater than 85% to our equipment installed base, generating years of steady revenue at gross margins well above the corporate average. AI-related chemistry revenue represented 10% of our electronics and packaging chemistry revenue last year, and it is now tracking towards the high end of the 15%-20% range we had talked about for 2026.
Including all of our E&P capabilities, chemistry equipment, chemistry, and laser systems, AI exposure is expected to represent approximately 25% of total E&P revenue for the full year, an approximately 180% annual increase in dollar terms. As we have reported throughout the year, our momentum is accelerating. At the midpoint of our guidance, we expect approximately 1/3 of our E&P revenue to come from AI in Q4, and we expect this to continue to increase as we help customers meet growing demand for AI applications. Chemistry equipment sales were up more than 75% year-over-year in the third quarter, and we expect full-year sales of more than $300 million, over 50% above our historic annual peak.
Current capacity is sold out through 2027. To meet accelerated chemistry equipment demand, we are expanding capacity in Guangzhou, China, and this will double our overall capacity when completed, which we are targeting for Q3 2027. Across the electronics ecosystem, AI demand is increasingly challenging semiconductor innovation, as well as advanced packaging substrates and PCB technologies. As package sizes grow, layer counts increase, and package architectures become more complex, we are leveraging our broad electronics and packaging portfolio to address these technological challenges. Looking ahead to Q4, order activity remains extremely strong across the board, with chemistry equipment now booking for deliveries well into 2028. We have also seen considerable new order volume for our laser systems for rigid PCB applications, including optical modules, with deliveries expected to accelerate significantly in 2027.
These wins reflect years of coordinated go-to-market groundwork across our PCB laser drilling systems and chemistry businesses, which has positioned us well to meet the industry's needs for innovation at just the right time. We expect Q4 electronics and packaging revenue to increase over 40% year-over-year, driven by strength in chemistry equipment, AI-related chemistry, and rigid PCB laser drilling systems. On an annual basis, our E&P business is on track to grow nearly 40% in 2026, as AI continues to drive elevated capital investment across the PCB industry. As new equipment is qualified and ramps in coming quarters, we expect our larger install base will support steady growth in our higher-margin chemistry consumables over the long term. Turning to our specialty industrial market, revenue grew 15% sequentially and 27% year-over-year, well above our guidance range, led by strength in datacom and improvement in general industrial markets.
Automotive posted modest growth despite soft vehicle production, highlighting our value-add position in the market. The growth of these businesses in 2026 demonstrates our ability to extend our core capabilities into attractive markets. Looking ahead to Q4, we expect revenue to remain at this level following the significant growth we delivered. Last month, we announced that we entered into an agreement to sell Ophir Optics business to TTM Technologies. Ophir Optics develops high-precision infrared thermal imaging and laser optic solutions for defense, security, and industrial applications. We grew this business organically, improved its profitability, and have agreed to sell it at an attractive valuation to an industry leader. For MKS, the transaction gives us balance sheet flexibility and shows how our specialty industrial activities enhance shareholder value creation. Wrapping up, MKS is poised to end 2026 on a strong note, and we are excited about what lies ahead.
As the only company in our space broadly exposed to powerful trends driving innovation in both semiconductors and advanced PCBs, we're in a great position to significantly grow our business in the coming years. AI is not just driving investment, it's pulling forward our customers' technology roadmaps across the semi and electronics packaging landscapes, elevating the value of innovation for those who can deliver it. As a foundational enabler of that innovation, the future is bright for MKS. I want to thank our outstanding MKS team for their tireless efforts to deliver for our customers amid unprecedented demand, and our suppliers and customers and industry partners across the electronics ecosystem for their continued support and collaboration. Now here's Ram to run through the quarter and our financial outlook in more detail.
Thank you, John, and good morning, everyone. We delivered another very strong quarter driven by broad-based demand across all our end markets. Our results demonstrate our ability to translate high revenue growth into even better earnings growth through disciplined execution. We are driving strong operating leverage while continuing to invest in the multiple growth opportunities that we see ahead. For the third quarter, MKS recorded revenue of $1.41 billion, up 13% sequentially and 43% year-over-year. As our guidance indicate, we expect strong demand across all our end markets to continue in the fourth quarter. Third quarter semiconductor revenue was $638 million, up 15% sequentially and 54% year-over-year. In addition to continued strength in DRAM and logic demand, we saw increased momentum in NAND upgrade activity.
Collectively, this demand is driving continued strength across our key product categories, led by plasma and reactive gas solutions and vacuum products, as well as accelerating growth in power solutions, optics, and photonics. Third quarter electronics and packaging revenue was $415 million, up 9% quarter-over-quarter and 43% year-over-year, continuing its record growth. The sequential improvement was driven by higher chemistry and chemistry equipment sales, partially offset by typical seasonal decline in flexible PCB drilling system sales. The strong year-over-year growth was driven by demand for chemistry equipment, chemistry solutions, and flexible PCB drilling equipment, underscoring our strong market position despite smartphone market softness. As John mentioned, our chemistry business continues to benefit from accelerating demand from AI-related applications, with sales up 26% year-over-year, excluding the impact of FX and palladium pass-through, at a record year-over-year growth rate.
In our specialty industrial market, third quarter revenue was $360 million, an increase of 15% sequentially and 27% on a year-over-year basis. The year-over-year sequential growth was driven primarily by datacom and general industrial, while our automotive business remains stable. We reported third quarter gross margin of 47.7%, supported by higher volumes and a 30 basis points benefit from IEEPA tariff refunds, which we do not expect to repeat in Q4. Our gross margin continues to expand, driven by the value of our solutions, as well as higher volumes despite modest headwinds from growing sales of lower-margin chemistry equipment, as well as cost incurred from the expansion of manufacturing capabilities. While we expect these headwinds to continue into next year, both are expected to become margin tailwinds longer term as chemistry consumables grow with our newly installed chemistry equipment and new capacity reaches full utilization.
Third quarter operating income was $393 million, with operating margin improving approximately 700 basis points year-over-year to 27.8%, well above our guidance and our highest quarterly operating margin in over eight years. Operating expenses of $281 million were in line with our guidance as we continue to drive operating leverage in the business. Third quarter adjusted EBITDA was $434 million, yielding a 30.7% margin and above the high end of our guidance. Net interest expenses were $33 million compared to $45 million in the third quarter of 2025, reflecting the benefits of our first quarter financing actions as well as continued proactive principal prepayment. Our third quarter effective tax rate was 19.1%, slightly favorable relative to our guidance. Third quarter net earnings were $292 million, or $4.18 per diluted share, more than doubling year-over-year and above the high end of our guidance.
Let me now turn to our cash flow and balance sheet. We closed the quarter with over $1.6 billion of liquidity, comprised of cash and cash equivalents of $676 million and our undrawn revolving credit facility of $1 billion. We generated strong free cash flow of $243 million, about 17% of revenue. We expect to continue to invest in CapEx and working capital through the year-end to support organic growth, with full-year capital spending remaining within our target range of 3%-5%. With excess cash, we made a EUR 50 million principal prepayment on our euro term loan in Q3. In addition, we made another $100 million prepayment on the USD term loan this month, bringing total year-to-date prepayments to over $450 million.
Our net leverage ratio at the end of Q3 was 2.4x based on a trailing 12-month adjusted EBITDA of $1.3 billion, down 1.5 turns from a year ago and within our target net leverage of 2.5x . With our stronger balance sheet and healthy business outlook, our board recently approved a $500 million share repurchase program, providing flexibility to repurchase shares opportunistically. Finally, we paid a dividend of $0.25 per share, or $17 million. Let me now turn to our fourth quarter outlook. We expect revenue of $1.49 billion, plus or minus $40 million, which represents a 44% growth over the prior year. Our fourth quarter outlook by end market is as follows. Revenue from our semiconductor market is expected to be $700 million, ± $15 million.
Revenue from our E&P market is expected to be $430 million, ± $15 million. Revenue from our specialty industrial market is expected to be $360 million, ± $10 million. Based on anticipated revenue levels and product mix, we estimate fourth quarter gross margin of 47.5%, ± 100 basis points, similar to where we ended Q3, excluding IEEPA tariff refunds. We expect to continue to deliver strong operating leverage with fourth quarter operating expenses at $288 million, ± $5 million, and increasing at a much slower rate than revenue. We expect fourth quarter operating income of $420 million, ± $29 million, with an operating margin of over 28%. We estimate fourth quarter adjusted EBITDA of $461 million, ± $29 million.
We expect our fourth quarter tax rate to be approximately 9%, and full-year tax rate to be just over 16%. Based on these assumptions, we expect fourth quarter net earnings per diluted share of $5, ± $0.38. Our strong Q3 performance and Q4 outlook position us for an outstanding second half of the year. Order volumes are healthy, visibility is improving, and strong execution is driving higher profitability and cash generation while we invest in the business to address the strong growth cycle we see ahead on our semiconductor and Electronics & Packaging businesses. With that, operator, please open the call for questions.
Thank you very much. Ladies and gentlemen, we will now begin the question- and- answer session. If you would like to ask a question, please press star followed by one on your touch phone. You will hear a confirmation once your line has been placed in the queue. If you wish to withdraw your question, please press star followed by one again. If you are using a speakerphone, we kindly ask that you lift the handset before pressing any keys. Please hold for a moment while we gather questions.
Give me one second.
Our first question comes from the line of Matthew Prisco, Cantor.
Hey, guys. Thanks for taking the questions. First, starting on the semi side, can you give a bit more color on that visibility that the customers are giving you today? Maybe how that splits between actual orders and forecasts, and maybe your latest thoughts on MKS's ability to outgrow WFE through 2027. What type of magnitude should we be thinking? Thank you.
Yeah. Good morning, Matt. It's John. So we are in obviously constant contact with all of the semi customers, and they are giving us much better visibility than in the past. It extends out certainly into the 2028 timeframe. And those are guidance levels. The bookings and actual orders, of course, are in a shorter period of time because you actually need the details of actually what they need. But the visibility is great, as you would expect. During upcycles, MKS has always demonstrated that we outperform WFE, and we see that happening now. I think early in 2026, it was a little slower start. I think the critical subsystems folks were trying to rev the engine, if you will, in our supply chains. Now you're starting to see that acceleration. I think with the guidance, we'll probably grow something like 40% year-over-year.
I think WFE is kind of in that mid-30% range. I think that will continue in 2027.
Great. Thank you. Then speaking on semis, can you offer some more color on the constraints that you're seeing in today's market? Are there any share opportunities that you see arising from this? Any problem areas for you guys in securing supply? Thank you.
Yeah. I think there's been reported shortfalls in certain commodities, and some of those commodities are things that we make as well. Those are share-gain opportunities for us. I think if you look at our delivery, our operations team has been doing a great job. We talked about our factory expansions, and we're well on our way to supporting 300 billion WFE. I like to take a little time to also just remind everybody how much hard work this is for the entire supply chain. We have thousands of suppliers. They're all stepping up. We've asked them to double, and then we've asked them to double again. This is not a small feat, right? I think it shouldn't be lost that we're asking the entire supply chain to do something that's never been done before.
We may end this year as an industry increasing WFE by 50 billion just in one year. Of course, that was a slower rate in the beginning of the year than the end of the year. So, I think the accomplishments for the industry are really impressive.
Thank you.
All right. Thank you very much. Our second question comes from the line of Krish Sankar of TD Cowen.
Yeah. Thanks for taking my question. John, if you look at some of the big well-known constraints out there, one is MFC, the other one is the rigid PCB drilling tool. You have a position in both of those, and it looks like the constraint is coming from one of your Japanese competitors. I am wondering, is there a chance for you to gain market share in both the MFC side and also the rigid PCB side?
Yeah, I think, for sure, those are opportunities, especially since we have been delivering pretty well. I would say that in our prepared remarks, we did call out a little bit of the rigid PCB drilling business and how that has been very strong now and will continue to accelerate through 2027. And that is, a lot of it, driven by the fact that we have already been qualified, but there are constraints there, and that is an opportunity for us. So, yes, these are share- gain opportunities, one of which we are calling out already.
Got it. The other thing I just want to find out is that, clearly, you have been selling quite a bit of these tools this year on the EPC side, and my understanding is that the chemistry follows later. Is it fair to assume 2027, the chemistry revenues could be higher than 2026, and what is its implication to gross margin?
Yeah, so as you know, our gross margin for chemistry is higher than corporate average, significantly, and that remains the same. As that chemistry starts being put into the tools we have been delivering, we will get that tailwind and gross margin as the chemistry revenue increases. I would say we are already seeing some of that chemistry revenue from the first tools that we have shipped several quarters ago. So, that is starting. Obviously, the shipment of tools has continued since three or four, maybe five, six quarters ago. We expect that to accelerate in 2027 and that chemistry revenue to come with that.
Thanks, John.
Thanks, Krish.
Thank you very much. Our third question comes from the line of Melissa Weathers from Deutsche Bank. Go ahead.
Hi. Thank you for the question. I guess, following up on that gross margin point, can you help walk us through the different puts and takes as we go through next year? You've got some mix headwinds, you've got some capacity headwinds, but then you do have that chemistries piece, and volumes are clearly going higher. So, can you just kind of hold our hands as we walk through next year and how you're thinking about gross margins?
Yeah, sure. Hi, Melissa. This is Ram. We are improving our gross margins, as you noted, as we saw this quarter. We have improved it sequentially and year-over-year. We continue to execute very well, and we are translating that high revenue to higher gross margin, earnings, and cash flow. In the past, we have said we will be 47%+ , and we are there now with the two headwinds you noted. That's the investments we are making to improve capacity and capabilities, and the mix impact from fast-growing equipment mix. Those two are masking our true underlying performance, if you may, in the near term. However, you know that this will turn to tailwinds in the longer term. We do have a path to a higher gross margin, and that'll come. The volume is certainly helping, and ongoing improvement activities will help margins in 2027.
In the near term, we expect the margins to stay at these levels, but we do have a path to higher gross margins, and we'll talk more about that in a month in our investor day.
Perfect. Looking forward to that investor day. You called out in the prepared remarks the NAND upgrade spending, and maybe it seemed like a rosier outlook on greenfield NAND spending for 2027. Can you give a little more color on the signals that you're seeing in that market and kind of what's changed and how you expect that to grow through the next couple years?
Yeah, I think what we have seen is the NAND upgrade is in full swing. One of our biggest customers has mentioned that that's been pulled in. So, we're seeing that. We're seeing the RF power that goes with those upgrades, so we're really happy to see that. Of course, this has no greenfields. The publicly announced greenfields are coming online kind of in the late 2027, early 2028 timeframe, so the equipment will go in hopefully a little before that. So, I think that upgrades will continue for the most part of 2027, but then greenfields start taking off in the later half of 2027 likely, and into 2028. You hear every day another announcement about another NAND fab out in the future.
I think it's a multi-year tailwind in terms of NAND equipment building that has to happen to support this AI infrastructure.
Thank you.
Thanks, Melissa.
Thank you very much. Our fourth question comes from the line of Steve Barger from KeyBanc.
You said chemistry equipment is sold out through 2027, bookings extend into 2028. Then the Guangzhou capacity doesn't come on till the third quarter of next year. Can you help us frame the cadence of E&P growth next year? How much growth is constrained by available equipment capacity right now versus customer qualification timing? Just how should that larger consumable base allow chemistry revenue to grow faster than equipment revenue?
Yeah. Steve, thanks for the question. I think I'll give you a couple of pieces. We are likely to grow equipment revenue, chemistry equipment revenue to that $300 million range in 2026. As we said in the prepared remarks, our historic peak has never exceeded $200 million. We hit that in 2025, actually, and this year we're at $300 million+ . That's without new factories. That is really just using the factories we have, working with our partners, supply chain partners to help us with their space, taking every bit of space we can while we prepare for the next capacity. Even though we've been able to increase our revenue by 50% without adding a factory, that is really why our bookings are booking out into 2028. There is obviously a constraint.
We'll try to pull in the Q3 2027 timeframe, but when that comes online, that doubles our equipment capacity. We'll try to deliver that as fast as possible, and I think that will allow the revenue growth to accelerate towards the second half of 2027 and on. The chemistry revenue, to your point, we have said it's between 20 months- 30 months from the acceptance of a PO. There's a six to eight month timeframe to build the thing. There's an installation period, and there's a qualification period of the customers, and then there's a ramp. As I said, some of that equipment that we shipped six or seven quarters ago is now seeing that chemistry revenue, and we expect that to accelerate as more of that equipment gets qualified.
That accelerates, especially if we continue putting more equipment in in the second half of 2027 and beyond.
Yeah, that is great detail. Looking forward, do you expect stability or maybe even improvement in attach rates as layer counts and process complexity increases? Can you talk about trends in chemical consumption per machine? Meaning, are more complex boards driving higher chemical consumption per machine?
Yeah, I'll answer the second question, it's a little easier. Each board is made one layer at a time, so the consumption is pretty much consistent. It's just that there are more layers and therefore more square inches of PCBs as layer count grows. It's really that. At the same time, we're making more complex PCBs, so the chemistry is changing. We're making different kinds of chemistries that allow you to fill smaller features, allows you to bond 80 layers together instead of 20, much better. All these technological innovations are occurring at the same time as we're increasing the number of layers and shrinking the device sizes. To your point, if you can provide that chemistry and that technology, it is much harder to displace that. There's very little motivation to change that because it's such a difficult process now.
It's kind of the same story as semi, right? The Copy Exact idea in semi, which is, it is so hard to make a chip work, and there's thousands of steps. You really don't want to change anything. I think we're in a great position because the thesis for buying Atotech was to have the chemistry and the equipment knobs. When you have both knobs, you're optimizing both, and therefore, you're going to come up with a solution that I think is much better and faster and harder to displace. We're really happy with the position we're in with our E&P business.
That's great. Thank you.
Thanks, Steve.
Our fifth question comes from the line of Jim Ricchiuti of Needham & Company. Go ahead.
Hi. Thanks. Good morning. You alluded a couple of times, I think, to this, but the growth that you're seeing in chemistry, which I think you said was 75%, if I heard you correctly, in Q3, are you able to actually parse out how much of that is coming from Legacy? Because you are beginning to see some initial revenues, I think you said, from the equipment that was installed over the last, I'll call it six quarters or so. But any color on how much of that is coming from, if you will, the Legacy hardware in the field?
Jim. I think what we said in prepared remarks is that in Q3, chemistry revenue organically grew about 26% year-over-year. And of that, very little of it is this chemistry from new equipment. That is just starting. The vast majority of that chemistry growth is from installed equipment that's already out there. And I think that our year-over-year growth will be strong as well, and I think as equipment chemistry does come in with our equipment, you'll see that percentage grow over time for sure. And our growth rates for chemistry, we think, will also follow that.
Thanks for clarifying the growth in chemistry. That makes it a lot clearer. With respect to the fact that you are essentially out of capacity on the hardware side, even though you are expanding, have there been other options for customers that need capacity earlier, or is this, do you think, more of an industry-wide phenomenon?
Yeah, I think we talked to obviously the whole ecosystem of customers, and I would just say that there are some that are much more aggressive in their expansion, and some that are a little more measured, as you would expect with a large, fast array. But I would say that all of them are starting to accelerate. Whatever their original plan was, they are all starting to accelerate their pace. So, there are some customers, though, that are making some really big investments, and you probably follow them. And those are the customers that we certainly saw start earlier, and now we see everybody kind of jumping in now.
John, any concerns that you see, and the question we get a lot is, at what point do we get into an overbuild situation? Clearly, the AI demand is driving this. But as you think about what you are seeing in the market, do you have any concerns? What signs are you looking for that potentially things are, as you look out into 2027, potentially could get overheated on this side of the business, since it is easier to add this kind of capacity?
Yeah, you are right, Jim. It is a little faster to add capacity on the E&P side than the semi side. But I would say this, the things I look at are, when data centers are built, are they turned on? So far, the answer is absolutely yes. And then, certainly if the people building those data centers are making money, and certainly they are. So, I think those are the kind of signs we see. We see the same thing, we hear the same things about pushback on data centers, et cetera. But the demand for the data centers and the ability to make money building those data centers is still very much intact. And so, those are the things we watch for, Jim, because we have been in semi a long time, you and us both, and we know the cycles change, and they change fast.
We have had a long history of being able to react very quickly because we have had to, having lived in semi for 65 or 75 years. Just a final point, our CapEx intensity is still very low, Jim. We are doing 3%-5% is our CapEx intensity, while we are building a semi fab as well as a chemistry equipment fab factories. So, in terms of the financial strength we have, it is still a relatively small risk for us.
Got it. Thank you.
Thanks, Jim.
Thank you very much. Our sixth question comes from the line of Vijay Rakesh of Mizuho Group.
Congratulations on a good quarter and guide here. Just on the, as you look at your semis and E&P, it looks like you are growing much faster than WFE. It looks like growing almost 40% year-on-year. Given the visibility that you have out to 2027, 2028, and you mentioned $300 billion WFE, would you expect the growth to kind of track in those same ranges as you go out? Just wanted to get some more visibility on those two big markets. Thanks. And a quick follow-up.
Yeah, thanks for the question, Vijay. I think I would comment on this. When you look at our growth rates in semi for the first four quarters of 2026 relative to WFE, you will see that it took a couple of quarters to rev up. And Q3 was the quarter where we started kind of starting materially exceed WFE. And that is just because it takes time to rev up the entire supply chain. So, we are kind of in that phase where, for MKS, the engine is humming, and we are ready to continue accelerating that build. And for the next several quarters, if not a year or two, we see that we will continue to have to accelerate this. This is the feedback our customers are giving us. And as we have said in the past, that is usually a time when we overperform and exceed WFE by a large factor.
I think that is kind of our expectations. Then, to your point, at some point, the thing flattens and the thing comes down. So, I think that is still far away. At least, that is the customer conversations we are having. So, I think you will start seeing us continue to accelerate our performance, over-performance relative to WFE in the coming quarters.
Got it. And just a quick one for Ram. When you look at the gross margin side, just wondering, are you seeing any ASP tailwinds on the equipment side or the material chemistry side, given how tight things are or given how some of the chemistry costs have gone up, I guess. Are you contemplating any price increases, ASP increases into 2027, 2028? Thanks.
Yeah. Hi. Thanks for the question. Can you hear me?
Yeah.
There are pockets of inflation that we are seeing. It is not widespread so far. We always try and balance our cost and price. Cost is always a reference point for our pricing decisions. It could increase in the second half and into 2027, but right now we are seeing certain pockets of inflation.
Vijay, I would say too that we have always tried to get value pricing for the technology we bring. This is an environment where there is a lot more need for that technology. We are continuing to do that and to accelerate that value-based pricing.
Got it. Thank you.
Thank you very much. Our next question comes from the line of Elizabeth Sun of Citigroup. Go ahead, please.
Good morning. Thanks for taking my question. My first question is on the, if we look into next year, so this year semis and E&P are going similar rates, both around 40%. Next year, semis clearly outperforming the other fee again. If I think about the growth in E&P, are you seeing it's again similar growth with the semi side, or can you outperform or grow even slower than the semi side?
Yeah. Good morning, Elizabeth. I would say this. The difference between the semi side and E&P side is that the E&P side has a consumables component to it, which does not grow as fast as a CapEx component, and I think that's just normal. Whereas the semi side is all CapEx. So, the expectation would be that the semi side would, as we start accelerating, the supply chain revs up, that should grow faster than E&P, but not necessarily the equipment side of E&P. As we talked about, the equipment side of E&P is sold out through 2027, and now we have lasers in it as well as chemistry equipment. So, I think that's the only difference, Elizabeth, I would call out, is a CapEx-only market, semi, and a consumables plus CapEx market in the E&P side. The growth rate should track those kinds of businesses.
Understood. Thanks. That's helpful. On the supply chain side, obviously you are doing a much better job right now, giving a lot of visibility to your suppliers. I'm just curious, are you seeing any supply chain constraint right now for your own? Is this kind of a Q4 guide, and if we look into the next couple of quarters next year, is your growth kind of supply constrained? Obviously, it's very strong growth, but if there is no supply constraints, can you do better?
I would say this. Our supply chain is an incredible group of people that have really stepped up. We just had our supplier day, met with all the key CEOs. They are all behind us, investing and hiring people. I would say this. There's always a golden screw. Something happens, a yield bust happens somewhere further down the supply chain that even our suppliers can't control. That's happening, but still really relatively in control for us, at least in our supply chain. So, I would say the revenue and the guidance we're giving is, there's very little constraint from our supply chain. That may change over time, but right now we believe that our supply chain is quite strong, maybe unique, in that they have been stepping up and helping us deliver to our customers.
Great. That's good to hear. Thanks, John.
Yep.
Thank you very much. Our next question comes from the line of Shane Brett of Morgan Stanley. Go ahead, please.
On Krish's earlier question on rigid PCB, would you be able to quantify how much of your E&P tools business comes from rigid PCB application at the moment? My assumption is the majority of your lasers are for flex. I'm asking this question because my understanding is that the TAM for rigid is multiples of flex. If we do have the capacity to deliver tools, just how big can this opportunity get for you in 2027 and 2028? Thank you.
Yeah, Shane, good question. I think for flex was pretty strong in Q3, but flex has that seasonality to it because of consumer product cycles. We expect it to come down in Q4, kind of the low point Q1, and then goes up in Q2, Q3. So, we're seeing that. The guidance for the future rigid drilling is, or the laser drilling is really rigid. And you're right, the rigid drilling market is multiples times bigger than the flex market. That's a huge opportunity for us. And as you know, we started this business many years ago and have had some success, but not as much as we'd wanted. Now the market is giving us this opportunity, and we're working extremely hard, you can imagine, to expand our capacity, expand the supply chain for that particular product line as well.
We'll report more on it going forward. As we said, we expect that to accelerate through 2027.
That's exciting to hear. For my follow-up, I was going to ask about semi. If I look to prior cycles, share gains across subsystem players have been more about OEM or customer performance more than anything, but a lot of smaller suppliers haven't been able to keep up with the OEMs this year and may have difficulty next year, but you guys have executed, adding a lot of inventory in advance. Just beyond your end- market exposure, do you think your scale and execution has led to share gains this year and can contribute to outgrowth next year as well? I.e., are your OEMs giving you a lot more responsibly given the performance this year? Thank you.
Yeah, it's a good question. I would say this, yes, OEMs, our customers are certainly asking everybody, including us, if we can get more, if we can give more and deliver more. I think in some of those opportunities, they are share gain opportunities. I would say quantifying it is a little difficult, but I would say it's pretty small in 2026 because this is just kind of a recent phenomena. We'll see in 2027 if that becomes more material. The only thing we've talked about is laser drilling, for sure. But in semi, I think that could be a more interesting number in 2027. I think size does matter now. I think even we, as well as our customers, all think about our supply chains and their ability to scale.
As I said earlier in the remarks, we never asked the industry to scale by $50 billion in one year. In order to do that, you have to have companies that can actually make those kinds of investments in inventory and factories. Fortunately, MKS has the financial strength to do that, and we are doing that. You saw us taking a lot of inventory very quickly. You have heard us talking about building the factories. I think when you are trying to grow at this kind of scale, $50 billion a year, you have to be big. If you are not or not willing to spend on those investments, then I think you will get left behind, for sure.
Great. Thank you.
Thanks, Shane.
Thank you very much. Our next question comes from the line of Wells Fargo, Joe Quatrochi.
Yeah. Thanks for taking the question.
Please go ahead.
Thanks. Maybe on the gross margin side, can you quantify just the impact within the guidance that is related to the chemicals equipment mix and capacity investments that you are making? And then historically, you guys have been kind of incremental gross margin around 50%, but given that chemicals continues to increase in mix, why should we not think about that being potentially higher?
Yeah. Hi, Joe. Let me talk about near term versus longer term. In the near term, it is a mix between investments we need to make and the mix impact from the ramping chemistry equipment sales. And as we have said before, both these will turn to tailwinds. So in the longer term, to your second question, gross margin could be higher than 50% on incremental sales. We will talk more about that again on the investor day. But in the near term, we have ongoing programs to offset most of that. In 2027, there will be a meaningful impact, especially from accelerating chemistry equipment. Investments step up happened in Q2, and now we will stay at these levels. There will not be much incremental investments for building chip manufacturing capabilities into 2027. It will stay at these levels through most of 2027.
You will see some incremental impact from chemistry equipment accelerating sales. We have a path to higher gross margin beyond that. We will get to the puts and takes of that again in the investor day. To your question, in the short term, we will maintain that 50% incremental gross margin on sales. In the longer term, it can be higher than 50%. I will also say that we are making great progress in our operating margin. Operating margin is well above the 40% we have talked about. We are driving scale, and as that top line continues to grow, we will drive more scale out of our OPEX.
Thanks for that. You guys announced a $500 million share repo authorization. Historically, MKS hasn't really been a big participant in share repurchase. Maybe can you talk about just the focus of excess cash flow for share repo versus debt reduction?
Sure. We welcome that authorization, the $500 million authorization. It just gives us more optionality and flexibility. As you noted, we are moving to a new phase now. The balance sheet is strong, and that has happened mostly because of the cash flow we are generating and the disciplined approach to managing debt. We have stayed focused on that for several quarters now, and we are moving to a phase where our balance sheet is now strong, and the growth we see ahead will further strengthen our cash position. Making investments necessary to support organic growth and managing our debt will remain top priorities, but we will actively look at opportunistic buyback going forward.
Thanks.
Thank you very much. Our next question comes from the line of James from Goldman Sachs. Go ahead, please.
Good morning. Thanks for taking my question. I was wondering if you could maybe just comment on the outlook for 2027 for WFE up 35% or so. Clearly, you are not supply constrained, but I am wondering if some of your peers are to the point where you see any problems with the industry actually achieving that from a supply perspective. I guess, the question is, do you think there is a point in time where your own shipments could get impacted because of supply constraints from others that are also selling into your customers?
Hey, James. It is John. I will take a crack at it, but I think that is logical. I think what you say is logical. I think for our customers to build a whole tool, they need all the parts, right? If someone else cannot deliver a very critical part that we do not make, let us say, that will certainly constrain us for sure. That is really an industry commentary, right? I think, just as an anecdote for sure, you know as well as we do, when we came into 2026, we thought $135 billion was going to be awesome, right, from $115 billion WFE, and then that went to $145 billion and $155 billion, and now people are talking about $160 billion. What that says is everybody in the industry, everybody making all the parts, was able to come through.
I think we will see what happens, but certainly increasing another $40 billion or $50 billion will be a challenge. But I think we are certainly going to be ahead of that, and I think many of our peers will try to do the same.
That is helpful. Thank you, John. Maybe on the gross margin side, I know this may be something you cover at the investor day in a month or so, but can you maybe kind of comment on your ability to drive any kind of like-for-like pricing resets as we head into the calendar year 2027, and whether that can actually contribute to some gross margin uplift beyond the factors you already talked about?
Yeah, I think, as I said, we are continuously looking at getting value pricing for what we deliver. And those discussions, I would just comment, it is an environment where it is a little more conducive to those discussions just because everybody understands constraints, everybody understands that inflation is happening, and everybody understands that those suppliers that can deliver, that is another leg of value beyond the technology, right? So, if a supply can deliver, that is very valuable to our customers, and so that gives us another leg up in terms of being able to have those pricing discussions.
Thank you.
Thanks, Jim.
Thank you all very much. And our last question comes from the line of Michael from Bank of America.
Hi. Thanks so much for taking my question. My first question is just on the competitive landscape, particularly in China. Are you seeing any meaningful domestic competitors from China, whether in chemistry equipment or laser drilling systems? I know in some cases these are probably customers as well, but are you seeing these customers more when you attempt to qualify some of your local customers there? Also on the chemistry side too, has there been any sort of change in the competitive dynamics related to the chemistry consumable landscape within China as well? Thank you.
Yeah, Mike, I would say that for chemistry equipment, we provide the industry-leading equipment that enables HDI and MLB processing. There are always competitors in China and in other countries as well, but I would say when you're pushing technology, you kind of need the most advanced tools. So, I think our position in chemistry equipment is very strong. With laser drilling, as we talked about, our market share had been very little, very small in the past. Now, while the technology has been qualified, the volume wasn't there until now. Again, this was an industry constraint challenge that we are benefiting from, and we want to try to take as much share as we can. So, that's really more a commentary on the industry rather than a China-specific competitor or a non-China-specific competitor.
In terms of chemistry, I would say the same thing is happening. The chemistry needs to be better, needs to be more innovation in it, and those competitors are usually in other countries, U.S. competitors, Japanese competitors, et cetera, the highly technological competitors. Many of our competitors in China in the past have been more on cost, competing on cost. As technology evolves, and that's our strategy, right, which is to be in markets where technology continuously evolves. Therefore, we are always concerned about competitors, but really it's about innovation competitors at this point.
Great. Thank you. I think you mentioned an important all-DC power design win for a pretty significant conductor etch application. Could you talk about some more, just the share gain at an existing customer or new customer? How do we think about the content on a dollar-per-tool basis, maybe relative to something like your standard RF power product?
Yeah, thanks for the question. There is an inflection going on in conductor etch using something called pulsed DC, and that is an opportunity, right? Anytime technology changes and inflections occur. We have been using and doing pulsed DC in dielectric etch, which has been our strength. We usually do not talk about design wins until after we have won, and that is why we are calling this one out. This is with, obviously, there are not a lot of potential customers there. It is a customer of ours for other products, but this particular application is something we were not in and is displacing the incumbent. I am not going to get into dollar terms, but I would say this.
We called it out because we believe it will be significant in the future, but hopefully it is just the beginning of the use of our technology, our pulsed DC technology, in the conductor application. That is probably all I would add to it, Michael.
Thank you very much. There are no further questions at this time. I will now hand the call back over to John Lee for any closing remarks. Go ahead, please.
Yes, thank you. Thank you all for joining the call. As you can see from our results and Q4 outlook, MKS continues to gain momentum. The strength of our business model is driving profitable growth at scale. The midpoint of our Q4 guidance suggests more than 85% growth in EPS this year. Looking out further, our order growth and future design wins point to new opportunities across our semiconductor and E&P businesses. We believe we have a unique position across both markets, and this positions us to play a foundational role in enabling advanced electronics in the AI era. Our balance sheet and cash generation are strong, and we just announced a new $500 million share repurchase program.
Suffice to say, we're excited about the future and look forward to sharing much more with you at our investor day in New York City on December 14th. Thanks, everyone, for joining today. Operator, you may now close the call.
This concludes today's conference call. Thank you for participation. You may now disconnect.