MKS Inc. ($MKSI)

All right. Good morning, and welcome to JPMorgan's 54th Annual Technology Media and Communications Conference. My name is [ Harlan Sur ]. I'm the semiconductor -- and semiconductor capital equipment analyst for the firm. Also with me today is our SMidCap semiconductor analyst, Mayur Ramdani. We're very pleased to have the team from MKS here with us today. John Lee, President and Chief Executive Officer; Ram Mayampurath, Chief Financial Officer. John is going to kick us off with a brief overview of MKS. It's been a very busy earnings season. So I've also asked the team to provide us with a summary of the March quarter, June quarter outlook, and then we'll go ahead and kick off the Q&A. Gentlemen, thank you for joining us this morning. John, let me go ahead and turn it over to you.

Thanks, Harlan. Pleasure to be here. When you think about MKS, we are really focused on advanced electronics, enabling the building of advanced electronics, so providing the foundational technologies to do that. And there's 2 parts to One is the semiconductor chip making. And the other is the packaging of this chip together. So in the semiconductor equipment, we address over 85% of every piece of equipment in every fab in the world. So no 1 else can actually have that scope. So -- and then in packaging, the PCB, advanced PCB manufacturing to put these chips together, we address over 70% of the steps, the chemistry, the chemistry equipment, the laser drilling equipment. And no 1 else has that kind of scope. And so this is how we have transformed over the last 10 years. We were only originally a surround the chamber, meaning the vacuum chamber kind of company. So this is only semi and only part of semi, the semiconductor equipment part of it. that was vacuum chambers. And the customers there would be Applied Materials and Lam Research and Tokyo Electron. With the acquisition of Newport Corporation in 2016, that brought in optics and photonics and lasers and motion. That allowed us to address the lithography, metrology and inspection part of the market. And those customers, for instance, are ASML and KLA. Those 5 customers are the big 5 equipment OEMs for semi and they comprise over 85% of the market share. So that's how we get that number. And then we bought a laser company, ESI, and that introduced us into the packaging business, the PCB manufacturing business, which got a lot more interesting over time. And 1 of the things we saw that was happening in PCB packaging was it was going through that same kind of history that semi did, meaning more complexity, more layers, smaller features. We've seen that movie before, and we thought that this was going to be a very interesting market that MKS has the right capabilities take advantage and grow. And that's why we did the Atotech acquisition in 2022. That was the biggest acquisition in our history. I think we were early. A lot of people didn't see that packaging was going to be that important. We did see that. And then we'll kind of a 2-year downturn for both semi and packaging. So it was hard to see the numbers there. But obviously, in the last 1.5 years, with the advent of AI, you can now see the growth in packaging as well as the growth in semi. And so that is how we've changed from a 2,000-person company, $700 million a year kind of before 2016 to now a $4 billion company, pushing 5 this year, if you read all the analyst expectations and 10,000 people. And that's the transformation of MKS over the last 10 years.

Perfect. Why don't we start off with your semiconductor franchise. It's about 45% of your total revenues, your largest customers have pointed to roughly $140 billion in wafer equipment spending this year, that's up 25%, 30%. And which shrink broadly across all segments as well as in some of your key areas like NAND, there's a big upgrade cycle happening in NAND as well. Historically in prior cycles, 2016, 2020, your semiconductor business outperformed WFE by 2.5x, 3x x, respectively. We're not asking you to endorse these specific figures, but would be helpful if you could comment on the similarities, right? And key differences you're seeing this cycle versus the last few cycles. .

Yes, great question. I think maybe before I get to that, longer term, we've been able to outperform WFE CAGR and by 200 basis points throughout through the cycle. Now during the upturn in the cycle, we outperform because we have to make our stuff first before our customers can ship their stuff to the chip fabs. The numbers you quoted, I think some differences this time. Number one, NAND is not as big a part of this cycle as of now. than it was in those other 2 cycles. We also didn't have really much of any lithography, metrology and inspection and the amplitude of cycle swings lithography metrology inspection are a little less than deposition and edge. So keep that in mind. And then, of course, China, we used to have much more revenue in 2 Chinese equipment OEMs. That has mostly gone out of our numbers. of the geopolitics of the semi industry. And those Chinese equipment OEMs used to be a very pretty small part of WFE. Now they're not as smaller parts of the denominator got a little bigger. So I would think about those 3 things, keep those 3 things in mind as we think about how we will outperform WFE this year.

Next year, should again to be a very strong spending here as well. Our preliminary estimates put WFE spending at about $165 billion, so up another sort of 20% year-over-year doing, again, the initial stages of the ramp, as you articulated, you're typically shipping well above demand. Based on your discussions with your largest customers, how much visibility do you have into next year's demand profile? We were -- for example, we were talking with 1 of the larger semi cap equipment guys last week was 1 of your big customers. They're talking about customers giving them sort of 8-plus quarters worth of demand visibility. I'm wondering if that's translating into extended visibility for the MKS team?

Yes. So certainly, there's always a little more extended visibility during the ramp, and that's normal. We only guide a quarter out. Obviously, you saw our Q2 guidance was up versus Q1. I would say this, we're in very close constant communication with all the big customers in semi. We have to be, right? They have to give us that visibility so that we can prepare our supply chain in our factories to meet that demand. . I would agree that right now, as an industry, we feel that this cycle looks like it has much more legs and could extend much longer because the fundamental driver is AI. And as of right now, that is certainly something that's continuing to grow all the way from the CSPs, all the way down to people providing the Boards and the systems and therefore, the chips and the packaging. So right now, we are preparing for the potential that you hit $165 billion to $180 billion WFE in 2027 and beyond that.

Perfect. And you articulated a very broad portfolio, vacuum, RF power, microwave power for NAND applications, plasma, reactive gas offerings for advanced [ logic ] and DRAM, photonics and optical solutions, right, for 1 of the areas that we really like, which is process control and lithography. I think last time you provided us an update, you were about 60% foundry/logic, 40% memory. Looking ahead, if memory WFE sees a strong recovery in the coming years, do you expect your mix to revert back towards more kind of historical levels or kind of stay more biased towards foundry and logic?

Yes, it's a good question. I think it will depend. We do have a little more weight towards NAND because of our market share in NAND equipment. But in general, we've been able to outperform because we're addressing 85% of WFE. So we're addressing every part of WFE, foundry, logic, DRAM and NAND. So we have been -- if you look at our growth rates year-over-year on a quarter basis, we're already outperforming WFE without much NAND, and I think that's our expectation. . I think if you look at the outgrowth, we're really exposed to a lot more steps. I think 1 of the things that is true this time is there's a lot more depth etch. It's an inflection in the industry, a lot more chips going vertical. And that's really a little less litho, you still need a lot of litho, but a lot more debt batch processes. And we have been traditionally strongest in the depth etch part of the semi market.

On NAND, in particular, like I said, vacuum products, strong market leadership, RF power, you tend to benefit as customers upgrade from layer cost. We've gone from hundred layer. We're seeing the transition to 200 layers. Some of your customers are already talking about the migration to 300 plus layer sort of NAND architectures. We are starting to see that inflection in NAND wafer equipment spending. Some of your large customers have suggested roughly sort of $40 billion of NAND upgrade cycle in front of the industry, which may not be getting sort of pulled forward, right? Given your strong NAND heritage, how should we think about that opportunity set in sort of NAND going forward? .

Yes, it's a great question. So when you're upgrading your equipment in order to address higher layer counts or even more precise holes, you can go from TLC to QLC, type of NAND, one of the biggest critical subsystems that must be upgraded is RF power which is a product line that we have that gives us a little bit more percentage of the BOM. So upgrades, we benefit from. You're right. One of our customers said, this looks like it's pulling in billion, of course, is there, SAM. Ours is obviously not that. But the upgrades are a great sign that the industry has to meet this NAND need. And I think 1 of the things that's important you may get to later is that the need for NAND has increased driven by AI. And that's a relatively new thing that's happening, which has also now driven a lot of our customers' customers to think about capacity expansion for NAND. You saw 1 big customer say they are going to build a new fab dedicated to NAND in that mid-'28 time frame. And if that's manufacturing in 2028, tools have to be in 6 months before that. So that is a great sign for greenfield NAND in addition to the upgrades, as you said, that are pulling in.

On the -- sticking with the semiconductor side, we hear many of your customers now starting to architect what they call these integrated material system solution, IMS. Well, these are platforms that integrate like 7 different process steps into a single platform, right, surface treatment, deposition, etch, clean, in-line metrology without breaking vacuum, right? And it seems like these kind of platforms are potentially -- are very attractive for the MKS team because it integrates like all of your technologies into a single platform, right? And their customers, what do they benefit from. They get better performance better yield, better defectivity, better throughput, lower footprint. Has this IMS evolution improved MKS' sort of dollar content capture per platform?

Yes. I think in general, that's true. This idea that you have to integrate more things together to have better yield, right, and the performance that you need. In general, that requires more process control, more measurement, more precise delivery. So in general, that goes to the strengths that we have in deposition etch, metrology inspection. So in general, we love that. We love that increasing complexity. I would also point out that in PCB manufacturing, we're seeing the same trend. So 1 of the pieces of equipment that we supply, we're the market share leader in PCB manufacturing equipment, our equipment there is 100 meters long. It's a continuous in-line process. PC boards run through it. and it's always kept under liquid. So the kind of same idea is under vacuum. So you don't expose it to air and things -- different things happen. And so that's 1 of the reasons why we've been successful. We can actually allow all these wet processing steps on a PCB over 100 meters so that in the beginning, you have holes drilled on PCBs in the end, you have copper filling and lines and spaces on these in a very high-yielding small feature kind of event. It's exactly the same thing that Harlan, you mentioned in semi.

You talked about your entry traction and process control and lithography. And for those of you that don't know process control, possess control is measurement, which we call metrology and inspection. Everybody knows lithography. Revenues for the team growing at roughly a 20% CAGR, reaching about $300 million revenue run rate for MKS. Presumably, this segment of the market has been longer lead times, probably less susceptible to inventory whipsaws Longer term, given the focus on leading edge applications, rising process control intensity, it also appears to have some very strong tailwinds for the team. Do you see this business sort of going in line with the overall semiconductor franchise from a mid- to longer-term perspective?

Yes, absolutely. From a mid- to longer time frame perspective, we certainly see that. In fact, we, 5 years ago, took action because our market share in lithography metrology inspection was not as high as our traditional market share in deposition and etch. And there's a lot of opportunity there that was missing. And this is because the previous company that we bought felt like then they want to be too levered to semi. We're already in semi. We love semi. We know that the key customers in lithography, metrology inspection have very high market share. So if you're designed in, you'll be designing it for a long time. . So to your point, we were $150 million 5 years ago, it's going to $300 million. It's a little bit of a flat area for the last couple of years, but we're seeing the same kind of trends now as they have also announced that their revenue is going up, and we're seeing those bookings correlate to that.

Yes. And we follow -- obviously, we follow the -- our European team follows ASML, the leader in lithography. We follow here in the U.S. KLA, which almost has a monopoly-like position in metrology and process control and the the innovation that's coming out of these companies, I think KLA said like they were launching like 13 new platforms and products this year as well as some of their competitors. So lot of innovation happening in the space, probably a very good opportunity for the MKS team as well?

It is. And as you know, we have the broadest portfolio of serving vacuum equipment as well as now the to inspection. So some examples of that would be optics, optical subsystems, lasers and motion. So motion -- precision motion is also very important -- more and more important in lithography, metrology and inspection. You also -- remember that the lithotomy machines now have vacuum in them, which is kind of interesting, and we love providing things for vacuum. So that's another opportunity as well. . So having that broad portfolio has been part of our strategy because we just don't know what inflections will occur. No 1 knows. And I've been in semi for 65 years, well, not that old yet. But a lot of time, and I can't predict what kind of inflection because there's so much innovation going on in our industry. When those inflections happen, new critical subsystems or different critical subsystems might be more important. Then if you have that in your portfolio, you can actually go invest and take advantage of the growth opportunities. The big example is when chips -- NAND chips went vertical from flat horizontal NAND flash to vertical that require a lot more RF power. We made an investment. It was 3 years before we saw a nickel, right, because you got to hire engineers, develop it, work with a customer, they have to make a tool. It has to go to a chip fab, 3 to 5 years. That's the kind of horizon investment horizon we have as a company.

On the -- on your internal manufacturing, you're set to open your new supercenter facility in Malaysia, I think it's just June. With production facility closer to some of your largest customers, which is obviously very beneficial. Malaysia, I would assume is a lower cost manufacturing region. Could you just share with us some of the color on what the capacity ramp is going to look like and any expected margin benefits?

I'll let Ram take that. .

I can take that. So given all the discussions we've had on demand so far, we are very pleased with the timing of the Malaysia plant. We took advantage of the down cycle and set up the plant over the last couple of years. It's turning out to be 1 of our largest facilities. It's in about 17-acre plot with about 500,000 square feet of built capacity so far with opportunities to expand further, if you may. -- the proximity to customers, like you mentioned, is very attractive and the suppliers as well. We hope to take advantage of the developing ecosystem there to make that a supercenter and do more than semiconductor there. We are going -- opening is in June this year. From a cost point of view, the early part will be an investment phase. Those costs are embedded in our guidance in the early part of this remainder of this year, if you may. In the back end, once that plant starts fully running, we certainly expect to have a benefit to our gross margin. And you probably know, we have an Investor Day scheduled for December 14 this year, and we'll give you a lot more on the long-term margin implications in that.

Perfect. Looking forward to that. Before we move on to some of the next sections, does anybody in the audience have any questions? I would just request, if you do have a question, just wait for the microphone. Any questions? No. Okay, let's turn it over to the team's electronics and packaging franchise. I'll let take took over.

Yes, before you start Mayur, I just want to point out on Malaysia. We do not need Malaysia to meet $140 billion WFE.

That's important. So let's move over to the E&P business, which is about 30% of sales. When we look at the CapEx trends with the top PCB companies, aggregate spending to be up roughly 30% to 40% year-over-year in 2026. You have a strong portfolio across PCB drilling, electronic spending equipment and electronics chemistries. Could you discuss what you're seeing this CapEx cycle? How sustainable you think it is? And how Europe is going to capture this upturn?

Yes. So for our E&P, electronics and packaging business, there's 2 parts to the CapEx story. One part is our flexible laser drilling and that's really driven more by smartphones. And so we've had a good year this year from what we've bigly announced. And you can see that some of the high-end smartphones are doing pretty well. So that's consistent with that. And our market share there is #1 by a good margin. . The second part of our CapEx in E&P is chemistry equipment. And so this is the equipment that I mentioned earlier, that's a football field long. It's necessary and required to build some of the most challenging pieces PCBs that are needed for AI. You're right. There has been a lot of investment from our customers. They are showing confidence, obviously, in the future and expanding capacity. We have now probably talked about 7 quarters of strong bookings in our equipment business. It is a cyclical business in the old days, it probably was up a year and down 2% and up a year down to 2%. But for the last 7 quarters, the bookings have been very strong. We talked about that. The last quarter's earnings call, we also mentioned that the bookings are strong. I don't know if Ram, if you have anything to add to that?

No, I think about it. I think what we like about the business, it's -- in the quarter, it happens, the equipment sale happens, it's a little dilutive to our gross margin does a mix impact because the equipment margins are slightly lower than our corporate average. It's a good problem to have because the chemistry that follows the attach rate for the chemistry is very high and the chemistry that follows the equipment sales is at a very high margin, well above our copper average. So it's just promises future good business once the equipments are out there.

Great. So within the chemistry business, which is about 2/3 of total E&P revenue is a more stable business. You noted that AI currently represents about 10% of the business and exited at around 15%. And you expect that to remain in that kind of range in 2026. This kind of suggests that AI-related chemistry business could nearly double year-over-year this year. Given the continued increase in complexity of the AI server substrates, this will continue to drive a positive mix shift. So what kind of growth rate should we think about for the business going forward? .

Yes. So in 2024, the chemistry revenue. That was attributed to AI was up 5%. 2025 was 10% on average, as you mentioned. And so that was a doubling. And we said that in '25, it was 10% on average, but quarter-on-quarter and quarter-on-quarter was increasing, right? And exiting 25%, it was lower than 15%, but on average 10%. And we have said that we expect in 2026 that chemistry revenue that's AIs to be 15%. Again, probably quarter quarter-to-quarter increasing. Now in terms of long-term growth rates, AI is the fastest part of our chemistry growth rate. We had talked about in the past the PCB manufacturing industry market divided into 1/3. 1/3 is multilayer board is kind of older technology, 1/3 HDI, high-density interconnect boards, think smartphones, and then third, package substrates, think servers, advanced PCs and obviously, AI servers. And the growth rates were kind of GDP plus or mid-single digit for HDI and high single-digit for package substrates. And I think right now, everything is a plus on top of that because I turns out that's not just driving the high-end package substrate, it's also driving HDI boards, it's also driving MLB boards. And we've talked about the number of layers of Boards, MLB layer -- MLB boards used to be -- they only need to be 4 or 5 layers for dishwashers and washing machines. But for AI, they're 25 layers. For HDI, there might be 10 or 15 layers for smartphones, but now they're pushing 20 to 25. And the package substrates, 10 layers in the past for PCs and now it's 15, 20. So when you combine all those layers, the number of layers to enable AI putting all those chips together so they can communicate has gone from kind of like 30 to 40 to 60. The industry is working on 80 to 100 today, right, and beyond. And the size of the Board is increasing. And we -- in terms of our consumable business is a square inch play. So each layer is made 1 at a time. If they're larger boards, that's great, more square inches, [indiscernible] layers, more square inches. And on top of that, the features are getting smaller.

[Audio Gap] Headwinds and consumer end markets. You noted no material impact to date and suggested AI-driven growth could help offset potential consumer weakness in the back half of the year. Could you walk us through your chemistry segment's current end market exposure. For example, AI data center was tumor versus industrial, automotive and smartphones? And how do you expect that mix to evolve over the next few years?

Yes, I would say this, we have market share leadership in PCB manufacturing, we are number one. That means we're exposed to everything. And therefore, if the number of units of smartphones goes down, we will see some of that. But as I've said in the past, we're exposed to the higher end part of the smartphone market, and AI is growing so fast that if there was a decrement in the number of units of the lower-end smartphones because of memory pricing, I think AI will be more than enough to make up for that. . But we are exposed to everything. And so there's a little bit of headwind there that we should always keep in mind. Certainly, if the number of units of lower-end smartphones goes down. Now that is when supply is not meeting demand as well. So that need will eventually catch up in the future as well.

Let's turn over -- let's turn to your specialty industrial business. It's a well-diversified business, spanning defense, health care, automotive, broad industrial markets, strong free cash flow generation. Obviously, we cover 20, 25 of the largest broad-based semiconductor companies in the world. And we've seen those companies go through the cyclical inflection starting kind of second half of last year, improving as we move into this year, and we see a synchronized sort of cyclical recovery across all of the segments that I just mentioned. For you guys, revenue growth inflected positively in the December quarter with momentum continuing into the June quarter. So how sustainable do you think this recovery is? And what are some of the key drivers supporting it for the MKS team?

Yes. I can take that. So you're right, Alan. It's a bundle of several businesses. Like you said, we have defense, we have research, we have life health sciences, the general industrial lasers, auto, which is mostly GMF business, what we call general metal finishing business. First of all, let me say that it's a very profitable segment, high margins. Cash flow is very good. The segment benefits from the R&D work done in our core segments, which is in our semi and E&P. And within these businesses from a revenue point, we seem to have stabilized around $290 million to $300 million a quarter. So we think that the trough is behind us. It's not -- it's come out of its lowest point and seems to have stabilized, which is a good thing. Within the business, the auto is the biggest segment. That's the drag. As you know, auto has been weak for several quarters in a row. But on the other side, the datacom business and the defense business, in particular, are the ones that are growing within our specialty industrial. So puts and takes, it's hanging around $290 million to $300 million a quarter. So we're happy to see it stabilize now. Anything you want to add, John, or...

Yes. Datacom, by the way, it's a high-growth area because we make a certain product that allows people to build test stations that test data communication speed, right? And as you can imagine, data communications is a big part of how AI servers are talking to each other as well as AI data centers talking to data centers.

One of the potential new facets to that business is the emergence of these quantum computing companies. There's several different architectures out there. Obviously, as many of you know, that are attacking this quantum computing dynamic will only visit your quantum customers, manufacturing facilities. We see your tools across their footprint, right, from things like the vibration isolation tables to the laser and optical components, right, the control [Audio Gap]

[Audio Gap] new markets happen, new inflections happen. Quantum being a very interesting area, obviously, that has a lot of potential applications for not just communications but computation and sensors, right? I'm glad you guys want to go folks walk through a lot of those factories. You would see a lot of those products. A lot of these are [Audio Gap]. .

[Audio Gap] Progress in managing our debt. That's a combination of 2 things. One is our free cash flow has been very strong. And 2 is we have prioritize debt repayment as our #2 priority, number one, being investing in growth. So the capital allocation strategy so far has been very simple: invest in supporting organic growth, manage your debt and that has stayed consistent for several quarters now, and we've made great progress. And with the top line growth that we expect to see, we can accelerate that debt prepayment. So for the remainder of the year, that will continue to be our capital allocation strategy till the debt levels get down to where we need it to be. Beyond that, it just gives us more flexibility we can go to a much more balanced capital allocation strategy, which will include after investing in ourselves and managing debt. inorganic growth opportunities and also returning cash back to shareholders opportunistically through buyback or dividend. So we'll share more about that again in our Capital Market Day. But for now, our focus continues to be paying down debt and getting leverage down to where we need it to be.

You've -- the team has executed well on your surround strategy, right, across semiconductor, PCB manufacturing processes. What areas do you see as sort of most complementary to the portfolio going forward? And how are you thinking about M&A priorities criteria, portfolio adds, key technology ads and so on. .

Yes. I would say, first off, there are really no missing parts to our portfolio. We have the most -- the broadest portfolio in semiconductor vacuum, lithography metrology inspection and then, of course, PCB manufacturing. However, having said that, there's always something out there that could make sense. We did Photon Control which is temperature sensing using fiber optics inside etch chambers, something we didn't do. So I would say that going forward, we'll be very disciplined about M&A. We were disciplined about M&A in the past and walking away from certain big deals. We will continue to do that. I think though that maybe what's different -- a little bit different this time around versus maybe the last 20 years is in terms of M&A, we actually now know that we can actually perhaps do it faster, as fast and a lot cheaper organically. We made some big bets in the past. They have turned out mostly to be great. And so investing in ourselves, to Ram's point, could be a better path in some cases, than just straight out M&A. But we'll keep option both options open.

Great. Well, we're just about out of time. John, Ram, thank you for participating in our conference today. I look forward to monitoring the execution of the team as the year unfolds. Thank you very much. .

Thank you.

Thank you.