Qnity Electronics, Inc. (Q) Earnings Call Transcript & Summary

Okay. Excellent. Jon, your chemical mechanical polishing or CMP segment is arguably one of your most differentiated product lines. You participate in both pads and slurries tied to polishing those layers. So what are some of the underlying technology trends across leading-edge logic and memory that are driving differentiation for you? And what's your confidence level in being able to outperform that market segment into next year and beyond?

Yes, Jim. So our chemical mechanical planarization or polishing or CMP business is just over 50% of our total semi segment. We provide a full suite of products there from pads, slurries as well as cleans. We're the market leader for both polishing pads as well as for the post-CMP cleans that are formulated chemistries, and we've got a strong slurry offering as well. It's been the fastest-growing part of our semiconductor business for the last 3 years, really driven by strong content gains in that part of the industry as well as some nice share gains also. When I think about the opportunities ahead, with each node migration, CMP process complexity, we add more layers and we add more CMP process intensity. Maybe just to give it a little bit of color. If I go back a few years to, say, 14-nanometer FinFET technology, it used, call it, x number of layers. When you accelerate that to today's technology with 2-nanometer gate-all-around technology, it's 2x the number of layers in that advanced logic device. And within there, there's more CMP process intensity in several of those layers. So it's almost a double materials multiplier for that part of our business. When I think about the next evolution of technology, there's maybe 2 that I would call out. And by the way, what I described in advanced logic, the same dynamic has played out in DRAM as well and especially with HBM because we're seeing the doubling in the number of layers, but HBM and anything that involves packaging also pulls through CMP from the front end of the line into the advanced packaging step as well. But a couple of the technologies that we're really excited about for that side of our portfolio is as we start to introduce backside power delivery into the architecture, Intel is doing a bit of that today, but some of the other leading players will start to introduce backside power here in the Angstrom Era nodes coming up. And that's another significant step-up in CMP process intensity that we're really excited about. You've got -- when you go to -- similarly on the memory side, when you get to more than 400-layer count NAND, and you start to do the string stacking of the NAND modules, those modules have to be perfectly flat and polished so that you're getting seamless connections between the different layers of the NAND architecture. So getting to that, whether you call it from V9 to V10 or above that 400-layer count and you start to do the stacking of the NAND modules, that's another key inflection point that we're pretty excited about for our CMP business.

Okay. Great. And now from the time of the spinout, I think people, including me, have been surprised at how robust the Interconnect growth has been. You talked about some of the drivers for that already. But maybe unpack the segment in terms of more detail. How much of that is being driven by advanced packaging tied to AI infrastructure? And how much is that advanced packaging area growing sort of this year and the next?

Yes. So advanced packaging is -- look, every customer conversation I've had for the last 2 years has focused on how can Qnity help with advanced packaging because we're pretty unique from -- especially with our semi customers because we've long been a trusted partner with the front-end materials. With the rise of advanced packaging, they're all becoming very familiar with the Interconnect side of our portfolio as well, and they've asked for our help on how can we accelerate and improve the architecture and the performance of advanced packaging. It's been the fastest-growing part of our business for the last 2 years. And I expect that will continue because it's much easier to add new capacity for advanced packaging than it is to add a new fab, a new front-end fab. So you can -- that capacity comes on a little bit faster and then it scales. So the -- maybe the couple of the fundamental trends that we're seeing in advanced packaging is really kind of 2 key things. Number one is the expansion of larger format sizes. So you're trying to get -- I equate it to you're putting enough compute that you're on a 10-lane freeway, but without advanced packaging, you've only got a 3-lane exit. And so you get all that compute starts to bottleneck in the device. What advanced packaging does is it creates a 10-lane freeway with a 10-lane exit. So you get a really seamless transition for all of that compute capacity to be able to extend to the package. And then similarly, that's why you do an AI PCB is because you want that 10-lane exit to go to a 10-lane country road as well so that, that compute flows reliably without any loss or latency anywhere in the system. And that's really kind of what our materials are providing. And so the larger format packaging sizes help to ensure the signal reliability and the power efficiency. But fundamentally, it creates more opportunities for content -- and then the other trend that they're doing is they're very similar to chip architecture, you're trying to use the real estate in the package as efficiently as possible by shrinking the geometries. And so often I call this -- we're moving from a world where the most important technology driver was the power of shrink and shrinking the geometries, whether that's on a transistor or on a circuit board. And now we're adding to that shrinking and stacking. And this combination of shrink and stack is what unlocks the next frontier of computing and what will continue to allow customers to scale to meet the demand of AI, both in the cloud as well as all the emerging applications in physical AI. And all of that leading-edge compute will all require advanced packaging technologies in order to deliver the functionality to the end markets and the applications for which it's being built. So we're really excited by that trend.

Excellent. I would give almost anything for a 3-lane exit ramp myself. But anyway, just maybe lastly on advanced on the Interconnect business, maybe what are the other areas, whether that be thermals or PCB, as you said, that are sort of outperforming your expectations?

Yes. The thermal business. So if you think about the fundamental system level challenges that I talked about, signal reliability is really important, getting those perfect chip-to-chip communications and chip-to-board communications. That's where a lot of our metallization content is going into. Power delivery is another key challenge that we work closely with our customers on. But as you solve those challenges for signal and power, it all generates increasing amounts of heat. And you get localized hotspots at every step of the process at the chip level, at the package level and at the device level. And we bought a company in 2021 called Laird Technologies, and Laird had a market-leading portfolio of thermal solutions that span that entire range. So we're helping our customers solve those heat issues kind of at the chip level, at the package level and at the device level. And it's really accelerated because all of this compute is generating enormous amounts of heat and heat is the -- heat maybe the #1 failure mode in any device is overheating. So managing that heat effectively is proving to be really important. And so that business is really driving significant outperformance for us. The other key technology coming back to that signal reliability topic that I mentioned before that the Laird acquisition brought into our portfolio was a leading position around EMI shielding. And electromagnetic interference is one of the top causes for signal failures. And so we're seeing a very robust growth in EMI shielding. The most common application that most people are familiar with is automotive radar, ADAS systems or ADAS modules in vehicles. But very quickly, that same technology is extending into personal devices. It's extending into the data center because as you put more antennas and more wireless connectivity in all of these devices, you have to protect the -- how the signal is being transferred over and over again. And like I said, you don't want any loss or latency to happen and that shielding technology becomes critical. What that's allowed us to do is even in markets where unit volumes have been a little bit more challenged this year, whether that's consumer electronics or automotive, in our portfolio, the content gains coming from increased electronic content, we've seen high single digits to even double-digit growth in both consumer electronics and automotive despite a sluggish unit volume backdrop.

Yes. Maybe some more financially oriented questions for you. I think one of the hallmarks of the supply chain in semis recently has been this idea of constraint. And obviously, that's driven sort of what used to be a deflationary industry into an inflationary industry instead where a lot of people are raising prices across the supply chain. So what's happened to your input prices right now in terms of raw feedstocks and chemicals? And sort of what's the tolerance among your customers to absorb higher prices from Qnity? And do you think you're going to be able to pass those along?

Yes. Good question, Jim, and it's something that we watch closely. We've been fortunate in that from a raw material and an input cost point of view, we haven't hit any significant supply pinch points that are material. And so we haven't seen as much inflation as other parts of the ecosystem have seen. I would say we watch kind of the situation in the Middle East. I'd say the one place where we have seen a little bit of inflation is in some of the logistics and shipping costs. And we sized that for the year at about $20 million of inflationary headwinds. Over the last couple of years, any time we have some of these unique and maybe kind of one-off events that result, whether it's tariff -- during the COVID environment, we saw some of this during the tariffs a year or so ago in the current environment, we've always been able to pass through those things like freight or logistic cost increases. We're able to successfully pass that through to our customers, and we haven't had any problem doing that. There's always a little bit of a timing adjustment there, but we're in good shape from the rest of this year. As I think about it more broadly, we're constantly -- this industry historically, it seems like the last few years have supply reliability is also one of those key topics that every customer conversation includes. And so we're working closely with our customers. I think the industry has shown an incredible amount of agility to be able to adapt and respond to supply chain issues, whether that's memory or clean room or different component materials within the supply chain in order to meet the broader market demand. And I expect that, that agility and resiliency will continue. We're in a pretty good place. And when we think about pricing for us, it mostly comes down to pricing for value on new products. So we're constantly introducing new products kind of at the leading edge of technology, and we're pricing for value on those new product launches in both of our business. In the legacy technology or the older technology, there's always a bit of a price fade in the older technology, but we're really pricing for value for new technology. And what we're seeing is those -- the value that we're creating with the launch of the most advanced products is really kind of outpacing some of that historical. You see it with the wafer prices and you see it kind of every step along the value chain where the value is increasing with innovation, and we see that value of innovation driving significant benefits, and it's part of our outperformance this year and what we would expect going forward.

Okay. Great. And then on gross margins, how do you handicap your ability to expand gross margins over time? And what level do you think is realistic over both the shorter and longer-term relative to the current level around 47%, could you hit 50%?

Yes. So we're pleased by the progress that we've made. Gross margins for us, as you said, at the company level, we're sitting kind of in the high 40s, 47%. In our Semiconductor segment, we're sort of right at that 50% line already. In our Interconnect segment, we've seen some nice margin expansion in that business because the fastest-growing parts of that business, the advanced packaging, the AI PCBs and the thermal management also happen to be the highest value parts of that portfolio. So you see some natural mix enrichment as those parts of the business continue to accelerate the growth. And so I think we'll see -- obviously, there's kind of 3 main drivers to margin expansion. First, as we continue to grow, we get nice operating leverage by putting more volume through our plants. The second one is the mix enrichment that happens as we get the faster growth from the most valuable parts of the portfolio, which are the leading-edge technology. And then the third driver for margin improvement over time is in the first quarter, we announced the transformation program. We sized it at about $100 million over the -- of EBITDA run rate over the next couple of years, focused on about 50% of that is plant-based productivity, things like automation, improvements in commercial and innovation excellence and optimizing our local-for-local model. We're making good progress on that. And so we expect that, that will, over the course of the next few years. If you put all 3 of those things together, I think that it's -- we have a real opportunity to get the entire company up to that -- up to and maybe even slightly above that 50% mark over time.

Okay. Excellent. Maybe I'll just, kind of, like close with one last question on capital allocation. We've seen some M&A activity in your sector. Solstice announced a $14.5 billion acquisition of Element Solutions. On a go-forward basis, to what extent is M&A on the table for Qnity? And do you see any kind of particular valuable assets that you would look to expand your portfolio or potentially diversify the business?

Yes, it's a good question. On capital allocation, our first priority is always organic reinvestment in the business. We see tremendous opportunities to continue to drive organic growth. But this portfolio has been built by really smart acquisitions over many years, right? And so we're always going to be looking for complementary technologies that will be additive to our portfolio, to our ability to serve customers and that have an attractive financial profile. I think the areas -- I think right now, I don't think that we're necessarily looking for something that would be transformational. I think much more likely to be kind of a tuck-in or bolt-on opportunity. We've got an attractive pipeline and a disciplined process, and we'll continue to work that. The areas that we've talked about that are of interest to us are some of the faster-growing parts of the portfolio, advanced packaging and thermal management, both are still relatively fragmented spaces where we think there's some opportunities for some M&A. Equipment consumables or services is another interesting area for us where we think that's maybe a less talked about part of the ecosystem that there may be some opportunities for a company like ours to take advantage of some opportunities. It's also a pretty fragmented landscape. So we expect to be active in M&A over time. Like I said, our primary focus is consistent, steady execution, but we're ready for the right opportunity. And especially for our first deal, we wanted to make sure it's the right one. But we're excited by the opportunity to continue to build out the portfolio over time.

Excellent. Well, we're almost out of time. But Jon, thanks so much for being here. We really appreciate it.

Jim, thank you so much.