MKS Instruments, Inc. Aktie

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 SMID Cap semiconductor analyst, Mayur Ramdhani. 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.

Okay. 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 that. One is the semiconductor chip making and the other is the packaging of those chips together.

So in semiconductor equipment, we address over 85% of every piece of equipment in every fab in the world. So no one 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 one 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 one 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 to take advantage and grow. And that's why we did the Atotech acquisition in 2022, and 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 went to 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 billion 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% with strength 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 2.5, 3x times, respectively. We're not asking you to endorse these specific figures, but it 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 by 200 basis points through the cycle. Now during the upturn in a cycle, we outperformed because we have to make our stuff first before our customers can ship their stuff to the chip fabs, and so that's typical. 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 in lithography, metrology inspection are a little less than deposition and etch. 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 because 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 small a part. So the denominator got a little bigger, right? 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 is shaping up again to be a very strong spending year as well. Our preliminary estimates are put WFE spending at about $165 billion, so up another sort of 20% year-over-year. During, again, the initial stages of the ramp, as you articulated, you're typically shipping well above end demand. Based on your discussions with your largest customers, how much visibility do you have into next year's demand profile? For example, we were talking with one of the larger semi cap equipment guys last week, one 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 a 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 and 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 one 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 one 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 depth etch 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 counts, right? We've gone from 100 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 now 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, that'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. $40 billion, of course, is their 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 one 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 one 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, right? 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 one 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. It's the kind of same idea under vacuum. So you don't expose it to air and different things happen. And so that's one 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 in PCBs. In the end, you have copper filling and lines and spaces on these PCBs 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 in process control and lithography. And for those of you that don't know process control, process 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 growing 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 was a lot of opportunity there that was missing. And this is because the previous company that we bought felt like they didn't want to be too levered to semi. We are 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 designed in for a long time. So to your point, we were $150 million 5 years ago, it's going to be $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 innovation that's coming out of these companies, I think KLA said like they're launching like 13 new platforms and products this year as well as some of their competitors. So a 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 lithography, metrology 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 lithography 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 one knows. And I've been in semi for 65 years -- well, not that old yet, but a long time. And I can't predict what kind of inflections will happen 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 those growth opportunities.

The biggest example was 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 the 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 this 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?

Yes, I'll let Ram take that.

Yes, 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 one 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 Mayur take over.

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

Okay.

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 for the top PCB companies, aggregate spending appears to be up roughly 30% to 40% year-over-year in 2026. You have a strong portfolio across PCB drilling, electronics plating equipment and electronics chemistries. Could you discuss what you're seeing in this CapEx cycle? How sustainable you think it is? And how you're positioned 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 publicly 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 of 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. And in the old days, it probably was up a year and down 2 and up a year, down 2. But for the last 7 quarters, the bookings have been very strong. We've talked about that. The last quarter's earnings call, we also mentioned that the bookings are strong. I don't know, Ram, if you have anything to add to that?

No, I think you covered 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. It's a mix impact because the equipment margins are slightly lower than our corporate average. But 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 corporate average. So it 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&T revenue and 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 increasing complexity of the AI server substrates, this should continue to drive a positive mix shift. So what kind of growth rates 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, it 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, it 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 AI to be 15% on average, again, probably quarter-on-quarter and quarter-on-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 thirds: 1/3 is multilayer boards, kind of older technology; 1/3 HDI, high-density interconnect boards, think smartphones; and then 1/3 package substrates, think servers, advanced PCs and obviously, AI servers. And the growth rates were kind of GDP plus for MLB, 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 AI turns out that it's not just driving the high-end package substrates, 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 -- there only to be 4 or 5 layers for dishwashers and washing machines, but for AI, there are 20, 25 layers. For HDI, there might be 10 or 15 layers for smartphones, but now they're pushing 20 to 25. And if 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 with each other and to the outside world 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 may one at a time. If they are larger boards, that's great, more square inches. If more layers, more square inches. And on top of that, that, the features are getting smaller. So it's harder to do. The chemistry is more expensive. Fewer people can deliver that kind of technology. So 3 different things driving our consumables in the E&P business.

So there are concerns about memory-related headwinds in 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 versus consumer versus industrial, automotive and smartphones? And how do you expect that mix to evolve over the next year?

Yes, I would say this. We have market share leadership in PCB manufacturing. We're #1. 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 and 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, Harlan. It's a bundle of several businesses. Like you said, we have defense, we have research, we have life health sciences. There's 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 a 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 hang 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, is 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. When we 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, the physical qubits. Could you quantify your current revenue exposure, revenue growth rate to the quantum end markets and highlight some of the key products you supply into this segment of the industry?

Yes, sure. I think it's another example of new things happen, 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 -- one of your folks walked through a lot of those factories. You would see a lot of those products. A lot of these are, I should say, laser-based surround-the-workpiece kind of products. So vibration isolation, keeping things still, optomechanics moving different parts of the laser train and then the lasers, et cetera.

So quantifying that amount, I would still say it's in the low double digit, maybe was single digit just a few quarters ago, kind of going to double digit now. That's the range now. But we have seen it grow. And so from a low base today, and we'll see how that progresses over time.

Perfect. I just want to touch on your capital structure. You've been actively repaying debt and currently at around 3.5x net leverage. You've outlined a near-term goal of reducing net leverage to somewhere in the range of 2 to 2.5x, which you could potentially reach by year-end or in early '27 if deleveraging continues alongside the sustained growth fundamentals. How should we think about your priorities for capital returns once you achieve that target range?

Yes. So you're right. We've made a lot of progress in managing our debt. That's a combination of 2 things. One is our free cash flow has been very strong. And two is we have prioritized 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 until 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 adds 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 -- 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, Harlan.

Thank you.

Good day, and thank you for standing by. Welcome to the MKS Q1 2026 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Paretosh Misra, Vice President of Investor Relations. Please go ahead.

Good morning, everyone. I'm Paretosh Misra, Vice President of Investor Relations, and I'm 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 first 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 reports 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'll turn the call over to John.

Thanks, Paretosh, and good morning, everyone. 2026 is off to an outstanding start for MKS. First quarter revenue, gross margin and EPS all came in at the high end or above our guidance ranges, and our Q2 guidance shows that we expect this momentum to continue, driven by strong bookings across our end markets. In the semiconductor market, MKS has a long-standing track record of outperforming WFE in up cycles. We are in an excellent position to capitalize on chip makers' ambitious AI-driven CapEx plans, which are accelerating technology inflections that enable more complex vertical structures in semiconductor devices.

In Electronics and Packaging, our leading position in chemistries and chemistry equipment sets us up for long-term growth with strong margins. Similar to semi, AI is driving increased complexity and layer counts in advanced circuit board manufacturing. Together, this translates into rising deposition and etch intensity in semi and more equipment in chemistry for PCB plating. And our specialty industrial portfolio is expected to continue delivering steady performance over the long term with incremental cash flow generation as we leverage our leading technologies across this end market.

We are well equipped from a capacity perspective to support the demand growth we are seeing today, and we are positioned to support higher levels of growth into the future as we prepare to open our new supercenter facility in Malaysia this June. MKS' strong position is a function of a broad portfolio of foundational technologies, strengthened by design wins through the down cycle that are now powering results as demand increases. We continue to prioritize investing in collaborative development programs with our customers that are driving new design wins. These investments are yielding a broad array of advanced products like our enhanced precursor monitoring capabilities, ultrafast lasers for back-end semi applications and dissolved gas solutions for leading-edge nodes, among others.

Our commitment to investing in R&D on a through-cycle basis is a key reason our customers continue to partner with us, and we are excited about the opportunities that these partnerships are creating for MKS. Starting with the semiconductor market. Revenue for Q1 came in just above the high end of our expectations, growing 13% year-over-year and 7% sequentially. The growth was broad-based across products targeted to DRAM, NAND and foundry logic applications. The sequential revenue growth was the best we've seen in some time, driven by our vacuum and power products serving deposition and etch applications, our plasma and reactive gas offerings for advanced logic nodes and our photonics solutions targeted to applications in lithography, metrology and inspection.

Notably, our Power Solutions growth reflects increasing NAND equipment upgrades. AI is driving demand for more enterprise storage needed to support growth in inferencing applications, and that is leading to the faster migration to higher layer counts. Looking into Q2, we continue to see strong order activity, especially in remote plasma and microwave for advanced DRAM applications, dissolved gas for logic applications and lasers for back-end applications. As a result, we expect semiconductor revenue to accelerate, growing high teens sequentially and over 25% year-over-year.

Turning to Electronics and Packaging. Revenue surpassed the high end of our expectations, up 6% sequentially despite normal seasonality related to the Lunar New Year and up 27% year-over-year. This strength was led by flex PCB drilling systems following consumer electronics seasonality as well as continued strong performance in chemistry and chemistry equipment. Excluding the impact of FX and palladium pass-through, chemistry sales increased 22% year-over-year, driven by AI-related advanced PCB manufacturing and high-end smartphones. We continue to see a very robust order environment for our laser drilling equipment, chemistry and chemistry equipment.

To that end, we expect Q2 electronics and packaging revenue to grow in the high single digits sequentially and over 30% year-over-year with strength in both chemistry and chemistry equipment. Laser drilling orders remain very healthy as PC manufacturing complexity increases across end market applications. The strength we are seeing is primarily in flex for smartphones and wearables, but also for rigid PCB laser applications related to the low earth orbit satellite market.

Overall, our performance in Q1 and guidance for Q2 indicates that we are not currently seeing any material impact from higher memory pricing on the consumer electronics end markets. In Specialty Industrial, performance was steady as anticipated with a modest sequential decline primarily due to seasonality, but an 8% growth year-over-year, driven by strength in certain applications such as Datacom and defense. In Q2, we anticipate a slight uptick sequentially. We remain confident in Specialty Industrial as a steady contributor to our business with attractive margins and incremental cash flows.

As we look to Q2 and beyond, we believe we are in an excellent position. Our visibility is improving in a rising demand environment and the fundamental trends of rising complexity and increasing layer counts favor MKS across our key end markets. Order volumes are healthy and serve as a leading indicator of our deeply embedded position in leading-edge processes and systems critical to addressing advanced electronics in the AI era. Foundational nature of our products can be seen in our gross margin performance, which underscores the value we are delivering to customers. We are focused on capitalizing on the robust set of opportunities in front of us, and we're well prepared to do so with the capacity in our global production footprint.

With that, I want to thank our MKS teams for their dedication and outstanding execution, our customers and suppliers for their partnership in a dynamic demand environment and our shareholders for their interest and support.

Now I'll turn it over to Ram.

Thank you, John, and good morning, everyone. We delivered an excellent first quarter. We are seeing increased demand across our key end markets, and we remain focused on disciplined execution and driving profitable growth. Let me begin by reviewing Q1 results in detail. MKS reported a revenue of $1.08 billion, up 4% sequentially and 15% year-over-year. First quarter semiconductor revenue was $466 million, up 7% sequentially and 13% year-over-year.

The result was driven by strengthening demand, especially in DRAM and logic and foundry applications. The sequential increase was led by our vacuum products and plasma and reactive gases offerings. We also saw an uptick in revenue related to NAND upgrade activity, which benefits our RF power business. Year-over-year comparisons reflect broad-based strength across many product categories, consistent with an improving semi demand environment. First quarter Electronics & Packaging revenue was $321 million, an increase of 6% quarter-over-quarter and 27% year-over-year. This sequential improvement reflected higher flexible PCB drilling and chemistry sales even with the seasonal impact of the Lunar New Year.

The compelling year-over-year comparison was driven by healthy underlying growth across chemistry, flexible PCB drilling equipment and chemistry equipment. Chemistry sales in the quarter were up 22% year-over-year, excluding the impact of FX and palladium pass-through, underscoring the accelerating demand from AI-related applications. In our Specialty Industrial market, first quarter revenue was $291 million, a decrease of 2% sequentially, reflecting Lunar New Year seasonality. Revenue was up 8% on a year-over-year basis, supported by modest improvements across several of our key market categories.

Turning to gross margin. We reported first quarter gross margin of 47%, which is the high end of our guidance. As a reminder, Q1 2025 did not include incremental tariff impacts. We're seeing benefits from higher volume and favorable mix, including higher chemistry revenue, which more than offset the impact of higher palladium prices, which are passed through at 0 margin. First quarter operating income was approximately $235 million, yielding an operating margin of 21.8%, which is well above our guidance midpoint. Operating expenses of $271 million included higher R&D investments and a seasonal increase in stock-based compensation.

First quarter adjusted EBITDA was $277 million, yielding a 25.7% margin and also at the high end of our guidance. Net interest expenses was $37 million compared with $45 million in the first quarter of 2025, reflecting the benefits of the financing transactions we closed in the first quarter as well as continued proactive principal prepayments.

Our first quarter effective tax rate was 20.9% and in line with our guidance. We started the year strong with first quarter net earnings of $157 million or $2.30 per diluted share, which is above the high end of our guidance. Let me now turn to cash flow and balance sheet. We closed the quarter with $1.5 billion of liquidity comprised of cash and cash equivalents of $569 million and our undrawn revolving credit facility of $1 billion. Free cash flow was $29 million.

As a reminder, Q1 is typically the low point of the year due to timing of variable compensation payments. In addition to this, we are also seeing an increase in working capital related to the ramp in demand. As we have said before, our first capital allocation priority is to make the investments needed to support business growth. Additionally, we continue to focus on proactive deleveraging, including another payment of $100 million on our term loan earlier this week. Net debt at quarter end was $3.6 billion. That combined with trailing 12-month adjusted EBITDA of over $1 billion resulted in a net leverage ratio of 3.5x.

Finally, during the first quarter, we increased our dividend by 14% to $0.25 per share or $17 million. Let me now turn to second quarter outlook. We expect revenue of $1.2 billion, plus or minus $40 million. By end market, our second quarter outlook is as follows: revenue from our semiconductor market is expected to be $550 million, plus or minus $15 million. Revenue from our electronics and packaging market is expected to be $350 million, plus or minus $15 million, and revenue from our specialty industrial market is expected to be $300 million, plus or minus $10 million.

Based on anticipated revenue levels and product mix, we estimate second quarter gross margin of 47%, plus or minus 100 basis points. We expect second quarter operating expenses of $275 million, plus or minus $5 million. We estimate second quarter adjusted EBITDA of $328 million, plus or minus $26 million. CapEx for the year is expected to be in the range of 4% to 5% of revenue. We expect a tax rate of approximately 20% in the second quarter and our full year tax rate to remain in the 18% to 20% range.

Based on these assumptions, we expect second quarter net earnings per diluted share of $2.90, plus or minus $0.30. Wrapping up, we are very excited to see the growth opportunities ahead for MKS. We continue to execute at a high level, and we are in a strong position with our manufacturing capacity and capabilities. We have continued to strengthen our balance sheet with a clear and disciplined capital allocation strategy, and we remain focused on driving profitability, cash flow and improving EPS to create value for our shareholders.

Thank you for joining today. And with that, I'd like to turn the call back over to John. John?

Thanks, Ram. We are pleased with the results this quarter and look forward to keeping you posted on our progress. On that note, I wanted to share that we are planning to host our next Investor Day on December 14 of this year in New York City. We're excited to share more about what we have built at MKS and our plans for the future. Stay tuned for more details.

Now operator, let's open the call for questions.

[Operator Instructions] Our first question comes from the line of Jim Ricchiuti of Needham & Company.

Just as we think about the semi business, wondering, are you still -- I think last quarter, John, you were talking about the fact that you were shipping to demand in semi. Are you still doing that? Or are you seeing the production ramp now that is more consistent with customers' plans to build inventory ahead of the stronger cycle that we're seeing.

Jim, thanks for the question. I would say this, the best people to answer that is probably our customers, but they have been very clear about what they need for their quarters in terms of shipping for their revenue and also their desire to build inventory. And I believe we are in a great position to meet that right now. So I assume some of it is to build inventory at this point, Jim. You can see from our guidance that our supply chain has revved up and we're starting to accelerate our factory builds because our supply chain is delivering to us. So I think in general, I think that is probably the case.

On the E&P side, I think you alluded to strength in the laser drilling business as a contributor to the growth. I'm trying to reconcile the strength in that business because normally I associate it with smartphones. And I think right now, we're seeing concerns about overall unit demand in light of memory prices. So I'm wondering what might be driving that? And then just more broadly on the E&P side of the business, can you give us any sense as to how the equipment pipeline looks in Q2 and beyond, just given the demand we're seeing and capacity adds from your customers?

That's a great question, Jim. So there are 2 drivers. One is the advanced smartphone build, and that's really what's driving our flexible PCB drilling. So you're correct there. But the driver is the high-end smartphones, and that's why we're seeing the good strong demand in our flex drilling. The other is AI, of course, and that's driving the larger E&P market for us and our business for us, including chemistry equipment. So we're seeing continued strength in chemistry equipment as well as continued strength in flexible PCB drilling.

Our next question comes from the line of Steve Barger of KeyBanc.

Great to see both sides of the business really pulling in a strong way. First question for me. We've talked a lot about the potential for NAND tool upgrades over the past 2 or 3 quarters. But as everyone in the industry tries to ramp capacity across device types, can you talk about non-NAND opportunities for upgrades in front of new tool shipments?

Steve, so you're right, we did start seeing some of these NAND upgrades as we called out on our prepared remarks. Regarding DRAM and logic foundry, I think most of that, our understanding is it's just greenfield. So it's really for new tools for advanced DRAM and advanced logic and foundry applications. Certainly, there are some upgrades, I'm sure. Certainly, our customers have said their upgrade business continues, but certainly not at the rate it used to in the past couple of years. So we believe that most of what we're shipping now are for more advanced tools for the more advanced nodes for DRAM and logic foundry.

Got it. And then on E&P, the front-end names and the chip makers are saying visibility in the cycle is the best it's ever been. Are you hearing that same message from PCB and substrate makers? Are they giving you longer forecast than normal? And are you seeing formerly Tier 2 and Tier 3 players trying to move upstream to get into more complex substrates?

I would say, in general, that's true, Steve. And we can say that because of the strength of our chemistry equipment orders. So that is really a great indicator of the visibility that our customers are seeing, their plans for meeting that visibility. And last quarter, we said the equipment -- chemistry equipment continued to be strong in bookings. And we can say that this quarter, that is still the case. So given that, I think we would agree that the visibility that our customers and PCBs are seeing is giving them confidence to order this equipment from us.

Our next question comes from the line of Melissa Weathers of Deutsche Bank.

Congrats on some really nice results here. I wanted to ask on the supply side of things. I think if we track the number of fabs that are expected to come on, whether it's logic or foundry or DRAM over the next couple of years, like we're seeing some pretty massive WFE numbers. So as you think about your ability to supply, just any color that you have on how much WFE you can serve? I know you have the Malaysia factory coming online very soon, too. So can you just talk about any kind of supply side metrics that we should understand that can help us frame the next couple of years as these fabs come online?

Yes, that's a great question. So let me break it down to kind of a near term, like 2026, where WFE estimates are in that $140 billion range. We can meet that. We had already put in capacity, as we said maybe a couple of years ago for $125 billion WFE with a 25% to 30% surge. So we are fine for 2026 in terms of our capacity. And we believe our supply chain is more robust as well to support that.

Having said that, we have already started plans and ordering equipment to expand that capacity for 2027 to meet the 2027 needs, which is in that $170 billion to $180 billion WFE. In order to do that, we do not need any more new buildings. We have enough buildings, especially with Malaysia coming online. And then beyond that, of course, we'll have to see whether we need to continue expanding there, but we're ready to do that as well.

Great to hear. And then for my second question, I wanted to touch on the AI side of things and some of these next-gen AI processors. I think there's a story a couple of weeks back just with some concerns on warpage and how existing packages are kind of struggling to hold all the HBM and all the GPUs on top of them. So I guess as we think about next-gen packaging architectures, can you talk about the trends that you guys are seeing, where you see the direction of travel going over the next few years and what that could mean for your E&P business? That would be helpful.

Sure. Yes. You're right. There's a lot more chips on top. The boards for AI are getting bigger and there are more layers. And so all those things would drive potential warpage of the boards. But the whole industry is working on these kinds of technical problems. A couple of ways to solve it is, of course, glass cores. That's a big topic right now. Today, though, most people are still using just regular non-glass cores and making them thicker. And they're working on making sure that the bonding between the various layers of the boards is stronger.

That's an area of opportunity for MKS. We are one of the market leaders in the chemistry needed to bond layers to each other. We don't talk about that too much. We're really talking about plating and putting the copper lines in, but obviously, bonding the layers together is also something difficult and also a big contributor to yield. And we like our position there. We like some of the products we're offering there. So you're right, these are all the kinds of technical problems one would expect. But every time there's a technical problem, it's also an opportunity, and we at MKS certainly love those opportunities.

Our next question comes from the line of Matthew Prisco of Cantor Fitzgerald.

I guess starting on the semi side, how have customer conversations kind of evolved over the past 90 days? Where are you seeing the greatest change? What are you seeing in terms of visibility? And maybe how are you thinking about your ability and the magnitude at which you can outgrow WFE at this point in the cycle?

Thanks for the question, Matt. Certainly, our communications with our customers have continued to be very close. And of course, they have communicated their needs very clearly for us. So I don't think there's any change in that. I think we are always going to be knowledgeable about their needs going forward. I would say MKS has demonstrated historically the ability to outgrow WFE certainly during a ramp. And it's really obviously because we have to be shipping our stuff first before our customers can ship theirs.

And then to Jim Ricchiuti's earlier question, our customers are going to want to build inventory as well. And I think I've talked about the fact that the industry thinks that this ramp is -- this cycle is going to be a lot longer than maybe previous cycles. And so that drives us to build inventory even more, it drives our customers to build inventory even more. So if it's a 2-year cycle or 2.5 years and beyond, then we have to kind of run through the tape at the end of 2026.

That's helpful. And then shifting to the gross margin side. Can you walk us through the primary drivers of the better-than-expected results? And then into 2Q, I would think you get better seasonality out of chemistry, which is a higher-margin business and all that. So kind of why is that flat quarter-over-quarter? Then just how do we think about the levers through the year? And any change in that long-term fall-through as the business evolves with AI-related dynamics?

Matt, I'll take that. We are very happy with the gross margin performance in Q1. As you can see with the right cost structure, when the top line came back, we are seeing the 50% conversion. Volume certainly helped us in Q1 and continue to help us in Q2. Operational excellence programs will continue to work on the product cost. But for the Q2 guide, we are also taking into account mix primarily the growth in equipment and the VSD business. The VSD business, as you know, is ramping and the gross margin there is slightly below the corporate average. The Op income on VSD is great, but the gross margin is slightly below the corporate average. And then we're also taking into account inflation on certain key raw material like palladium. So all that included, we are guiding 47%, plus or minus 100 bps. Overall, a 50% conversion is a good proxy to use on incremental sales.

Our next question comes from the line of Shane Brett of Morgan Stanley.

My first question is just how should we think about the consumer electronics exposure in your E&P chemistry business? And just how are you thinking about the second half relative to the first half? I'm asking this because my worry is that there may have been some pull-ins on the consumer electronics side, but please tell me if otherwise.

Yes. Thanks for the question, Shane. I would say this, there's 2 dynamics for the second half in our E&P business. One is AI, which is a great tailwind. And the other is potentially consumer electronics kind of going through its cycle seasonality, but also as we -- the industry has talked about potentially fewer units because of the cost of memory. We are more levered to high-end smartphones, let's say, and PCs as well. But we are a market leader. And so we do have chemistry in the entire market. .

So I think I've said in the past, if the consumer products go down single-digit percent in terms of units, AI will be more than enough to make up for that and then some. Of course, if it goes down even more, we'll see some of that. So I think from a modeling perspective, we know that AI will allow us to outgrow in the second half, if you will, the rest of '26. But you want to add a little bit of that consumer products mix in there to meet the model a little bit.

Got it. And for my follow-up, Newport's ULTRAlign towards ultra line seems to have caught a bit of attention as it's part of the kind of CPO test supply chain. But can you give us some color around your fiber alignment stage business? And I'm not sure if it's segmented into semi or E&P, but can that shift the needle for you in '26 or '27?

Yes, Shane, I think you meant the Datacom business. And if that's what you meant, then certainly, that's been a great grower. It is in our specialty industrials category as of today, but it is driven by AI. Our optical to electronic converting -- conversion product line helps test makers to build test stations to test datacom. And of course, that is a great market right now. It is still a relatively small part of our business, but it's been growing quite nicely to the point where it's actually helped our just entire specialty industrials market grow a little bit quarter-on-quarter. So we're really happy with that business and how it's growing.

of Citi.

I guess my first question is, just talk about within your chemistry part of the business, there could be some softness in the smartphone consumer electronics related market and the AI is going strong. So I was just wondering, last year, you talked about AI is maybe 10% of your chemistry portfolio. So I'm wondering this year, what percent -- how big of AI is expected within your chemistry.

Elizabeth. So yes, it's a good question. I think last year, we said it was about 10% on average for the year, but it was a quarter-on-quarter-on-quarter growth. So coming out of probably the end of '25, it was on the higher end of maybe closer to 15%. So we're kind of expecting that range right now. That's what we're seeing right now. Of course, it just depends on how fast AI grows and the chemistry that goes with it and potentially how much consumer products might go down, if at all. So I think in that 15% range is the right way to think about our chemistry revenue -- our AI part of our chemistry revenue.

Got it. And just a follow-up on the gross margin side. So last time you talked about your goal is to get gross margin to 47%. And now since you are already at it and you're guiding Q2 at 37% as well. So just wondering like what is kind of the updated gross margin maybe this year and going into next year?

Yes. Elizabeth, actually, our goal was 47% plus. So we're still yet to get to that plus factor. That will be our primary objective to continue to stabilize a 47% plus number. And there are ongoing programs to improve gross margin, both from manufacturing excellence, procurement and from design improvement side and volume will help. So not that there isn't any -- there aren't any headwinds. There are headwinds from inflation and other possibilities, but we will continue to work on driving it forward. And you'll get more color on the Investor Day.

Our next question comes from the line of Michael Mani of Bank of America.

First on the semi market. If you look at the company's history with the semi markets growth relative to WFE, I think it's been around 200 bps from a CAGR perspective in terms of outperformance. But in years when WFE is really ramping, your performance in semi market is actually quite remarkable and grows -- outgrows the industry significantly.

With that being said, when you look at like the next couple of years, there seems like a lot of great tailwinds that work in MKS' favor, right? So a lot of that is up in intensive inflections, more verticalization, if we get NAND greenfields on top next year, that's icing on top. And then also some new inflections potentially like square DRAM, which also could be great for you. So I guess when you compare this coming up cycle and your opportunity set versus prior ones, I mean, what gets you more excited? Like would you say like the ability to outperform here relative to other cycles could be greater and greater for longer?

Michael, that's a great question. I think the way we think about it is, certainly, historically, we've shown that we can really outperform during that up cycle when there is a lot of etch. That's been historically our strongest part of the semi market. And it's also the one that goes up and down the most in terms of amplitude. I think in the past, we've done that, but we've done it even more sometimes when there was a NAND component to it because of our exposure in RF power. So this time, there may be some NAND may not be in terms of upgrade versus greenfield. So I kind of want to put that into perspective.

I think relative to the previous cycles, we are now a much broader-based supplier in semi in terms of the fact that we're supplying lithography, metrology and inspection markets. And those don't swing as much. Certainly, in a ramp, we would have the same kind of dynamic. We'd have to ship more of our stuff before our customers could ship more of theirs. But the swings aren't as much. So I think that's one other factor taking into account. And then the third one is, of course, in the past cycles, we were able to ship to many Chinese equipment OEMs where that business is certainly much less now. And they're a bigger part of WFE. So the denominator is a little bigger because of their contribution. So I think those are the puts and takes. But in general, when dep etch accelerates, we do, do a lot better.

Very helpful. For my follow-up on E&P. Are there certain customers within the PCB maker base that we should think of MKS is more levered to or not given that I mean they're all spending or hiking their CapEx plans significantly. But is there leverage to any particular type of player or one supplier in the market? And then more specifically, you've noted very strong share overall, especially in flex PCB drilling and chemistry. But in your electroplating business, I think maybe in the past, that's where the company has been a little under-indexed, but maybe there's been more focus on share gain progress there. Is that -- how do you feel about share gains there over the next couple of years? Like what are you doing to maximize your progress there?

Yes, it's a good question, Michael. I would say this, the top 30 PCB makers are all our customers, and we have very good position in all of them. I would say that some of them are investing more heavily than others. I wouldn't say though that there was a trend that only the most advanced ones are investing versus maybe people are trying to catch up. It's kind of across the board. So I wouldn't say there was any particular customer that was going to be more indexed for us.

Now over time, there could be consolidation, et cetera. But right now, I think it's broadly the industry that's driving the entire growth of our equipment for chemistry as well as our chemistry revenue. Regarding market share, as we have said many times, we address 70% of all the steps in PCB manufacturing. And overall, we have the highest market share. However, you're right, we don't have the highest market share in every one of those various steps. And there are areas where we could do better, and those are opportunities for us. I think that how do we gain share?

Our strategy has always been being the broadest portfolio provider allows us to see inflections faster as well as allows us to solve the problems, therefore, faster for our customers. And really, that's the opportunity to gain share, whether it's in a particular step where we don't have much share or in a step where we do have strength, but to continue growing that share. So I think that's been our strategy. And -- but you're right, there are still opportunities for us to grow.

[Operator Instructions] Our next question comes from the line of David Liu of Mizuho.

On for Vijay here. Congratulations on the great guide. Maybe a quick modeling one. What was the tariff impact on your June quarter guide? And how much is expected for the rest of the year?

Yes. So we are seeing -- so we have neutralized the tariff cost dollar for dollar as we reported earlier. We're still seeing a little bit of a gross margin impact from the math. And we continue to see about 30 to 40 bps of impact, and that's included in the Q2 guide.

Okay. Got it. And then you guys mentioned LEO rigid PCB opportunity. Can you guys maybe size the opportunity, the MKSI content there and maybe how much growth you see going forward?

I'll take that one. So the LEO market is certainly something that's actually growing very quickly. We were designed in as a process tool of record for laser drilling, several years ago, we talked about it. And we continue to maintain that process tool record. So as that market grows, we are benefiting from it. It's a pretty healthy growth rate for us, but LEO market is a subset of the entire rigid PCB market. But as you probably read, the LEO market, more and more people are getting into it. It makes sense from a telecommunication standpoint. So we're just really excited about being the process tool record in that growing market.

[Operator Instructions] This concludes our question-and-answer session. I would now like to turn it back to Paretosh Misra for closing remarks.

Thank you all for joining us today and for your interest in MKS. Operator, you may close the call, please.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.

I'm Shane Brett, U.S. Semiconductor Equipment Analyst. Let me just read out the disclosure real quick.

For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

Joining me today from MKS are Dr. John Lee and Paretosh Misra from IR. Get started?

Yes.

Okay. I'd like to begin with some longer-term questions. So it's been a few years since your last Analyst Day, and a lot has changed since then. Can you discuss just the direction MKS is headed in. Just as a CEO, what are your top priorities over the next 2 to 3 years?

Yes. Well, I think the direction really hasn't changed. I think at the Analyst Day 4 years ago, we talked about packaging becoming more important and part of the really important ecosystem of enabling advanced electronics. So that's still the case. I think more and more of our investors understand that pattern now.

So Semiconductor still remains one of our core markets as does electronics and packaging. So that strategy was the reason we acquired Atotech, the reason we moved into developing advanced packaging. And so between those two markets, we now address 85% of every piece of equipment in every semiconductor fab in the world. So just think about that every fab in the world, 85% of all pieces of equipment have multiple MKS subsystems in them. And then on packaging, we address 80% of all the -- 70% of all the steps to enable packaging with laser drilling via holes, chemistry plating and chemistry equipment. And so those two areas are our growth trajectory and strategies for MKS. So that really hasn't changed. In fact, I would say it's accelerating.

Got it. So I guess, as you kind of focus on semi and E&P over the next few years? You sort of talked about covering 80% to 85% of those respective markets. Is MKS' strength as you approach as markets kind of scale? Is it a specific tool that stands out? Is it R&D? Just can you level set what your strength is when approaching those markets?

Yes. I think the uniqueness of MKS is that we've been able to figure out how to manage a broad portfolio. We have the broadest portfolio, not just in semi, but also in electronics and packaging. And what that broad portfolio gets to you is conversations with customers every day. And what that gets you is understanding inflections and their road maps and how those inflections could affect the products that we make, the critical subsystems, the chemistry, the systems.

And when you have that kind of insight, you have a lot more confidence in terms of knowing where to go, making those big bets. And I think having that broad portfolio allows you to make those bets without having to start something brand new. And that's been our strategy for decades in terms of allowing us to outgrow the markets that we are playing in.

Got it. So I guess before we start going into your end markets, so you're talking about these inflections, kind of codeveloping with almost with customers. Just 2 to 3 years out, just what do you think this audience would be most surprised about kind of thinking about MKS?

Yes. I don't know if we were surprised, but I think even some investors today are a little surprised that we're not just a semiconductor critical subsystems company anymore. I think that's been our longest -- the long part of our history. And people are a little surprised now to understand that, well, we're just not just vacuum equipment, critical subsystems, but we're also lithography, metrology inspection equipment as well. And now we have systems. We have entire tools, and now we have chemistry. I think those are the kind of some of the surprising things that will enable us to grow in the future. And I think we are positioned really well from our standpoint in terms of addressing those two markets, semiconductor and electronics and packaging with the broadest portfolio and not just a critical subsystem supplier just by itself anymore.

Got it. It's almost kind of like a broadening of your supplier status.

Exactly.

Got it. Got it. So let's start with semi, conditions are clearly getting better. And I feel like the key question now for you guys is just how strong this cycle could be, but just how much demand you're positioned to me, just what we think about in supply. Can you walk us through just what you're currently seeing on the demand profile and just manufacturing capacity, what you're able to meet?

Yes. I think the industry is very positive about this particular ramp, if you will. I think what's a little different about this particular cycle is that people are much more confident about how much longer it will last? A lot more confidence that it will be multiple years. And when you kind of look at why I think a lot of that is driven by AI. A lot of the uses of AI are making those customers money, right? And so they'll continue to need more chips.

I think when you look at MKS' capacity and our ability to meet that, our factories are -- have plenty of capacity. We were prepared for $125 billion WFE 2 years ago with a 30% surge on top of that. We just talked about a Malaysia plant that will have a groundbreaking -- or sorry, a grand opening in the middle of this year, and we'll start putting products into that factory. That's not needed for this particular cycle, we don't think, but it's there in case we do.

So we're not really worried about our internal factory capacity at all in terms of meeting this demand, whether last year or 2 years or even longer. I think we're well positioned to meet even larger demand should that arise in the future as well.

So just going back on that $125 billion question. So at this moment, I guess, if you can supply $125 million plus 30% based on just the current capacity you have?

Correct.

And I guess just talking about Malaysia, could you just give us a little bit of color on what the kind of capacity would look like, if there's any kind of benefits around margin, financial margin anything there? And just kind of location efficiencies from closer to customer proximity as well?

Yes. Well, number one, Malaysia is the biggest factor we've ever built in the history of MKS. It's about 500,000 square feet and that allows us the ability to scale that particular region. It is closer to a lot of the supply chain. So it is more efficient. It's close to many of our customers' factories as well. So a little more efficiency there.

Certainly, as it comes up, there's always a little headwind to gross margin, just like any big CapEx investment. But as it becomes utilized, of course, that becomes accretive to gross margin, that's our expectation.

So I think, again, it's something we planned on 2 years ago, and we decided to do this. This was a business continuity planning for just thinking about 2 to 5 years from now. and we're ready to open it in another 2 quarters.

Is that semi or is there some fungibility with other end markets?

Today, the current plan is semi, but it's a big place. Also the site allows us to build other buildings if we wanted to. And so remember, we're really a final test and assembly kind of manufacturing house. So we can certainly transition to non-semi, if that made sense, or E&P, that matter.

Got it. Got it. So I want to talk about kind of you MKS reflective to the cycle. So were back in 2020, you guys grew semiconductor 49%, and your two biggest customers are up in the mid-20%. Just as we enter this up cycle, just how should we think about your ability to outperform -- just what are the key differences versus 2020 per se?

Yes. Well, typically, where we are in the supply chain, we do outperform. We talk about our long-term outperformance of WFE being WFE CAGR plus 200 basis points.

During the ramp, we certainly outperformed to your point, we did 2.5x in 2020, 2021, and we did 3x in 2016, in fact, I would say the only -- the differences between those ramps and now is that there's not as much NAND actually in this particular ramp as expected versus those two. So a little more muted because we do have a great position in NAND.

Back in 2016, we didn't really have lithography metrology inspection kind of a different kind of amplitude in terms of the WFE cycle. So we have that now that smooth things out a little bit. And certainly, we didn't have E&P right? And E&P is also growing at -- the reason E&P is growing is because semi is growing. And so that's going to be another area for us to see positive growth as well.

So I guess, just going to clarify, you don't see as much of the NAND tailwind in 2020, but you have other drivers that you've kind of built up over the last few years that maybe would offset that a little bit?

Yes. We expect to outperform WFE during the ramp. No one is designing new things in the ramp. They're ordering things that have been designed in, right? These are all the things we've already worked on with our customers over time. So -- and as I said earlier, we're addressing 85% of WFE. So whether it's logic that's driving the demand or DRAM or NAND, we're going to see most of that.

Got it. And it does feel, given kind of your etch and depth customers have put out a relatively higher WFE target. Those two customers have historically been your biggest customers that does bode well for MKS.

That's right. They put in some numbers in that 20% range, right? And of course, we're in direct contact -- constant contact with them in Q4 as well as Q1. And we understand their needs. We understand their motivations, they want to prepare to be able to meet their customer needs. They also want to prepare for the ramp.

And everybody's thinking this ramp might last a lot longer than a few quarters. And so we kind of all have to run through the tape at the end of 2026. We can't be slowing down. We might have to be accelerating.

And so building up inventory, we'll have to build up inventory, they'll have to build up inventory, just to be able to make sure that we can run through the tape at end of 2026 into 2027.

So you're keeping very busy.

We're very busy. We are totally focused on our supply chain for sure, because we need them. We think that our supply chain is stronger now than it was the last cycle. You learned things, you make different changes. We went to some bigger suppliers. We went to multiple suppliers. We also even took inventory, obviously, in certain components. So we're better prepared now, and we'll see how that works out. But I think our ability to deliver and not disappoint our customers in every ramp. We expect to do that as well.

I guess you called out litho, metrology is something that's probably different to your position this cycle. But kind of based on those customer wins over the last 2, 3 years, just are there any specific technology wins or strategic investments that you made, that should kind of meaningfully contribute to growth and share gains over the next 1 to 2 years?

Yes. I think our power, if NAND takes off, will be icing on the cake. I think litho, metrology inspection also will grow because we've actually made those investments over the last 5 years.

A lot of our peers talk about this design win, that design win, the number of design wins there. We have exactly the same kind of pattern except we have 20 product categories with design wins that might be an extra $5 million or an extra $15 million. But when you add it all up, it's really a much larger number.

So we do have this broad portfolio. As I said, again, this allows us to talk to all our customers all the time. about what they need. So I think overall, all of our products are continuing to be that #1 or #2 in their position in their particular product category.

Before moving to E&P, I feel a big thing that's happened with MKS over the last 4 years is you've had demand come intra-quarter. Just given how much demand has strengthened through the quarter. Just at what point does it become tricky to kind of meet that demand surge late in the quarter? What are you asking in terms of visibility from these customers right now?

Yes. I think in the last couple of quarters in '25, we did exceed expectations within the quarter because lead times are short 4 weeks to 12 weeks, and we can turn things within the quarter if new demand came in within the quarter. I think right now, we have great visibility with our customers. They have given us targets to meet for the next several quarters. So we know what our goal is, what our bogey is, and we're preparing that supply chain for that.

So I think that's -- we'll still be shipping quickly as much as we can every quarter. And I think our guidance showed a little bit up, semi, for sure, quarter-on-quarter. But as we've talked about, when semi ramps, it can really take off quickly.

Got it. Got it. I'd like to turn to E&P next. I want to kind of break this discussion into tools, which is roughly 1/3 of the segment and then chemistries, which is kind of the remaining 2/3. Let's start with the tools portion first. Can you just kind of level set the audience on what is this tools business consist of? What's the growth drivers? What's kind of demand outlook you're seeing?

Yes. So in E&P, our electronics and packaging market, as you said, tools, equipment is about 1/3 of that market. It's made of two components. One is flexible laser drilling of flexible circuits. And that is driven by a lot of things like smartphones or wearables, things like that, a lot of things that need flexible circuits. And that's our ESI business, if you will. That's seen 2 years of normalized up cycle. It's a consumer product cycle. So Q1, Q2 are the big quarters, and then it tails off through the year. So we've seen that. That's part of that equipment for E&P.

The second part is chemistry equipment. And that's what we talked about being at record levels today. We talked about it being at record levels of '25. We talked about full for the first half of '26. The incremental thing we talked about in the earnings call was we've continued to have another 90 days of constructive discussions and bookings with those customers. And so you can do that math. And that continues. And so that equipment for chemistry is really installed base that then follows through with the chemistry, our chemistry which has a very high attach rate.

If you like throughout the course of 2025, we kept discussing the durability of chemistry tool growth, and it kept sort of surprising to the upside. But just can you approximate that sort of mix within that total business. Is there any kind of hints you can give the audience and how much of that might be sort of more chemistry related versus sort of flex drilling related.

Yes. I would say on the chemistry equipment side, it's driven by AI customers as well as a China Plus One customer base. I would say that we are at kind of that $200 million a year run rate. And to your point, we kind of -- it's a CapEx industry, so it always has cycles. We were thinking, when is this going to go into the downturn and surprisingly, it's continued to stay at this high level. So we're not constraining our customers today.

But we certainly have enough capacity should the volume pick up. And I think $200 million of equipment going in every year, would be really great eventually for that chemistry revenue to can follow with.

I want to talk about that attach rate in a second. Just before we go to that, just -- how are you thinking about the demand outlook for these customers? You kind of said it's just kept getting better than your expectations throughout 2025. If you had to have sort of kind of an outlook for '26 and '27, it's okay, I don't have one as well, but like what would you kind of say towards that outlook?

Yes, I would say this. As I said, constructive discussions for another 90 days. 90 days from now, we'll update you in the next quarter. If that continues, then it will be 2 full years, right, of kind of record level chemistry equipment. So it's hard to predict after that, but it's certainly a CapEx industry. So it will have a cycle to it. This one is quite long, longer than it's ever been. And maybe that's a important of the fact that everybody kind of expects this current WFE cycle. Lasts a lot longer than maybe we have confidence in the past. So right now, we're just working hard to meet the demand. And we'll see quarter-on-quarter, if that continues.

Got it. Got it. I want to switch over to the chemistry portion because when I think about your chemistry business, the consumer electronics exposure, which may not be that great, you have an AI exposure business where things are getting great, but you also have the attach rate from just a better more on installed base. Just can you level set us on just kind of that chemistry mix per se? Well, part of it might be AI part of it might be consumer electronics.

Yes. I would say this, as we talked about in the past, the PCB industry, we look at it as 1/3, 1/3, 1/3. 1/3 is multilayer boards. 1/3 is HDI boards. And 1/3 is substrate board. So increasing complexity. But kind of 1/3 of the revenue is in these three subsegments.

I would say we talked about the percentage of chemistry revenue that's AI related. In 2024, that was 5% of our chemistry revenue. In 2025, it was 10%. So it doubled. And then I think in our earnings call, we talked about in '25, 10% was the average. But quarter-on-quarter and quarter-on-quarter, it was increasing. So we expect that run rate to continue through 2026.

And then the PCs and the smartphones does have that consumer product cycle. The lowest chemistry revenue is in Q1 because of the Lunar New Year. And then Q2 picks up and Q3 picks up and then Q4 back down again. Those are large markets as well. PCs and smartphones. So that's still a strong, healthy component of our revenue.

Got it. So can you give us a little bit of clarity on where your kind of chemistries play a part in the AI supply chain doubling is pretty good growth. But just kind of what are you seeing there? Where are you playing part in?

Yes. I think those three subsegments of the PCB market, it turns out we were a little surprised. We thought it was always the high end, this package substrate that was going to be driven by AI. And that's true. So a lot of the chemistry revenue goes to that. But it turns out that a lot of the substrates have been put on to HDI layers, which have to be put onto MLB layers. And so those are also driving the equipment revenue, but also the chemistry revenue.

So chemistry is actually being driven at all three subsegments of the PCB industry by AI. Equipment for us is really about the HDI level and the MLB level.

Got it. Got it. And as we think about sort of -- so you have a bit of a consumer electronics headwind, you have an AI tailwind, but you have a tailwind on the chemistry tool attach rate as well. I know we've spoken about kind of for every $100 million of tool purchases, you get sort of a $20 million to $40 million attach rate. Just could you kind of level set the audience on what that kind of $20 million to $40 million tails what do we need to get to the $40 million versus $20 million?

Yes. I think -- so number one, there's the lead time for it, right? So we get the order. It takes us 6 to 12 months to build a tool depending on the size of it. And then we install it, they have to qualify it test revenue. So just the new chemistry. So we are already starting to see some revenue come from those tools installed that we talked about in the last 1.5 years. But most of the chemistry revenue is coming from tools that were installed 3 years ago.

For every $100 million of equipment, you're right, we can get $20 million to $40 million of annualized chemistry revenue forever, basically. And whether it's $20 million or $40million, it depends on the process, it depends on the size of the tool. And so that's really where the range occurs. And so that $20 million to $40 million, though, is that much higher gross margin, right? Our chemistry revenue gross margin is in that high 50s range. and the attach rate is extremely high in the beginning and stays at 85% even after the long term.

Got it. Got it. And I want to talk a little bit about kind of sequencing the year for chemistry because the attach rate is great, but I do want to talk about the consumer electronics weakness that we might see in the second half.

So just for this kind of first half, you have the Lunar New Year weakness in Q1, you kind of -- hopefully, that reverses in Q2. Just how are -- are there any discussions around just a possibility of a consumer electronics tailwind? Just where is your kind of mind at in terms of that front?

Yes. I think for consumer products, there are a couple of things that are a little bit of a tailwind. I think the smartphone market this cycle is a little healthier than it has been in the last year or 2. And I think there's some exciting new form factors coming up in the next cycle, this fall or early next year. So I think those are good for chemistry for flex PCB drilling.

And then, of course, everybody is talking about could there be headwinds because memory is too expensive, et cetera. And as I said in the earnings call, if it does lower handsets and PCs by low single double digits, low single digits, then I think the AI revenue will more than make up for that.

Got it. Got it. But maybe not as well if it was down more than low single digits?

Yes. I think we hear some reports that have really large numbers, which are quite hard to believe, right? I would just say this, there's a lot of demand for smartphones and PCs. And yes, they can go down a little bit. But if they were going down that much, they will be a lot more demand and people would figure out a way to get those PCs and those smartphones into the hands of the consumers. If there is a little degradation in supply, then it just pushes out that demand maybe into the next year, which is not necessarily a bad thing.

Got it. And just before I go to financial questions, so I want to talk about kind of 2 to 3 years ahead, what and MKS might surprise on the E&P front for the audience. So I guess for 2025 was the strength of this tooling business. Just anything two to three [indiscernible] where there might be an inflection or just kind of the strength of demand, the attach rate, what do you think people will be surprised about regarding your E&P business?

Yes. Well, I think one of the things that, hopefully, happens when we execute on our strategy is that the idea of being able to serve with a complete portfolio of solutions should allow us to be more important to our customers and should allow us, therefore, to gain share.

So I think part of the strategy that we have is we're going to address 70% of E&P and 85% of WFE. And if we can do that, we will be able to provide solutions faster to our customers and therefore, gain share. We have laser drilling as well, right?

And so I think in E&P, that's an amazingly exciting area. I think what's new for some of our investors is that when we talked about buying Atotech 2021, and we said packaging matters, I think a lot of people really just didn't understand that, especially a lot of our customers -- or investors were semi-oriented I think people are starting to understand that now. A lot of more of the questions are on E&P. People are understanding that market better.

We have talked about E&P potentially. It is already as important as semi. It's coming from a semi guys is a big statement, right? So E&P, if it was not for the ability of the industry to put 40 layers together or 60 layers below those chips, you wouldn't need as many chips for AI, just one. So it is already as important as making those chips better. And so I think that's hopefully going to be the strategy that we demonstrate to the investors over the next few years.

I don't want to put you on the spot, but E&P grew more than semi in 2025. So if I look at E&P and semi, you're allowed to say both, but which should we be more excited for?

Yes. Both. Now I would say this, semi was relatively muted for us in '24 and '25. So even though we outgrew semi in '25, it was by 4%, 3%. That's nothing compared to what we talked about earlier, where it's 2x potentially, right, during that ramp. And so that's the expectation in '26. We should see that kind of normal historical overperformance during the beginning of a ramp. That shouldn't be a surprise.

But then having E&P continue to grow because that's more of a consumable revenue stream, that's going to be exciting as well. That will demonstrate that people are utilizing the tools out there. And then when our tools come online with chemistry, even better for us from a market share standpoint.

Got it. I'll ask two questions on financials, and then I'll pass it to the audience for questions. But you have a little bit of a delimiting gross margin because you have better tool sales, that's a little bit lower gross margin than the chemistries. And you also have the impact of palladium costs. Just could you kind of level set the audience on where your gross margins are now why they're maybe a little bit lower than last year and where you kind of see gross margin progressing for the year?

Yes, I'll ask Paretosh to talk about that.

Yes. So Shane, I mean you know that our gross margins even last year were pretty good if you exclude the tariffs. And as you look ahead for Q1, when you look at our outlook, I mean the basic moving drivers are the same, the volume and the mix.

In Q1, we have the Lunar New Year, that impacts the E&P business because of the chemistry. But keep in mind, even the specialty industrial as chemistry, so it back to two places. And then as you pointed out, palladium, which is a pass-through, so no impact to our gross profit but it does create some dilution. So we can't predict palladium, but we -- what we have in Q1 is what the prices have done in the last 3 to 6 months. So that's an adverse impact.

So as you look into these moving parts, you can -- that gives you a clear path forward as to what the gross margins will be and you look into Q2, Q3, Q4.

So I guess just on the clarification of the palladium point is -- that's the biggest input cost for the E&P chemistries, you passed it on for revenue but not gross profit. So it kind of weighs on the gross margin line a little bit.

Exactly.

And then on the kind of seasonal for the year, I guess, just given the utilization on the chemistry front, Q1 just looks a little bit lighter for gross margin.

Yes.

Okay. And then last one before I open it up. So at your 2022 Analyst Day, you outlined a 26% operating margin target. In 2024, it might have seemed like a little bit of a distant target, but just given the industry tailwinds that we're seeing, it may seem a little bit more realistic just where you guys are on operating margin? What should we expect for the year?

Yes. I mean, look, high volumes or higher revenue, make a lot of these targets a lot easier. What we have said for Q1 and for the rest of the year. But for the Q1, we have given you specific OpEx guidance. And for the rest of the year, what we have said is that OpEx will grow less than revenue. So the OpEx percentage sales was, what, 26% last year and Q1 is also at around that level. So that gives you a good base level. and then you can build it from there.

Got it. I'd like to open it up to the audience. If anyone has got any questions?

If not -- Stephen?

When it comes to the E&P equipment side of the business, right? Is there any reason that, that piece for us should undergrow substrate and CapEx. Because I think if we look at substrate and PCB CapEx plans going forward, right, the Asia guys are extremely aggressive when it comes to this CapEx ramp, right? So, I mean, if hypothetically, their CapEx is all up 30% year-on-year into '26 or '27, is there any reason that, that portion for us weren't grow the same sort of magnitude?

Yes, thanks for the question. I think one bit of clarification just so the audience understands, the equipment we are shipping is we said for HDI and MLB because it's a horizontal piece of equipment. For substrates, it's vertical. So we don't do the vertical equipment. So there, we just compete for chemistry.

But in general, if you're going to increase your CapEx, our customers are going to increase their CapEx for PCBs for AI they have to increase the vertical, horizontal and the horizontal for [ HDI ] and horizontal for [ MLB ]. So in general, we shouldn't see any kind of difference.

We do have leading market share in those horizontal tools. And so -- as well as the chemistry. So I think, as you know, we have the top 30 PCB substrate customers as our customers. So we are certainly intimately involved with all the discussions that they have with CapEx, we see that they are aggressive for sure. So if they have those kinds of numbers, we should see our fair share is how would characterize it.

I want to follow up on that. So as we go to higher layer counts, how does that intensity differ between the vertical and the horizontal?

So every layer is made one at a time. So that's important. So that's important because in [ MLB ], those layers are increasing the fastest. [ HDI ], the next and then substrates not increasing but not as fast. So if you're going to increase MLB layers the fastest, you need more equipment. And then HDI and then substrates. So I think in that sense, you probably need even more equipment for MLB and HDI than you might need for substrate.

Got it. But just between kind of like the horizontal tooling versus, I guess, the vertical laser drilling?

So the vertical chemistry tools, those are for substrates, but the horizontal are for HDI and MLB. So those are the tools we're making.

And those HDI and MLB are the layers growing the fastest. The number of layers are growing the fastest versus substrates. All are growing, and MLB the fastest HDI next and substrate next.

Got it. Any other questions?

Great. Just going back to the E&P front. Just can you kind of level set the audience on what your lead times are for these tools because you've kept talking about kind of orders strengthening throughout last year. like what your current capacity is sort of the questions that we asked on the semi front and capacity, but kind of plugged in E&P?

Yes. So we're kind of running at a $200 million a year run rate. that capacity consumes the major factor we have, which is in China. We've done a little expansion there. We have not built a new building there because we have an entirely larger independent site in Germany. And that site is already taking some of the overflow. So we have plenty of capacity to do both.

So now longer term, as we look at strategic planning for the company 3 to 5 years out, if we think equipment is going to continue to grow because it's more critical, then of course, we might start thinking about capacity then, but we have plenty of capacity right now.

Got it. So enough capacity to meet stronger demand signals that your customers are giving.

Yes.

I think it's on that $200 million, just how long do these tools take to install? And when should we start thinking about that $20 million to $40 million attach rate, like when does that start kicking into the numbers?

Yes. So as I said, we get an order and then it takes us 6 to 9 months to build the thing. During that time, we actually recognized some revenue because we can because we already have prepayments. So as we're building it. So that's kind of a little subtlety, but it's important to note. So the first, let's call it, 9 months, we still have the tool. We haven't shipped it, but we're recognizing revenue. So then we ship it, installation could take 6 months. and then commissioning.

And then they're testing a particular process for their customers. And if they get qualified, they can run. So you could add another 6 months, you could add another 12 months, right, depending on that customer. So that's what we say 18 to 24 months from the first recognition of revenue, you should start seeing some of that revenue from that piece of equipment.

And then it's just a matter of when does that become fully utilized? When it's fully utilized, that's a $20 million or $40 million number that we're talking about.

So I guess for the strong tool shipments that you had in 2025, we probably shouldn't factor that $20 million to $40 million this year. But maybe start trickling that in for '27?

I think that's fair. I think we were seeing some of it already, but these are like pilot line chemistries. So it's not really that $20 million, $40 million, but I think that would be a fair way to look at it. The chemistry revenue, we expect to grow this year. we grew last year. That's on equipment we installed in 2022, 2021.

Got it. Just last question for me. Anything that you think that investors misunderstand about MKSI, anything that you think you're probably a little bit more excited about than kind of this audience on MKSI and then we can wrap that.

Yes. I would say that the uniqueness of MKS is the fact that we're the only company that is addressing semi and packaging of semi right? There's no one else doing that. A lot of our peers and even our customers who talk about in semi, who talk about packaging, they're talking about CoWoS. That's the one or two layers of the redistribution layer. We're talking about the 50 layers below, PCBs. That's what we talk about when we talk about packaging. And as I said, there's no other company who's leverage in both of these. And the most important point is that you need both of them equally to enable today's advanced electronics like AI.

Great. Well, we'll call it a day there. Thank you, John. Thank you, Paretosh.

Thanks, Shane. Okay. Thanks, everybody.

Good day, and thank you for standing by. Welcome to the MKS Fourth Quarter and Full Year 2025 Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Paretosh Misra. Please go ahead, sir.

Good morning, everyone. I'm Paretosh Misra, Vice President of Investor Relations, and I'm 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 fourth quarter and full year 2025, 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 report 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 of our GAAP measures. Our investor website also provides a detailed breakout of revenues by end market and division. Now I'll turn the call over to John.

Thanks, Paretosh, and good morning, everyone. 2025 was a year of impressive execution for MKS in a gradually improving demand environment. Year-over-year, we delivered 10% sales growth, 20% EPS growth and over 20% free cash flow growth. We maintained strong gross margins despite trade policy dynamics while staying focused on delivering for our customers, investing in our business and proactively bringing down our leverage.

We're proud of our accomplishments in 2025 and grateful for the continued support and collaboration of our customers, suppliers and employees. Our partnerships and engagement have been critical as we work together to deliver the broadest portfolio differentiated solutions that are foundational to advanced electronics in the AI era. As we begin 2026, the demand outlook across our semiconductor and electronics and packaging markets is strengthening and we are already seeing this in the ambitious CapEx plans announced by large chip manufacturers. MKS has a long track record of outperforming WFE in rising spending environments and we are in an excellent position with our broad and deep portfolio of designed in products and are foundational to semiconductor manufacturing and electronics and packaging. I'll highlight some examples as I review our financial and end market performance.

Our Q4 revenue, gross margin and earnings per diluted share all came in above the midpoint of the guidance ranges we provided on our Q3 call in November. Revenue was strong across all three of our end markets. In our semiconductor market, revenue was above the high end of our guidance, driven primarily by subsystems serving etch and deposition applications in the DRAM and logic foundry markets. Our plasma and reactive gases business delivered another strong quarter. We also maintained healthy momentum in dissolved gases for advanced logic applications and in back-end applications related to high bandwidth memory. Order activity in both areas remains robust. NAND-related activity remained stable sequentially as expected.

I'm also pleased to note that our semiconductor business outperformed estimated WFE growth for the full year 2025, consistent with our track record of outperforming industry spending and improving demand environments. Looking to the first quarter, we expect semiconductor revenue to be up on a sequential basis. We believe this outlook is consistent with market views a steady improvement in industry spending over the course of the year. With our global footprint, broad product portfolio and deep technical expertise, we are ready to respond to demand as it comes with solutions that solve our customers' hardest problems and enable their increasingly complex road maps.

On that front, we're excited to be ramping our new supercenter factory in Malaysia in the second half of this year, which will give us added capacity and resiliency to meet our customers' needs. Turning to Electronics & Packaging. Revenue came in near the high end of our guidance. The sequential increase was primarily driven by increased flexible PCB drilling and chemistry equipment sales. The Flex market continues to largely follow seasonal patterns tied to smartphone and PC cycles.

And we also saw continued momentum in orders for our chemistry and chemistry equipment solutions for advanced PCBs related to AI applications. AI is driving increasing packaging complexity, and we are uniquely positioned to help our customers with the broadest portfolio of differentiated solutions. Excluding the impact of FX and palladium pass-through, the chemistry sales increased 16% in the fourth quarter and 11% for the full year compared to the same periods in 2024, reflecting another year of healthy growth. When we acquired Atotech in 2022, we saw the importance of advanced packaging for electronic devices, well ahead of many in our industry.

With AI now rapidly driving demand for more complex PCBs with rapidly increasing numbers of layers, we are seeing growth despite multiyear softness in smartphones and PCs. Looking ahead to Q1 and the anticipated seasonal impact from the Luna New Year holiday, we expect electronics and packaging revenue to be up slightly sequentially and to increase in the low 20% range year-over-year. Key drivers for our expected performance in Q1 include higher flexible PCB drilling revenue and a continued strong performance in our chemistry equipment business. In our specialty industrial market, revenues came in at the high end of our guidance. We saw sequential improvement in research and defense in certain industrial applications.

Looking ahead to Q1, we expect specialty industrial revenue to decline low to mid-single digits, mainly due to the Luna New Year holiday, which impacts our general metal finishing business. Year-over-year, we expect revenue to be up in the mid-single digits, led by the industrial and research and defense markets. Overall, our specialty industrial market continues to deliver steady performance and contribute attractive cash flows. Our fourth quarter performance and outlook for Q1 underscore our strong position across our 2 key end markets.

In semi, we continue to strengthen our position in supporting leading-edge foundry and high-bandwidth memory investment through our vacuum and Photonics offerings while also remaining well positioned to capitalize on large scale investment in NAND equipment upgrades expected over the next several years. In Electronics and Packaging, we are demonstrating momentum with equipment and chemistries ideally suited to support a smaller, more complex and more vertical packaging structures for AI and other emerging devices such as foldable phones. We expect this business to grow over time as we realize long-term revenue streams from proprietary chemistries moving through production lines built with our equipment.

The secular drivers powering our end markets are fully intact present exciting opportunities for MKS in the years to come. Our business is in a strong position with a resilient global footprint and margins that reflect the value we deliver and strong free cash flows that we are reinvesting into the business and using to pay down debt. Lastly, we are proud to have been honored for the third consecutive year as one of America's most responsible companies by Newsweek and Statista. In honor to reflects our continued focus and commitment to our people, customers and suppliers.

Now let me turn it over to Ram to run through the financial results and first quarter guidance in more detail. Ram?

Thank you, John, and good morning, everyone. We ended the year with a very strong fourth quarter. Demand increased across all 3 end markets. We delivered healthy margins, robust free cash flow and made meaningful progress on our deleveraging goals. That progress has continued into the new year with another $100 million voluntary prepayment on our term loan in February as well as further optimization of our capital structure with the recently completed issuance of EUR 1 billion senior unsecured notes as a refinancing and extension of our term loan maturities.

I'll cover these topics in detail in my remarks. Let me start with the results for the fourth quarter. MKS reported revenue of $1.03 billion, up 5% sequentially and 10% year-over-year. Fourth quarter semiconductor revenue was $435 million, up 5% sequentially and 9% year-over-year. The result was driven by strengthening demand, especially in DRAM and logic and foundry applications. The sequential increase was led by plasma and reactive gases products. Year-over-year comparisons reflect more broad-based strength across many product categories. providing further evidence of an improving semi demand environment.

Fourth quarter Electronics & Packaging revenue was $303 million, an increase of 5% quarter-over-quarter and 19% year-over-year. This sequential improvement reflected higher flexible PCB drilling and chemistry equipment sales. The strong year-over-year comparison reflected healthy underlying growth across chemistry flexible drilling equipment and chemistry equipment. Chemistry sales in the quarter were up 16% year-over-year, excluding the impact of FX and palladium pass-through. Marking another strong year in chemistry revenue.

In our specialty industrial market, fourth quarter revenue was $295 million, an increase of 4% sequentially largely due to the improvement in our research and defense markets as well as certain industrial applications. This was partially offset by a decline in automotive. Revenue was up 5% on a year-over-year basis, supported by modest improvement across several of our key market categories. However, automotive segment remain soft. Turning to gross margin. We reported fourth quarter gross margin of 46.4%, which is above the midpoint of our guidance. While margins were down year-over-year, it was a very solid performance given ongoing impact from higher tariffs, higher palladium prices, which are passed through at 0 margins and the effect of higher chemistry equipment in our overall mix.

Fourth quarter operating expenses were $263 million, slightly above the guidance range, primarily due to higher variable compensation due to stronger-than-expected results. Fourth quarter operating income was approximately $217 million, yielding an operating margin of 21%, which is above our guidance midpoint. Fourth quarter adjusted EBITDA was $249 million, yielding 24.1% margin and also above the midpoint of our guidance. Net interest expenses was $42 million. Fourth quarter effective tax rate was 1%, which was in line with our guidance. We finished the year strong with fourth quarter net earnings of $168 million or $2.47 per diluted share which is above the midpoint of our guidance.

We closed the quarter with approximately $1.4 billion of liquidity comprised of cash and cash equivalents of $675 million and our undrawn revolving credit facility of $675 million. Net debt at year-end was $3.6 billion, That, combined with improving adjusted EBITDA resulted in a net leverage ratio of 3.7x based on full year 2025 adjusted EBITDA of $966 million. Quickly summarizing our full year 2025 results. Revenue was $3.9 billion, up 10% year-over-year. Semiconductor revenue totaled $1.7 billion, up a healthy 13% year-over-year, driven by plasma and reactive gases and racking products.

Our service business remained a steady and meaningful growth contributor. Electronics & Packaging revenue was $1.1 billion in 2025, up a strong 20% year-over-year. Total chemistry sales increased 11% year-over-year excluding the impact of foreign exchange and palladium pass-through. Specialty Industrial revenue was $1.1 billion, down 4% year-over-year primarily driven by softness in industrial markets, including automotive. Gross margin was 46.7%, down 90 basis points year-over-year, driven by additional costs related to tariffs and product mix, including record chemistry equipment sales. We moved quickly during the year to mitigate the impact of tariffs.

That impact was largely mitigated on a dollar-for-dollar basis by the fourth quarter but will still continue to impact gross margin by about 50 basis points. Full year operating margin was 20.7%, down 60 basis points year-over-year as a result of lower gross margin. However, our operating expenses as a percentage of sales was 26% and improved by 30 basis points year-over-year. Let me now turn to cash flow and balance sheet discussion. For 2025, we generated operating cash flow of $645 million, an improvement of $17 million year-over-year. Even with an uptick in capital expenses, full year free cash flow was $497 million, an increase of 21% year-over-year and reflective of a very healthy conversion rate of our non-GAAP net earnings. In 2025, we made a total of $400 million of ordinary prepayments on our term loan.

This month, we made another voluntary prepayment of $100 million. Since February 2024, we have paid down over $1 billion of our debt. We continue to remain focused on deleveraging. We also closed a few key financing transactions in recent weeks. The repricing of our term loan facility reduced credit spreads on our U.S. term loan by 25 basis points and the euro loan by 50 basis points. In connection with this repricing, we increased the size of our revolver to $1 billion. Finally, our successful EUR 1 billion bond offering has allowed us to diversify our capital structure, reduce interest rates on our debt, replace a portion of our secured debt with unsecured debt and extend our maturities.

Based on current interest rates, the combined effect of these actions we took in this month will reduce annual interest expenses on a run rate basis by approximately $27 million. In addition, to lowering interest rates. These transactions will provide greater flexibility for the company. Finally, during the quarter, we paid a dividend of $0.22 per share or $15 million. As we announced last week, the Board authorized a 14% increase in the next dividend, which is payable in early March. Let me now turn to first quarter outlook, we expect revenue of $1.04 billion, plus or minus $40 million. By end market, our first quarter outlook is as follows: Revenue from semiconductor market is expected to be $150 million, plus or minus $15 million. Revenue from electronics and packaging market is expected to be $305 million, plus or minus $15 million and revenue from our specialty industrial market is expected to be $285 million, plus or minus $10 million.

Based on anticipated revenue levels and product mix, including sequentially lower chemistry sales due to the Lunar New Year, we estimate first quarter gross margin of 4% to 6% plus or minus 100 basis points. We expect first quarter operating expenses of $270 million plus or minus $5 million. Looking to the rest of the year, we will continue to invest in the growth of our business, but we expect operating expenses to grow at a rate lower than revenue. We estimate first quarter adjusted EBITDA of $251 million plus or minus $24 million. We expect capital expenditures to average in the 4% to 5% of revenue through 2026. We expect a tax rate of approximately 21% in the first quarter. For the year, we expect our tax rate to be in the range of 18% to 20%. Based on these assumptions, we expect first quarter net earnings per diluted share of $2 plus or minus $0.28.

Propping up, MKS continues to execute at a high level meeting growing customer demand and maintaining strong profitability. We continue to prioritize making the necessary investments in the business and proactive deleveraging. We believe that we are in an excellent position to capitalize on what we expect to be a robust demand environment.

With that, operator, please open the call for questions.

[Operator Instructions]. Our first question comes from the line of Steve Barger with KeyBanc Capital Markets.

Thank you. I wanted to start with the 46% gross margin midpoint guide. How much of that is from chemistry equipment mix? And does the lower 1Q sequentially suggests an upward inflection in 2Q from higher chemistry sales volume? Or how do you expect that to play out as the year progresses?

Steve, this is Ram. I'll take that. I'll start with your second question. The answer is yes. It is due to the seasonality from lower chemistry driven by Lunar New Year and we expect the mix to improve in Q2 and further in Q3. So mix is the main reason for the 4% to 6% plus or minus 100 basis points guide.

Got it. And so that should be the low point of the year? Understood. And John, can we just talk about the memory shortage. It seems like that could be both good or bad for you. Can you talk about what you're seeing with NAND tool upgrades and other memory investments that could be coming. And then can you talk about what happens with consumer products just given the increase that you're seeing in the market?

Yes,Steve. So I think the customers and our customers' customers are putting a lot of the investments in DRAM, obviously, for AI, and that's causing this crunch in terms of availability of memory. I would say this, the industry is moving very fast to try to meet those demands. You see a lot of announcements of fabs going up and whatnot. And then more recently, NAND has become potentially a bottleneck as well in terms of availability.

And so you saw one large chip company announced a new NAND factory, brand new greenfield us out a little ways, but that's good because it extends the ramps, as you will. In terms of upgrades, I think our customers are best to answer that. I would say this. We have plenty of capacity to meet those upgrades should they come. And as a reminder, our position in RF power for NAND vertical channel etching allows us to enjoy upgrades almost as much as greenfield. So I think NAND is something that's going to be kind of icing on the cake as that happens throughout the year and the next couple of years.

Got it. And then just any comment on consumer products, what the potential effect could be?

Yes. I mean I think it's going to depend on how much availability there is. I think you read some analyst reports, people are kind of thinking maybe low single-digit decreases in PCs and phones, but that really is going to be dynamic throughout the year. I think it's really going to be a function of how fast the industry can make those chips for that segment of the market. So I think if we have a little decrease in PCs and smartphones, I think it's going to be more than made up with AI.

Our next question will come from the line of Jim RicchiutI with Needham & Company.

Thank you. Yes, I'm wondering if we look at the electronics and packaging business, the 20% plus growth in 2025, John, any sense as to how much of that was a function of capacity additions. And I'm curious how much of a tailwind would you anticipate this being in 2026 in this area of the business?

Yes, good question, Jim. I think what we said also is that while the electronics and packaging grew 20%, chemistry grew about 11% year-over-year. So that's great growth, too. So chemistry would be more utilization dependent. And then the rest of that growth is capacity additions from chemistry equipment as well as flex drilling equipment. So we've talked about our chemistry equipment. That's a nice leading indicator of future chemistry revenue. We're now into the fifth quarter of strong bookings and revenue for that.

I think in the past, we talked about the first half of '26. Our factories are full through then. I think we're not going to guide bookings going forward in equipment, but I would say the difference between 90 days ago is we continue to see strong chemistry. So I think that continues, and that's really just something that, over time, will lead to that high gross margin chemistry revenue that will be on our production equipment.

And a follow-up just on -- you highlighted the improving demand in CD drilling equipment. How would you characterize the recovery that you're seeing in this part of the business. versus previous cycles. I know it's been a while since we've seen a decent upturn in this business.

Yes, I know you've covered ESI for a long time, Jim. I would say there was a super cycle maybe 4 or 5 years ago. This is more like a normal cycle. So probably 2 years now where it's kind of been more normalized. So we're happy to see that. I have to see that our share continues to be very strong. and that some new devices that we talked about full phones are driving more flex demand. So I think I would characterize this as not a super cycle, if you will, for Flex, but more of a normalized cycle that we have expected on a more consistent basis throughout the years.

One moment for our next question. Our next question will come from the line of Melissa Weathers with Deutsche Bank.

Thank you for the question. John, I was hoping to ask you to pull out your crystal ball and get your opinion on WFE growth this year. So we've heard some pretty strong outlook from some of your customers and peers on WFE. Any sense of magnitude or how are you guys thinking about like the magnitude of growth the equipment spending could have this year? And then how should we think about that flowing through to your semiconductor system sales?

Yes. I'll pull out my crystal ball, Melissa, it's cloudy, but I guess it's a positive. A couple of our edge customers are talking about 20% year-over-year WFE growth, a couple of our listometrology customers are talking more in the mid-teens, if you will. So you put it all together, WFE will be a large grower. And I think more importantly, I think everybody is kind of assuming it's more than just a 1-year thing. It's going to be a cycle that maybe lasts longer than that. MKS has always outperformed during the upturn. That's just math. Everything is designed in already in an upturn. People are just ordering things that are already designed in. We have to ship before our customers could ship. At the same time, during a ramp our customers are going to try to build inventory. And so all that leads to outperformance.

Even in 2025, when there wasn't really a ramp I believe we will have shown that we outperformed WFE even in a relatively stable 2025. And I would say in my commentary a couple of months ago, the ramp has started. We have started. Supply chain teams are working hard with our suppliers. We're in constant communication with our customers and everybody in the industry is getting ready for this ramp. And MKS, as you know, is supporting 85% of WFE. So we're going to see all of that. And we're really looking forward to meeting that demand. I think we also talked about the Malaysia plant. Which will come online midyear. And that will give us just extra flexibility in the future. But our factories today are ready to meet the demand that we see in the next year or 2.

Perfect. And then maybe following up on something you've already touched on, on the call, but the ability for the AI side of things sort of offset the -- any slowness that we could see in consumer electronics. And you talked about like the board complexity and layer counts going up for AI boards. Is there any other way to quantify like what is your revenue opportunity with or 2027 Board versus what you've seen in the past? Just any other way to frame how we should think about that content opportunity and sort of how much that could offset any weakness on the consumer electronics side.

Yes. Maybe the way to think about it is, let's say, smartphones. The number of layers and the PCBs for smartphones could be in that 10 to 12 layers, give or take, and it's increasing as well. but the HDI type of boards for AI are in that 15% to 20% already. And in addition, AI also needs multilayer boards, which are in the 30 to 40 layers. And then, of course, the substrate -- the package substrate layers. So I would say that PCs and smartphones, the number of layers is consistent. It goes up a couple of layers every cycle. The AI, we're talking about doubling the number of layers. And so we've talked about in the past that our chemistry revenue from AI in 2024 was about 5% of our revenue -- our chemistry revenue in Electronics & Packaging. And now in 2025, it's 10%.

And I would say it's a sequential increase quarter-on-quarter-on-quarter in '25. So we expect AI to continue taking a larger percentage of our chemistry revenue even with a slightly muted PC and smartphone market.

And one moment for our next question. Our next question will come from the line of Michael Mani with Bank of America Securities.

To start, I just wanted to ask about your capacity position what this Malaysia facility fully ramping over the next course of next year? How much revenue do you think that could ultimately support for your business? And if there's any way to kind of quantify how much that footprint has expanded for you over the last couple of years to be great. And then as you look out, are there any other areas where you feel like you need to invest in your capacity position? I know there's a Thailand facility that you're ramping up, I believe that's for chemistry, but anywhere else where you anticipate any supply constraints?

Yes. Thanks, Mike, for the question. I think with Malaysia, it was built as a business economy replan. It wasn't built to anticipate needed more capacity for this particular ramp. So we already have plenty of factory capacity for that. I think Malaysia is kind of think about it as future capacity needs for WFE. We haven't sized it. I would say this, we always build our factories and phases. So we have the shell and then we'll put in a certain amount of lines and product lines beginning middle of this year. And then we'll plan on what makes sense to grow there. But it will give us a lot more capacity than we have currently.

I would say we've added a little bit of CapEx here and there, kind of nip and up with our factories in anticipation of this particular cycle. But we had talked about being ready for $125 billion WFE 3 years ago. and we did that. And remember that $125 billion is run rate. We always have 30% surge capacity in addition to that. So I think we're quite comfortable with our capability I think always in ramp constraints or supply chain. Our suppliers are better, they're bigger, they're ready, but the golden school effect will happen.

And so that's really where our execution has always been among the best, is finding those issues and then dealing with them and delivering to our customers on time. And we've always done that through every cycle. So I'm very confident we'll have the capacity. We have the team and the supply base to help us deliver to our customers this ramp as well.

Very helpful. And just moving on to electronics and packaging. So as you look out over this next year, is it fair to say that most of the growth this year, if it is sustainable in this kind of double-digit growth area would be -- would largely come from more chemistry revenue now that you've seen significant equipment orders over the last couple of months that are going to be ramping in terms of utilization?

And then more broadly, this kind of relates to the previous question. I think in the past, you've said that every $100 million in install equipment translates to $20 million to $40 million in chemistry sales per year for utilization. So I just wanted to ask what are the sensitivities around that? Is the revenue function much higher if it's a substrate versus will be and as your customers are talking about pushing a number of layers to over 100. Like what does that do to that attach rate for revenue?

Yes. Thanks, Michael. I think in general, our model is still the same, $20 million to $40 million is per $100 million of equipment sales. And it doesn't really change too much between particular types of boards. And it's really a function of utilization. So if that tool is running 100%, then you're getting into that $20 million to $40 million range. And then I think, in general, we're just very happy with the continued shipments of our equipment, as I said in the earlier question, it continues to get better. It continues to be consistently strong even from a quarter ago. So if that's the case, then we will have had potentially 2 good years of record level chemistry equipment shipments. Now I also think we've talked about how long does it take for a piece of equipment to turn into chemistry revenue. We've said 18 to 24 months.

That's still the case. So a lot of the chemistry revenue that you saw grow in 2025 was with equipment we shipped in 2021, 2022. And so that's why I think the equipment we're shipping now will be great capacity for future chemistry going forward into -- into '26, '27 and going forward. So I just want to make sure that was clear. The chemistry revenue now is not constrained by the equipment more shipping. That chemistry revenue is growing because of the capacity we've already shipped in terms of equipment a few years ago.

Our next question comes from the line of Shane Brett with Morgan Stanley.

I want to follow up on Mani's question. Just based on the knowledge you currently have, should we be anticipating chemistry revenue to accelerate or decelerate in 2026? And I'm asking this because I want to better figure out just how much of this chemistry revenue is associated with just higher growth AI or should be kind of benefiting from a higher installed base. But how much could be impacted by just weaker consumer electronics sales.

Yes, Shane, I think, well, there is a seasonality to the chemistry revenue, as Ron pointed out. So Q1 is for the consumer product cycle type of products is lowest. Because of Lunar New Year. And then the Consumer Products chemistry will continue to grow throughout the year. That's the consumer product cycle. To your point, if there's a single-digit decrease, then we'll see that in that chemistry revenue for that market. But at the same time, AI chemistry is really -- we are expecting that to continue to grow. All our customers that are in that AI supply chain are running capacity, they continue to add tools and add -- and bring those tools up. So I think, as I said, that's why I expect that even with a slight decrease in PCs and smartphones the AI part of the chemistry will more than make up for that.

Got it. And for my follow-up, on the E&P tooling side, late last year, you sort of mentioned that your book through the first half of 2026. Just how should I think about this E&P to -- your current capacity for E&P tools relative to the existing demand for these tools.

Yes. I think we've added some capacity. We didn't need to build a new factory if you -- if that's your question. And we've been able to meet the timing demands of our customers even at these elevated levels. And as I said earlier in the commentary, based on changes from 90 days ago, we continue to see these strong bookings. So I think it's going to be another strong year for equipment. And our capacity to meet the time lines need by our customers right now is sufficient. We're not constraining our customers.

Our next question comes from the line of David Liu with Mizuho.

Let me ask the question. On for Vijay at Mizuho. Maybe the first one just back on WFE. I think your customers and peers have mentioned second half-weighted strength and acceleration. Do you think like we can see that and revenue hit probably a 5 handle starting in September, December?

Sorry, David, 5 handle...?

On semis revenue.

Semis revenue, I see. It's -- we're guiding 450 years. Well, I would say this, if WFE grows in that same range between 15% to 20% as many of our customers are saying, we're going to have to ship ahead of that. We're going to have to shift to build that revenue for their inventory. I think in the past, we have hit that 5 handle at the last ramp. That wasn't constraints from our factories, that's constrained some supply chain, right? And so I think that -- I think we're better at managing supply chain. I think the supply chain is better.

So 5 handle would not be surprising. I just can't predict when it will be. But in order to meet a 20% WFE increase. We have to get to a 5 handle probably as MKS. Otherwise, the industry won't get to that 20%.

Got it. And then a longer-term question, I think part of the industry is beginning to look at moving to panel for advanced packaging. I'm just wondering what kind of conversations you guys are starting to have there in the advanced packaging side and if there's any sort of outlook or time line that benefits and KSI.

Yes. I think you're referring to redistribution layers going from wafer shaped to panel rectangular shape. And I think -- many customers are working on that. And of course, when they go to panel, that's MKS. We are participating in the wafer type of packaging. But our strength has always been in panels. And so that is a tailwind for MKS. But as I mentioned in the past, that's kind of 1 or 2 layers of redistribution layers, and that is still relatively small in terms of market growth for us because the HDI and MOB are growing at 10 layers a year or more each. So while it's a tailwind, I think we don't want to miss the bigger picture, which is that the number of layers of MLB and HDI and package substrates are growing much faster.

[Operator Instructions]. Our next question will come from the line of Peter Peng with JPMorgan.

Some of your semi customers are already talking about inventory build. Have you seen that in your -- in the second half of 2025? Or are you starting to see that now in terms of inventory build?

Yes. Well, you can look at their inventory numbers and you see if it's building. But I would say this, Peter, a lot of the conversations on getting ready happened in that Q4 time frame, and they have continued to accelerate in the Q1 time frame. And so we're ramping our factories in our supply chain. And I think it will take a little while to show up as inventory build in our customers because right now, we're -- as a supply chain, we're all just getting ready to just meet the higher demand. So you'll probably see that build up in their inventory numbers over the next couple of quarters. But we are still shipping to demand at this point just because we're just in the early stages of that ramp.

Got it. And then in the lines, there's a lot of, I guess, constraints and greenfield capacities even from your end customers as you kind of engaged, is there any -- I guess, are you seeing any constraints from your customers where they just don't have enough space to move equipment yet. And so maybe you can talk about that dynamic.

I've not heard that, Peter. I think our customers are well run customers. They have large factories located globally. At the last ramp we all added capacity, got more efficient. So I don't see that as a constraint in terms of not enough space to build the tools, if that was your question.

And one moment for our next question. Our next question comes from the line of Joe Quatrochi with Wells Fargo.

Maybe just kind of on that line of thinking on the semi business. You're guiding for kind of 3-ish percent sequential growth, and I think some of your main customers are guiding for high single-digit, low double-digit sequential growth through the first quarter. So just kind of curious if you could kind of give us the puts and takes there.

Yes, Joe, I think we're guiding based on what we -- our best view today. But I think you've been in this industry a long time. When that ramp occurs, it just accelerates fast. This is our best view today. But during a ramp, as you know, things can accelerate rapidly. And so we're going to stick to this guidance. But certainly, we give a range. And even last quarter, we gave a range and we went higher than the upper end of that range. And that's kind of a characteristic of ramps. And so this is what we see today. I would say this, if we could ship more, our customers will probably take it. So we're trying to ramp as fast as we can.

That's helpful. And then maybe just as we think about the ramp of the course of the year and think about just the puts and takes on gross margin, should we still think about 50% is kind of incremental gross margin leverage just thinking about the tariff dynamic as well?

Joe, this is Ram. I'll take that. The quick answer is yes. We are very pleased with the gross margin for 2025. And if it weren't for tariffs, you would have been to your point or 47%. And if you remember, last 3 quarters, we were focused on mitigating the cost of the tariffs. And by we offset the cost dollar for dollar. And going forward, we'll be focused more on mitigating the impact on the gross margin itself. So yes, the volume and the right mix will certainly get us back to the 4%.

[Operator Instructions]. Our next question will come from the line of James Schneider with Goldman Sachs.

Just as a clarification initially, you talked about your semi customers citing a 15% to 20% outlook and your ability to kind of do towards the high end of that, presumably, given the mix of your customers and the mix of your business You'd also just referenced potential constraints in terms of ramping your production. Can you maybe just give us a clarity on whether you see yourselves as constrained in your ability to ship in the next quarters? Do you think you'll be able to catch up to your customers' full demand -- unconstrained demand run rate by the middle of the year at least?

Yes, I'd say this is Jim. During the beginning of the ramp, we're never the constraint because I think we have a supply chain with inventory as well. And even during the peak ramp and even after many quarters of a ramp, we have never constrained our major customers. And I think it's an industry that's always met demand as an entire semiconductor industry. And companies that don't meet demand and constrain their customers they're not around anymore, right? And so I think we have plant capacity. The challenge is getting the supply chain to ramp up. But even then our biggest customers have always been a priority and we've never disappointed them.

Very clear. And then just in terms of how we think about the forward model, you've clearly stated that you expect to grow OpEx slower than revenue, but give us a sense about the leverage you expect there, please? 2:1 or et cetera?

Jim. So if you look at -- so we will be investing. We want our OpEx very carefully, but we will be investing this year to support the growth. But in terms of leverage. That will be a focus to drive our leverage further. If you look at 24% to 25%, our OpEx dollars grew, but our OpEx as a percentage of sales was lower. So we finished around 26% for 25 and 26, we will be lower than that.

Thank you. And I would now like to hand the conference back over to Paretosh Misra for closing remarks.

Thank you all for joining us today and for your interest in MKS. Operator, you may close the call, please.

This concludes today's conference call. Thank you for participating, and you may now disconnect.

Good morning. Welcome to the 28th Annual Needham Growth Conference. The next presentation will be a fireside with MKS. We're pleased to have with us this morning, CEO, John Lee; Michelle McCarthy, Chief Accounting Officer. Also in the audience is Paretosh Misra, VP, Investor Relations.

My name is Jim Ricchiuti, Senior Analyst in the Equity Research Department at Needham, covering companies in the industrial technologies space. I think most of our audience is familiar with MKS. John, Michelle, thanks for joining us at the conference today. So I think MKS over the years has compiled a strong track record in M&A, resulting in the company that we see today.

And with that, I'll turn it over to John just to give us a brief overview of the company today, and then we'll dive into some of the discussions.

Yes. Great. Thanks, Jim, and thanks for having us. It's always a great conference to kick off the year. I think Jim is right. We've done a lot of M&A. We've done a lot of organic growth. But our strategy today is made up of being foundational to all the technologies needed to enable advanced electronics. And so when we think about advanced electronics, AI is the latest thing that everybody talks about. But before that, it was PCs, before that, it was smartphones, et cetera, et cetera, right?

And this was always made up by just Semi. Semi was getting better, so you got better advanced electronics. And that was Moore's Law. But in the last decade or so, that model no longer held true. Semi was getting better, but advanced electronics by themselves weren't getting twice as good every 2 years. You needed to put these chips together through packaging in order to keep on that road of more than Moore's Law.

And in order to do that, we said in 2021, we needed to decide whether we're going to be foundational just to Semi and part of advanced electronics or to all of Advanced Electronics. And we decided, obviously, to be foundational, continue to be foundational to all of Advanced Electronics. And that's why we did the Atotech acquisition.

A little early for sure. Many investors didn't understand it. I think they understand it now, but we address 85% of all wafer fab equipment in every fab in the world. 85% of every piece of equipment in every fab in the world has multiple MKS subsystems in it. No one has that kind of market share.

70% of all the steps needed to make advanced packaging, for instance, 20-layer boards, 40-layer boards for AI, we address 70% of all those steps. So no one is even close to all that. And so this is the reason why we did the acquisitions we did. And the reason why now you're starting to see some of those numbers show up, especially as AI starts filtering into advanced packaging as well as, of course, semi.

Yes. And for what it's worth from where I sit. I mean, it's been interesting to see the questions that I get, and I assume some of my peers get about the company. There's really been a shift toward more of what's happening on the E&P side of the business.

And I think for a while, maybe you're right, investors didn't quite know what to make of it, but I think it's pretty clear now that it's certainly -- it's been -- it's about -- E&P is about 28%. Revenues, it's been your strongest growth market in 2025. I think little over 20% through the first 9 months. If you were to take a step back, John, maybe list the top reasons why we've seen that kind of growth. It's been a healthy market. But just in general, what can you point to?

Yes, for E&P, for sure. And by the way, not to forget semi, it's also growing well.

We'll talk to [indiscernible].

But E&P, is certainly, some of the growth drivers have been AI. And AI has actually driven a lot of the equipment orders for plating chemistry. And that was a bit of a surprise to us because that equipment is to make higher layer count HDI PCBs as well as MLB PCBs. Because at the end of the day, when you put the chips on top of your package substrate, the highest end, most complex layers of the PCB, you start to connect that to the rest of the world through HDI, less complex and MLB even less complex. And so -- and then the chemistries that come with that. So what's driven the growth in E&P has been just chemistry for AI as well as equipment for some of these parts of the PCB industry for AI. So we're starting to see a lot of that.

One of the most important points we like to make is when we sell our equipment, the chemistry that goes on that equipment is ours. That's great for market share. And long term, we keep 85% of that market share on our equipment. When it's not our equipment, we compete on chemistry, and we are a market share leader in chemistry and packaging anyway.

But having this now about 4 quarters of strong equipment revenue. This is -- this is a record equipment year for us. We've talked about kind of first half of '26, strong bookings. We know we're going to be building through that. And every month, we'll be -- we are talking to customers about what they need for beyond that.

You alluded to AI being a driver. Can you put -- give us a sense as to -- of the E&P business, what -- in terms of both equipment and chemistry, what that may represent? Is there a way for us to quantify that?

Yes. Maybe, Michelle, you can talk about the chemistry part.

Chemistry. So it's really hard to be precise about that because we sell into kind of high-end and complicated PCBs.

Probably 10% now?

Yes. So chemistry revenues, we estimate about 10%. That's about double what it was in 2024, but we don't have perfect visibility in terms of the end use, whether it's AI or otherwise, but that's what we've been able to trace through.

Yes. And that's just chemistry. The equipment, of course, is on top of that.

And you said it's been a record year.

It's been a record year.

Do you think the bulk of that growth that you're seeing is tied, do you think, to AI?

Yes, because if you think about dishwashers and washing machines, they're not growing, I don't think. And even smartphones, this is HDI. It's a little better year this year, but it's been pretty flattish, right? PCs, HDI and some substrates. So all of it is really AI for packaged substrates, AI for HDI, AI for MLB.

And in addition to the backlog, the strength in bookings, how do we think about this as far as extending into 2026, converting into revenues, I guess?

Yes, yes. So when we get an order for a piece of equipment for plating equipment, it takes us 4 to 6 months to build it, install it. And then it takes our customers another 6 to 9 months, depending on their business to qualify it and use it and then bring it up to ramp. So when we look at a piece of equipment from the day we get the order to revenue, it's in that 18 months, 1.5 years to 2.5 time frame. And over time, it ramps into high utilization.

At full utilization for every $100 million of equipment we sell, we will get $20 million to $40 million of high gross margin chemistry every year for decades. So $20 million to $40 million for every $100 million of equipment. And that's just when it's on our equipment, right, but along with our chemistry on other people's equipment.

And so from the time it's commissioned, John, the equipment is commissioned, how quickly do you see that revenue flow?

Yes, that's kind of that 9 months to 18 months. It really depends on the customer, and they have to win, #1. And then they win, likely they order more equipment, by the way. But then they have to ramp it. Right.

So we've seen good growth in chemistry this past year. If we continue to have these kind of tailwinds, and it sounds like we do, is there any reason why you wouldn't anticipate the chemistry demand? I'm thinking in terms of the equipment that you're putting into the field, you wouldn't continue to see pretty healthy chemistry demand in '26.

Yes. We'll see -- so yes, I think we will see a healthy demand in '26 because the equipment we've been putting in, in '25, some of that might start hitting in '26. But in addition to that, obviously, the package substrate that's driven by HDI, that chemistry is already growing. You did point out, I think we grew 12% or something year-over-year in just the chemistry.

And so that is when the industry has gone from 40 layers for an AI server board to -- sorry, from 20 layers to 40 layers. And that we're already working on 60 as an industry. People are talking about 80. People are talking about 100 layers now. So these layers are made one layer at a time, and they might go through our tool one layer at a time. So we are a square inches consumables model there. So that is great.

Consumables also, by the way, have a short shelf life. So our customers can't buy a year's worth and then sit on it. It has to be kind of several weeks, maybe a couple of months. And so this is really, I think, portends well for '26 for chemistry and beyond that if AI continues to ramp and the number of layers continues to grow.

And the margin profile on that chemistry business?

Yes. The margins we publicly disclosed the MSD division, the Atotech division is in the mid-50s. And that's always a mix of chemistry and equipment. When there's more equipment, the margin goes a little lower. When there's less equipment, the margin goes a little higher. So think mid-50s for your modeling for chemistry revenue. Our nearest competitors are much lower. And so that tells you a little bit about our differentiation.

I think personally that we have the best R&D team to provide new chemistries and a new road map. That's more and more important as you get to higher layer counts because if you think about it, when you're making 5 layers, you have a certain yield per layer, right? So that fifth layer, it's important because if you screw that up, kind of the 4 below it, that's all gone.

Think about 40 layers. And you're on layer 40. You have 39 layers that work and you can't screw that up. So yield becomes really important. Chemistry becomes more important. The equipment becomes more important. Think about going 60, going to 80, right?

And so scale to do R&D is really important and Atotech/MKS has the biggest R&D team for electronics. In addition to that, we also have the biggest footprint of tech centers co-located with our customer clusters as well as analytical labs and material science labs. So these are labs that are co-located with our customers.

So something happens, I don't know if the chemistry is contaminate, send me a sample literally in the same city, and we'll analyze it for you with all the analytical instruments that we have. They're consistently tested between all the sites, so that we know that the results will always be correct.

There's also material science labs where we'll cut the PCB to make sure the holes are filled to make sure there's no issue with the various layers, right? So this is the kind of support that we have that no other competitor has. And I think that's why we're valued. We're going to be their -- not just their R&D partner, but their yield partner. That is very differentiating.

And this really ties to the point you made earlier about the benefits of being the only equipment and chemistry supplier. I mean I think some people say, well, it's maybe just because they're in the customer's facility, they have the opportunity to continue to sell. But it's more than that.

It's much more than that because, by the way, we don't sell every piece of equipment because not every piece of equipment is differentiating, right? There are some that are more commoditized, and we don't do that. The kind of equipment we sell is horizontal plating equipment, meaning the plates are going through horizontally versus vertically. And that has allowed us to demonstrate better performance in terms of yield for plating.

Just to be clear, we are the only company that has plating equipment, plating chemistry and laser drilling equipment. No one else has all 3. A couple of competitors have plating chemistry and plating equipment, much smaller companies. So really, when you have all those knobs and the problem is more difficult -- the yield problem is more difficult, it could be the laser didn't drill it right. It could be the plating chemistry is a little off. It could be the plating equipment was a little off. Now I've got all 3 knobs to turn in my tech center.

So we have all 3 components in our tech centers co-located with the customers. It's not just in Berlin, right? So our customers can come in and troubleshoot with us with all the knobs, right? And so if they couldn't, they'd have to have 3 different companies. They'd be shipping stuff between 3 different R&D centers. And that takes time. And also things happen when you ship, right, versus all in the line. We're trying to emulate what our customers see and then solve the problem faster because we have more knobs to turn.

And I think when we look at the example of the equipment orders that we've been getting recently, one of the changes that we had to make with the equipment was, well, the boards are now, remember, 40 layers, 20 layers. They used to be 5.

Well, the equipment that makes 5 can't make 20, right, because that board is a lot thicker. So we had to make adjustments on that equipment. Well, we could just go do that a lot faster because we understand that if we do this and we modify the chemistry, we can solve that problem much faster. And then a customer asking an equipment guy, can you make -- modify your tool to go from 5 to 20 layers? And the chemistry person, can you modify your chemistry to be able to do that.

So this is the kind of speed to solution that we think is differentiating for us and more and more important for the industry as things get more complex. When things get more complex, it takes longer. It just takes longer to solve these problems. The industry is not going to wait, right? Whoever can get there faster is going to win. We want to enable our customers, the ones who want to partner with us to get there faster.

Do you think you've gained share in '25 in the chemistry side of the business? Or is this just a case of rising tide lifting all those...

Yes. We measure market share all the time, let's put it in this way. I think we're pretty comfortable where we are. Let's put it this way. We're a market share leader. The next 2 biggest competitors in chemistry together is our market share, right? So we don't have dominant market share for sure, but we have the strongest market share.

And I think the equipment installations that we've been talking about for the last 12 months as well as the future perhaps 12 months, that portends well for market share growth because that is our chemistry only.

You mentioned the laser drilling business, which was the old Electro Scientific Industries business. My impression is so much of that business was tied to handsets and the overall growth of the market. Are there some other factors that are contributing to the growth in that business?

Yes. Maybe you can take that, Michelle?

So yes, we're a market leader in Flex PCB laser drilling equipment, which predominantly serves the mobile device market. So that market is cyclical, right? It will fluctuate quarter-to-quarter year-to-year, but we had a good year in Flex in 2025. Beyond smartphones, you can think about wearables, so AirPods, the watch. Those all have flex circuits. But in the coming years, we think the growth is really within handsets really through increased content or features like the foldable phones.

Right. And I was going to bring that up, Michelle. I mean there's, I think, widespread view that we're going to see more foldables, including a foldable from a pretty large consumer electronics company getting introduced. And the benefit for you from that change in form factor would require more laser drilling equipment.

That's right.

Yes, for Flex for sure.

For Flex.

Yes. But there's already foldable phones out there, right, Samsung and Huawei. But you're right, the noticeable missing phone maker, if that takes off, that would change things.

Absolutely, we shift over to semi, which is probably time to do, but I just wanted to ask you about the competitive environment, just in light of the spin-off of the DuPont Electronics Material business, which now is known as Qnity or I'm not sure...

I don't know either.

So do you see -- what are the ramifications of that?

Yes. Well, look, Jon Kemp, he's a great guy. Qnity is a great company, great competitor. But I would say this, Qnity is strong in the semi side of plating, which we're not. It doesn't mean they're not in PCBs as well. So we compete in the PC part, but that's where we're the strongest.

So they're a good competitor. I think they should be more flexible. It's a smaller company. That's the whole idea. But they've been a good competitor for a long time, and we tend to win more, we think, since our market share will tell you that. But we certainly expect them to be -- to remain a good competitor, and I wish Jon well.

So on the semiconductor business through the first 9 months, I think it was up around 15%. I guess, the upgrade in NAND, it was in Q2 where that you got some nice tailwind from that. What were some of the other contributors to that growth in semi through the first 3 quarters of the year?

Yes. I think part of it is the fact that inventory burn down is finally done. And so we saw the full year's effect in '25 versus there was still a little bit in '24. So that naturally gives us a year-over-year growth. The NAND upgrade does add to that in Q2. And then I think in general, things are picking up. In general, things are picking up a little bit. I think the whole industry is preparing for what potentially could be a great next 2 years, right?

And so we have been in this a long time. We've seen these cycles a long time. We know that if you don't get ready and you're behind, you never catch up in a ramp. We've done that. We've seen that so often. So we are preparing, as I'm sure most of our peers are, for the potentiality of it. And you've seen a lot of announcements of fab build-outs for DRAM and HBM for sure and logic for sure. I guess we're all waiting for TSMC's commentary soon.

We haven't seen a lot of commentary on NAND yet, except for upgrades. And so I think the discussion of the meeting is when will you see that? And I guess I would say it feels like it should happen, like it should have happened. So we're kind of assuming something will happen there. And as I said earlier, we're levered to 85% of WFE. So we're seeing all of that now. And NAND, should it have more upgrades or greenfield even, that will be icing on the cake for '26 and '27.

And remind us, you tend to be over-indexed to NAND?

We're slightly over-indexed on one particular product -- power, right? But remember, we have 20 different product lines all around vacuum chambers. We also have litho metrology inspection, optics, lasers, et cetera. So we're addressing the ASMLs and KLA product lines as well. But yes, if NAND takes off, our market share and market position in high aspect ratio power delivery is very solid.

If it doesn't, if we still see a muted recovery, but we are -- as you alluded to, there's been a lot more positive commentary around DRAM, how do we think about that in the context of your ability to outgrow WFE, which historically you've been able to with the exception of inventory adjustment here?

Yes. So typically, through cycle, we've outgrown WFE by 200 basis points. So whatever CAGR WFE is, we've outgrown 200 basis points. That's just data. Typically, on an up cycle, we outgrow by a lot just because people are pulling our products. I think in the past, when WFE is 10%, we've been 25% to 30% on the up cycle. In the down cycle, the inventory burn, we underperform. That's why you go through the -- we calculate through cycles.

I would say this year was 15%, as you pointed out. I don't think WFE grew 15%. So we're already seeing a little bit of that momentum as things are picking up, and we haven't really picked up yet. We really haven't picked up. If you look at our semi revenue, it's incrementally better kind of quarter-on-quarter, but it's not what you would -- what we have seen in the past when there's a ramp where that semi revenue really rockets up. So I think it's in a good place. Our market position is very strong in WFE. And I think as the industry picks up, we will -- we're not worried about outgrowing WFE.

On the DRAM side of the business and all of the discussion around HBM as it relates to AI, can you maybe help talk to us about which areas of your semi business will benefit -- typically benefit the most from that?

Yes. I think when DRAM takes off, it's relatively more dep etch than litho. When logic takes off, it's relatively slightly more litho than dep etch for the reasons of shrink versus verticality of processes. So we are still more levered to dep etch as a company, even though we have much more litho metrology inspection now than we ever did in the past. So when DRAM takes off, we should be a beneficiary of that. When chips go vertical, so even gate-all-around, which is not DRAM, there is soft etch, there's soft deposition, there's ALD, soft clean, right? All those things are product lines that we have.

So when things are more complex, we tend to see that upside just because of the breadth of our technology and also the fact that we're highly engaged with the entire industry in terms of what's next. When you're at 85% of all the equipment, they're probably going to come to you with here's our next thing, right? Here's the next thing that's going to need you to do this to this particular subsystem. So I think DRAM and dep etch is what I would call potentially a tailwind in '26 just because there's more dep etch going for not just DRAM, but also some of the logic processes.

How satisfied, John, are you with the progress you've made on the optical side of the semi because you touched on it, but I'm curious as it relates to how we might think about the opportunities over the next 1 to 2 years?

Yes. I think we talked about world-class optics. This is our effort to be more important to that supply chain for lithography, metrology inspection. We -- to do that, we had to make investments for people, for CapEx. We did that 5 years ago. We started that 5 years ago. And we grew that revenue from $150 million to $300 million. So that was great progress.

I think this year was a little flatter kind of because the industry is a little flatter, lithography and metrology. But I think as we start looking at a WFE numbers in '26 and '27, they are increment -- pretty much a lot bigger. You'll see also the world-class optics revenue grow as well. That's what our expectation is. So we're not done yet. It's still mid-innings, I would say, in terms of our ability to gain more share in lithography, metrology and inspection.

And maybe lastly on semi, and this has been going on for a couple several months, but folks seem to have settled in on this stronger second half '26 recovery strengthening. Is that consistent with some of the conversations you were having with customers back in Q3? Or to what extent have those conversations maybe changed?

Yes. I would say in Q3, it was more of a second half '26 discussion. I think even in our last earnings call, 90 days later, I think it's incrementally more positive. So I think 2 things are happening. 1 is people are worried about '27 being even higher, and that might add to pull-ins because you want to kind of get ahead of it before you get behind. As I said earlier, you don't want to be behind because during a ramp, you never catch up. So normally, if our customers need to ship in Q3, we would see those orders in Q2. That's -- no change there.

But if they were worried about not just the shipment in Q2, but what they're going to really need in '27, you could see them wedding the pipeline a little more. And I think many of them are as we are, people are preparing for a potentially sustained ramp, right? And when there's a sustained ramp, you kind of want to let the supply chain a little more than if you just saw like the next 3 quarters are going to be good. So I think that would be the dynamic that we're checking on.

So reflected more so in the semi outlook for Q2, we would see it in that...

Maybe, maybe. I think it wouldn't be a surprise. We're not planning on it because we haven't been told about it. We are planning internally to do it, right? But if our customers pull, then you'll see it.

Yes. Then shift to the financials just in terms of the target model that you gave back in late 2022, you've achieved these gross margin, 47% plus gross margins sooner than I think anticipated at a lower level, I think, of revenues is fair to say.

That was, I guess, mix related, some chemistry and some other things that you've done. I'm wondering how we should think about your target in terms of getting to the 26-plus operating margins that you highlighted back in '22?

Yes. So we're really pleased with the execution on the gross margin side. We also think it obviously demonstrates the value our customers see in our offerings. To your point, we operated at that 47-plus percent level all through '24. That trend would have continued in '25 had it not been for tariffs, but we've managed through that really, really well. In our Q3 call, we had said by Q4, we were going to offset tariff cost dollar for dollar. But we also still see a drag of about 50 basis points because it's still dilutive, right, even if you're passing through those costs. So we're continuing efforts to try to mitigate even that 50 basis points, but that will take a little bit of time.

But beyond tariffs, mix and volume are really the key factors to expand gross margin. So we've talked about the tailwinds that chemistry revenue provides just given high margin. But we've also talked a lot in 2025 about the tremendous strength in chemistry equipment. So that's low margin on the equipment, but it obviously is a good leading indicator that we're going to see future chemistry revenues at that high margin with attach rates of over 85%, so for a long period of time thereafter. So we've provided a flow-through model of about 50% on gross margin for any incremental revenues from current levels.

On the operating margin side, we have been super disciplined in terms of managing costs. We kept our '23 and '24 operating expenses flat, trying to manage through the cycle. In '25, we did say the run rate was going to go up $250 million to $260 million. We've stayed within that range because we had to invest in the business, but we really set the cost structure at a place where we believe from here on in, we'll start to see some leverage as that top line expands.

Do you feel on the R&D side, there are areas that you might have to step up in terms of the way the market may be changing?

Yes. We look at R&D all the time, and we're not afraid of stepping up a lot, and we have in certain areas. So we're not starving R&D at all. In fact, we're very disciplined about it. The unfortunate thing for my team is I'm a tech guy. So if they say something that doesn't make sense technically, they're not going to get the R&D. But we've been pretty happy with our ability to afford that.

And I think scale helps. Scale helps 40% recurring revenue, consumables and recurring service revenue helps at great gross margin and cash generation. So we've been able to meet any kind of customer demand about, hey, can you put more R&D here? And we don't do it for every customer, but for certainly some of the customers that have great opportunities, we've been able to do that. No issues with R&D.

Talk about debt leverage and some of the debt leverage targets. Your net leverage while exiting Q3 was [ 3.9 ]...

3.9.

In the trailing 12 months. You've made significant voluntary debt payments, what about $400 million through October. Going back to the Analyst Day, you talked about bringing gross leverage 2x longer term, but there are lot of puts and takes. The market has changed. There's been changes in the market. I'm just wondering since you set that goal, how you're thinking about it?

Yes. So we're really happy with the cash generation of the business. It's performing incredibly well. To your point, we prioritize deleveraging. So we've paid down $400 million this year. That's on top of over $400 million that we paid voluntarily last year as well. Beyond that, we're proactive repricing, refinancing our debt. We've cut our interest expense by almost half since the exit rate in 2023, just taking those actions. From a net leverage standpoint, right now, kind of near-term goal is 2 to 2.5x is where we'd like to get. We think that's appropriate given our view of the business right now.

We have a few minutes, would you -- anybody questions from the audience?

[indiscernible].

Bottlenecks for delivery of tools, especially in lithography? I would say lithography subcomponents, if you will, subsystems, much longer lead time as lithography tools are. So there's less of that up and down kind of things. So at least on the products that we are supplying, we feel strongly that we won't be a bottleneck for lithography. I can't speak for everything else. ASML should answer that. But I feel that we've got plenty of capacity to deliver whatever is being asked right now.

Any others?

[indiscernible].

Yes. Well, we talk to all the customers for sure. But I would say it's -- a lot of it is driven by memory and DRAM, particularly. So that's really been the increment. I think logic has always been big and strong, and we'll see what T6C says. They might change that view. But it's really been driven by the move from many chip companies to HBM, which is less efficient per bit and so taking up capacity. And so they're all adding capacity right now, right, with the shells and building shells for the future.

NAND, I think, is kind of, well, when will that happen? And I think it has to happen to match the memory and the logic. So at some point, it will happen. And I think we just got to get visibility on that because remember, you got to build a shell first if you're going to do greenfield NAND versus just upgrades. I think upgrades will happen. But I think at some point, we kind of expect greenfield NAND has to eventually happen. But a shell takes 1.5 years, 2 years to build. So we're kind of waiting for that to happen.

Okay, great.

Thank you, Jim. Okay. Thanks, everybody.

Great. I'm Shane Brett [indiscernible] from Morgan Stanley. Joining me at MKS are John Lee, CEO; and Ram Mayampurath, CFO; and we also have Paretosh Misra from Investor Relations in the audience. Before I start my questions, I'm going to hand it over to John for a quick introduction to MKS.

Yes. Great. Thanks, Shane. So maybe I thought I'd start with a little introduction for some of you who may not know the MKS story as well. So MKS is a 65-year-old company. We started with one product. That product was an instrument that measures the pressure inside a vacuum chamber. And from that, we were able to move into the semiconductor industry, as you probably realize, semiconductors has a lot of vacuum chambers. And that one product has taken very high market share. And after 55 years, it's still #1 market share. But from that one product, we were able to organically and inorganically build a strategy of surrounding the chamber with all other types of critical subsystems. So valves, RF Power, plasma, mass flow controls, et cetera.

So that was the strategy up until 2015. At that point, with semiconductor only in terms of the market but only the vacuum equipment of semiconductor. In 2015, we bought a company called Newport Corporation. Newport had about 20 product lines, lasers, optics, motion. We had 20 product lines, vacuums, critical subsystems. Two things happened with the Newport acquisition. One is it brought to us the missing components of the rest of semiconductor equipment, lithography, metrology and inspection. So with that acquisition, we now address 85% at every piece of equipment in every fab in the world with multiple subsystems. No one else is even close to that market share. And we can say that because the big 5 are Applied Materials, Lam, Tokyo Electron, ASML and KLA. And together, they're about 85% market share.

The second thing that Newport acquisition did was it brought to us new markets. And one of those new markets was the application of lasers to manufacture precise things. One of those is drilling holes and PCBs. And that led us to the acquisition of Electro Scientific Industries. And that was the first time we actually bought a systems company. And what that allowed us to do is to talk to another layer in the food chain. So not just the OEMs, but the customers of the OEMs that allow us to understand their structure and the ecosystem much better. And then from that, we did the acquisition of Atotech, which is chemistry and chemistry equipment for PCB manufacturing. And the strategy behind all of this is we want to be foundational to everything that makes advanced electronics advanced, not just the semiconductor but the packaging of semiconductors together. In the past, if you wanted to be critical or foundational to electronics, all you had to be was a great semiconductor equipment company.

That was all that mattered, and that was -- semi was the only thing that drove the advanced electronics to be better. Over time, that was Moore's Law. Over time, Moore's Law wasn't as relevant anymore, it started slowing down. And so what did people do where they started putting chips together and packaging them together such that they behave like one big chip. And because of that, we can actually continue extending that Moore's Law concept of everything is twice as good every 2 years for the same price. That's now true for 70 years in a row. That's why things like AI are possible. And a lot of folks think, oh, AI, that's going to change the world, and it might."The way we look at AI is it's just a great thing and a list of other great things such as the PC, such as the smartphone, such as data centers, this was all driven fundamentally by Moore's Law and now more than Moore's Law.

And we want to be foundational to that. And from a shareholder standpoint, we think that foundational technology provider status is a sustainable long-term investment. It's not about the fad of the day. It's about an infrastructure builder that is critical, and it's an infrastructure that continues to grow over time. And you can argue it's even more important now than it was even 10 years ago, right along 50 years ago. So that's a quick introduction to MKS.

Got it. Thanks, John. I'll kind of talk through the questions by segment. And I want to start with Electronics and Packaging, E&P. So your Q4 guide implies about 20% growth for the full year, which is pretty good. Just could you talk about what has drove this really strong growth this year?

Yes, 2 factors. So chemistry, we provide a lot of chemistry to the PCB industry. A lot of that is driven by AI. So AI, as I said, is about packaging chips together. And so a lot of the AI customers, the guys that are buying our chemistry to build AI boards, they're growing for sure. But in addition to that, we're seeing chemistry equipment. So we're the only provider of chemistry that also provides chemistry equipment in the PCB industry. We decided to do that strategically because we think that if you can bring more tools to the game, you can provide solutions to your customers faster.

If you can bring chemistry tools, if you can bring equipment tools, you can actually come to an optimized solution faster. And so the last 4 quarters, we've seen strong equipment bookings and revenue for chemistry equipment. And that's also been a significant driver of the year-over-year outgrowth in E&P.

Got it. And with this equipment growth, so the flex PCB drilling has been a pretty good driver for you guys this year. Just can you talk about the trends you're seeing with kind of your customers for these flex PCB drilling tools? And also, you've kind of talked about you're adding some capacity to your [indiscernible] factories. Just could you kind of talk about how that sort of ties in with your growth outlook for this equipment portion?

So in our E&P market, we have equipment, and we have 2 types of equipment. The chemistry equipment that I just talked about, driven a lot by AI, but also laser drilling equipment. So these are tools that are actually drilling holes, thousands of holes per second. So think about that. I'm going to drill a few thousand holes in one second. That's how fast these laser tools are. And we are the market share leader in flexible PCBs versus rigid PCBs.

Flexible PCBs, what are they used for? Well, think about phones. A lot of the circuitry inside phones, connecting the camera to a microprocessor and other things, these are flexible circuits. They're actually quite complex. AirPods. So all of these wearables have tiny flexible circuits in them. And we're a market share leader there. We also have laser drilling tool for rigid PCBs, There, it's an opportunity for us. We don't have the #1 market share there. We have some technology there that we think is unique, and we've already demonstrated some wins there.

I guess if I just take a step back on the E&P segment, if I'm correct, it's 2/3 chemistry, 1/3 sort of equipment and tooling. How would you sort of characterize the growth profile between the 2/3 chemistry business versus kind of the 1/3 of equipment?

Yes. So that's right. 1/3 is equipment that includes the chemistry equipment and laser equipment. And that can be lumpy, right, because it's CapEx. The 2/3 is chemistry, and that's more -- it is a consumable kind of market. And so that's been growing probably about 10% year-over-year this year and likely about 10% year-over-year last year. And so this is driven by a lot of the volume of AI. So many of our customers are building more complex layers of PCBs for AI servers. And that chemistry is coming through to the growth that you see in our chemistry revenue.

So when I sort of think about your 20% growth this year, it's been kind of -- you were 2/3 that's growing 10% and then the equipment growth is sort of layering on top of that?

Exactly.

And when I think about kind of the durability of that equipment growth that's been going on for 4 quarters right now, sort of how do you kind of see an early setup into '26 or kind of...

Yes. So 4 quarters of great equipment orders for chemistry. We're booked through the first half of '26, and we continue to have discussions with customers about beyond that. So, so far, so good. equipment continues to be a strong part of our potential growth in 2026. It is a CapEx environment. So it will turn over at some point. But the most important part is when we sell equipment for chemistry, the chemistry is ours. And our chemistry gross margins are above 55%. Equipment is lower, right? And so if you think about that equipment revenue, it is going to drive annualized year-over-year chemistry revenue for decades. And that's been the history of our equipment sales.

So I guess I was probably going to ask this a little bit later on the financial portion, but gross margin has been a little bit lighter, I would say, just given just so much equipment sales going on. But equipment may roll over at some point, but chemistry is more utilization based. How would I kind of think about maybe the attach rate between equipment and chemistry and how better equipment -- I mean better chemistry may also feed into the financial model?

Yes, that's true. So after 5 years, the attach rate drops to about 85%. So we have very high attach rate when we get out of the gate on and you're right, the chemistry sales that follow the equipment sales are very higher than our corporate average gross margins. In the future, mix will be a big part of our gross margin play. If you look back into Q4 -- sorry, 2024 up to Q1 of this year, we were running gross margins well above 47%. We finished Q1 at 47.4%. Since then, we had 2 headwinds to deal with. One is the impact of equipment sales and the tariff impact that hits in Q2 and Q3 in particular. Q2, we had 115 basis points from tariffs. Q3, we had 80 basis points. By Q4, we will offset the impact of that tariff dollar-for-dollar.

However, from a gross margin point of view, we will still have a 50 basis points impact going forward because we are not marking up the pass-throughs. It's a dollar-for-dollar. So the math will be against us. In the long term, we are confident that we can offset that 50 bps through just efficiency and manufacturing excellence programs. And as the mix gets back to more normalized levels, we will get back to the 47-plus percent gross margin that we have targeted.

Got it. Thank you, Ram. And before I move over to semi, I have to mention, so you're awarded the Optica i4 Individual Lifetime Achievement Award, the Global Photonics Economic Forum in October. Just -- could you remind us about MKS' sort of position like MKS' optical businesses and how -- kind of what part of the supply chain you guys play a part in there?

Yes. So that was a great honor, but it was really a reflection of MKS actually. And it was a recognition that MKS is one of the leading players in the optics industry, the photonics industry. And the areas that we work in, in photonics are not just lasers and industrial type of applications, but also in semi. And so when we thought about areas for growth or outgrowth, semiconductor equipment for lithography, metrology and inspection was something we were under indexed to.

And so 5 years ago, we decided to change that. We hired more people. We added more CapEx, develop new processes so that we can do more complex things, optical subsystems and optics for the lithography, metrology and inspection customers. So that revenue 5 years ago was $150 million. Now it's $300 million. And we're still in early innings of that area of the semiconductor WFE market.

Got it. That kind of ties us into talking about semi. So you've seen a nice year in semi. Q4 guide implies about 10% growth for the full year. So your customers have talked about kind of a big second half 2026 ramp. Could you kind of talk about what your sort of early expectations are kind of, I guess, what you're sort of expecting for your semi business in '26? And also it would help with kind of what drove the sort of 10% growth this year as well?

Yes. Well, so this year, 10% growth. A lot of it is -- part of it was inventory being burned off -- our inventory being burned off for NAND, and we saw some upgrade patterns there. So that was helpful. And it's also a lot of in-quarter terms because our lead times are very short, back to normal now. I would say pick your favorite WFE model for 2026, but people are saying it can go up 5%, 10%, 15% now, incrementally better as the year has gone on. And a lot of it is driven by logic, DRAM and HBM, not so much NAND yet. And so as I said earlier, we are addressing 85% of WFE.

So when logic goes up, we go up. When DRAM goes up, we go up. When HBM goes up, we go up. NAND is potentially an upside to all that. If there were more NAND upgrades there. I think the industry is worried about capacity in terms of clean room space for all the equipment. So that's a great problem to have. People are going to fix that as fast as they can. But right now, as we look at the industry view of equipment in 2026, it's very robust. Our lead times are short now back to normal. Our inventory is -- we're shipping to demand. So I think 2026, if that holds, will be a great year for MKS.

Got it. We're at 11% growth for '26, so a pretty good setup for you guys. I guess just in terms of that lead time. So you guys are at 4 to 8 weeks right now. I guess what does a more normalized lead time look for MKS? And sort of what sort of visibility would you ideally like your customers to provide you?

Yes. Well, so I think 4 to 8 weeks is kind of normalized and there's ranges, right? There's some complex subsystems that might be a few months. But that's kind of normalized. Now during a ramp, things extend and that's normal. Our communications with our customers are very, very close. There's only 5 big customers in the semi. So we talk to them all the time. We also talk to the end users, the chip companies as well to try to get as much insight as possible. So I think no one wants to be supply chain constrained. And so our customers are going to tell us as soon as they know what is their needs for the next quarter or 2. And I would say, when I think about what's being said nowadays versus a quarter ago, it's incrementally more positive.

Got it. Got it. And I just want to touch back on the NAND portion. So when I look back at '21 and '22, you guys had did really well in hand and WFE kind of disappeared for 2 years to start to come back this year. But how would this sort of a recovery in NAND WFE layer on to kind of your outperformance versus WFE if we think about '26 and '27 seeing hopefully a bit more better NAND WFE?

Yes. So NAND is pretty much in a historic low. So if upgrades happen, we get -- we participate in that because one of the components of that upgrade RF power and we're market share leader there. If new greenfield as we'll certainly get the RF power, but also the surround the chamber portfolio as well. So I think NAND upgrades as well as greenfields are going to be extra tailwinds to the 2026 WFE. I think it feels like it's going to be constrained by the amount of clean room space at this point because people are shifting even NAND clean room to HBM and DRAM because there's an even stronger pull there, even higher pricing there driven by AI.

Got it. And even though that kind of NAND WFE dropped off in 2022, you guys had some nice kind of revenue ramps in the metrology and inspection side. You're talking about kind of your exposure to ALD to me a little bit earlier. Could you talk about kind of the more idiosyncratic sort of MKS initiatives that should lead to sort of WFE performance over the next 2 years?

Yes. The last earnings call, we talked about the concept of 2-nanometer and the gate-all-around that goes with it and a lot of the deposition processes that are new like atomic layer deposition. So we provide some key critical subsystems there that we're pretty unique in. But I think if I were to step back and think about how does MKS outgrow the WFE market over time, I think that our strategy has been, if we can manage a broad portfolio we have a better chance of outgrowing the market because I can't tell you which inflection is going to cause which critical subsystem to be more critical.

But I can guarantee you, it will change. And if I have all -- or most of the critical subsystems, I can actually do something about it. So the best example was then, right? NAND went vertical, who would have thought of that? And then we acquired a lot of RF power. Well, I have RF power, so I just got to decide whether I want to invest in it more. If I was a single product category, and I didn't have RF power, I'm kind of stuck, right? If I extrapolate that to a higher level. Well, so in 2010, EUV wasn't ready. So what does the industry do? We double pattern. And we triple pattern. Well, it's a lot of dep etch steps. Well, we enjoy that overgrowth or your outgrowth of WFE. Then EUV happened and litho became a little more important.

That's why we did WCO, world-class optics to increase our share in litho metrology inspection. So now we can do that. In the next 5 years, a lot of industry folks are thinking it's back to dep etch. The point is, these things change all the time, had a broad portfolio, if you can manage that well, allows you a better chance of outgrowing the industry sustainably over decades.

I guess what also helps is just the scale of MKSI and the ability to do kind of R&D through cycle. And even the scale, I think you previously mentioned that metrology and inspection was, I think, $150 million 5 years ago, now closer to $300 million. But that's -- that growth is also driven by your customers kind of telling you that if you do more R&D, you can get more business.

Right. Yes. Exactly. So many of our customers are looked for partners that can actually give them gifts of technology as we look to our suppliers. And that's how the ecosystem works. And so when you have scale, you have a better advantage of being able to satisfy some of the customers' ask of high technology that requires multiple years of investment. So in the 1990s, when I started, you could develop something and have it in production in 12 months. Now everything is a lot harder to do. Those easy things have been done. It takes years. RF power has developed over years before we saw a nickel. We put in a lot of investment for multiple years before we saw any revenue from that investment. But that's the way the game is played now.

EV in our industry is the biggest example. 20 years of investment finally is paying off for ASML for sure. So I think size does matter in an industry where the technology becomes more complicated, more difficult to do and the R&D investment requires a longer duration.

Right. Ram, I want to pass it over to you for a few financial questions. But the first one, just on the near term, you kind of talked about it earlier, but gross margin has been weighed down by tariffs and sort of product mix. But could you kind of talk about -- so how have these tariffs impacted your business and sneak peek into what gross margin could look like in 2026 and kind of what the puts and takes might be?

Yes. So the tariff had an impact on our gross margin. It did not have any impact on the top line. And the highest impact was in Q2, and we had 115 basis points of impact. Our gross margin for the year after including the tariffs was 46.6%, would have been well above close to 48% if we didn't have that tariff impact. That dropped to 80 bps in Q3 and our gross margin was 46.6%, including that, would have been above 47% without that tariff impact. And it's dropped to 50%. And like I said, we have matched dollar-for-dollar. We are recovering 100% of our tariff cost.

But since we are not marking up the tariffs, we'll continue to see a 50 basis points impact on the gross margin which we will -- we are confident we will overcome with the operational excellence programs going on in just manufacturing excellence and procurement activity primarily. We'll also have more design savings coming in the future years that will help with the margins. With a normalized mix, we are very confident to get back to the 47-plus percent in '26.

Got it. Got it. And I mean, when I kind of compare you guys to what you laid out back in '22 for the Analyst Day, like you're well ahead of where you guys kind of thought you would be in terms of gross margin?

So the cost control side on what we can control has been working well. And the next step change in margins will come with top line growth and the right kind of mix.

Got it. I ask one more question, and then I want to open it up to the audience for a question or 2, but just less interest expenses has been a pretty big driver of net income because you guys have been very proactive with paying down debt. I think exiting Q4, you'd be at 3.9x net leverage. Where would you want to get to in the kind of next year or 2? What's the sort of target net leverage that you guys are eyeing up?

So we're very happy with the progress we have made on managing our debt. And it's a combination of 2 things. One is the cash flow generation that we have had. And the two -- second is the focus on our capital allocation strategy and prioritization of strengthening the balance sheet. Our cash flow -- our free cash flow this year, up to -- in 3 quarters was almost equal to all the free cash flow we generated last year. So we are well on our way to beat our free cash flow generation year-over-year. So we not only have strong cash flow generation, but it's growing.

And with our current cost structure, that top line comes back to more normal levels, we can accelerate the debt repayment. With regard to capital allocation priorities, after we invest in ourselves with the CapEx expansion and a little bit of P&L design and R&D improvements, our focus is 100% to pay down our debt. And our goal is to get to 2x to 2.5x net leverage, which will get us more into a more balanced capital allocation strategy.

Got it. I'd like to open it up to the audience if there's any questions. Gentleman in the back.

I'm relatively new to the company, but what's the -- over the last couple of years and going forward, what's the unit volumes versus price equation for you guys? Would you have a lot of pricing power?

Yes. I think we have. We work hard on that every year. It's not an event kind of driven thing. You can see, as Ram said, our gross margin over the last couple of years improving. Remember, in 2022, we gave a 5-year model that said, when our revenue is $5.6 billion, we'd be at 47% plus gross margin as Ram said, at $3.8 billion, we already hit 47% plus in 48 months. So that's an indication of the value and the pricing power we have. So we've held our own. I think there's more opportunity going forward. I think the time to get an improvement in gross margin is the new design wins, right? It's harder to go back, I think, in change pricing. But for sure, a new stuff, if you're unique, then we're getting paid fairly for that.

Any other questions? I guess then I'll ask if you -- so on the semi portion, so for ALD, I guess, the kind of story there is your ozone generators, if I'm correct. Can you just kind of elaborate on that, sort of what makes MKS' solution there kind of differentiated versus competition?

Yes. So ozone is oxygen, 3 oxygen atoms together, and that's needed for every cycle in an atomic layer deposition cycle. And the uniqueness of our ozone generator is that it generates a much higher concentration that's much cleaner than a lot of folks in the industry. And there aren't a lot of left competitors. We talked about our -- at our earnings call that at 2 nanometers and below, there's a lot more ALD, a lot more ozone generation that has to go on that's higher concentration and cleaner. And so that's been the unique features of how we've been winning that share.

So when I think about kind of your content per, I think WFE dollar, it's kind of 1.8% to 2.2%, if I'm correct. Deposition would be probably on the lighter end, but hopefully, ALD kind of drives it upper.

Yes. Yes. So our revenue as a function of WFE varies between 1.8% to 2.2%, kind of depends on cycle, et cetera. But I think on the lower end of it would be our lithography metrology inspection because we're just early innings there. I think on the higher end would be NAND because of our RF power there and then a lot of other things in between. But I think the bigger picture is that whether it's DRAM building fast or NAND or logic or whether it's dep etch or litho, we kind of don't care because we're in 85% of it. So we're going to see most of it. And our job is to try to continue growing that share over time.

Great. So kind of hopefully, the customer is talking about a big second half 2026 comes true and you guys see good '26 then?

Yes. As I said, it's incrementally more positive since 90 days ago, for sure.

Great. That brings us up to time. Thank you, [ Don ], thank you, John. Thank you, Ram.

Okay. I think we'll go ahead and get started. Good afternoon, everybody. Welcome to this session for MKS. I'm Rob Mason, the senior analyst at Baird, that covers Advanced Industrial Technology. I certainly want to welcome MKS to the Industrial Conference. As you may be aware, MKS is a leading technology solutions and subsystems provider into leading-edge semiconductor manufacturing, electronics and packaging.

Very pleased to have Ram Mayampurath, the Executive Vice President and CFO with us; as well as Keith Loop, who's the Vice President of their Vacuum Systems and Services business. Ram is going to go through a few slides. There should be a little bit of time at the end for Q&A. And if you have any questions, direct those up to us via the iPad, and I'll work those in.

Thank you, Rob. Hello, everybody. Let's just get right and we have quite a few. So MKS is a foundational leader in technology. We'll get into the details of that in a minute here. But we provide precision solutions to our customers. We are engaged in solving our customers toughest problems, if you may. And as the technology demand gets more complex, as the demand on equipment and technology increases, it's good for MKS as we get into product miniaturization and more technology requirements, it works to our advantage.

We have a very strong close relationship with our customers. We do co-development with them. We -- the proximity to the customers and the technology discussions is a core strength for MKS. We are also very focused on driving value for our shareholders. Our execution remains very strong. We'll get into some of the numbers here in a minute, and we are very focused on driving profitability and cash flow.

These are 2024 numbers, and we'll take you through year-to-date 2025 as well, but $3.6 billion. We spent about 8% on R&D. It's the technology differentiation that helps -- that separates us from our competition and also gives us the price and the margin advantage that we have. We are about 25% EBITDA, and we'll get into some of the other numbers here in more detail in the slides ahead, the 85% of surround the chamber strategy and the 70% of the steps in the chemical business that we are in. We'll talk about that in a little detail in the slides ahead.

If you look at our main market segments, these are our 3 main market segments, semiconductor, which includes semiconductor -- traditional semiconductor that MKS has been involved in and also world-class optics, which is the litho metrology and inspection. Electronics and packaging that came out of the large acquisition we did about 3 years back of Atotech business; and specialty industrial, which is a collection of several markets, if you may, it includes automotive, it includes general industrial, it includes aerospace and defense, life health sciences and research. And by no way is it commodity business. It's very profitable, high-margin businesses, and we'll get into all of them in very much in detail here in the slides ahead. But just to give you an overview, those are the key market segments we play in.

And to take you through the next couple of slides, Keith will take you through the technology part.

All right. Thank you, Ram. So as Ram said, semiconductor is our core business, as you saw on the last slide. And so -- as you can see, the semiconductor business has a long history of steady growth over the last several decades, whether it's semiconductors for PCs or semiconductors for your mobile or handheld device. There's been strong steady growth of chip sales over that period. And now as we look forward in the last few years and as we look forward, there's still strong growth drivers in the semi business, really driven by AI, big data or any other high-performance computing. And so there's a pretty broad consensus in the industry that the semiconductor industry is going to grow to about $1 trillion in revenue by 2030. And even there's some -- even more recent reports of even numbers significantly higher than that by 2030. So there's a lot of good strong end demand growth for semiconductor chips.

And so walking the next layer back to kind of how that impacts MKS to make all those chips, you need to build factories and fill those with equipment. And so there's a measure called wafer fab equipment spending, which is how much money spent on equipment every year. And you can see in the last 5, 6 years, there's been a significant increase in equipment spending from about $30 billion 5, 6 years ago to over $100 billion now in the last several years. And so as the chips have become more complex to make the revenue that you saw there on the revenue side, it's the equipment intensity and the amount of money to spend to make that chip has gone up as well.

And so again, more factories need to be built, more equipment needs to be purchased. And if we hit the $1 trillion in revenue by 2030, on kind of a similar intensity assumption, that's going to mean that we need to increase WFE from a little over $100 billion today to well over $150 billion in just the next several years by 2030. So a great spot to be, good and growth drivers and good strong end demand for our semiconductor industry.

So if we go another layer down and say, all right, what is all this equipment that people are buying? What's in that factory? So if you go to a semiconductor fab, they're making that chip there that's in the middle. And it's kind of a complex drawing there cross-section of what a semiconductor chip looks like these days. And you can see multiple features, many layers, many different features that are made on that semiconductor chip. And to do that, you can see it's a circular repeating process in that semiconductor fab of photolithography, complex photolithography equipment to make the images etching and deposition equipment to put the patterns down and etch away and create the patterns that you need. And then you need to measure it and make sure everything is fine down to a nanometer scale.

So every one of those segments has very complex equipment to produce that semiconductor chip. And so this cycle repeats over 80 -- 90 times over 1,000 process steps just to make one wafer and can take over 3 months to make that wafer. So not very simple. And so if you look at where MKS plays in this space, we're in 85% of those pieces of equipment that are on the fab floor. So broad exposure, true critical technologies that enable that equipment to run in every one of those steps. And so we're not just selling some components, a screw or other part. We are selling critical enabling technologies.

One example is RF Power, which is critical for creating plasma and etching away very, very fine features. And so you need very precise power, very much controlled power, that's a key area of strength for MKS that we are, particularly in etch and deposition equipment where we provide that main kind of heartbeat of that piece of equipment. We also have been getting into the photolithography and inspection space with the acquisition of Photonics business back in 2016. And there, we're, again, enabling critical optics subassemblies into lithography and metrology systems to enable those to continue to push the limits of what we can do for our customers.

So we go to the next slide, basically, as we look at the semiconductor business, you see strong end market growth, great long legacy position that MKS has had over the last 60 years of providing solutions in that semiconductor space, and emerging with the lithography and metrology space and the photonics that's growing and building a base of as well. But that chip can't run just having a chip. It's got to go into a system. It's got to go into an overall advanced electronic device, which includes wafer level packaging, package substrate and printed circuit boards. And so that leads into the next segment, which is electronics and packaging that Ram had covered.

And so we play a critical role, just like we do in semiconductor space in the electronics and packaging space. We have electronic chemistry solutions that create those patterns on the printed circuit boards and those package substrates. We have equipment that goes along with that those chemicals. And we also have laser drilling equipment to create the features and the interconnects between the layers of the printed circuit boards. And so -- in the past, the semiconductor industry has improved performance, improved costs and improved power efficiency through improving the semiconductor chip. We've gotten to a point now where these -- especially these complex AI systems are creating needs that not -- we don't need just innovations on the semiconductor chip, but we need that package. Every layer you see below the chip to improve as well, need better performance, more layers, quicker connections, less power consumption. And so there's a lot of innovation now. You're probably hearing a lot about AI and packaging and the different constructions to help enable those complex systems and we're at the heart of that with our chemistry solutions and our laser drilling solutions.

So to kind of finalize here on the market overview. The -- really, this chart really shows the value chain and the supply chain of where we play all the way from the components that we make to the equipment that we feed into. The manufacturers that make the chips and then ultimately to the end device OEMs. And you can see that both on the semiconductor side where we sell to the big 5 equipment makers. And on the electronics and packaging side, where we feed chemistry and capital equipment to printed circuit board manufacturers that you see there and package substrate manufacturers. We are foundational to both sides of those industries that equipment can't run without our subsystems and those PCBs can't be made without our chemistries. And as the technology continues to evolve, we are key enablers partnering with our customers to develop solutions in those areas.

So to catch you up a little bit on what 2025 key financials, if you may, you saw the 2024 numbers. If you look at our three quarters of actuals in our fourth quarter guide, we are well on our way to be a $3.9 billion, close to $3.9 billion of top line, which is about a 9% growth year-to-date from prior year. EPS, which had a strong growth in '24 -- '23 to '24 is projected to grow more at about 22%. This is again year-to-date growth. And free cash flow, in the first 3 years of -- first 3 quarters, I'm sorry, of 2025, we have almost made the free cash flow we did all of '24. So we are well on track to exceed our free cash flow growth this year compared to last year. Last year, we were about average 11% of revenue. In this quarter, we will be about 15% of revenue. So free cash flow generation has been strong. So we are very good at executing changing agile responding to the geopolitics and the market requirements, and we are very focused on managing our cost as we grow our top line.

To get into some of the more specifics of each business segment that Keith just went over, $415 million in top line for semiconductor in Q3, that's a quarter-over-quarter, slightly down, mostly because the NAND upgrade cycle, which tends to be a little lumpy, was very strong in Q2 but was not as high in Q3. The fundamentals of the semiconductor business remains very strong, with the high Q2 NAND impact made the sequential comparisons negative. The year-over-year change, you can see is over 10%, and our guide for Q4 remains at Q3 levels. Again, we will see less impact of NAND because it's more driven by upgrades at this point.

Electronics & Packaging, which is part of the acquisition that I talked about and the details of what Keith just went through. Quarter-over-quarter, 9% improvement in Q3. Year-over-year, we have a 25% growth in that business, and it's chemistry and chemistry equipment. And a good part of that equipment business, in particular, is driven by the AI demand. And we have a strong guide getting into Q4 as well at $295 million.

Specialty Industrial, like I said, it's got a bunch of segments within it. GDP is a good measure to track that. PMI index is a good measure to go by. We are stabilized. It's still below what it used to be, but we started the year at about $270 million, $275 million a quarter. We're happy to exceed get to this $284 million level, $280 million level in Q3, Q4. And it's really tied to mostly auto industry and general industrial, which are the 2 bigger segments within that. And again, like I said, PMI is slightly started ticking above 50 now. And we hope as it gets to its more normal levels, we'll start to see much more profitability in cash generation.

To touch upon our capital allocation strategy, we are expanding our CapEx to get closer to our customers, mostly and to modernize our -- manufacturing facilities. We are building a new plant in Malaysia, and we have acquired land and build a chemistry plant in Thailand. We also have some activities going on in China and in Europe and Romania. Our CapEx tends to be about 4% to 5% of our revenue, closer to the 4% range, and that will continue for 1 more year, and then it'll get back more to normal levels of 3% to 4%.

So investing in ourselves, investing and supporting the growth of the business and continuity of the business is primary focus, investing in technology remains our primary focus for capital allocation strategy. And the second focus is we pay a modest dividend, about $60 million a year and strengthening our balance sheet by lowering our leverage. That's going to be our primary focus after the first 2 for the remaining period of time until we get our debt down to 2 to 2.5x net leverage. And the debt was -- is nothing new for MKS. We always borrow money for acquisitions. We borrowed money for the Atotech acquisitions, and we've been paying it down. It's just the discipline of paying it down.

So that remains our primary focus. Once we get our debt down to more acceptable levels of 2.5x net, we can get into a more broader capital allocation strategy that includes returning cash back to shareholders, if you may, and also inorganic growth support, which is a core part of our strategy.

We probably don't need to do any large acquisitions like the ones we have done in the past, the ones that for what we look at more will be tuck-ins and bolt-ons to our existing core businesses. We did buy back a small amount of stock in Q1 of this year, mostly to offset dilution, and that's very opportunistic.

So to sum it up, we have some -- we are in some very secular growth markets as we went through the segments of market we are in. We are very focused on driving profitability and creating value for our shareholders, and we'll continue to focus on cash generation and deleveraging and strengthening our balance sheet. As we look at 2026, given the tailwind we have on the top line, given our cost structure and the cash generation and a strengthening balance sheet, we are looking at a very good 2026 as we look ahead.

With that, I'll stop and take any questions.

Absolutely. If there are any questions, just feel free to raise your hand and we'll work you into the dialogue.

So Ram, maybe just a high-level question. As you think about the technology portfolio that you do bring to bear. You checked a lot of boxes as we looked at the diagram around wafer construction or chip construction. How do you differentiate on the technology side versus your peers? Is it breadth just having the touch points that you do or just elaborate on that?

Absolutely. Keith, do you want to start with that? And...

Sure. So I think one of the key things we do is, again, with the breadth of the products that we have, we have close relationships with our customers. And what we ultimately do is we solve our customers' hardest problems, as Ram has said earlier. So we really do -- when those technological changes happen, we're right there with them. We can see it coming with them. We can develop those solutions and enable their equipment to do what it needs to do. And so I think it's really about customer intimacy, which our broad portfolio enables us to be even closer to see those inflections coming earlier and develop the solutions that are differentiating in the marketplace.

Yes. Yes. And the differentiation that our R&D does is reflected in the differentiation we bring to our product that provides the stickiness in the business, the price stability and the margin. So the R&D dollars we spend are very well put to use. That's the core strength there.

Yes. You mentioned service several times in your overview. How does that mix in with the service revenue streams, mix in with those that are going to be more directly tied to CapEx? What's the mix there? And are you trying to change that dynamic?

I'll start and Keith runs the Service business, so he can certainly talk more about it. So we are very, very happy with the service component in our business. The acquisition of the Atotech business and the growth of our E&P was primarily focused on driving broader portfolio of products to minimize the volatility of semiconductor business, if you may. The service side of our business, including the chemistry, provides -- it's about 40% of our revenue with a high -- very high margins. That -- as that grows, it provides more stability to our overall revenue stream. And Keith feel free to add on anything more you want.

Yes, yes. So I think the service business in total is about $500 million of that kind of 40% that you said. And so it's been growing. Obviously, as the installed base grows, as we sell more equipment, that service business naturally grows and then we've really focused on engaging the end users who are using the products and our OEM partners and finding ways to add more value even in the aftermarket, and we've been able to do that and kind of outpace the growth on the service side and bring more value leading to increased margins as well.

And we have service associated with both semiconductor, photonics and MSD. And to Keith's point, as the installed rate base increases, the service revenue potential is going to increase and the profitability of that segment is very attractive for us.

Yes. You made mention at the end, you feel good about where you sit heading into 2026 around growth. How should we be thinking about MKS growth in the context of the WFE growth as a barometer for how fast that you could grow?

Yes. And I can again start and Keith can talk more about the WFE impact to our business. But where we sit, we are very happy with the level of execution and the focus we have had in deleveraging and strengthening our balance sheet. We are happy with the investments in the portfolio that we have. And the general shift in the discussion that we are having with you folks from semiconductor, just semiconductor to electronics and packaging as well. So the acquisition that we did a few years ago is really hitting its stride now. We're seeing it in the top line and AI is going to only take it forward. And when you look forward into the years ahead, we think we are in a very well position to both drive top line and profitability. So that's what I meant. But WFE, you can talk more about it.

Yes. So again, I highlighted the kind of history of WFE growth and the forecast of it going forward from the industry analysts. And MKS has a long history of outperforming WFE. We've outperformed WFE about 200 basis points, and we've done that over the last several decades, and we -- everything we see going forward, we should be able to continue to outperform WFE by about that 200 basis points.

Okay. What about the margin profile, thinking about the near-term margin profile, the puts and takes on gross margin given where the business is currently trending?

Yes. So the -- if you look at 2024, all the way up to actually Q1 of 2025, we were well ahead of 47%. We finished Q1 at 47.4%. Since then, two things happened. One is we started the impact -- we started seeing the impact of tariffs in starting Q2. And we started seeing the impact of mix, the equipment side of the chemistry business that I talked about earlier, we started seeing the impact of that. That equipment business is not -- is lower than the corporate average margins, if you may. But it's a good problem to have because -- it guarantees future very high-margin chemistry sales. So among our competition, the main competition we have are -- we are the only ones who sell the equipment. And that model of equipment plus chemistry works very well for us because more equipment out there, it's more chemistry for us. And the attach rate after 5 years, we say it's about 85%. So in the earlier years, it's higher than that. So that's very attractive for us. So that mix did help did hurt our overall gross margin in the short term. Regard to tariffs, we had 115 basis points of impact in Q2, without which we would have been close to 48%. We had 80 basis points of impact in Q3, we'd have been 47.4% without that.

As of Q4, we have offset the impact of tariff dollar for dollar. However, just because of math because we don't mark up those tariffs, especially pass through what we need to pass through, there will be a 50 basis points impact to the gross margin, although not -- no impact to the dollars itself. And we'll offset that. We are very confident of getting back to our mid-40s margin, 47% plus with just ongoing operational excellence, programs that we are running and once we get to a more normalized mix.

One thing that we've been asking all of the companies here is to try to get some sense as to how real is AI, right? And how you may be applying it? Yes, there's a lot of push to make it external customer, work it into customer solutions. But internally, I'm curious if you have any areas that there are examples that you could point to where you've applied AI tools and are driving some efficiencies or savings that you'd call out?

So internally, you mean within MKS or topline?

Internally.

Internally, I can start and Keith, if you can think of anything specific to. So we are early in our adoption of AI. We have teams of specialists in AI that's working with us. We are trying to train more experts to be embedded in the functions, if you may, functional leaders. So within finance, for example, there's a lot that AI can do, and we are early stages. We are scratching the surface. There's things we can do in R&D. And that is going to make our OpEx, in particular, a lot more scalable as we use more of that. But we are in very early innings right now. Anything specific you want to add, no?

Yes.

And did you effort to delever the balance sheet to your target level? Have you put a time line on when you think you could get to 2.5?

I haven't -- we haven't put a time line. We are very focused on getting 2 to 2.5x. And our past actions of prepayments, we've been putting money where our mouth is. The wildcard or the unknown there is really the top line. At our current muted top line, if you may, '23-'24 was very flat. We've been able to manage about $0.5 billion of payments around that every year prepayments and mandatory payments together. But as that top line comes back to more normal levels, we can certainly accelerate that. So that's the bit of the unknown plus anything else we can do from a portfolio point of view or to accelerate that, we will look at. So we haven't given a time line, but we are confident that we'll get to the levels we want to. And like I said, it's not uncommon for MKS. It's just that the last borrowing was larger and the market didn't get the top line where we needed it to be. So it's taken a little longer. But the discipline to get it back to acceptable levels is very critical for us. We've always done that.

Yes. Just on the Specialty Industrial segment. You mentioned that has crept up as the years unfolded from where you began the year. But are you seeing any green shoots of more substantive improvement in that part of the business? Any particular area?

So not really. So I think too, we have seen slight growth in aerospace and defense and in life health sciences, if you may. But the two big segments there are general industrial and auto. And as you all know, I mean, the auto news last one was slightly better, but not a meaningful impact yet. So unless we see something there, hopefully, the interest rate cuts will drive further demand. So unless we're something meaningful in those two segments, factory built and we have lasers that go into the factories. That's the Specialty Industrial component there. And the business related to the auto, we won't see a step change from where we are.

Yes. Is that a global business? Or is it -- pretty exposed to any particular region?

No, 100% global.

Okay. Any regions stand out as maybe better than another? I'm thinking maybe North America might be better than Europe?

No. We have businesses spread all over the world. We have local-for-local manufacturing all over the world. So I mean, if you look at MKS, our China exposure is about lower 20%, 22%. Most of that is related to the chemistry and the -- Chemistry business, if you may, and that China manufacturing is all local done in China. We have factories in Europe, and we have factories in North America.

Very good. Again, maybe the last call, if there's any questions before we wrap here? No. We'll call it then. Thank you very much, Ram.

Thank you. Thank you, all.

Thank you.

Good to see you.

Good day, and thank you for standing by. Welcome to the MKS Third Quarter 2025 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Paretosh Misra. Please go ahead.

Good morning, everyone. I'm Paretosh Misra, Vice President of Investor Relations, and I'm 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 2025 which are posted to our investor website at investor.mkscom.

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, 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'll turn the call over to John.

Thanks, Paretosh, and good morning, everyone. MKS delivered a solid third quarter with revenue and EPS in the upper half of our guided ranges and healthy results across each of our 3 end markets. Third quarter revenue of $988 million was up 10% year-over-year, driven by strong demand in our semiconductor and electronics and packaging end markets.

We continue to demonstrate strong execution in delivering value to our customers' most critical needs. Net earnings per diluted share totaled $1.93. We also continue to take advantage of our improved cash flow to reduce our leverage with another voluntary prepayment of $100 million on our term loan completed in October. MKS is uniquely positioned at the forefront of accelerating innovation and enabling the advanced technologies that power the AI era.

Increasing device complexity is creating significant challenges and opportunities in both the semiconductor and advanced packaging markets. We are differentiated in our ability to serve many critical applications with our comprehensive portfolio of semiconductor capital equipment subsystems advanced packaging chemistries and advanced packaging equipment systems. Our C3 performance in our end market demonstrates how we are benefiting in this dynamic environment.

Starting with our semiconductor market, we reported solid revenue growth year-over-year, driven by continued strength in our products supporting deposition and etching applications which are increasingly critical for advanced memory and logic manufacturing. Our dissolved gas systems for advanced logic applications were also a solid contributor to our performance, and our services business continues to contribute steady year-over-year growth.

Lower NAND upgrade activity, which was expected after a very strong second quarter, drove the sequential decline in semiconductor sales. However, our leadership in power delivery remains as strong as ever in this space. We expect fourth quarter semiconductor revenue to remain flat on a sequential basis, which would translate into a healthy double-digit year-over-year growth for 2025. This underscores how well positioned we are with the broadest portfolio of products and technologies to drive our industry's increasingly challenging technology road maps.

In Electronics & Packaging, revenue exceeded the midpoint of our expectations, growing 25% year-over-year. This strong performance reflects continued momentum across our portfolio, driven by robust demand for our chemistry solutions and, in particular, our chemistry equipment. The investments we have made over the past several years to position MKS to optimize the interconnect in advanced electronics are now paying off as we gain momentum in AI-related applications.

Today, our chemistry revenue growth reflects our position as a leader of the most advanced package technologies used in high-performance computing applications. Longer term, our chemistry equipment business highlights how critical we are to our customers as they rapidly build their next-generation infrastructure. The high attach rates from our equipment sales are a leading indicator of sustainable longer-term revenue from our proprietary chemistries. It's important to keep in mind that once we build and install the equipment, it can take 6 to 12 months for customers to qualify it and then put it into production.

Once in production, chemistry provides a long tail, steady consumable revenue generally for the life of that equipment. With high single-digit growth in chemistry revenues and strong equipment sales through Q3, we have confidence our proprietary chemistry will be a key revenue generator for us in the years ahead. In Q4, we expect revenue from our electronics and packaging market to be up on a sequential basis and up double digits on a year-over-year basis. Our strong performance reflects our ability to capture emerging AI-driven demand. even as broader industry demand trends remain stable in markets such as smartphones and PCs.

We anticipate continued strength in our chemistry equipment business, supported by AI offset by modest sequential declines in chemistry due to seasonal factors consistent with prior years. Assuming the midpoint of our Q4 guidance, our electronics and packaging business is on track to deliver robust full year growth of approximately 20%. Our specialty industrial market revenue was consistent with the stable trends we've seen over the past several quarters. Within this market, the industrial category showed sequential improvement. In life and health sciences and research and defense end markets remain steady.

We had a healthy quarter of design wins, particularly in research and defense. This success highlights how MKS leverages its semi and electronics R&D investments to unlock new opportunities in specialty industrial markets that generate attractive incremental margins and cash flow. Looking ahead to Q4, we expect specialty industrial revenue to remain relatively flat sequentially.

Overall, MKS is continuing to perform at a high level in 2025, with year-over-year growth powered by our semiconductor in electronics and packaging markets. Our broad portfolio of differentiated products and technologies in areas such as Baku, power, photonics, laser drilling and advanced chemistries positions us favorably to win new opportunities in applications critical to enabling the AI transformation.

Against this exciting backdrop, we are executing with financial discipline, aligning our business to win in our key markets and reducing our leverage. I'll close, I extend my thanks to our MKS team for their tireless work driving the great results we are reporting today and also to our customers and our suppliers across the globe for their collaboration and support.

With that, let me turn it over to Ram to run through the financial results and fourth quarter guidance in more detail.

Ram?

Thank you, John, and good morning, everyone. We delivered strong results in the third quarter, driven by healthy demand in our semiconductor and electronics and packaging end markets and continued stability in our specialty industrial end market. As in prior quarters, our execution remains strong with healthy margins, robust free cash flow and continued progress on our deleveraging goals. Third quarter revenue was $988 million, up 2% sequentially and up 10% year-over-year.

The result was at the high end of our guidance and reflected better-than-expected trends in key end markets. Third quarter semiconductor revenue was $415 million, down 4% sequentially but up 10% year-over-year. This result was at the high end of our expectations. The sequential decline was driven by lower RF power sales due to the timing of NAND upgrade activity as expected. The year-over-year growth was driven by strength in many product categories, including our vacuum products and plasma and reactive gas businesses.

The fundamentals of our semiconductor business remains strong. Third quarter Electronics & Packaging revenue was $289 million, up 9% sequentially and driven by growth in our chemistry and Equipment businesses. On a year-over-year basis, sales were up 25% and driven by growth in chemistry, chemistry equipment and flexible PCB drilling equipment sales. These strong results underscore the strength of our electronics and packaging business as we deliver enabling technologies for high-growth emerging AI applications and today's advanced consumer electronics. Chemistry revenue was up 10% year-over-year, excluding the impact of FX and palladium pass-through, continuing the strong growth trend over the last year.

In our specialty industrial market, third quarter revenue was $284 million, an increase of 3% sequentially mainly due to the improvement in the industrial market. Revenue was down 1% on a year-over-year basis. Overall, our specialty industrial business has remained steady for well over a year. Third quarter gross margin was 46.6%, just above the midpoint of our guidance. Gross margin was stable relative to the prior quarter, with tariff impact of about 80 basis points, 35 basis points better than last quarter, offset by a higher mix of chemistry equipment sales.

As we have stated before, the strong equipment sales we have seen throughout 2025 are a good indicator of future high-margin chemistry revenues. Third quarter operating expenses were $256 million at the high end of our guidance and higher sequentially, primarily as a result of an increase in variable costs, mostly related to employee incentive compensation tied to stronger business performance. Third quarter operating income was $205 million with an operating margin of 20.8%. Third quarter adjusted EBITDA was $240 million and above the midpoint of our expectations with adjusted EBITDA margin of 24.3%.

Net interest expenses was $45 million, in line with our guidance. Third quarter effective tax rate was 17.9% and just below the midpoint of our guidance. Third quarter net earnings were $130 million or $1.93 per diluted share and above the midpoint of our guidance. Free cash flow generation was very strong at $147 million, representing over 100% of our net earnings and 15% of our revenue. Through the first 3 quarters of 2025, we generated cumulative free cash flow of $405 million, nearly as much as we did in all of 2024. We invested $50 million in capital expenditure in the quarter. We expect CapEx to sequentially increase in Q4 but fall within the low end of our annual CapEx guidance of 4% to 5% of revenue.

We closed the quarter with approximately $1.4 billion of liquidity compared to cash and cash equivalents of $697 million and our undrawn revolving credit facility of [ $675 ] million. As John highlighted, we made a voluntary principal prepayment of $100 million in October. In total, we have made $400 million in voluntary payments thus far in 2025. We remain focused on executing our long-term capital allocation priorities of investing in organic growth opportunities while reducing our leverage through principal prepayments and working with our vacuum partners to reduce our interest expenses as market opportunities arise.

We exited the quarter with a gross debt of $4.4 billion and net leverage ratio of 3.9x based on our trailing 12-month adjusted EBITDA of $953 million. We continue to bring down our net leverage ratio as we generate strong free cash flow, make proactive principal prepayments and deliver high year-over-year adjusted EBITDA. Finally, during the quarter, we paid a dividend of $0.22 per share or $15 million. Let me now turn to our fourth quarter outlook. The guidance we are providing represents our best estimate based on the dynamic trade environment in which we are operating. We expect revenue of $990 million, plus or minus $40 million. By end market, we expect semiconductor revenue to be $415 million, plus or minus $15 million, reflecting the continued strong fundamentals of our business.

Revenue from electronics and packaging market is expected to be $295 million, plus or minus $10 million, which would be up 16% year-over-year at midpoint. As we look to model 2026, we would remind you that chemistry equipment revenue is poised to have a record year in 2025 and has historically varied significantly from year-to-year. Chemistry revenue which is the majority of our E&P revenue is much steadier and more predictable. Revenue from our specialty industrial market is expected to remain relatively steady at $280 million, plus or minus $15 million. We are guiding gross margin of 4% to 6%, plus or minus 100 basis points. The sequential decline is due to higher chemistry equipment sales in the mix and lower chemistry sales due to seasonality, partially offset by lower tariff-related impacts.

We anticipate our mitigation actions will nearly offset tariff cost dollar for dollar beginning in Q4. However, these costs are passed through 0 margins, and we anticipate tariff will continue to dilute our gross margin in Q4 and moving forward by approximately 50 basis points. With our mitigation initiatives in place, we remain confident and our plan to deliver our long-term gross margin objective of 47% plus. We expect fourth quarter operating expense of $255 million, plus or minus $5 million. As a reminder, OpEx is typically higher in Q1 as a result of higher stock-based compensation and fringe benefits consistent with prior years.

We expect fourth quarter adjusted EBITDA of $235 million plus or minus $24 million. We expect tax rate of approximately 2% in the fourth quarter benefiting from certain favorable discrete tax items in the quarter and bringing our full year tax rate to just over 14%. We expect fourth quarter net earnings per diluted share of $2.27 plus or minus $0.34. Wrapping up, MKS is executed at a high level through the third quarter, and we are expecting this momentum to continue in Q4.

We are winning exciting opportunities across our semiconductor and electronics and packaging end markets, and we are focused on managing our business with discipline to drive profitability and free cash flow. We remain focused on reducing our leverage. With our broad portfolio of products, strong secular tailwinds and an improving balance sheet, MKS is in a great position as we look to 2026.

With that, operator, please open the call for Q&A.

[Operator Instructions] Your first question comes from the line of Melissa Weathers with Deutsche Bank.

I think first, I want to touch on the E&P side. You said a couple of times in your commentary that equipment orders generally precede chemistry orders, and that can take about 6 to 12 months. You also mentioned that chemistries were at, I think, a record year in 2025. But I was quite clear on how you were guiding 2026, whether or not that should maybe come down or be stable. So any color on how we should be thinking about the chemistries flow through into 2026 after all the strong equipment sales?

Melissa, it's John. Thanks for the question. So we're not really guiding 2026, obviously, or chemistry or for the company. But I would say this, the equipment that we are building and installing now puts us in a very good position for additional chemistry revenue starting in 2016 and forward. I would say this, we really look at the whole market and its growth, and we've kind of said in our E&P market, we would grow 300 basis points above GDP. And that was made up of -- that was what we said at the Analyst Day, and that was made up of higher growth substrate business, single -- mid-single-digit HDI business and GDP-type MLB business. .

And those numbers are what we're staying with for now. But obviously, when we gave those numbers, [indiscernible] in the mix, right? And so I think, generally, things are better -- and I would say our ability to hit the 390 basis points above GDP, our longer-term target, is that we're very confident in that fundamentally because we are shipping a lot of that equipment and a lot of chemistry that goes with it. will help us get to those longer-term targets.

Okay. And then maybe on the semiconductor side. It seems we've seen some really positive pricing data points in memory in the last couple of weeks or months. And I think a lot of people are expecting a shortage situation in memory in 2026. So can you talk about like the order patterns that you guys saw in the quarter? Have you seen an acceleration in orders ahead of maybe potential capacity additions in the memory space?

Yes. We read the same reports as you do Melissa. So I think in general, we're happy that memory is recovering. Pricing is recovering and that the industry is moving towards a more constrained supply constrained environment. And I think our customer is probably better to answer whether they're going to be ordering more equipment from us. But certainly, in general, I think everything is positive in the trend towards memory equipment. .

Your next question comes from the line of Jim Ricchiuti with Needham & Company.

Wondering if you could give us a little bit of a better sense within the E&P business, and you can comment on Q3 or 9 months? How much of that growth is actually coming from equipment, which admittedly has been strong, and we know it can be a little bit lumpy?

Yes. Thanks for the question, Jim. I think we've said historically, when we looked at the MSD business, equipment can be anywhere from 5% of total revenue to 15%. And I would say because of the last 4 quarters of really strong revenues, orders and therefore, revenues were towards the higher end of that range and maybe a little higher than that. So it's really going to be probably the historic 4 quarters of a year for the equipment business.

Then, John, the -- also curious, there's another element of equipment in the PCB area. Are you seeing -- any signs of a cyclical pickup in the flex PCB drilling equipment business, just given somewhat improving smartphone shipments and I guess, the potential that there may be some form factor changes coming in the market next year?

Yes, we are actually seeing a pickup in flex the business there, as you know, we're a market share leader in flex laser drilling. And so we have seen that pick up. And this is actually the second year where we've seen a healthy business there. It's not at the historic rates that were kind of in the 2000 time frame, 2021 time frame, but it has recovered to a very healthy level.

Your next question comes from the line of Shane Brett with Morgan Stanley.

I want to follow up on the E&P question earlier, but considering that your chemistry sales for this year up high single digits, some back-of-envelope math indicates that your tooling business could be almost doubling this year? One, is that kind of the right way to think about it is that in the right ballpark? And just how much visibility do you have on equipment sales on a go-forward basis?

I think your math is roughly right with respect to the equipment business for chemistry equipment. And then I think what we could say is that we've had 4 strong quarters of bookings for that chemistry -- and we can look out, certainly, the lead times of our equipment are 4 to 12 months. And so we have added some capacity even to some of our equipment factories not new buildings, but just expanding within the space that we have. And so we look forward to a couple more quarters at least of large equipment bills. We know that we have the backlog for that. .

Got it. And for my follow-up, so your semi customers have spoken about a pickup in equipment shipments from the second half of next year. And I think your peers have been kind of cautiously optimistic towards the pickup from Q2. Just -- where are you guys in terms of your expectations towards semi revenue cadence through 2026? And if there's sort of any idiosyncratic tailwinds for MKS that should drive your shipments above WFE in 2026, they are very helpful.

Yes, certainly, we read the same things, and yes, a lot of folks are saying kind of second half 26 is where WFE really picks up. I think we're just focused on this quarter, next quarter and the next 6 months, I would say this. our semi revenue has improved double digits year-over-year on a quarterly basis as well as year-over-year. And this is really not with a lot of NAND upgrade, yes, right? We had a good NAND upgrade in Q2, not so much in Q3. And so that's still yet to come. Certainly, our customers think that's going to happen.

I think we know and we're very confident in our position in our power for the high aspect [indiscernible] we're very confident that when those upgrades occur, that will be us -- and then certainly, even without the NAND upgrade, you can see the broad portfolio of semiconductor critical subsystems we have continued to outgrow WFE even this year. And so we look forward to 2026, where WC follows the trend that people are expecting, another maybe high single-digit increase. We're going to enjoy some of that as well.

The next question comes from the line of Krish Sankar with TD Cowen. .

John, just to follow up on the previous question. If you do assume that in the second half of next year, let's just pick a time frame and say, in Q3 of next year's inflection in theory, should you not start seeing it 1 quarter earlier? Or do you think there's something else different in this cycle?

No, in general, I think that's still true, Chris. We -- if our customers are shipping in Q3, for instance, to your assumption, then we would certainly see that at least a quarter ahead of time. Our lead times have come back to historically low lead times anywhere from 4 to 8 weeks, sometimes 4 weeks depending on how complex the system is. But in that 4-week time frame and 8-week time frame, we do see a lot of in-quarter turns, as we've talked about in the last couple of quarters. So yes, I don't see any changes to that assumption, Krish. .

Got it. And then I just had a 2-part question. One is, how much of your E&P sales was advanced packaging chemistry? And how much you think that was AI? And then on the PCB drilling side, are drill bits a constraint? And is that impacting your business? Or you're not seeing any of that?

Yes. Maybe I'll talk about chemistry and how AI has played a part in that. In the past, we have talked about AI servers driving the top 1/3 of the PCB industry. The Pine calls that the substrate right? And that top third was the AI part of that top third was going from 5% to 10% to 15% of that top 1/3 of the piece of the industry. Since then, though, as we now know, AI is also driving the equipment for HDI and MLD. This is the next third and the last 1/3 of the PCB industry.

And of course, the chemistry that goes with those. So in general, our AI revenue has gone from -- for the chemistry, kind of that 5% of the total PC business, not just the opt to double that. over the last year. So the kind of 10%. If you had equipment to that, of course, we're pushing the mid-teen percentage of the MSD business due to AI.

I think your second question about maybe clarify your second question, it...

I was just wondering on the PCB drilling side, is dilbit drill bits are constraint -- and is it impacting your PCB drilling business?

Yes, I don't know if I can comment on that, Bill, is we don't do that. That's a mechanical drilling, I think, what you're referring to. We're really doing laser drilling. But I have not heard that, that mechanical drilling is constrained in the industry. .

Your next question comes to the line of Michael Mani with BofA Securities.

On E&P, could you help us parse through when you look at your growth drivers, what is exactly secular versus more idiosyncratic to MKS. So I mean, it seems like a lot of the HCI MLB momentum reflects some of this secular uptake in the AI. But Obviously, without a tech, you're able to go into many of these opportunities in both equipment and chemistry. So is there a share gain overlay aspect to it that you're seeing? Can you attribute these wins to that deal? Or is it mainly just broad-based secular growth?

Yes, I think it's both, Mike. So the regular growth is we're industry leader in it. And so more square meters of boards on the chemistry can not just enjoy that. But I would say the thing that is different this time and that's beneficial for Encasis the AI is driving these incredibly thick boards, many, many layers of HDI boards, substrate boards as well as MLB boards. And as we talked about, a lot of the equipment orders that we have gotten tied to AI for HDI and MLB are because our equipment is uniquely qualified to process much thicker boards.

We had to make modifications to the equipment. We did and then we got those orders. Now as we said, we have very high attach rates of chemistry to our equipment. So if we are unique in being able to supply that equipment versus our competitors, we're also going to get that chemistry as we talked about in the call. So I think that's unique this time around.

Great.

And maybe a question on gross margins. Given this flow-through from potentially higher chemistry revenues over the next couple of quarters, -- how should we be thinking about as a good baseline for gross margins through next year? It seems like volumes are training the right way you're getting -- you're having seen a little more of this margin accretive business. But -- just any way to think about auto model margins through 2016? .

Michael, this is Rom. I'll take that. So if you look at the progress we have made in gross margin in 2024, all the way to Q1 of 2025, we were well over 47% in gross margin. Since then, a couple of things have happened. One is the impact of the mix that you talked about of very high fast growing equipment sales and the impact of tariffs. As we said in our prepared remarks, we have offset the impact of tariffs dollar per dollar, but we'll see ongoing 50 basis points impact on our gross margin because we are not marking up the tariffs that we pass through, right?

So in time, we'll offset that with efficiency and ongoing operational excellence programs. And in the long term, with a normalized mix, we are very confident we can get back to that 47-plus percent that we were having before.

Your next call comes to the line of Matthew Prisco with Cantor.

I guess to start, -- how do you see the NAND lumpiness playing out over the next handful of quarters? Kind of what are the primary moving parts you are focused on here as determinants for the linearity of that upgrade cycle?

Yes, Matt, I wish I knew. But I would say this, we have plenty of capacity, manufacturing capacity to meet any kind of uptick in either upgrades or greenfield. And I think 1 of our key customers has said, there is a large opportunity still of upgrades just in the '26 and maybe beyond time frame. But they have said it's lumpy. But then I think overlay on top of that, the industry discussion of NAND pricing that I think Melissa asked earlier, that's just a tailwind, the discussion by many of the chip makers that NAND is now constrained.

And then what's exciting is potentially a new application for NAND, driven by AI again, of course, which is in the cell -- replacing solar, solid state drives using more NAND for AI. and that would drive another layer of growth. So I think we're ready. It's lumpy, can be lumpy. We will certainly try to guide you guys as best we can in terms of when we see that coming -- and -- but things can change and things probably will change rapidly.

And then maybe you can talk about progress you've made in the litho inspection and metrology part of your business, maybe remind us of kind of year-to-date highlights and what success would look like to the team from a share gain perspective through next year?

Yes, Matt, we have talked about world-class optics. This is our effort to gain more presence obviously in litho metrology inspection. And we talked about in the past, revenue from that sector kind of going from the $150 million to $300 million because we invested in it. And as you know, litho metrology inspection is a little flatter this past year. And so we're not immune to the cycles, but the cycles are more muted than in debt etch. But we're really happy with some of the really difficult things that we have been asked to do and delivered on that are now integral to some of the most advanced Lepage machines in the world. .

So we will continue to invest there and continue to try to grow that share. I don't think anybody would say litho metrology and specing won't be important to semi, right? It will always be important to semi, always be a key component of semi -- and I think maybe stepping back a little bit, the strategy for MKS is to be a foundational technology supplier to the entire industry. So in 1 decade, Det etch is more important because it's multi-patterning. In the next decade, EUV takes over and the filmetrology inspection become a little more important.

And from an MKS standpoint, we kind of hope that all the markets grow. But if something shifts, then we can -- we don't have to worry about it shifting away from what we're doing.

Your next question comes from the line of Steve Barger with KeyBanc Capital Markets. .

John, you alluded to some of this already, I think, but we've been reading that CoWoS or other packaging formats are evolving from organic interposer to -- from your perspective, is that just switching from 1 format you enable to another? Or is that evolution good for you due to more layers or smaller features?

Yes. I think the industry is certainly working hard on various configurations for this redistribution layer, the RDL layer using Koos, CoSaraclel, and then even coat, right, on TV. So I would say this, that RDL layer is more complex as we move to organic layers. That's good for us. That's our traditional strength, organic layers versus silicon. And when you go to organic layers, the RDL layers increased a little bit, maybe from 1 layer to 2 or 3 -- so that's good for us. But I think the bigger picture the 40 layers beneath that, that are all the substrates and PCBs. And that's really the largest growth factor for us -- and that used to be 20 layers, now it's 40%.

As we visit customers as we work with our customers, they're already looking at 80 layers. So think about that. It's gone from 20 to 40 just in the last couple of years. and we're working on 80. And the 1 after that is 3 digits. Let's put it that way in terms of number of layers of these layers made 1 at a time. you can imagine the challenges of yield, making sure that when you put 100 layers on top of each other that it still yields the same as if you had 4.

So those are great challenges for the industry and opportunities for us. So that's the bigger picture. At the same time, to your point, there's a lot of [indiscernible] and all that going on. We're involved in all of that. If it goes more towards organic that's a tailwind for us. But the bigger picture is 40 layers going to 80 going 100.

Right. That's good detail. And -- and just listening to some of the OS, this is being driven by compute right now, which is high growth, but smaller unit volume maybe -- but at some point, this likely transitions to like PC or mobile, higher-volume applications. Is that your understanding? And any view on like time line of when that could happen?

Yes. I think our view is consistent with the industry is that as inferencing goes out to PCs and phones and whatnot, The checks will be bigger and more complicated. There will be more chips that need to be integrated together. And therefore, there will be more layers of PCBs or substrates underneath. So that still has not really happened much yet, Steve. And so that's a huge potential growth driver for us. And I think everybody is working hard to make sure that things that AI drives this inferencing need. So think TBD, but we're optimistic that, that will happen or some form of that will happen. .

Our next call -- our next question comes from the line of David Lu with Mizuho.

On for Vijay. Maybe the first 1 on revenue by GE. Can you just highlight what types of trends you're looking at split by geo? I know your customers mentioned some write-offs, but there's also maybe some tailwinds in the U.S.

Dave, just to me to understand your question, you wanted some color on revenue by geography?

Just what you're seeing in terms of the demand trends yes.

Yes. Well, certainly, a lot of Asia is driving a lot of the growth, for sure. But as you know, -- some of that's coming back to the United States as well as the Japan and Europe as people start onshoring chip fabs and packaging fabs to that matter. But I think the other larger geographic trend is China plus 1 trend as things move to Southeast Asia. As you know, we are building some factories in Southeast Asia to meet that demand because our customers are moving there.

So I think there is a lot of geographic movements in the industry today, especially the packaging industry, but also the chip industry, as you see fabs coming up in the United States, Europe, Japan and potentially India as well.

Okay. And then I don't know any comment on the recent rumors of potentially selling the specialty coating divestiture.

Well, we're aware of those articles, but we really don't comment on market speculation, Dave?

Your next question comes from the line of Joe Quatrochi with Wells Fargo.

Yes. Maybe 1 on the semi side. Given the entity list affiliate rule, it looks like it's delayed. Have you seen any change in order patterns or discussions with your customers?

Yes. Thanks for the question, Joe. Not really because I think when that rule came out, we didn't have -- I don't think the industry had time to react, but some of our customers have said the impact is and on late. So as you know, the tariff environment is kind of wake up every day and changes. So we really haven't had any kind of different discussions with our customers based on that specific role.

Got it. And then just your, I guess, conservative comments in terms of looking at like chemical growth into 2026. Is there a particular end market that you're maybe a little bit more conservative in the outlook for the smartphones or PCs, something like that?

Yes. I would say the PC and smartphone markets have been stable, if you will, go, but there are some things that could drive it higher in the future. We're just not sure if they will 1 of which is new form factors for phones, multiples, for instance, more foldables. And the other ones that we talked about earlier, I think what Steve asked a question about inferencing cut out to phones and PCs, that certainly would be would change the outlook in terms of more of a growth outlook for PCs rather than kind of more stable, which is kind of our assumption. .

Your next question comes from the line of Mark Miller with the Benchmark Company. .

Thank you for the question. You noted strength in dep and etch. Are you getting getting share in those areas?

Yes. I think we've had a traditional strength there in deposition that's kind of a legacy MKS business. I would say this, we gained share in multiple areas. We talked a little bit about even dissolved gas. And as the industry moves towards more advanced nodes like 2-nanometer, the ability to clean wafers, the ability to do soft etching and soft cleaning. These are all things that are driving some of our subsystems in the reactive gas part of our business. .

So we've got a lot of good opportunities there that we've been capitalizing on. And of course, power for NAND is something that we are very confident we will hold that share and as that grows, into higher aspect ratio edging for things like DRAM. And then we're working hard on conductor etch. And we have some great solutions there that our customers have told us are industry leading.

I was wondering if you can give us some color on lasers and your outlook for next year from the laser business.

Yes, lasers has been a little muted because, as you know, lasers are used in industrial applications and industrial applications have been more muted than the last couple of years. PMI is still kind of hovering around that 50% or a little below. So I think we really have to see a change in that, Mark, before we would kind of see the lasers part of our business grow. .

[Operator Instructions] Your next question comes from the line of Jim Schneider with Goldman Sachs.

I was wondering if you could maybe kind of comment on -- given all the things we covered earlier with respect to tariffs, how you expect your direct China business to trend directionally heading into next year? What do you expect it to be sort of up, down or flat-ish?

Yes. Well, in China, we have 2 markets that go to China. The semiconductor equipment to rent to China. That's out of our numbers. We still sell a little bit there, what's allowed. So that's not -- that's been out of our numbers for a while. So we do have an indirect exposure in China based through our OEM customers, and that's well known. But then we also sell obviously advanced electronics packaging to customers in China. And that still remains a good portion of our business, but many of those customers are also building new capacity in Southeast Asia, as we talked about earlier. So we see that trend probably China will be a big part of our business. from a packaging standpoint, not so much from the semi direct standpoint. And then things start moving, I think, outside of China from the packaging standpoint.

And then maybe relative to your leverage target, you've talked consistently about 2x in 2027. Maybe talk about sort of the level of urgency to get there. Could you achieve it perhaps a little bit earlier than that? And maybe talk about some of the levers you might pull to sort of achieve it.

Jim, this is Rom. I'll take that. So we've made great progress in keeping our focus on deleveraging. We paid down $400 million in prepayment this year that's following $426 million of prepayment we did last year. And that remains our focus. Our capital allocation strategy has not changed, investing in our business and then paying our debt down. That's been our focus. In terms of accelerating that, the best way to do that will be with our current cost structures when we see the top line come back to more normal levels, we will be able to generate more cash and accelerate our debt payment. -- you're right is the net leverage target we want to get to, and that's our goal. I don't want to speculate on a time when we'll get there, but 2.5% is our net leverage target.

I'm showing no further questions at this time. I would now like to turn it back to ParatasMisra.

Thank you all for joining us today and for your interest in MKS. [indiscernible] you may close the call, please.

Great. We'll go ahead and get started with the next session. Thanks, everybody, for joining us at the DB Tech Conference here at Dana Point. I'm Melissa Weathers. I'm the lead analyst covering semi cap equipment and memory here at Deutsche Bank.

And for our next session this morning, we are pleased to be joined by John Lee, President and CEO; and Ram Mayampurath, CFO of MKS. And I had to remind myself to call it MKS and not MKS Instruments this time.

Before we get started, if anyone has any questions from the audience, feel free to raise your hand, and we can get a mic over to you.

So I guess to kick us off, I'm going to keep it a bit more near-term focus, just to kick us off. You reported earnings a couple weeks ago. A pretty strong quarter, in my view, which is very impressive given some of the other trends that we're seeing in WFE and in the semi cap equipment space right now. So could you just recap us on what are the main takeaways from the quarter you just printed? And what are the main takeaways you want investors to have walked away with after that print roll?

Ram, why don't you take that?

Sure. So it's interesting to see what top line can bring to the overall P&L and cash flow, right? We had 473 -- sorry, $743 million as top line, and it's been a while since we saw that kind of a top line. It's been 8 quarters actually. Semiconductor did very well. Electronics and packaging, which is a very profitable part of our business did very well. And that speaks for the breadth of the portfolio and the reason why we did that acquisition to take us away from the cycles of semiconductor.

The flow-through in gross margin was very strong, 46.6% with the 115 basis points impact of the tariffs. This is the first quarter we saw the tariff impact. Without that, we would have been close to 48% gross margin. Cash flow was 14% of revenue. And OpEx scalability, we saw. OpEx was in the low end of what we guided.

So the takeaways are the steady improvements we have made over the last several quarters to the cost structure. And what that has -- we've been running 47-plus percent gross margin for 7, 8 quarters now. Last quarter was the one where we dropped again, mostly because of the tariffs. And what the current cost structure will help do when that top line comes back to more normal levels and the flow-through that we saw is, I would say, the key takeaway.

I would add, the other takeaway, obviously, is our progress on deleveraging. And so the last 2 months, we prepaid another $200 million. The free cash flow is allowing us to do that. And this is, as Ram said, in a very relatively muted market for us. So those of you who follow MKS know how much it flows through on the top line growth. So we're pretty happy with where we are today in controlling the costs and making a progress towards deleveraging and then spending ourselves up for lots of engagements with customers for design wins as well.

Great. Maybe let's dig into that top line performance. The WFE environment has been relatively mixed. I think we've seen some mixed prints from some of your customers in the last couple of weeks. Can you just remind us where are we in terms of inventories at your semi cap customers? And then how do we think about MKS' performance relative to the broader WFE market, especially in a world where we don't have as much of an inventory overhang as we have?

Yes. So inventory has burned off. So that's good. You saw our first half performance versus our first half last year was 18% higher year-over-year, first half to first half. That's comparing ourselves to ourselves. So there was still some inventory burn occurring last year. NAND upgrades happened, whereas last year didn't. And that was a part of it as well. So growing 18% year-over-year is excellent compared to WFE, which is kind of 5%, give or take.

You're right. Going out, it's hard to predict. Some of our customers are saying, good. Some are saying, not so good. But we always look at it long term because quarter-to-quarter, even half-to-half, it can vary for sure. But when I look at the macro trends for semiconductor equipment, it is more tailwinds for us now. And a couple of them are NAND upgrades continuing to happen. They can be lumpy, but they are going to continue to happen, and we have really strong market share there. So remember, when you're upgrading, you have to upgrade from something that's already there and it's kind of been well known that we're the only ones there, right?

I think also our broad portfolio strategy is to allow us to take advantage of wherever inflections are occurring and how that impacts particular subsegments of critical subsystems. That strategy has allowed us to outgrow WFE by 200 basis points a year for 10 years. And if you think about what's going to happen in the next 5 years at least, chips are becoming more vertical. Last 5 years is about litho. EUV came in and we were print better. Five years before that, it was double patterning because litho wasn't ready, right? So these things always happen. In the next 5 years, it's going to be probably more etch-dep centric. Now we want to be a foundational supplier to litho, metrology, inspection as well as dep, etch, and we've made some progress there. But we are still stronger in dep, etch. And so I think that's going to be a relative tailwind for us going forward in the next 5 years because of an inflection in chip structure.

I want to dig into more of that because I don't think you get quite as much attention on the leading-edge node side. Everyone pays attention to NAND and the memory piece. But gate-all-around, I think, is a -- like you said, it's much more dep-etch intensive and you guys have decent share there. So any more color technologically on some of the ways that you're able to enable some of those critical dep and etch technologies.

Yes. So gate-all-around is another example of chips going vertical, right? Before it was just planar lay down a layer, print it, lay down another layer. Now you're making gate-all-around means a tube. And you're going to surround that tube, and you got to make a tube, and then you got to get rid of stuff around it and then you go and then put the materials you want around it. That's crazy, right?

A lot of that requires atomic layer deposition processes, putting things down one atom at a time in all directions simultaneously. And a lot of the subsystems that we make enable that. So we've been in ALD a long time with ozone systems. And now it's just a lot more ALD-type applications. You can see some of the customers who are -- have traditionally been strong in ALD have really grown, ASMI, for instance, as well as Lam and Applied. And those critical subsystems, we're seeing that pull as well.

And the other thing that maybe gets lost is a lot of cleaning. Cleaning of surfaces after you remove some material. Now you're not cleaning just a surface, a flat surface. You're cleaning, again, 3 dimensionally. And that, again, requires dissolved gas kind of cleaning. And that's what we talked about in our earnings call, a big pull in dissolved gas for 2-nanometer applications. And that's where it's getting harder.

We have had competitors in the past. But over time, as things have gotten harder, we've been able to invest in making the next-generation dissolved gas systems. And I would say now, our market share has continued to increase there. A small subsegment of our business. But when you add a lot of these things up, that's how we are able to outgrow WFE by 200 basis points a year.

You talked about lithography. I want to touch on your world-class optics business and specifically the semiconductor side. I think you had talked about a big design win or some increased momentum at some lithography and maybe some metrology and inspection. And so can you talk about the progress you're making there and what the market outlook you're seeing is?

Yes. So it's something that we started 5 years ago. We said litho, metrology, inspection is a great market. We have some capability that limits us in terms of what other things we could do for these companies. They told us that. And so if you invest in other capabilities, we'll give you more to do. And so we did. More CapEx, more process engineers. So we're developing new processes to make advanced optics. And then we're putting together optical subsystems. And so 5 years ago, we were about $150 million, that subsegment, litho, metrology, inspection, now $300 million.

And by the way, the first 3 years is just about investing design wins until you see that volume. And in that space, it's much stickier, right? Those critical subsystems stay for a very long time, decades, even longer than vacuum-based equipment. It's a little less lumpy as well. And so we can see ourselves continuing to do this. I think it's still mid innings, if you will, in terms of our ability to continue gaining share through investments.

Maybe let's go back to the NAND topic. I think when you first spoke, you said that the NAND upgrades happened, past tense. But then you said that NAND upgrades are happening. Can you help us understand, at least from your perspective, what kind of buying trends are you seeing? What kind of upgrade trends are you seeing? What are the key drivers of that NAND upgrade cycle?

Yes. So if you step way back up to the highest level, what's the fundamental need for NAND memory, right, nonvolatile memory. And if you go back in the 2010s, the reason NAND really rocketed up was because it was replacing hard disks for smartphones and for PCs. That's kind of done now. So the question is what's the next big application for NAND? And you're starting to see some of it in AI data centers, right? It's not as much as DRAM, HBM, but people are starting to talk about high bandwidth flash. Pretty exciting, kind of taking NAND chips and stacking on top of each other. So fundamentally, it's going to be the market driver that requires us to -- as an industry to put CapEx into NAND manufacturing.

If I look at today, it's still most efficient for our customers' customers to upgrade. But at some point, they're going to need capacity. And even today, some customers are saying, I just don't have a fab to upgrade, so I got to build greenfield. But there are not a lot of players in NAND. So that's why it can be lumpy.

Lam has talked about a certain number in terms of the opportunity. Their SAM is some subsegment of that, sorry. And ours is a subsegment of that because we're really talking about [ biometric ] etch. But you can see that when it happens, that was the upside surprise in our Q2, and it was significant. And to Ram's point, it flows through very quickly.

And as we think about those semi cap customers resuming now that inventories have burned down. I think we talked about this on the last earnings call, but their order patterns, do you expect kind of a rush back to refill their inventory? Or what kind of rebound do you expect from the purchasing side from your...

Yes. Well, I think we're shipping to end demand. I think that's the bottom line. And just to give you a little more detail, we have inventory at our customers. We own it, right? It's consigned. So they always have some inventory to pull very quickly. And as they pull, then we refill. So there's a buffer, built-in buffer by design, right?

Our lead times now are pretty short, back to kind of normal. Now our power decks are pretty complex units. So those lead times are a little longer than our Baratron or flow meters, but they're back to normal. So our customers can plan. They know that if they order X, they're going to get it in that same time period. So they're able to plan and not need to over order or order for inventory. And so I think we're in a good spot as an industry and certainly for MKS's inventory, we're shipping to end demand.

Great. And is that the case across DRAM and foundry logic as well?

It's a case across all of our critical subsystems.

Is there any tightness in particular areas? I know HBM, we can get into the advanced packaging side later on in the discussion, but...

Yes, it's advanced packaging that's got the tightness in, then the equipment orders, but not in the semiconductor chip manufacture part for us.

Got it. Well, with that, let's transition over to the E&P side. This has been a nice profit driver for you guys in recent quarters and a nice revenue stabilizer, I think. So I guess at your 2022 Analyst Day, you outlined the revenue growth target, I think, for this business of GDP plus 300 basis points. There are a couple of different segments within this business that you've talked about growing at different growth rates. So can you just remind us what are the moving pieces within this E&P segment? And maybe we can dive a little deeper into each of those.

Yes. So how we characterize the electronics and packaging market is PCBs, printed circuit boards, right? That industry can be segmented into 3/3. The bottom 1/3, we call multilayer board PCBs. Those are lower technology, if you will, fewer layers, bigger features, think washing machines and dishwashers. Big industry, though, and we have market share leadership there. The middle 1/3 is HDI, high-density interconnect PCBs, think smartphones, more layers, smaller features, more complex, higher ASPs. And then the top 1/3 is what we call package substrate PCBs. They're all PCBs and even smaller features, and that is what you need to connect large chips to a large chips. So GPUs together or CPUs together, or GPUs with CPUs and HPM. And that's really what's enabling data centers in AI today.

And the top 1/3, we think grows at high single digits; middle 1/3, mid-single digit; and lower 1/3, GDP. And we [ mush ] it all together, and that's where we came up with GDP plus 300 basis points for the entire slug because we participate in all 3. Now we're not changing our model right now today, but I would say some things for us to consider is we have been getting a lot of orders for equipment for HDI and MLB. Those 2 lower technology levels. And we asked why. We're not making more washing machines or smartphones than normal, and it's all driven by AI.

So AI boards, the chips go on that higher level package substrate, but then it's got to go on to something else, HDI, and then something else MLB before it can talk to the outside world. And those HDI boards are many more layers than what you need for smartphone. So more complexity. And the MLB boards are many, many more layers than you would need for dishwasher.

So AI is actually driving the entire industry from the most advanced to the middle to lower edge. And what we're seeing in terms of constraints is a lot of our customers are ordering equipment for HDI and MLB processes. So they don't have the capacity. And we've had 4 quarters now of very strong equipment bookings. And historically, it's been a very lumpy kind of business, chemistry equipment, but it's been 4 quarters of strong equipment bookings, and you can start seeing in our numbers as well.

And I guess two questions on that. The sustainability of that spending, are you worried that it could fall off? And then second question, how would you characterize utilization levels of the current capacity that's in place today?

Well, the current capacity is very high. Otherwise, they wouldn't be ordering equipment. Equipment is lumpy. So we come from a semi CapEx world. We just deal with the cycles. So at some point, the equipment orders should slow down. But we haven't seen that yet. In fact, after the first quarter of higher bookings and equipment, I thought maybe it's over, right? And here we are on the fifth quarter, and it's still looking pretty good.

But the most important point is that equipment that we're selling comes with our chemistry, almost 100% market share. And that chemistry is, of course, much higher gross margin and consumables and is always going to be used for the future. Even after 5 years of -- after 5 years of running that piece of equipment, we still have 85% market share of our chemistry on our equipment. So the installed base of equipment that we're putting in now and for the next few quarters, that's going to pertain to great market share gains in chemistry.

Maybe let's just zoom out a little bit on that topic. Atotech, I think it's now been 3 years since the acquisition closed. And sorry, Ram, know some of this predates you, but can you give us a high-level review of like how have those 3 years been? And how has the acquisition played out versus what you were hoping for?

Yes. I'll start, maybe Ram can add. But I think in terms of cost synergies, we got that, that was pretty fast and easy to do. I think in terms of the strategy, like the reason why we bought Atotech, we thought packaging was going to be more important. We thought packaging was going to be harder to do. And we thought it was going to be the same movie as semi. That all not just been reaffirmed, but even more because when we decided to make the offer to Atotech, AI wasn't in anybody's consciousness. AI just put an exclamation point on that strategy.

The other part of the strategy was that having equipment and chemistry knobs was going to be an advantage to gaining market share. We just talked about ordering equipment with all our chemistry, that's another exclamation point on that strategy. So I think when we closed Atotech, the industry went a downturn. So it didn't look good. Like, well, and of course, interest rates are much higher. So all these assumptions were kind of against us. But now you start seeing the strategy play out and you start seeing what we believed was the reason of putting Atotech together with the rest of MKS.

Ram, if you have anything else to add to that?

No.

As we talk about -- or as we think about some of those new packaging technologies, that's -- I agree with you, it's some of the most interesting growth drivers in the space right now. As we think about CoWoP, CoPoS, some of those new acronyms that we all have to learn what they mean, which one of those makes you the most excited? What should we get excited about for MKS on that packaging piece?

Yes. I think there are incremental tailwinds. So CoWoS, we all know, is TSMC's chip on wafer on substrate, that substrate is the PCB, the highest level is PCB. So that's good for us. The wafer, the chip on wafer, that's redistribution layer of silicon. So we're not as strong there. So okay, but it's 1 layer.

CoPoS, chip on panel on substrate. Substate stays the same, chip stays the same. The panel is replacing the silicon RDL with the PCB. For us, that's great. So an incremental tailwind but it's 1 layer versus 10 more layers in HDI or 15 more layers in MLB.

And then CoWoP, chip on wafer on PCB. So the Ps are different. The idea there is to get rid of the S, which is also a different type of substrate. It's the most advanced PCB substrate. Let's skip that step. Let's go right to HDI. If we can do that, it's cheaper and faster for the integrated server board. But that requires more layers of HDI, smaller features than we've ever made. And I think they're going to come to technology providers with more knobs in order to do that because if we could have done that, we would have done that. We couldn't do it, and that's why we went to substrates, different layer, different type of PCB.

So now the idea is if we can make HDI even better, could we remove that need for a substrate. That's going to require a lot more development. And we're, of course, intimately involved with our customers.

Maybe if I could squeeze one more in. Glass substrates. Can you remind us how you play in on the glass side?

Yes. So people have talked about a glass substrate. There's 2 -- when we talk about it, there's 2 different applications, a glass substrate core of which PCBs are put on both sides that allows that package of PCB layers to be more rigid, okay? That's a great idea. It's one layer. We've been working on glass for 15 years. We hope it happens, actually, and because we've been working on it for 15 years. But it doesn't happen, it's okay, too, because that core layer just stays a PCB in which we play as well.

The other glass layer potentially is at the chip level. Chips going right on to glass, and that's probably a little further out, I would say, a lot more technical problems to solve. So glass is something we've worked on it happens, great. It doesn't happen, okay, by us.

Okay. I'll just pause here to see if anyone has any questions. No. We can keep going.

On the specialty industrial side of your business. This, I think, is a less appreciated part of your business. There are a bunch of different moving pieces. It's difficult to model. If -- I guess for my first question, what's the most misunderstood part of your specialty industrial business that you wish investors could appreciate more?

Well, I think we've talked about it, but it's leveraging the R&D. We're spending in semi and E&P. It's not like we don't spend any R&D in specialty industrial, certain areas where we do for sure, but much lower relative R&D percentage for the same revenue and the same profitability. So it's stable -- more stable business, many markets. So you're right, it's hard to model, but when you mush it all again, it kind of is flattish, right?

Recently, I think we've had some automotive headwinds and industrial-industrial headwinds, like everybody else, has come down a little bit. But it's a nice stabilizing part of our revenue stream. Now it's not that -- it's not part of our strategy is to buy companies to grow specialty industrials. Our strategy is to grow semi and to grow E&P. And it comes with a specialty industrial component that leverages that technology, it fits the model and it's good for the P&L.

Does it even make sense to -- a lot of people ask, why not divest the business?

Well, I think part of our strategy is always -- our responsibility is always to 2 things. When we buy a company, make everything better, whether it's in semi, E&P or specialty industrials. It's also our responsibility to look at each one of our businesses and say, is there a better home for it? And we always do that. We've set out a couple of things over the last 10 years, not many. Because when you make things better, say, "Well, why don't I want to get rid of this," right? But we always look at that as an option for sure.

And some of the things we've spun off have gone to other companies, they've grown it. The employees we spun off, there's 3x more. The revenue is better because they're in that market, and those companies care about that market more than we would have. So we'll always be looking at that portfolio management.

Well, let's get Ram involved in the conversation. Ram, I think you're coming up on your 1-year mark at MKS. Can you give us a scorecard? How have things gone versus your expectations? What has positively surprised you? What has negatively surprised you? This 1-year anniversary.

That's a great question. Yes. So I was -- I am very impressed with the execution the company has done in -- if you look at just '23 to '24, the top line was slightly down, actually, flat almost. But the gross margin grew 190 basis points. Operating income grew 180 basis points. OpEx was flat, maintained all inflation made up for all inflation with efficiency. So the financial acumen of the leadership team and how quickly they get to execution has been very impressive. That probably goes back to the semiconductor industry background and the riding the cycles and knowing how quickly to adjust. That's been very impressive.

Agility, the tariff is a good example, how quickly the teams came together to quantify, forecast, identify mitigation actions and implement those actions was very impressive. And it's a whole company got together, a core team from various parts of the business because as you know, this has been changing too. It's a very fluid environment, right? So you come up with strategy and next Monday morning, it's old, and then there's a new problem. That's what happened to us in Q2 where China was the biggest impact item identified when we did the earnings call. And soon after that, it became metals. And that changed the guidance we had given.

So being agile to adjust with the changes in the market, the tariff being one example, I find it very impressive based on what I have -- where I have worked before. So the challenges mostly are adapting to a market that's so rapidly changing and the geopolitics of it. And I'm sure at our cost structure, like we said before, when that top line comes back to more normal levels, you'll see much more flow through both to the bottom line and cash flow.

Let's dig a little deeper onto the tariff side. You talked about some -- can you just remind us what are the mitigation measures that you guys are taking? I was very impressed with your ability to continue to optimize gross margins in such a difficult environment. I think a lot of companies have struggled with that. So what are the actions that you're taking to mitigate those risks?

So there are a broad area of actions we are considering. The good news is that we are having very productive discussions both with our customers and our suppliers. And people are transparent. There's nobody who's trying to make money off of this thing. It's out in the open. And those include those mitigation actions include supply chain activities, using bonded warehouses where possible, routing production. The multi-site manufacturing capability we have helps us source products from different parts of the world as necessary and some commercial actions and pass through where necessary, right? So it's a broad range of actions, and it's being addressed very openly with our key customers.

On the gross margin piece, you guys have seen a little bit of a boon from the E&P side and that chemistry piece carries a pretty accretive gross margin to your business. It's gotten me questioning really what is the long-term gross margin potential of MKS? Could it have a 5 handle? Could it be a healthy 5 handle? So I guess as we think about the moving pieces on gross margins going forward, what are the levers that we should be thinking about in terms of what could drive gross margin upside?

So the gross margin has been -- it's something the company has worked on for a while. And like you mentioned, Melissa, it's been over 47% for several quarters, last quarter, like we said, without the tariff, it have been high 47%, close to 48%. The fundamentals of the gross margin and the P&L structure and cost structure is very strong. It's these things that happen that we need to mitigate and there are actions in place to do that.

The product cost structure work we are doing in terms of identifying manufacturing excellence programs, procurement savings and design improvements will continue to improve the margins. But the step change is going to really come from volume as that top line comes back. And I always say that the road to 50 goes through 48 and 49. So hopefully, you'll get a chance to ask the question again.

I'm getting greedy. On the OpEx piece, can you talk about where is -- where are your incremental OpEx dollars flowing through? You've kept it pretty tight in the most recent quarters, but there also are a lot of organic growth opportunities for you. So where is the OpEx priority at this point? And how are you thinking about the trajectory?

So when the revenue was not growing in '23, '24, we held OpEx flat. It's something where we -- which we focus very carefully. And as you saw in our Q2 numbers and Q3 guidance, we are at the bottom end of that range, the $250 million to $260 million. The investments we are making are in people, mostly and some infrastructure, but mostly to retain talent and help with long-term growth.

And going back to the discussions we have had on profitability and cash flow, the improvements we have made is not by starving the business. We have invested in business in the P&L and in CapEx. Our CapEx is 4% to 5% this year. The debt repayment we have done is after making the necessary investments. So the careful investment that you initially look for always reallocating resources before we look for new dollars, but the investments we are making in OpEx is tied to retaining talent and driving growth.

Maybe as a final wrap-up question for both of you. On the capital allocation piece, you are highly levered, and I know that's a priority to bring down that leverage. First, can you remind us where you are in that journey? What are your expectations or goals in the next 18 months on the leverage side?

And then second, I'll be greedy again, but you have a very strong history of M&A and inorganic growth at the company. And so how are you thinking about further inorganic growth opportunities and maybe some of the holes in the portfolio?

Well, you start first, Ram, and I'll follow up with the strategy going forward.

Sounds good. So you're right. So the capital allocation priorities are, first, invest in the business to support growth and business continuity and then focus on strengthening the balance sheet, which is lowering our debt. Now we are at net 4x leverage now. Our goal is to get to 2 to 2.5 over the last in a period where demand has been pretty flat in the last 7 quarters, including the one we are in now, we paid down $800 million towards our term loan. So that remains our continued focus. And with our cost structure today, as that top line, again, comes back to more normal levels, we can accelerate that payment quite a bit.

Yes. And I think once we get to that 2 and 2.5 net leverage ratio, M&A will always be part of our strategy. I don't think big M&A makes a lot of sense anymore. We just did one. So we have the foundations for our strategy, which is advanced electronics, semi, advanced packaging to make advanced electronics and be foundational to that. But there are a lot of tuck-ins that make a lot of sense.

Fewer in the vacuum equipment side because legacy MKS did a lot of that consolidation, probably more in optics and lasers because it's still a disaggregated market. Some in chemistry, but not much because Atotech is already a market share leader. So -- but our standard for acquisition is higher now, the bar, just because we have made some big bets in the last 10 years that have paid off. And the reason you do M&A is to get there faster. And some of these big bets, though, are certainly a lot cheaper than buying somebody, but we're getting there almost as fast. And so I think a bar is going to be a lot higher. Why should we buy this company? If it's such a good idea, why don't we invest? Why don't we do it ourselves, especially if we're already halfway there.

So -- but I think tuck-ins might make sense to me, as we're waiting for Atotech to close, we did felt on control. We didn't do it. It's perfect. It's around the chamber, same sales channel, great technology, differentiated, same sets of customers. So those things we'll do all day.

Great. I think that's a great place to end it. Thank you guys so much for joining us. And enjoy the rest of the conference.

Thanks, Melissa.

Good day, and thank you for standing by. Welcome to the MKS Second Quarter 2025 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Paretosh Misra, Vice President of Investor Relations. Please go ahead.

Good morning, everyone. I'm Paretosh Misra, Vice President of Investor Relations, and I'm 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 second quarter of 2025, 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, our most recent annual report on 10-K and our most recent quarterly report 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 reconciliations to our GAAP measures. Our investor website also provides a detailed breakup of revenues by end market and divisions.

Now I'll turn the call over to John.

Thanks, Paretosh, and good morning, everyone. MKS delivered excellent results in the second quarter, highlighted by strong revenue performance and solid profitability. We executed well in delivering for our customers in a dynamic environment while continuing to manage our costs. And since our last earnings call, we made two additional prepayments on our term loan totaling $200 million, demonstrating our continued ability to use healthy free cash flow to delever the balance sheet.

Second quarter revenue of $973 million was above the high end of our guidance, driven by demand growth in our Semiconductor and Electronics & Packaging end markets. Net earnings per diluted share of $1.77 were at the high end of our guidance. Our gross margins, while in line with our guidance, reflect higher cost absorption due to tariffs. However, we held the line well and remain confident in our mitigation strategies. Ram will share more in his remarks.

I'll turn now to Q2 performance in our 3 end markets. Starting with our semiconductor market. Revenue came in above the high end of our guidance. With customer inventories having largely normalized, we benefited from very strong NAND upgrade activity that drove continued sequential momentum and demand for our RF power solutions, and we saw sequential improvement in our vacuum products business as well.

We continue to gain traction with our remote plasma and gas delivery solutions for advanced logic applications. We also continue to execute well in our services business, which is seeing strong growth as our customers increasingly rely on higher-value solutions for reliability and uptime. Over the past couple of years, we have expanded our value-added services capabilities. And this, combined with our larger installed base, is resulting in higher levels of growth.

Services is a stable annuity-like revenue stream that delivers margins above our corporate average. In the third quarter, we expect semiconductor revenue to moderate on a sequential basis, mainly due to anticipated lumpiness in NAND upgrade activity. We believe it is still relatively early in the upgrade cycle, but customer indications suggest that the pace of conversions will fluctuate from quarter-to-quarter.

Our semi outlook represents a mid- to high single digits year-over-year growth rate for the quarter, putting us in a strong position to outperform WFE for the year based on available industry commentary and forecasts. Electronics and packaging revenue was well above the high end of our guidance. The better-than-expected result was driven by strength in both chemistry and chemistry equipment which more than offset normalization of flexible PCB drilling equipment shipments following a strong Q1 as we noted on our last earnings call.

Our products and technologies play a key role in enabling the manufacturing of increasingly complex devices, and that is validated by the momentum we are seeing in advanced packaging and AI-related applications. This includes continued strong orders for our chemistry and chemistry equipment solutions for advanced multilayer boards and high-density interconnect boards related to AI applications as well as several advanced packaging and AI-related chemistry design wins.

The trends we're seeing demonstrate our unique capabilities and how we collaborate with customers to solve their most complex problems. We expect revenue from our Electronics & Packaging market to be up on a sequential basis and up double digits on a year-over-year basis in Q3. This is particularly noteworthy in an environment where many analysts see fairly muted smartphone and PC growth, validating MKS' position in a market where complex electronics applications like AI are driving growth.

We believe revenue from our chemistry solutions will increase sequentially, consistent with prior years, and we anticipate continued strength in our chemistry equipment business, where we've already seen 4 consecutive quarters of strong orders in what has historically been a lumpy business. We view equipment sales is a good leading indicator of future chemistry revenue given our high attach rates.

Our specialty industrial market revenue was slightly above the midpoint of our guidance in Q2. Within this market, the life and health sciences and research and defense end markets showed modest sequential improvement and industrial remains steady. Notable orders in this business include dissolved gas delivery systems used in flat panel display manufacturing, highlighting how we are successfully leveraging our R&D for Semiconductor and Electronics & Packaging end markets into other areas of high technology.

We also secured multiple design wins for applications in areas including research and defense and life and health sciences. Looking ahead to Q3, we expect revenue in our specialty industrial market to be flattish. Overall, we executed well and delivered strong financial results in Q2.

Our integrated portfolio of power, vacuum, chemistries and photonics remains well positioned to capitalize on the advanced applications driving growth in our semiconductor and electronics and packaging end markets. I'd like to thank our global teams for their hard work in driving these results and our full momentum in a dynamic market environment. An important pillar of our success is the culture we have built at MKS, and I'm happy to see the broader recognition we have received.

Recently, U.S. News & World Report named us the Best Company to Work for and TIME included us among America's Best Midsized Companies.

With that, let me turn it over to Ram to run through the financial results and third quarter guidance in more detail. Ram?

Thank you, John, and good morning, everyone. We delivered strong results in the second quarter, driven by healthy demand in our semiconductor and electronics and packaging end markets, continued stability in our specialty industrial end market and disciplined execution. Second quarter revenue was $973 million, up 4% sequentially and up 10% year-over-year. The result was above the high end of our guidance and reflected better-than-expected trends in key end markets. Second quarter semiconductor revenue was $432 million, up 5% sequentially and 17% year-over-year. This result exceeded the high end of our expectations.

Sequential growth was driven by healthier demand in our Vacuum Solutions business, while year-over-year growth reflected continued demand in our broad portfolio of technologies enabling deposition and etch applications. Results also benefited from normalization of customer inventories and FX tailwinds.

Second quarter Electronics & Packaging revenue was $266 million, up 5% sequentially and above the high end of our guidance. This was driven by growth in our chemistry and chemistry equipment business, partially offset by lower demand for flexible PCB drilling equipment, which, as we communicated on our last call, was lower after a strong growth in Q1.

We believe a small portion of the sequential improvement in Electronics & Packaging revenue reflects tariff-related pull-in demand. However, underlying demand trends remained favorable, especially as we gain traction in AI and more complex applications, as John noted.

On a year-over-year basis, sales were up 16%, driven by growth in chemistry, chemistry equipment and flexible PCB drilling equipment sales. Chemistry revenue was up 10% year-over-year, excluding the impact of FX and palladium pass-through, continuing the strong growth trend from last year. Chemistry is a large portion of our consumables and service revenue stream, which adds stability to our business and accounts for roughly 40% of our revenue.

In our Specialty Industrial business, second quarter revenue was $275 million, an increase of 2% sequentially and above the high end of our guidance midpoint. Revenue was down 5% on a year-over-year basis, primarily due to continued softness in the industrial market, partially offset by a modest improvement in research and defense.

Moving down to P&L. Second quarter gross margin was 46.6%, just above the midpoint of our guidance. The sequential decline was largely driven by incremental costs related to tariffs. We estimate that incremental tariffs negatively impacted our gross margin by 115 basis points, which was slightly higher than expected, reflecting the volatility in the tariff landscape at the time of our projection in May.

While the situation remains dynamic, we have implemented a range of mitigation strategies over the past few months that we anticipate will be effective in limiting the tariff impact going forward. Second quarter operating expenses were $251 million, slightly favorable to our guidance, demonstrating our continued focus on managing our OpEx as we balance investing for growth with driving profitability.

Second quarter operating income was $202 million with an operating margin of 20.8%. This reflects the strong revenue performance and OpEx discipline that I highlighted. Second quarter adjusted EBITDA was $240 million and above the high end of our expectations, with adjusted EBITDA margin of 24.7%. Net interest expenses was $46 million, slightly favorable to our guidance.

The second quarter effective tax rate was 18.2%, which is consistent with our guidance. Second quarter net earnings were $119 million or $1.77 per diluted share and at the high end of our guidance, reflecting our strong financial performance. Free cash flow, a defining strength of our company was up sequentially and year-over-year to $136 million, representing over 100% of our net earnings and 14% of our revenue.

We invested $29 million in capital expenditures in the quarter. We continue to expect full year CapEx to fall within 4% to 5% of our revenue. We closed the quarter with approximately $1.3 billion of liquidity comprised of cash and cash equivalents of $674 million and our undrawn revolving credit facility of $675 million. We made a voluntary principal prepayment of $100 million in June and another $100 million prepayment earlier this month. We remain focused on executing our long-term capital allocation priorities of investing in organic growth opportunities while reducing our leverage through principal prepayment and working with our banking partners to reduce our interest expenses as market opportunities arise.

We exited the quarter with gross debt of $4.5 billion and a net leverage ratio of 4x based on our trailing 12-month adjusted EBITDA of $945 million. Our net leverage ratio improved slightly from the end of the prior quarter, reflecting our strong free cash flow and higher year-over-year adjusted EBITDA sales. Finally, during the second quarter, we paid a dividend of $0.22 per share or $15 million.

Let me now turn to our third quarter outlook. The guidance we are providing represents our best estimate based on the dynamic trade environment in which we are operating. We expect revenue of $960 million, plus or minus $40 million. We believe our technology is integral to our customers' success, and we are designed into many of the advanced applications of product support.

By end market, we expect semiconductor revenue to be $405 million, plus or minus $15 million. Revenue from Electronics & Packaging market is expected to be $285 million, plus or minus $10 million. And revenue from our Specialty Industrial market is expected to be $270 million, plus or minus $15 million. We are guiding gross margin of 46.5%, plus or minus 100 basis points. Our estimated tariff impact is expected to be below 100 basis points, marking an improvement from Q2.

As I noted earlier, we have largely implemented our short-term mitigation strategies based on the current trade environment. This environment has remained fluid, but we are committed to optimizing our performance and offsetting these costs. We expect third quarter operating expenses of $252 million, plus or minus $5 million and adjusted EBITDA of $232 million, plus or minus $24 million.

We expect a tax rate of approximately 18% in the third quarter. We expect our full year tax rate to be at the lower end of the 18% to 20% range we provided previously. The new U.S. tax bill was passed subsequent to quarter end. We are currently evaluating the impact of this legislation, which is not reflected in our guidance. We expect third quarter net earnings per diluted share of $1.80, plus or minus $0.29. We are pleased with our performance in the first half of the year. Despite trade-related challenges, our revenue, earnings per share and free cash flow in the first half of the year are up significantly relative to the prior year.

In the second half, we will continue to work on capitalizing on opportunities as we collaborate closely with our customers, maintain a disciplined cost structure and keep our focus on strong cash generation that will allow us to make the investments necessary to support our long-term growth and to continue to lower our leverage.

With that, operator, please open the call for Q&A.

[Operator Instructions] Our first question comes from Krish Sankar from TD Cowen.

John, I had a couple of them. Number one is, when I look past the September quarter, even if I try to flatline semis in December, it looks like you might probably grow 10% year-over-year, which is better than WFE. I'm just kind of curious how to think about semi revenue trends beyond September? And are there anything that we need to keep in mind kind of like what you mentioned, there is some Q-over-Q volatility with NAND, et cetera.

Krish, thanks for the question. I think the way to think about it is that the basic WFE portfolio that we have is growing year-over-year, and we believe it's growing faster than the market. So that's good. And the way I think about it is that there's a NAND upgrade overlay over that. You saw that result in a really strong Q2, but it can be lumpy.

And certainly, our customers are going to tell us when they need it. But longer term, of course, the NAND upgrade cycle is great for MKS given our long history in providing high aspect ratio dielectric etch, power for dielectric etch. So I think that's the way to think about it, Krish. The base is pretty strong growing year-over-year for us. And then the NAND upgrades can be lumpy and can make the quarter much higher or more flatter.

Got it. And then as a quick follow-up. On the E&P side, I think your PCB business, 3 months ago, you said they might be a little slightly weaker in June because of pull-ins of the tools in March, but then it looks like June came in better. I'm wondering if some of the PCB strength you're seeing has to do with more of downstream smartphone pull-ins or how to think about the PCB business going forward?

Yes. I think we saw a little bit of pull-ins. It's hard to tell, but it's pretty minimal, Krish. I think Q2 was just strong because a lot of it was driven by AI, both the equipment and the chemistry. And our guidance in Q3 is higher. And as you know, typically, Q3 is higher due to the consumer product cycle that we have in chemistry. And equipment for chemistry remains very strong. So I think there probably was a little bit of pull in EP. We don't think there was any pull-in for semi, but Q3 was still guiding higher.

Our next question comes from the line of Steve Barger from KeyBanc Capital Markets.

John, I'm going to stick with the chemistry equipment orders and some of the momentum there. Does it feel like that's the beginning of a sustainable trend? And what are you hearing from substrate manufacturers in terms of capacity utilization and how they're viewing growth, whether it's from traditional products or AI-related products?

Yes, I'll take the last one first, the substrate makers, they are seeing high utilization rates, and we're seeing that in our chemistry business. And it's fundamentally driven by AI. So no mystery there, really, Steve. I think your question on equipment. Traditionally, historically, it's been a pretty lumpy business. We've seen now 4 straight quarters of sustained relatively high bookings and then the shipments that follow for chemistry equipment. And we believe most of that is related to demand for AI capacity, not necessarily package substrates, but in HDI and MLB that support that AI need. And so having this really broad portfolio is really helpful for MKS. When E&P goes up, we benefit from that, especially given semi could be a little lumpy. Also having the broad portfolio of chemistry and chemistry equipment really helps us deliver solutions faster and more completely to our customers.

That's good detail. And I suspect you all have been engaged in strategic planning for next year. And certainly, with things feeling maybe a little bit better than last year, any high-level thoughts on where you want to point the company, what your operational priorities are or anything in the portfolio that we should be thinking about?

Well, I think some of the areas that we talked about that we're focused on to outgrow in semi, for instance, world-class optics power for high aspect ratio etch, both anti electric and conductor, those remain. And then certainly, our efforts in Electronics & Packaging, giving that a complete solution of chemistry, chemistry equipment, as well as laser equipment. So I don't think those priorities really change. Those have been well thought out long-term priorities. And you're starting to see some of that benefit as those markets come back.

Our next question comes from Melissa Weathers from Deutsche Bank.

I wanted to go back to the NAND piece within the semis business and talk about that lumpiness. I totally understand we're in the early innings on that upgrade cycle. But I also know there was a pretty large inventory overhang in that business. So like could we see some inventory replenishment on that side of the business? Or is it really just that customers are just pulling what they need and nothing more than that. So it should move pretty closely in line with demand?

Yes. I think I would characterize it as the latter, Melissa, just because inventory has burned as we have said in the past, also lead times are much better now in general, getting the chips to make our power supplies, you have normalized lead times. And so given that, then I think it's probably going to be more tied together rather than a buildup of inventory. Of course, during a large ramp, very large ramp, then, of course, you could see some buildup of inventory, but right now, it feels like because our lead times are relatively back to normal, we expect that we'd be shipping to demand.

Got it. And then on the gross margin outlook, I don't know if this is for John or for Ram, but I know the chemistries piece does typically carry higher gross margins, and the E&P business is supposed to grow pretty nicely. So the moving pieces on that gross margin outlook, why wouldn't you see more of an uplift just from that higher chemistries mix in the third quarter?

This is Ram. I'll take that. So we did see -- we do see a seasonality pickup in better chemistry in Q3. And we are seeing the benefit of that in the margin. However, we are also seeing higher equipment sales, which, as you know, comes with a lower gross margin, but we are very happy to have equipment business because it commits to future chemistry orders with high margins. So that equipment orders will sort of offset some of the mix advantage we get from chemistry. Tariffs are a bit better, as I noted in Q3 compared to Q2, but then our volume is slightly lower than Q2. So we are guiding margins relatively at the same levels.

Our next question comes from Shane Brett from Morgan Stanley.

Firstly, on E&P. If I take your Q3 guide, you're tracking about 20% year-over-year growth through Q3, which is well ahead of the GDP plus 300 basis points you spoke about at your 2022 Analyst Day. Just given the AI strength that you're seeing, maybe in some revenue synergies with Atotech, have your growth expectations for this business materially changed since the Analyst Day?

Yes, Shane, thanks for the question. I think it hasn't really changed. We're not updating our 5-year model yet. But I would say that we are seeing that advantage driven by AI. I think we're seeing a unique advantage for MKS, which is that we're providing a more complete solution. So the chemistry revenue, organic chemistry revenue, we believe, is also outgrowing some of our competitors quarter-on-quarter year-over-year. But also in addition to that, we have equipment and which most of our competitors, if not all, don't have that. And that equipment, we're finding is incredibly crucial for our customers to be able to deliver the more complex HDI and MLB processes needed for AI. So we're benefiting from both of those right now. And then -- so we're in a great position to hit our long-term models.

Got it. And as for my follow-up, so this might be a bit of a long shot question, but there has been talks that the big GPU customer may move from CoWoS to CoPoS, but just including this inflection, how should sort of this inflection or the any other inflections that may sort of significantly impact your business for the E&P side going forward?

Yes. So I think what you're talking about is CoWos moving potentially to CoWoP, I guess, I don't know how we say this anymore, but that S used to be substrate -- stands for substrate and the P stands for PCB. So the idea of CoWoP is that you remove and you skip substrates, as I think you know, going right to the PCB, which is the HDI and MLB.

Traditionally, our -- we have had a very strong position in HDI, not only in chemistry, but in equipment, as you know, and we're seeing that as well driven by AI. So if the industry were to skip the substrate or some part of the industry were to skip the substrate, we believe that's actually a tailwind for us because of our historic position there, and because our tools are uniquely enabling for that HDI layer. And this goes back to the longer thesis that we have for the acquisition of Atotech. If that were to happen, the HDI boards would have to become much more sophisticated, smaller lines, smaller features, many more layers. And the whole idea there is in order to do that, you need that, we believe, combination of chemistry knobs and equipment knobs to get there. So the industry is very flexible. They will always look for the most economic solution. And this is certainly an area of interest for some companies.

Our next question comes from Peter Peng from JPMorgan.

Within your semiconductors, can you kind of provide some color on how the lithography and inspection applications are doing? I think the last you updated us, you guys were kind of in this $300 million revenue run rate, any color on that?

I would say that we're not immune to cycles in world-class optics either for lithography metrology inspection. So as you know, it's been a little more muted than it has been in the past. I would say this, the cycles there are a little more muted. So I would say that $300 million range is still intact. And maybe it might be pushed out a little bit in terms of growing from that. But we're really happy with the design wins we continue to participate with, with our customers. We designed in, as you know, into the most advanced pieces of equipment in that market. And so when the market returns, we'll enjoy that growth.

Got it. And then my follow-up on. In your Electronics & Packaging, if I look at from an absolute dollar year-over-year, you guys have been almost growing like $40 million to $50 million in terms of absolute year-over-year. And you mentioned that the smartphone and PC markets are [indiscernible]. Can I kind of correlate that this is all driven by AI applications this $40 million, $50 million? Or is there any other stuff in there that's driving that kind of year-over-year growth?

Yes, Peter, I think that's the right way to look at it. We're happy with the year-over-year growth despite the fact that it's well known that certainly PCs and smartphones are still muted. And we saw that a year ago, and AI was a part of our growth, but not as important or not as big as you see it now. So PCs, smartphones remain muted, but we're outgrowing due to the fact that more and more of our business is targeted to AI. And as I mentioned before, we not only have the chemistry, but we have the equipment that's enabling AI.

[Operator Instructions] Our next question comes from Joe Quatrochi from Wells Fargo.

Maybe just a follow-up on that. I guess as I think about the expectations for chemistry growth in 3Q, it sounds like relatively seasonal. So do we assume that to get to seasonal it's because you're seeing outperformance at AI and your kind of traditional applications would be otherwise below seasonal growth?

I think the way to think about it, Joe, is that the seasonal growth is driven by consumer products. So that's kind of the PC smartphone market. And so that really hasn't changed too much. We said a little earlier to an earlier question. It might be a little pull in, but we're still seeing an uptick in Q3 versus Q2. And then overlaid on top of all that is just the growth in AI. So the seasonality is still driven by those consumer products, Joe.

But I guess the rate of growth is -- I mean, is it better than normal seasonality given that there's added AI applications that are seeing incremental demand?

Well, I think that's true. The base, the foundation is much higher because there's an AI additive to it. So yes, I think that's the way to think about it. And as a reminder, as you know, Joe, because of seasonality in Q4 for the consumer product cycle for chemistry is usually one of the lower quarters as well.

Yes. That's helpful. And maybe as a follow-up in the semi business, just outside of the NAND lumpiness, I mean, are you seeing customers -- we've heard customers kind of focusing more on inventory optimization versus buying incremental new components or keeping inventory flat, just given kind of the tariff dynamics and trying to avoid some of those. Are you seeing that in your business as well?

Yes. No, I think we saw some peers say that. We haven't really seen any of that, Joe, because our lead times are very low, our -- we believe our customers are buying to need rather than trying to optimize inventory. So we didn't see any of that.

Our next question as from Mark Miller.

Some of the laser firms are reporting that after many sluggish quarters that their business is improving. I'm just wondering what you're seeing in your laser segment?

Yes. No. I think our laser segment, we continue to gain some design wins in some of the key markets. I think we talked about HBM dicing in the past. But in general, industrial lasers, that remains relatively muted, Mark. It has really no change from the several quarters before. I think some of it is just customers being a little more cautious as well as you can see from the PMIs around the globe that it's still relatively balanced between growth and contraction. So No, we haven't really seen a lot of pickup there for lasers for industrial applications.

In terms of your key component suppliers, are you seeing any price increases from them due to tariffs?

We partner with our suppliers as well as with our customers, especially with tariffs. And so we're trying to find ways that both of us can reduce the impact of tariffs. So no one's trying to make money on this, obviously. So I think it's been a collaborative working relationship with our suppliers, and we haven't really seen any impact of tariffs and price increases from our partners there.

Our next question comes from Jim Schneider from Goldman Sachs.

I was wondering if you could maybe focus on the topic of tariffs from a different angle for a moment. First of all, can you talk about whether you baked any relative conservatism into the September quarter guidance based on some of the pull-in commentary you had earlier? And secondly, as a result of President Trump's announcement on semiconductor tariffs last night, I'm wondering if you see any kind of competitive advantage for you relative to your competitors as a result of that or kind of any other angle on that you can foresee at this point?

Jim, it's John. I'll take maybe the first one, and Ram can add. But the announcement last night was last night. And so it's hard to tell where that will end up. Certainly, broad strokes, it's complex. It may or may not impact the entire semiconductor ecosystem. So I would say it's hard for us to tell right now the puts and takes.

I would say in general, though, with respect to tariffs, as Ram said, we had more of an impact in Q2. We're looking at less of an impact in Q3 as some of our mitigation actions start taking hold. But it is a very dynamic environment and things can change quickly, as you know. So I think it's a little hard for us to determine if there's any kind of competitive advantage or disadvantage with what was announced last night. I don't know, Ram, if you want to add anything to that?

Yes. I think you covered it, John. I'll just add that with regard to the guidance, there are 2 key variables here. One is the shifting rules itself and the second is the timing of our mitigation actions kicking in. So when we guide, we guide based on the best information we have at this point of time based on the rules we know at that point. So I wouldn't say there's any conservatism built into the guide, it's the best information we have at that point.

[Operator Instructions] David Liu, the floor is yours.

I was wondering if you can provide a little bit more color on your HDI, MLB for AI applications, maybe to the extent you have visibility, whether you see them going into [ merchant ] GPUs, hyperscaler versus neocloud, custom ASICs, any color you have there?

I think in general, it's probably customers trying to get all that business. It's a little difficult for us to tell if it's going to particular parts of the AI food chain. But I think, in general, many of our customers need that capacity, many customers are trying to get into that market in a stronger sense. And so they're building that capacity up, and that's where we're seeing the equipment orders, which have been, as we said, strong over the last several quarters.

So I think it's a little hard for us to tell specifically what that substrate or that HDI MLB is going towards, but I think in general, HDI-type chips require a lot more layers in HDI, more layers in MLB and that's why that is the application these customers are asking for.

And then maybe a follow-up on OpEx. Are you guys still seeing the $250 million to $260 million range for fiscal '25? And then maybe 2026, where do you guys see you're investing in your business?

Yes, David, this is Ram. I would keep the $250 million to $260 million as the range for Q4. We are not guiding beyond Q3, but that's a useful range to model. As you saw in Q2 and our guidance for Q3, we are at the lower end of that rate. So OpEx is something we take very seriously and try and manage while making the investments needed for the company's long-term success. So it's a balance between meeting profitability and investments to -- for long-term success. But it's something which we watch very carefully.

Our final question comes from the line of Shane Brett from Morgan Stanley.

Let me ask another question. I just have one. So in the June quarter, your Specialty Industrial business grew quarter-over-quarter for the first time since I think June quarter of '23, if I'm correct. I know you're guiding the September quarter down a touch sequentially, but are there any positive lead indicators in that business that you would call out?

Yes, Shane, I think as you know, our Specialty Industrial segment is made up of several different markets. And I would say, in general, industrials has been muted and remains muted. I would say that. Defense has been a bright spot, growing quite a bit. And life and health sciences remains relatively stable. So lots of puts and takes, but I think those are the ones I would point out.

This concludes the question-and-answer portion of our session. I would now like to turn it back to Paretosh Misra, Vice President of Investor Relations for closing remarks. The floor is yours.

Thank you all for joining us today and for your interest in MKS. Gerard, you may close the call, please.

Thank you, and thank you for your participation in today's conference. This does conclude the program. You may now disconnect.