MKS Instruments Q4 2024 Earnings Call Transcript

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February 13, 2025
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Operator

Thank you for standing by, and welcome to the MKS Instruments Fourth Quarter twenty twenty four Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. As a reminder, today's program is being recorded. And now, I'd like to introduce your host for today's program, Paretosh Misra, Vice President, Investor Relations.

Operator

Please go ahead, sir.

Paretosh Misra
Paretosh Misra
VP - Investor Relations at MKS Instruments

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 Mayimpurath, Executive Vice President, Chief Financial Officer and Treasurer. Yesterday after market closed, we released our financial results for the fourth quarter and full year 2024, 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.

Paretosh Misra
Paretosh Misra
VP - Investor Relations at MKS Instruments

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. 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.

Paretosh Misra
Paretosh Misra
VP - Investor Relations at MKS Instruments

Now, I'll turn the call over to John.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Thanks, Paritosh, and good morning, everyone. Before I discuss our quarterly results, I'd like to take a moment to review 2024, which was a year of impressive execution in a challenging environment. Despite roughly flat year over year revenue of $3,600,000,000 we achieved a 190 basis point expansion in gross margin. We managed our operating expenses effectively, increased earnings per share by 49% and improved free cash flow by $178,000,000 Additionally, we took several actions to proactively manage our leverage and significantly reduce our interest expense. This included an upsized $1,400,000,000 convertible note offering, voluntary prepayments of $426,000,000 on our term loan facility and an opportunistic refinancing and repricing of our term loans.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

We took these steps while also maintaining investments in R and D and strategic initiatives, including delivering technology innovations in areas such as world class optics, lasers and laser systems, and new chemistry solutions for advanced packaging in the AI era. We also upgraded and expanded our operations in Romania, broke ground on our new supercenter factory in Malaysia and purchased the site in Thailand for a future chemistry factory and tech center. These investments add capacity and resiliency to our manufacturing footprint. We're proud of our accomplishments in 2024 and I want to acknowledge our teams across MKS who delivered these results despite muted end markets. I also want to thank our customers across our semiconductor, electronics and packaging and specialty industrial markets for their support and engagement as we work to deliver unique solutions that enable their success.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Entering 2025, MKS is in a strong position with one of the broadest and deepest product portfolios that uniquely allow us to solve our customers' most complex challenges. These challenges are placing increasing pressure on traditional Moore's Law innovation cycles. MKS is enabling solutions to this more than more environment through design and production wins in areas like optical modules for the lithography, metrology and inspection market, lasers for next generation back end applications and chemistry equipment for multi layer substrates for advanced AI servers. These examples demonstrate the impact that technological innovations have on our industry and we believe our position as a foundational enabler across semiconductors and electronics sets us up well as these trends accelerate. Now let's discuss our fourth quarter results in more detail.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

We ended 2024 on a strong note with revenue, gross margin and earnings per diluted share above the midpoint of our Q4 guidance ranges. Revenue was up 5% year over year driven by double digit growth in both our electronics and packaging and semiconductor end markets. We continue to make good progress proactively managing our leverage, including another successful repricing of our term loans and a $100,000,000 voluntary principal prepayment in January 2025. Combined with similar actions we took in 2024 and a slight improvement in the interest rate environment, we have reduced our annual interest expense run rate by over $130,000,000 compared to the prior year. Looking at our performance in our three end markets.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Starting with our semiconductor market, revenue increased 6% sequentially above the high end of our guidance range. Similar to the trend seen throughout the year, this higher revenue trend was mainly driven by better than anticipated in quarter demand, primarily related to DRAM and logic foundry applications for our vacuum product offerings. NAND has picked up from early twenty twenty four, but remains at historically low levels. We are well positioned for both upgrade activity as customers move to higher layer counts and potential new greenfield investments when that market recovers. We are achieving a healthy pace of design wins that create great opportunities for us when semiconductor investment recovers, including reactive gas solutions for leading edge nodes.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Additionally, we continue to advance our positions in lithography, metrology and inspection with another design win supplying optical assemblies for a leading customer. We also maintain our momentum in the back end applications related to high bandwidth memory with more orders for our lasers during the quarter. We have continued to invest in our lasers business over the years and we believe we are well positioned for strong growth. In the first quarter, we expect semiconductor revenue to be flattish on a sequential basis. The guidance demonstrates continued stability in DRAM and foundry logic demand with NAND remaining at low levels.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Overall, while demand remains low, it is higher than a year ago. The investments we're making along with our design wins strengthen our confidence and our ability to outperform as the market recovery gains momentum. Turning to Electronics and Packaging. Revenue grew 10% sequentially and above the high end of our guidance. The sequential increase was driven by increased equipment sales.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

We saw continued momentum in orders for our chemistry and equipment solutions for advanced MLB, HDI and packaged substrates related to AI applications. This shows the key role our products and technologies play as advanced packaging and specifically the interconnect becomes more critical in enabling the manufacturing of increasingly complex electronic devices. Excluding the impact of FX and palladium pass through, sales of chemistry increased 9% in the fourth quarter over the prior year. For the full year, chemistry sales finished up 12% and significantly outperformed the PCB industry in 2024. Looking ahead to Q1, we expect revenue from our electronics and packaging market to be down 4% on a sequential basis, primarily due to seasonality associated with the Lunar New Year.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

In our Specialty Industrial market, revenues decreased 2% sequentially and was at the lower end of our guidance range. While the life and health sciences and research and defense end markets were steady, we saw softness across the broader industrial market. As a reminder, our specialty industrial market consists of a variety of applications across multiple end markets. Looking ahead to Q1, we expect revenue in our Specialty Industrial market to decline 6% from Q4, mainly due to softness in the Industrial market and Lunar New Year impacts, especially related to our General Metal Finishing business. Overall, we executed well and delivered solid financial performance in the fourth quarter and full year 2024.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

With Green Shoots emerging in a few key areas of our business and improving profitability, MKS enters 2025 in a robust financial position. I mentioned the strength of our team earlier. Their efforts coupled with our dynamic culture are reflected in the industry accolades we received during the year. For the second consecutive year, we were named to U. S.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

News And World Report's Best Companies to Work for in our industry, as well as named by Newsweek and Statista as one of America's Most Responsible Companies for 2025. Now let me turn it over to Ram to run through the financial results and first quarter guidance in more detail. Ram?

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Thank you, John, and good morning, everyone. As I've had a few months now to dive deeper into my role, I'm impressed with the level of execution that MKS delivers, especially in light of the industry demand backdrop of the past couple of years. In the coming quarters, we will maintain our focus and discipline on managing costs, while we make the necessary investments for long term growth and business continuity. I will talk a little more about how we are looking at the coming quarters in a moment, but first let me review our Q4 and full year performance in detail. For the fourth quarter, MKS reported revenue of $935,000,000 up 4% sequentially and 5% year over year.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

The result was above the midpoint of our guidance range and was driven mainly by better than expected semiconductor and electronics and packaging revenue. Fourth quarter semiconductor revenue was $400,000,000 up 6% sequentially and 10% year over year. The result was above the high end of our expectation as our team continued to execute on strong in quarter demand, especially as related to DRAM and logic foundry applications, where we have seen relative normalization of inventory levels at our customers. NAND is bouncing off very low base, but we are seeing evidence that we are making good progress in burning through excess inventory at some customers. Fourth quarter electronics and packaging revenue was $254,000,000 an increase of 10% quarter over quarter and also above the high end of our expectations.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

This result was led by higher flexible PCB drilling and chemistry equipment sales, partially offset by normal seasonal declines in chemistry. On a year over year basis, sales were up 13% driven by stronger performance in chemistry, flexible drilling equipment and chemistry equipment. Chemistry sales were up 9% excluding the impact of FX10 palladium pass through, continuing a gradual recovery trend from the industry wide softness. In our Specialty Industry Markets, fourth quarter revenue was $281,000,000 a decline of 2% sequentially and below our guidance midpoint largely due to softness across the broader industrial markets. Revenue was down 8% year over year basis, also primarily due to softness in the industrial market.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

The prior year result benefited from strong chemistry equipment sales within the General Metal Finishing business. Turning to gross margin, we reported fourth quarter gross margin of 47.2%, which is above the midpoint of our guidance. Gross margin was down sequentially due to higher equipment mix in the fourth quarter and consistent with our expectations. We continue to prudently manage our costs balancing investing in our business with near term profitability and cash generation. Fourth quarter operating expenses were $242,000,000 and within our guidance range.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Fourth quarter operating income was nearly $200,000,000 yielding an operating margin of 21.3% and above our guidance driven mostly by higher gross profit. Adjusted EBITDA was $237,000,000 and also above the midpoint of our expectations yielding a 25.3% margin. Net interest expenses was $45,000,000 lower than our guidance of $48,000,000 as a result of a year to date reclassification of approximately $3,000,000 of pension plan interest costs to other non operating expenses. Net interest expenses was otherwise in line with our guidance. The fourth quarter effective tax rate was 4%, which was lower than our guidance due to certain favorable discrete items in the quarter.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Fourth quarter net earnings were $146,000,000 or 2.15 per share, above the midpoint of our guidance, reflecting strong operating performance and lower income tax I just detailed. For the fourth quarter, free cash flow was $125,000,000 or 13% of revenue. We recorded capital expenditures of $51,000,000 in the quarter, slightly above 5% of revenues. We expect CapEx to average 4% to 5% of revenues for the foreseeable future. We closed the quarter with approximately $1,400,000,000 of liquidity comprised of cash and cash equivalent of $714,000,000 and our undrawn revolving credit facility of $675,000,000 We exited the quarter with gross debt of $4,600,000,000 and net leverage ratio of 4.3 times based on our trailing twelve month adjusted EBITDA of $9,140,000 We continue to prioritize deleveraging our balance sheet, which remains our top priority after investing in our business.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

As John mentioned, in 2024, we made a total of $426,000,000 of voluntary prepayments on our term loan. In January 2025, we repriced our term loan, reducing credit spreads by an additional 25 basis points and made another $100,000,000 of voluntary principal prepayment. Based on the current interest rates, the combined effect of these recent actions will reduce our annual interest expense run rate by approximately $15,000,000 dollars As the demand environment improves alongside our continued focus on prudently managing working capital and gross margins, we expect to see stronger flow through to the bottom line and higher cash flows allowing us to continue to make good progress on deleveraging. Finally, during the fourth quarter, we paid a dividend of $0.22 per share or $15,000,000 Moving to full year 2024 results, revenue was $3,600,000,000 down 1% year over year. Semiconductor revenue totaled $1,500,000,000 up 1% year over year and up 2% excluding the impact of foreign exchange.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

We experienced growth in world class optics and continued stability in DRAM and logic foundry applications, while NAND remained at low levels. Electronics and Packaging revenue was $922,000,000 in 2024, up 1% year over year excluding the impact of FX and Palladium, sales were up 7% driven by strength in chemistry. Total chemistry sales increased 12% year over year excluding the impact of foreign exchange and palladium pass through. Specialty industrial revenue was $1,200,000,000 down 5% year over year, primarily driven by softness in the industrial market. Excluding the impact of foreign exchange and palladium pass through, sales declined 3% year over year.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Full year gross margin was 47.6%, up 190 basis points year over year, driven by product mix as well as operating efficiencies. In addition to successfully capturing value through our truly differentiated product portfolio, we have also taken measures to manage our material and labor cost efficiently. Full year operating margin of 21.3% was up 180 basis points year over year, primarily as a result of higher gross margin coupled with disciplined operating expense management. Turning to cash flow, we generated operating cash flow of $528,000,000 an improvement of $2.00 $9,000,000 year over year. Full year free cash flow was $410,000,000 an increase of $178,000,000 year over year.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Free cash flow conversion of 11.4% improved 500 basis points over the prior year. We are pleased with our execution on the margins and the strength in the underlying cash generation in our business, despite a challenging demand environment in our end markets. Let me now turn to first quarter outlook. We expect revenue of $910,000,000 plus or minus $40,000,000 consistent with the guidance we provided last quarter and consistent with our view that the market is relatively stable, albeit at a slightly higher run rate than what we saw a year ago. By end market, our first quarter outlook is

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

as

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

follows: revenue from our semiconductor market is expected to be $400,000,000 plus or minus $15,000,000 revenue from our electronics and packaging market is expected to be $245,000,000 plus or minus $10,000,000 and revenue from our specialty industrial market is expected to be $265,000,000 plus or minus $15,000,000 Based on anticipated revenue levels and product mix, including lower chemistry sales in the light of the Lunar New Year, we estimate first quarter gross margins of 46.5% plus or minus 100 basis points. We expect first quarter operating expenses of $255,000,000 plus or minus $5,000,000 We expect our OpEx spending to remain at this range of $250,000,000 to $260,000,000 a quarter as we continue to invest in people and infrastructure. We estimate adjusted EBITDA of $217,000,000 plus or minus $23,000,000 We expect tax rate of approximately 22% in the first quarter. For the year, we expect our tax rate to be in the range of 19% to 21%. Based on these assumptions, we expect first quarter net earnings per diluted share of $1.4 plus or minus $0.27 Our execution has remained strong despite the cyclical challenges in our end markets.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

We are confident that we are uniquely positioned to capitalize on the opportunities that lie ahead. With that, I will turn the call back over to John for concluding remarks.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Thank you, Ram. I'll wrap up by saying I'm very pleased with the performance we delivered in 2024. We've leveraged our broad and deep product portfolio to capture opportunities across our businesses in a tough demand environment and that's thanks to the deep engagement we enjoy with our customers. We've managed our costs well, maintained strong margins and made progress on our deleveraging agenda. Going forward, we're well positioned on multiple fronts: improvement in NAND when it comes, continued order and design win traction in our world class optics portfolio and incremental design win and order activity in both chemistry and chemistry equipment, which are benefiting from increasing complexity for advanced packaging in the AI era.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

You also heard from Ram that we will invest incrementally both in growth and business continuity to ensure we're ready to capture exciting opportunities when markets return to growth. Of course, we'll do that while maintaining the product and the prudent focus on profit and cash generation that investors know us for. We're looking forward to an eventful year ahead. With that operator, please open the call for Q and A.

Operator

Certainly. And our first question for today comes from the line of Chris Sanker from TD Cowen. Your question please.

Krish Sankar
Managing Director at TD Cowen

Yes. Hi. Thanks for taking my question. I had a couple of them. First one, John, you mentioned how some of your NAND component inventory at your semi cap customers is being burnt.

Krish Sankar
Managing Director at TD Cowen

I'm kind of curious where do you think those levels are today versus before? And how much ahead would they start purchasing your components again when they anticipate a NAND up

Krish Sankar
Managing Director at TD Cowen

turn?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes. Good morning, Krish. Yes, it's a great question. So we have seen green shoots there.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

We've talked in the past about a lot of inventory being burned off. We're starting to see some of that happen and we're starting to see some new orders for that. So it's already happening. So we're happy with that progress. It's just that it's still off of a low level.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

So good progress, green shoots, but certainly not at the level where it used to be.

Krish Sankar
Managing Director at TD Cowen

So is it fair to assume just given what your customers are seeing, what you're seeing, semi revenue should remain around these levels and even the June?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Well, we're not guiding out beyond that as you know, but I would say this, because we're starting to see these orders coming in for NAND, it will depend on how much upgrade business occurs or whether there's a new greenfield. So if those happen, they would drive that part of our revenue up. And so we're in a good position if and when that happens.

Krish Sankar
Managing Director at TD Cowen

And then just a quick follow-up for Ram. You kind of mentioned $250,000,000 to $260,000,000 in OpEx. Is that the run rate used for the rest of the year? I mean and should it normalize because it seems like it's stepping up quite a bit from last year?

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Yes. Hi, good morning, Chris. So first of all, let me just say that we are very disciplined and focused on our OpEx spending. Our OpEx in 2024 was flat to slightly less compared to the previous year. In 2025, we see some opportunities to invest in long term growth and to build some efficiencies within our business.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

And that's why we are having the additional step up investment. Over the long term, we remain committed to a 40% incremental operating margins, which we'll see as the top line picks up.

Krish Sankar
Managing Director at TD Cowen

Got it. Thanks, John. Thanks, John.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Thanks, Krish.

Operator

Thank you. And our next question comes from the line of Peter Pang from JPMorgan. Your question please.

Peter Peng
Equity Research Analyst at JP Morgan Chase & Co

Hey guys, thanks for taking my question. Just on your semiconductor segment, some of your customers and peers are talking about a mid single digit growth for WFE. So I guess that's just given some of the end market dynamics and some of your design wins, how are you thinking about your relative performance versus that level for the year?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes. Good morning, Peter. Well, as you know, we've been able to outperform WFE over the long term by 200 basis points through cycles. So we're really well positioned. The design wins activities that we've seen are really helpful.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Our focus on world class optics is another lever for us to gain share relatively. You're right, most of our peers and customers have said kind of mid single digit growth in WFE. And if that happens, we certainly will be enjoying that level of growth as well. As you know, during a strong upturn, we outperformed because our customers are pulling a lot more. And then downturn, we underperformed.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

And overall, as we look through the cycle and that's where we are still at that 200 basis points above long term CAGR.

Peter Peng
Equity Research Analyst at JP Morgan Chase & Co

Got it. Okay. And then on your specialty industrial, that business looks like it's kind of been steady declining over the last few quarters. Any idea of when you think that business would kind of bottom and start to recover?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes. And as we said on the call, Peter, it's made up of several different kinds of markets. And so we called out that general industrial is the area that is seeing weakness, which is not a surprise. I think if you read all the PMI data, that wouldn't be a surprise. And even organically though, it's only down 3% year over year for the entire that segment of our market.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

So it's bouncing along the bottom and I think our best visibility is the guidance we gave. And it can be lumpy because it's made up of several different markets. So I think steady and slightly down is how we see it right now.

Peter Peng
Equity Research Analyst at JP Morgan Chase & Co

Thank you.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Thank you, Peter.

Operator

Thank you. And our next question comes from the line of Melissa Weathers from Deutsche Bank. Your question please.

Melissa Weathers
Melissa Weathers
Director - Equity Research at Deutsche Bank

Hi there. Thank you for letting me ask a question. I wanted to go back to the NAND side. Can you talk about when we're seeing the spending happen in upgrades versus greenfield capacity, where does MKS fit in that narrative? Do you have higher content in greenfield versus upgrades?

Melissa Weathers
Melissa Weathers
Director - Equity Research at Deutsche Bank

Or how do we think about the upgrade dynamics this year?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Good morning, Melissa. Yes, so certainly a greenfield requires brand new tools. And as you know, MKS has a broad portfolio around those tools. With upgrades, most of the benefit for us is in the power, the arc power. And as I've said before, it depends on what the upgrade is.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

And if it's going from 100 layers to 200 layers, there's certainly a lot of arc power that is needed. And so that's where we're starting to see some of the inventory burn off as we talked about and some of that pulls on certain particular product lines there.

Melissa Weathers
Melissa Weathers
Director - Equity Research at Deutsche Bank

Got it. Thank you. And then still on the semi side, but on the logic piece, this year we're expecting some pretty healthy spending on the leading edge nodes. Gate all around volumes are going to ramp throughout the year. So can you talk about what the impact of that trend is on MKS' business?

Melissa Weathers
Melissa Weathers
Director - Equity Research at Deutsche Bank

Is there do you have any kind of content story with Gate all around nodes? Or how should we think about that logic piece continuing to ramp through this year?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes. There are lots of things that we play in and contribute to enabling this advanced logic capability. One thing we called out in the earnings call is advanced ozone applications for gate all around. And so we have a broad portfolio, so we are playing in that advanced node growth, but we have particular areas of product lines that enable that particular growth as well.

Melissa Weathers
Melissa Weathers
Director - Equity Research at Deutsche Bank

Thank you.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Thank you.

Operator

Thank you. And our next question comes from the line of Jim Ricchiuti from Needham and Company. Your question please.

James Ricchiuti
Senior Analyst at Needham & Company

Hi, good morning. Hey John, besides NAND, which other areas, markets or subsectors are you seeing some signs of recovery, green shoots as you pointed out?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes. Good morning, Jim. Well, we are starting to see some of that chemistry recover in advanced packaging. Even though quarter on quarter can be lumpy, we did see year over year an increase in the PCB chemistry world and we grew 12% organically. We believe that is far outpaces the industry by the way.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

And the other green shoots that I would call out besides NAND as you say is the equipment, chemistry equipment for Advanced Packaging. We saw these orders pick up a couple of quarters ago. They continue to pick up and this is for MLB and HDI applications for AI.

James Ricchiuti
Senior Analyst at Needham & Company

Got it. Hey, John, looking at that E and P business, can you help us maybe remind us again how much of that you would characterize as advanced packaging and whether you want to give it to us for the quarter and just some sense as to how that might have grown or the year?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes. I think what we used to talk about for Advanced Packaging was really the IC substrate part, the one that is really enabling for things like AI servers and non AI servers and PCs. That's about a third of the PCB market. What's surprising and good for us is that because of the number of layers and the complexity of the number of chips being packaged, we're starting to see AI drive growth in MLB and HDI. And so, MLB is a third of the market, HDI is a third of the market and IC substrates are a third of the market.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

And the equipment that we talked about is driven the equipment orders is driven mostly by HDI and MLB. Package substrates remains the part for the AI servers is great. Those customers are really ramping. But as we've talked about, that's still 10%, fifteen % of the entire IC substrate market. And so the other 85% of the market is still relatively muted because that's driven by PCs and non AI servers.

James Ricchiuti
Senior Analyst at Needham & Company

Got it. Thank you.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Thanks, Jim.

Operator

Thank you. And our next question comes from the line of Vivek Arya from Bank of America Securities. Your question please.

Michael Mani
Michael Mani
Equity Research Associate at Bank of America

Hi, this is Michael Mani on for Vivek Arya. Thanks so much for taking our questions. To start maybe on gross margins, it seems like they're dipping into this quarter, if that's related to higher equipment mix. But what are the puts and takes for gross margins as we go through the year? Should we expect the greater contribution from chemistry to help any other segment dynamics there?

Michael Mani
Michael Mani
Equity Research Associate at Bank of America

Appreciate any color. Thank you.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Yes. Hi, Michael. I'll take that. First of all, we're very, very happy with the improvements we've seen in gross margin year over year. We improved our gross margins by 190 basis points, 23 to 24.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

And a lot of that was due to the commercial actions and operational excellence programs in place. Most of those operational excellence programs will continue, which includes manufacturing excellence and procurement savings, and will continue to help our gross margin in the coming quarters. What we are seeing in Q1 is a higher concentration of equipment that we saw in Q4. That is going to continue and that will impact our mix. That combined with the impact of the Lunar New Year, reducing our chemistry mix is the reason why we are guiding our gross margin slightly lower in Q1.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

So to your question, the actions that we control to influence the gross margin will continue and the mix is seasonal.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes. And I'd add to Michael that it is seasonal, the chemistry revenue for packaging, because we do have a consumer products component to our business. And Lunar New Year, where many of our customers are shut down for a week or so, doesn't occur going forward. And so we kind of expect if normal cyclicale happens that the proportion of our revenue that's chemistry returns. And so that's a tailwind for gross margin.

Michael Mani
Michael Mani
Equity Research Associate at Bank of America

Great. Thank you. And then for my follow-up, I just wanted to ask about your design win pipeline. So with Adatech, Electro Scientific and all, how does your design win pipeline look based off the synergies you're able to generate from a customer revenue basis from these acquisitions? Has it grown?

Michael Mani
Michael Mani
Equity Research Associate at Bank of America

And when do you expect most of these revenues to kind of convert? Is that something we could see later this year? Is it more further out in 2026, '20 '20 '7? And then finally on that, were there any other were there any areas within that pipeline where, maybe the company was surprised at how competitive it was, like areas that that maybe it didn't expect to land a win, but it was more competitive than they initially anticipated? Thank you.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes. No, we still have great engagement with many customers on this portfolio that we are able to provide, meaning laser systems as well as the chemistry and chemistry systems. So that engagement and the design wins that come from that remain strong. We have multiple design wins that we've talked about in the past. To your point, it does take one or two or three years depending on the customer for that revenue to show up.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Your other question about were there any headwinds and whatnot, I think most of the headwinds would be you win a design and then maybe that customer is not levered to AI and they may not grow as much. Maybe they're levered to PCs and so they would certainly not be adding volume. But once you win that design win and once that market returns, we expect them to be successful as well.

Michael Mani
Michael Mani
Equity Research Associate at Bank of America

Great. Thank you.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Thank you.

Operator

Thank you. And our next question comes from the line of Steve Barger from KeyBanc Capital Markets. Your question please.

Steve Barger
Steve Barger
Managing Director - Equity Research at KeyBanc Capital Markets

Thanks. John, for your comment about a healthy pace of design wins for optical assemblies, are those coming from a product refresh or are those new programs that you haven't been on before?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes, both Steve. Some are a program we're already on, but it's an upgrade, the next generation of it. And some are literally new things that no one's ever done, including our customers. So it's exciting to do both. Number one, you're not losing share, you're actually being asked to upgrade what you already delivered.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Number two, we're being asked to do things that are more and more complex, require more and more of our portfolio and therefore much stickier and fewer and fewer our competitors can actually do that. So it's a combination of both, Steve.

Steve Barger
Steve Barger
Managing Director - Equity Research at KeyBanc Capital Markets

Are you seeing the pace of RFQs or the conversion rate from that initial process to wins change as the cycle starts to move forward or how would you characterize that process?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Well, I think for world class optics, those design the timing for designs is multiple years before they go into the market. So really no change because that pace has to continue no matter where you are in the cycle. I would say we are seeing more of it on average over time because of the investments we made in capability in world class optics. So it's really long design cycles, difficult things to do, and they continue through cycle.

Steve Barger
Steve Barger
Managing Director - Equity Research at KeyBanc Capital Markets

Got it. And then as you look at the progression of advanced packaging demand, is there a meaningful difference across different variations like COWAS S versus COWAS L? I guess, is there an optical demand trend beyond just broader packaging proliferation?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Well, packaging to your point is evolving quickly and it's a very dynamic area, which we love, right, because that means new technology, new opportunities. I think to your point, COOS S is moving to L to R and all that. And that's important. But really what we're talking about at MKS are the 50 layers below that and the chemistry and the drilling and equipment below that. And so that 50 layers used to be 40 and before that was 30.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

So that's an exciting area for us and that's really why we thought putting AdityaC together with MKS makes a lot of sense, enabling that roadmap to go faster.

Steve Barger
Steve Barger
Managing Director - Equity Research at KeyBanc Capital Markets

Understood. Thanks.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Thanks, Steve.

Operator

Thank you. Our next question comes from the line of Toshiya Hari from Goldman Sachs. Your question please.

Toshiya Hari
Toshiya Hari
Managing Director at Goldman Sachs

Hi, good morning. Thank you so much for taking the question. John, a couple of your customers have spoken to the recent export restrictions and how that's having an impact on revenue in calendar twenty twenty five. I know most of this should be indirect for you guys, but I'm curious if there's a way to quantify any negative hit from the recent restrictions in semi's obviously.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes, may

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

I let Ron take that?

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Yes, I can start. So our guidance reflects our best view at this point. We don't see any material impact based on what's in place today. Now as you know, the situation is quite fluid and we are evaluating it closely.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes. Toshiya, I think you're asking about the BIS restrictions that came out at the end of the year or you're asking about tariffs?

Toshiya Hari
Toshiya Hari
Managing Director at Goldman Sachs

At the end of the year, the BIS restrictions.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes. Well, yes, as you read KLA, Lam, everybody's come up with some new numbers. And we are, as Ram said, this is our best view because of what we see from our customers. Obviously, if their revenue goes down, we will see that. But I would say our direct sales to China for the semiconductor market is very, very low.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

The numbers that impacted us were occurred in October 2022 and those numbers are out of our that revenue is out of our numbers right now. So, it's still indirect impact on the same order as what it impacts our customers.

Toshiya Hari
Toshiya Hari
Managing Director at Goldman Sachs

Got it. That's helpful. And then as my follow-up, maybe one for Ram. So you've been with the company for a couple of months now. I'm curious, I know you guys are very focused on paying down debt on the balance sheet, but curious if you've been able to identify any opportunities to sort of improve the operations of the company, how you guys think about working capital, tax strategy, anything that you've been able to kind of identify and potentially improve going forward?

Toshiya Hari
Toshiya Hari
Managing Director at Goldman Sachs

If you can share that with us, that would be really helpful. Thank you.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Yes, certainly. On cash flow itself, where you are going, as John mentioned in his script, $410,000,000 increase from $178,000,000 year over year, strong free cash flow generation and a good link to the P and L, 11.4% of our revenue was 500 basis points improvement year over year. So to on debt repayment, our continued focus will be start from the P and L, maintain and continue the actions we are working on now to keep the margin growth and profitability going. Free cash flow is about 92% of our non GAAP net earnings. So that bridge is very good and we need to see that translate into the cash flow.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

We continue to look at repricing and prepayment of our debt that you saw in January. Those opportunities will continue. And in terms of P and L, I think the company is executing well. We are constantly looking at operational excellence programs, which we will continue to do and then drive that cash flow to help with the debt repayment. And our capital allocation strategy has not changed.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Repayment of debt is our number one priority after we invest in the business.

Toshiya Hari
Toshiya Hari
Managing Director at Goldman Sachs

Thank you very much.

Operator

Thank you. And our next question comes from the line of Shane Britt from Morgan Stanley. Your question please.

Shane Brett
Shane Brett
Equity Research Analyst at Morgan Stanley

Thank you for taking my question. So your balance sheet inventory was down twenty days quarter over quarter. Is there anything worth noting here? And how should we think about your targets on days of inventory going forward? The reason why I'm asking is that with what seems like within lead time orders increasing with semi, I'm just trying to understand how much longer can you support semi continue to come higher than your expectations?

Shane Brett
Shane Brett
Equity Research Analyst at Morgan Stanley

Thank you.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes. So, we're happy with the progress we made on inventory, Shane. And I think as it starts burning down, we're getting to leaner normalized turns rates. And as you know, if there's a large ramp, obviously, we would use some working capital to prepare ahead of time for that. That's normal.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

But I think we have a little higher inventory than we have in the historic past. And that's because of certain strategic components that we have elected to keep, given what happened at the last ramp with shortages. So inventory is a little higher, but we're happy with the progress we made in decreasing it.

Operator

Does that answer your questions?

Shane Brett
Shane Brett
Equity Research Analyst at Morgan Stanley

Yes.

Shane Brett
Shane Brett
Equity Research Analyst at Morgan Stanley

Thank you very much.

Operator

Thank you. Our next question then comes from the line of Vijay Rakesh from Mizuho. Your question please.

Vijay Rakesh
Vijay Rakesh
Managing Director at Mizuho Financial Group

Yes. Hey, John and Ram. Just on the AI side, you mentioned the tailwind in packaging. Can you talk to like what percent is that AI mix as a percentage of your total revenues and how do you see that obviously growing in 2025? I know you mentioned as a percent of

Vijay Rakesh
Vijay Rakesh
Managing Director at Mizuho Financial Group

the substrate market, it's pretty small.

Vijay Rakesh
Vijay Rakesh
Managing Director at Mizuho Financial Group

But if you walk through like just for you what the exposure is?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes, Vijay. Yes. So it's a little it's easy to say in certain submarkets like the IC substrate part, which we talked about being kind of 10%, fifteen % is driven by AI. It's harder to break that out with respect to MLB and HDI. We see the two orders because those are big markets that are levered to other device types.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

I would say also remember that AI is driven by semiconductors, a lot of semiconductors. And we have over 85% of every step in the process for making semiconductor chips. If you you do understand certainly that AI is driven by Moore's Law. Moore's Law is driven by semiconductor progress and packaging progress. We address 85 of semiconductor processes, 70% of packaging processes.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

So as a company, we're levered to AI as much as we always have been to Moore's Law. So that's our best answer for you because otherwise breaking it up is pretty difficult for us to do.

Vijay Rakesh
Vijay Rakesh
Managing Director at Mizuho Financial Group

Got it. And then Ram, as you look at in a better free cash flow and driving faster, better prepayments, any thoughts on the deleveraging from the 4x down to the two times longer term target? Any time in there, are you pulling it in?

Vijay Rakesh
Vijay Rakesh
Managing Director at Mizuho Financial Group

How do you look at that? Thanks.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Yes. Let's just go back to last year, just to drive the point home that we are very focused on what you're asking. In a year when we did not get much help from sales, we repaid close to $500,000,000 4 70 6 million dollars including the $50,000,000 mandatory. That alone has brought our number down to 4.3 times. And all expectations are that with a little help from top line, we can accelerate that given our current cost structure.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

So the plan and the focus is exactly what you said to get that down to acceptable levels, which we have said two times net. That's our focus. As for timing, I don't want to predict that now, but rest assured our focus is to get it down to that level.

Vijay Rakesh
Vijay Rakesh
Managing Director at Mizuho Financial Group

Thanks.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Thanks, Vijay.

Operator

Thank you. Our next question comes from the line of Joe Quatricke from Wells Fargo. Your question please.

Joe Quatrochi
Joe Quatrochi
Director & Equity Research Analyst at Wells Fargo

Yes. Thanks for taking

Joe Quatrochi
Joe Quatrochi
Director & Equity Research Analyst at Wells Fargo

the questions. I think in

Joe Quatrochi
Joe Quatrochi
Director & Equity Research Analyst at Wells Fargo

the past, like during the December call, you talked about like the growth that are in your optics business within the semis business. I was curious how that did in 2024 and how do you think about the opportunity for growth in 2025 given the outlook for some of those customers?

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Yes, Joe, good morning. It's John. We've talked about optics, world class optics and we've talked about that revenue over a longer time period, as you know, going from kind of the $150,000,000 to the $300,000,000 level run rates. So over the last year or two, we've actually outgrown that segment of WFE, the lithography, metrology inspection segment. So '24 was a good year, strong year.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Certainly, we're not immune to any cycles in that subsegment of WFE. But as we talked about earlier, it's really the design wins that really give us confidence that we will continue this effort and it will lead us to outperform certainly in that subsegment in WFE overall.

Joe Quatrochi
Joe Quatrochi
Director & Equity Research Analyst at Wells Fargo

Thanks. And then just as a follow-up, maybe a little bit more housekeeping, but I think you're guiding interest expense to be up slightly quarter over quarter. I know it's a net number, but I would have thought I guess that would down given the repricing and prepayment in January.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Yes. The main reason is because of there was two things we clarified the pension reclass impact in Q4, right? Did you guys said? So if you take that out, we are our interest in Q4 is $48,000,000 which is very close to what we guided. The full impact of the $100,000,000 prepayment and the 25 basis points of reduction that we got in January has not included in our Q1 guidance.

Ram Mayampurath
Ram Mayampurath
CFO at MKS Instruments

Our Q1 guidance is 49.5%, which is if you look at quarter over quarter, we have dropped our interest rates by 40% compared to Q1 twenty twenty four versus Q1 twenty twenty five. So that's a good model for you to look at what we have done today, the impact of what we have done today and we will continue to look for additional opportunities to bring our interest rate down and also to accelerate our prepayments.

Joe Quatrochi
Joe Quatrochi
Director & Equity Research Analyst at Wells Fargo

Okay. Thank you.

John Lee
John Lee
President and Chief Executive Officer at MKS Instruments

Thanks, Joe.

Operator

Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Paretosh Misra for any further remarks.

Paretosh Misra
Paretosh Misra
VP - Investor Relations at MKS Instruments

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

Operator

Certainly. Thank you ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.

Executives
    • Paretosh Misra
      Paretosh Misra
      VP - Investor Relations
    • John Lee
      John Lee
      President and Chief Executive Officer
    • Ram Mayampurath
      Ram Mayampurath
      CFO
Analysts
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Earnings Conference Call
MKS Instruments Q4 2024
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