MKS Inc. (MKSI) Earnings Call Transcript

Good day, and thank you for standing by. Welcome to the MKS Second Quarter 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.

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 2026, which are posted to our investor website at investor.mks.com. As a reminder, various remarks about future expectations, plans and prospects for MKS comprise forward-looking statements. Actual results may differ materially as a result of various important factors, including those discussed in yesterday's press release and in our most recent annual report on Form 10-K and any subsequent quarterly reports on Form 10-Q. These statements represent the company's expectations only as of today and should not be relied upon as representing the company's estimates or views as of any date subsequent to today, and the company disclaims any obligation to update these statements. During the call, we will be discussing various non-GAAP financial measures. Unless otherwise noted, all income statement-related financial measures will be non-GAAP other than revenue and gross margin. Please refer to our press release and the presentation materials posted to the Investor Relations section of our website for information regarding our non-GAAP financial results and the reconciliations to our GAAP measure. Our investor website also provides a detailed GAAP revenues by end market and division. Now I'll turn the call over to John.

Thanks, Paretosh, and good morning, everyone. Momentum is continuing to build at MKS. Strong demand across all of our markets. Second quarter revenue and key profitability metrics came in at the high end or above our guidance ranges. Our Q3 guidance is supported by strong order activity that we expect will drive continued robust year-over-year growth. Against the backdrop of intensifying AI-driven investment across semiconductor and advanced packaging applications, we are demonstrating the strength of our foundational position, from vacuum, plasma, power products that enable leading-edge etch and deposition applications to optical components and photonics subsystems for the lithography, metrology and inspection markets, to laser systems, proprietary chemistries and chemistry equipment from the advanced circuit boards on which leading-edge semi devices are integrated. We are a leading enabler of advanced electronics. This is MKS at its core. . Our performance reflects the benefits of investments we've made and continue to make in broadening our capabilities and expertise, deepening our relationships with customers across the electronics ecosystem, and building out the global capacity needed to meet the unprecedented demands of this invest cycle. We're not only excelling in the current environment, but also generating new design wins that position us to capitalize on long-term growth opportunities. Now I'll review our Q2 end market performance and Q3 outlook. Starting with our semiconductor market. Revenue was above the midpoint of expectations as we and our supply chain partners continue to ramp operations. Revenue grew 19% sequentially and 28% year-over-year, which accelerated meaningfully from the 13% year-over-year results in Q1. Growth was broad-based across deposition and edge products, including our power for NAND upgrades and vacuum subsystems, plasma generators, reactive gases for advanced logic and DRAM applications. Our Photonics and Optics solutions also continue to gain momentum in the lithography, metrology and inspection market. Overall, we continue to see strong order activity and a very healthy order backlog that gives us good visibility through the second half of the year. We also continue to achieve design wins, including an advanced logic where we are the process tool of record for dissolved gas applications. And in RF power, where we have segment share leadership in high aspect ratio dielectric etch applications. Our semi outlook for Q3 implies year-over-year growth will accelerate to over 50% with strength across our entire portfolio of solutions. This anticipated growth is an indicator of MKS' long-standing track record of WFE outperformance during improving investment environment. Turning to Electronics and Packaging. AI-related applications are driving a meaningful increase in investment. Revenue was above the high end of our outlook, up 19% sequentially and 44% year-over-year. Laser drilling system sales into the flex PCB markets for advanced smartphones and peripherals were strong, and chemistry sales remain robust as well. In chemistry equipment, we said last year that order activity has been elevated for multiple quarters. It has moved another level above that. Our chemistry equipment demand is easily the strongest it has ever been, supported by AI server investments, including optical modules. Our visibility now extends through 2027. And to meet this growing demand, we recently announced we are doubling the capacity of our Guangzhou equipment factory. And notably, in rigid PCB drilling, we're pleased to see increased order activity as the market embraces our differentiated capabilities and a compelling cost of ownership proposition. As we have noted in the past, our proprietary chemistry carries higher gross margins than equipment, and we have high chemistry tax rates with our equipment customers, so we believe the stage is set for continued attractive high-margin chemistry growth through the cycle. We continue to be actively engaged with customers on their future plans which serves as a good leading indicator for strong equipment orders. Overall, the growth we're seeing in E&P reflects our long-held view of the trends driving device scaling in semi would ultimately come to the advanced PCB market as device integration becomes a core requirement for advanced electronics. That day has arrived, and advanced PCBs are rising in importance as increasing layer count requirements and integration challenges extend to higher-end smartphones, AI servers and other advanced electronics. In Q3, we expect electronics and packaging revenue to be up over 30% year-over-year, with AI-related investment, partially offset by flex equipment-related seasonality. Our flex market is typically down sequentially in Q3 ahead of the next design cycles, and we are coming off a very strong first half. I'd like to highlight how we are scaling in our semiconductor and electronics and packaging business, to meet anticipated demand growth today and over the next several years. Near term, we are increasing our working capital investments to address rapidly accelerating demand in the current cycle. Longer term, capacity planning is also key. Our new Malaysia supercenter, which opened in Q2 can be expanded at our option, and we are building out our chemistry equipment facility in Guangzhou, as I mentioned earlier. These facilities will play an important role in supporting our future capacity needs and their proximity to many of our customers strengthen engagement as well as deliver performance benefits as the new facilities ramp. Switching to our specialty industrial market. We delivered a strong quarter, up 8% sequentially and 14% year-over-year. Revenue has not been this high since 2023, driven by our datacom and defense markets. Performance across our remaining specialty industrial markets was steady in Q2. We expect strong performance in our specialty industrial market in Q3, led by the markets I called out. We're pleased to see how our foundational enabling technologies extend beyond semi and electronics and packaging into adjacent opportunities that leverage our R&D spend and deliver strong incremental cash flows. Wrapping up, MKS is executing at a high level financially, operationally and technologically. We further broadened our capabilities and expertise to address key opportunities across the ecosystem, resulting in deepening penetration in areas like lithography, metrology and inspection and advanced PCB at a critical time for the industry. We're also making strategic investments to support our customers and drive profitable growth well into the future. Our customer engagement and design win activity underscores our role as a foundational enabler of advanced electronics who looks ahead and solves ahead. Thank you to our MKS team, our suppliers and customers for your hard work and partnership. We are incredibly excited about what lies ahead. Now here is Ram to run through the quarter and our financial outlook in more detail.

Thank you, John, and good morning, everyone. We delivered an excellent second quarter and are seeing increased demand across all end markets. We remain focused on driving profitable growth with disciplined execution and continue to make the investments needed to capitalize on the growth opportunities that we see ahead. Let me begin by reviewing our Q2 results in detail. MKS reported revenue of $1.25 billion, up 16% sequentially and 28% year-over-year. Year-over-year growth trends accelerated through the first half of the year and we expect that to continue in Q3 as demand increases across our end markets. Second quarter semiconductor revenue was $554 million, up 19% sequentially and 28% year-over-year. In addition to continued strengthening of demand in DRAM and logic, we saw increased momentum in NAND upgrade activity. Collectively, this demand is driving strength across our key product categories led by plasma and reactive gases and vacuum products, while also supported by robust growth in our power solutions, optics and photonics offerings. Second quarter electronics & packaging revenue were $381 million, an increase of 19% quarter-over-quarter and 44% year-over-year. The very strong sequential improvement highlighted elevated and across our portfolio, including chemistry solutions, chemistry equipment and flexible PCB drilling sales. The even stronger year-over-year comparison was driven by demand for chemistry equipment, which continues to inflect higher, we are also seeing very healthy demand for chemistry solutions and flexible PCB drilling equipment. As the chemistry business continues to benefit from accelerating demand for AI-related applications, sales in the quarter were up 21% year-over-year, excluding the impact of FX and palladium pass-through. In our specialty industrial market, second quarter revenue was $313 million, an increase of 8% sequentially and 14% year-over-year. The year-over-year growth was driven by datacom and defense applications, while the sequential improvements reflected continued momentum in datacom as well as seasonal recovery following the Lunar New Year. Turning to gross margin. We reported second quarter gross margin of 47.6%. In addition to higher volume, we also saw a benefit from certain discrete items in the quarter. Excluding these discrete benefits, gross margin remained very healthy despite unfavorable product mix and accelerated investments necessary to address pricing demand. Second quarter operating income was approximately $320 million, yielding an operating margin of 25.6%, which was up 480 basis points year-over-year and well above our guidance midpoint. Operating expenses of $275 million were in line with our guidance. We are driving very healthy operating leverage in the business as revenue scales. Second quarter adjusted EBITDA was $358 million, yielding a 28.6% margin and also above the high end of our guidance. Net interest expenses was $33 million compared with $46 million in the second quarter of 2025, reflecting the full quarter benefits of our first quarter financing actions as well as continued proactive principal prepayments. Our second quarter effective tax rate was 19.6% and in line with our guidance. Second quarter net earnings were $232 million or $3.30 per diluted share, up 86% year-over-year on a per share basis and above the high end of our guidance. Let me now turn to our cash flow and balance sheet. We closed the quarter with over $1.6 billion of liquidity comprised of cash and cash equivalents of $611 million and our undrawn revolving credit facility of $1 billion. We generated free cash flow of $188 million, about 15% of our revenue. We expect investments in CapEx and working capital to increase through the remainder of the year as we continue to prioritize our organic growth. Beyond that, we will maintain our focus on proactively deleveraging to strengthen the balance sheet. We made a $100 million prepayment on our term loan earlier this week. Our leverage at the end of Q2 were 3x based on a trailing 12-month adjusted EBITDA of $1.1 billion, which is down one full turn since Q2 of last year as we continue to make strong progress towards our target leverage ratio. Finally, we paid a dividend of $0.25 per share or $17 million following the 14% increase in our dividend in Q1. Let me now turn to our third quarter outlook. We expect revenue of $1.35 billion, plus or minus $40 million, which represents continued strong sequential improvement and further acceleration in year-over-year growth. Our third quarter outlook by end market is as follows: revenue from our semiconductor market is expected to be $630 million, plus or minus $15 million; revenue from our electronics and packaging market is expected to be $385 million, plus or minus $15 million; and revenue from our specialty industrial market is expected to be $335 million plus or minus $10 million. Based on anticipated revenue levels and product mix, we estimate third quarter gross margin of 47%, plus or minus 100 basis points. We expect third quarter operating expenses of $280 million, plus or minus $5 million. We expect operating expenses will grow at a much lower rate than revenue. We expect third quarter operating income of $355 million with an operating margin of 26.3%. We estimate third quarter adjusted EBITDA of $395 million, plus or minus $28 million. We continue to expect CapEx for the year to be in the range of 4% to 5% of our revenue. We expect our third quarter tax rate to be approximately 20%, and the full year tax rate to be at the lower end of the 18% to 20% range we provided previously. Based on these assumptions, we expect third quarter net earnings per diluted share of $3.58 plus or minus $0.31. As our Q2 results and Q3 guidance indicate, our business momentum continues to increase. Our focus is on meeting accelerating customer demand. We remain committed to making the investments necessary to support growth while continuing to prioritize our deleveraging efforts. We are in a great position entering the second half of the year. And with that, operator, please open the call for questions.

[Operator Instructions] Our first question comes from Steve Barger at KeyBanc Capital Markets.

I'm going to start on some of the NAND tool upgrade. You've talked about that activity will contribute in coming years. But greenfield NAND, I think is even better business. Can you update us on what the upgrade cycle looks like and how that bridges to greenfield projects you may see entering equipment planning?

Yes, Steve. So we did mention that we are seeing upgrade activity in Q2. We certainly expect that to continue. It can be lumpy, but we know that the industry is certainly trying to increase capacity in NAND. And then, of course, there's been some announcements of greenfields and those factories, as you say, will be even better for our power as well as the rest of our portfolio. And those factories, fabs will be coming in towards the end of '27 beginning of '28. So that's the plan right now. So between now and then, we would expect continued upgrade activity. .

Got it. Can you compare the magnitude of dollar spend for a new leading-edge tool versus an upgrade?

Yes. We don't really disclose that, but I would just say that the power part of that upgrade is the largest part of the BOM in terms of cost, and, therefore, opportunity for MKS. That's why when there are upgrades, we benefit from that. Of course, as it's a brand-new tool, we would have the rest of semiconductor portfolio around that tool. So that would be better, but our power content is large.

Got it. And then one quick follow-up. Really appreciate the commentary on visibility into '27 in electronics and packaging. As we've gone through earnings, some of your biggest semiconductor customers said visibility is the best it's ever been for their business. Can you talk about lead times and visibility into 2027 on the semi side?

Yes, sure. We are in constant communication with our customers, as you know. They have given us their plans, expectations much further out than normal. And we are building capacity and inventory and scaling our factories and getting the labor in to meet those anticipated increases from our customers. So we are planning to make sure that we're not the constrained. Lead times right now for us are still kind of normal. So we're executing really well given we're already a couple of quarters into the ramp. So of course, we've got to manage many suppliers. But right now, our supply chain is stepping up. .

Our next question comes from Bhavesh Lodaya, BMO Capital Markets.

Can you give us an update around the ramp-up of Malaysia and capacities as you ramp up those things? And are you still comfortable with the $180 million to $200 million of WFE that you can support with those plans?

Yes, Bhavesh. Malaysia has started ramping. In fact, we could say that the first revenue shipments have occurred there. It's still early days, of course. We've said in the past that we did not need Malaysia for 2026 to meet the 2026 demand. So Malaysia is ramping up to meet the 2027 demand and then beyond that. We had talked about capacity planning last quarter that we would need Penang as well as perhaps other sites. Right now, we have reconfigured things so that we believe that when we fill out Penang, we will be able to support a WFE in that $200 billion to $250 billion range, which is an incremental improvement from what we said last quarter. And of course, in addition to that, we announced the doubling of capacity in our chemistry equipment factory in Guangzhou.

Got it. And a question on your specialty industrials platform. the nice step change in the earnings growth profile, your guidance seems to indicate it's going to grow in the high teens in 3Q. Could you touch on some of the end markets or sectors that are helping? I know you called out a couple of them, but it looks like pretty -- it goes up to be very strong for the overall platform to grow in the high teens. Maybe talk about the durability of those early -- are there any timing benefits? And how should we just think about the baseline of this platform into the next year?

Yes. Thanks for that. I think we called out two of the submarkets, and that was datacom, data communications. And again, that's driven by AI. So communications testing for AI data centers. That continues to be strong. We expect that to continue to be strong. It should follow, for instance, the AI investments for the industry. The other segment we called out was defense. And that has continued to be strong and grown over the last several quarters. And that's really a market where it probably depends on your view of defense. But those two markets continue to remain strong. That's why our guidance for specialty industrials in Q3 remained strong. So that's the color we can give you. The other sub markets, one is automotive, that's kind of bouncing along, no degradation, no material improvement either, so -- and then industrials, that is also we're seeing incremental improvement there, but not to that same order magnitude as datacom and defense.

Our next question comes from Matthew Prisco at Cantor.

I guess, first on the E&P side, how should we be thinking about the chemistry growth potential moving forward given this continued equipment strength? Is there something kind of we look for meaningful growth inflection in '27, '28 as those systems move to high volume manufacturing? And any update you can provide on the AI contribution as a percentage of those revenues?

Yes, Matt, maybe I'll start with the AI contribution. We had said 24% was 5% AI chemistry as a percentage of our chemistry overall, then 10%. And this year, 15%. Last quarter, I would say it's incrementally better. So think about 15% to 20% as the right number now for chemistry as a percentage of our chemistry for AI, so that's one update. I would also say that the equipment business -- the chemistry equipment business is growing very, very fast. We did talk about the fact that we have visibility through 2027, which gives us the confidence to build that Guangzhou factory, expand that capacity. I would say too that we have said the percentage of chemistry or the amount of chemistry that comes out for every dollar of equipment sales is in that 20% to 40% range. That's still true, but maybe the update here for your modeling is that we're selling a lot more of the higher-end pieces of equipment fundamentally because AI boards are more difficult, you need higher-end equipment. Those come with higher ASPs, and so mathematically, that 20% to 40% range, think of it at the lower end now, and that's just a math problem. The chemistry is still there, but the ASP of the equipment is higher now.

Perfect. That's helpful. And then on the debt side, we're seeing strong sequential growth in 2Q, guided strong sequential growth in 3Q, voluntary prepayment kind of staying the same. And I understand you're investing in supply to meet demand, but can you maybe give us updated thoughts on strategy around deleveraging? And at what point do these voluntary payments to get to move more meaningfully higher?

Matt, this is Rama. I'll take that. It's a great question. As we have said before, investing in organic growth, supporting our organic growth is first priority and then strengthening the balance sheet, the prepayment on our term loan as #2, a close #2, I would say. In the second half of the year, you will see our CapEx picking up and inventory growing as we prepare for the ramp. Having said that, we continue to make the prepayment of $100 million each quarter, and we are looking at making additional payments in Q3 and in Q4. So although it has not happened yet, it is high on our priority.

Our next question comes from Michael Mani at Bank of America Securities.

To start on semi market, nice to see that on a quarterly run rate basis, you've crossed the last peak that the segment saw back in 2022. If you were to compare then versus now, could you give us an update on how much of the mix is NAND versus DRAM versus logic? So especially NAND, could a rough sense of how far it is off from the bottom? And like looking ahead, how do you expect that mix to evolve, especially as you pick up more wins on the lodging side?

Michael, I'll start with that. I think the way we're looking at it in terms of our end markets, it's still largely a logic DRAM-driven semi market, and an upgrade was nice to see. We kind of expect that to continue. It might be even better. But eventually, in '28, with NAND greenfields, that will be a bigger percentage of our semi revenue. I think also you pointed out that we are getting to that point of overperformance of WFE doing the ramp as we've done historically. And our guidance in Q3 of our semi revenue implies that we will be over 50% year-over-year in Q3. And to just give the audience a little more color, Remember, we are exposed to 85% of WFE, so every segment of WFE. And as we've said in the past, in litho metrology inspection, those amplitudes are smaller in terms of the ramp and depth etch. So our average is over 50%, but you can do the math as well as I can, that the depth etch part is significantly higher than that average.

Great. Very helpful. And then on E&P, could you help decompose between this past quarter you reported and what you're seeing into Q3 and potentially into Q4? Like where is the strength coming from between chemistry versus electroplating versus flex drilling? And is it fair to say that maybe some of the demand destruction peers related to mobile were more benign than feared? Or is it kind of too early to make that judgment?

Yes. Regarding the demand destruction that the industry had feared earlier in the year, I think it is more benign than feared, that's true. We could see it in our flex drilling because the flex drilling business has -- was very strong in the first half. There is seasonality to it, but new form factors and high-end smartphones have been fairly strong for us, and that's reflected in our flex drilling system revenue, so that's pretty good. Now the chemistry for the rest of the consumer products also goes through seasonality, but it's really AI that's driving the quarter-on-quarter growth in our expectation. And then the other part is chemistry equipment. We are shipping that chemistry equipment as fast as we can. And to add a little more color to the prepared remarks, we talked about the Guangzhou factory, doubling capacity there. We've talked in the past about what happens if the current Guangzhou factory is full, and that was to use our Germany factory, and we have turned on Germany as well to fill the gap between now and when the Guangzhou second factory comes online. So we are shipping equipment as fast as we can. To the earlier question, that's great for market share of chemistry in the future. And the equipment does have a lower gross margin, so that mix does affect the overall company gross margin, but we're okay with that because it's a great market share and much higher chemistry gross margin later.

Our next question comes from Shane Brett at Morgan Stanley.

I want you guys to help us unpack the gross margin portion a little bit. If my numbers are correct, your gross margin ex palladium for the June quarter would have been kind of in the mid-4% to 8% range. Just how much of your quarter-over-quarter decline into September is a result of some E&P chemistry weakness? And are you expecting palladium to be a tailwind or a headwind to gross margin in the September quarter? .

Shane, the last part of your question, we expect palladium to kind of stay flat in the third quarter at about $1,300, probably stay at that. But to get back to your question on gross margin, let me touch on a few points here. So in Q2, 47.6% is what we had -- what we reported. That includes about 100 basis points of discrete items, mostly coming from the refund of tariffs and duties. It's also important to point out that without these discrete benefits, GM would have been consistent with what we have in the past several quarters despite the impact from some investments we are making to support growth. John talked about getting Malaysia ready for 2027, and we continue to invest in the ramp. We are stepping up our investments to prepare for the demand and these investments come with the P&L impact. So those are included in the numbers as well, and you'll see that for the remainder of the year. And then on the mix side, mix is unfavorable, and will remain so as long as VSD and the chemistry equipment ramps. As we've said before, these are good problems to have because as higher VSD means higher operating income, and higher chemistry sales follows the equipment sales like we have explained before. So overall, our gross margin remains healthy with all these puts and takes, so the investments will continue, and we have made a strategic choice to push forward on our equipment sales. So those two will have a -- will be a headwind temporarily to the gross margin.

Got it. And for my follow-up, I'm actually going to ask another gross margin question. It is going to be on VSD specifically, which I assume is a lot of semi the VSD gross margins were north of 46% in 2021. As of the March quarter, we were at 42.9%, just where are we in the margin recovery path there? And what do we need to have happen for margins to get above that sort of mark that we saw in the prior peak?

Yes. So VSD, like I said, VSD margins are slightly lower, but where we benefit from VSD ramp is in the operating income side. We have continuously worked on operational excellence programs that will help us, but it also depends on the mix within VSD as to what will drive the margins. And that's what you're seeing now. What products that make up a lot of the VSD sales are not our highest end VSD products.

Shane, maybe to add a little bit about that. In the prior cycle, when we hit that 45%, 46%, it was China direct sales for VSD, which is much, much lower now, that came with a gross margin tailwind. There was also a lot more RF power for NAND, greenfields, and that's accretive to BSD gross margins. And then the third point is what Rama already pointed out, we are in that part of the cycle where we are investing in labor ahead as well as CapEx ahead. So those are the three things that are a bit of a difference between the quarter you quoted and where we are now. But we think that over time, the investments will catch up and that will be no longer a headwind. China is China, that is what it is. And then I think volume will continue to help.

Our next question comes from Melissa Weathers at DB.

I was hoping to talk a little bit about 20 the second half, it seems like you guys are off to a really, really strong start in the second half, but I was hoping to get your thoughts on how you're thinking about 2027 growth rates, like what do you think will grow faster between the semis and the E&P business, both of those are doing awesome, but which 1 do you think grows faster next year?

Yes. Thanks for the question, Melissa. I don't think we know. I think though, that they're both at historic growth rates, as you know, I think, though, that they are coupled, right? When you think about all the investments in WFE and maybe of the semi customers talk about that, as many of our investors are aware of that. But when you pivot to our packaging, the equipment orders we're seeing are in the same order of increase that we're seeing in WFE and maybe even higher, so they are coupled. If you're going to make a lot of chips, you got to package them together. And so both industries are coupled to support advanced electronics. So it would be pretty hard to tell -- to determine now which ones are higher than the other. But there are a little dynamic differences between the two markets. We have short lead times in semi. And therefore, that's why we always guide just a quarter out, and then we look at the industry to see where we might be in '27. In chemistry equipment, our lead times are much longer. We talked about 6 or 9 months in the past. And because of that, we require down payments. Those down payments are things that give us confidence, and that's why we said we have visibility through 2027 because of those long lead items similar to maybe some of the semi guys that have long lead equipment lead times. So those are the dynamics, but I think there are a couple of Melissa, if one grows, the other must.

Well, I'll take that. And then maybe along those lines, from a pricing perspective, can you just talk about like clearly, you're expanding capacity to serve the strong demand. But is there any change to how you guys are thinking about pricing? Is there any like, I don't know, opportunistic or any leverage that you can get across either business on the pricing side?

Yes. I think our strategy for pricing has always been to get fairly paid and to do it continuously. So we're always looking at every product line and whether there is a pricing problem and we're not getting fairly paid. And so we're certainly in a competitive environment. We also value the long-term relationships we have with our customers, so I think we're pretty happy with where we are -- what we are doing in pricing. We're not going to take advantage of any opportunistic short-term dislocations in supply and demand. The long-term relationships are something that we're proud of and we want to maintain. .

Our next question comes from Krish Sankar at TD Cowen.