MKS Instruments Inc

NASDAQ:MKSI

Earnings Call Analysis

MKS Instruments Shows Strong Revenue and Plans Continued Growth Amidst Market Challenges

MKS Instruments reported a solid third quarter with revenues hitting $896 million, a 1% sequential increase, driven by strong semiconductor and electronics sales. Semiconductor revenue reached $378 million, up 3%, surpassing expectations. The company anticipates fourth quarter revenue of $910 million, plus or minus $40 million, with gross margins projected at 47%. Operating income was robust at $195 million, reflecting effective cost control. MKS showed significant cash generation potential, reporting free cash flow of $141 million. Despite industry softness, MKS plans to maintain investments in growth and innovation, indicating a stable outlook and continued focus on debt reduction as markets recover.

Navigating the Market with Strong Fundamentals

In the third quarter of 2024, MKS Instruments demonstrated strong resilience in a challenging market environment, achieving revenues of $896 million. This figure represents a slight sequential increase of 1% and is at the top end of the company's guidance. Particularly noteworthy is the semiconductor market, which reported a 3% revenue increase both sequentially and year-over-year, highlighting robust demand, especially in DRAM and logic/foundry applications. Overall, while the economic landscape remains tough, MKS's solid execution reflects its ability to navigate these challenges effectively.

Bringing Margins Back on Track

MKS reported third-quarter gross margins of 48.2%, which is above the high end of the guidance. The operating income totaled $195 million, showcasing an impressive operating margin of 21.8%. This solid margin performance was primarily driven by an advantageous product mix and strong operational cost management. Looking ahead, MKS anticipates a gross margin of approximately 47% in the fourth quarter, which indicates a slight compression due to changes in revenue mix but still reflects healthy profitability.

Strategic Debt Management and Strong Cash Flow

The company has been making significant strides in managing its debt load, having prepaid $426 million year-to-date, including $216 million just last month. As a result, MKS has managed to reduce its annual interest expense run rate from around $330 million to approximately $220 million, a decline of more than 30%. The third quarter's free cash flow was robust at $141 million, or nearly 16% of revenue, underscoring the firm's strong cash generation capacity to support its financial goals.

Sector-Specific Outlook and Revenue Guidance

For the upcoming fourth quarter, MKS has provided a revenue guidance of $910 million, with a potential variance of plus or minus $40 million. Breaking this down, semiconductor revenue is expected to be around $380 million; the electronics and packaging market is projected at $240 million; and the specialty industrial sector is estimated to reach $290 million. Moreover, their estimated adjusted EBITDA for Q4 is $226 million, reflective of effective operational strategies amid a challenging backdrop.

Resilience Amid Sector Weakness

Although MKS faced an overall decline in revenues within some markets, notably a year-over-year drop of 5% due to fluctuating palladium prices and equipment sales, the company continues to find strength in niche areas such as their semiconductor and electronics divisions. For instance, chemistry sales saw a growth of 7% year-over-year, demonstrating a gradual recovery amid a difficult industrial backdrop. The ability to persistently innovate and adapt remains crucial for MKS as they eye a market rebound.

Investments for Future Growth

MKS's recent initiatives, including the groundbreaking for a new semiconductor factory in Malaysia, indicate a strategic move to diversify its production footprint and capture future growth opportunities. The company anticipates maintaining its capital expenditure between 3% to 5% of revenues, ensuring adequate funding for expansion while being judicious with costs during uncertain times. This approach will allow MKS to better position itself to capitalize on emerging trends and technologies.

Anticipating Market Recovery

While the forecast for 2025 suggests that favorable market conditions may remain subdued due to ongoing industry challenges, John Lee, the CEO, expressed a cautiously optimistic outlook. Expectations of sustained demand in DRAM and logic segments, coupled with a potential stabilization in NAND, provide a foundation for future revenue growth. The company is adapting to changing market dynamics, positioning itself strategically to leverage opportunities as they arise.

Earnings Call Transcript 2024-Q3

[Operator]

Good day, and thank you for standing by. Welcome to the MKS Instruments Third Quarter 2024 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.

[Paretosh Misra, executive]

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; Ram Mayampurath, Executive Vice President, Chief Financial Officer and Treasurer; and Michelle McCarthy, Vice President and Chief Accounting Officer. Yesterday, after market close, we released our financial results for the third quarter of 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.

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.

[John Lee, executive]

Thanks, Paretosh, and good morning, everyone. I'm pleased to introduce and welcome our new CFO, Ram Mayampurath, to MKS. Ram joined MKS in October and is actively diving into the business, engaging with our business leaders and already contributing to our strategic initiatives. We're excited to have him on board, and I'm confident his leadership will be instrumental as we continue to drive growth and execute on our long-term strategy. Ram will share some brief remarks later on this call, and he'll take the lead in discussing our financial results next quarter. Michelle will handle the financial results today, and I'd add that she's done a terrific job for MKS during this transition period.

MKS delivered a strong third quarter with all key financial metrics at or above the high end of our guidance ranges. Our gross margin strength reflects the value of our broad and differentiated product portfolio, including our chemistry revenues, which have supported profitability during a period of muted semiconductor demand. Additionally, our operating margin profile demonstrates our continued cost discipline, resulting in continued strong cash flows. We have also made meaningful progress on our highest priority, proactively managing our leverage. During the quarter, we repriced our U.S. dollar and Euro Term Loan B's, reducing our interest rate by 25 basis points. And we continue to actively pay down our debt, supported by our strong free cash flow generation of over $140 million in the third quarter.

These actions bring our year-to-date 2024 prepayments to $426 million. During my recent travels to Asia and meet with customers, we discussed many of the key trends and challenges they must overcome to execute their technology road maps, especially as many of them prepare for the next-generation challenges in AI-related advancements. As node sizes continue to shrink and technology grows more complex, the importance of our broad portfolio of critical technologies has never been more important, and our customers recognize this. As a result, I came away from these conversations even more confident that our differentiated capabilities will accelerate our customers' road maps and lead to their market success. Now I'll review our performance in our three end markets.

In our semiconductor market, revenue increased 3% sequentially and above the high end of our guidance range. Similar to our first half results, this higher revenue trend was primarily driven by in-quarter demand conversion related to DRAM and logic/foundry applications. NAND has remained relatively stable, albeit at historically low levels, and we remain well positioned when that market recovers. Our teams are engaged with equipment OEMs and leading semiconductor fabs in addressing a broad range of technology inflections such as atomic layer deposition in both logic and memory applications, high aspect ratio etching for memory devices and selective removal processes for logic gate-all-around transistors. Additionally, we continue to advance our strategy to grow segment share in lithography, metrology and inspection.

Following the strategic photonics win we talked about last quarter, we recently achieved a design win for our world-class optics initiative with another customer that further highlights our increasingly differentiated technology capabilities in this attractive segment of the WFE market. In our laser business, we also received an order for a back-end application related to high-bandwidth memory, validating the important role that MKS solutions play in AI-related applications. In the fourth quarter, we expect semiconductor revenue to be flattish on a sequential basis. The guidance demonstrates continued stability in DRAM and logic/foundry demand, with NAND remaining at low levels.

Overall, we remain confident that the work we have been doing in the development of innovative solutions for the next wave of technological advancements positions us well for the future success. Turning to Electronics and Packaging. Revenue grew 1% sequentially, driven by chemistry sales. Equipment sales were down sequentially, in line with our expectations and reflecting typical quarter-to-quarter variations. While demand overall remains muted, we are seeing encouraging order activity, including in flexible PCB drilling used in smartphone applications and for our chemistry and equipment solutions for advanced MLB, HDI and package substrates related to AI applications. Our combined expertise in laser drilling, chemistries and chemistry equipment enables our unique role in optimizing the interconnect, which is central to addressing increasingly complex packaging needs in the AI era.

These wins are expected to support higher electronics and packaging revenue in Q4 with growth anticipated to be in the low single digits on a sequential basis. In our specialty industrial market, revenues decreased approximately 1% sequentially with steady performance in the industrial and research and defense end markets, offset by softness in the life and health sciences market. As a reminder, our specialty industrial market consists of a variety of applications across multiple end markets. We leverage our proprietary technologies and R&D investments in the semiconductor and electronics and packaging sectors to provide unique solutions that yield strong incremental margins and cash generation.

Looking ahead to Q4, we expect revenue in our specialty industrial market to increase slightly from Q3. In conclusion, we are pleased with our execution and financial performance in the third quarter. Given our strong third quarter results and our fourth quarter outlook, we now expect second half revenue to be up low to mid-single digits compared to the first half. Although signs of a recovery have not yet emerged across our end markets, our execution remains solid in the areas we can control. Our strong gross and operating margins have led to solid cash flow generation to support debt reduction throughout a year where our major end markets have been soft. This, along with our design wins and continuous innovation, gives me confidence that we are well positioned as markets recover. Now let me turn it over to Ram to provide some brief remarks, and then Michelle will run through the third quarter financial results in more detail. Ram?

[Ramakumar Mayampurath, executive]

Thank you, John, and good morning, everyone. I'm very excited to be a part of the MKS team, and I look forward to working with John and the leadership team to execute our strategic plan. It's obviously early days at this point, but let me share a few comments on my initial observations. MKS is a technology-driven secular growth company. The breadth of our product offering and early engagement strategy with customers, combined with the execution capabilities of the MKS team, puts the company in an enviable position. We are focused on attractive growth areas that enable today's advanced electronics devices. In the past few weeks, I have had a chance to meet many of our employees, and I have tremendous respect for their knowledge of the business and ability to execute. I see great value in the talent, culture and discipline here at MKS.

As for my own team, we have a deep bench of finance and accounting professionals with a mosaic of talent. We have a good mix of several recent hires with new ideas and capabilities, and veterans with in-depth knowledge of MKS. In the coming quarters, my focus will be on maintaining our cost discipline, driving profitability. We will continue to maximize cash generation to support our capital allocation strategy, which will primarily be centered around debt management and investing in CapEx to support our business strategy. We will remain focused on improving our overall cost structure to ensure that we are well positioned to take full advantage as the semiconductor and electronics market returns to normal levels of growth. With that, let me turn it over to Michelle to review our financial results for the quarter.

[Michelle McCarthy, executive]

Thank you, Ram, and good morning, everyone. For the third quarter, MKS reported revenue of $896 million, up 1% sequentially and at the high end of our guidance range, driven by better-than-expected semiconductor and electronics and packaging revenue. Third quarter semiconductor revenue was $378 million, up 3%, both sequentially and year-over-year. The result was above the high end of our expectations. Consistent with the first half of the year, we executed on strong in-quarter demand, especially as related to DRAM and logic/foundry applications. Third quarter Electronics and Packaging revenue was $231 million, an increase of 1% quarter-over-quarter and also above the high end of our expectations. This result was led by seasonal strength in chemistry, partially offset by lower equipment sales, which were in line with our expectations.

On a year-over-year basis, sales were down 5%, primarily due to palladium prices as well as natural variability in our equipment business. Excluding the impact of FX and palladium pass-through, chemistry sales grew 7% year-over-year, continuing a gradual recovery trend from industry-wide softness. In our specialty industrial market, third quarter revenue was $287 million, a decline of 1% sequentially and just below our guidance midpoint. Revenue was down 11% on a year-over-year basis, primarily due to general industrial weakness. Consistent with the prior quarter, we observed minor and mostly offsetting fluctuations throughout the multiple end markets served within Specialty Industrial.

Turning to margins. We reported third quarter gross margin of 48.2%, above the high end of our guidance. Gross margin was up sequentially due to product mix as well as operating leverage on higher revenues. We continue to prudently manage our costs, with third quarter operating expenses of $237 million coming within our guidance range. We have a strong track record of managing our cost structure throughout market cycles, which allows us to balance investing in our business with near-term profitability and cash generation. Looking ahead, we expect operating expenses will increase modestly from third quarter levels due to compensation costs, including the timing of new planned hires as well as certain third-party spend. Third quarter operating income was $195 million, yielding an operating margin of 21.8%, both well above our guidance, driven by strong sales, higher gross margin and prudent operating expense management.

Third quarter adjusted EBITDA was $232 million and also above the high end of our expectations with a 25.9% margin. Net interest expense was $53 million, slightly favorable to our guidance of $54 million, reflecting a decrease in Euribor rates in the quarter. Third quarter net earnings were $116 million or $1.72 per diluted share, well above our guidance range, reflecting the strong operating performance I just detailed and a lower-than-expected tax rate. Free cash flow was $141 million or nearly 16% of revenue, demonstrating the cash flow generation potential of the business. As the top line expands and we continue to prudently manage working capital and operating costs, we expect to see strong flow-through to the bottom line and higher cash flows, allowing us to accelerate our deleveraging.

We closed the third quarter with more than $1.5 billion of liquidity comprised of cash and cash equivalents of $861 million and our undrawn revolving credit facility of $675 million. We exited the quarter with gross debt of $4.9 billion and a net leverage ratio of 4.5x based on our trailing 12-month adjusted EBITDA of $895 million. We continue to prioritize deleveraging our balance sheet while managing the cash and investment needs of the business. In July, we made $110 million voluntary prepayment on our Term Loan B in connection with our repricing. Additionally, in October, we made another voluntary prepayment of $216 million on our Euro-denominated Term Loan B. These actions underscore our continued focus on debt reduction.

To put perspective around the impact of our debt actions this year, we entered 2024 with an annual interest expense run rate of approximately $330 million. With the actions we've taken year-to-date and favorable movements in Euribor rates, we have reduced our annual interest expense run rate by 1/3, or over $100 million, to approximately $220 million. Finally, during the third quarter, we paid a dividend of $0.22 per share or $15 million. With that, I'd like to turn the call back over to John, who will review our outlook. John?

[John Lee, executive]

Thank you, Michelle. Let me now turn to our fourth quarter outlook. We expect revenue of $910 million, plus or minus $40 million. By end market, our fourth quarter outlook is as follows: Revenue from our semiconductor market is expected to be $380 million, plus or minus $15 million. Revenue from our electronics and packaging market is expected to be $240 million, plus or minus $10 million, and revenue from our specialty industrial market is expected to be $290 million, plus or minus $15 million. Based on anticipated revenue levels and product mix, we estimate fourth quarter gross margin of 47%, plus or minus 100 basis points.

We expect fourth quarter operating expenses of $240 million, plus or minus $5 million. We estimate adjusted EBITDA of $226 million, plus or minus $23 million. We expect a tax rate of approximately 6% in the fourth quarter, benefiting from certain favorable discrete tax items in the quarter and bringing our full year tax rate to just under 16%. Based on these assumptions, we expect fourth quarter net earnings per diluted share of $1.95, plus or minus $0.32. Our execution has remained strong despite the cyclical challenges in our end markets. We are confident that we are uniquely positioned to capitalize on the opportunities that lie ahead. With that, operator, please open the call for Q&A.

[Operator]

[Operator Instructions] Our first question comes from the line of Matthew Prisco of Cantor.

[Matthew Prisco, analyst]

I guess maybe to start, on your semiconductors business, can you maybe add some more color on what you're seeing in terms of customer utilization rates, spare business, ordering patterns or anything else that may help inform an early view into 2025 dynamics?

[John Lee, executive]

Matt, it's John. Thanks for the question. I think we've continued to see utilization rates pick up. Certainly, HBM DRAM utilizations have been great. So we're seeing the same things that many people have talked about. Logic and foundry, certain customers remains very strong. And then NAND remains muted. So I think when you think about 2025, I think the views have come down over the year, but it's still generally an up year. And that's not necessarily our opinion. That's what we're seeing from many of our customers and what they're telling us. So I think NAND still remains muted and depends on when that turns. But foundry/logic, DRAM seem to be holding up well, and the expectation is that it will hold up well in 2025 as well.

[Matthew Prisco, analyst]

Great. That's helpful. And then I would love to hear a little bit more color on your progress in the photonics initiatives. And then also given the pushouts experienced by your largest litho player, how does this change your ramp expectations around your new photonics win and subsequent duration of that margin headwind?

[John Lee, executive]

Right. So, yes, we talked about last quarter a photonics win. This quarter, we talked about another photonics win with a different customer. So this is in the lithography, metrology inspection space, as you know. Certainly, the lead times for those kinds of subsystems as well as, of course, the systems are much longer. than in the vacuum area for WFE. And so short term, I don't think there's really any effect because the lead times are quite long for our stuff as well as their stuff. So longer term, of course, market demands will determine what the long-term needs are for critical lithography tools, metrology tools and inspection tools. So I think our point is there's lots of opportunity there to gain share with the technology we provide. We think we're unique because we can bring more tools to the toolbox, integrating different kinds of technologies together that makes us unique. So longer term, we're still very excited about our growth in the world-class optics initiative as well as the market share gain opportunities in this segment of WFE.

[Operator]

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

[Steve Barger, analyst]

At the -- looking at the guidance at the midpoint, gross margin steps down about 120 basis points sequentially. Is that mix? Or can you talk through what the swing factors are around that range?

[John Lee, executive]

Yes, Steve, thanks for the question. It is mix. We expect Electronics and Packaging revenue to be a little higher next quarter, as we just said. And that -- a lot of that is driven by equipment. So we did see some promising orders in Q3 for equipment related to AI. And this is equipment that's servicing all segments of the PCB industry, the HDI, the MLB and then the package substrate. And as we've talked about in the past, to make an AI board, you need the package substrate, of course, that's the highest density type of -- most advanced part of the PCB industry. But then you've got to put it on HDI and MOB boards. And so it was quite interesting for us to see some of our customers start ordering for those applications. And so that equipment revenue will flow through into Q4. And as you know, our equipment gross margin is slightly lower than the chemistry. So that's really part of it. That's really that mix.

[Steve Barger, analyst]

Got it. So, encouraging, but a little lower margin on the equipment. That's good. And maybe a question for Ram. You're coming into a situation where end markets are recovering, but there's still some uncertainty. How are you going to balance cost control versus the market share initiatives that we're talking about, inventory levels, just to make sure that service levels are high? Maybe just talk about what you're prioritizing as you go through the next few quarters?

[Ramakumar Mayampurath, executive]

Yes. Thanks, Steve. That's a great question. I think it's always a balance between meeting your current quarter and forecast guidance and making sure your long-term strategic plan initiatives are well funded and resourced. So we have done a good job in maintaining our cost discipline. And my immediate focus will be to make sure that continues. The margin progression continues and the cash generation that we have demonstrated keeps going so that we can strengthen our balance sheet with debt management. So those priorities don't change, will remain our focus.

[John Lee, executive]

Yes. I would add too, Steve, that we're really investing where we think the best opportunities are. So R&D is not starved. We expanded -- even field service to service the growing base of equipment as well. So to Ram's point, it's always a balance, but we are certainly very aggressive in putting money into opportunities as we see them. And some examples were RF power 5 years ago and world-class optics more recently as well as lasers and other opportunities that come up out as the markets change.

[Ramakumar Mayampurath, executive]

Yes. And just to add one more thought to what John just said. We are not starving our CapEx or we continue to invest in the business. Both in CapEx and in the P&L, like John said. So those activities and focus will continue.

[Operator]

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

[Chris Grenga, analyst]

This is Chris Grenga on for Jim. Could you elaborate on what you're seeing from a demand standpoint in some of the primary industrial end markets, in particular, automotive? And could you remind us what share of revenue is exclusively for enabling EV type applications?

[John Lee, executive]

Yes. Thanks for the question, Chris. So what we've seen in automotive is certainly more muted, and that's not a surprise. It's well documented. Our automotive revenue has been pretty stable, though, even in this muted environment. And this is really the GMF business, the kind of brake calipers and decorative type of things that go into cars, both ICE and EV. We haven't broken out EV versus ICE. I think there's a lot of opportunities that arise with EV, such as all the components that go into the battery that require metal coatings. So those are opportunities, tailwinds. And then some things go away, such as perhaps as much chrome on the front of the grill. So there's puts and takes.

But right now, we think that EVs offer a slightly better opportunity for our GMF business. And that's not even adding to the electronics part. So the electronics part for automotive, it's really still not categorized in the automotive part of our business. It's really part of our electronics business. So automotive units are down worldwide, but our business there seems to be holding up pretty steadily.

[Chris Grenga, analyst]

And given some of the concerns that we're reading about in terms of WFE spend in China and prospectively, can you offer any sense of how much your business in semiconductor, either directly or indirectly, is exposed to that region?

[John Lee, executive]

Sure. In 2022, October 2022, that's one that affected us the most because it restricted our ability to sell directly to -- specific equipment OEM customers in China. We had talked about that publicly to the order of $200 million that was at risk. So those numbers are out of our numbers now. They've been out for 2 years now. So there's no additional risk besides just the normal WFE market of China, and we're selling indirectly. We're selling to the five big equipment OEMs as well as others. And as they ship to China, then that's where our revenue comes from. So we really look at the exposure as much more in line with the market exposure, not anything particular to MKS.

[Operator]

Next question comes from the line of Vijay Rakesh of Mizuho.

[Vijay Rakesh, analyst]

Just a couple of questions. When you look at the March quarter, just wondering how the -- how you're thinking about the seasonality? And then just big picture on 2025 on WFE, with some of the puts and takes between the China restrictions and the CHIPS Act, especially with the new administration, how are you thinking?

[John Lee, executive]

Yes. I think your first part was about any cyclicality -- or seasonality, sorry, in Q3. There is always a little seasonality to our chemistry business for electronics because it has that consumer product cycle to it. So chemistry was higher, but it was even higher year-over-year in Q3 as well. So there was that normal seasonality. We kind of expect chemistry to kind of moderate a little bit in Q4 just because of seasonality. But as you -- as we just talked about, E&P is up and a lot of that is driven by E&P equipment. So those are the puts and takes of seasonality.

With respect to 2025 WFE, I think your question was, does the election change anything? And certainly, there's a lot of smarter people that can have opinions on that. I would say this, specifically in terms of how the geopolitics will shake out, we have been in the opinion that, that's been a bipartisan agreement in terms of how the United States treats that. And so we don't expect any change from the particular semiconductor restrictions. So whatever that was going to be going forward, we don't expect that to change too much.

[Vijay Rakesh, analyst]

Got it. And then on the debt side, what are you -- [indiscernible] planning in terms of paydown through '25, I guess, in terms of leveraging the balance sheet?

[John Lee, executive]

Yes. Well, we'll certainly be -- that's still our #1 priority. We will be using excess free cash flow focused to delever. We'll certainly do other things such as repricing and whatnot, if it makes sense, if the market allows. So our focus for the next 12 to 18 months, as we've said before, is to really focus on delevering with any excess free cash flow. How much that is, of course, will depend on the markets. As you can see, in 2024, with a very muted market for semiconductors and electronics and packaging, our two main markets, we were still able to prepay $426 million. And so there's a lot of leverage in our model. Certainly, if revenue were to go up significantly, a lot of that would flow through the -- the free cash flow. As Michelle said, this quarter, it was 16% of revenue, free cash flow.

[Operator]

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

[Sreekrishnan Sankarnarayanan, analyst]

I have two of them. John, one of the things you mentioned was you saw strength in semi business in DRAM, logic and foundry, not in NAND. I'm trying to figure out when do you expect to see NAND strength because some of your other component peers like Ichor said that they're beginning to see NAND strength for their business. I'm kind of curious, is there a lag effect? Have you begun to see anything? Or is it more of a 2025 event?

[John Lee, executive]

Yes. Thanks for the question, Krish. Certainly, we can't comment on what other peers are seeing. We can comment on what we're seeing. And I think what we're saying is it still feels very muted. Some customers have talked about upgrades and things like that. And upgrades come in a couple of different flavors, right? To upgrade significant increases in layer count, you really need new RF power. But you can also upgrade with smaller changes, and that might not require a new RF deck, it might just require chemistry or cryo. So I think that all depends on what the customers see and what their customers want them to do. But right now, we see NAND is still pretty muted. So that's all we can say about what we see.

[Sreekrishnan Sankarnarayanan, analyst]

Got it. Got it. That's very helpful. And a quick follow-up, John. If I remember right, you said that the E&P strength was in flex PCB drilling? I hope I heard it right. Because the question was mainly -- I thought Flex PCB is mainly used for smartphone end markets, but it seems like that end market hasn't quite recovered. So I'm trying to figure out what drove that strength for you in the quarter on the E&P side? And then I just want to like to also say that welcome to the team, Ram. I hope to interact with you more in the future.

[Ramakumar Mayampurath, executive]

Thank you, Krish. Look forward to more conversations.

[John Lee, executive]

Yes. To answer your question, Krish, there are actually two things that are driving E&P up quarter-on-quarter. It is both the Flex equipment. So for smartphones, you're right there. So we did see an increase there in bookings, and that's going to turn into revenue in the next quarter or so. And in addition to that, we saw an increase in bookings for rigid PCB equipment for chemistry related to AI. So it's actually both that are happening.

[Operator]

Our next question comes from the line of Joseph Moore of Morgan Stanley.

[Shane Brett, analyst]

This is Shane on behalf of Joe. My first question is, how should we think about the idiosyncratic gross margin tailwinds and headwinds that you're envisioning for 2025?

[John Lee, executive]

Yes. Gross margins in 2025 is certainly -- you can see that our gross margins are slightly different by division. Chemistry and the Atotech acquisition has really helped keep the profitability up even during a down cycle. So we're really happy about that, and it's improved, right? Under MKS, the last 2 years, the gross margin for particular volume of business at Atotech has improved. That's also the case with PSD, is the case with VSD. Volume will improve all of them. And so if 2025 volume is higher, we should expect that 50% gross margin flow-through that we talked about in our model. And then, of course, the inflationary costs have come down over this year. So the PPV is pretty much balanced now. It's not back to where it used to be, where we can always count on some kind of 1% or 2% lower PPV year-on-year. But some parts of the supply chain and some parts of the materials are getting to that point as well. So right now, it's still in balance. And so that could be a tailwind. Of course, if inflation goes up, it's a headwind. So those are the things we think about in terms of gross margin drivers going forward.

[Shane Brett, analyst]

Got it. My follow-up is, so when NAND CapEx eventually returns, how is MKSI positioned that customer tools sort of relative to the last up cycle in 2023 through 2022?

[John Lee, executive]

Yes. We believe we still have the leadership position for certainly some of the most -- the most critical etch in VNAND with our RF power. And so we're pretty confident that the next up cycle that we will enjoy that with our RF power business. I think you're probably talking about new kinds of power such as Pulse DC. We're working on that as well as others, and that will remain to be seen as to when that gets put into production, but certainly not probably in the next cycle.

[Operator]

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

[Joseph Quatrochi, analyst]

I know you guys announced kind of a new semiconductor factory you're building in Malaysia. I was wondering if you could talk about, one, maybe the CapEx kind of requirements there over the next 2 quarters as we think about excess free cash flow for debt paydown? And then also, how do we think about the mix in production? I think a lot of your semi-related production capacity is located in China.

[John Lee, executive]

Yes, Joe, that's a great question. So we announced the groundbreaking in Malaysia for another factory targeted towards our semiconductor and maybe even photonics types of products. And that's expansion for capacity that we think we will need. It's certainly putting less risk in our footprint, our manufacturing footprint, and that's certainly something our customers want to see. So those are the two reasons why we're doing that. In terms of CapEx, I think the way I think about it, Joe, is we've always been in that 3% to 5% level in terms of CapEx spend. So very, very low. Maybe the next year or two, it might edge up towards the 5% because we've got a couple of factories being built for good reasons. But this past year, I think we'll be in that 3% range. And then it could oscillate between 3% to 5%, but still quite a low CapEx intensity model that we have.

[Joseph Quatrochi, analyst]

That's helpful. And then I guess, I know you guys obviously guided December, but how do we think about -- is there anything to call out in terms of seasonality into the March quarter?

[John Lee, executive]

The March quarter usually is a little lower from a consumer product cycle standpoint. That's true. So that's typically what we would see, in part, of our MSD Atotech business, just like we saw an uptick in Q3. So that's the expectation. Things can change. Certainly, a new product release of some sort could change that. I think the only kind of difference is equipment. Equipment is not necessarily a consumer products cycle, right? It's just -- it's an investment cycle and capacity cycle. And so that's where we see kind of a Q4 uptick in E&P because of not just Flex equipment, but also rigid equipment. And it remains to be seen what that will be in Q1.

[Operator]

[Operator Instructions] Our next question comes from the line of Melissa Weathers of DB.

[Melissa Weathers, analyst]

Look forward to working with you, Ram. I think I heard in your preamble that you talked about a back-end win for HBM. Can you give us any more color on what that is, how big it can be? And if you expect any other similar wins?

[John Lee, executive]

Yes. Thanks, Melissa. The HBM win we talked about was lasers. And so lasers can be used -- are used to do cutting of chips. That's not news. But HBM type of die -- you're putting dies on top of each other. And so precision and the fineness of the edges and all that are giving laser makers, us, opportunities because the more precise you can make those cuts, the better yield you're going to have on those kinds of chips. So -- and we called out one particular customer, and it's pretty significant, but MKS is pretty big. So -- but for the laser group, it's significant. And it's not just one customer. So it's multiple customers doing this.

[Melissa Weathers, analyst]

Got it. And then on the like advanced logic side, you guys said you saw strength in the quarter there. It's pretty clear that the main player there is seeing strength. But the two kind of second-tier foundries are struggling. So any way that we should think about if that market recedes to just one major player, how would that impact MKS? And how are you derisking for that dynamic?

[John Lee, executive]

Yes. I think we're not too worried about that, Melissa. I think the reason is because we've been in a consolidating industry for 30 years. And so you could argue that there were 30 chip companies, now there are five. There were dozens of OEMs, now there are five. So -- and certainly, we want to provide the best value to our customers. But we also want to get paid for the fair value that we bring. And as you can see, our gross margins are in the same ZIP code, if you will, as our customers and our customers' customers. And I think that's just a corroboration of the value of technology that we bring. And I think all companies that bring this kind of technology -- you need those kinds of gross margins so you can invest in the next generation. So we've been able to demonstrate that over 50 years. And so, yes, there could be consolidation and whatnot throughout the industry, but we feel that the value of our portfolio is really going to be what determines the gross margin.

[Operator]

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

[Steve Barger, analyst]

John, when you think about the initiatives around photonics or litho or some of the other growth areas you're targeting, can you talk about how this affects the market opportunity for you, whether it's growth rates or how this affects the TAM longer term?

[John Lee, executive]

Yes. I think it's really back to the playbook we've demonstrated over the last 10-15 years, Steve. There's only so many ways you can outgrow WFE, and we've demonstrated that we could do that by 200 basis points. And more recently, we've had headwinds, China, right? A lot of that business got removed. And so we have to make it up somewhere else. And so I think lithography, metrology, inspection, that was a great area where, as a company, we were less indexed to that than then our contribution to the vacuum part of WFE. So that's where we made the investment, and we've demonstrated that we can continue to outgrow even that subsegment of WFE, and we have been over the last couple of years. So that's just an example of the plan and the playbook of outgrowing WFE. We have to move to where the opportunities are. And I think that is also really the strength -- leveraging the strength of having a broad portfolio. You can move to those areas much faster because you're already in them.

[Operator]

I'm showing no further questions at this time. I would now like to turn it back to Paretosh Misra, Vice President of Investor Relations, for closing remarks.

[Paretosh Misra, executive]

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

[Operator]

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