MKS Inc. (MKSI) Earnings Call Transcript & Summary

So it's my pleasure to introduce MKSI Instruments. Speaking about the company today we have the CEO John Lee and the CFO Seth Bagshaw. I will hand it over to them. And thanks for coming, guys.

Thank you. So obviously, we're in a quiet period, so we'll be limiting our comments to certainly long-term growth trajectories for MKS. And certainly, we'll be making some forward-looking statements as well, but -- so please read the safe-harbor statement afterwards. So the MKS story is that we have been a global technology leader, leveraged to high-growth markets for many years. We've had a long track record of sustainable and profitable growth, using and driven by our robust and disciplined business process. We have been enabling technology for over 50 years. We started in the semiconductor industry back in the '70s. And for the first 30 years, we were only in semiconductor. We went public in 2000. And then in 2016, we began the journey to diversify our markets beyond semi, and we call that Advanced Markets. And so today, we're about 50-50 in terms of semiconductor in Advanced Markets. I'll show you some more details later. If you look at just the comparison of the last couple of years, 2013 you can [indiscernible], that was the beginning of the -- of Jerry Colella, the previous CEO's tenure, 2013. So we had $670 million of revenue. You can see the split. The green is semi, and the blue is Advanced Markets. So we were about 70% leveraged to the semiconductor market in 2013. Fast forward to 2019, total revenue, obviously, has grown to $1.9 billion. This is assuming we hit the midpoint, obviously, of our Q4. And it's a very much more balanced mix between the semiconductor market and Advanced Markets. If you look at the 6-year CAGRs of each of those submarkets, Advanced Markets growing 29% CAGR over the last 6 years, 75% to 12% in the whole company, 19%, part of that organic, part of it inorganic. If you look at the product portfolio of MKS, we have the broadest technology portfolio of any company in our space. The left side or the blue columns, each column is a product or a market category. The blue columns are the original legacy MKS products. These were the types of products we're focused on, vacuum-based semiconductor processes, things like pressure management, flow control. And then the green in the middle are the product categories that came from the acquisition of Newport Corporation in 2016. And these are product categories that are based -- focused on photonics, lasers and optics. And then the last 2 columns on the right in turquoise are the product categories that were brought to us from the acquisition of Electro Scientific Industries this year -- sorry, 2019. And this acquisition brought to us equipment solutions. So it's higher equipment versus just the critical subsystems. You see the top row there with the numbers 1, 2 or 3, that's our market position in each of those categories. And then you see the rows. Those rows are our competitors. You see the dots. The dots are where we compete with that particular competitor. And so obviously, we have the broadest technology portfolio of any competitor in these markets. Now why is that good? Well, as you know, there's been a lot of consolidation, not only in the semiconductor industry, but also -- as well as industrial laser microprocessing. These OEMs have gotten bigger, and they want suppliers who can supply them a broader portfolio of products. It's becoming a huge advantage for us. In addition because we're exposed to these markets, many aspects of these markets, we can usually see the inflections coming before most other folks. And number one, we can see it, but we can also react to it. We can actually pivot towards inflection points. And as you know, semi-conductor has been an industry that's grown and adapted and inflected for over 60 years. And what's very much a growth trajectory this year may not be the same one in 10 years. We have the ability to attract these inflections. So that's why we have this broad portfolio. Now a little more detail about the markets that we are working in, industrial technologies, semiconductors, life and health sciences, research and defense. So those are the 4 main market segments that we address. Semiconductor is about half a company. And the other three we call Advanced Markets, and they make up the other half. Our main focus on the Advanced Markets, though, is the industrial laser-based manufacturing technologies, and that's where many of the growth drivers are coming from. Now when we look at this industrial technology segment, we see that it's composed of things like electronics manufacturing, making flexible circuits and PCBAs. Electronics thin film manufacturing, that's a category that's very much similar to semi. So think about solar panel manufacturing. A lot of the vacuum processes there are semi light or LED processing, MOCVD processes. And then industrial manufacturing, where you're really using lasers to cut and replace industrial manufacturing processes. So these are the 3 submarkets that we call industrial technology segments. And we'd like to describe our product portfolio that addresses the laser microprocessing part of the industrial segments with this cartoon. We call it Surround the Workpiece. So Workpiece is a piece of glass that you might want to cut for your -- my phone. You might want to cut the hole out of the camera on that. You might want to drill holes on a PCBA using lasers. And so that Workpiece has to sit on something that moves at stages. It has to sit on something that prevents it from migrating, vibration isolation. So those are the products on the bottom. We're talking about lasers. And so obviously, you need a portfolio of different types of lasers because lasers interact with materials differently, depending on the wavelength, the power as well as the pulse width. So these lasers are not continuous lasers. They're pulse. And the reason they pulse is so that you can actually process a material and then remove the energy. And so then you don't have thermal damage. And that's why you can actually make more precise features. And so we have a whole portfolio of lasers on the left side here. Now obviously, you have to get that laser beam through beam steering optics and other types of integrated optics to that work piece. And then on the right side are the various process-control instruments that measure the quality of that laser beam. Its power. Its beam shape, and you need to do that because these lasers are now used 24/7 in industrial manufacturing processes. So this is our -- how we characterize that portfolio of products Surround the Workpiece. An example of how Surround the Workpiece enables something that everybody has today is the smartphone. So if you just look at smartphones, 10 years ago, kind of a couple of years ago and what we see in the future, you can see that many, many more processes that are the components that make up the newest iPhones require precision machining. And a lot of that precision machining requires lasers to make these features. You can see also that as the phones become smaller in form factor or foldable, a lot of new types of circuits are needed, flexible circuits. Flexible circuits are manufactured and processed using lasers as well, for instance, our Electro Scientific Industries group has the leading market share in Via Drilling, making little holes in the flexible circuits. And so the smartphone market has gone from phones that had hundreds of components to thousands, to tens of thousands. And when you do that, those components are obviously smaller. And they have to be manufactured in a more precise fashion. And that's how Surround the Workpiece using lasers achieves that and contributes to this. So this is an example. Smartphones are a big driver, they continue to be a big driver for our markets, but other consumer products as well. iPads, AirPods, for instance, have flexible circuits and small components as well. So moving to the other markets in a little more detail, semiconductors. So in beginning, we had that picture in the middle, which we call Surround the Chamber, similar to that Surround the Workpiece analogy. And in the middle of that is a gray box, that's a cartoon for a vacuum chamber. And what MKS did in the beginning is we had one product that measured the pressure in that vacuum chamber that was the Baratron. That propagated into many other types of instruments around the vacuum chamber that actually measure the conditions of that vacuum chamber, control the conditions of that vacuum chamber, deliver gases to that vacuum chamber, power the chamber, deliver plasma to that chamber. So all the critical subsystems around that chamber was what we assembled as the legacy MKS group, the vacuum analysis group. Now with the acquisition of Newport in 2016, we extended our semiconductor exposure to include lithography and inspection because Newport brought optics, lasers and photonics. And those components are used in the lithography and inspection OEMs tools. They're actually also used in advanced packaging tools because those also have different types of lithography, different types of laser packaging and cutting. So some examples of semiconductor and how this remains a growth opportunity for MKS. There aren't a lot of industries, and I can only think of one other that have over 60 years, continue to improve its ability to deliver products twice as fast, every 2 years or half as cheap, every 2 years for 60 years. That's Moore's Law. Obviously, many of you heard of that, that is really hard to do for 60 years and still continues. A lot of innovation has to occur through that. We've heard about lithography. We've heard about dep and etch. The current kinds of innovations that we're seeing now that enable us to take advantage of these inflections or things like atomic layer processing. So chip designs have gone from plainer, mostly plainer to more vertical structures. When they become vertical, you still have to deposit thin films that conform, now to vertical structures. And that's really hard because gravity doesn't really help you there. So people move to atomic layer processing. So we supply the ozone generator, the special gases, control the pressure that allow atomic layer processing. So you're putting down layers one atom at a time, and it's self-limiting. That's an amazing set of technologies that allows the vertical structures that we see now. These vertical structures, high aspect ratios are the best example of VNAND, of course, vertical NAND. The aspect ratios are the features they're drilling holes through these things. It's on the order of 10 to 15 Freedom Towers in terms of aspect ratio. So stack 10 or 15 Freedom Towers and that's the aspect ratio we have in a microscopic level to try to remove material in a very tiny hole with that kind of aspect ratio. This is how we get the 96-layer VNAND. We start at 32, 48, 64 and 96. Companies are already working at 128. A lot of the ability for people to drill those holes is enabled by our RF power. We have 100% market share in that space. So we enable that being a whole etch. That is the most difficult process. There are many other difficult processes, but that is the most difficult one, and we supply the RF power for that -- enabling that. We have [the] key enabling franchises that continue to be enabling franchises for semiconductor. So they're RF power I'd mention, but also plasma and reactive gases. Ozone is an example of reactive gases. There are other types of reactive gases that allow, for instance, global CVD deposition in FinFETs. And we continue to have the franchise -- the strongest franchise and pressure measurement as well as all the other vacuum components to go around the chamber. Maybe pivot a little bit to update on the motivation and the strategy for the ESI acquisition. So ESI, Electro Scientific Industries, is an equipment OEM that supplies 2 main categories of equipment: laser-based manufacturing to drill holes in flexible circuits as well as multilayer ceramic capacitor, MLCC test equipment. And ESI is really a natural extension of Surround the Workpiece. When you think about Surround the Workpiece, you have lasers, you have beam steering optics, you have motion to control the motion of the Workpiece. You have beam power measurement, beam profile measurement. That's the entire equipment -- piece of equipment for an OEM. What ESI does is put all that together and what they add to it is integrated, coordinated motion. That is something that's unique, and that's why they have market share leadership in Via Drilling. They can actually move that laser beam to drill very precise holes, 30 microns wide, 30 microns deep, without damaging the layer below, with the walls exactly the right angle, hole after hole after hole, 5,000 times a second. So when I first heard that in our diligence, I said, you mean a minute, at least, right? Maybe an hour? No, 5,000 holes are drilled per second. That's how fast these laser tools are now. And you can't do that, obviously, with just stages moving or even galvanometers moving. You have to do it electrically with acousto-optic deflectors, and they coordinate, they have all 3 and they coordinate all 3 motions. So that's a very unique and very difficult thing to do. And that's why they have that market position they do -- they have. One of the other main synergies that we will get out of this combination of MKS, Newport and ESI is the synergistic road maps that will come from equipment people say, I need these new -- I need -- I have these new applications and I have a need for a laser that does something different than what the lasers you make are today. We have an entire laser group with its road map that can now pivot to serve those needs. We have an entire motion group that can pivot to serve whatever the motion needs are for an equipment group. We have an entire integrated optical subsystem group that makes the optics as well as design it that can pivot in order to serve whatever the equipment group needs. So that synergy between the road maps of some of our key groups within the Newport acquisition are going to be very -- we think, very much an enabling advantage for our ESI group. ESI actually brings in another $2 billion of SAM, Newport brought in about $4 billion. So we've increased our SAM in the last 3 years by $6 billion. You can see industrial machining, printed circuit boards, as I mentioned before. Electronic component testing is the multilayer ceramic capacitors. We also have lasers that have been used in the semiconductor processes, for instance, wafer marking. So I'm going to turn the rest of the presentation over to Seth, who will go over some of our financial execution.

Great. Thank you, John. Good morning, everyone. So as John mentioned, we've had a long history of being a technology provider to our customers. We've got a very complicated processes to solve for our customers. We also have a long history of really driving strong financial performance. We have sort of 3 pillars here. One is we've got a long track record of generating above-average returns, I believe, for the revenue we have in the marketplace. We have put in place a team, probably dating back 6, 7 years ago, that meets on a monthly basis side of MKS, driving profit and cash improvements. It's not just executive level, it goes down to multiple levels below that level in the organization as well to continue drive ways to be more efficient and more profitable going forward. And then if we look at one of the key to the capital deployment, we've had a lot of acquisitions over the years that surround the process chamber on the semi side. It's all through acquisitions going back to the IPO date in 2000. And as John mentioned, we acquired 2 good acquisitions with Newport Corporation and ESI in the last 4 or 5 years. And then we've got a long impact, I mentioned before, to drive, it is improvement to drive top line growth as well as profitability. So to kind of lay out -- kind of what happened in the last 5 years, again, Jerry Colella took over in 2014 time frame. He put that team in place to drive profit improvements. And you'll see a 25% CAGR on revenue in that time frame as well, that's both organic and through acquisitions. In '17 and '18, we grew the Advanced Markets by 14% on an organic basis. And semi grew substantially last year in 2018 as well. And then non-GAAP EPS to be a model is to have a 2x multiplier. So for every percentage increase in revenue, you have a 2x multiplier non-GAAP EPS. So with 25% CAGR on revenue in that period, you'll see a 54% increase in non-GAAP EPS. So on the acquisition strategy, you saw the slide that John presented and had kind of all of our technologies, all of our market share and then a competitive landscape on the left-hand side. What we laid out here was how we got those technologies inside of MKS. And if you look at that first 4 columns, that was MKS back to the IPO date in 2000. That's the pressure base in the business, very semi-centric. That franchise has grown substantially since that time frame as well. And in the right-hand side are all the acquisitions we've done since the IPO date in 2000. And it really gave us much more opportunity to grow into new markets, new products, usually #1 and 2 in the markets we serve. I mentioned before, on the Advanced Markets, the last 2 calendar years, prior to '19, we grew 14% organically in those Advanced Markets, and semi was very strong as well. So we have a good track rate of identifying good assets, acquiring good companies, integrating them very quickly and driving above field of returns, we believe. And then last thing on the capital deployment, again we look at acquisitions, we've done share buybacks in the past. But back in 2011, probably one of the first companies in our space and our size to really initiate dividend in the marketplace. That's really a view we have on the cash flow coming off the business, the comps we have in generating long-term returns for shareholders. We've increased that dividend 6x in that time frame as well, a 33% increase. So we have a dividend. It's one capital deployment that's front and center with how we give shareholder returns. Acquisitions, we've done delevering the balance sheet. We've done share buybacks in the past as well, so trying to be a balanced approach. But dividends, I think, is I guess a little bit unique for a company of our industry and size starting back in 2011. So with that, I'll stop here. And any questions, we'll be happy to take those from the audience.

I have a question starting for laser drilling equipment. Would that put you in competition with some of your customers, like KLA?

Yes. I'll repeat the question, but the question was, we have an equipment solutions segment now, division now that has potentially -- would that compete with some of our customers? So in the laser drilling and laser-like machining type of market, almost every company that is an equipment company also has a component of research. So ESI had a laser group. They actually used their own lasers previously for some of their equipment, but also used our lasers as well as our competitors' lasers for some of their products. So -- and that's true of the other types of customers that are for the new product with the laser group. So everybody seems to be in this area where we collaborate strongly here. And over here, they're going to use an in-house source. I think -- I don't know if that's a stable state, but certainly what the industry is doing right now. So right now, it doesn't seem to be that much of an issue. I think if you have -- if you're an equipment company mostly and you have a component group, you can imagine the focus is always on the equipment side. And so that component group might be able to make a certain level of components. If you're really a component type of company, you are moving fast and pushing the boundaries of possibility on that component. And so what we see is that these equipment companies that are customers of ours tend to use our lasers or motion for the most difficult types of applications, and they may use their own for some of the easier applications. And more broadly for MKS, we want all those product categories. We want to be in markets where differentiation is necessary, innovation is necessary, not just once, but continuously. That's the only way we believe we can inoculate ourselves from people copying it. If you're in a market where innovation is not required, then it becomes commoditized, obviously, and we don't really want to be in those markets. We have exited from areas. If you're in a market where innovation is required once, you don't want to be there either because eventually people catch up. So our approach is that we want to be in an area that continually innovates. We're pretty good at it. Semi is the definition of that, right, for 60 years. In every -- so every 2 years, you can pierce twice as fast. There's a lot of stuff that has to go on 5 years before that to make those chips the way they are, right? And you can imagine EUV was done 20 years ago and finally, it's reaching production. So those are the kind of -- that's our philosophy in terms of approaching that. So -- but to your question, it doesn't seem to be an issue.

Can you share your market outlook and end positions for 2020 on your major markets? And if there's a resolution between U.S. and China, would you [ benefit greatly on the ] investment side?

So the question is, can we share our outlook for 2020 in our markets and if there's a resolution on the trade war between U.S. and China, what would that do to our business? So we only guide a quarter out. And I think I've been quoted as saying, anybody who wants to predict WFC more than a quarter out is probably wrong, with the exception of [ Robert Meyer ], of course. But it's just that things change so fast. But I think in general, people are feeling a little more positive about 2020 than 2019. I think we agree with that. But certainly, we don't really know if -- we know that whatever we say to you today will be wrong. How is that? It just changes so fast. In terms of the trade issues between China and the U.S., that is -- it seems to be calming down, but we did see an effect as we've said publicly of that trade war, putting kind of a damper on our Advanced Markets that are tied to that ecosystem of Chinese laser-based manufacturing. We saw that happen in the middle of Q2, right, when the Huawei ban came in. And just people became more cautious. We're happy, as we talked about at our Q3 earnings call that it seems to have stabilized versus continuing to go down. And we guided Q4. And if we hit the middle of that, the guidance, then we would be continuing to be stable. And that was assuming that the trade war kind of bubbled along as it is. So obviously, the trade war gets better. I think we'd expect a more positive spending, of course, but that remains to be seen. If that really gets better.

Where do you feel like you are currently in your penetration of the HDI opportunity as far as expectations when you acquired ESI?

The question was where do we feel we are with respect to HDI, high-density interconnect penetration with respect to what we thought it'd be doing the acquisitions? So when we acquired ESI, they had just announced this new tool. This is a new laser-based Via Drilling tool that addresses a market called a high-density interconnect market as opposed to the flexible PCBA market. So flexible means that dense HDI is rigid, but it's much denser in connectivity. So it requires a lot more laser processing. And it's denser so you could put more chips on it and more components on it. So as we talked about in our Q3 call, we had shipped 2 betas to customers and 1 PO. And so we'll update that, obviously, in the next couple of weeks during our earnings call, but we think we're pretty -- we're actually pretty happy with the momentum they've gotten. That tool really seems to be hitting all the right market needs that the customers wanted. And so we're -- I think we're going to be pretty happy with how it ends up. But obviously, a lot more work to do. We have no market share there. We're trying to penetrate a market that has 2 incumbents. So those are all hard things to do, but we believe we have the right tool. Okay. Well, thank you, again, for your interest in MKS. And I appreciate it.