MKS Inc. (MKSI) Earnings Call Transcript & Summary

[Audio Gap] analyst here at Citi. Joined today by John Lee, the CEO of MKS Instruments; and Dave Ryzhik, the Head of Investor Relations at MKS. We're going to start off with just a brief investor presentation, just to kind of set the scene for those of you who might not be as familiar with MKS. And then we're going to dive into questions. I would like to make this nice and interactive, so if you do have questions, once we get into that part, just go ahead and press the silver button, and we can kind of make this as interactive as possible. And so with that, John, go ahead.

Great. Thanks, Amanda. So obviously, there are going to be some forward-looking statements. So hopefully, all of you have read this and memorized it and now we'll move on. So this first slide is a little introduction in numbers of MKS. We're almost 60 years old now as a company, as a technology company with 5,500 employees, operating in 100 countries. 2019 revenue was $1.9 billion, and about $164 million in 2019 R&D. 2,200 patents worldwide. And then I think we can safely say that 100% of the chips made are -- made worldwide are with MKS products. We address about 85% of all WFE in the fab today. I'll go into that a little more detail. So Slide 5 here. What you see is an evolution of MKS with respect to our markets. In 2013, it was -- we were a $670 million company. About 70% was semi and 32% was, what we call, Advanced Markets. Advanced Markets includes things like display and solar as well as industrial manufacturing, life and health sciences, research and defense. And then through several -- through one big acquisition and then some more in 2019, we've transformed the company. The size, of course, has grown to almost $2 billion, $1.9 billion. That's about 50-50 now in terms of semi and Advanced Markets. So when we talk about executing our strategy, please show this slide here, you see a couple of pie charts, MKS in 2013, in 2016 and 2019. And why are those dates important? Well, 2013, we just talked about, that's kind of how we started the journey towards trying to diversify. And it was 70% semi. With the acquisition of Newport in 2016, that turned into 56% semi. And then with ESI, about a year ago, that turned into almost 50-50. And if you look back to what MKS was like in 2013, the technology leadership that we had was in Vacuum Measurement & Control and Plasma. And we had really kind of one channel, it was the large semi OEMs. As we acquired Newport, the technology leadership expand into other things like RF power, lasers and motion. And then we now have multiple markets and customer types. So not only just OEMs, large OEMs, but also major OEMs, smaller OEMs as well as a large disparity of different types of customers around the world. And then when we added ESI, we added another part to our technology leadership, that's system integrations, so system solutions. And then, of course, sales and then service has become a big part of our revenue. [ At or ] about $300 million out of the $1.9 billion now in service revenue. There are a couple of important secular trends that benefit MKS. So one of the biggest ones is this explosion of data. Data drives many things. But among other things, it drives more need for memory, more need for microprocessors to analyze that memory and more transmission of data with higher bandwidths. The second trend is the complexity of technology transitions, particularly in the semiconductor manufacturing. And by complexity of technology, it causes inflections. And we have the broadest portfolio of technologies to address those different kinds of inflections. And then the third mega trend, we believe, is this growing need and use of precision manufacturing based on lasers. And this is enabling things that are much smaller, much higher density that could never be done before without lasers. The smartphone will be a poster child for that. Many of the components in a smartphone are made using lasers and can only be made using lasers. So we focus on these 4 markets. Semiconductor and what we call Advanced Markets is broken up into industrial technologies, life and health sciences, research and defense. And what we mean by these particular areas, I'd like to talk about industrial technologies a little bit because that's usually a bigger catchall. But there's a couple of components to industrial technologies. One is electronic thin film manufacturing. So these are processes like display, solar. Then there are electronic component manufacturing. These are for consumer products, for instance. And then truly industrial type of manufacturing, such as welding and ceramic cutting, things like that. So getting back to the entire portfolio of MKS. You can see that we have these columns. These columns are various product categories. The section on the blue, those columns are our legacy MKS products. Those are the products that surround the vacuum chamber for semi. So that's how MKS started. The green are all the product categories brought to us through the acquisition of Newport Corporation, so lasers, photonics and optics. And then on the right is the newest product categories that are systems, so the entire pieces of equipment, and that was brought to us through the acquisition of ESI. On the rows, you see that the large number there, the row with numbers 1, 2 or 3, that's our market position in those particular categories. And then the various rows underneath are the competitors. And where there's a dot is where we compete. And obviously, we don't have any competitor that comes close to the technology breadth that we have. So the question then is, so what? Right? What do we get out of this? We think that with this broad portfolio, we have a couple of advantages relative to cause our peers to jolt. One is, we are into almost every aspect of the markets we're in -- that we participate in, in particular semiconductor and laser manufacturing. So if you're in semiconductors with RF power and valves and pressure and plasma and ozone generation, you have a higher likelihood of finding and seeing inflections. Same for Surround the Workpiece lasers. If you're in the Surround the Workpiece kind of environment with lasers, photonics, motion, power meters, beam profilers, then you have a higher chance of seeing where the inflections are moving. More importantly, if you have a broad portfolio, and you see that inflection moving, you have a higher chance of doing something about it. So for instance, if we saw that RF power is going to become more important in semi. If you have an RF power group, you can actually do something about it. If you're only a valve company, you really can't do much about it. If you see the inflection is moving towards ozone generation for atomic layer deposition in semi, if you have ozone generation, you can do something about it. If you only have RF, you can't do anything about it. So that's really the strength of having this broad portfolio, is seeing inflections first and then, more importantly, being able to do something about it. So we see here, the center part is our Surround the Chamber cartoon. It's a vacuum chamber with a bunch of critical subsystems around it. This is the legacy MKS. We started with 1 product, the capacitance manometer. And then over time, we organically developed other critical subsystems around it and/or acquired critical subsystems around it. With the acquisition of Newport in 2016, we extended the leadership in the semiconductor equipment market with lithography, inspection and metrology with optics, lasers and photonics. So if you look at the key customers, the key OEM customers of MKS today, you have the vacuum guys like in Applied Materials, Lam Research, Tokyo Electron. You have the litho companies like ASML. And you have the inspection and metrology companies like KT. Just those 5 companies represent 85% of every piece of equipment that goes into a semiconductor fab today. So we supply to them many different kinds of critical subsystems. So we are actually addressing 85% of all the equipment that goes into a semiconductor fab. So we have a really high chance of figuring out what's changing and where the next opportunities would be and then being able to do something about it. So the acquisition of Newport actually extended our leadership in the semiconductor market. And some of the high-growth opportunities in semiconductor today, atomic layer processing, being able to deposit films one atomic layer at a time. This allows you to deposit films on vertical surfaces, horizontal surfaces and every surface in between, all at the same time. That's not easy when gravity wants you to deposit only on horizontal surfaces. The transition to 3-dimensional structures and high aspect ratios that come with that gives us new opportunities for RF power and deposition there as well. And then we continue having these key enabling franchises, if you will, of power of plasma, reactive gas and vacuum measurement. So our pressure measurement franchise continues to be one of the strongest pressure measurement products in the world. When we move to the Surround the Workpiece kind of portfolio, this is characterized here by a workpiece in the middle, which is -- can be a PCBA or it could be a iPhone screen, it could be an OLED. And you're going to do something with it in terms of processing it with lasers. And so that workpiece has to be moved and controlled with wafer stages and/or vibration isolation on the bottom. You have to have a laser source, obviously, and a whole portfolio of lasers. And then you have to have beam-steering optics to take that laser beam to the workpiece. And then more importantly, on the right side are a suite of different kinds of process control instruments that measure the quality and the profile of that laser beam. The epitome of that is the ESI tool. And so when you Surround the Workpiece, that is a system. And when we bought ESI, the Capstone Tool is the market leader in flexible printed circuit board via drilling. And it uses motion, it uses lasers, it uses beam-steering optics, it uses power meters, and all those are incorporated into tools like ESI as well as other customers that do similar things. So some of the high-growth segments in industrials. As I mentioned before, electronics manufacturing, this is things that are used to build consumer products, for instance, flexible circuits, print circuit boards that use lasers and power and vibration control. Electronic thin film is the other subsegment in industrials, and that's about solar and flat panels. And then industrial manufacturing is about cutting and welding and embossing. We don't make fiber lasers. Some of our lasers are used in these applications, and our motion and our power measurement, our beam profile is used in these heavy industrial manufacturing applications as well. So one of the key growth drivers in the electronics manufacturing part of industrials is mobile devices. Think on the lower right, you see the number of smartphones being built every year. It kind of peaked, and it's kind of staying at that 1.5 billion units per year. But you can see in 2020 and out, that there are more and more 5G phones. And why is that important? 5G allows you to transmit data much faster, higher quantity. And so you also need to interconnect the various devices and components in that 5G phone with flexible PCBAs. A 5G phone, we expect to have 30% -- 10% to 30% increase in flex PCB content just for that reason. 5G phones also drive our semiconductor market because they need to have the latest kinds of technology for processing the data, such as 7-nanometer processes. When you have high capability for processing data, you also need more memory chips to store that data. And so DRAM and VNAND are big drivers -- are driven by the 5G adoption. You also have increases in high-density interconnect. These are the same as PCBs, except they're rigid, they're not flexible. And of course, you have display content increasing in these 5G phones as well. So those are the kind of the drivers for the company going forward. I'll spend a few minutes on the financials and our history on managing the financials. The long track record of financial performance. Over the history of MKS, I think we only have 1 year, in a very cyclical industry, where the cash flow is not positive through very many cycles throughout the industry -- throughout the market. We've had a culture of continuously improving our profitability over time. Certainly, between 2013 and 2019, we had almost a 400% increase in non-GAAP EPS. If you look at revenue from fiscal '13 to '19, 19% CAGR. And then EPS, as I mentioned, 31% CAGR. In terms of our acquisition strategy, the first 4 categories were products that we develop organically. And many of the growth -- many of the divisions and product categories that have been used to fill out the portfolio, have been acquisitions. Some of these acquisitions are 20 years old, where we've owned them for 20 years, and we've transformed them into a much more profitable divisions, and some are more recent. But our history is that acquisition is a big part of our growth strategy as well. We have a cash dividend, and we're probably one of the first semi CapEx-type companies with a dividend way back in 2009. This dividend has increased about 33% since that first dividend in 2009. And so with that, I'll turn it over for questions. I think, it gives you a little bit of background of MKS, and I'd be happy to take any specific questions to the presentation or any other topics. Thank you.

Great. Thank you for that overview, John. I'm just going to start with sort of a near-term question, sort of on everyone's mind, this coronavirus and what the impact there is. One of your peers in the space reported yesterday and commented that demand is still very strong in the environment on both semis and industrials. But the supply chain is a little bit constrained. Can you talk about what you've been seeing in terms of your business and how it's being impacted by coronavirus?

Yes. No, I think we would generally agree with that kind of tone. We have 2 factories in China. Both are running to back up and started. One has 90% of their workforce back. One had 30%, but back up to almost 40%, 45% now. And so we're pretty happy with the fact that both our main factories are now running with a significant part of the workforce on site. I think we've reached out to our supply chain to make sure that they're not constrained. Many of them are in the same boat in China. They started up a week or so ago. They have some percentage of their workforce. They're trying to catch up. But the good thing is, they're running. They're starting to catch up. So I think there was a 2-week, 3-week delay, maybe in terms of the -- in general, China starting back up. And I think it remains to be seen. It's a very fluid environment of whether we can catch up all that demand for the -- within the quarter or whether it pushes a little bit out into Q2, that wouldn't surprise me. But to your point, the demand for our products has not slowed down in this time frame.

Just jumping back into sort of longer-term trends in the industrial segments. You talked about the 3 different divisions: Electronics, manufacturing thin film applications and then industrial manufacturing. What should we look at as sort of the key growth drivers in each one of those segments and what should we benchmark against?

Yes. So I think -- let's take the microelectronics type of consumer products type of market. So really today, much of that is driven by the smartphone. Just the volume of smartphones and how much flex PCBA content it drives, how much memory content it drives, how much OLED screens it drives. So that is a big part of what drives that subsegment of our industrials, so the microelectronics. I think if you look at the electronic thin films, that's more like solar and display. They have their own unique kind of market dynamics. Display has a different kind of a cycle than semi sometimes. Sometimes it's the same, sometimes it's not. And then solar has yet a different cycle. And so -- and then finally, the welding and the batteries. Some of those are high growth. Some are markets that are just starting to grow. But I think in general, the interesting area for us is that each of these markets is using more and more laser-based manufacturing tools. And that's really what's of interest to us and how we want to grow in those markets.

So are these products more sort of disruptive to the way industrial manufacturing has traditionally been done? And does that create a challenge or an opportunity in terms of driving growth?

Yes. No, I would say that the use of lasers is very disruptive to how humanity makes things. Some of the markets that we're in that use pulse lasers, we were in a microprocessing using pulse lasers versus macro processing, using continuous wave of high power lasers. The pulse lasers, those are enabling things that could never be done before. So the example would be our ESI tool, which has the market share leadership in -- via drilling for flex circuits. Those holes, those vias, are anywhere from 40 to 80 microns. You cannot drill those holes with physical drill bits. You have to use lasers. If we didn't have lasers, those holes will be bigger. The -- your phone will be a lot bigger. And number of interconnects will be a lot bigger. And so we look at this as very disruptive. It's enabling something that could never be done before, the use of this precision laser manufacturing capability.

Is growth in these markets possible in 2020, given the macro environment, given what's happening in China? Or is this more of a 2021 story?

Yes. I think 2019 was a big digestion period for many of these markets, certainly, the consumer electronics market. So there was a -- as many of you know, a cell phone super cycle in '17 and '18. A lot of equipment got put in to increase capacity, to make the various components in the cell phone cycle. So 2019 was much more of a digestion year for a lot of the CapEx there. We saw that in our ESI group. We saw a little bit of it in our Light and Motion group, some of the laser-based manufacturing tools. We expect that 2020 would be a more normalized year just because digestion has been mostly done in 2019. And then I think just [indiscernible] the coronavirus may make things a little more interesting. But in general, I think we would have expected, and still expect a more normalized CapEx year for those kinds of tools.

Can you talk about the organizational structure of the firm to really be able to gauge the inflections you talked about? Because a lot of times, companies get bigger, you get into different verticals and it actually goes the other way. But it sounds like you're trying to describe it as a strength. Just as you have teams meeting weekly, monthly quarterly, just how do you make sure you're managing that in the industry that can change quite quick?

Yes. So we have a strategic -- annual strategic planning process where we will look at all the opportunities from an annual standpoint. But every month, we have business reviews. Every quarter, we have strategic market trend reviews. And so we're tying all these kinds of different cadences of meetings together. At the same time, I spent a lot of time talking to customers, going out to see the markets myself. At the same time, we bring in a lot of market intelligence from our various sales forces. And so there is a corporate cadence to this. It's not a haphazard thing. It's a very well sequenced and planned. There might be a core group of 20 to 25 people who see all these -- to see all these markets all the time. So -- that wasn't us, right? Everybody is still alive, right? So it's a very disciplined and organized process to look at these markets and these trends.

Can I ask you -- I don't know the company, [indiscernible] in Massachusetts, [indiscernible] very disappointing [indiscernible] why are you so much different?

Yes. So IPG participates in what we call macro processing with high-power, continuous lasers. So their lasers are always on and really high powered. And that's great when you're trying to cut stainless steel, miles of stainless steels as fast as you can or weld. Our lasers are in -- they're pulsed. They're not always on. And they're pulsed because you want to remove some material and then not have any heat left to damage the surrounding material. That allows you to make really small features without damaging around it. And so we would have pulses that are nanoseconds long, picoseconds long, femtoseconds long. These are really hard to copy. This technology. And so that's why we've been asked many times and we look all the time, are low-cost Chinese competitors trying to copy us? Our competitors still remain western companies with decades of laser design experience. And more importantly, in-house deposition and optical coating technology that we also have in-house that's IP. And so you can't copy that very easily. And so today -- as of today, we have been able to enjoy growth. Our margins stay strong in these micro processing markets. And we're not suffering the same kind of competition that people like IPG may be seeing in the high-power continuous wave lasers.

Going back to the comments you made earlier about 2019 being a digestion year. Specifically, I think it relates to ESI. And some of the concern is that you bought ESI at sort of the peak of that business. Can you talk about the rationale behind the timing of that acquisition and the acquisition generally? And if there is room to kind of expand that business or if the peak is behind us?

Yes. So when we did due diligence on ESI, we weren't buying it on a cycle. We were buying it because we thought that had a long-term potential that was very good. And I think we paid a fair price for it. But so when you look at the markets that ESI is tied to, it’s flexible PCBAs. Then you've got to ask is our flexible PCBAs growing? Well, as I just said, in smartphones, a 5G phone is 30% to 40% more flexible PCBAs in it. So things like your AirPods have flex PCBAs in it. Anything that needs to have a flexible circuit go around different shapes, really will use flex circuit. So we saw that as a positive for the main market that ESI is in. Additionally, we saw that some of the technology could be taken to other parts of laser microprocessing. So we've talked about how we've entered into the high-density interconnect via drilling market. So we have high share in flexible via drilling market. We have 0 share in high-density interconnect via drilling. The flex PCBA equipment market is anywhere from $150 million to $250 million a year, growing at high single-digit CAGR. The HDI market is a $500 million equipment business of which we have 0 share. And it's also growing at high single-digit CAGR. And the reason is because as things shrink, not only do you need flexible PCBAs, but you also need denser, rigid PCBAs. And so we look at ESI as being positioned well to being -- to addressing those kinds of markets and growing there.

Yes. Could you help us understand how you may or may not be exposed to some of the disruption taking place in with EUV, ASML, even if you're not directly impacted on lithography side of the business? Obviously, there's talk that LAM and AMAC could be quite impacted down the road?

Yes, that's a great question. So number one, with our Newport acquisition, we actually supply to litho companies like ASML. So not only to their EUV tool, but their 193 immersion, 193 dry deep EUV. So it's been a long history of supplying optics and optical subassemblies to litho companies like that. I think the clarification I would make for EUV is that it was kind of a false narrative. The narrative went, if we go to 5-nanometer and EUV happens, there will be less multiple patterning, and therefore less dep and etch. And that would be bad for the dep-etch companies of which we have a lot of share in contents. So it will be bad for us, too. And the false part of this narrative is, there would be no 5-nanometer without EUV. The reason I say that is because if EUV didn't exist, you can't quadruple pattern, small features and have transitions that work. It becomes too uncertain. The features become too grainy, if you will. So that's the false part of the narrative. There was no 5-nanometer without EUV. So we didn't actually lose anything, right? Now because EUV does happen and is happening, it enables 5-nanometer. So we can print those really small transistors now that do work because we don't have to quadruple pattern in them -- pattern them. But because the 5-nanometer feature is smaller, everything above it gets smaller. So when it gets smaller, you need multiple patterning -- more multiple patterns. So the comparison was to something that was never going to happen. Because EUV is happening, you're actually growing multiple patterning for companies like Applied and LAM and us as well. So that's how we look at EUV.

Let's go back to the organizational topic that was brought up before. You just started as CEO 2 months ago, the beginning of the year. And you also brought in a COO, someone from Emerson Electric.

Yes.

Can you just talk about how those changes at the top of the management structure won't impact the business going forward. And should we expect to see more on the industrial side by bringing in someone from Emerson?