MKS Inc. (MKSI) Earnings Call Transcript & Summary

Hi. Good morning. My name is Amanda Scarnati. I'm one of the semiconductor analysts here at Citi. We're joined this morning by Seth Bagshaw, the CFO of MKS Instruments; and David Ryzhik, the Director of Investor Relations. We're going to start off today with just a quick elevator pitch introduction of MKSI, just to kind of set the stage for this morning. And I have some prepared questions. If you're on the Zoom, you can feel free to either send me questions via the chat function or the question function on the app, and I will be happy to ask them. You could also send me questions directly@amanda.scarnati@citi.com. And we'll dive into those investor questions a little bit later on in the call. So with that, Seth, can you just go ahead and set the stage on where MPSI stands today.

Yes. Thank you, Amanda. Good morning, everyone. So MKS, those of you who know the company pretty well, have been public for about 20 years. We're very -- about half our revenue is leveraged to the semi cap industry and where we sit in that supply chain as we provide critical technologies to all of the OEMs in the industry. So Lam, Applied, KLA, ASML, Tokyo Electron, any chip that's manufactured around the world uses MKS equipment. So again, we're pretty critical to all those applications. And we ship into the memory, the foundry, the logic industry as well. So we're pretty exposed to all of those opportunities. And that business has grown substantially. We tend to outperform wafer fab equipment spending in the long term, just given where we are in terms of technology and how we enable these new technology nodes and new shrinks. The company has also had, we call it Advanced Markets exposure to other markets outside of semi. And 4 years ago, we acquired Newport Corporation in 2016, and that brought to us a very large SAM and revenue opportunity. Also in semi, that brought in the KLA and the ASML accounts, but more importantly, gave exposure to laser and optics and photonics. And that was again 2016. And then year, we acquired another company called ESI, which is now a separate division in MKS, which provides advanced tools to manufacture PCBs used in mobile device and other applications as well. So really, in the last 10 years particularly, we've expanded our team quite a bit, brought a lot more revenue in Advanced Markets. We're roughly balanced, 50% in Advanced Markets and with the semi revenue as well. And the run rates last quarter, again, about $2.2 billion range. So that's kind of the high-level overview of MKS, and I will turn it back to you, Amanda, for your questions.

Perfect. So we're going to start with sort of the elephant in the Zoom room on the semiconductor side this week. And that's the news out of the Department of Defense that they're potentially looking to restrict SMIC and then add them on to the entity list. Can you just talk about, first, the restrictions that are already in place with Huawei and military end users and what impact SMIC would have if that were to be added also onto the entity list?

Yes. Sure, I'll add some color behind that. So regarding any restrictions that have already been put in place by the Department of Commerce that's in Huawei and kind of any other license requirements, we dedicated that pretty well. I would say those on a consolidated basis have not had a material impact on our business. Our direct sales to Huawei were relatively small. And we've navigated, again, all the new license requirements quite effectively and quite efficiently. So from that perspective, the announced and in effect trade restrictions have not had, again, a material impact on our business. On the SMIC, obviously, there was reporting over the weekend that SMIC be added to the entity list. Again, it's early on in those stages, hard to really assess what the impact would be. What we really look at, quite honestly, is total spending in the industry. So wafer fab equipment spending for us is a critical driver for our overall growth in our semi business. So if there's any potential short-term disruptions where SMIC needs to be on any list for a short period of time, we'll probably see that indirectly through our major OEM customers, our direct sales to SMIC are actually quite low. It will be through, again, the bigger OEMs. But in the long term, we think that will even itself out. Again, we care about overall growth in chip revenue and then the capital intensity along with that chip revenue. We don't think any of those key drivers for us in the long term will be really affected by anything in the SMIC or Huawei side that we can tell. And then, again, what we really try to focus on are things we can control. So where we've kind of become important in the supply chain in the semiconductor side is, again, every chip in the world is manufactured, we enable that process, is really work on critical technologies, work with our major customers and invest in R&D and new product development. And that's what we have done in the past. That's why we're so important in the supply chain in the world today. And that's our goal going forward as well. So again, in the short term, it's hard to really give a good granularity on how SMIC will roll out to our business. But again, the long-term drivers are still firmly in place and how we run our business is really focused on our major customers and developing new technologies. So that's kind of how we've viewed the -- at least the reported results over the weekend.

Great. Thank you. All right. Now that's out of the way, we can move on to a little bit more depth into the business. So let's start with the semiconductor side of the business, 50% of the business. On the June Q earnings, you mentioned that the demand environment was still strong and that you saw record revenue in Power Solutions. Are you seeing that strength continue as it sort of normalized? There has been some concerns recently around DRAM potentially slowing down. So can you just talk about what you're seeing in terms of semiconductor growth recently?

Yes, sure. So obviously, we saw the uptick in the business, probably starting in Q3 or Q4 last year. And then we came through the first half of this year in really good shape and [ going up sequentially to the right ]. And then our Q3 guidance, we also at the midpoint showed an uptick in our revenue, mostly driven by semi in our view. So not to provide an update today, but obviously, coming into the year and through the last quarter, we saw things in pretty good shape. And we think that will continue going forward. The -- in terms of bottlenecks, the team has done a really good job managing the COVID-19 environment. And just a little bit of history, when we gave our Q2 guidance, we had factored in probably a $50 million potential headwind on manufacturing constraints. And again, we are in every major country around the world, developed country in the world, in manufacturing. What, say, most of we do is deemed essential by those local jurisdictions. Like again, navigating through COVID-19, we did expect some type of headwind on getting all the products out the door. We did put in place a team right away that meets on a daily basis to kind of navigate through that. And you can tell in our Q2 results, we not only went through the $50 million, we've got that revenue back out the door, but actually exceed expectations for the quarter as well. So I give a lot of credit to the operations, the support teams, who are really working through the challenging environment. So right now, all of our factories are up and running. This is how you say the new normal will be in terms of production activity or order rates. But we're not seeing any major impact from COVID-19 in our business today. I would say with the normal ramp in environment we're seeing now, you're always having -- looking for certain parts from different suppliers. And it's, again, a very typical environment where we are right now. I think the long term, I don't see any real major long-term changes again in our secular growth rates in our business. There's always more demand for data storage and processing over the long term. The work from home environment -- remote work environment, I think, is beneficial as well and we support that to a large extent as well. So, so far, we're very pleased, navigating through this challenging environment. And again, our long-term drivers, we're pretty optimistic going forward as well.

In the semiconductor business, was there any sort of pull-in of demand as you were sort of managing through the COVID impacts that you saw in the first quarter and the second quarter by customers trying to preempt some of the supply chain issues? Or does it seem sort of like a normal environment in terms of demand?

Yes. I would say it's more of the latter, Amanda. I don't think I can -- there's nothing we see in terms of abnormal pull-ins. We are a turns business. So an order comes in, we obviously try to turn that around in a short period of time. We can book and turn. Half our revenue in the quarter could be booked and turned in that quarter. So I would say there's nothing unusual that we can discern that would indicate any pull-ins. I think everybody was trying to, obviously, meet very strong end-user demand with device manufacturers. So that was definitely the case, and that is the case today. When you look at the COVID-19, I think people will try and navigate that other, I call it speed bump as well. We're trying to manage that environment pretty aggressively as well. But I don't think that would be anything -- there's nothing unusual in the order patterns. I've seen that are indicating major pull-ins that we could tell.

Can you talk a little bit about the power business in semis? And what's driving this record revenue? And what the expectations are going forward?

Yes. So we had acquired the -- our power business back in the 2002 time frame from an acquisition, and we like that space quite a bit. And we saw, probably 4 or 5 years ago, an opportunity to really expand our design win capabilities and to service the major customers in the Power Solutions business. And as a result, we put in very high level executive support to drive that opportunities. And then we actually went out and added more engineering resources internally and also a higher focus as well. So we sort of saw an inflection point again 4 or 5 years ago, and the dividends have started to pay off. So we've had a number of design wins. You mentioned in the last earnings call, we had record revenue in our Power Solutions business. When you look at the memory applications, high aspect ratio, when you're drilling through multiple layers on a 3-dimensional memory device, our Power Solutions group enables that high aspect ratio etch step, which is critical for driving down a lower cost of ownership for our customers as well. So I would say it's a case. We've been in the space for a number of years. We've been a strong player. We did see an inflection point or an opportunity years ago and kind of jumped on that from a high level executive viewpoint. And then it has really driven that opportunities, certainly this last year or so and going forward as well. We announced a few design wins, which have not hit high-volume production yet as well. So very bullish on the semi space. Obviously, in general, in the Power Solutions group has probably above-average focus inside the company for sure.

Last question I want to touch on, on the semi space is some comments made during SEMICON West by Applied Materials. They announced a goal to reduce energy, chemicals and consumption and clean room square footage in manufacturing by 30% over the next 10 years. Can you talk about what MKS is doing to improve the sustainability? And how this plan by Applied Materials could potentially impact your growth trajectory?

Yes. It's something we take very serious in MKS as well. We've had an internal focus on what we call corporate social responsibility, or CSR. And that activity inside of MKS is chaired by John Lee, our Chief Executive Officer, and oversight by the Board of Directors. So there, we've had a lot of focus on and really have kind of upped the ante, if you will, to perhaps better communicate what we do to the outside world. It's important for a lot of investors. And a couple of little -- kind of give you a little color on what we're doing. Environmental sustainability, there are probably 3 major areas we've kind of focused on across 3 different divisions. In the E&S division, the HDI tool that we released in the marketplace is substantially lighter and smaller than competing solutions. So it's ease of service. When you think about the service team, occupational safety in mind, it's an easier tool to service from that perspective. In the Light and Motion division, we use precision laser technology that drives higher efficiency in manufacturing environments, so less waste and higher throughput. And then the Vacuum and Analysis group, in some of the applications we have, we used to clean toxic gases from a process chamber and create those output as inert materials, so again, for environmental safety. We also have other tools and products that monitor the toxic output of chambers, again, for safety reasons. So just a couple of examples at a product level that we've been engaged with for in the CSR perspective. We also look to manage our internal functions as efficiently as possible, reduce our cover footprint the best we can. And then in some of the customers in the markets we serve, we enable a lot of clean tech opportunities as well. So in the solar market, we enable through the semiconductor, the VNA group as well as the Light and Motion with the lasers. We enable that technology in the marketplace as well. So in terms of green energy production, we are a critical enabler for those type of applications. So those are the areas we've kind of focused on sort of in the last several years. You'll see us spend more time on this going forward as well. We've done some updates on our website to better communicate to the investment community what we're doing. I think we've done a lot in the past and it has not been, again, communicated to the outside communities. So that, we've upped that disclosures quite a bit. We've got an impact already from external rating agencies about -- our CSR scores have actually upped quite a bit in the last quarter or 2 as well. So it's a multipronged approach. It has senior level oversight at executive level for sure, John Lee's level and then also report to the Board on a regular basis. So we're very supportive of these activities.

Switching gears over to the ESI business. Can you talk a little bit about how the ESI acquisition is tracking relative to expectations? Or is that last about 1.5 years ago when you acquired the business? And then what revenue synergies we should expect going forward?

Sure. Yes. So just a reminder, we did -- we acquired ESI in February of 2019. Kind of 3 major investment theses for that acquisition. One is we do like the flex PCB market. So the E&S division is a leader in that market. If you look at mobile devices, the flex content is substantial today, we believe a 5G phone can be 30% higher flex content. And again, ESI or E&S division is a leader in that marketplace. We also like the SAM expansion to a new market, so-called high-density interconnect, HDI. It's a much larger market, it's about a $500 million, we believe, ongoing run rate market, growing sort of mid-single digits. And in that market, there are 2 incumbents that make up most of the equipment supply to the HDI market. And then we announced a tool called the Geode that released about a year plus or so ago. And that's gone through a number of data evaluations and we just announced last week a major high-volume order for that tool in the marketplace. So that's been, again, a validation of our investment thesis in HDI, our opportunity out there. And then kind of a qualitative level, we have also an ability to -- when you go back, a lot of the technology that the E&S division utilize are laser-based, obviously. And having E&S group and the Light and Motion Group, the systems group and the laser development and production group all under the same corporate umbrella, you have an opportunity to share different road maps that you couldn't have if you were 2 separate public companies. And so we've had a number of technology meetings inside the company to kind of share the end-user experience and port that back to development of laser opportunities going to next-generation tools. So that's kind of a qualitative but important aspect of that investment thesis as well. So you pivot to kind of where we are on the ESI acquisition, E&S division. So a couple of kind of data points here. In terms of integration, we're substantially ahead of schedule, the cultural fit here is very good. That team that's managing that division is excellent and very strong and just doing really good -- really doing good things. In terms of cost synergies, we announced $15 million over 18 to 36 months. Last quarter, we're over $17 million, well ahead of schedule. So again, a lot of good support there. I did mention the HDI tool win. We've had a number of beta testing applications in the field. Really, 2020 was a year to get the tool out in the hands of major customers for their evaluation. We had an order from a major U.S. company that bought this tool for advanced material processing application. So think of a very advanced research environment with a well-known company, they purchased the tool to do those type of applications. And again, we announced this high-volume order from Meiko last week as well. So it's progressing pretty well. And then the flex market, again, it's a good market. There was a lot of capacity put in that market back in 2017 and 2018, and we're well aware of that in the acquisition process. And the growth drivers there will normalize over time where the capacity gets more normalized. We have released a new tool to service that market called the CapStone, well received. Again, higher throughput and a lower cost of ownership. And so we're going to solidify our leading position in that marketplace. And so if you ask me today how we feel about that acquisition, we're more bullish today [ than ] back when we acquired that company. Flex is normalizing. The same opportunity will be a greenfield for us going forward as well. And again, that team is executing very well. So we're very pleased with the acquisition.

Then what's sort of the normalized revenue rate that we should be looking at within this business division?

Yes. We haven't provided that level of detail yet, but I would say that the flex market, we think, normalized before 5G would be sort of the $150 million,[ $20 million ] run rate. And again, we have very high share in that marketplace. There's a recurring service business, which is running about $60 million a quarter. We hope to grow that over time as well. A year -- I'm sorry, $60 million per year. And then when you look at the HDI opportunity against a $500 million market, we believe our tool has competitive advantages in that marketplace. We've said in the public realm, we asked the question is, what share of that market rate did you expect to achieve? And we've said externally, we'd be at 10%. We believe 10% of that market in a 2- to 3-year period. We want to be more aggressive, obviously, internally, but it's kind of how we think of it as an external perspective. And there's other market like MLCC, which has some opportunities there as well to grow over time. So a number of levers, but we haven't laid out exactly [ the normalized way of running ] that business yet, but there's definitely some good growth opportunities going forward.

A part of this business is smartphones -- and lasers and smartphones. Obviously, we've talked a little bit about the opportunities in PCB. But when do you expect to really start generating a significant amount of revenue off of that? And what other aspects within the laser business do you have that sort of attach on the smartphone side?

Yes, it's a great question. So the 5G for us is a very positive drive. I mentioned the flex PCB market, we believe there's about 30% more content in flex PCB versus a 4G phone. So the timing of that will come in, obviously, when those high -- when the smartphone conversion occurs and drives growth going forward. So that is, obviously, an important thing for the E&S division. When you look at kind of the Light and Motion division, if you look at kind of a mobile device today and what's the [ thought apart ] years ago. There's a lot more content, obviously. There's a lot more desire to fit more into a smaller form factor into the smartphone today versus one, even 5 or 10 years ago and substantially more need for laser microprocessing to fit the smaller component to a smaller form factor. So the mobile device is certainly one -- mobile handset is certainly one area we see growth in the future and to be 5G-driven. But it's not the only driver. When we look at Surround the Workpiece, there's a lot of opportunity in the solar, the wearable devices and the flex PCB and other applications as well. So there's a number of multiple players or opportunities we can leverage in the handset and the 5G in particular going forward.

I'm just going to remind investors as well, if you have any questions, you can use the question function on the Zoom screen or you can e-mail them to amanda.scarnati@citi.com, and I'll be happy to ask those questions for you. Let's kind of continue on with the industrial markets outside of smartphones. On the June -- Q call, you mentioned that you expect your GDP-driven business to pick up as sort of nonessential manufacturing recovers. Do we need to see a full macro recovery before this market starts to see significant and sustainable growth? Or are there opportunities to grow outside of a macro recovery?