MKS Inc. (MKSI) Earnings Call Transcript & Summary

Thank you very much, and welcome again to the 2021 Stifel Cross Sector Insight Conference, which is again, virtual. Up next on my agenda, is MKS Instruments, a leading supplier of semiconductor subsystems and other periphery items as well as a leading player in the laser market and the advanced marketing side. With us today is CEO and President, John Lee. MKS Instruments is one of our preferred names here at Stifel. The company has evolved into a leading player in both the semiconductor as well as the advanced market space, and it's one where we believe that the company will continue to outperform on a going-forward basis. So John, thank you very much for your time and efforts today.

Before we get into the MKS-specific questions, maybe we just start off in terms of the near-term environment. We get a lot of questions on that. And obviously, there's been a lot of positive sentiment on overall Wafer Fab Equipment spending trends. So with that in mind, can you just kind of provide an update maybe from your last earnings call and how you see overall Wafer Fab Equipment trends for 2021? And maybe as a second part to that question, something that I've talked about is as you look at the industry as a whole, do you believe there are evolving secular changes? Or are we still in a traditional cycle, maybe this time around super cycle environment?

Yes. Great. Thanks, Patrick, and again, thanks for the invitation. Happy to be here at the Stifel Conference. So as we noted in our Q1 call, relative to even the Q4 call, things changed rapidly here. And so in our Q4 call we kind of thought Q1 -- sorry first half of 2021 would be stronger than the second half. That was just an agreement with some of the commentary from our customers. You fast forward another quarter and it's reversed, right? So Q2 -- sorry, second half is now being viewed as stronger than the first half. And so we listened to our customers, we look at their book gains, et cetera. So we would not disagree with that. So 2021 is looking like it will be a very strong year, again. And the second half looks like it will continue to be as good as it seems, relative to the first half based on commentary from our customers. So we think that makes sense because a lot of the underlying drivers are still there for chip demand. So a lot of desire for the data economy, not everything that goes around the data economy. And so with respect to the underlying drivers, we're very bullish on that as well, long-term as well as in the near term. And then with respect to cyclicality, I think we always assume it's a cyclical environment that we live in. Just by the nature of big fab builds and whatnot. So we're always prepared for that. I think we all got a little comfortable about maybe this is up and to the right forever at the last cycle, and we did not, for sure. But -- and we saw that, that was not true. To your point, it could be a super cycle, and we hope it is. But we're always ready to be looking at rapid changes within our business as well as within the whole market. But long term, we believe this is an up and to the right kind of environment. That's why we love being in semi. That's why we continue to invest in R&D, in semi and as well as continue to make our capacities for delivering in this environment bigger and more robust.

Great, John. And maybe that last comment you made about meeting your customer demands. Before we go to the specific market opportunities, I think one of the things that has differentiated MKS just from an operations standpoint is your ability to meet customer demand, whether it was through the pandemic, whether it's through this extremely high demand environment. I kind of probably know the answer about saying you guys have been doing it for 40 years. But if you could give a little bit of color to the audience and investors, your ability to keep up with your high customer demand today and not only meeting it, but in a lot of cases, exceeding it based on your financial results?

Yes. Thanks, Patrick. Yes. No, so I think if you discuss -- if you're thinking about the short-term component shortages, we're not immune to that as well. Everybody is suffering from it in the whole industry. And our operations team has been doing this for a long time, and they've been doing it really well to recover from these kinds of shortages today. It's electronic components. In the past, it might have been cheap metal, it might have been something else. So we've gotten pretty good at this. And I would argue that everybody who's still left in the supply chain is good at it. Otherwise, he wouldn't be around. And some of the things that we do that may or may not be unique to us is we have a very asset-light approach to our manufacturing. We only do final test assembly and only vertically integrate when it's really necessary for IP purposes. So that allows us that flexibility to go up and down when changes occur in our business. And in the semi part of our business, it does go up and down, as you know, quite a bit. Last couple of years, we've had 50% growth year-over-year for the whole part of our semi group. And in some groups, like Power Solutions, which we might talk about later, it's 100%. And so that's an amazing amount of change within a very short period of time. And then when you look at how we've invested over the years into our capacity, we've done that all -- we do that all the time. And I would note, one piece of data, which is that the V&A part of our business in Q1 2021 was double -- almost double Q1 2019, and we didn't add 1 extra foot of factory space. We'll do that for other reasons. We didn't need any more of factory space. So that just shows you the flexibility and the leverage we have in our asset-light approach.

Right. That's really helpful color there, John. Let's start off from a market opportunity standpoint on your semiconductor business. You're a leader in the subsystems in the Vacuum and Analysis segment of that business. But one area I kind of want to focus on are the share gains. On your last earnings call, you highlighted some of the share gains that you've achieved in the RF power segment, which is a one high market and a growing segment within the overall subsystems base. One, can you give the audience a little bit of color on the application wins that you've achieved? And secondly, as you look, going forward, given some of the supply chain issues and some of the other issues out there in terms of the ability to meet customer demand by others, how do you see potential additional incremental share gains in that segment?

Yes. No, I think as we just talked about it, we are not immune to electronic shortages, but we've done a pretty good job in meeting the demand of our customers and meeting the demand as we gain share. So that's pretty significant. As I said, we've been meeting demand, but we've grown around 100% year-over-year. So that's a huge change. And regarding market share, as you know, a few years ago, we were a distant #2 in our power supplies. And now in 2020, according to third-party published results, we are neck and neck for #1. And that's a dedication of a lot of work that the team has done over the years, a lot of betting at a strategic level on this being a strong growth opportunity. Now because we saw that the increasing verticality of the structure of chips was going to rely and be enabled by higher aspect ratio etching, which a big part of that enabling part is RF power supply. So that is where we've gained the share, dielectric etching for high aspect ratio etching for vertical type of structures. But we continue to win and conduct our etches well. That's not as big a business for us. And the opportunity usually is when something changes and their collection changes that causes these critical subsystems to have to evolve very quickly. That was the case for dielectric etch and our power. We believe that conductor etch, as structures become more vertical, even in DRAM and even in logic and foundry, that conductor etch may also go through this kind of evolution of a rapid change and capability. And we're ready for that. That will be a great opportunity for us to take continued share. So even though we're tied for #1, basically in our power supply in 2020, the story is not over. There's still a lot of opportunities for MKS and our power supplies.

Great. That's very helpful. Moving on to another side of the semiconductor business, which I believe, is another incremental or additional opportunity for you to grow is on the optical side of things that you acquired from Newport. Admittedly, going back to Newport's days as a stand-alone company, it was kind of a sleepy business for them. But this is an opportunity, which I believe you have begun to capitalize upon, particularly in areas like metrology and inspection as well as lithography. Can you give the audience a little more color on the efforts you've put into that business segment and how you can continue to grow that on a going-forward basis? Because, again, high margins it's value critical types of components. What are the efforts on that end to grow that business segment?

Yes. Thanks, Patrick. You're right. I think Newport, when we acquired them, these large customers that were inspection, lithography customers, it was one of many customers for them. And our view in MKS is that these companies like ASML and KT, for instance, these are market leaders. They're going to be around a long time. It is really worthwhile to really become more important to them because they're going to be around. And if you get their business, that is going to be an annuity that pays off for a very long time. So we shifted the mindset of the Newport team. And lots of folks loved it. They said, "Oh, we're getting investments now. Investments in CapEx, investments in process engineers, investments in optical design engineers." So that we can actually offer more to these customers. Because in the past, they would not come to us for certain kinds of opportunities because we couldn't do them. Now they are. And so this has really been really satisfying to see that our investments in world-class optics is paying off. Because our customers have responded in kind. They've actually come to us. Okay, that's great. Now you have this capability, that capability. Here's an opportunity, right? And we still have to win it head-to-head with others, but we're winning a fair amount. This is also design wins that take a little while, as we know in semi to turn into revenue, but we're starting to see that happen and at the same time, it's also a very sticky business. These are really precision optics or optical subassemblies that are really intimately designed into their tools. So once you design in, it's a great business long term. So again, we're really happy with this investment and we're patient, and we will continue to invest in this business because our customers are seeing that we'll bring them more to the table every day.

Right. That's helpful. Before we move to the Advanced Markets business and the opportunities there, I did want to touch on something that, again, I think, highlights the evolution of MKS Instruments, and the recent creation of your office of the CTO. And what interests me there is it's bringing your technology innovation with increased collaboration with your customers, so both obviously for the semiconductor as well as our Advanced Market businesses. One, can you detail just the creation of that office of the CTO? And two, how you can create greater collaborations, not only with your customers, but even internally in terms of technology and how you can share that type of information?

Yes. I think if you step back a little bit, the office of the CTO structure that we have, which is made up of technology leaders across all the business units, it's really about scalability. If you're going to be the broadest supplier in semiconductor equipment and the broader supplier in photonics, lasers and optics and perhaps going into laser systems. You're going to have a lot of technology and how are you going to scale that level of technology. So we -- that's how we started the office in CTO. No one human being can be the CTO call that. It's just a lot of technology to understand. And so what this group does is they sit at a certain level, looking at road map changes, inflections and technology that could affect MKS and could affect how we might invest in future technologies. At the same time, they also encourage collaboration across MKS. So we hold an internal technology conference. They sponsor, every 2 years, there's 200 or 300 papers that are submitted. And everybody is invited, if you have a paper to, in the past, a in-person meeting where there's a lot of collaboration, everybody's listening to everybody's papers. There's ample time for poster sessions, et cetera. This year, because we could not be in person, we actually held it virtually. So actually, instead of having a couple of hundred people attend, we actually had 600 or 700 people attend. So actually, COVID actually forced us to get a lot more attendance, and it worked out very well. So going forward, we'll look at some kind of hybrid in between. But every time we have these technology conferences, new collaboration ideas come up. And we have a Presidential award. So the Presidential award is for funding of projects that come out of collaboration from this conference. So every year, there will be 10 or 15 submissions after the conference. And then I will sit there with the office's CTO, and we'll collectively choose some number out then to fund separately so that the 3 or 4 or 5 engineers, not to get more money just for them to work on that project versus kind of BU business-focused kind of funding. And so that's another way how we're trying to encourage this across the vision collaboration.

Right. Let's move to the Advanced Markets business. And before we get into some of the specific market opportunities, one of the things I was hoping you could touch upon, first, is the strategic vision of the Advanced Markets business. And what I mean by that is the company has been extremely successful on the semiconductor end, would it Surround the Chamber philosophy? And how you've evolved and built the semiconductor business over time? You've taken that same approach on the Advanced Markets and which Surround the Workpiece. One, if you can give the audience a little bit of color of why you believe that strategy is applicable for that marketplace? And two, how you believe MKS can continue to evolve and grow through that philosophy on that business segment?

Yes. Great. So it's Surround the Chamber was something we came up with in 2000. And what it did is it informed us as to our vision and our mission. And so it allowed us to decide very clearly, does this fit this vision with respect to organic development or inorganic acquisitions. And then when we acquired Newport, they had been actually doing something like that. They just never called it Surround the Workpiece. So when we got it, we said, this is really like Surround the Chamber, it's just Surround the Workpiece with lasers and motion and optical subsystems and process -- laser power measurement. And so it just made a lot of sense. And you surround it with all the critical subsystems, the trend in laser-based tools, equipment is that it's moving like semiconductor tools just a little later, just offset by time, but they're becoming more productive. They're becoming faster, they're becoming more accurate, they're trying to address the need for delivering precision to smaller and smaller features. So just a perfect analogy between Surround the Chamber and Surround the Workpiece. And then if I step back, at a higher level, what we're really thinking about in terms of theme, brand cast and how it ties all of our business together, is a concept of miniaturization. That is the overall idea for MKS. And when you miniaturize things, they become more complex to me. And the poster job for that is Advanced Electronics today, right? And so when you think about MKS, you think, well, miniaturization, I think that's a good theme. I think that's going to happen. That requires more complexity. That's logical. And by the way, if I like Advanced Electronics, which is driving a lot of this, and I think Advance Electronics will continue to grow, then I like anybody who's in that supply chain, especially in the parts of that supply chain, where there are great profit pools like critical subsystems. So when you step back and think about what's MKS like, I think some of our investors might think it's a semi company. Because they've been covering semi and they're semi analysts. And some are laser guys and they cover the laser part. And some are PCBA packaging guys, and they're covering that part. But a lot of analysts like yourself, Patrick, have learned, no, it's broader and educating yourselves and helping your investors understand the Advanced Electronics part, the lasers part. That's really helpful because the central idea, which I think makes MKS unique is that we're about miniaturization in advanced electronic. Then, if you think of it that way, it makes sense. I want to be in semi. I want to be in laser-based manufacturing. I want to be in advanced packaging. And obviously, that informs our M&A policies and pipeline as well.

Great. I think I had a hard enough time learning about semis and you guys adding the laser market, it's been educational, but I do see the opportunities emerging. Speaking of lasers, let's start with the pulse laser market opportunity and some of the market share gain potential that you can achieve. So from a market perspective, you guys are the leaders in the nanosecond pulsed laser segment, and you've recently reentered the picosecond market with a new product. First, can you talk about the broader market opportunities in the pulsed laser market and why? And I think you just briefly touched about the miniaturization and things of that nature. But again, the market opportunities there? And then maybe secondly, how do you see the picosecond laser offering that you now have expanding that market opportunity for MKS?

Yes, yes. So the idea of pulsing lasers, right, you're talking about pulsing and nanosecond pulse, a picosecond pulse or femtosecond pulse. That is all driven by miniaturization. And so if you can get energy to your workpiece and remove whatever it is you want to remove, and then not have any excess energy left, then you don't damage the material around what you wanted to move. And that is the whole idea of pulsing. And so why do you need nanosecond or picosecond and femtosecond, is basically it depends on the feature size and the material you're working with. You also need different wavelengths, by the way, in each of these types of pulses. So there's a whole segment of pulse lasers of different wavelengths that allows and enables many people to start making things in much smaller features, much more precisely than they ever could before. And then when you step back, as you say, we're leaders in nanosecond now. We weren't leaders in nanosecond, just 5 years ago, by the way. Weren't even a good second place. But with some great designs and some enabling technologies we've taken market share there. And then picosecond, as you talked about, we released several versions of our picosecond laser and we've talked about double-digit design wins already. And those will turn into volume orders once those customers start ramping as well. So we're really happy about our progress at picosecond. We're happy about continue to gain share in nanosecond. And then if you look to the future, femtosecond, that's like even shorter pulse, even more precise applications. Today, the main application, one of the main applications is LASIK surgery. So if you have LASIK, you were under a femtosecond pulse laser, whether you like it or not, maybe you -- I might scare you if you knew that ahead of time. But I think, in general, as things become smaller and miniaturization continues and you need more precision, then the trend will go to femtosecond as well. You still need nano, you still need pico, depending on certain sizes, but you'll also need more and more femtosecond types of lasers as well.

Right. Continuing with your advanced markets business Business that I understood because I covered ESI when it was a stand-alone company. So I saw the market share leadership position they had in the flex PCB laser market. That's -- I'll get to that in a second. But there's also additional incremental market share opportunities on the HDI laser front. Maybe again, a 2-part question is, one, how do you see the market opportunities with the flex PCB laser market from your vantage point? And secondly, how do you believe traction for your HDI laser products going? And how does that expand your market opportunity?

Yes. So flex PCB, we are the market leader. And then we really are pleased with the performance this past year because we -- you saw that our numbers in Q4 were a lot higher than they typically are at the annual cyclicality of ESI. And a lot of that was driven by flex PCB via drilling and continue to be strong in Q1. And typically, the first half of the year is strong for the ESI business, and the second half is more digestion. So 2 comments there, one, is the overbuild of 2018 has not been digested. So it becomes now more of a demand-driven volume-based flex market. In addition to that, there are more and more flex circuits. When you look at smartphones, you see more and more flex circuits in everybody's smartphone. When you go to 5G, you need more flex circuits in those phones as well as in the 5G base stations. And then when you see all the wearables, the watches, the AirPods, people got rings now, right, that measure everything that you ever want to know about your health. All those things have flex circuit on them. And so this trend in flex circuits is really a great tailwind. And if you're a market leader, then you're going to enjoy that. And we will continue making those tools more efficient going forward. So then we could take -- and we are taking the technical capabilities that enable us to be #1 in flex into high-density interconnect via drilling. So that's something where we don't really have a presence. It's actually a bigger market, actually a bigger equipment market for HDI than flex today. And so we've announced several design wins, but we also announced 2 multi-unit orders from volume manufacturers last year. One, we talked about publicly was Marathon. And the other was another large PCB, HDI-PCB manufacturing in Taiwan. We talked about 2 design wins last quarter on our earnings call, one of which was with a high-volume manufacturer. So we're really happy about our -- the interest that our customers have shown. We're happy with the fact that we've started now to be in volume manufacturing in 2 different customers. We're happy with the fact that we have multiple design wins with other customers that eventually will ramp as well. This is a $500 million market. We have low share right now, like 0. But I think that if we can get to 5% to 10% in the first couple of years with this new tool, that will be a big affirmation that what we have is really valuable to the market. And then every year, you get more design wins. You get more share of the design win that you had last year and a volume manufacturer. Then we hope to climb up that market share road map, just like with any kind of product when we start and then go up the market share road map.

Maybe as a quick follow-up to the HDI product, the Geode. I think in the past, you've mentioned to me that the footprint is a key differentiator for the product. Can you detail, one, if that is a key differentiator? And what other differentiators there are with that product versus the existing products that are out in the marketplace today?

Yes, you're right, footprint and weight are 2 differentiators relative to what's out there. But the biggest differentiator is speed. So we designed it so it's faster. So that if you went in with just footprint and weight, but less performance, no one's going to buy it. You go in with less weight and small footprint and a lot faster, then everybody gets really excited about it. And that's really one of the reasons why I think we've gotten -- we still have a lot of interest in our application centers to do demos, that continues. And it's continued for the last 18 months since we've had the release of a tool. So footprint weight are great. They're very differentiated. But speed is the biggest differentiator.

Right. Let's go to the operating model and your long-term financial model targets. The one thing I've always been impressed with MKS, over the years, is your ability to manage cost-driving synergies in your acquisitions. As you put out some of your new financial target models at your recent Analyst Day, what are some of the key levers, both on the margins as well as in the OpEx front investors should keep an eye on?

Yes. So at our Analyst Day, we talked about how we expect ourselves to perform relative to the markets that we're in. So with respect to WFE, we expect to perform 200 basis points above WFE CAGR. We've shown that we can do that over decades. In the last 5 years, actually it's been a little stronger. We also expect to grow Advanced Markets at GDP plus 300 basis points. And as you know, our Advanced Markets is divided evenly, 1/2 of it is more GDP like, like research. The other half is Advanced Electronics, which we think is low double digits. And so when you average the 2, we think we can get GDP plus 300 basis points. And so those haven't changed. And then, of course, the flow-through model is the same, 50% incremental gross margin flow-through and 40% incremental operating margin flow-through. Those remain intact. We do a little better on the upturn, a little worse on the downturn, as you can imagine, efficiencies of factories. But long term, that's been our model, and that's still very much intact, and you can see it in our gross margin profile in Q1.

Great. Let's go to your capital allocation strategy, which I believe, from a M&A perspective, you guys have been one of the standards for other companies to look at in terms of how you evaluate deals, how you bring companies together. And also the discipline you maintain in terms of the evaluation of bidding and going after companies. One, if you can just give the audience a little more color in terms of how you evaluate potential M&A opportunities? And two, how you stay disciplined in terms of, okay, you know what, we're going to bid for a certain candidate, but we won't overbid or overpay for some.

Yes. Well, that's fundamental to us, Patrick. We're here to protect the shareholders of MKS. And so fundamentally, we have to make sure that whatever M&A opportunity comes up makes sense financially for our shareholders. So that's fundamentally why we stopped in the coherent being like this makes sense for us. I don't know how it makes sense to the other guys at a higher price, but maybe it does, and so that's fine. But for us and our shareholders, we have a pretty disciplined approach to adding shareholder value through M&A. And then when we'd look at the characteristics of a potential target, it's really -- and we talked about it before, it's really about differentiated solutions. So if they are differentiated in their market and in their competitive environment, then they will have gross margins that are similar to ours. And if that is true, then now it's interesting to us. If they don't have the kind of gross margins that are required to support next-generation R&D, then it's a commodity, and that's a bad thing for us because we're not good at it. We're not -- other companies are better running commodity-type businesses. It's a different mindset. It's a different operational model. And so we're just not that. And so that's how -- that's the lens we look at through M&A. There are many, many opportunities, so we can stay disciplined because it's not this one, there will be another one. And we have a very robust and big pipeline where a lot of things could make sense. And so some in semi, we just announced Photon Control and optic solution for a semi application, right? And gross margins, obviously, well north of 50, that they're a public company. So those are the kind of criteria Photon Control is a company that kind of meets those kind of criteria, and that's a model. And that's a tuck-in. And we're -- in our pipeline, we have tuck-ins, we have midsized companies, we have big ones as well. And as you know, we can actually make sure that we are in the running for large acquisitions as well based on the strength of our balance sheet.

Right. I think that's all the time we have. So John, many thanks, again, for participating in our conference. I do remain excited about the company's opportunities, so continue the good work. Stay safe, and thank you again for attending.

Great. Thanks for the opportunity, Patrick. Take care.

Take care. Thank you.

Bye.