MKS Inc. (MKSI) Earnings Call Transcript & Summary

I am Shek Ho. I cover semi cap equipment and IT hardware at Deutsche Bank. The next company we have on stage is -- on stage for fireside, virtual stage, is MKS Instruments. MKS is a key supplier of components and subsystems in the semiconductor equipment market, and it also has a strong presence in other advanced markets, focusing primarily on laser applications. Also in the advanced markets, MKS is about to get a lot bigger with the pending acquisition of specialty chemical company called Atotech. And it's my pleasure today to introduce David Ryzhik, VP of Investor Relations at the MKS. Welcome, David.

Thank you, Sidney. Thank you, everyone, for the time.

Yes. Before we start, for those investors who are listening to the webcast through our portal, if you want to ask a question, there is a box on your screen where you can type in your questions, and I will try to ask those questions as we go through our discussion. So with that out of the way, let's dive right into the different businesses that you guys have, David? So I know we are at an industrial conference today, but a lot of the industry analysts that I spoke to also want to understand your semi cap equipment business, which is today is roughly, what, 60% of the total business. David, could you give us a brief update on the current state of the semiconductor equipment market as we go into 2022. MKS positioning in this market and a few themes you are most excited about this market.

Yes, absolutely, Sidney. So as we highlighted on our Q3 earnings call, demand in semi is strong. And our customers have talked about strong demand extending into 2022, and that's certainly good for us. So as you know, we're a leader in critical subsystems to the semiconductor market. So we provide these subsystems to the capital equipment OEMs that then sell those tools that are used in the fabrication of chips. So we have a pretty unique portfolio that stretches across vacuum products for such applications as deposition and edge. And we also have a photonics portfolio that address applications such as lithography, metrology and inspection. And we actually serve greater than 85% of the wafer fab equipment market. Historically, we've actually outperformed this market organically by about 200 basis points over the past decade. And that's actually our expectation over the long term moving forward. And Sidney, a big reason for that is our share gain. And so one of the examples of the share gain is RF power. We've talked a lot about this, but we saw a transition from 2D or planar NAND to vertical or 3D NAND. And we saw an opportunity there because there was a need for higher RF power content to address that transition and the growing verticality. We've made some investments, secured design wins and we took a lot of share. In 2020, for example, we grew that business by more than 100% year-over-year and took about 10 points a share in that category. And in 2021, year-to-date, we've grown that more than 50% here -- we've grown that more than 50% compared to the same period year-to-date. So that's one example of us being able to take share. We're also excited about a number of other opportunities. There's atomic layer deposition. There's an advanced lithography, metrology and inspection applications that we're investing in. And so that gives us confidence that we can outperform WFE over the long term by that 200 basis point organic growth. And I think that as far as cyclicality, we think that there are some really powerful trends in semi, and they're going to continue over the long term. There will be cyclicality. But the industry today is a lot healthier than it was maybe 10, 15, 20 years ago. And there are a few reasons for that. So number one, it's a lot more consolidated. So there are a lot less chip makers, and they're much more rational. And there are a lot less capital equipment makers and they're rationale as well. So that gives you just a healthier industry that's consolidated. Number two, the end applications for semi are more diverse. So you may remember 10, 15 years ago, a lot of semi was driven by PCs. And so it's very concentrated, that created a lot of volatility and cyclicality because it was concentrated around PCs. Now you can all see that its PCs are still important but it's smartphones that require a lot of chip content. It's automobiles that are data centers on wheels essentially. And it's cloud. These are hyperscale data centers. So a lot of diverse end drivers, and that actually makes the industry healthy and kind of -- it's positive for the cyclicality of the industry going forward. So we're really happy. We're really excited about this business. It's an area of growth for us. We're differentiated with our portfolio, and we expect to continue to take share.

Great. That's a great overview. Maybe just one follow-up question. If we look at the semicap equipment market, there has been a lot of constraints on -- supply constraints in the near term. I know the demand seems to be pretty healthy in the near term and the longer term. But where are we in this supply-constrained environment. Are we going to see a supply-constrained environment for a few more quarters? Or how is your take on that?

Yes, it's hard to predict exactly when it's going to alleviate. But we're managing it through it really well, Sidney. We're really pleased with how our operations team is managing through this. We have a lot of suppliers. And so we've been pretty much managing through this since the beginning of COVID. So we've been dealing with a pretty unusual and unexpected pandemic. Meanwhile, there's a very strong semi cycle. And so being able to secure supply, and we've done a really good job. So it's hard to tell when this exactly alleviate. But as we said on our Q3 call, we're even getting help from customers, right? It's a very collaborative environment these days to try to get supply. So we think that's good for the industry overall. So to answer your question, Sidney, we're working on addressing these supply chain constraints, but hard to tell when it really -- which quarter it really alleviates.

That's fair. That's fair. Why don't we switch over to talk about the other markets, which you guys call the Advanced Markets. That's roughly 40% of your business today but that percentage could go a lot higher after Atotech acquisition is complete. So maybe, again, I'll start off with some shorter-term questions supply/demand, those kind of things, but starting with the supply side. Supply constraints, similar to semi-cap equipment are having an impact throughout the electronic supply chain, and you called out supply chain constraints impacting your vacuum portfolio in your industrial application business. Can you help us better understand how these supply constraints are impacting your advanced Market business? Is it you can't get the components you need to make the devices? Or is it just customers holding back on orders because they can't get other components they need to complete system? Or is it just everything comes more and takes more to -- and takes more time to get?

Yes. So as we said, we're not immune to any of the supply chain constraints. It's a combination of not having enough components to meet the demand as well as inflationary pressures. But to better understand the Advanced Markets impact. As you know, we have a Vacuum and Analysis Division where we provide critical solutions to vacuum processes. And that's very well known in semi, right, because of the vacuum processes that are critical in semi. But there is about a mid-teens percentage of that Vacuum and Analysis Division that serves Advanced Markets applications, mostly industrial applications. There are certain deposition processes in solar and display. We serve synthetic diamond manufacturing applications. And so since the constraints are impacting our Vacuum and Analysis Division mostly, you could see some of that impacting not just semi but Advanced Markets. And that's really what you saw in Q3. But the good thing is demand trends are pretty healthy there as well.

Good segue to the next question. So despite all these supply chain issues, it seems like the demand environment for the Advanced Market is quite healthy. even after accounting for the seasonality that you typically see in the third quarter for your PCB business, can you touch on the demand drivers you're seeing in this business? And how you think about the tailwinds or headwinds to these businesses from the pandemic?

Yes. So if you actually exclude the seasonality in Advanced Markets and the constraints from our vacuum business, our Advanced Markets revenue is actually stable sequentially. But if you actually take the midpoint of our Q4 guidance and you take what we said, Q4 being consistent to up in Advanced Markets. You'll see full year -- that implies full year Advanced Markets revenue growth of about 20%, and that includes some of these constraints. So we're really happy with the demand in Advanced Markets, our execution there. But what's important is that the trends that we've seen in semi for decades around miniaturization and complexity, right? Chips getting smaller, more difficult to make, we're seeing in Advanced Markets, specifically in advanced electronics manufacturing applications. So today, we're addressing that largely with our photonics solution. So we're seeing a shift to laser-based manufacturing processes. Because you simply can't do certain things, you cannot address the miniaturization needed without a laser in certain applications. And so we see this nice trend and that's really the growth driver for our Advanced Markets. So -- and then going back, I think you had a comment on just some of the headwinds maybe from the pandemic. I think we have seen some headwinds last year in research, in the research market because we sell into universities. And so there were some closures there. and also some delays in elective surgeries in the life science business, but those are back to a prepandemic level. So we're pretty pleased with that.

Great. I definitely want to talk a little bit more about the drivers, longer-term drivers. But one more question before we get there. Every time -- in the short term, inventory has always been something -- I'm from the tech world and you're from the tech world as well. So we always think about inventory as being a factor. How are you thinking about inventory levels of your products of your Advanced Markets' customers? Is some of the strong demand driven by inventory build just to help protect against supply chain constraints? Or are inventory levels pretty lean across the board right now.

Yes, we don't see anything unusual with our customers in Advanced Markets around inventory levels. Demand trends are healthy. And our focus is really just to execute on design wins. There are some areas that we see opportunity in Advanced Markets. We've talked about taking share in the picosecond laser market, and also in the high-density interconnect market. So there are a number of opportunities for us to take share. And that's really what we're focusing on. But I wouldn't say anything unusual on the inventory side.

Great. So maybe let's talk about the growth driver a little bit. You touched on that earlier. But can you give us a kind of high-level overview how you think about the different end markets? Is there different markets in the Advanced Markets business and the growth profile and opportunity in these market?

Yes. So I'll try to segment our Advanced Markets into 4 subsegments. So the first segment, and I touched on this earlier, is advanced electronics. This is where we're seeing the trends of miniaturization and complexity. A lot of these semi-like trends, and this is a little more than 1/3 of our overall Advanced Markets revenue. And it's characterized by, let's say, PCB via drilling laser processing for solar, manufacturing, display, electronic component testing. So -- and we think that this market, like I said before, is a growth driver for Advanced Markets. And we expect that to grow about a low double-digit CAGR from 2020 to 2025. And I'm referring to the numbers we gave in our Q4 Analyst Day in 2020. And then after advanced electronics, so that's a little more than 1/3, there are a few other markets that are a little less than 2/3 of the business, which are more GDP growth type segment. So for example, there's a traditional industrial segment. So there are a variety of applications that we serve with our vacuum and photonics portfolio. So synthetic dining manufacturing, coatings manufacturing. And so this is a very broad exposure. So that's more of like a GDP grower. Life and Health Sciences, also, we participate in certain applications like lasik eye surgery. And those are nice opportunities, niche opportunities with nice margins, but also GDP-type growth. And then also, there's the research market and defense market. So in research, we're selling to university labs. In defense, there are a few applications that we serve, for example, optics for lower-range imaging. And so we think of those as GDP growers as well. So when you bring it all together, you have advanced electronics, we think, is growing low double digits CAGR. And then the rest GDP, you come up with like an Advanced Markets organic growth model of GDP plus 300 basis points.

So even though I can do this math, so advanced electronics is growing low double digits, and the rest of them is growing to [ GD plus ], you're probably, at some point, going to skew like now it's 1/3 for advanced electronics, 2/3 to others, it's going to go to 50-50 at some point. That's kind of the idea for us to track, right?

Yes, that's right. that's right. We would expect our advanced electronics business to grow a little faster and pick up a bigger piece of that.

So when you look at the advanced market business in aggregate, what are the best market parameters to monitor the health of this business? Is it -- to your point is it the -- some of the advanced electronics and what within advanced electronics, should we be looking at the smartphone? Is it complexity? Is it industrial growth? Is this GDP growth? Is there something else that we can benchmark against?

Yes. For advanced electronics, I would say it's not just the smartphone, it would be overall electronics devices [ SAM ]. Electronic device [ SAM ]. And that's probably the best measure. And then the other piece of Advanced Markets, when we talk about industrial, life, health science, research and defense, it's more macro, I would say, GDP macro type in there.

Okay. That's great. Maybe double-click on this advanced electronics business. Clearly, there's a lot of growth and that potential -- a lot of growth potential there. You guys are a market leader in the flexible PCB drilling business and has made a very aggressive push into HDI, the high-density interconnect via drilling market. Both these businesses should continue to grow as demand for laser drilling growth as the miniaturization of devices continues. Can you give us an update on what you are seeing in those 2 markets and how MKS is positioned to benefit from the opportunity in these markets.

Yes, absolutely. So the flex PCB via drilling market, which we serve primarily out of our E&S division, we have a system that provides the drilling. That's actually a great example of miniaturization and complexity. And I'm going to keep going back to that theme because the trends we saw in semi, things getting smaller, more complex are occurring outside of the chip. And flexible PCB is a good example. Via sizes are shrinking. So the PCBs are becoming denser, materials are changing, and that requires technology enablement. And so secular trends such as 5G are good for this market because we've actually done our work and we estimate that a 5G high-end smartphone has about 30% more flex content than a high-end 4G phone. And so that's just one proof point of some of the things that are going on in this market. And so we estimate this market to be about a $150 million to $200 million market and growing moving forward. There's also the high-density interconnect PCB via drilling market, which is a larger market where we have very little share. We're a new entrant into that market with a new tool that we've introduced into the market that happens to be lighter, smaller and has higher throughput than the competition. So we're actually pretty excited about the potential share gain we have in that market. And so we estimated about $500 million market where we can take share. So when you think about the PCB industry, we're pretty excited. And I think sometimes when we talk to investors, so people have this connotation of PCB as kind of commodity, not interesting, low margin. We're not actually making the PCBs. We're providing critical foundational solutions to enable new and next-generation PCB technology. And that's what we're really excited about.

That's great. You guys -- before we talk about the market share aspirations in HDI. My understanding is that, that business is really just down to a few guys, but obviously, a much bigger market than the flex PCB market. How quickly can you guys gain share? And what are the things that you guys are doing to get you some visibility into the share gain potential?

Yes. So we've already actually secured a few multiunit order -- multiunit orders from some key HDI customers. We're also in beta testing stage with a number of other customers. So we're definitely making progress. This doesn't happen overnight. This is a very sophisticated and complex problem that we're solving. These systems drill thousands of vias per second reliably, accurately. And the diameters of these holes, vias, are very small, and they need to be precise. And we have a really good tool. We're pretty excited about the feedback that we've gotten. And that's our playbook, just to convert some of these betas into design wins and then into multiunit orders. And so we have some initial goals on market share that we think are realistic, but our long-term aspirations are to become the leader like we are in flex.

Got it. Got it. Maybe one last question before we -- I know a lot of investors are probably interested in the Atotech. But before that, one last question. If I bring back the semi side of the business, along with the Advanced Markets, it might seem to investors that there isn't much overlap between the 2 business segments. Can you give us an overview on how you think about the synergies between your semis and advanced market businesses? And how it benefits MKS to have both businesses together?

Yes, absolutely. So I'll just come back to the theme of miniaturization and complexity. That ties everything all together. In semi, we're a leader there, enabling chips getting smaller, more precise, and we see an opportunity in advanced electronics, kind of reminds us where semi was a few decades ago. We see a lot of these semi-like trends and we're becoming -- and our vision is to become a foundational enabler of that. And we have a very differentiated laser drilling portfolio. And I talked a lot about our laser drilling systems, but we also have the critical components for that laser processing in lasers, optics, motion. So there's a lot of cross collaboration going on there. And then when you layer on Atotech, which we expect to close by the end of the year, that brings critical chemistry to address, again, a lot of the miniaturization and complexity in the PCB and packaging realm. So we think there are a lot of opportunities. And I'll just give you a proof point. When we acquired Newport in 2016, a lot of people didn't really -- they saw us as kind of like semi and Newport is lasers and where does it all fit, but we immediately drove some nice synergies with our Newport business because we have a leadership in certain semiconductor -- with certain semiconductor customers that we were able to bring that Newport photonics portfolio in and drive some nice cross-selling synergies. So we actually view our businesses as very complementary, and it makes a whole lot of sense to be together. And by the way, we have a pretty unique office of the CTO, as you will. We don't have one CTO. We have a collection of CTOs from the different product units. And there's -- we kind of foster cross collaboration amongst all of them to share notes, compare notes. We have -- every 2 years, we have a global technology conference, internal only, where we have posters, compare ideas, share notes. And so there is a lot of cross collaboration that occurs within the company across all of these units. And so that kind of informs us on where the trends are going, what -- where to invest. And so that kind of -- we think of that as a pretty unique differentiator for us. And that gives us the confidence to make certain investments to have -- we have kind of the capability because we have the scale, and we also have the outlets to invest.

Excellent. Excellent. So let's spend the rest of the time talk about the Atotech deal. Well, after the deal was announced, I think there was some questions on how Atotech fit into the MKS portfolio, which he kind of explained a little bit earlier. I think you guys have also done a good job outlining the potential for some of the revenue synergies and high levels of recurring revenue for the continue -- the combined company. Can you just touch on what excites you the most about this opportunity? And if there are still any areas that you think are still being misunderstood by the market.

Yes. So let me start with the electronics business. You may have heard us on the Q3 call talk about the interconnect. The interconnect is essentially the highway that carries data between chips on a PCB board, let's say, or between chips and sensors, right? And as application requirements change, the demand to build more cost-effective and higher-performing highways growth, okay? So that's why when we announced the deal, one of the -- the main theme was optimizing the interconnect, okay? Today, we provide critical via drilling solutions to the PCB market that basically drill a via, that creates an interconnect. Atotech provides critical process chemistry that place the interconnect. So that provides the conductivity. And so that directly impacts the performance, the reliability and the yields. So together, we think we can optimize the workflow. And more importantly, Sidney, is to accelerate time to market for our customers. And so that's something that we're pretty excited about. And we've sized this at $4 billion SAM, if you combine our laser drilling and their chemistry and plating. And together, we have less than 1/4 of that market as far as market share. So we're pretty excited about the electronics opportunity. And by the way, again, that fits entirely into our miniaturization and complexity thing. Now GMF is also -- we see some nice opportunities there as well. So that's a nice margin business, stable revenue. And there are some interesting trends there, for example, electrification in auto, light weighting, premiumization. So for example, there are certain parts in luxury automobiles that they're looking to use more lightweight parts. So they're plastic, but they have metallic coatings to give that luxury feel, less corrosion. So there are also some industry transitions away from Chrome VI, which Atotech is also positioned well. So GMF as well, we're excited to have that business. And we think combined overall, we're pretty excited to close on the Atotech deal.

Great. So for those investors who are listening, the GMF stands for general metal finishing, which is about 30% of the Atotech business, roughly.

It's about a 1/3.

A 1/3. So if I think about the combination, just looking at Atotech, what is the right growth rate that you guys are thinking about on a combined basis?

Yes. So we haven't given specific long-term targets, Sidney. I think that stay tuned after we close, sometime after that, we could look at refreshing our long-term pro forma model. But I think, in general, we think about GMF as more of like a GDP type business and the electronics business is a bit higher than that.

Okay. That's fair. So as you guys dig deeper into this deal with Atotech and speak with the customers of both companies, is there anything that surprised you since the deal was announced? Any additional opportunities or challenges that you may not have appreciated a time when you announced the deal?

So we -- at the time we announced the deal, we already had a pretty strong appreciation for what Atotech does. But after having an opportunity to interact with the team, we actually are more impressed with the talent and the strength of that team. So like I said, we can't wait for the team to join MKS. And another example is, while not surprising to us, definitely reinforcing and encouraging is the feedback from our customers. So we think that they understand the combination can deliver a lot of value for them. And importantly, again, accelerate time to market, help us deliver better and faster solutions for our customers.

Got it. I'll bring back some of the acquisitions you did in the past number of years and namely the big ones are the Newport and ESI. So I have 2 questions here. One is, if you look at -- look back at those 2 acquisitions as you think about Atotech, what are some of the lessons that you may have learned from those 2 deals in terms of integration, in terms of moving forward with the combined company? And the second question is if I -- you guys have a history of financially quickly delevering post-deal, is that the same kind of playbook we should be expecting from this deal as well?

Yes, absolutely. And so every acquisition is a little unique in its own way. Newport was more of a heavier cultural lift, and we transformed that business and delivered some really nice operating margin improvements. ESI had already undergone some changes before we acquired them. And so ESI is more like -- more around technology and extending our Surround the Workpiece strategy. And Atotech, we believe, is a very strong, well-run business today. And I think that what we're pretty proud of is that the management teams of both of those acquisitions are successfully driving those businesses. And a lot of them are the same as when we acquired. So it's a lot about empowering existing staff and kind of optimizing them to reach full potential. That's part of our DNA at MKS. And so we're pretty happy about that. And so our integration planning efforts are going very smoothly. You may have seen we announced some planned executive appointments pending closing. Jim Schreiner who is our current COO, will run the Atotech business; Dave Henry, who currently leads our corporate marketing, PMO and services organizations will take -- will also take leadership of MKS' V&A, L&M and E&S operations, again, pending closing; and then finally, Geoff Wild, who is the current CEO of Atotech will join the MKS Board, which we think will provide pretty invaluable insights into managing the business.

Excellent. Maybe just a last question to wrap it up. If I kind of look at both your semis and the Advanced Markets and obviously, Atotech is included. What are some of the growth drivers going forward that you're most excited about? And I know we talk about miniaturization, maybe sent down that path. But importantly, what do you think there is potential that is not being appreciated by investors?

Yes. So on miniaturization and complexity, semi, the trends there are very well understood and they're going to continue. Chips are going to get smaller, more difficult, and we're uniquely positioned with a very broad vacuum and photonics portfolio to address a wide array of WFE applications. So we're well positioned there. Advanced Markets, it's kind of like where semi was a few decades ago. And we're putting the pieces in place to become a foundational solutions provider for advanced electronics. We have a very differentiated photonics portfolio, where we have not just the systems, but we have critical components such as lasers, optics and motion. And then with the closing of Atotech, we'll bring in critical process chemistry. And so I wouldn't say that necessarily investors don't understand that. But I think that over time, we plan on executing and to prove that vision out by delivering long-term sustainable and profitable growth and share gains. And I think another item that maybe investors may not fully appreciate just yet is -- with Atotech, the volatility of our revenue stream is dampened. So post close, we expect about 40% of our pro forma combined revenue to be recurring and that consists of consumables, so a lot of the chemistry that Atotech sells. And the services businesses from both companies. And so we think that would -- will dampen the cyclicality of our business.

Great. I think we're just running out of time. Thank you for spending the time with us and for the investors, enjoy the rest of the day.

Thank you, Sidney. Thank you, everyone.

Bye-bye.