MKS Inc. (MKSI) Earnings Call Transcript & Summary

Good afternoon, everyone. Before we get started, -- If you are a member of the press or media, please disconnect at this time. This is a restricted line. Any unauthorized party in this meeting or any unauthorized use of the information communicated in this meeting is subject to prosecution to the fullest extent of the law. Any unauthorized person, including the media that is on the line at this time, please disconnect.

Good morning. I'm Joe Quatrochi, the semi cap analyst here at Wells Fargo. I'm happy to welcome MKS Instruments' President and CEO, John Lee, as well as David Ryzhik from VP of IR. [Operator Instructions] For anyone on the webcast, who'd like to ask a question, you can submit it through the Ask a Question tab or you can or you can e-mail me at go [email protected]. So John, thanks for joining us.

Maybe to start topic that's kind of top of mind right now, the pending acquisition of Atotech, I think that's expected to close sometime this month. Maybe first, can you start and just help us understand what do you think, I guess, discuss where this acquisition fits within MKS' portfolio? Maybe where do you think investors are least appreciating the merits of this acquisition and where it can fit with the MKS portfolio.

Thanks, Joe. Thanks for having us on your call. Happy to do that. I think the way to think about it in terms of how Atotech fits within MKS is really about the bigger concept of miniaturization and complexity in advanced electronics. And that's really the bigger concept that we think about within MKS. And that's the context of which we think about whether a particular market makes sense for us, a particular product would make sense for us or an M&A target makes sense for us. In that context, Atotech, as you know, has 2 groups. One is the electronics group and one is the general metal finishing. Let me start with the electronics. I think the electronics group certainly fits squarely within the concept of miniaturization and complexity especially as PCBs and the packaging of multiple chips together, chiplets, if you will, is continuing to actually help drive the Moore's Law that's really always been a semi, the chip part, it's really now moving to packaging. And that's really the area where chemistry is actually quite important. And that's where Atotech has leadership. And as you know, we have laser drilling of some of those markets. And so we see a great synergy there where we can accelerate the development of the next-generation electronic packaging for our customers. And then when you look at GMF, general metal finishing. I mean, that is also a pretty highly technical process as well. And so you're talking about plating things that are -- got to be corrosion resistance -- resistant, either because they're in pistons for brakes or pistons for automotive or even just decorative or premiumization, if you will. And that business has great margins, just like the Electronics division, and there's a lot of share in R&D, a lot of synergy between the 2 groups. I think if you think about what's not appreciated or maybe some investors still need to kind of get their heads wrapped around. I think PCBs, the general concept of PCBs has historically been not a very high-tech necessarily kind of industry. That's really what we see is changing. It's already changing, and we see this continued acceleration because it's miniaturization and complexity that's driving these technical changes in the packaging industry PCBs. So smaller holes, smaller lines of spaces, planning of that is more difficult -- but via drilling of that is more difficult. It's just like semi, right? Just sizes are a little bigger, but the challenges are just the same, shrinking and complexity. So that's one perhaps area where we have to educate investors. And I think the other area that I think some investors are starting to really appreciate now is that the combination of Atotech and MKS in terms of volatility of revenue is going to be much stronger, much more -- much less volatile. So as we've talked about before, the combined pro forma company in 2020, for instance, would be about 40% recurring revenue. And that's with exceptionally high revenue for semi equipped, that's still 40%. That reduced volatility, of course, gives you a lot of optionality in terms of continuing to invest in downturns because the equipment part is always cyclical for semi side as well as even for Atotech side. And of course, if there was a downturn, that reduced volatility would become a bit -- a huge leverage point for us relative to perhaps competitors who are only [indiscernible].

That's a really helpful overview. Maybe just to kind of follow up on the PCB side. I think Atotech's talked about serving, I think 28 of the 30 largest PCB suppliers. I guess, how does that compare to MKS? And where do you see those, I guess, are there cross-selling opportunities that maybe didn't exist for MKS previously?

Yes, sure. So Atotech has been in that industry a long time. So they have, as you said, 28 out of 30 top PCB makers. Many of those are the same customers for MKS but many are not, just because we're not as big, if you will. We're exposed to Flex through via drilling. We are entering HDI via drilling. Atotech is very strong in HDI cleaning and has some presence in Flex plating. And so I think if we can combine the 2 companies so that we can develop processes faster for our customers . Then I think there are opportunities, obviously. I think the customers always choose the best tool process. But if we can help them get there -- get to their road maps faster, I think we add that extra value for them.

That's helpful. One of the things I think you've also talked about for Atotech's expertise is in IC packaging. I guess can you expand a little bit on that opportunity? I think when we hear Intel or AMD, Samsung, others talk about chiplet architectures. I guess is that something that MKS or Atotech, the combined company could play into in terms of those architecture changes?

Yes. No, absolutely. In fact, that's the wheelhouse. So as companies like Intel and Samsung, TSMC talk about packaging, what they're talking about is putting multiple chips on to maybe some silicon interposer. But then that goes on to a PCB. And so that kind of packaging, I don't think a lot of folks think, well, the silicon that's different sizes, different features, and it's really more like the front end of chip making or etching or silicon etching through the -- through silicon via etching and plating in very small features. And that's true. And that's where we play with our semi type of portfolio. But once you do that, once you do that kind of silicon interpose a packaging, then it goes on to things like high-density interconnect PCB packaging. And every one of these 3D packages has both. And so that kind of advanced packaging is really the thing that's driving the road maps, the next-generation PCB packaging. And that's really where Atotech plays as market leadership.

So I mean, maybe, John, if you had to try to think about rank ordering like the opportunities that Atotech brings to MKS. I mean where -- what would you say is maybe the -- in the near term in the 3-year range or in the 5-year range? How do you kind of rank aware of those opportunities in terms of size?

Well, I think the high-density interconnect packaging area where Atotech is strong. I think that's an area where we have the most upside, if you will, because our laser drilling tool is just entering. We're going to talk about that later. And we talked about it in our earnings call. This is our GEO tool, it's a system that's used to drill holes into rigid PCBAs. And I think there is an opportunity for us to learn faster with Atotech and then provide the next-generation processes faster. And hopefully, they're -- grow in market share. I think in Flex, where we already have a strong position in laser drilling. I think that's another opportunity, but reversed. For Atotech, to learn about what kind of plating challenges there might be in flex circuits. I think they know a lot about it for sure. It's not like they don't have any presence. But perhaps that's an area where we jointly can develop road maps and accelerate road maps as well. And so those 2 are the biggest, I think, opportunities where together, I think if we can really demonstrate the value proposition to customers getting to their solutions faster, I think there, we have a better opportunity for both sides.

Got it. Super helpful. Maybe on the combined model, you talked earlier about 40% of revenue being recurring, be it consumables plus services. How do you think about that from like an EBIT or EBITDA perspective?

Yes. That's a good question. I think what I would say now is 40% of the revenue is -- would be recurring on a combined basis. And I would say that the profitability from an EBIT perspective or net income or EPS is probably similar, 40%-ish, maybe a little higher. And that's only because the equipment is -- as you know, it's just 50% growth year-over-year. All the factories are really running at peak efficiency. The constraints are really supply chain constraints, not in our factory. So we have a lot of efficiency. As you know, our model is 50% drop-through for gross margin. And so we're at a kind of a really efficient point in time in terms of utilization of our factories. And then -- but if there's a downturn and that utilization drops, just what would happen in the semi downturn. I think you could see that 40% revenue and EBITDA percentage, probably the EBITDA percentage being higher from the recurring revenue just because you're less efficient on the equipment side. So I think that's another area of strength as we talked about having EBITDA being even stronger during downturns, that is really an amazing lever that you can use to continue to invest in R&D during downturns to move your positioning and your design going forward.

Yes, that's helpful. And in terms of -- I think you guys have talked about $50 million of annual synergies kind of as a target. Can you talk about where that's may be coming from? Because it doesn't seem like maybe there's a lot of duplicated costs outside of maybe being a public company?

Yes. No. So you have the public company costs, as you pointed out. And a lot of it is in still their supply chain overlaps because even though MKS is not buying chemistry and Atotech is, there's still a lot of stuff that we buy that's indirect materials. And they do have an equipment arm. And so equipment is 10% of Atotech's revenue. So there's a lot of PCBAs and things like that where we could see a lot of areas where we can get to that $50 million, but I would say also that we didn't buy Atotech for synergies, we bought Atotech from synergy side. We bought Atotech for potential revenue synergies and looking forward in driving our road map of miniaturization and complexity. And so I think that $50 million is fairly de minimis. We don't have extra people that are hanging around. We don't have extra chemistry factories. We got none. And so I think you're right. There's a well-function company, and Atotech is a well-functioning company in MKS. The people are really -- both companies have been run pretty efficiently, I believe. And so I think most of the synergies are going to come out of corporate costs, company, public company costs and the supply chain where it makes sense.

Got it. Got it. And so one of the questions I've been getting recently, you guys successfully raised, I think it was oversubscribed debt offering to finance part of the deal. I think you raised a little bit over $5 billion. And one of the questions I keep getting is kind of what's the plan for the extra cash raised because I think you raised a little bit more than kind of what you are planning to use from a debt perspective to do the deal. So any help that you could give us there? Are you looking to retire pre-existing debt or just how do you think about the cash kind of post deal? Anything that would be helpful.

Yes. Well, so you're right. We were really pleased with how we executed with our banking partners on that debt of 2x oversubscribed, I believe. And the short answer is, yes, we're going to retire our current debt in any current debt Atotech has as well as obviously paying for the deal. So that's really -- there's no magic there. And I think we're thinking of keeping on the order of $800 million in cash to run both the combined businesses. And that's got -- it's a pretty conservative number. We're pretty comfortable with that. And we also have a line of credit that's $500 million should we need to tap into it. So it's really no secret there. It's just retiring the debt and then paying for the deal.

Perfect. Maybe moving on kind of diving into the MKS business as we can today. On the semi side, obviously, demand is really strong given the demand for equipment. Can you talk about your visibility into customers' inventories and in demand? I think in the past couple of quarters, it seems to have been relatively tight. I guess, how does that translate into your demand visibility into next year?

Yes. Well, certainly, we're -- the demand visibility is much further out than it's ever been. But we're always cautious because things haven't always changed 3 quarters out and you know better and things can change fast in semi. But we have the visibility. And so we are planning capacity. We're planning materials for that visibility 3 to 4 quarters out, while fighting the fight for this quarter and the next quarter in terms of supply chain constraints. We're shipping everything we can. So we're -- we -- our inventory is flattish to slightly up. That's because a square it sits really and driving higher volumes, frankly. I think that's the same with our customers, our semi OEM customers. They're shipping everything that's a square set they can ship out. I think you heard in MandaLam, big -- our 2 biggest customers, they are shipping everything they can. They're constrained as we are constrained by electronic component shortages. And as I said before, and I think they've also said the collaboration, I think, along the supply chain is so much tighter now than it's ever been because we collectively all know that we all have to work together to make sure that we get through these supply chain constraints. So the communication is much tighter than I've ever seen before between us and our customers. Collaboration, if there's some component that's missing of short, they're asking if they can help. And we're taking that out whenever we can. So I think in terms of inventory, I think everybody is shipping everything they can at this stage.

So I guess, like thinking about it that way. I mean, in the past, right, you've historically kind of -- you outperformed WFE outside of share gains, right? And then kind of when things slow down, there's a little bit of an inventory correction. So I guess as you think about the demand into 2022, obviously, and that without saying -- thinking 10% growth right now, it seems like a good number. But for you guys, right, like is there a little bit of an inventory restocking that we should think about in terms of kind of maybe helping you continue to outgrow the industry? Or does that maybe help make a softer landing as things may be starting to loosen up in terms of supply/demand?

Yes. I mean it's a good question, Joe. It could, it could. I think the change now in this cycle versus previous cycles, is that supply chain resiliency is much more top of mind now for everybody, including us as well as our customers and their customers. I think folks, we've worked as an industry to be really just in time, the entire food chain has been really efficient that way. And with COVID, I think we saw disruptions. First, it was a country shutting down for 2 weeks at a time and 3 weeks at a time, disruptions in supply and then shipping got all gummed up. So now you have additional stuff. And then freight got gummed up as well. And then because of COVID, certain industries shut down and then they came back up, and that come things up. And so I think most supply chain managers, most companies, us included, are certainly shifting our focus to supply chain resiliency. And so when we get out of the supply chain constraints, the electronic component constraints that we're under now, whenever that happens, I think folks are going to be a little more aware that we shouldn't just take everything down to just in time levels. And I think that's just too dangerous for the next upturn, if you will.

That's helpful. Yes. I mean we've heard that from a lot of customers -- a lot of different companies that may be moving away from just in time and maybe more of a just in case inventory model might make a lot more sense. So I mean that's helpful. And in terms of the costs that you're seeing, I'm sure that you're seeing higher costs, you're able to pass that through to your customers?

Well, yes, but not specifically because of this event. We're seeing higher costs for sure, just like everybody else. But we've talked about it in the past, we have in our DNA and our processes, the profit and cash recovery meeting. Every month, I chair with my direct staff, and we've moved that down to division levels as well. So they're chairing a different level of profit and cash meetings. And what we do in those meetings is we just look at everything that we do and where can we improve profitability and cash generation. And it ranges across the gamut of everything we do, every function within the company. No one's absolved from being able to come up with ideas for that. And so part of it is pricing for sure. But there's many other things that go into that profit and cash. So I will leave it at that is it's something we've always done make sure that we get paid for the value that we bring.

That's a good point. So maybe sticking with the semi side, can you talk a little bit about market share gains? Because I think when we look at kind of -- you talked about AMAT and land being your largest customers right now, the revenue growth that you guys are seeing from some of your large customers has been pretty remarkable. Can you talk about some of the share gains you've seen? I think you've had some success, especially on the RF power side, gaining some share. Maybe talk about the competitive differentiation there? Why is the customer choosing MKS over maybe other products out there?

Yes. I think that fundamentally, it's the same reason why customers choose MKS in any kind of product, which is technical differentiation gets you in. You have to have that. And that really is the mantra by which we decide for all products, whether we should develop this new product in this new area or not, it's really -- is there a need for it -- a technical need for it? And can we be the supplier that's differentiated from everybody else. And that's a story of our power. I think when you think about our power, it was driven by a technical need in the industry, 3D NAND, never happened before, right? And suddenly, etching became much higher aspersion as you start stacking 3D NAND. And a lot of that is driven by, among other things, are power, more RF power, more precise RF power, different frequencies, it's more complex care. So we took that inflection as an opportunity. And we invested in it. And as we talked about, that investment was made 2 to 3 years before we knew we would make money just because it takes that long, right? And then we partner with a great customer, and they've done really well. And they have their contribution to it for sure. We have our contribution with our power. And together, we win. And I've been in this industry, probably longer you, Joe, because you look a lot younger than me. But the market share gains that we have seen in our power over the last 5 years, I've never seen that kind of change in market share in that period of time ever in semi. A lot of it is driven by inflections for sure, but it's not like our power wasn't a new thing. It's been there in semi for 60 years, and we were just in #2. And last year, we're neck and neck now with the previous industry leader, as we talked about this year, we grew -- we're growing another 50% year-to-date in 2021, over 100% growth in 2020. And that 100% growth in 2020 was a 10% market share gain. Third-party VLSI data, right? So we're growing 50% again this year. And so we expect another significant market share gain. And so that change from being a very distant #2 to -- I expect to be #1 in our power over 5 to 6 years. That is rare in semi. That is a huge market share gain. And that's really the idea behind why we have a broad portfolio surround the chamber, if you will. A lot of folks say, "Oh, it's too complex. So you're sure you like everything you're doing". So we do have a portfolio, and we will go and prune things that become commoditized. But everything we have in that portfolio is differentiated. And as inflections happen. Again, they will. You think about ALD, you think about 3D DRAM, for instance, right? These are going to drive certain other product categories that could grow. Maybe not as much as our power has in the last 5 years, that was, as I said, once enough career for many of these events. But it's really the secret to why, on average, we grew 200 basis points of WFE. And a lot of folks think, well, that's not -- that's good, right? But that doesn't sound like a lot, but I have to put that in context. Remember, some of our product categories are 80% market share. So we are WFE in some of these product categories. There's no way we're going to grow 10 basis points above WFE in those product categories. You know what those are. So in order to grow 200 basis points above WFE for the whole portfolio surround the chamber means, things like our power have to grow a lot faster. So that's what you're seeing there. So we're really happy with the partnership. We're really happy with our ability to execute. And we're really, really happy about our ability to continue to execute when opportunities like RF power arise.

Yes. And I think maybe that's a great segue into kind of -- I think one of your customers had recently announced a new etching tool where they talked about a new level of RF pulsing power that wasn't previously possible. And so kind of that being said, like, can you talk about just like the value that you provide your customers that maybe when people think about advancing, let's just take 3D NAND, for example, advancing to that higher level or layer count, you guys are also participating in creating that ability to do that, not just your customer that provides the tool. Maybe talk about that value that you add?

Yes. And I think that's true of many of our products because when we talk about our market in semi, we talk about critical subsystems that we're critical is critical. We're not just doing things that anybody can do. Some of the things we do, only we can do, that's why we might have over 80% market share in some categories. Our power for sure, our OEM partner is certainly doing a lot of things that we can't do. they have other partners that do certain things. But I would say that I think it's well understood that without the RF power road map that we've enabled, there would be no etching tools that could do 3D NAND to where we are today. And that's really why it's a partnership with our customers. And I think customers who recognize that partners to enable are really something that they want to encourage and bring it to their family. I think those strategic relationships really serve those customers really well.

That's helpful. I think at the Analyst Day about a year ago, you talked to WFE driving to over $60 billion sometime between 2021 and 2025. And here we are in 2021 going to hit over $80 billion pretty easily, could be higher if we had the supply. So I guess, how do I think about the investments that MKS has made just in your supply chain to support the capacity, assuming you had the components, right? But how do you think about the investments that are needed to support that kind of -- what seems to be maybe closer than people thought $100 billion WFE?

Yes. I think at our Analyst Day, we were conservative, but we didn't think it would be $80 billion going to $100 billion this fast. One of the secrets of MKS is we've always tried to be asset-light because you have to be that flexible, especially in an industry that goes up and down like semi. And so that's still our policy, our strategy. And because we're asset-light, we certainly have the ability to ramp up and down very quickly. And when you think about how we are now literally supporting $80 billion WFE because we are, I mean that's what's happening today. But we've already planned for $100 billion. And when we looked at $100 billion WFE, do we need more factory space? We've already added a lot in the last 24 months, and so we're probably good. And we needed more final test stations for various products? And we did. And this was identified 12 months ago. We cut the POs that equipment, half of it is already in, the other half is coming in. And so this is the $100 billion WFE. And then it's all labor after that. And so I think MKS is really well positioned from that $100 billion WFE. Now remember, when it's $100 billion on average, MKS sees the peak in the beginning, that could be 30% more, 50% more, as you can see, in our revenue. So we're not just -- when we say $100 billion, we're planning for the surge capacity as well. And now we're planning on $125 billion WFE. We're doing the exercise now. What if it was $125 billion WFE, would we need more factory space because that's a 2-year kind of thing where you got to plan that ahead . So I think we're in a great position right now. I think the supply constraints, if they were to ease over time, I think we can easily support $100 billion WFE run rate with what we have today and what will come in, in terms of test stations over the next 6 months.

No. That's good insight. Unfortunately, I think we're out of time. Thanks, everyone, for joining.

Great. Thanks, Joe, and great questions. Thank you.

Thanks.