MKS Inc. (MKSI) Earnings Call Transcript & Summary

Perfect. We'll go ahead and get started. So my name is Joe Quatrochi, I'm the semiconductor equipment analyst here at Wells Fargo. Excited to have David Ryzhik, the VP of IR for MKS Instruments. David, thanks for joining us.

Thank you, Joe. First off, unfortunately, Seth was unable to make it. So you have just me. But let me just start off with the forward-looking statements, and then you can kick it off, Joe. So obviously, any forward-looking statements that we may make today are subject to our risk factors in our SEC filings. You can find the GAAP reconciliation to any non-GAAP numbers that we may talk about on the IR page of our website.

Perfect. Maybe to start, there's obviously, there's a lot going on with the MKS story right now. I think when you take a step back and you think about the opportunity that's in front of the company, what do you think that maybe investors don't understand or are underappreciating today? And then as you look at the next 3 to 5 years, I know you're going to have an Analyst Day in a couple of weeks, but what do you think that, that biggest opportunity is that maybe people just don't understand today?

Yes, absolutely. So when most people think of MKS, they think about semi and being a critical subsystem provider for semi. And that is true. For decades, we have been a critical enabler of semiconductor manufacturing, and we continue to be. In fact, over the years, we've cultivated a market-leading portfolio. And so that is going to continue. But what we've realized is that as you know, when you think about an electronic device, right, semiconductor has been the critical building block for that. As chips get smaller, more powerful, that makes the device better, more powerful, the form factor gets better. But what we realized is that there are other critical building blocks of those electronic devices. And in particular, we believe that the circuit boards, the printed circuit boards are becoming more important, becoming more miniaturized, becoming denser and more difficult to manufacture. And also, there are what are called package substrates, which are pretty critical to what we all may know as Advanced Packaging. And so the part of our story, which I think we look forward to flushing out in a couple of weeks at our Analyst Day, is that we are now foundational not just to the manufacturing of the chip, but to the manufacturing of these circuit boards and package substrates because with Atotech, we now combine our legacy laser drilling expertise where we drill very microscopic vias into these boards and substrates, thousands per second. And we now have the critical chemistry that basically fills those vias. That's very simplistic. There's more to it than that. And so when you wrap it all together, we're now foundational to these critical building blocks. So I think that's what we're really excited about, and that's where we're going to talk a little bit more about in a couple of weeks.

Perfect. And maybe to stick with the acquisition of Atotech. You know, might -- MKS kind of now anticipates that deal being accretive in the 2024 time frame. And I'm sure we'll get more in a couple of weeks. But just talk to us about maybe like what has changed relative to when you made the announcement of the acquisition, I think that the accretion was expected in the first 12 months. Is it just interest rates? Or have you seen like a change in demand? Just maybe talk through some of that.

Yes, I'd say the biggest change has been on the interest rates. So when we announced the deal in July of 2021, we were assuming at the time about a high 2% interest rate on our $5.2 billion of debt. And now that number is 6.3%. So if you do the math, that is a significant amount of EPS that's impacted by higher interest rates. Certainly, we couldn't have forecasted this historic increase in interest rates. But where we stand today, we're actually pretty comfortable with the cash generation of the combined business. So that we can actually delever and bring that interest expense down over time. And the beauty of delevering is that not only is it accretive to EPS, but it's accretive to free cash flow because there's a chunk of free cash flow that's going to interest expense today. And so we're going to work on moving that down through delevering over time. And I also say that we are hedged. So half of our interest rate, half of our debt is hedged today. So upside risk certainly is minimized as well.

In the amount of leverage, right, I'll talk about your comfortability with that, it sounds like you're very comfortable with that and the free cash flow. The covenants of the debt, is that something that you maybe just double-click on for investors?

Yes. So first off, we are very comfortable with our cash generation. The combined cash generation is pretty powerful. If you just look at 2021 pro forma, we did about $1.3 billion of EBITDA ex synergies. And then if you just do EBITDA minus CapEx, it was about $1.2 billion ex synergies. So you can do your assumptions for interest and tax and working capital. But in general, the fundamental cash generation of the combined company is very strong. And so that gives us confidence with the amount of leverage that we have and that gives us confidence to work that down. And so on covenants. So we have a couple of different types of debt. We have a Term Loan B, 2 tranches, so that's, I think, north of $4 billion. Then we have about $1 billion and change of Term Loan A, and that has a covenant. It's about a 5.5x net leverage ratio until December of 2023. And then every year, that steps down about 0.25x until 2026. So what I would say is that we are pretty comfortable with the cash generation and certainly, we're going to focus on delevering. That is our priority for capital deployment.

And I think your net leverage, right, last quarter was about 3.3x.

That's right. That's right. It was -- net leverage ratio was 3.3x on a trailing basis. And of course, that's also ex synergies as well.

Perfect. Maybe shifting back to kind of the Atotech business. Help us kind of understand -- you talked a little bit about it at the beginning but marrying the 2 of having a more complete kind of via formation on the PCB side. How does that benefit your customers? And what are the discussions you're having with your customers? How excited are they for now all this to be under 1 house?

Yes, absolutely. So like I said before, prior to Atotech, we had the critical laser via drilling expertise. And with the acquisition of Atotech, we have the chemistry expertise. And so together, we've called it Optimize the Interconnect. Because not only can we co-optimize and maybe accelerate customer road maps as far as new designs, but we can simply do things faster. And that is pretty valuable because our customers have technology road maps. And if we can do things faster and better for them, that's really where we can see some really nice synergies -- revenue synergies. And we may have said this before, but it's -- this space of advanced PCB and substrates reminds us of semi couple of decades ago. And it's got the same trends of features are getting smaller, density is rising, and it's getting harder to manufacture. So as the challenges continue to increase for customers, they're going to look to their technology partners. And we're really unique in our capabilities. There's really no one else who has this combined capability. And by the way, Atotech on its own was quite differentiated in its capabilities because not only did Atotech have -- does Atotech have the critical chemistry, but it also has the plating equipment. And so together, we have the chemistry, the plating equipment and the laser drilling equipment. It's pretty unmatched in the industry.

That's helpful. Maybe one of the other areas that I think I am very interested in at the Analyst Days, Atotech had some expertise in IC packaging. And so pretty early in that market opportunity. Maybe talk about where you think that could go, and maybe just give us a little overview of exactly like where Atotech sits in that kind of architecture.

Yes. It's a pretty exciting space. And when we talk about the advanced PCB opportunity, there's a slice of that, which is what we call package substrate, also known as IC substrates or IC packaging. And if you think about the -- right now, what's going on, when you hear about Advanced Packaging, what is really Advanced Packaging? Advanced Packaging is, the industry is trying to figure out ways to put lots of chips, different chips together as closely as possible in a package and drive more performance, better power, area and cost. And so that relies to a large extent, on package substrates. So when you're taking, let's say, a memory chip and a logic chip and putting -- and trying to package it close together, that is mounted on a substrate and that substrate needs to be drilled with laser drilling and it needs to be plated with chemistry.

And just to kind of level set, right, that's an incremental architectural change, right? When we hear Intel or AMD talking about chiplet architectures relative to maybe the single monolithic chip today that, that substrate is new, right? And so that opportunity for you guys is new. Is that the right way to think about it?

I would say the substrate has existed in other applications. You can see the substrate in smartphone applications as well. But to your point, this is the -- the fastest growth area within the substrate is in these heterogeneous integration applications, like the ones that you mentioned, chiplets, advanced packaging, GPUs also. So those are the drivers of package substrate. And that's why it's really the higher growth element of this business. And in fact, Atotech and we now are the leader in chemistries for package substrates.

Got it. Okay. Maybe the other piece of Atotech that -- I think maybe it gets not as much love from investors in terms of the focus, right, is their general metal finishing business. Talk to us about just what does that market entail, what are the kind of key growth drivers there? And then how are the kind of -- can you leverage synergies across the kind of the 2 companies or the 2 business segments within Atotech.

Yes, I agree. I agree. That may be an area that folks may not fully understand, and we look forward to digging a little deeper into the general metal finishing business in a couple of weeks. But essentially, what we've talked about so far today is on the electronics side, some of the key secular trends in our combined opportunity. But Atotech, does provide critical chemistries for a number of industrial applications, surface finishing, corrosion protection, functional coatings. And the auto market is actually a big piece of that, about half of that GMF business. Now it may not sound as exciting, coatings for certain lightweight parts and grills and door handles, but it is really hard. And there are not a lot of players that can do this and the gross margins are very good. And so this is a business that requires a lot of proprietary technology. It's got a good mix of good consumables, chemistry business, and it's got high barriers to entry. And there's actually some interesting secular trends going on. So the move from internal combustion engine, autos to electric vehicles does carry bit of a higher content of this general metal finishing content, which is a nice secular trend. So over time, as you see that transition, that is a nice tailwind for that business.

Perfect. Maybe we'll shift gears a little bit and talk about the semiconductor business. Obviously -- right, the forecast for next year is to think about WFE declining, call it, 20-plus percent year-over-year. Can you just kind of remind us maybe the levels of the discussion, how do we think about MKS business relative to WFE in performing over cycles. And then we can talk about some share and some opportunities to maybe offset some of the decline.

Sure, sure. So at a high level, pro forma combined company, our semiconductor revenue is about 45% of total revenue. And then when you pull out the services business of that 45%, which is much more resilient, much more stable. As your previous speaker had talked about in service, there's a lot of spares and replacements and repairs. It's really nice service and driven by consumption and production. So if you pull out service, the actual equipment to WFE, what we provide is maybe 40% -- just under 40% of overall revenue. So that's really what we're talking about here related to WFE. And what we've done is we've taken share. So I think if you look over the past decade, we've outgrown WFE organically by at least 200 basis points. And that is really how we look at this market over the long term through the cycles is outperforming. How do we do that? Well, there are a couple of things. So first, there's classic technology market share gains. So we have examples where we invested like in RF power. We secured the design wins and the rest is history. And so we continue to drive growth, for example, in 3D NAND. We enable every leading-edge 3D NAND node in the world today with our RF power. And as you get to higher layer counts, that's more chambers and that's more power content per chamber. So those are the things that we really like. But also in addition to technology, R&D scale is very important. Operational scale is very important because what the semiconductor industry and our customers want is they want someone who can scale with them, who can grow with them. And that's exactly what we've done. So I think in semi, it's a market that we are very excited about. And again, we're going to talk a little more about that in a couple of weeks.

Perfect. And you mentioned RF power, I think that's a market where you were relatively distant #2, and now you're actually #1 in that market. Can you talk about what drove that, #1? And then #2, how sustainable is that share? Because obviously, your competitor is not sitting still. And then the customer wins that you get, can you just talk about the length of those is not that like every year or 2 years, there's a new etch tool that you have to go and redesign. Just how do we think about the stickiness of that?

Yes, yes. One of the things we really like about semi, and this pretty much applies across a lot of our business is that the design cycles are long, the revenue cycles are long. And it's pretty sticky. And so RF power, we -- that's a function of investments that we made, I would say, about 7, 8 years ago, where we saw an inflection the planar to 3D NAND inflection. And we realize that RF power is a critical bottleneck. And so we invested significantly into driving higher power, more precise power to enable high aspect ratio etch. And so we secured design wins and the success that we've seen in 2021 is really a function of design wins, many years before that. And so I think just to add, what we're talking about here is really dielectric etch for that high aspect ratio application, which has been a critical enabler of 3D NAND architectures. We still see opportunity in dielectric etch. As I said, as layer counts grow more vertical, you need more chambers and more power per chamber. But the conductor etch opportunity is pretty sizable. And for us, it's really largely untapped. And so we think there's a really nice greenfield opportunity for us to take our learnings, our track record, our history of enabling dielectric and port that over to conductor.

And other -- on the conductor etch side, are there architectural changes like what we saw in the dielectric side for 3D NAND that maybe help facilitate that kind of opportunity for you? How do we think about that?

We haven't seen as many or as sharp technological changes there as we've seen in dielectric. And that's probably why our share gain there has been a little slower. But that doesn't mean that -- we're not going to sit back and wait for any kind of massive inflection to take share. We're actively working with customers in seeding new opportunities. And so we -- so far, we're pretty encouraged about that opportunity.

Okay. That's helpful. Maybe on the Advanced Electronics and Specialty Industrial, I think you recently kind of broke out those as new end markets. Help us maybe understand how do we think about the growth drivers for the Advanced Electronics business? And how do you think about their exposure to consumer versus nonconsumer, or I guess, end markets? Maybe just help us understand that.

Yes. So the way I think about Advanced Electronics is just think about next-generation electronic devices. So that could be smartphones, that could be PCs, that could be servers and data center architectures, that could be automobiles. They're becoming electronic devices, if you will, or data centers on wheels. And so we touch all of these applications. And I'd say that if you want to think long term, it's not just the CapEx, it's really volume-driven now just given the chemistry exposure that we have and content per device. So that's the way we're thinking about Advanced Electronics over the long term. And I think there's a market growth across all these devices. But there's also -- for MKS, there's a revenue synergy opportunity because there's a pretty -- it's a pretty sizable SAM that we're addressing on the laser drilling and chemistry side. And we think, as we discussed earlier, given our differentiated approach, we think that over time, we can generate some nice revenue synergies. That's Advanced Electronics. For Specialty Industrial, that is a collection of a lot of different markets that require proprietary technology across industrial, life science, research, defense. So think of all the innovation that we're pouring into semi and advanced electronics. We can port a lot of that investment and leverage that into other applications. So 1 great example that I'd like to use is our vacuum solutions for semi, obviously, we invest in vacuum for next-generation capital equipment. But oh, by the way, we've found that synthetic diamond manufacturing uses a lot of the products that we sell into semi. So that is a great way -- we're not investing incremental R&D. It's a great way to port that into synthetic diamonds. Same things with lasers for, let's say, life science, optics, for other applications. And so these are a collection of really good margin, good cash flow businesses in Specialty Industrial. And then you layer on Atotech's general metal finishing business which we already talked about, and that slides right into the Specialty Industrial. So I think longer term, think about it as more of a stable GDP, GDP plus type of business, but with good margins, good cash flow.

That's really helpful. One of the other kind of areas that is within your Advanced Markets business, the HDI opportunity, obviously has many-- more that the investors have been interested in. Maybe talk about that the value proposition that MKS can offer their customers with their tool because it's a market that you're still kind of new, relatively new, relative to your competitors in? Maybe talk about that value proposition which you will.

Yes. So HDI, we've talked about for a couple of years and we have a tool in the marketplace, a Geode that does laser drilling for these high-density interconnect PCB boards. And we're talking thousands of holes per second. So this is extreme precision right here. And we've secured a couple of design wins, we have dozens of units in high-volume manufacturing. So we're pretty encouraged about that. It's a tool that works obviously, otherwise, customers wouldn't put it in high-volume manufacturing. We're probably making a little slower progress than we had -- we had thought maybe a couple of years ago. But we're pretty patient. And we actually see a pretty sizable opportunity. Just stand-alone on HDI on the laser drilling side. But then when you roll in Atotech, who is the leader in chemistries for HDI, now we can come to customers and say, we can do things better and faster for you. So we think that could be one of the revenue synergies where we can accelerate some of our market share gains in HDI, given our combined capabilities.

Yes. That's helpful. I think you mentioned earlier, right, that you've guys have kind of viewed the PCB market as maybe 10 years behind where the semi market is. I guess how do you -- you talked a lot about like maybe some of the similarities, but how are they maybe different? What do you think is, I guess, a different driver of how to think about that PCB opportunity that is not the same with semi that might be a bigger opportunity for you? Or how do you think about that?

Well, certainly, we see some similarities in the sense of there's greater miniaturization and complexity, just like we've seen in semi with Moore's Law and transistor scaling. We're not really seeing Moore's Law in PCBs but we are seeing smaller features. These HDI boards that I just talked about, right now, I think the leading-etch diameters are about 30-micron diameters. It used to be 100 micron. It used to be higher. It used to be drilled with mechanical drills. Now it cannot be done with that anymore. Now it has to be a laser. And then it's getting -- the features are getting even smaller, so you need more innovation. It reminds us of semi. That's what I meant. And the boards are getting denser. They are more layers. And so the level of complexity that is coming to this market reminds us of semi. It's not exactly like semi, but it reminds us of semi, it rhymes. And so we want to be here. We would rather be a little early, but we'd rather be in front of this. And what's a little different is that in semi, we started out with a couple of products many decades ago, and we've cultivated a portfolio of critical subsystems and became a market leader and took share, and that's going to continue. In this opportunity, we're pretty uniquely positioned with the laser drilling equipment, the plating equipment and the chemistry. So it's a pretty -- it's a little bit of a different positioning that we have for this trend. But we think there are -- this trend has certainly has legs for many years to come.

So is it fair to think that when you think about your competitive positioning say, 10 years ago in semi, you feel really good about the competitive positioning on the PCB side now with Atotech is offering a pretty unique solution to your customers?

That's right. And I would also add that not only do we have the laser drilling systems, but we have the in-house component and subsystems for lasers. So don't forget, we acquired in 2016, a company called Newport, which provides lasers, optics, motion. And so having that in-house expertise can be leveraged in the future when you're thinking about laser drilling systems.

Perfect. Well, I think we're out of time. That's a great place to leave it, and we look forward to learning more at the Analyst Day in a couple of weeks.

Thank you, Joe. Thank you, everyone.

Thanks.