MKS Inc. (MKSI) Earnings Call Transcript & Summary

Good afternoon. Welcome to Day 3 of the 25th Annual Needham Growth Conference. My name is Jim Ricchiuti, the advanced industrial technologies analyst at Needham. Pleased to introduce Seth Bagshaw, the CFO of MKS Instruments as well as David Ryzhik, Vice President of Investor Relations for MKS. MKS, I think as most of our audience knows, has a long history of doing M&A. [indiscernible] semiconductor, capital equipment market and in recent years in laser and Photonics. And then in mid-August, completing the largest transaction to date, acquiring Atotech, a leader in processed chemicals and equipment for the PCB as well as semi IC packaging and industrial markets. Before we kick this off with Seth, David is going to go through some of the usual disclaimer information we need.

Sure. Thanks, Jim. Hello everyone. So because we're in our quiet period, our comments will solely focus on the long-term growth and opportunities for MKS and we'll not address results for the fourth quarter of 2022. In addition, 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 our IR page of our website. Give it back to you.

Terrific. Thank you, David. Seth, welcome to the Needham Conference. Happy to have you here today.

I want to -- I know a lot of folks always like to start and ask you where we are in the WFE cycle. We'll get to that. But I think we probably should start with Atotech, the Atotech acquisition. And for folks who may not be as familiar with the company Atotech, talk to us about that business. Give us maybe a brief snapshot of the business, talk a little through the financials and really how it complements the legacy PCB drilling business, some of the semiconductor business you guys are in.

Yes. Great. Thank you, Jim, and thanks for inviting me here today. So as you mentioned, we did the acquisition back in August of 2022. We've been public a little over 20 years now. We've done about 24 acquisitions. So we do have a long track record of growing organically the acquisitions as well as growing the business through M&A activity. Go back in time, years ago, we were primarily a semiconductor levered company in most of our portfolios. That's our -- one of our core competencies. We have technology to innovate advanced semi devices that are foundational to the world we live in. We serve about 85% of wafer fab equipment spending any chip in the world is manufactured, we touch it some level, we believe. And our track record in the semi market about growing about 200 basis points higher than WFE secular spending. So very strong core competency, very strong growth rate and we've done acquisitions in that industry as well. The key theme there is really miniaturization and complexity. We all know Moore's law very well. And now you get into smaller form factors in new manufacturing techniques and that kind of brought us to the Newport acquisition in 2019. And then the next frontier, we see miniaturization and complexity, as we call electronics and packaging market. And so if you look at our consolidated revenue on a pro forma basis, that's probably about 1/3 of our overall $4.4 billion using 2021 for pro forma revenue. And that covers advanced PCBs and package substrates. And those are all the trends that we've seen in the semi industry, they're continuing to [indiscernible] as well. So we're seeing more of a borderline between the semi industry, advanced packaging, critical substrates, and PC market in general. And then if you go another extension on that, what we saw was the chemistry portion of these advanced electronics become increasingly important and integrate the overall capability and design process of semiconductors and the electronics industry which really in adjacency we saw an opportunity to expand to that market. Same type of challenges, similar type of requirements. It's all focused on miniaturization and complexity with semiconductor manufacturing design, it's laser-based processing. And now the chemistry piece, which we call surround or optimize the interconnect, the next frontier we see on expanding the opportunities in that marketplace. With Atotech, we brought about a $5 billion served available market. Atotech is a very unique company. It's a leader in the chemistry market. It's also a leader in plating equipment that uses the chemistry design within the Atotech's portfolio. And it also has a group called general metal finishing, which is really levered to general industrial applications, general household goods, but more importantly, to the automotive market, which has EV content as well. So we're seeing a lot of same trends in that PCB, advanced electronics market we saw in semi. Those are only an extension of kind of that portfolio. And then to kind of wrap up, if you look at the overall like pro forma revenue for the combined company using 2021, the last 4 year available information of public realm, we're about a $4.4 billion company, gross -- non-GAAP gross margin, high 40% range and EBITDA, about $1.3 billion on a non-GAAP basis, just the EBITDA. So a very broad-based platform, very broad-based seismic company and a very strong financial base to kind of grow on. And so we're really excited about the acquisition.

And thank you for that. One of the -- in addition to expanding your served available market, I think you guys have talked about one of the attractions was the recurring revenue stream that it provides MKS huge historically has not had -- you've had a service revenue business, but not significant. How resilient, Seth, is this part of Atotech's business, if we are going into a period of economic weakness, how resilient has this been? And certainly with respect to some of the concerns people have about the economy, [ especially about the ] economy in '23.

Yes, sure. So on a consolidated basis, the chemistry revenue that Atotech brought to MKS and the service revenue we have as well as Atotech's service revenue, we think that's about -- that is about 40% of the combined business. So again, if you go back to 2021 on a pro forma basis, it was a $4.4 billion total consolidated revenue. About 40% of that is that more resilient, more unit-based revenue stream which to your point, and we said this on the Analyst Day, it has more resiliency than most of our capital equipment-levered type portfolio. So it's a more sticky. It's a more integrated business. We've been focusing very heavily in MKS and growing the service business, which has performed very well for us. And then bringing in the chemistry piece kind of gives us that overall 40% of more resilient, again, more unit-based, less capital-levered business. And that, we think, will is not immune to certainly macroeconomic activity and certainly headwinds, but it's much more, we believe, more resilient than our existing base business. So we acquired Atotech for the reason I talked about from a strategic perspective and growing to these new trends and leveraging new opportunities. And then it also gives us that resiliency in our revenue stream as well as our cash flow as well. So we think it's more resilient. And again, is a more robust financial model looking at any type of downturn we see in the semi industry.

Okay. And I'd like to dig a little more deeply into what you see as this complementary nature of the Atotech business with the PCB flex and HDI drilling business in MKS and the PCB drilling business. I think that those folks have known Atotech for a while. And Atotech, I guess, sells to most of the major PCB manufacturers. So talk a little bit about what you see as potential revenue synergies from this combination. And then what kind of a timeline would you expect to see this occur?

Yes. We see a lot of opportunity to deliver innovation and we call optimize the interconnect. And with the ESI acquisition, we have a very strong presence in flexible PCB via drilling the laser portfolio. We are a leader in the industry. We see opportunities to develop additional market share opportunities in the HDI market on the laser-based drilling. Now you can combine that capability with Atotech's plating in chemistry expertise, and they have a unique solution to the industry that no one else can provide. So we have the chemistry piece. We've got the chemistry plating piece, both leaders in the industry that Atotech brings to us. Now we can marry that with our laser-based drilling capabilities of both flexible market and the HDI market. So we think that can accelerate road maps for our customers. It's a unique value proposition, again, no one else has in the marketplace. And the reality is the lines between the semiconductors and these PCBs tend to be blurring over time. So we think there's a mellowing of those opportunities and again, having that capability, I think, is again a unique opportunity for us to grow within those markets and solve complex customer problems. It also will help shorten, we believe, product life cycle for customers. And typically, when design at PCB, have a chemistry application. We have to iterate that through demo tools, inducing drilling, create some boards, come back and test that again. And that's a pretty complicated iterative process. The fact we have that capability to do the laser-based drilling, the plating chemistry in one product development activity or program, you can definitely shorten that life cycle, and that's very beneficial to our customers. We've already gone out. The transaction closed in mid-August. The last 5 months, we've already gone out and had a number of discussions with end customers. In fact, we announced the transaction, but before we close, certain customers that already reached out to us and said, once the transaction closes, we'd love to talk to you and kind of get a sense of where we could interact with MKS to develop more quickly on our product life cycles. And so we've gone out there and actually take those customers been very encouraging and very good feedback. So it's really having that capability, Jim, under one umbrella. We have material processing, laser-based processing in the chemistry piece, all-in-one solution in one company is kind of the unique value proposition that I think will generate substantial revenue synergies in the long-term. The timeline of that could take 1, 2 or 3 years will be some time to accomplish that, but it's a very compelling revenue opportunity we see with Atotech.

Got it. The Atotech's been around for a while. And again, not everyone is familiar. Talk to us a little bit about market share for them in this PCB market and what the competitive landscape looks like?

Yes. Atotech is unique in the sense it's the only company in the industry that offers equipment in chemistry and services, again, under one portfolio. The equipment portion of Atotech's business, now Material Solutions Group, is a critical enabler to pull-through the chemistry applications because we can optimize the chemistry solutions with having that equipment capability as well. And again, no one in the industry has that type of capability. So that is very unique. We also have a very localized service opportunities. We've got about -- we're in every major geography where our customers are from a service perspective. We have about 16 tech centers that allow us to work very closely with customers. We can help develop solutions that can be done on the ground and in country. And it's something I think is unique as well. Nobody -- anybody else has that type of capability. And then we add in our laser drilling systems and we can add that type of capability, no one else has the industry as well. So if you heard at the Analyst Day climbing 2 individuals who came from our chemistry division in [indiscernible] Solutions Group, one of their comments has been one of the major dreams that have that capability all under one umbrella. Rather than just have chemistry in the plating equipment, now you can add the drilling content component as well. You get a more broad-based solution and quicker time to market. So that's where Atotech has been unique and then adding that capability we already have in-house makes it even more unique proposition.

Seth, we know that the ESI business that you acquired a few years back, certainly was a cyclical business. And I get the fact that there's a recurring revenue stream associated with Atotech, how do we think about that hardware portion of that business? How much -- how susceptible have they been to the cycles, that part of the business?

Yes, absolutely correct, Jim. The PCB laser drilling business is equipment business, kind of capital -- based on capital expansions. It has a bit more cycles than the Atotech business, those trends are very, very attractive. Atotech's electroplating business is, again, more of a unit base and more of a steady consumable-driven business. So I think there's less volatility there for sure. And the fact that we can optimize the chemistry with our own equipment, I think, create a more sticky customer relationship in the long-term as well. But fundamentally, it's more unit-based and much less, I think, a volatile business. Less [indiscernible] that we have seen in our underlying capital equipment with PCB via drilling. And again, we're very optimistic that's going to be a great opportunity for us in the future.

You mentioned, and I didn't -- it was certainly discussed in the Analyst Day, the tech centers that they have. Atotech has had near their customers. And this really ties into the question I have on Geode. And we can talk a little bit about, Geode is your high-density interconnect tool. And you've gotten traction with it, but it seems to have taken longer to really ramp than some of us had expected. First off, talk to us about how satisfied you are with the progress you're making in this area. And then to the extent to which having Atotech as part of MKS, you're going to be able to potentially leverage it a little more.

Yes, in the HDI market, so we're -- this is a laser drilling piece. So we're very -- we like that market a lot. That was the initial theme in acquiring ESIO back in 2019. And we've had some penetration into major customers. We have a number of high volume -- a number of tools operating in high-volume manufacturing environment. So we have had some traction in the HDI market, for sure. But you're right, it's a little bit slower than we anticipated. It's a primarily you because you've got a pretty large incumbent in that market already. You've got to kind of time some design cycles to pick the right opportunity to take those design wins and convert to revenue longer term. And we still are very optimistic that we can do that in the long-term. But now when you roll-in Atotech, Atotech is very strong in the chemistry portion, electroplating portion of the HDI market. So they sell to virtually every one of the major HDI manufacturers. And so having, again, that capability where they know the market, they know the players, they're very well respected, we are well respected. And now we can use that opportunity to bring in and leverage some opportunities in the HDI drilling platform. So we've already had those dialogues with customers. That's our next phase, if you will, to kind of pull through the Geode tool adoption process. At the same time, we're also investing in next-generation Geode tools as well. So continuing to make those R&D investments and really try to stay ahead of the market. Making a Geode tool has differentiation. It's a smaller tool, it's a lighter tool. The throughput is very good. It's just a matter of getting that -- the design and win some major end PCB manufacturers. And again, with Atotech brought to the portfolio and their expertise and their relationships, I think that will be beneficial for us as well. So we're playing a long game. Again, we're very optimistic. We like that market a lot. And now we have another lever to pull and the opportunity to kind of, again, bring more customer value propositions to the marketplace. So that's where Atotech could be very helpful for us, we believe.

Okay. And obviously, the competitor you're talking about with Geode is Mitsubishi, correct? And that's what you think you might have some more success as you leverage Atotech. On the electroplating equipment at Atotech, talk to us a little bit about -- I thought it was interesting, and there were some data points and metrics you guys provided in the Analyst Day in terms of how much of that equipment that's out in the market and is using still continues to use Atotech chemicals as well? There's a stickiness to this, and it's a stickiness aspect that I guess is what I'm pursuing, so.

Yes. No, it's a great question, Jim. Yes. So you you're absolutely spot on. So at the Analyst Day, we talked about how a lot of our chemistry we developed in the marketplace is optimized to run on our plating capabilities. And some of these plating production lines ours will hung as a football field, they're quite complicated. Once they're in, they're in and that's the manufacturing environment. But fundamentally, about I think about 85% of the equipment that we put in the field is using our chemistry. So that is a very -- again, a unique proposition. It's very unique in the marketplace. No one on the chemistry side that we compete with has that type of capability. So that's where we see again that pull-through with the equipment piece into, again, create that more unit base at more of a stickier chemistry revenue in the long-term. And these plating lines have a relatively long life. Once they're in, they're in, they're very large and complicated. We get a recurring service revenue and spare parts of that business as well. But really, fundamentally, they're optimized to run our chemistry and that with 2 plus 2 equals 5. It's the customer values that quite substantially. And that's why that stickiness and that pull-through is as high as it really is.

And I know you can't wait to tell us about where we are in the WFE cycle. But I promise I'll give you that opportunity, but I want to also talk a little bit about the specialty industrial portion of this business level set this in terms of overall revenues because it is a somewhat newer area for you, for the folks who have known MKS. Talk to us about what some of the bigger end-market contributors are in the faster-growing segments of the market.

Yes. So we broke up our market to 3 categories. We have the semi, electronics and packaging, specialty industrial. Specialty industrial is roughly about 30% of our combined revenue, depending on what period of time you're looking at. And the biggest piece within that the industrial market is Atotech's general metal finishing business, which is about a $500 million roughly run rate business. What's also in specialty industrial is the MKS legacy general industrial market, life health science, research and defense.

The Newport business, the Newport...

Yes, primarily Newport, correct. A little bit of legacy MKS. And what's interesting about that -- those markets are is I'll take the GMF off the site for 1 second, but the life health science, the R&D, general industrial, typically, those products in those markets are leveraging the technology we developed for the semiconductor market as well as electronics and packaging. So the beauty is you develop a technology like a Baratron, measuring pressure in a vacuum environment, which is essential to the semi industry. There's many other industrial applications that can also utilize that technology. Same thing for lasers, for research and so forth and defense. So the R&D dollars are spent kind of the other couple of markets. But the technology can be reported to these other applications. But then you look at the general metal finishing piece of the Atotech business, about $500 million of revenue run rate, about half of that is in the auto industry. And what's interesting is the Atotech's electronics business was actually initially came out of the GMF business years and years ago. So a lot of cross-pollination in terms of R&D dollars in the chemistry side between GMF as well as with the electronics business of Atotech. And in general, that collection of markets and products we believe is more of a GDP-plus grower-type business and attractive margin, attractive EBITDA margins. It's got some good opportunities as well in terms of growing in different categories. And then when you step back on the automotive piece, which again is about $250 million of that overall industrial market. The migration from internal combustion engines, the EV vehicles, creates about a 50% additional content for GMF technologies. So auto is actually a great place for us to be because of the EV content going forward. So these are nice markets, a nice collection of businesses. Again, most -- in many cases, some of the R&D dollars are spent in the other markets import of those products. And then the GMF piece of the Material Solutions division, the Atotech acquisition is really probably the biggest single piece of that overall specialty industrial market.