MKS Inc. (MKSI) Earnings Call Transcript & Summary

2024 Global TMT Conference. I'm Elizabeth Sun with Citi Research. And for this session, we're pleased to have John Lee, CEO of MKS Instruments; and Paretosh, new IR, welcome. So this session is for Citi clients only. So John, thanks for joining us today. I guess we'll turn over to you to have a brief introduction of MKS and provide any like opening remarks, and then we'll get into Q&A.

Great. Thank you, Liz. Thanks for inviting us here. Some of you may know the MKS story well and some may not. So maybe just a background to set everybody to the same level. MKS historically was really in semiconductor equipment only. And in fact, it was a subset of that. It was vacuum-based semiconductor equipment. And in the last 10 years, it has been a big transformation at the company. And it started off with the acquisition, Newport Corporation, followed by the acquisition of Electro Scientific Industries, a laser systems company, and a laser critical subsystems company, Newport. And then it followed with the last big transformation, which was the acquisition of Atotech, which was a chemistry plating and chemistry equipment company. And these are transformative acquisitions and all tied towards the vision that we have, which is enabling and being foundational to advanced electronics. And our thesis is that advanced electronics, while it has been historically driven by advancements in semiconductor chips, that is still necessary but longer sufficient. We need advanced packaging to put these advanced chips together so they can talk to each other much faster. And I think that's a story that was something we told about 2, 3 years ago when we justified the acquisition of Atotech. I don't think a lot of investors really got that then. It's like that sounds like it might be true, it might not be true. But more recently, I think everybody understands that packaging is just as critical as the chips. And the example, of course, is AI, NVIDIA, right? When that happens, and you see NVIDIA's CEO always folding up boards, right, with lots of chips on it. His chips and some are not his chips. But his solution requires that all these chips work together, talk to each other very quickly, very fast. And that board is what enables that. And that board, while we have maybe thought about it as a PCB, it's all technology. I don't know how hard it is. It's really different now. That's the change that we saw 3 or 4 years ago when we said advanced packaging is taking on the same historical attributes as semi, miniaturization, complexity, harder to do, more layers, larger boards and smaller features. And as a result of that, it's going to be harder and harder to drive the next generation of advanced packages. And when things get hard, that's what we love as MKS because we're wired to do these things, because of our 60-year history in semi. And so we now have the major components that we need to enable advanced electronics. So that's the transmission we've seen and driven over the last 10 years. I think we were a little early in on that transition, the acquisition of Atotech. But I'd rather be early then we actually did something about it because we saw this opportunity in advanced packaging.

Great. Thanks for the introduction. So let's get into the questions. So I want to start with some questions on the overall market. In the June quarter earnings call, like a month ago, you slightly adjusted down your earlier outlook from now is second half to be flat with first half. So without going into too many details, what changed your outlook compared with a quarter ago? And is there any changes coming to the market.

Yes. I think it's a good question. I think as we talked about in our earnings call, we had a slightly better Q2 than we had thought we were going to have. A little bit of that, but that wasn't the real reason why we're guiding second half to be similar to first half. It's really the recovery we thought would be occurring in the Q3, Q4 time frame, though muted, that has pushed out. And I think that's not news to most of you and most of you following WFE. And that's consistent -- that's what we're seeing. Our visibility also is slightly lower now because our lead times are back to kind of that 6- to 8-week lead time. Our customers know that, obviously. And so they order knowing that they're going to get products from MKS in that 6-day week lead time. So that's within the quarter, obviously. And that was a reason why we have less visibility, but also a reason why we have a bit of an upside surprise in Q2, there was more book in term within the quarter we could execute on. We guide our best for Q3 from what we see, and we make an assumption on book and term within the quarter, and that's within our guidance. But what we see now is the upturn that we were hoping for in that Q3, Q4 time frame is a little more muted, a little more pushed out. We probably were hoping for a little more NAND to come in sooner. That's not happening in 2024. DRAM is happening, but maybe not as fast as we would have liked. But logic continues to motor along. So that's really a slight adjustment from first half, second half.

Got it. And could you remind us your end market exposure to memory and logic foundry? And I think you previously mentioned, I think it was last year here at Citi's conference, you said were at about 50% exposed to memory with memory down for the last 2 years [ was right now ].

Yes. So the comment we carried last year was in 2022, our memory-to-logic exposure was more memory, 55-45. 55%. And a lot of that was driven by NAND. Now obviously in '23 and even in '24, NAND is in a correction for sure, and DRAM wasn't a correction that's kind of coming out of it with -- driven by HBM. We also think NAND will eventually come out of it because when you're doing AI boards, you need solid state drives to enable those AI servers as well. So in '23, it was probably more like 2/3, 1/3, more logic than memory, just because both DRAM and NAND were down. And '24 is kind of similar to that. And even though that 1/3 of memory is still 1/3, still mostly DRAM. So we still are happy with our position in NAND. When it comes back, we'll enjoy that market leadership that we have there.

Okay. Yes. So I think your novel effort kind of over-indexed in NAND in the past. So it's more NAND -- sorry, more DRAM right now? what's the normal level of your exposure like.

Yes. I think it probably depends on your view of where NAND will be long term in terms of its percentage of WFE. We have a view that it's probably more around 50-50 memory logic long term. If NAND takes off again, of course, so we'll be a little more over-indexed. I'm okay being over indexed. It's okay, especially given the market leadership position we have in RF power in enabling NAND. But more importantly, beyond all that, we've had this long history of outgrowing WFE. And that's really about getting design wins in areas where we're under-indexed, such as lithography, metrology inspection and then taking advantage of inflections with our growth portfolio.

And do you see any greenshoots in NAND recovery or what signs are you looking at?

Yes, not yet, frankly, in NAND. Obviously, we talked about inventory burndown has finished for everything, but some of our key products in NAND. And so certainly, some of its being burned down slowly. But it would take a kind of a change in the NAND CapEx to burn down inventory and then, of course, new orders for the NAND equipment. So right now, NAND is still [ field ] muted. And a lot of folks are thinking 2025, and that's moved around early '25 to late '25 to middle of '25. So right now, we're certainly keeping a pulse on it. Obviously, we have very close relationships with all our customers there, not just direct customers, equipment OEMs, but also the chip fabs. And they know who we are. They know that if they're going to have a plan to build out a NAND fab, they've got to get their whole supply chain lined up for it, and we'll get those notices.

Okay. That's fair. So you guys have a wide range of products, and you have this strategy, you've got Surround the Wafer, if I'm correct. And you've talked about you are like exposed to 85% of WFE equipment. So could you talk more about what are the main areas of strength for MKS and what will be the main growth driver?

Yes. I think just to remind everybody, we've talked about being exposed to 85% of all WFE. So every fab in the world that's built, the 1,000 tools in every fab, 85% of those tools, we can walk around that fab, and you will see multiple MKS pieces of equipment on 85% of the tools. No one else can say that, right? And frankly, it's simple math. Just take Tokyo Electron, Lam, Applied, ASML, KLA, the big 5, all our customers and that's 85% WFE. And then we have some more wet clean as well. So we don't even count that. And so this exposure allows us to see inflections much faster. We're in talking to all the customers about their new challenges. And so where are the opportunities for growth? Fundamentally, sometimes these inflections happen and no one really expected it like VNAND. And then if you have a broad portfolio, you can do something about it. If you don't have RF power that's going to be the critical subcomponent for enabling VNAND hole etch, even if you understand you need it, you can't do much about it, right? But I have RF power, so I can just decide if I want to do that and that's occurred over and over again. And then the other area for growth, I believe, is our world-class optics initiatives. So world-class optics means we have been under-indexed in terms of market share in lithography, metrology and inspection. And that's fundamentally because the company we bought, Newport, had those customers they brought ASML and KLA and those kinds of customers to the MKS portfolio. But Newport treated those customers as more of one of good -- very good customers. We don't want to be over-indexed to semi. They kind of understood semi goes up and down. We don't want that. Having bought Newport, we were different. Our approach is -- if I get designed into those 2 customers, are they going to lose their share, unlikely, right? So let me get designed in. And to do that, though, we had to invest. We had to invest more in equipment, we had to invest in process engineers because that equipment everybody can buy equipment to process optics. But the recipes that are developed on those pieces of equipment require process engineers. That's the IP. So kind of like a chip company, right? You can buy the equipment but the process engineering is really kind of what the chip company adds similar into that world-class optics initiative. And because we've done that, you can see the numbers. You can see our revenue in lithography, metrology, inspection over the last 2 or 3 years, has outgrown WFE for lithography, metrology and inspection, not just WFE, but just those. And I think you also know that lithography, metrology, inspection has much more stable CapEx revenue because the lead times on EUV are quite long. Inspection tool is quite long. And so they don't go through some of the cycles that some of the vacuum equipment companies go through. So that's another area where we will continue to invest.

Okay. A couple of more questions on the semi and then we'll move on to other markets that we would like to talk about. So in the semi market, you are expecting 200 bps WFE performance in your target model? And so what gives you the confidence about this outgrowing? And what's your competitive advantage?

Yes. Well. One bit of data is that we've done it for the last 10 years. But as investors like to say, past performance doesn't predict the future. So how do I feel -- why do I feel that we're going to go continue to do that? I think, though, when you gain share, it's really because there are changes and inflections that become harder to do. When things become harder to do, fewer companies can actually do that for a couple of reasons. One is you've got to invest more longer. So size does matter, actually. Number two, you have to be wired to do that. Number three, you have to have a broad portfolio, I believe, so you can see those inflections and act on those inflections much faster than the other person. And of course, even if you're able to react quickly, you have to have a base of a foundational product in whatever it is that's going to cause that inflection. So I believe that we have all those pieces at MKS, and that's unique. There's no one else with the portfolio we have just in semiconductor vacuum critical subsystems, let alone lithography, metrology, inspection-critical subsystems. So that allows us the opportunity actually to grow a lot faster than the rest of the industry.

And just want to double click into one of the competitions. So regarding Advanced Energy, I think historically, you are stronger in the electric etching, but they have talking about like this new tools to hoping to gain some shares in that area. So could you talk about your competition environment there?

Yes. So we don't like to talk about specific competitors, but we respect all our competitors because all of our competitors like us have survived 30 to 60 years of a very cyclical industry. We're all strong. We're financially strong. We have innovation engines, no doubt about it. I would say that in power, -- the reason we gained #1 market share in 2022 time frame was because of VNAND. And the RF power that we provide there is foundational, critical to enabling VNAND hole etch. And we're on generation 9. So there's been 9 generations of VNAND. With that has been 9 changes in the equipment to do channel hole etching specifically on RF power, meaning there's always 3 power sources on a chamber, every one of them has changed in terms of power level 9x in 9 years. We never had that happen before. That's the kind of innovation engine that we have that demonstrated. It's kind of scar tissue we have too because we learned with our partner. There's a lot of things you have to solve, right? So once we get the RF power, put in the chamber, lightning happens, sparks happen. You've got to fix all that. That's the kind of capability that we have that I believe is unmatched by any other RF power company.

Okay. And now just move on to the [ NPA ] segment. So in Advanced Packaging, I think you have like 25% of exposure in Advanced Packaging, so which I think is right now the breast wall of E&P segment. So what's your growth expectation there? And would you compete with in that area?

Yes. So in Advanced Packaging, the PCB industry, if you will, there's 3 segments, if you will, of PCBs. There's the -- we call it old stuff, multilayer boards. That's the stuff that it's easier to do. It's in your refrigerators, some cars, et cetera, but it's also changing. It's also having more layers. So there's a growth there too. But we kind of call that as GDP plus growth. That's 1/3 of the market. The middle third is what we call HDI, high-density interconnect PCBs. They're all PCBs, by the way. And HDI PCBs are, think of smartphones, they're driving the smartphones. And they're growing kind of in the mid-single digit range CAGR. And then that final 1/3, the most advanced is what we call package substrate PCBs. These are the most advanced, most number of layers, bigger boards, smaller lines, smaller holes. This is what's driving and has driven server boards and advanced PC boards and of course, even more AI server boards. So the difference between a regular server board and an AI server board is more layers, maybe 30% more layers. Because an AI board, server board is putting more stuff on it. And so you can imagine the Board is the highway that allows chips to talk to each other. And when you make bigger chips, we have more I/O talking to other bigger chips with more I/O and HBM that's going from 8 to 12 to 16, they all got to talk to each other through these highways. So what do you do? Well, I'm going to make more highways. I'll shrink every -- I'll shrink the lines, I'll shrink the holes. And that is what we're doing as an industry, but that's not enough. So how do I do this? So I make more layers. Okay, I'm just going to make more layers so I have more highways within this big stack. And that's happening. But that's not enough. I'm making the board bigger as well. So three things are driving the chemistry and the chemistry equipment, that's the high single digit to maybe double-digit CAGR part that you're talking about, the IC substrate. That's, of course, the most exciting thing. It's the hardest thing to do. We love that. It's the hardest thing to do, and it, therefore, requires suppliers like us who have an advantage by bringing more solutions to our customers. We can bring a chemistry solution. We can bring the laser solution. We can bring the chemistry equipment solution. No one else can do that. And if we co-optimize this with the customer, they get to their solution faster. And so that's the most exciting part of the PCB industry, the electronics and packaging industry that we see.

Got it. And you just talked about like 30% increase in layers for like AI [ overboard ] compared with non-AI, so what's the content increase for MKS setting.

So think of -- so when we bought Atotech, just like Entegris, Bertrand said earlier, Atotech is a square inches kind of business. So we placed each board one layer at a time. And if the Board is bigger or square inch is more chemistry, if the number of layers is more, more layers, more chemistry. And so it's really square inches of the layers for this. So when the number of layers just goes up 30%, that's exactly the amount of chemistry needed, 30%. If the size of the board goes up 10%, 20% or 30%. If everything else is equal, that's more chemistry. That's exactly how it works. Then if the features are smaller, it's not necessarily volume of chemistry, it's the type of chemistry, the precision of the delivery of that chemistry to make smaller holes and smaller lines, the delivery of the laser beam to make smaller holes. And so that's really a little different. That's about technology and winning share there.

Got it. And you just mentioned Atotech and I guess your June quarter, you talked about like one of the first wins of the Atotech synergies. So can you remind us what was the area? And what kind of future opportunities you are looking at?

Yes. So in the June quarter, we talked about a synergy win. And just to remind everybody how we count it. If Atotech was already in that customer and the laser group, ESI was already in the customer. And they both win, one wins and one doesn't. We don't count that. That's -- they were both there. As soon as you win is when one is there, the other is not, and the other is brought in and wins. And that's what we're talking about here. And earlier in the -- right after the close of the acquisition, we talked about a couple of laser wins that were synergy wins. So Atotech brought us in, the laser guys never had a relationship and they won. I call those blue birds because they're so fast. I just happened to work out right. The laser tool was just perfect. They were buying, et cetera. What we talked about in the June quarter was something we've been working on for 2 years. This is probably more common. You're working on the next-generation road map item for the next-generation PCBs. So Atotech was brought in. They didn't have a relationship by the laser group. First time, you just have a PowerPoint presentation. And then you have, hey, let me try some samples. And then, okay, that's interesting. Let me run a lot of samples and over and over again. And then you go from development tool or [ carrier ] development process of record to production tool record, production process of record. And that's what we were talking about in these 2 Atotech wins. They were in some of the more advanced areas of PCB manufacturing.

Okay. All right. Before I move on, is there any questions in the audience. Okay. Let's just move on. Yes. So I just want to quickly touch on the specialty materials segment. So it's a relatively, I guess, stable business and you think about it, it's GDP-plus growth. And so just could you talk about the puts and takes within this segment?

Yes. So Specialty Industrial is about 1/3 of our revenue and very stable, great gross margins, great flow-through profitability. A couple of points there. One is that it leverages the R&D that we're spending in the semiconductor area and that electronics and packaging are 2 core growth markets. That's really important because if you think about it, our R&D spend, if you measure our R&D spend is not as high as you would think compared to my peers, right? Because we have 1/3 of our business that's leveraging it. So the denominator is a lot bigger when you divide. Okay. So we're not starved for R&D. In the specialty industrial market, it's made up of several different kinds of markets. It's got industrial, industrial, it's got life and health sciences. It's got research and defense. The one area, and it can be lumpy, things go up and down, but in general, kind of all averages out. The one area where we do have a little more exposure with the acquisition of Atotech is automotive. And so we're not making chips for automotive. We're making all everything else, in the [ realm ] of brake calipers, pistons, shock absorbers as well as all the decorative stuff that goes around a car. So this is about putting metal on either metal or metal on plastic. You can do that really well with some really tough customers. The automotive industry is a pretty tough industry, right? You don't get designed in, unless you really can deliver at cost and reliability. And so that's 1/3 of the Atotech business. It's been pretty stable, which we get that question a lot. The chip guys in automotive are kind of going through a [indiscernible] period. And because the automotive industry couldn't get chips 2 years ago, so they bought a lot, and now they don't need all that. But they didn't really overbuild. Our customers did not overbuild door handles and shock absorbers and brake calipers. Because those things, there was not a shortage of it. And so it's been pretty stable. So we're really more unit-driven today. And so if you look at the world's number of cars being built. It's kind of in the 90 billion -- 90 million, sorry. I wish it was 1 billion, 90 million units kind of for the last 3 or 4 years. which explains why we've been pretty stable in the Automotive Chemistry business for the last 3 or 4 years.

Yes. That makes sense. And then on China to ask that. So I think your China exposure has been increasing for the past few years. Now it's like, I think this year is more than 20% so far. So what markets are you most exposed to, is it memory and logic or which segments of your business is mostly closed to China.

Yes. So it's interesting. China, it may be not be as clear for MKS, but when the new rules came out 2.5 years ago, we said that about $0.25 billion, $250 million of our direct sales to China was at risk. So this is selling to Chinese equipment OEMs we've had 20-year relationships with building up our market share with them. That is drastically reduced. That's the $250 million we're talking about. So in terms of direct shift to the semiconductor market in China, we are very, very small. We do benefit because a lot of the equipment OEMs, as you can see from their numbers are shipping to China. Sometimes 30% of the revenue, sometimes 50% of the revenue. So we indirectly get that. But we don't count that as China because we don't know if it's really going to China or not. So we enjoy that. And if that changes, we'll be affected for sure. But really, most of our revenue to direct ship to China is in packaging. Many packaging companies, customers are in China. And that's Atotech. And so that's direct. And so that's really why it's 20% now. It's actually all -- almost all Atotech. Now there is movement in the customer base, the packaging customer base towards Southeast Asia or other countries, if you will, just to derisk the China exposure because their customers are demanding it. And so we're following those customers. As they move to Southeast Asia, we are also moving to Southeast Asia to support them. And so who knows what the China revenue will be for packaging longer term. But I for sure know that Southeast Asia Packaged revenue will grow.

Got it. And do you see incremental competition from domestic Chinese makers?

Not more than normal. I think there's always been competition chemistry. And some lower end equipment that we don't do in China. But we see that same in Japan. We see it in Korea. So that's kind of not really changed the competitive dynamics for the Chemistry business. But I would say Atotech is #1 market share in electronics, chemistry and equipment.

Okay. And just finally touch on capital allocation. I know you've got the new CFO, but he's not here so what's the top part -- I know the top priority is still going to be debt pay down. But like are you still looking for M&A at the same time?

Yes. Well, so we announced that Ram Mayampurath will join us as our CFO in mid-October. Some of the attributes that were very attractive that Ram brings to the table is seasoned CFO, public company. He's gone through some challenging times in his previous company, for sure. He knows how to run the organization. He's measured and conservative is kind of what you want in your CFO, and very experienced. So those things, I think, will be nice [ patterns ] to the finance organization. But really, no change from our priority. Our priority right now is deleveraging. Next 18 to 24 months, as we've said, this is the #1 priority. We've been able to take out a prepay, kind of on the order of $50 million to $100 million a quarter, prepay of debt even during these trough levels of our Semi business and our E&P business. We did a lot of things to help the balance sheet. We did the $1.4 billion convert. We've repriced again. And maybe if they will help us out next week as well. But we'll continue looking at any opportunities to lower the interest costs and delever. In terms of M&A, your last question, nothing's really changed. I think there are always going to be opportunities, but they're really going to be on the -- not on the table until the leverage gets to something closer to where we want to be long term. And I would say, though, that I don't see a transformational M&A in the future because we just did our transformational M&A. We're really well positioned for electronics and packaging already. Sure, there are lots of tuck-ins that can certainly enhance that. And then I think the other point I'd make is because of the last 10 years of being able to organically take share significantly when some inflection happens, VNAND being one, world-class optics being the second. Our criteria for M&A is a lot higher now. And by that, I mean, we will always look at can we do it organically faster. Now in the past, when we were smaller, it was hard to add 50 engineers to RF power when the whole company was $700 million. That would kind of blow the bank in terms of OpEx. Now that we're bigger, now that we've made these bets and demonstrate to ourselves that we can do this, we can make these big bets, I think the bar for M&A becomes a little higher. And so it has to be something unique, something we don't do, something that really tucks in right to the portfolio.

And I guess sort of portfolio is diversified right now, you're happy with the exposure right now?

We're very happy with the exposure. As I said, 85% of all WFE has multiple MKS subsystems on it. The other thing I didn't say is 70% of all the steps needed to make Advanced Packaging is addressed by MKS. So 85%, 70% of everything that's needed to make advanced electronics. There's no other company that can say that.

Yes. And just finally, anything just you want to add, you think investors are not fully appreciating of your company.

One area that Paretosh had talked about is we try to explain this with the TSMC example of packaging called CoWos, chip-on-wafer on substrate, right? And we said, look, the chip on wafer, that's TSV etching, hybrid bonding. That's great. That's growing really fast from a very low base. And we're going to enjoy that when a vacuum -- piece of vacuum equipment goes through silicon via etching, et cetera. But the S is really, I think, where we still have work to do to educate investors. The S is Atotech, that's substrate. I think people are starting to understand that. That S is where the Atotech chemistry, the laser drilling occurs. That S, for us, chemistry is a lot bigger number than the chemistry needed for the CoW. So when you're doing hybrid bonding and chip-on-chip for HBM, there's chemistry there. Because you've got to plate these. You got to make sure the bumps are picking up the right coatings, et cetera. There is chemistry there. That's an order of magnitude less than the chemistry needed to fill all those lines and holes for the substrate, and the number of square inches of substrates being made. So every time we've got 1 stack of hybrid bonding on an AI server. There's 25 layers of S. That's, I think, an area where I think some investors are starting to appreciate that. And I think it's because maybe a lot of our investors have been semi. They came from semi, they understand semi. It's not a stretch to understand through silicon via etching and hybrid bonding of those chips, but they're not necessarily the investor set that came from the other side of chemistry, investing in chemistry, investing in PCB and packaging. So I think that's an area where we still have work to do to try to educate the investor base.

Okay. Sounds good. Just before I conclude the session, is there any questions in the audience?

Thank you.

Okay. Great. Thanks, John. Thanks, everyone.