MKS Inc. (MKSI) Earnings Call Transcript & Summary

Let's get started. Hello, everybody. Thanks for joining our 53rd Annual TMT Conference. My name is Peter Peng, small and mid-cap semiconductor analyst for the firm. I'm pleased to have John Lee, President and CEO; and Ram Mayampurath, CFO at MKSI here with us today. Gentlemen, if you can just start off with an overview of MKS Instruments and then a summary of the March quarter and June quarter outlook, and then we can kick off for Q&A.

Yes. So thanks, Peter. Thanks for having us. So some of you know MKS, but for those of you who don't, MKS is almost a 65-year-old company. We started in just the semi market, and we were making instruments at the time. That's the name, MKS Instruments. These instruments would control things around a vacuum chamber. And then when we moved into semi, of course, vacuum chambers became quite important in the semiconductor equipment industry. And so that's how we became a market leader in -- surrounding the chamber was our motto. So anything that surrounded a vacuum chamber that was critical, controlling pressure, controlling flow, measuring things, we thought was part of a portfolio that made strategic sense for us. And so we're private into 2000. And then at that point, we went public, did a series of acquisitions, probably 10 or 15 just in the vacuum space for semiconductor equipment. And then in 2015, we did one of our biggest acquisitions that moved the company from just a semiconductor equipment company only to something much broader in terms of foundational technology and that was the acquisition of Newport Corporation. Newport had also done a lot of consolidation in their market, photonics, optics, lasers. So together, we became the broadest portfolio of foundational technologies that address not just the vacuum equipment part of semiconductors, but also lithography, metrology and inspection. And the combination of those customers allows us to say that we are in 85% of every piece of equipment at every fab in the world with multiple subsystems because you just add up Applied Materials, Lam, Tokyo Electron, ASML and KLA's market share and you get 85%. And we're on every one of their tools with multiple subsystems. And then we did a couple more acquisitions later as we saw this change in Moore's Law. Moore's Law was running out of gas and people were dividing cores up to get another 10 years and then that started running out of steam and so then they started putting chips together. And when you put multiple chips together, you still want them to act like they are one big chip. Otherwise, you don't really get that performance boost. And this led to the era of heterogeneous integration. This is where we are. This is what enables AI. It's what NVIDIA shows. Every time they talk about all their AI chips, they hold up a board, right? They don't hold up a chip. They hold up a board with lots of chips on it. That interconnection, those boards, that's very, very complex. It can be 20 to 40 layers of different interconnecting layers with copper, small lines and spaces. And when we did the acquisition of Electro Scientific Industries, this is laser drilling of those PCBAs, making those holes. And then we did the acquisition of Atotech in 2022, our biggest acquisition to date, and that was adding the chemistry capability and the chemistry equipment capability to make those heterogeneous PCBs. And so today, we are foundational to Moore's Law and more than Moore's Law because everything now that drives that is no longer just semi. It's the packaging of the semi. I think we were early. We said that when we did the acquisition, no one really kind of understood that. They get it now. And so we address 70% of all those steps for making that dense interconnect. So 85% of all chips have multiple MKS equipment on it. 70% of all steps in making that interconnection is addressed by MKS equipment, laser equipment as well as chemistry. And so that's where we are today. Q1, a recap of Q1. So Q1 was strong. We exceeded guidance in all metrics, top line, bottom line. We're really proud of the fact that the gross margin held up in a quarter where there's a lot more equipment revenue, and usually equipment is a little lower gross margin than chemistry revenue. So I think it's the fifth quarter in a row, Ram's pointed out, where gross margin is now over 47%. A few years ago, we did our 5-year model at Analyst Day and the long-term model in 5 years at $5.6 billion of revenue was 47% gross margin. We're already there at $3.6 billion. So a lot of work on pricing, a lot of work on efficiency of factories. And so we've made some good progress there even though the top line hasn't helped us. I think also EPS was a good story for us. Exceeded the guidance -- exceeded the high end of the guidance actually. We worked hard on things like tax rates as well as, of course, the OpEx. And so Q1 was a strong quarter. We guided relatively flat, I'd call it, in terms of top line. We do have a little bit of impact from tariffs, we'll probably talk a little bit about that and we called that out during the call. So otherwise, pretty steady right now for our markets as of today.

Okay. Why don't we just kind of start off with the near-term stuff on the tariffs because that's been very topical and top of investors' mind. So Liberation Day was just a month ago and your customers are facing numerous uncertainties. Some of them are spending and strategic spends are less likely to get cut back such as node migrations, AI accelerated compute. But then there are other segments like industrial, automotive and the consumer-focused smartphone and PC that could likely get impacted by tariffs. I think you have a very unique vantage point given that you have 3 different business segments. And so what have you kind of observed over the last several weeks in terms of your customer discussions? Any notable discrepancy among your customers in your different end markets?

Yes, I have to say it's been pretty consistent. So when I talk -- when I think about the semi market and the packaging market that goes with semi, that's been pretty consistent. It hasn't really changed because of the tariffs. Certainly, that's what we said in the earnings call for our Q2 guide. And a lot of those investments are strategic, as you know, node migration from 1 layer, 1xx NAND to 2xx NAND, going from 3-nanometer, 2-nanometer to even beyond that. So that really has no -- we haven't seen any changes there. Where we have seen some effects that are macro related, some of it caused by tariffs, some of it not, is in some of our industrial segment. So just normal industrial market as well as automotive. Automotive, of course, is impacted by tariffs. And so we have seen those 2 markets be a little weak, and that affects our Specialty Industrials market segment of MKS. But the semi part and the packaging, Electronics & Packaging, have been pretty steady and really no changes to really call out at this point.

And then just on the direct tariff costs. Your gross margin guidance includes 100 basis points of gross margin impact and it's primarily impacting your Vacuum business. If you can just kind of elaborate on what -- the assumptions that you're making and then some of the near- and longer-term mitigation strategies. And then, I think, earlier, one of your peers also talked about because of the recent trade easing that this could be a worst case scenario in terms of that. So are you seeing that as well?

Yes. So like you said, Peter, we have baked in up to 100 basis points in our gross margin for tariffs. Our goal is to mitigate the tariffs as much as possible and then get into any commercial actions if needed. So it's a broad area of things we are working on. We also have a global footprint. And if we know for sure these are the rules and these are here to stay, we can make the changes in the supply chain and rewire our supply chain to make sure that the tariffs are mitigated. But that comes with some costs. So we want to make sure that we have definite clarity before we get into that -- those steps. But for now, we are doing all we can to mitigate the short-term impact of tariffs, and our actions will also include some commercial actions as needed selectively to pass those through. So we are confident that we can come up with the mitigation plans to overcome the tariffs impact and keeping close touch with developing rules as they come along. And in the long term, we are committed to a 47-plus percent gross margin with or without tariffs.

And the announcement Monday is certainly helpful for the quarter, right? But as you said, that can change tomorrow, who knows.

Okay. Starting with your semiconductor business. Your large customers have largely reiterated their view of the mid-single-digit percentage WFE revenue outlook for 2025 kind of highlighting the strength in leading-edge foundry and logic, NAND technology upgrades and strong spending in advanced DRAM and HBM. Just kind of -- you historically highlighted a 200 basis points premium to WFE. Kind of based on your visibility and discussion with customers, how are you assessing your relative performance against this mid-single-digit WFE outlook?

Yes. So some facts, of course. If you take our Q1 semi results and our midpoint of our Q1 semi guide, half over half, first half '25 versus first half '24, we'd be up 15%, okay, just in semi. Now 2 factors there. One is, let's say, WFE is up 5%, give or take. That's kind of a consensus number. So we would enjoy that because of our position in semi. But also, as you recall, we were still getting our inventory being burned down at our customers in '24. And so when you compare ourselves to ourselves, it's going to be better than just the market of 5%. And that's typical, that's what happens on a downturn. Our inventory burns and we underperform. In an upturn, we overperform as they restock and prepare for the ramp. We're still committed and we think we have avenues for that 200 basis points outperformance of WFE. There has been a huge headwind though, right? We are down about $250 million out of our $2 billion peak semi revenue because of the restrictions to China. So we can't sell to certain companies there that are competitors that are not U.S.-based can and are selling. So that's just headwinds for us. And so that's why we've got to look at other ways to grow like lithography, metrology and inspection, going after more RF power in different segments, going after different regions where we're not as strong. And so we've got a little more headwind now. But I think the strength of MKS' portfolio we think we can still do that.

On the NAND technology upgrade, your customers are starting to upgrade from 100-plus layers to 200-plus layers, eventually 400 layers, right? We're starting to see this drive an inflection in NAND WFE. How do you anticipate the trajectory of these upgrades, right? You have a pretty strong market leadership in RF power. And so maybe if you can just give us insight on how you're thinking about the technology upgrade for the year?

Yes. I think even 90 days ago today, the change is actually in the NAND part of the market for us. 90 days ago, we were hoping upgrades would happen. We were sure that our inventory was burning off, but we weren't sure if it was going to be burned off to the point where our customer would need to pull more inventory. 90 days later, those have happened. Upgrades are happening. Our inventory has normalized. So they are pulling and so we're benefiting from that, you can see in our numbers in Q1. And I think going forward, obviously, any upgrades does benefit MKS because when you upgrade, you have to upgrade with something that's already there. The only installed base is from Lam and our RF power is us, right? And so that's helpful when these upgrades occur. There's also been a greenfield as well, and some of the end users are talking about future greenfield. So -- but the benefit for us is RF power is the biggest part of the BOM for us. Greenfield is even better because then we have the surrounded chamber portfolio also benefiting because it's a brand new tool versus just an upgrade of the RF power. So I think depending on the future of decisions by all the NAND makers, that will determine whether the NAND upgrades continue at pace, accelerate or decelerate. We just don't really know that because I don't think anybody knows that until those companies decide.

One of your lead customers just recently talked about for the 2/3 of the installed base that's still in the 100 layers to convert into 200 layers, that would drive a $40 billion of spending just to convert. And so maybe if you can just give us some qualitative or quantitative thoughts on how that would translate into MKSI.

Yes. Typically, in general, our Vacuum portfolio is anywhere from 1.5% to 2.5% of the BOM of our customers. It depends on our market share and particular components. So that gives you a range, we're not going to call out exactly RF power. And so you've got to do that math, and that's market share leadership. And so if one of our customers is seeing $40 billion for themselves, then if we're seeing, take it, 1.5% to 2.5%, that's the opportunity for us if they see $40 billion.

Okay. Just relatedly, we get asked this question quite a bit. On the opportunities between just the upgrade and greenfield, how would you kind of compare the revenue opportunities between these 2 opportunity set?

Yes. Well, as I said, the RF power is the biggest part of the BOM for us. And so in an upgrade, that's usually the main thing that's being upgraded from the MKS portfolio. In the greenfield, they need everything else, the pressure measurement, valves, flow delivery. And so we just get another enhancement from that. We're not going to break out how much is RF power versus that. It depends on the chamber sometimes, by the way, it depends on our market share. But greenfield is certainly better.

Perfect. Let me just pause here to see if there's any questions.

Yes. I've got a question. Yes. If I look at the trend of some of your customers, Applied Materials, KLA, Lam, Tokyo Electron, they all seem to be focused on moving towards these more integrated systems, what Applied calls their system like Integrated Material Systems where they're integrating multiple chambers, deposition, etch and so on. And in addition to that, they've got all this integrated metrology. I would think that, that would be a pretty big benefit for the MKSI team because you've got so much more vacuum requirements. You've got so much more RF requirements, you've got so much more metrology requirements and all being sort of optimized and integrated into the single system. Do you view that as sort of a content gain opportunity as you look at some of these next-generation opportunities?

Yes, I think that's right. It's a good observation. I think the bigger -- the way we view it is that as things get more difficult, there's a need for more critical subsystems. Critical subsystems that measure things more precisely, deliver things more precisely, et cetera. So when you're integrating things together, the idea is you're not breaking vacuum because when you break vacuum, oxygen gets on the wafer, stuff happens and that's not good. So that's just one of the indicators of complexity and making things more difficult to do. Now in that, there's a lot more precision and control, moving things around. And so those are opportunities. Things like our optical thermometry, measuring the temperature of the wafer, we bought that company a few years ago. That, in the past, was like some chambers needed it. But now it's like most etch chambers need that. And I think the same -- I'll take the opportunity to talk about the same trend is happening in electroplating of PCBs. So one of the tools, pieces of equipment that Atotech makes, MKS now, that one else makes as well is something called horizontal plating tool. It's 50 meters to 100 meters long. Why is it that long? It is because the panel that's being plated is continuously submerged through different process steps for 50 meters or 100 meters. It never breaks surface of water or liquid. And that is a huge advantage. So many other tools, you do one step, you got to take it out. Now things have happened. And then you put it back in, and the interface, these connections of copper to copper is just not as good. That's exactly why Applied is doing the PVD tool that has everything connected together, the same trend is actually happening -- is already happening in electroplating for advanced PCBs.

Historically, you've been very strong in the dielectric etch market. I think at your last Analyst Day, you kind of discussed some penetration opportunities in the conductor etch market. Maybe you can just share your progress in this area.