MKSI - MKSI's Ransomware Attack Could Have Significant Implications For Applied Materials

Summary

• Applied Materials’ guidance at its earnings call today could be affected, as will its strategy on inventory reduction.
• The impact of a ransomware attack on MKS Instruments could invalidate CY 2Q23 revenue guidance of -26.9% QoQ already given by Lam Research.
• Applied Materials and Lam Research are the largest customers of MKS Instruments, so supply-chain disruptions, which affected these companies in 2022, could resurface.

On February 3, 2023, MKS Instruments, Inc. ( MKSI ) became aware of a ransomware attack and reported it on February 6. Now, it plans to announce its fourth quarter earnings on February 28 instead of February 13, as originally scheduled. According to MKSI, the incident has affected specific business systems, including production-related systems.

The company said in a filing with the U.S. Securities and Exchange Commission.

"The Company's investigation and assessment of the impact of this incident is ongoing and appropriate incident response professionals have been engaged."

It is important to understand the significance of this "event" because MKSI's two largest customers are the two largest U.S. semiconductor equipment companies - Lam Research ( LRCX ) and Applied Materials ( AMAT ). Together they accounted for approximately 27%, 24%, and 18% of net revenues for the years 2021, 2020, and 2019, respectively, as shown in Table 1.

MKS supplies subsystems, instruments, and components to semiconductor manufacturing equipment OEMS and end-users. MKS is the largest maker of gas-phase process control instruments and subsystems and components for the IC industry.

Supply Chain Impact on AMAT and LRCX

Supply chain disruptions have plagued semiconductor equipment companies and I discussed this in a November 9, 2022 Seeking Alpha article entitled " Ultra Clean Holdings' Downplayed China Sanctions Inconsistent With Peers And Customers. " For clarification, MKSI was discussed in the article, and Ultra Clean Holdings ( UCTT ) is a major supplier of parts to AMAT and LRCX.

I've written several articles about these problems from LRCX in my SA article " Lam Research: Expect More Supply Chain Woes In Upcoming Earnings Call " and AMAT " Applied Materials Earnings Call Following Poor Quarter Still Left Unanswered Questions ."

AMAT's Earnings Call is Today, So Guidance be Unreliable

AMAT will be announcing its F1Q 2023 earnings call on Thursday, February 15. Guidance for Q2 2023 and CY 2024 will be based on several factors, but with limited visibility about supplies of products from MKSI, guidance will be unreliable.

What we do know is that AMAT has nearly $20 billion in backlog and is about to enter a period of negative semiconductor equipment growth in 2023. I discussed expected revenues for AMAT and the rationale for my mid-2021 thesis for a semi-cap meltdown in my February 9, 2023 Seeking Alpha article entitled " Applied Materials: Important Questions Are Still Unresolved Leading Up To Its Next Earnings Call ."

MKSI's Q4 earnings call was scheduled for February 13, and we could have estimated AMAT's earnings call set for February 16 based on financial results and guidance from MKSI. That has changed.

MKS' Q4 2022 consensus EPS Estimate is $1.34 (+0.8% YoY) and the consensus Revenue Estimate is $994.01M (+157.2% YoY). Taking a closer look, the $994.01M consensus would represent a +4.2% QoQ growth for the company, which would be down from a +24.7% QoQ growth the company reported the previous Q3 2022 quarter, as shown in Table 2.

MKS didn't provide guidance on Semiconductor, so we can infer what to expect from customers and competitors from only LRCX and Ichor ( ICHR ) that have already announced. It's important to note that for 2021, ICHR's two largest customers were Lam Research and Applied Materials, which accounted for 53% and 32% of sales, so their guidance is valid for estimating AMAT's guidance for its quarter ending April 2023.

Table 3 shows guidance provided by LRCX and its major supplier ICHR for CY Q1 2023 of -26.9% and -25.4%, respectively. These are significant drops from the previous quarter. Because of MKSI, these also may be invalid, because if LRCX is supply-chain limited, it will affect deliveries from ICHR.

Investor Takeaway

MKSI was a victim of a ransomware attack on February 3. Since then, its earnings call has been postponed from February 13 to February 28. Importantly, its website is down after two weeks as it determines the extent of any damage to the company.

MKS reported the ransomware incident only one day after national cybersecurity agencies and security experts around the world warned about a global ransomware attack that hit 3,200 servers in France, Germany, Finland, the US, and Canada running on VMware ESXi.

There are important takeaways for MKSI, its customers, and its competitors:

• Since the February 3 announcement, MKSI's share price has dropped 10%, from $109 to $99.
• The earnings call can ideally shed some light on the near-term impact on MKSI.
• Applied Materials announces its earnings on February 16, and any guidance it provides will be subjected to the uncertainties from the ransomware attack on MKSI.
• Lam Research provided revenue guidance of -26.9% QoQ for the quarter ending in March 2023, but that guidance was provided before the attack on MKSI, meaning its guidance may be invalid.
• If Applied Materials and Lam Research are supply-chain limited, they will push out deliveries from other suppliers such as ICHR and UCTT.

Applied Materials may provide insight on Thursday's call, which I expect will follow that of LRCX, KLA ( KLAC ), and Onto Innovation ( ONTO ), which indicated headwinds in the near term. That would include expected announcements of pushouts of equipment purchases and possible cancellations.

Already, Intel ( INTC ) and Micron ( MU ) have announced a deceleration in their fab construction. This raises the issue of whether AMAT's $20 billion of inventory can be reduced as supply-chain challenges, or whether its customers will refuse acceptance of equipment as chip demand plummets.

Finally, my thesis that there would be plummeting equipment purchases in 2023, which I made in mid-2021 and is referenced above in this article, contends that the downturn in equipment purchases due to excess capex spend and resultant chip oversupply will last well into 2024.

It took one year after my forecast for analysts to start projecting a downturn of equipment, but their forecasts project that the downturn will last only for 2023. According to our report entitled Global Semiconductor Equipment: Markets, Market Shares, and Market Forecasts , this downturn will extend into 2024.

I rate AMAT a sell. The headwinds it has been facing regarding sanctions in China, plummeting purchases of equipment by memory companies, and a second drop in equipment purchases by logic/foundry companies in 2023, will be further complicated by supply-chain disruptions from MKSI.

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