Ladies and gentlemen, thank you for standing by, and welcome to the MKS Instruments Fourth Quarter and Full Year 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question and answer session [Operator Instruction]. I would now like to introduce your host conference call Mr. Dave Ryzhik. You may begin.

Good morning, everyone. I am Dave Ryzhik, Vice President of Investor Relations, and I'm joined this morning by John Lee, President and Chief Executive Officer and Seth Bagshaw, Senior Vice President and Chief Financial Officer. Yesterday, after market closed, we released our financial results for the fourth quarter and full year 2020, which are posted to our Web site, mksinst.com. As a reminder, various remarks about future expectations, plans and prospects for MKS comprise forward-looking statements. Actual results may differ materially as a result of various important factors, including those discussed in yesterday's press release and in the most recent annual report on Form 10-K and any subsequent quarterly reports on Form 10-Q for the company. These statements represent the company's expectations only as of today and should not be relied upon as represented in the company's estimates or views as of any date subsequent to today, and the company disclaims any obligation to update these statements. During the call, we will be discussing non-GAAP financial measures. Please refer to our press release for information regarding our non-GAAP financial results and a reconciliation of our GAAP and non-GAAP financial measures. Now, I'll turn the call over to John.

Thanks, David. Good morning everyone, and thank you for joining us today. Before I discuss our quarterly results and current market trends, I'd like to take a moment to reflect on the past year. 2020 was full of challenges for all of us both personally and professionally. But for MKS I can best characterize 2020 with the following three words, resilience, opportunity and growth. Let me start with resilience. Our foremost priority when the COVID-19 pandemic started was the safety and wellbeing of our global workforce, and it continues to be our top priority. We responded quickly at the onset of the pandemic and implemented a number of safety precautions for our employees, while also shifting to a work from home environment for a significant portion of our workforce. We also remain steadfast in delivering on the needs of our customers during this challenging time. Our team worked tirelessly to ensure continuity of operations by swiftly responding to disruptions in our factories and supply chain partners while adhering to stringent safety protocols. Now let me discuss what I mean by opportunity. Disruptions we face did not interrupt our cadence of innovation and this allowed us to take advantage of new opportunities in the markets we serve. In 2020, we were awarded 170 new patents. We also grew new product releases by 48% year-over-year and secured a number of important design wins for both our semiconductor and advanced markets. And I am pleased to announce for the second year in a row that we are a finalist for an SPIE Prism Award this time for our Ophir beamsplitter for high power lasers. But we also view opportunities through another lens, employee development, diversity, equity and inclusion. In 2020, we develop new leadership programs and rolled out a new diversity training program…

Thank you, John. I will cover our fourth quarter and full year 2020 results, then provide additional detail and guidance for the first quarter of 2021. Sales for the fourth quarter were a record $660 million, up 12% sequentially, up 32% year-over-year and above the high end of our guidance range. Our performance reflects strong demand in our semiconductor market, continued rebound in our advanced markets. In the fourth quarter, semiconductor sales set another record at $393 million, up 9% sequentially and up 45% year-over-year, reflecting our broad exposure across memory, foundry and logic applications. Our power solutions portfolio continues to outperform the underlying power market and we're pleased to report another quarter of record revenue. As we highlighted at our Analyst Day last month, our advanced control algorithms, modularity, and SaaS development cycles, are key differentiators of our power solutions, and will continue to create new opportunities to accelerate our customer roadmaps. For the fourth quarter, sales for our advanced markets were a record $267 million, up 16% sequentially and up 17% year-over-year, led by strong growth in advanced electronics applications and continued recovery in our research market. As John said, we saw strong early cycle demand for our flex PCB via drilling systems, driven in large part by both capacity needs in essential technology transitions for 5G smartphones and other devices. We estimate the amount of flexible PCB content in high end 5G smartphone is on average 30% higher than compared to a high end 4G phone. Moreover, continuous flexible PCB design changes are driving demand for our leading edge via drilling solutions. We’re also pleased to see recurring demand for our MLCC test systems. As a reminder, we offer multiple MLCC test system solutions in the market addressing two main categories. The first is ultrasmall form factor…

[Operator Instructions] Our first question comes from Jim Ricchiuti with Needham & Company.

A couple of questions on the E&S business. And I'm wondering if there's any way you can elaborate on the strength you saw in the business versus Q3. As it relates to how much of the demand you would attribute to the better smartphone cycle, the type of recovery that you're seeing in the MLCC portion of the business and maybe to the extent to which Geode was a contributor in the quarter?

I think Geode was a contributor but not a large contributor. So I think in general, we're attributing both the MLCC and the flex upside in to a stronger smartphone cycle and a little earlier than is typical. So it's really, we believe, driven mostly by the smartphone market.

And John, just, I wanted to just ask you about -- I mean, obviously, it's been a high profile M&A development within the laser photonics market of late. And I'm wondering how you see this impacting MKS from the standpoint of whether this may signal further consolidation in the market, or maybe as it relates to multiples for potential M&A that you may be pursuing in this space?

Well, certainly, we've talked about one of our strategies for growth is in M&A. And we've talked about the fact that we have targets both in advanced markets, as you know, as well as semi. There's just more targets in advanced markets. So I think the photonics industry does have more room for consolidation. I think that that will occur. And as you can imagine, we're certainly going to be a participant in that.

Our next question comes from Paretosh Misra with Berenberg.

So we've been hearing about the chip shortage, particularly at several automotive producers. So just curious, how is MKS positioned to help customers to increase volumes, are you seeing any incremental demand because of that shortage?

I can't say we can put a finger on anything specific with respect to the published shortages and automotive chips. I think we certainly sell a lot of service and spare parts to the older fabs that are the ones building a lot of those kinds of automotive chips. So I don't think we can really tell if a lot of that is going to the automotive manufacturers.

And then just as a follow-up on your laser business, so some of the fiber laser producers are seeing increased demand, primarily from manufacturing. I was just curious are you seeing some of that too? I know you don't have that much exposure to the fiber lasers mostly pulse side. But just curious, what are you seeing on the demand side?

Broadly, Paretosh, I think we do see industrials as well as advanced electronics manufacturing increasing. You can see that in our numbers in Q4 and our guidance in Q1. So we see a little bit of that as well. As you say, we don't make the fiber lasers but we do make the rest of the surround the world piece diagnostics that go around it. So I would say we're seeing something similar to what some of those participants are saying they're seeing in the fiber laser market.

The next question comes from Patrick Ho with Stifel.

John, maybe first off on the semiconductor side of things. You've talked about share gains on the power and for your semi business. Can you just discuss, I guess, maybe some of the emerging opportunities on the optics side, particularly as it relates to litho and process control? Do you expect to outperform the industry growth rates as you gain more share in that segment?

That's certainly one of our strategic objectives, as we talked about at Analyst Day and our investments in there with respect to engineering as well as CapEx to allow us to address more of the optics market for lithography inspection as well as outside semi. And so we'll see, but it's kind of the playbook of MKS. We see an opportunity, as you know and we invest in that inflection and it's a multiyear plan. And we're pretty positive about the opportunity there because our share there is lower than our vacuum chamber type of businesses.

And maybe as my follow-up question for Seth, you've actually delivered long working capital numbers in an environment where logistics and supply chain is tight across the ecosystem. One, how are you looking at the supply chain today, are you facing any shortages? And two, what are you able to do to maintain these pretty strong working capital numbers despite the high demand, particularly in the semi side of things?

So I would say on the supply side, we have normal ramp environment, obviously, looking at parts that we work on supply chain. So I think it's a typical ramp environment. You're always chasing a few parts, which is quite typical. The operations team, you can see our numbers have been, just a really fantastic job navigating that in this environment, especially go back when COVID-19 hit in Q1 and Q2. So I put that in kind of novel category and we're managing that pretty well. In terms of working capital, we mentioned a couple of calls, I think the Analyst Day as well, is we're really focused on cash conversion. Obviously, we've got a very strong operating model. And then the cash conversion opportunities we're seeing is working down receivables. We did that starting back again in early 2020 and maintain momentum going forward. We'll do the same thing on being more efficient on inventory levels and velocity of turns and so forth. So that will be little bit a journey for us because we have a long list of parts. And one of our strength, again, is to really respond quickly to our customer base. So we always have a little bit probably higher than average inventory levels, but we're definitely looking at that as an opportunity going forward. So it's a holistic approach. Obviously, the operating model is in good shape. We'll continue to drive that improvement over the long term. And now cash conversion is a focus for us as well. And we're seeing impact, obviously, this year in the record free cash flow and operating cash results. So we think we do a little better going forward. That's our goal.

Our next question comes from Krish Sankar with Cowen.

This is Steven calling on behalf of Krish. John, my first question for you. In terms of the semis business, I was wondering if you could provide some more color on the March quarter guidance for the semis business. Any color on the components that will be driving that would be helpful? And also if you'd also look a little further out, just one of your good customers last night talked about a front half loaded WFE year. I was wondering if the trends you're seeing or consisting with that if you see any other factors that might lead to differentiation there?

So we're seeing a strong Q1 for sure. And the midpoint of the guide is $650 million, slightly lower than our $660 million that we actually achieved in Q4. But Q4 was really quite a record quarter. So we see a very strong semi quarter in Q1. We don't guide out more than Q1, but I would say visibility is okay in the first half. And I think that in the second half, I don't think anyone really knows, there's a lot of things that could go drive it better or worse. So I think we're strongly positive about semi in Q1. And then the first half is looking okay but we wouldn't want to guide beyond the first quarter.

And maybe one quick one for Seth. Seth, in terms of the gross margin guidance. Can you talk a little bit about the puts and takes for the high and low end of the gross margin guidance?

So our published model is a 50% variable gross margin and in 2020, we achieved that for sure and again, pretty close to fourth quarter. The Q1, there's a little bit of a mix dynamic in there. I'd say the L&M division had a little bit -- we sold products in Q4. We think in Q1 but a little bit below the corporate average. So it's probably a tick below that 5% flow through. If you take the midpoint, but it's really not that far off for the model. And again, we range the margin obviously. So that's kind of a high level takeaway for the quarterly guidance for margin. The other piece we're managing very well is we do have some headwinds in the COVID world, obviously, freight cost a little higher. We've been very careful on within the factory, social distancing and making sure that everybody is maintaining the right protocol. So that's kind of affecting a little bit the efficiencies but that's kind of in the run rate as well. But the team is managing very well on that. So really that big takeaway is just a little bit of mix, I think, in the L&M group in Q1. Again, we ranged the guidance. So I would kind of be looking at that range as a good thoughtful estimate for us.

Next question comes from Sidney Ho with Deutsche Bank.

This is Jeff Rand on for Sidney. After growing your business, your semis business almost 50% in 2020, do you believe this business could still outgrow the overall WFE market in 2021 or do you expect some destocking to take place?

Typically, for suppliers in this part of the food chain of critical subsystems, we tend to overperform during the ramps and we tend to underperform when the ramps turn. And so that's really a question of when you think the thing will turn. And I know there's a lot of talk about people trying to call the peak right now, which we're not going to. I would say, though, that we're still very confident in our long term model, as we talked about at Analyst Day, which is our historic 200 basis points above WFE CAGR over the long term. And so that model is still very much intact.

And just as my follow-up, gross margins were close to the midpoint of guidance, but on the strong revenue beat. Can you discuss how you think about the opportunity for margin expansion as you grow revenue over time?

So clearly, volume is the bigger driver. And again, a 5% flow through is our model and well intact. So that's a bigger driver going forward. Obviously, I think when the COVID-19 pandemic eases up, we'll have a little bit of tailwind there on margins just because the protocols will be relaxed a little bit is our belief. And then we do have some trade friction, which is in the run rate. So if that was to move differently going forward, that would be slightly helpful as well. And then on the long term, we do look at product development activities and our road map is to deliver products in the long-term that have higher value for our customers, and that should have an impact, obviously, on gross margin. The cadence we have across all three divisions on a regular basis and that's sort of the ongoing, again, process, which will I think help margins going forward. And then we do have a team, a widespread team in place to look at profitability improvement. So that's always something we do on a regular basis as well. So there's really multiple levers, Jeff, that we've always been pulling. Working pretty hard at all those right now. But in the short term, I'd tell investors, the margin impact is really that 5% flow through on revenue. So that's kind of how I look at the margin growth going forward, the biggest lever.

Our next question comes from Mark Miller with The Benchmark Company.

Just was wondering in terms of design wins, any notable design wins besides in the power area?

So we have several in our portfolio of semiconductor other products. So pressure, flow of valves as well as remote plasma source for reactive gases. So there are multiple design wins there. As we talked about in 2020, we released 48% more products than we did in 2019, even during a remote work protocol for many of the engineering teams. So not just power but the whole portfolio there. We also had design wins in our world class optics efforts as well as in lasers. And so we're pretty happy with our design win activities across the portfolio. Obviously, we talked about ESI in terms of HDI. And we've certainly also maintained share in our leading flex drilling tool as well.

And the laser design ones, were these nanosecond lasers?

Both nanosecond and picosecond.

Final question, margins were up significantly sequentially and year-over-year. Besides higher sales, what was driving it, was it a mix improvement?

No, Mark, I think volume is definitely, again, a bigger driver, I would say. And then if you look at our cost structure, we do a pretty good job maintaining our pretty disciplined cost structure in that ramp environment. Higher variable comp in '20, obviously because of record results. But fundamentally that's kind of what we did in 2020 with the volume piece, maintaining good cost controls and strong execution.

Next question comes from Joe Quatrochi with Wells Fargo.

On the semi side, some of your customers have been continuing to increase inventory to support the stronger demand. But they've also been talking about building some buffer inventory just given the supply chain disruptions. I was curious, do you have any kind of visibility into that across your customer base?

I don't think we have a broad view of it. We certainly have certain product lines and at certain customers where they've asked us to do that, and we have done that because that's their plan. So that's a customer specific and probably product specific kind of safety inventory, if you will. So it's really not a broad based thing, but customer specific or product specific.

And then on the strong E&S results this quarter, was that reflective of any of the 80 unit capstone order that you got early in December, or is that still kind of more ahead of us in the guide?

I would say that, that 80 unit order, the majority of it was not shipped in Q4.

Our next question comes from Tom Diffely with D.A. Davidson.

John, I was hoping to get a little bit more on the microelectronics part of the business. And I know it's come back a bit recently, but what is your outlook for the year? And do you think your growth in that industry or that sector comes from share gains, or is it going to be recovery in the space that's going to be the biggest driver?

I think the majority is recovery in the space for sure. But as you know, our HDI momentum is good now. I think we're starting from a small base. So that's why my answer is that the recovery is probably from the larger flex and MLCC markets where we already have established leadership. But we hope that HDI will continue to accelerate and at some point, it will be both.

And does HDI run on a similar cycle or is it little bit off cycle versus the rest of the business?

I think in general, it does run in a similar cycle. But HDI boards, as you know, are broader in terms of applications. They're not just tied to smartphones. Flex is still very tied to the iPhone and the Samsung type phones form factors. And it's also broadening as well for the use of flex, but HDI is broader. So it has a broader base of different kinds of applications.

And then, Seth, when you look at the tax rate, it looks like it's edging up a little bit here. Is there anything to read into that?

No, Tom, it should be -- we said 18% in this guidance. It's probably our view for 2021. I think in the fourth quarter, precisely, it was like 17.5%, which were the 17% guidance. So it's really around that ZIP code for sure. And it's really based on the mix of income by geography. So that's the only driver, frankly, on tax rate. But I think for modeling internally, we're using 18% for 2021.

Our next question comes from Amanda Scarnati with Citi.

The first question I have is on the advanced market side of the business. It looks like it's sort of accelerating off of the trough here. Is that the way to look at it or is it more just sort of one-off ordering that you saw in the December quarter to drive that strong sequential growth?

It's the broader order patterns from multiple subsegments, most notably advanced electronics. So I don't believe it's a one off quarter kind of events. As we guided in Q1 and as we said in the script, we expect to have even stronger Q1 in advanced markets.

And then on the HDI order that you saw in the quarter. Remember last quarter, you talked about having some new inquiries that were sort of unexpected. Was this order driven off of that or is this something in addition to sort of the inquiries that you were seeing earlier in the year?

Our reference to inquiries coming in a little earlier than we thought was really more about flex, Amanda. And then you saw our Q4 being a lot higher than normal seasonality. So it was really driven by flex those inquiries.

[Operator Instructions] Our next question is the follow-up question from James Ricchiuti with Needham Company.

I just wanted to go back to the L&M business, particularly the non semi portion of that business. And I'm wondering where would you say we are with respect to pre pandemic levels of demand in some of the major verticals?

I think we still have the trade friction headwinds. So that was before the pandemic and then the pandemic added even more headwinds, as you could say. So I think the pandemic headwinds are kind of gone now. The trade headwinds are still there, and things hopefully will normalize over time. But that's kind of how we're viewing this final return to growth, organic growth.

And John, on the E&S side of the business, clearly, a little change here in the seasonal patterns of demand. And I'm wondering how we should think of that flex demand, the flex drilling demand as it relates to the normal seasonality you see in the business? And then what's the outlook for this recovery in the MLCC business? What are you hearing from some of the customers there? Is that near-term outlook still pretty strong?

Yes. I mean, MLCC, near term, it does still seem to be strong. It seems to be strong, has been strong, and we believe it will continue to be strong for at least another quarter as far as we can see. And I think the seasonal pull in, if you will, I think your question is, is the flex a pull in or is it just additive. And from what we can tell now, because of the bookings and activities we see in Q1 and Q2, that's the normal activity and we still see that. And so Q4 seems to be an additive quarter to what is normally a Q1, Q2 high quarters for the E&S Flex business.

Our next question is a follow-up question from Tom Diffely with D.A. Davidson.

Just a quick clarification. John, did you say you had over 200 patents issued in the year?

170, Tom.

And then what segments are those concentrated in?

It's pretty broad. I would say we have so many products. We have a fair number of pressure products, valve products, RPS products and power products. And then you have the entire array of products in light and motion. So optics, lasers, photonics. So it's really pretty broad based. And we have a pretty rigid and good patent processing in terms of evaluating whether things are worth fattening or not and that goes across all the divisions. E&S has some patents, too, but those are really a little fewer in terms of the number because those are mostly system integration type of ideas.

And maybe just on that, when you look at your R&D spending for the upcoming year, are there particular focuses that you have? Or are you going to be pretty broad based across all your markets spending R&D as well?

No, I think we've talked about it in the past too, Tom. We are very targeted in terms of where we would put it on R&D dollars. We always look at areas for growth, opportunities for growth. And so for us, we will invest in all the products appropriately, but the areas where we are investing for future growth are power, world class optics to address that and lasers and HDI.

I'll say too, Tom. If you look at our -- we're not guiding for the full year, obviously, but internally, we're leaning pretty heavy to the R&D spending in 2021. So the majority of our spending increases in OpEx will be heavily geared towards R&D efforts. And we see a lot of opportunity there for sure.

And I'm not showing any further questions at this time. I'd like to turn the call back over to our host for any closing remarks.

Thank you, Kevin, and thank you all for joining us today and for your interest in MKS. Operator, you may close the call.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.