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Edited Transcript of MKSI earnings conference call or presentation 30-Jan-19 1:30pm GMT

Q4 2018 MKS Instruments Inc Earnings Call

ANDOVER Mar 12, 2019 (Thomson StreetEvents) -- Edited Transcript of MKS Instruments Inc earnings conference call or presentation Wednesday, January 30, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gerald G. Colella

MKS Instruments, Inc. - CEO & Director

* John T. C. Lee

MKS Instruments, Inc. - President & COO

* Seth H. Bagshaw

MKS Instruments, Inc. - Senior VP, CFO & Treasurer

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Conference Call Participants

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* Amanda Marie Scarnati

Citigroup Inc, Research Division - Semiconductor Consumable Analyst

* J. Ho

Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector

* Mark S. Miller

The Benchmark Company, LLC, Research Division - Research Analyst

* Robert Bruce Mertens

Cowen and Company, LLC, Research Division - Research Associate

* Shek Ming Ho

Deutsche Bank AG, Research Division - Director & Senior Analyst

* Thomas Robert Diffely

D.A. Davidson & Co., Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Fourth Quarter and Full Year 2018 Earnings Conference Call. (Operator Instructions)

As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference call, Chief Financial Officer, Seth Bagshaw. You may begin.

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Seth H. Bagshaw, MKS Instruments, Inc. - Senior VP, CFO & Treasurer [2]

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Thank you.

Good morning, everyone. I'm Seth Bagshaw, Senior Vice President and Chief Financial Officer. I'm joined this morning by Jerry Colella, Chief Executive Officer; and John Lee, our President and Chief Operating Officer. Thank you for joining our earnings conference call.

Yesterday at the market close, we released our financial results for the fourth quarter and full year 2018. Our financial results and scheduled pro forma revenue by market have been posted to our website, www.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, in our 2017 Annual Report on Form 10-K and subsequent quarterly reports on Form 10-Q. These statements represent the company's expectations only as of today and should not be relied upon as representing the company's estimates or views as of any date subsequent to today, and the company disclaims any obligation to update these statements.

Today's call also includes non-GAAP adjusted financial measures. Reconciliations to GAAP measures are contained in yesterday's earnings release.

Now I'll turn the call over to Jerry.

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [3]

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Thanks, Seth. Good morning, everyone, and thank you for joining us today. I'll start with the results for the full year and fourth quarter 2018, followed by several business and market highlights, and then I'll turn the call over to John, who'll share additional details on our strategy, customers and markets. Seth will then provide further information on our financial results and first quarter 2019 guidance before we open the call to your questions.

Revenue for fiscal 2018 was a record $2.1 billion, an increase over 8% from $1.9 billion in 2017. Non-GAAP net earnings were $7.83 per share, an increase of 31% from a year ago.

Our ability to deliver these record results despite second half semiconductor market headwinds was driven primarily by a balanced exposure to a diverse range of Advanced Markets, coupled with our longstanding commitment to managing expenses.

For the fourth quarter, we achieved revenue of $461 million and non-GAAP net earnings of $1.54 per share, both of which were at the higher end of our guidance.

I'm very pleased with our strong performance in 2018. Despite the slowdown in semiconductor CapEx spending, we continued on our path, sustainable and profitable growth. We have managed through semiconductor fluctuation for many years due to a combination of strict cost control, leveraging our flexible manufacturing capabilities and increasing market share with key design wins. We have been clear in our strategy to broaden MKS exposure to customers and markets. The pending acquisition of Electro Scientific Industries, or ESI, is another significant step in executing this strategy and expands our addressable market by approximately $2.2 billion. We have received all necessary regulatory and shareholder approvals, and we anticipate closing on February 1, 2019. We expect the addition of ESI to strengthen our expertise in the lasers, photonics and optic markets, enabling us to develop systems to provide unique and cost-effective solutions to meet the challenges of our customers' evolving technology needs.

Our strong and longstanding relationships with our semiconductor customers have helped us deliver over $50 million in Light and Motion design wins in 2018. This selling model is working well for us, and we'll apply the same strategy to ESI's product portfolio.

The last 5 years that I've been CEO, we have focused on delivering sustainable and profitable growth, executing on a combination of internal improvements and strategic acquisitions. During this period, we have tripled revenue from $670 million to over $2 billion and delivered a 770% increase in non-GAAP net earnings per share. In terms of broadening our customer market reach, we grew our semiconductor market business by 150% and our Advanced Markets by over 340%. These accomplishments are a testament to the MKS business process, our close relationships with customers and suppliers and the skills and dedication of our strong MKS team around the world.

In terms of our outlook, we anticipate that our semiconductor customers will remain muted in their capital equipment spending through the first half of 2019. However, we remain very positive on the long-term strength of this market as well as the continued strength in our Advanced Markets.

Turning to our Q1 2019 revenue and earnings guidance. We estimate that sales in the first quarter to range from $400 million to $440 million and first quarter non-GAAP net earnings per diluted share to range from $0.95 to $1.18 per diluted share.

Seth will provide the balance of our first quarter guidance in his remarks. At this time, I'd like to turn the call over to John.

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John T. C. Lee, MKS Instruments, Inc. - President & COO [4]

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Thanks, Jerry.

As Jerry mentioned, we remain very bullish on the long-term trends in the markets that drive our business. For the semiconductor market, our exposure to all device types, including 3D NAND, DRAM and logic, combined with our broad exposure to 85% of WFE spend, including deposition, etch, lithography, metrology and inspection, positions us well when capital spending returns to normalized levels. We have an industry-leading portfolio and laser-based solutions for advanced industrial manufacturing, and we anticipate continued long-term growth in these markets.

We're also excited about new market drivers, such as the implementation of new 5G technology over the next few years, which will require upgraded wireless infrastructure and new mobile devices. This will require increased data processing and storage capabilities, which is positive for our semiconductor and laser diode testing businesses as well as our pending acquisition of ESI.

Our strategic initiatives over the last 5 years has been to broaden our reach into Advanced Markets as well as enhance our strong semiconductor market portfolio. In our Advanced Markets, revenue increased to a record $931 million in 2018 or 14% over 2017. This is on top of the 14% year-over-year growth achieved in 2017 on a pro forma basis, reflecting the full year results of Newport Corporation, which we acquired in 2016.

In the fourth quarter, we continued to see strong demand for our products across a number of diversified advanced market applications. Our industrial microwave generator, designed in for thin-film bottle coating in the beverage industry. In another microwave application, we received a large order for a synthetic diamond manufacturing application. In the analytical instrumentation market, we had a significant multiyear contract win for our unique multi-filter module that enables a significant improvement in the speed of sample testing. In the photovoltaic market, our new pressure control valves displaced a significant competitor. And in the industrial packaging and coding market, our multi-range, multi-gas Mass Flow Controllers were designed into production roll coaters. We also received a number of significant design wins for ultraviolet NIR lasers for applications to improve photovoltaic efficiency as well as to process advanced printed circuit boards.

As mentioned, we expect to close on the acquisition of ESI shortly. This will bring to the MKS portfolio a leading innovator in laser-based manufacturing solutions for the micro-machine industry. The acquisition further broadens our Surround the Workpiece offerings by adding advanced systems expertise and deep technical understanding based on materials interactions. We expect ESI's leadership in complex printed circuit board processing systems and other capabilities to provide MKS the opportunity to accelerate the roadmaps and performance of our laser, motion and photonics portfolio.

We continue to invest in and position ourselves to take advantage of market opportunities for our products in the semiconductor market such as developing new solutions for 5-nanometer logic devices, 3D NAND stacks of 128 layers and beyond, and next-generation DRAM structures. Our strength and differentiation are based on our ability to work closely with our customers to develop solutions that address their most complex technical problems. Jerry mentioned our financial success for the last 5 years. And the key component of this is our demonstrated ability to significantly outpace the semiconductor market growth rate. In fact, in the past 5-year period, we have exceeded the semi growth rate by over 500 basis points.

Our outlook remains very positive as our continued design wins in the semiconductor market and strength in Advanced Markets positions us for long-term success with a balanced and growing portfolio of products and services.

At this point, I'd like to turn the call over to Seth.

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Seth H. Bagshaw, MKS Instruments, Inc. - Senior VP, CFO & Treasurer [5]

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Thank you, John. I'll cover the fourth quarter and full year financial results and discuss our Q1 2019 guidance.

Revenue for the quarter was $461 million, which is slightly above the high end of our guidance range primarily due to stronger than expected sales to semiconductor customers. This compares to revenue of $487 million in the third quarter 2018 and revenue of $512 million in Q4 of 2017.

Sales to semiconductor customers were $235 million, a decrease of 10% compared to the third quarter of 2018, and sales to Advanced Markets were $226 million in the quarter, consistent with the sales in third quarter, driven by continued strength in our Light and Motion Division.

Our mix of revenues was approximately evenly split between our semiconductor and Advanced Markets in the quarter, resulting in a balanced end market exposure.

Sales in the Vacuum and Analysis Division were $258 million, and sales in Light and Motion Division were $203 million.

GAAP and non-GAAP gross margins, approximately 46%, slightly below expectations we have at this volume due to product mix and lower factory utilization.

Non-GAAP operating expenses were $101 million, which is favorable to the low end of our guidance range. We continue to undertake cost containment actions throughout the quarter as well as adjustments to the variable compensation plans. Acquisition costs related to ESI acquisition are excluded from non-GAAP operating expenses.

Non-GAAP operating margin was 23.7%, slightly favorable to our expectations with revenue level due to lower operating expenses.

And the non-GAAP and GAAP tax rates were both approximately 21%, slightly above our projected rate of 19% due to the geographic mix of taxable income.

GAAP net income was $72 million or $1.32 per share, and non-GAAP net earnings were $84 million or $1.54 per share.

At the end of the fourth quarter, we had cash and short-term investments of $718 million, an increase of $99 million in the quarter, of which 65% was in the U.S. and 35% in our international operations.

The balance outstanding in our term loan at December 31 was $348 million.

Free cash flow for the quarter was $109 million or 24% of revenue.

In terms of working capital, day sales outstanding was 58 days, inventory turns were 2.6x at the end of the fourth quarter, both consistent with the third quarter.

In the quarter, we paid a cash dividend of $11 million or $0.20 per share.

I'd like to now cover some highlights for the full year.

For the full year 2018, we achieved record revenue of $2.1 billion, an increase of 8% compared to 2017 revenue. Our semiconductor revenue increased 4% to a record of more than $1.1 billion after a 45% increase in 2017 on a pro forma basis. And our revenue to Advanced Markets achieved another year of double-digit growth and increased 14%, $931 million, also a record.

For the full year, the revenue split between the semiconductor market and Advanced Markets were 55% and 45%, respectively. As a result of the strength of the operating model as well as the benefits from last year's Tax Reform Act, in 2018, we achieved a 31% increase in non-GAAP earnings per share on an 8% increase of revenue over the prior year.

Free cash flow was $351 million, which is also a record and was 17% of revenue.

In 2018, we maintained a balanced approach to capital deployment. We increased our dividend rate by 11% and paid a total of $42 million in dividends to shareholders. We repurchased $75 million in stock. We announced the acquisition of ESI expected to close on February 1.

2018 was also another record year for Light and Motion Division, and sales increased 15% to $814 million compared to 2017 revenue of $709 million. Annual sales in Light and Motion increased 35% compared to 2016 pro forma revenue, the year MKS acquired Newport Corporation.

Non-GAAP operating profit for Light and Motion was $211 million or nearly 26% of revenue compared to 10% of revenue immediately prior to the acquisition.

Now turning to Q1 2019 guidance, which excludes the effect of ESI acquisition.

Based upon current business levels, we estimate that our sales in the quarter to range from $400 million to $440 million. At this expected sales range, our Q1 gross margin can range from 44.5% to 45.5%. Non-GAAP operating expenses can range from $112 million to $118 million, R&D expenses can range from $33 million to $35 million. And SG&A expenses could range from $79 million to $83 million.

As a reminder, operating expenses are seasonally higher in the first quarter due to payroll, taxes and certain fringe costs.

Non-GAAP net interest expense, again excluding debt related to the pending acquisition is expected to be approximately $3.1 million and non-GAAP tax rate to be approximately 19%.

Again, these assumptions, first quarter non-GAAP net earnings can range from $52 million to $65 million or $0.95 per share to $1.18 per share. In the first quarter, amortization of tangible assets is expected to be approximately $10.4 million, and GAAP interest expense is estimated to be approximately $3.7 million.

GAAP net income is expected to range from $42 million to $56 million or $0.78 to $1.02 per share on approximately 54.6 million shares outstanding.

This concludes the prepared remarks. I'll now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Sidney Ho from Deutsche Bank.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [2]

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Maybe just to start off, what's your assumption in your guidance for -- between semis and other Advanced Markets for revenue growth or revenue?

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Seth H. Bagshaw, MKS Instruments, Inc. - Senior VP, CFO & Treasurer [3]

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Yes, this is Seth. Yes, I would assume that the -- again, we don't really guide by market, but a good assumption, I think we would expect that Q1 guidance would assume that the Advanced Markets are relatively steady from the fourth quarter.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [4]

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Okay, great. So I guess, well, if you -- if all the decline in revenue is coming from the semi side, my rough math would tell me it's down around 15% to 20% quarter-over-quarter. You started to see weakness about the same time as your -- one of the biggest customers. But your revenue outlook, including guidance, will be down like 40% from peak level versus, for them, it's more like down 20%, 25%. Do you think you are at a level that should start growing in line with your customers or WFE starting, say, in Q2?

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [5]

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Well, it's a little difficult for me to project where a -- an upturn comes in the business. I think I've been quoted to say -- this is Jerry. That I feel like we're in a canoe, which we've been in before, that the length of the canoe is determination. As far as the difference in guidance, we -- business at this -- we hit this level saying things can be a bit lumpy. In Q4, as an example, we had customers that wanted to pull orders in from Q1 into Q4, so it looked like there's an imbalance between Q4 and Q1 because we had allowed them to take orders in early because they had some opportunities for revenue. And so that obviously affects what happens in Q1 and Q2. But we think the business is consistent from here. The order rate is consistent. And what's really great is we're seeing a lot of opportunity on design wins. And frankly, I know this may seem odd, but we look at these downturns in our business as an opportunity to gain share. People want to do business coming out of these things with larger companies, gives us an opportunity to reassess our structure of our company, what our costs look like. So we are actually -- we've been through this for -- well, me -- 35.5 years now. So I've been through more of these than I care to count. But it feels consistent now. Like we said before, the business looks pretty steady. And I'm not going to predict what Q2 or Q3 or Q4 looks like. I have my team prepared. We're a lean company. Lead times are short. We have the ability to respond quickly. And we have inventory a little higher, but we consider that store capacity. That's why we can outpace the ramp of other people. So we feel pretty consistent with the business. And when it comes back, it'll come back. And I've never been one to worry about the forecasts. When I ran operations I told my team the forecast is wrong, get over it, get fast. And that was 30 years ago, and I feel the same way now. But it feels consistent. And what I'm really pleased with is the Advanced Markets are so strong. We're really grateful to the Newport team for the -- and Light and Motion now, what they've done to increase the stability of this business and give us another place to go, and that business will continue to grow. So I'd leave you with the thought that I think it's consistent for now. And I can't predict what the future looks like, but I'm very positive over time it'll improve and we'll be the first ones to recover quickly.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [6]

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Great. Just to be -- just to clarify that. So the upside in Q4, about $20 million, seems like it's all coming from semiconductors. And so that's the pull-in that you talk about that potentially should happen in Q1?

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [7]

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That's a mix, yes. So -- but it's all -- it's pretty much all semi. And there's the opportunity to provide customers product faster than they originally had expected and they asked for. That's correct.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [8]

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And you also mentioned that can -- the -- your order has been consistent, I think, sometime in Q4 and that hasn't really changed.

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [9]

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Yes, it feels pretty consistent. It does. I watch -- and every -- as you know, I watch them every day. So yes, it feels pretty consistent.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [10]

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Okay. And for -- I mean, switching topics to the Advanced Markets side. It's great that you gave some background about how you think about that market. But if you look at the revenue from that -- those markets, I would -- it's been slightly -- down slightly for 4 consecutive quarters, including the guide. Are you concerned that this market may be a little -- so is there anything beyond just the normal business environment getting a little softer? Or do you think the growth rate is not as strong as maybe you had expected before?

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John T. C. Lee, MKS Instruments, Inc. - President & COO [11]

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Sidney, it's John. I could take that one. So we -- you do see a little bit more caution mostly in Asia. And so it doesn't change our ability to win designs. But certainly, spending is a little more muted there than it has been maybe last year. But I think that's really part of the macroeconomic issues and perhaps some tariff issues. So I don't think it's endemic of our ability to grow that against market going in the future.

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [12]

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And that's after 2 consecutive years of 14% growth. The average growth rate of those markets, Sidney, on an annual basis is 4%. So if you consider what we've done in the last 2 years, we think there's continued opportunity there. And if you listen to the amount of design wins that John talked about, it was very wide and deep in terms of packaging, agricultural, synthetic diamonds, multiple solar opportunities and more thin film applications or industrial coating applications. So it's a wide swath of opportunities. So we feel very confident that our projected growth with those markets will be consistent.

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Operator [13]

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And our next question comes from Amanda Scarnati with Citi.

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Amanda Marie Scarnati, Citigroup Inc, Research Division - Semiconductor Consumable Analyst [14]

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Can you just clarify where the inventory levels are at customers? I know last quarter we talked about it could take another quarter or so for the burnout to continue. But if you saw pull-ins this quarter, is some of that inventory already collected at your key customers?

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [15]

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Yes, Amanda, it's Jerry. So it's a little difficult for us to really project what the inventory level is by customer, at customer. And oftentimes, they'll get some unique opportunities on a specific line to pull a product in more than they had expected. Typically, when we see these types of downturns, they last 4 quarters or so, people go through their inventory burns. I mean, I can't project what it is this time, but it does appear right now that there's a stabilization, what we see in terms of people build schedules and what our inventory position is with them. So I think we're at a good place as far as a stabilized business is concerned. But I really can't see it in their inventories. And during these times, too, you get a lot of mix changes, which affect sometimes what the inventory position looks like and the amount of revenue. But I'd say we're in a very good, consistent spot at this point.

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Amanda Marie Scarnati, Citigroup Inc, Research Division - Semiconductor Consumable Analyst [16]

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And then can you just talk about the geographic split in revenue in the Advanced Markets? Is it more heavily weighted towards Asia? Just kind of continuing on the conversation from the last question. Or is it more kind of heavily weighted to the U.S.? Just kind of trying to gauge whether or not if macro condition is weak or that we should see some continued weakness.

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John T. C. Lee, MKS Instruments, Inc. - President & COO [17]

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Yes, Amanda. Yes, we'll get you the exact percentage, but most of the advanced market opportunities are Asia. China is a big market for us but as well as Taiwan and Korea and Japan. So those are the major markets as well.

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Amanda Marie Scarnati, Citigroup Inc, Research Division - Semiconductor Consumable Analyst [18]

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Right. And then you mentioned that design wins are still relatively strong in that market.

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John T. C. Lee, MKS Instruments, Inc. - President & COO [19]

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Yes, in certain markets, yes. For instance, in certain markets like solar, it's still very hot and still lots of opportunities and demand for new design wins.

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [20]

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And just to give some additional color, all of the design wins that John just talked about, Advanced Markets, 90% of them came from either Europe or the United States.

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Amanda Marie Scarnati, Citigroup Inc, Research Division - Semiconductor Consumable Analyst [21]

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And then just the one question I have is do you expect to update any sort of guidance next week once the ESI acquisition closes? Or is that just we'll hear about that more next quarter?

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Seth H. Bagshaw, MKS Instruments, Inc. - Senior VP, CFO & Treasurer [22]

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Yes, this is Seth. I mean, yes, we'll try -- maybe next quarter. So again, we close on Friday. So we'll need a little time. We know that company. Worked well with the team. The integration has gone very well. We shall make sure we get in there for a while, understand the business before we update the guidance, which is what we did with Newport as well. So our pretty standard procedure, so.

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Operator [23]

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And our next question comes from Tom Diffely with D.A. Davidson.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [24]

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A couple more questions on the Advanced -- okay, on Advanced Materials side. So I guess first of all, when you look at your laser business and the kind of the flattish environment we've been in for a while, that's much better than most of your peers that are calling for pretty big sequential declines. Is it just because you don't have as much exposure in the -- that market? Or do you think it's geographic exposure? Or is it share gains? How do you think you're outperforming?

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [25]

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Yes, Tom, so I'll talk a little bit about the growth rate. So we saw our laser revenue grow over 24% year-over-year on a full year basis. And it's -- there's multiple applications. So we -- we're really happy with the strength. And then what that does is that pulls along with it other opportunities for optics and motion, beam profiling. So things on that line. So we're really thrilled about how we've seen the growth in that business. And John would like to talk a little bit about the applications and the difference.

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John T. C. Lee, MKS Instruments, Inc. - President & COO [26]

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Yes, Tom, I think we've mentioned it before. The difference really is the high-power industrial type of laser applications versus the lower-power pulse microprocessing laser business. And so we're exposed to the latter much more than the former. And I believe some of the tiers that we have that have seen headwinds are really because they're exposed to that high-power market.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [27]

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Okay. And then at this point, are there certain seasonal trends that you've seen in advanced packaging that have changed over the last couple years as you've gotten more exposed on the laser side?

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John T. C. Lee, MKS Instruments, Inc. - President & COO [28]

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Yes, there is a bit of a cycle in terms of consumer products, right? So there's a component of the business that we're starting to see a little bit going back where in the spring, they kind of decide -- the big consumer products people decide what their likely volumes will be for Christmas, which then backs up the chip guys and the packaging guys and all that. But as Jerry mentioned, there are many other markets, so -- that aren't cyclical in that way.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [29]

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Okay. And then just finally, shifting over to the semiconductor side of the business. When you look at the different OEM customers, is there a difference in ordering patterns based on geographic locations where your customers in Korea order at a different pace or rate than the ones in the U.S.?

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [30]

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It actually comes down to their operational confidence and capability. There are customers that still stick to the old MRP process where they want to build schedule, load it in MRP and they place blanket orders. There are customers that we have Lean arrangements with where as they build and pull our equipment, we stock it. And then there are some hybrids between it. There are some people that buy inventory in advance of a ramp and stock their shelves until they're bulging. And there are other customers that keep their inventory lean. It depends on how short lead times and cycle times to replenish it. So really, it's really all over the map. And I think we see with some customers we can sell what they appear to be, but we can't quite calculate a little heavier inventory because of their ordering patterns versus what their revenue appears to be and others that appear to be consistent. But it's really all over the map, Tom. We've tried over the years because we're a Lean provider. Our short terms are very quick. And we have all lean factories and just-in-time delivery systems from our suppliers. So we have Lean material acquisition systems. And we have tried for years to convince our customers to move away from MRP and long-term contracting and schedule deliveries to line-side supply because it just is consistent and just it takes all the forecasting concern out of it. And we've converted probably half our customers to see it that way, and the other half remain with old line production problems. So it's really a mix.

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Operator [31]

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And our next question comes from Patrick Ho with Stifel.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [32]

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Jerry, maybe first off, in terms of some of the design wins and share gains you've talked about in your prepared remarks, are they all coming from the Advanced Markets side of things? Or are you also seeing gains and new opportunities on the semiconductor side? And if so, on the semi, is it more in your core backend analysis or on the Light and Motion side that you acquired from Newport?

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [33]

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Yes. So Patrick, I'll split the question with John. But the proponents of the design wins we mentioned in the script are all from the Advanced Markets. So thin film for beverages, synthetic dye or -- diamond manufacturing. It's across a number of different applications, whether it's power -- a microwave power or lasers or pressure control or our Mass Flow Control. So it's really nice to see that it's a wide swath of technology across multiple divisions and for multiple long-term applications. It's really widespread. So I'd say V&A and L&M are enjoying almost equally the opportunity. We did talk about over $50 million of Light and Motion semiconductor design wins in '18, and those were our cross-sell opportunities from the V&A group. So the old MKS of Vacuum and Analysis group, our sales team worked with their customer base in semi to introduce the Light and Motion product portfolio, whether it be lasers or motion, and we saw over $50 million of cross-sales in that case. As far as the design wins inside semi, I'll turn it over to John to give you a little more cover about that.

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John T. C. Lee, MKS Instruments, Inc. - President & COO [34]

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Yes, Patrick. So the answer is we're seeing both the Light and Motion and Vacuum and Analysis divisions get semi design wins. And we didn't mention a lot about the semi design wins, but they continue to be very strong in power and plasma as well as in some of our gas analysis business groups.

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [35]

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And I know it sounds crazy for me to say we -- there are parts of downturns we like because nobody likes that. But over my career with the company, we have always emerged stronger and larger out of a downturn because of the design opportunities. And customers continually want to see larger, stronger, global footprint of suppliers that they can depend on that are financially stable. And our ability to increase the revenue in Advanced Markets makes us even more attractive to our semiconductor customers because they know we have the capability to invest in R&D, in infrastructure and inventory because we don't suffer the same concerns as somebody that's so semi-dependent. So we're really looking forward to more market share gains from this -- the design win. And I make our sales people get on the road even more so on the design win side and maybe just get another order.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [36]

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Great, that's helpful. And maybe, Seth, as my follow-up question in terms of the gross margins, I think you mentioned in your prepared remarks that it was primarily absorption. Were there any other variables that impacted gross margins both for the December quarter and your March quarter outlook? Or is it primarily just the lower revenue levels that are impacting that metric?

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Seth H. Bagshaw, MKS Instruments, Inc. - Senior VP, CFO & Treasurer [37]

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Yes, Patrick. So yes, the bigger driver is lower volumes. You're right. And so it becomes higher when the factories aren't running at full capacity. So that's the biggest driver. A little bit of mix there, too, in Q4, which is sort of forecasted continuing through into Q1 as well. But I would say that the factory utilization and mix are the 2 biggest drivers for sure.

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Operator [38]

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And our next question comes from Krish Sankar with Cowen.

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Robert Bruce Mertens, Cowen and Company, LLC, Research Division - Research Associate [39]

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This is Robert Mertens on behalf of Krish. First question, just sort of around your semi customers' inventory. I know you've mentioned that it's very hard to gauge and there's a whole lot of moving pieces of the puzzle there. But for these customers that are sort of on the older inventory systems that tend to run higher inventory levels, do you expect a bigger bounce back in demand once they run through this inventory and the semi market starts to rebound a bit? Is that the correct way to think about it?

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [40]

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Yes. Actually, they're counseling us to don't go away, keep your inventory high, keep your people in place. We want you to respond. And so look, we won more awards for ramping ability than almost technology wins. So have no fear. We manage the expenses appropriately, but we'll be prepared. And that's absolutely what will happen. Sometimes, people drain their inventory too low and then they go, oh no, okay, we drained too low. Can you respond quickly? And we're like, sure, we'll take any order and we'll turn it within a quarter if necessary. So that we expected to happen. Some people come back consistently and other people just panic and place a bunch of orders and we have to turn around quickly. We're used to that. We've built a machine that can respond to anything.

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Robert Bruce Mertens, Cowen and Company, LLC, Research Division - Research Associate [41]

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Great. And then just as a follow-up, turning to the Advanced Markets side of things. It looks like that you're seeing strong, steady demand but maybe a little bit of a moderation in the second half of this year and coming off of this high -- or this double-digit growth into maybe a softer macro demand environment. How should we sort of think about that throughout this year? I know you've mentioned a lot of design wins in a lot of different areas, which is great. Or is there a time frame that a typical design win goes into a revenue recognition? And -- or is it all over the place since they're pretty specific applications?

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [42]

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Yes, it really varies in terms of the duration. Some can be almost immediate and some take a year or 2 to come to fruition. The industry average for our Advanced Markets is 4%. So the fact that we grew it 14% 2 consecutive years tells you about our design win and capturing share. And we expect -- and our internal goal is always to be twice what the industry average is. And so we'll do whatever we need to do to get share because we don't have 100% market share. So even if the growth rate in a year moderates, our expectation is to get out in the street with our salespeople and our capability and products to take share. So we still see the industry average as 4%, and us growing at least twice that over time. But you'll see the -- you may see a bit of a moderation due to tariff concern or whatever the issue that may impact us. But over time, it's pretty significant. And again, one of the things that I'll reiterate, over 90% of the design wins John mentioned in his portion of the script were in Europe and the United States, which he talked about a nice opportunity outside of Asia for growth of the business. So John, do you want to comment on anything else on Advanced Markets?

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John T. C. Lee, MKS Instruments, Inc. - President & COO [43]

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Yes, I think we were always targeting that 2x monthly growth rate, as Jerry says. That's 8%. And we just overshot it, obviously, 2 years in a row. Our plan is to -- we expect to go another 8% this year, but we have a history of overshooting. And so that's what we'll strive for internally.

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Operator [44]

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(Operator Instructions) And our next question comes from Mark Miller with Benchmark Company.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Research Analyst [45]

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Just was wondering if the Chinese New Year along with the government shutdown, especially for your research lasers for like NIH, did they have any impact on your guidance for the third quarter?

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Seth H. Bagshaw, MKS Instruments, Inc. - Senior VP, CFO & Treasurer [46]

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No. Not -- no. Not at all.

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [47]

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No.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Research Analyst [48]

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Okay. I just was wondering about ESI. How exposed are they to the smartphone market?

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John T. C. Lee, MKS Instruments, Inc. - President & COO [49]

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Mark, this is John. Flex PCBs are used in the mobile smartphone market quite a bit, as well as other kinds of devices. So they have a fairly significant exposure to the phones, which is good and bad. But the way we look at it is mobile has been very strong over many years. It was not as strong as past year for sure. And it's not about one customer. I think it's just the macro smartphone market, but we expect the content of flex to increase per phone going forward. So we still look at that exposure to mobile as a good thing from an ESI perspective.

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [50]

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Plus the application in things like automotive. If you think about dashboards on cars today, there's more -- anywhere where you have to twist and turn for some type of illumination or read-out, there'll be a need for a flexible PCB application, the growth of 5G over time, which John mentioned about. So we're very excited about -- beyond mobile and peripheral devices, the application of their product.

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John T. C. Lee, MKS Instruments, Inc. - President & COO [51]

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Yes, Mark. The other -- I think you know that ESI had released a new, via old drilling, a tool addressing the high-density interconnect market. So not flexed. And so that's a whole market opportunity that is another growth driver as well but not as tied to phone.

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [52]

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And that's all upside for them.

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John T. C. Lee, MKS Instruments, Inc. - President & COO [53]

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Right.

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [54]

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All upside.

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Mark S. Miller, The Benchmark Company, LLC, Research Division - Research Analyst [55]

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So they had a strategic position of starting to develop their own lasers for some of their products. How has that come along? Or will you be supplying some of the lasers for them?

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John T. C. Lee, MKS Instruments, Inc. - President & COO [56]

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Mark, it's John again. So we had mentioned in the past we actually won our first laser for their tool. And that was before we talked about buying them, though. So it was legitimate. But you're right. Historically, they have had their own laser division that has supplied lasers to some of their tools. But historically, they've also used other people's lasers at the same time. And so of course, as we put ESI into the family, we'll look at our laser division, and it may add to our laser portfolio if this -- they do some unique things there as well.

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Operator [57]

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Ladies and gentlemen, that concludes our Q&A portion of today's conference. I would now like to turn your call back over to Jerry Colella, Chief Executive Officer, for any closing remarks.

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Gerald G. Colella, MKS Instruments, Inc. - CEO & Director [58]

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Thank you.

We're pleased with our results for fiscal 2018. Despite the slowdown in semiconductor CapEx spending, we delivered a record year for both revenue and non-GAAP net earnings. Our significant exposure to diverse end markets combined with our global leadership position in the semiconductor market will continue to drive sustainable and profitable growth. I am more confident than ever that the strategy we've put in place has positioned us for the long-term outperformance. Thank you for joining us on the call today and for your interest in MKS. We look forward to updating you on our progress when we report our first quarter 2019 financial results. Thank you.

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Operator [59]

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Thank you. Ladies and gentlemen, that now concludes our conference call. Thank you for attending, and have a great day. You may all disconnect.