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MKS Instruments Inc (NASDAQ:MKSI)
Q2 2020 Earnings Call
Jul 30, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to MKS Instruments' Second Quarter Earning Conference Call. [Operator Instructions] I would now like to introduce your host for today's conference, David Ryzhik, Vice President of Investor Relations. Sir, please go ahead.

David Ryzhik -- Vice President, Investor Relations

Good morning, everyone. I am David 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 second quarter of 2020, which are 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 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 representing 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.

John T.C. Lee -- President and Chief Executive Officer

Thanks, David. Good morning, everyone, and thank you for joining us today. MKS delivered strong second quarter revenue of $544 million above the high end of our guidance range. Non-GAAP net earnings were $89 million or $1.62 per diluted share, which was also above the high end of our guidance range.

As we noted on our Q1 earnings call, our second quarter guidance assumed a negative impact to revenue from COVID-19 shelter-in-place disruptions. However, our factory constraints eased throughout the quarter and by working closely with our suppliers, we were able to deliver strong results. I'm very proud of our worldwide team and how we continue to manage through COVID-19 challenges without compromising our relentless focus on serving our customers.

The COVID-19 pandemic remains fluid and we continue to monitor its impact on our global operations and will respond as necessary. Sales to our semiconductor market grew sequentially, driven by all product categories, but most notably by our Power Solutions business. One of the strengths of our Surround the Chamber strategy and broad technical expertise is our ability to see technology inflections on the horizon and to proactively address these market needs. Several years ago, we decided to strategically invest in our Power Solutions business in order to solve the critical etch challenges presented by extreme vertical scaling. I'm happy to announce that in the second quarter, we delivered record revenue in this business.

Demand for our market-leading pressure measurement solutions was also strong and we secured several design wins on advanced deposition and etch tools. Our plasma and reactive gas portfolio continues to gain traction in atomic layer deposition and advanced wet clean applications. In ALD, we secured two design wins for our Remote Plasma Sources, one of which includes a key design win at a leading OEM. We also secured several design wins for our dissolved reactive gas solutions, which are becoming more important in an increasing number of applications for leading-edge semiconductor manufacturing. Our optical components and subsystems are a key strategic growth initiative within our semiconductor market.

We see an attractive opportunity to strengthen our optical capability to help solve critical challenges across lithography, metrology and inspection applications. And we are investing accordingly in what we have termed world-class optics. We are very pleased to announce that we have already secured double-digit design wins over the past 18 months.

As we look into the third quarter, we expect semiconductor demand to remain healthy and we estimate our semiconductor revenue to increase sequentially. Within our Advanced Markets, we experienced strong growth in PCB drilling applications, offset primarily by lower revenue from certain industrial applications, as a result of a softer macro-environment and government restrictions on customers whose businesses were designated as non-essential.

As a reminder, within our Advanced Markets, we are especially excited about the long-term opportunity in advanced electronics manufacturing, which is a key driver of precision laser-based processes that enable miniaturization and increased functionality. MKS is positioned to be a key beneficiary of these trends, given our unique portfolio and expertise across lasers, optics, photonics, motion and laser-based systems.

In the second quarter, we secured a meaningful laser design win for a solar application with a key OEM customer and we see continued strong interest in our lasers across PCB, display and advanced packaging applications. Moreover, we have secured more than 10 design wins in the first 12-months, since introducing our new picosecond UV lasers, with several in the second quarter alone.

Revenue from our equipment and solutions division exceeded our expectations, led by strong demand for our Flex PCB via drilling systems. While unit volume and content are important drivers of Flex PCB capacity demand, new requirements also drive technology transitions such as the need for smaller and more accurately placed vias as well as advanced material specifications for 5G antennas. We believe we are well positioned to address these critical technology transitions with our leading-edge CapStone Flex PCB solution.

Testing of our new high-density, interconnect drilling tool continues to progress as planned and we have received positive feedback from our beta customers. In fact, we are pleased to announce that one of our beta customers has successfully qualified our HDI tool, which represents a major milestone for MKS and a key validation of our HDI technology. As a reminder, 2020 remains a year focused on qualification of our beta tools and we are optimistic we will begin generating meaningful revenue in 2021.

We are encouraged by the overall stability in our Advanced Markets during the second quarter and we expect the stability to continue in the third quarter, as we project seasonal softness in our Flex PCB Systems business, offset by a recovery in revenue from certain industrial applications. Before I turn the call over to Seth, I would like to comment on the recent changes in export rules announced by the Department of Commerce, which went into effect during May and June. Our global team has completed the work to ensure compliance of the new rules. We have carefully evaluated these regulations and we currently do not expect them to have a significant impact on our financial results. We will continue to monitor and respond to any changes in the regulatory environment as necessary.

And now, I'd like to turn the call over to Seth.

Seth H. Bagshaw -- Senior Vice President, Chief Financial Officer and Treasurer

Thank you, John. I'll cover our second quarter results then provide additional detail on a third quarter guidance. Sales for the second quarter were $544 million, up 2% sequentially and 15% year-over-year. The strong performance reflects continued strength in our semiconductor market as well as exceptional efforts in managing shelter-in-place restrictions throughout our worldwide manufacturing and service operations. For the second quarter, semiconductor sales were $321 million, up 3% sequentially and up 50% year-over-year, reflecting strong industry fundamentals.

Sales for Advanced Markets were $223 million, consistent with the first quarter. As John mentioned, strength in advanced electronics manufacturing applications led by demand for our flexible PCB drilling systems were offset by a lower revenue from certain industrial applications. In addition, revenue from our research market was consistent with the first quarter levels, which was better than we anticipated as demand appears to stabilized.

For the quarter, the revenue split between the semiconductor and Advanced Markets was 59% and 41%, respectively. Second quarter non-GAAP gross margin was 45.3%, a sequential increase of 60 basis points and 180 basis points above the midpoint of our guidance range due to higher volume and favorable product mix. Non-GAAP operating expenses were $129 million, a sequential decrease reflecting our continued focus on cost control even with higher than anticipated revenue volumes. Second quarter non-GAAP operating margin was 21.6%, a sequential increase of 110 basis points, reflecting strong financial leverage in our operating model.

Non-GAAP net interest expense for the second quarter was $7 million and a non-GAAP tax rate, which reflects a higher U.S. mix of taxable income, was 18.5%. Non-GAAP net earnings for the second quarter were $89 million or $1.62 per diluted share, which exceeded the high end of our guidance range. In the second quarter, revenue from our equipment and solutions division was $64 million, a sequential increase of 25% driven by strong demand for our Flex PCB via drilling solutions.

We expect revenue from our equipment and solutions division to decrease sequentially in the third quarter, reflecting a typical seasonal decline in the Flex PCB drilling market. Equipment and solutions' non-GAAP gross margin increased 90 basis points sequentially to 46.5% in the second quarter driven by product mix and higher volume. Last quarter, we announced that the integration of the ESI acquisition was substantially complete and we had achieved our target of $15 million of annualized cost synergies, well ahead of schedule. We are pleased to announce that exiting this quarter, we've increased these savings and have now realized a total of $17 million of annualized cost synergies. Now turning to the balance sheet. Exiting second quarter, we maintained a strong balance sheet liquidity with cash and short-term investments of $607 million and $100 million of incremental borrowing capacity under an asset-backed line of credit, subject to certain borrowing base requirements. Our net leverage ratio further decreased to 0.5 times, highlighting our ability to generate strong EBITDA and cash flow.

Also in the second quarter, we made a dividend payment of $11 million or $0.20 per share. In terms of working capital, day sales outstanding were 64 days at the end of the second quarter compared to 65 days at the end of the first quarter and inventory turns were 2.4 times compared to 2.5 times in the first quarter. Free cash flow for the quarter was a record at $118 million or 22% of revenue and included $21 million of capital expenditures. Operating cash flow of $139 million was also a record for the quarter.

I'll now turn to our third quarter outlook. Based on current business levels, we estimate that our revenue in the third quarter could range from $535 million to $585 million. We estimate that our non-GAAP -- our third quarter non-GAAP gross margin could range from 44.5% to 46.5%, reflect anticipated product mix in revenue levels. Third quarter non-GAAP operating expenses could range from $126 million to $134 million. R&D expenses could range from $41 million to $44 million and SG&A expenses could range from $85 million to $90 million. Non-GAAP net interest expense estimated to be approximately $6 million and our non-GAAP tax rate expected to be approximately 18%. Given these assumptions, third quarter non-GAAP net earnings could range from $86 million to $108 million or $1.55 to $1.95 per diluted share.

I'd like to now turn the call back to you, operator, for Q&A.

Questions and Answers:

Operator

Certainly. [Operator Instructions] Our first question comes from the line of Patrick Ho with Stifel. Your line is now open.

Patrick J. Ho -- Stifel Nicolaus -- Analyst

Thank you very much and congrats on the nice quarter. John, maybe first off, you mentioned the gains you've made on the Power Solutions business, particularly for etch applications. Can you detail just a little more color on the types of etch applications that they are in? Are they for like high aspect ratio etches and some of the more complicated processes that we're seeing today?

John T.C. Lee -- President and Chief Executive Officer

Hi, Patrick. Yeah, I'd be happy to comment on that. I think historically, we've had strong leadership in dielectric etch for high aspect ratio etch processes and that's continued. But in addition to that, we are also seeing meaningful revenue now in conductor etch and so it's a combination of both. Majority is still dielectric etch for high aspect ratio etch, but we're seeing both now.

Patrick J. Ho -- Stifel Nicolaus -- Analyst

Great, that's helpful. And maybe on the Advanced Markets side, obviously, the macro-economy is having some pressure on some of these industrial markets, do you believe that that's the only variable that will eventually cause a turn in that business or are there other, I guess, company-specific or industry-specific variables that we should be looking out for?

John T.C. Lee -- President and Chief Executive Officer

Yeah, I think, the only other thing I would point out Patrick is any kind of trade tensions that either will ease up or could get worse, so that we had noted in the past has affected kind of the Advanced Markets as well. So that would be an additional one that we always keep an eye on.

Patrick J. Ho -- Stifel Nicolaus -- Analyst

Great. And final question from me for Seth. In terms of opex, it's been strong in the June quarter and it looks like it continues to be managed well going into September. Now, part of that probably is also less travel and less expenses on some of those type of areas. How do you look at opex particularly as the environment starts to normalize somewhat and you get to called back to normal conditions, where travel picks up again and things of that nature?

Seth H. Bagshaw -- Senior Vice President, Chief Financial Officer and Treasurer

Yeah, good question, Patrick. So our DNA has obviously managed the cost structure pretty diligently no matter what part of the cycle we are on. So there's definitely some savings in the quarter for, to your point, lower travel and also higher compensation in the quarter because we're performing better than we expected coming into the year. So I think those would net out in the second quarter and in Q3 as well. So I would say, looking forward, there will be a little -- get back to pre-COVID levels, a little more travel, but they're really not significant numbers relative to current run rates in the business.

Patrick J. Ho -- Stifel Nicolaus -- Analyst

Great. Thank you again.

Seth H. Bagshaw -- Senior Vice President, Chief Financial Officer and Treasurer

Yeah, thanks, Patrick.

John T.C. Lee -- President and Chief Executive Officer

You are welcome, Patrick.

Operator

Thank you. And our next question comes from the line of Krish Sankar with Cowen & Company. Your line is open.

Krish Sankar -- Cowen and Company -- Analyst

Yeah, hi. Thanks for taking my question. I had a couple of them, John. Just wanted to follow up on the power supply. You said, you're seeing traction in conductor etch, and if you look at the industry incrementally the spending on the memory side is coming from NAND. So that kind of probably ties in with the conductor extraction. So I just want to verify, A, is that true? And if that is true, how will your power supply business trend as the memory mix shifts toward DRAM?

John T.C. Lee -- President and Chief Executive Officer

Yeah, I think, so that is true, Krish. Some of the conductor etch is being driven by NAND. But I think, those kind of customers will also be equally effective or have share when it goes to DRAM. So I think, between V-NAND and DRAM, I don't expect a large difference. Logic would be probably a different story.

Krish Sankar -- Cowen and Company -- Analyst

Got it, got it. Fair enough. And then, I don't know if you have good clarity into this, but do you think at some point even in the second half of this year, your semi-OEM customers might build inventory or do you think they're going to just to be on the safer side or do you think they're going to be more pragmatic about it?

John T.C. Lee -- President and Chief Executive Officer

It's tough to say. The history has said that inventory always gets build up after multiple quarters of -- up into the right. And I don't really -- can't comment on what our OEMs are doing at this moment, but it tends to just go that way as people will start getting ready to make sure that they have enough raw material in their factories.

Krish Sankar -- Cowen and Company -- Analyst

Got it, got it. And then, John, if I can just squeeze in a question on the non-semi business. On the PCB drilling side, is the demand still mainly smartphone or are you seeing other applications? And then in September, you said the laser business is going to recover. Do you think that's a cyclical inflection for the industrial laser business or is it too early to call it? Thank you.

John T.C. Lee -- President and Chief Executive Officer

Yeah, I would say for the Flex PCB drilling that's really driven by flex circuits and that is still mostly driven by smartphones. But as we've commented in the past, other peripheral types of devices like airpods and iPads and things like that are also having -- increasing their flex content. So I think, it's still mostly smartphones, but other devices are also driving it. And then with respect to recovery lasers, as we have talked about, it's really about pulsed lasers for us versus fiber lasers. And so I think, we're just happy with the current status. Things have stabilized. We are still working very closely with OEM partners there and that activity hasn't really changed and stabilized.

Krish Sankar -- Cowen and Company -- Analyst

Thanks, John.

John T.C. Lee -- President and Chief Executive Officer

Thanks, Krish.

Operator

Thank you. And our next question comes from Jim Ricchiuti with Needham & Co. Your line is open.

James Ricchiuti -- Needham & Company, LLC -- Analyst

Hi. Good morning. Just question on the equipment business. Sounds like you're seeing some deceleration there. You've had a couple of really strong quarters. What kind of line of sight do you have in that business as you look out beyond the next quarter or so? Are you seeing perhaps some signs that maybe we're in for a longer pause or do you expect that the bookings to start picking up again?

John T.C. Lee -- President and Chief Executive Officer

Yeah, Jim. It's John.

James Ricchiuti -- Needham & Company, LLC -- Analyst

Okay.

John T.C. Lee -- President and Chief Executive Officer

I assume you are referring to the semiconductor market, right?

James Ricchiuti -- Needham & Company, LLC -- Analyst

Yeah, I'm referring to the flex business, John. It sounds like you've had some couple of good quarters in the year with ESI business and I know that business can be fairly volatile quarter-to-quarter. But what are you seeing in terms of -- what are you hearing from your customers as you look at over the next couple of quarters?

John T.C. Lee -- President and Chief Executive Officer

Yeah, I think generally as expected, you have some of this discussion in Q1. You see some orders pick up and you see some delivery and then, of course, Q2 is the big quarter and so I think that's what you're seeing now. I think, if you kind of look at Q3, it's usually -- it goes back down and then it's really determined by whether that smartphone cycle really picks up beyond the expectations of what our customers expect to build today. And so it can actually go back up a little bit or as we expect, it will go down. That's really going to be dependent on how popular some of the new models of phones are and whether smartphones in general start picking up in the second half of the year.

James Ricchiuti -- Needham & Company, LLC -- Analyst

Got it. And then on the Advanced Markets side of the business, looking at that business again, ex the semi piece, you are expecting some recovery in the industrial. It also sounds like and we've heard this from others as well that it's been a little bit more challenging getting into some of the research in labs because of COVID. Are you anticipating that freeing up a little bit as you look out into the second half?

John T.C. Lee -- President and Chief Executive Officer

Yes, so with respect to research, we were expecting that we would have a full quarter's worth of limitations on getting into research labs in Q2 and we didn't see that. We actually saw it stabilized relative to Q1, which did see kind of half a quarter's worth of those kinds of restrictions. We are kind of expecting it to be stabilized going forward as some regions start opening up and some regions may take a little longer. So with respect to research, we kind of are planning on it being stable going forward.

James Ricchiuti -- Needham & Company, LLC -- Analyst

Got it. Thank you.

John T.C. Lee -- President and Chief Executive Officer

Thanks, Jim.

Operator

Thank you. And our following question comes from the line of Sidney Ho with Deutsche Bank. Your line is open.

Sidney Ho -- Deutsche Bank -- Analyst

Great, thank you very much for the questions. My first question is, I see that the -- in terms of revenue guidance for Q3, I see that the range of that guidance is now back to the more normal levels of $15 million. Is that an indication that you guys feel there won't be much of an impact from the disruptions from neither your own operations or your supply chain? And maybe, it's just related to that, how would you characterize your visibility versus the pre-COVID levels maybe in terms of backlog coverage or lead times or whatever metrics you want to share?

Seth H. Bagshaw -- Senior Vice President, Chief Financial Officer and Treasurer

Yeah. So this is Seth. So you're right. We did take the range up this -- the third quarter back to pre-COVID levels and you're right, that's indication we feel supply chain operations are much more certainly in better shape now than entering the second quarter. So that's why we overachieved in the quarter as well. So that's true statement. Visibility, I would say, it's still very similar, I mean, for the semi side of the house where it turns business, so we'll book and turn a lot in the same quarter. That's true in the Light & Motion division as well. So I think, the visibility is similar now as it was before. I think, and we said this in the prepared remarks in John's section, there is still with the COVID-19 level of fluidity out there that we have to be aware of and be confident of, but I would say, right now, nothing uniquely different. We are seeing visibility now than it was in a pre-COVID level.

Sidney Ho -- Deutsche Bank -- Analyst

Great. Follow to that, do you think your shipment in Q3 is now reflecting the end consumption by your customers or does that reflect some sort of catch up demand from the previous two quarters? On the -- conversely, to ask the same question, do you think there may be some inventory build by a customer because, last night, one of the customers did talk about building some inventory to meet Q3 demand?

John T.C. Lee -- President and Chief Executive Officer

Yes, Sidney. It's John. I can take that. I think, as you know, we kind of front-run our OEM customers. So we've shipped a lot in Q2, as we're talking about today. We expect that Q3 we'll ship even more, slightly more. So I really can't comment on how much inventory they are building versus getting their equipment out. It certainly seems to be a strong market right now and as I said earlier, as the market goes up into the right and continues, there's always a little bit of inventory build. But we're still kind of in the early innings of the -- this cycle.

Sidney Ho -- Deutsche Bank -- Analyst

Okay, that's helpful. Maybe one last one from me. Maybe sticking with the semi side, based on the first three quarters, including your third quarter guidance, your semi business will be up 40%, 50% year-over-year versus the market is more like up 10% to 20%. I mean, we've seen that kind of outperformance before in like, let's say in 2017. But that's when WFE was a lot stronger, especially for memory. Is there a way to parse out your growth rate this year between market growth, maybe little bit inventory restocking, maybe some market share growth and maybe whether that's from existing product or your new product, so you guys talk about the RF power, the ozone solutions for ALD, etc. Just trying to understand how to think about the difference between your growth and the market growth and thanks.

Seth H. Bagshaw -- Senior Vice President, Chief Financial Officer and Treasurer

Yeah, I think I'll start with that, Sidney. So you are right, we are over achieving versus WFE estimates in the year-to-date so far and as John mentioned, some of that is typically a pre-run on the inventory in a ramp environment. But over the long term, we have outperformed the semi market for all the reasons you mentioned. Technology we provide is essential for next nodes and technology application. So in the long term, we do outperform the WFE estimates or actuals in the industry. Just hard to really quantify that in kind of a nine month cut. So it's really a little bit of a build and a ramp. It's market share gains. It's growth in the Power Solutions business and we have again in the long-term outperformed WFE. So number of those factors in there, but it's just hard to quantify in kind of a nine month slice what those pieces are.

Sidney Ho -- Deutsche Bank -- Analyst

Great. Thank you.

Seth H. Bagshaw -- Senior Vice President, Chief Financial Officer and Treasurer

Yeah.

Operator

Thank you. And our next question comes from the line of Amanda Scarnati with Citi. Your line is open.

Amanda Scarnati -- Citi Research -- Analyst

Hi, good morning. The first question I have is on China and were you seeing any sort of signs of a pull-in of demand ahead of these Commerce Department regulation taking place? I know that you're not seeing any sort of material impact from the regulations themselves, but do you think any of your customers were kind of taking a little bit more of a cautious approach?

John T.C. Lee -- President and Chief Executive Officer

Hi, Amanda. It's John. We look at that all the time and there was always a little variation but we have certainly not seen any kind of large move in that kind of direction. We talk to a lot of these customers all the time. We still think they're ordering for what they need and not trying to pull it, so that's kind of our view today for our business in China.

Amanda Scarnati -- Citi Research -- Analyst

Great. And then on the PCB side of the business, can you just help me understand the seasonality in that business? We look at sort of 3Q for smartphone suppliers for chipset that typically tend to be a stronger seasonal quarter and we're certainly seeing that in guidance coming out this quarter. We are calling for some seasonally down September quarter. Can you just talk about how that transition works in the PCB side of the business for you?

John T.C. Lee -- President and Chief Executive Officer

Yeah, I think it's a -- easy to explain. I think our customers are the people who need tools, our tools to make PCBs and so of course, as you pointed out, the smartphone makers need their parts in that Q3 time-frame, which means that the factories that make those parts have to have that equipment in kind of in the Q2 time-frame. So that's really kind of how we look at that quarter rise, the difference between when our PCB equipment sales goes up versus the industry wide-chip revenue for smartphones goes up. That makes sense?

Amanda Scarnati -- Citi Research -- Analyst

Yes, it does. And then the last question I have, if I could squeeze it in on the power side of the business. Are you starting to see any significant growth from logic and foundry? I know you mentioned that you have certain testing conductor etch vias there and is there any growth that you're seeing from there or is it sort of expected for maybe 2021?

John T.C. Lee -- President and Chief Executive Officer

As I mentioned earlier, the growth in power for conductor etch, I think that's your question, is still mostly memory-driven at this point for us.

Amanda Scarnati -- Citi Research -- Analyst

All right. Thank you.

John T.C. Lee -- President and Chief Executive Officer

Thanks, Amanda.

Operator

Thank you. And next question comes from the line of Joe Quatrochi with Wells Fargo. Your line is open.

Joseph Quatrochi -- Wells Fargo Securities -- Analyst

Yeah, thanks for taking the question and congrats on the solid results. Maybe first, if you could kind of talk about the 10 picosecond laser wins that you've had. How should we think about the timing of ramp of revenue for those over the next few quarters?

John T.C. Lee -- President and Chief Executive Officer

Joe, it's John, I'll take a crack at that. I think a lot of these design wins for lasers can turn into the volume revenue quite quickly actually and it just depends on the various customers. And so it's hard to kind of expect that but certainly not in the kind of time-frame for like semi design wins, where it could be a couple of years before you see volume. Views can actually turn within six months to 18 months. I think that that's kind of the sweet spot. Some could be longer and some could be even quicker. And I also wanted to clarify a little bit, when we say we saw some industrial markets that were a little weak in Q2, wasn't -- it wasn't in the lasers. So our laser business has been actually very consistent and strong.

Joseph Quatrochi -- Wells Fargo Securities -- Analyst

That's helpful. And then on the semi side, you talked about securing a number of wins around optics over the last 18 months. Can you talk about what's driving that and just is that an area of investment going forward that maybe we should think about a larger focus on?

John T.C. Lee -- President and Chief Executive Officer

Yeah, Joe. Thanks for the question. I think that is an area of focus for us. So those 18 or those design wins over the last 18 months were all -- we only count the ones that we won because of investments we made that were different from before. So we had other design wins, but that was with our previous technology. So we actually invested in new technology, processes, new capabilities and process engineering talent and so they are very specific investments we made and at MKS, we'd like to keep track of things. So that investment is really tracked toward these design wins and so basically we're expanding our capability, so that we can serve those customers with capability we were not able to before and so that's really exciting for us.

Joseph Quatrochi -- Wells Fargo Securities -- Analyst

Thank you.

John T.C. Lee -- President and Chief Executive Officer

Thanks, Joe.

Operator

Thank you. [Operator Instructions] Our next question comes from Mark Miller with Benchmark Company. Your line is open.

Mark Miller -- Benchmark Company -- Analyst

Congratulations on your quarter and the guidance. It's impressive. Just wanted to talk a little about the margins. The margins came in upside to the guidance by about 180 basis points. You indicated mix and volumes. In terms of mix, specifically what drove the higher than expected margins? Was it Power Solutions?

Seth H. Bagshaw -- Senior Vice President, Chief Financial Officer and Treasurer

I would say, Mark. in general, the volume is lot higher than we expected that's a number one driver in terms of normal margins. To your point, we usually see about a 50% variable gross margin. In this quarter, it's more I think in the 80% range sequentially versus Q1. The factories are running more efficiently now because we worked through our supply chain constraints with COVID-19, that's a big factor. And then we mentioned in the prepared remarks, the E&S division in the Flex PCB market, gross margins were north of 46% to corporate average. And so that's kind of the mix we're talking about in that one example. So it's volume, its efficiency in the factories and it's E&S division had a real strong margin quarter as well.

Mark Miller -- Benchmark Company -- Analyst

Just interested about pursuing this PCB drilling strength and specially with the smartphones kind of depressed, I'm just wondering where that's coming from specifically?

John T.C. Lee -- President and Chief Executive Officer

Hey, Mark. It's John. Even though volumes for smartphones is depressed relatively speaking the flex content in some of the more advanced phones can be significantly higher per unit and so that's kind of what's driving, I think this. But even though smartphone numbers are depressed, it's still large numbers and so the capacity is still needed in the industry. And so those two drivers, flex content per unit as well as just the fact that it's just a lot of units, even though it's less than what people had expected.

Mark Miller -- Benchmark Company -- Analyst

As the industry starts to transition to 5G phones, what opportunities that -- does that create for you?

John T.C. Lee -- President and Chief Executive Officer

Yeah, I think we've talked about it in the past. We think that in certain 5G phones, the amount of flex content could be 30% more than in a 4G phone and that's a huge amount of opportunity for us for flex PCB drilling. So that's how we look at 5G, but more broadly, 5G also drives more memory contents both Flash and DRAM. It certainly drives more advanced processing CPUs and so 5G and the trend toward that certainly drives our Flex PCB business, the E&S division. It drives our chip division, the V&A division because of those three types of chips. It also drives our Light and Motion division because of 5G phones anyway go to OLED and we have a lot of laser processes that are used for manufacturing displays. We also have a lot of lasers that are used for manufacturing some of the very small components within the next generation smartphones that aren't just flex.

Mark Miller -- Benchmark Company -- Analyst

Are you starting to see some traction coming from 5G or you expect more of that later this year?

John T.C. Lee -- President and Chief Executive Officer

That's hard to tell because when somebody is ordering a flex tool, we assume they're making some 5G phones and some non-5G phones, but we certainly don't have that visibility. We did read the industry where 5G phones might be something like 200 million units, I guess, this year. So that's a good tailwind for us.

Mark Miller -- Benchmark Company -- Analyst

Thank you.

John T.C. Lee -- President and Chief Executive Officer

Thanks, Mark.

Operator

Thank you. And I'm not showing any further questions at this time. I'd now like to turn the call back to John Lee for any further remarks.

John T.C. Lee -- President and Chief Executive Officer

Thanks everybody. So I'm very proud of the passion, dedication and resilience of our employees around the world. Needless to say, 2020 has had its share of challenges thus far, but I cannot be more proud and excited about the future of MKS. So thank you for joining us today and for your interest in MKS.

Operator

[Operator Closing Remarks]

Duration: 37 minutes

Call participants:

David Ryzhik -- Vice President, Investor Relations

John T.C. Lee -- President and Chief Executive Officer

Seth H. Bagshaw -- Senior Vice President, Chief Financial Officer and Treasurer

Patrick J. Ho -- Stifel Nicolaus -- Analyst

Krish Sankar -- Cowen and Company -- Analyst

James Ricchiuti -- Needham & Company, LLC -- Analyst

Sidney Ho -- Deutsche Bank -- Analyst

Amanda Scarnati -- Citi Research -- Analyst

Joseph Quatrochi -- Wells Fargo Securities -- Analyst

Mark Miller -- Benchmark Company -- Analyst

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