萬機儀器 (MKSI) 2004 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the MKS Instruments third-quarter 2004 earnings release conference call At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded today, Tuesday, October 19, 2004.

I would now like to turn the conference over to Ms. Jonna Manes, Director of Investor Relations. Please go ahead, ma'am.

Thank you. Good afternoon and welcome to our third-quarter earnings conference call. By now, you should've received a copy of our earnings release. If you did not, please go to our Web site at www.MKSinstruments.com, or you can call 978-284-4045 after this call.

As a reminder, various remarks that we may make about future expectations, plans and prospects for MKS constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in this afternoon's press release and in the Company's annual report on Form 10-K for the fiscal year ended December 31, 2003 and most recent quarterly report on Form 10-Q, each of which is on file with the SEC. In addition, these forward-looking statements represent the Company's expectations only as of today. While the Company may elect to update these forward-looking statements, it specifically disclaims any obligation to do so. Any forward-looking statement should not be relied upon as representing the Company's estimates or views as of any date subsequent to today.

Finally, I would like to remind everyone that during the Q&A period, each person will be limited to two questions. We will circle back for further questions as time allows.

Now, I would like to introduce John Bertucci, Chairman and Chief Executive Officer of MKS.

Thanks, Jonna, and thanks, everyone, for joining us today. With me is Ron Wiegner, our Chief Financial Officer. I'll give an overview of the third quarter, and then Ron will give a detailed review of the results. I will make some closing comments and then we will answer your questions.

Third-quarter sales totaled approximately 140 million and GAAP earnings were 12.2 million, or 22 cents per diluted share. Non-GAAP earnings, which exclude amortization of acquired intangible assets, were 15.8 million, or 29 cents per diluted share.

For the nine months, we achieved a sales growth rate of 80 percent, which reflects strong demand for our process control technologies and share gains in key markets. Over the same period, our semiconductor and thin-film sales growth rate was 98 percent, well above industry estimates of 61 percent growth for our semiconductor front end equipment market. You may recall that our order rates were higher than we expected in the first and second quarters of 2004.

Semiconductor OEMs increased their work-in-process inventories as they raised tool production rates to meet increased demand. In the third quarter of 2004, we saw some softening in semiconductor OEM order rates along with stretched out delivery requests and order push-outs. We believe these lower orders for our products reflected a closer alignment of product demand to our customers' production rates.

Despite this order softening, we did achieve successes in the quarter. Our ozone technology continues to do well in the marketplace and we continue to see growing interest in the use of ozone for ALD and opportunities in other processes. For example, our ozone gas generators and liquid delivery systems, which provide high concentrations of ozone, are achieving excellent acceptance at advanced semiconductor fabs in Korea and Japan. Those fabs are now requesting our ozone products on the tools that they're buying from various OEMs. We are positioned to grow as ALD processes proliferate with a move to smaller geometries.

In the power area, new opportunities for our RF and DC power supplies increased during the quarter. Our strength in microwave power supplies for resist strip applications continued with major orders and shipments to OEMs. Compressor and flow measurement and control -- our new pendulum control valve was selected for etch and final flat-panel display tools in the quarter (ph).

We are accelerating development of integrated subsystems in response to customer demand. One of those integrated subsystems is our TOOLweb-based process monitor. In the third quarter, several key 300 mm fabs began evaluating our residual gas analyzer-based control platform for advanced process control. It includes Web-based access to process chambers' specific reports. In addition, our technology leadership in integrating our reactive gas generator and gas analysis products has led to further penetration of leading edge applications at OEMs.

We are also delivering technical leadership across our product groups to diverse markets and we are encouraged by the acceptance of our new product offerings. For example, in the quarter, we received orders for our gas analyzers and vacuum technology equipment to support accelerator projects in the high-energy physics area. In other markets, our gas analysis products were selected for combustion and emissions testing applications, and we shipped multiple process-monitoring systems for use in fuel-cell manufacturing.

Last week, key OEM customers announced continued order push-outs and market softening and gave guidance for lower booking rates. Our semiconductor OEM orders have softened further in this more cautious market environment.

Looking ahead, although our short lead times limit our visibility, we currently expect that the fourth-quarter revenues could range from 115 to 125 million for a sequential quarterly decrease of 10 to 18 percent. The outlook for 2005 is unclear, given our limited visibility.

We will continue to look closely at our order levels and manage the business accordingly. We are focused on increasing our profitability at all sales levels. We are continuing to reduce our manufacturing costs by sourcing materials and transitioning products selectively to lower-lower-cost regions. At the same time, we are investing in R&D to meet and anticipate the needs of customers in current and new markets. We are also investing in an ERP system to integrate our global business processes, which is expected to increase our efficiency and operating effectiveness. We plan to convert our operations to the new ERP systems in phases over the next two years.

Looking longer-term, we believe that device manufacturers will need to add capacity at 300 mm and upgrade technology to smaller geometries to stay competitive and to support the growth of new and emerging electronic applications. With each technology upgrade, more process steps are required and processes must be controlled more precisely. As devices and wafers grow more valuable with higher functionality and more process depths, fabs and foundries are focused on managing and improving their yields. We are in an excellent position to support the industry's expanding needs for process control. With our broad technology portfolio, we can control the chemistry in the process chamber, where semiconductor devices are made, which is critical for yield management. Our sensors measure and control the flow and pressure of gases and monitor their composition in the chamber. Our power subsystems generate the plasma that drives the processes. Our instruments and subsystems detect contamination on the wafer and in the chamber and monitor the health of the process. Our information-management network enables real-time access to the process-chamber data for improving yield and throughput. We enable potential defect problems to be identified before large numbers of wafers are made. This broad technology portfolio is a major market advantage for MKS as the industry moves to a higher level of manufacturing complexity. We are enhancing strong customer relationships by providing a broad set of technological solutions to support our customers' advanced process needs, and we expect to continue to gain share as semiconductor process complexity increases.

Now, I will turn it over to Ron to discuss our financial result.

Thank you, John, and good afternoon, everyone.

Third-quarter 2004 sales were 139.7 million, or an increase of 71 percent from the third quarter of 2003 sales of 81.6 million.

Looking at sequential revenues, third-quarter 2004 sales were 8 percent below second-quarter 2004 sales of 151.6 million. This was within our revised guidance for an 8 to 11 percent sequential sales decrease as a result of weaker demand from semiconductor OEM customers.

GAAP net earnings for the third quarter of 2004 were 12.2 million, or 22 cents per diluted share. Second-quarter 2004 net earnings of 20.9 million were 38 cents per diluted share, included other income of 5.4 million, or 8 cents per diluted share.

On an operating or non-GAAP basis, third-quarter 2004 earnings were 15.8 million, or 29 cents per diluted share, compared to 20.3 million, or 37 cents per diluted share, in the second quarter. Non-GAAP earnings excluded 3.7 million in amortization of acquired intangible assets in both quarters.

Our third-quarter results were negatively impacted by lower orders from our -- for our products from our semiconductor OEM customers, which we believe reflected a closer alignment of product demand to their production rates.

In the third quarter, sales to semiconductor OEMs were down 13 percent sequentially, while sales to end-users were up 7 percent. Total sales to the semiconductor equipment market were down 11 percent sequentially and represented 76 percent of third-quarter sales, compared to 79 percent in the second quarter.

Thin-film sales, which include equipment for flat-panel display and data storage, decreased by 5 percent sequentially and totaled 8 percent of third-quarter sales, compared to 7 percent in the second quarter. Sales to other markets were up 10 percent sequentially and represented 16 percent of third-quarter sales, compared to 14 percent in the second quarter. This reflected our success in high-energy physics, combustion, emissions testing and fuel-cell manufacturing applications. Our top 10 customers accounted for 50 percent of third-quarter sales, compared to 53 percent in the second quarter.

Sales to Applied Materials, our largest customer, represented 19 percent of third-quarter sales, compared to 22 percent in the second quarter. Sales to subcontractors that are supplying the semiconductor equipment industry were down 4 percent sequentially and totaled 11 percent of third-quarter sales, compared to 10 percent in the second quarter. A major manufacturer of medical-imaging equipment continued to be among our top 10 customers in the quarter.

Looking at the third-quarter geographic sales mix, sales to U.S. customers were down 10 percent sequentially and represented 67 percent of third-quarter sales, compared to 68 percent in the second quarter. Sales to Asia were down 1 percent sequentially and represented 25 percent of third-quarter sales, compared to 23 percent in the second quarter. Sales to Europe decreased by 13 percent sequentially and represented 8 percent of third-quarter sales, compared to 9 percent in the second quarter.

Gross margin was 39.8 percent in the third quarter, compared to 40.5 percent in the second quarter, as manufacturing overhead increased as a percentage of sales due to lower sales volumes. We continue to work on gross margin improvement by gradually transitioning to lower-cost material and manufacturing sources.

We held operating expenses essentially flat in the quarter. Third-quarter R&D spending was 14.2 million, or 10.2 percent of sales in the third quarter, compared to 14.6 million, or 9.6 percent of sales, in the second quarter.

Third-quarter SG&A expense increased by 300,000 to 23 million, or 16.4 percent of sales, compared to 22.7 million, or 15 percent of sales, in the second quarter. Third-quarter cost included higher expenses for Sarbanes-Oxley compliance costs related to our new ERP system and higher professional fees, which were offset by lower foreign exchange expense compared to the second quarter.

Taxes on state and foreign income totaled 3 million, or 20 percent of income before tax. We recorded minimum federal tax expense because of the utilization of our net operating loss carry-forwards.

Our worldwide workforce decreased by 4 percent to 2,425 from 2,515, primarily as a result of adjusting our temporary and direct labor to reflect lower production levels in the third quarter.

Now, I would like to turn to the balance sheet. Our cash and investments increased by approximately 18 million to 217 million in the third quarter. Total debt was 30 million, which resulted in 187 million in net cash as of September 30. Cash from operations provided approximately 23 million in the third quarter and approximately 43 million for the nine months.

Days of Sales Outstanding for the third quarter increased to 56 days from 54 days in the second quarter, primarily as a result of the timing of shipments during the quarter. Third-quarter inventory turns were at 3.2, compared to 3.4 in the second quarter, as inventories stayed relatively level on lower sales volumes. Capital Expenditures of 4.8 million in the third quarter were primarily for investments in the new Company-wide ERP system and for manufacturing test equipment to further improve product reliability. We estimate that Capital Expenditures could total approximately $18 million in 2004. Depreciation in the third quarter was 2.9 million and we expect it to be approximately 12.7 million for the full year.

Looking ahead, our semiconductor OEM orders have softened further in a more cautious market environment. Therefore, we currently expect that our fourth-quarter sales could range from 115 to 125 million, or a sequential quarterly decrease of 10 to 18 percent. At these revenue levels, gross margin could range from 36 to 38 percent, which primarily reflects the effect of lower anticipated sales volume. We estimate that total operating costs could remain relatively flat in the fourth quarter. R&D spending could increase slightly and range from 14.3 to 14.7 million. Fourth-quarter SG&A expenses could decrease slightly and range from 22.4 million to 23 million. Amortization of acquired intangible assets is estimated to remain at approximately 3.7 million in the fourth quarter. Net interest income for the fourth quarter is expected to remain at approximately 400,000.

We expect that our effective tax rate for the fourth quarter could be approximately 20 percent. However, this excludes the effect of a possible restoration of the remaining portion of our previously written-off deferred tax assets. If these assets are restored in the fourth quarter, they could provide a one-time favorable adjustment to tax expense of 5 to $7 million. In the quarter after these assets are restored, we expect that our normalized tax rate could be 31 percent.

Based on these assumptions, fourth-quarter GAAP net earnings could range from 1.2 million to 5.2 million, or 2 to 9 cents per share based on 55 million diluted shares -- 55.5 million diluted shares outstanding.

On a non-GAAP basis, which excludes the amortization of intangible assets of 3.7 million, earnings could range from 4.9 million to 8.9 million, or 9 cents to 16 cents per share.

This concludes our financial discussion. I will turn the call back to John.

I'd just like to add that, as we look ahead to 2005, we will continue our cost-reduction efforts while maintaining our investment in technology leadership and providing the solutions that our customers require.

Ron and I will now take your questions.

Thank you, sir. Ladies and gentlemen, at this time, we will begin the question-and-answer session. (OPERATOR INSTRUCTIONS). Brett Hodess with Merrill Lynch.

Good afternoon. John, two questions -- first, on the semiconductor, or your OEM side, clearly things have slowed down and dropped off. Can you give us an assessment of how much of the drop is them correcting inventory versus what you think that the real production rate drop-off is at your customers? Do you have a feel for that?

I think we have a feel just for the demand change, which we've reflected in what we've guided to, Brett. It's difficult to separate out what is a reduction in in-process inventories from a reduction in production schedules, since it comes to us as a one-quantity demand.

Okay. The second question I guess I have is when you look at the cost structure, going forward, it looks like not too much adjustment to the operating expenses yet. You know, so that tells me that perhaps you are not looking at -- although the visibility isn't great, you are not really sure how much you should (indiscernible) aggressively cut back on the cost side if this is shorter term or a longer-term issue. Can you talk a little bit about what your cost reduction goals might be if we continue to see some weakness going into the first half of the year?

Well, we obviously have over time -- as you know, we went from about -- these are rough numbers -- about 2,000 people to about 2,500 roughly in a period in which we just about doubled our revenues. Some of that was done with temporary help, the additional temporary help, some with a large amount of overtime, which we continue to work, so we will adjust overtime. We adjust other expenses. We don't -- or at this point are not looking at reductions in headcount, although obviously that is always an alternative which we don't like to use but it's obviously an alternative.

The other expenses, as I said, as I indicated, we want to continue investing for technology leadership and market-share gains. We have lots of opportunities that are presented to us and at some point, we would make some decisions of whether we would pursue some projects or not in the engineering and budget-development area and then to hold those costs more constant.

Obviously, there's always some tightening that can go on on all expense levels. We are continuing to work on material cost reductions and manufacturing-cost reductions. With that will also come some -- over time -- some manufacturing overhead reductions that go with that to help us have a better gross margin than we would've had had we not taken those steps. That's really the biggest swinger in how we end up going through a downturn if we enter into one beyond what we are seeing now.

Very good. Thank you.

Avinash Kant with Adams Harkness.

Good afternoon, John and Ron. Did you talk about gross margins for Q4?

Yes, we did. We said that they would range from 36 to 38 percent.

Now, assuming that revenues fall slightly more -- I'm talking year-over-year basis in '05 -- would you expect to be an improvement in gross margins, given that you have been taking some initiatives to outsource some manufacturing?

Well, we're working on that continuously.

But do you think they will start to show an impact sometime in '05, early '05 maybe?

It's a gradual process and depending on the product mix, it's possible that you would see some further improvement.

Jim Covello with Goldman Sachs.

Good afternoon. This is Amanda Hindlian for Jim Covello. Two questions -- first, can you provide some color on the current pricing environment? Second, what would trigger the restoration of the written-off deferred tax assets?

On the pricing environment, I think that we could say that there has been no change in that environment over the last nine months or so. There is always a competitive situation as we get involved with new projects, but many of the things we are doing are also new areas for us and for our customers. We also have -- over time, we have agreements. I think we've talked about this before, on what the pricing will be for products, and so we tend not to have big changes over a period of time. So, I would say there's no change in the pricing environment; it's always a competitive environment.

On the tax question, I think Ron, that was -- (Multiple Speakers).

Yes, I mean, the accounting rules require you to have a look-back period and to also look forward as to what you think the Company's projections are. Depending upon that evaluation would determine whether or not we would restore that deferred tax asset in the fourth quarter. That's a determination we will have to make at that time.

Ali Irani with CIBC World Markets.

Yes, good afternoon. Looking at your guidance, gentlemen, for the fourth quarter, given that you are already pretty close to breakeven results, does this suggest that, at this point, you can bring the breakeven lower gradually and maintain breakeven or does it suggest that, for example, you just don't see a need to bring costs down materially and (indiscernible) environment is stabilizing on a monthly basis? Can you give us some color on perhaps the monthly sequential trends as you see them ahead in the fourth quarter?

Well, we've given guidance for the fourth quarter, which includes what we expect our operating expenses to be, SG&A and R&D. Those numbers were given what our revenue guidance is (ph). We can't project and are not projecting what will happen month-to-month.

I guess what I'm asking is what is the linearity that you see in the business in the fourth quarter?

Because we have short lead times, Ali, it's difficult to say what that linearity is. Normally, we would have -- the months would be linear but as we saw in the third quarter, the last quarter was not as -- within our projections, was not as linear. We don't know what will happen here in the fourth quarter. So, we're just projecting it out as just basically flat, given our running rate. (multiple speakers) -- if we have to make adjustments, obviously we will be looking at doing that.

Okay. Just looking as a follow-up, could you give us a sense of what percentage of your current mix is being produced in low-cost areas, such as your China factories, and where you see that going now that you don't have to rush out deliveries to customers?

Well, to go back to your assumption that we don't have to rush out deliveries to customers, our customer demand is still there. We reduce our production capacity as our demand reduces, and there's no difference in the lead time they are asking for, so it isn't as though they say, well, send it to us next week instead of tomorrow.

Given that, we are in the high 30 percent range and that varies by product area. I will not get into what product areas we're talking about for competitive reasons, but it is in that range for where we are in low-cost countries.

Any target on the outlook of where that would be twelve months from now?

I don't believe it would ever be more than 60 percent.

Phillip Lee (ph) with J.P. Morgan.

You say that your fourth-quarter gross margins are being adversely impacted by slowing down your factory production more than your revenues in order to draw down your inventory?

No, we didn't mean that, Phillip. What we meant was is that when the volume of sales decreases, the overhead cost just becomes a higher percentage of sales, which results in the lower gross margin.

Do you have a targeted ending inventory level (inaudible) Q4?

Well, the goal is to improve the turns to at least four turns is the longer-term goal, so I would imagine, in the fourth quarter, say relatively level -- maybe down slightly.

Okay.

Tim Summers with Stanford Financial Group.

Good afternoon. Getting back to the gross margin issue, you referenced that you wanted to move to lower-cost materials and more outsourcing. Can you give us what your goals are in terms of how much that could impact your income statement, going forward? What's the timing on this, or where do you want to reach 80 or 90 percent of your goals?

Well, first, we've never given that information because it a continuous process. As you know, we started this well over a year ago and in fact, when we acquired E&I, they were already doing manufacturing there.

Our target, as I said, it will depend on product mix and it would never exceed more than about 60 percent of the manufacturing. That could be possible to achieve through next year.

Just as a quick follow-up, to the degree you can identify it, how much of your business in the semiconductor space was 200 versus 300 mm?

Well, we can't identify that because many of the products are the same products. There are some product areas which are only 300 mm, however. The mix reported from several of the OEMs is that it's running at about 70 percent 300 mm. For us, that could be at least 70 percent, because we do have a tilt towards 300 mm in some of our process analysis products and information technology products, which are not basically 200 mm products at all; they are only targeted to 300 mm.

Stuart Muter with RBC Capital Markets.

Thank you. Good afternoon. A couple of questions, John, following up on the last question -- have you seen a slowdown in demand for some of those 300 mm products yet?

We don't break that out, Stuart.

(multiple speakers) -- just qualitatively.

You know, there is the transition to 300 mm going on from 200 mm and some of that is project-by-project, so I can't give you an accurate answer to that question.

Okay. Let me try another question. What would trigger you to reassess your expense levels during Q4?

Other than the variable cost levels? You mean, the SG&A and R&D levels?

Yes, exactly.

Well, it would depend on what we see for projections and indications for the industry, going forward.

If you saw another significant reduction in revenues, that would perhaps trigger that and would significant be maybe 10 percent, or could you help (indiscernible) that for me?

I don't want to get into Q1 because we only project -- we are only talking about guidance for one quarter.

Yes, I was just wondering.

I can't really give you an answer to that because then we would be getting into speculation on Q1 and we have our hands full dealing with Q4.

Fair enough. Thank you.

Tim Arcuri with Smith Barney.

This is Gary (indiscernible) for Tim Arcuri. You know, now that you're looking at a softening kind of demand outlook from your OEMs, some of these guys actually have really not kind of recognized the target gross margins on 300 mm products that they wanted to. Are you kind of seeing incremental pressures on recent rounds of pricing negotiations with some of your OEMs?

Secondly, if you are (indiscernible) to some price concessions there, are you at least getting sure renegotiating contracts on those prices?

The guys you are talking about not reaching their gross margins being the OEMs?

Right.

Have you actually seen that?

There are some products out there that obviously haven't gotten back to kind of pre 200 mm gross margins. So I am just wondering if you could speak about pricing on your products.

Well, I did speak about pricing. I said that the pricing environment has not really changed from what it has been. There's always competitive pressures but there's not more between 200 -- between 200 mm and 300 mm on some of our products; there is no difference in the product and there's no difference in the pricing or cost. In some other of the product areas where we have higher -- for example higher power maybe required, higher power because of the power density requirement or higher reactive gas quantities -- these prices and issues have been settled some time ago.

Okay, so there's no --?

We don't see any new issues on that, no.

Okay, no renegotiating efforts on RF or DC products specifically?

No, there are always ongoing discussions and there are new projects that go on; it's just the nature of the business, but it's no different than it ever has been.

Okay, great. Thanks.

Tim Summers with Stanford Financial Group.

Just a question on the tax rate -- if you guys saw business soften substantially in the fourth quarter, is there the possibility that you would simply defer bringing back in the (ph) deferred tax asset and reduce your tax rate in '05 below the 31 percent?

That's possible.

You would know that at some point in the fourth quarter?

We would evaluate it at the end of the quarter, yes.

Gentlemen, do you have any concluding comments at this point?

No. I would like to just thank you all for your continued interest in MKS and thank you for having listened in.

Thank you. Ladies and gentlemen, this concludes the MKS Instruments' third-quarter 2004 earnings release conference call. If you would like to listen to a replay of today's conference, you may dial 303-590-3000 followed by an access code of 11009618. (Operator repeats numbers). Thank you for your participation, and you may now disconnect.