萬機儀器 (MKSI) 2007 Q2 法說會逐字稿

Welcome to the MKS Instruments earnings conference call. Everyone will be on the listen-only mode mode. (OPERATOR INSTRUCTIONS). This conference is being recorded today, Thursday, July 26, 2007.

I would now like to turn our conference over to Jonna Manes, Director Investor Relations. Please go ahead.

Good morning, and thank you for joining our earnings conference call. Earlier today we released our financial results for the second quarter of 2007. You can access this release at our web site, www.MKSInstruments.com.

As a reminder, various remarks 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, section 27-A of the Securities Act, and 27-E of the Securities Exchange Act.

Actual results may differ materially from those indicated by these forward-looking statements, as a result of various important factors, including those discussed in today's press release, and in the company's annual report on forms 10-K for the fiscal year ended December 31, 2006, 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.

We ask that you limit your questions to two per firm during the Q&A period, and we will circle back for further questions as time allows. And now I'd like to turn the call over to Leo Berlinghieri, President, and Chief Executive Officer, of MKS.

Thank you Jonna, and good morning, everyone. Thanks for joining us this morning. I'll give an overview of the second quarter, our strategies, and outlook. Ron Weigner, our Chief Financial Officer, will review our financial results and guidance, and then we'll open the call for your questions. MKS continues to demonstrate that our technology leadership supports multi-market growth. In the second quarter we achieved $204 million in sales, with double-digit growth, in non-semiconductor markets.

We are continuing to leverage our process technologies in thin film, and other growth markets, that are less cyclical. After generating record sales of $211 million on strong semiconductor market demand in the first quarter, we saw some softening in the second quarter which is consistent with industry trends. Our second-quarter sales to OEMs and fabs were 10% lower sequentially, although OEM sales were down 4% sequentially. There were some bright spots in our semiconductor business. Sales to Applied Materials, our top OEM customer, grew by 13%. The sales increase was primarily for power, and reactive gas generators, for semi, flat panel, and solar tools.

We're encouraged that the increase in business for flat panel tools could reflect an improving market outlook. After our fab sales increased 20% sequentially in the first quarter, they decreased approximately 30% in the second quarter, and returned to levels we saw in 2006, or about 11% in total sales. About half of the second quarter decrease or about $5 million came from lower spending sequentially, by Korean memory device manufacturers after an unusually large order, in the first quarter. Although there were fewer tool hookups for new capacity additions in the second quarter, we continue to win new business at fabs with process solutions, for improving productivity.

Another bright spot in the quarter was our growth in the adjacent markets such as thin film, solar, and other alternative energy processes, and in other applications with complex analytical processes including medical and pharmaceutical manufacturing, and Homeland Security. Second-quarter sales were up 13% sequentially to 32% of total sales, as we continue to provide solutions in diverse, non-semiconductor markets.

We believe we have advantages in key markets. With our technology portfolio, we have the potential to enter new markets with lower development costs, and faster speed to market. For example, solar is an attractive, growing, market. Depending on which forecast you read, growth rates for solar equipment could be 30% or higher, and reach $3 billion, or more by 2010. We believe our total available market opportunity, could be $150 million or more. This is not a new market for MKS. We've built solid relationships with key solar OEMs in Europe, and the US, over the years, and our solar sales were about $7 million in 2006. We provide technology for both silicone substrate, and thin film solar processes. And we are seeing demand for multiple technologies. We estimate that our solar sales in the first half of 2007, almost equaled all of 2006. At this rate we would double our solar sales in 2007. In the second quarter, we won a relatively large solar order from a key Asian OEM for our power and reactive gas generators, mass flow controllers, and gauges.

Although silicon substrate processes are fairly mature, thin film processes aren't sorted out yet. With solar manufacturing processes evolving, we see opportunities for our process-enabling technology, and additional opportunities for our productivity improvement solutions, over the long term, as the technology matures.

In the second quarter, we continue to grow our sales in the high growth combustion and emissions market, as investment increased, to reduce greenhouse gas emissions. We won business from new customers with our multi-gas analyzers, protesting smokestack emissions, as well as combustion engine emissions. This is another high growth market, where our sales in the first half of 2007 are approximately what we sold in all of 2006. With the level of interest we are seeing, again, we could double our annual sales in 2007 in this market, as well.

We expanded our business in the area of Homeland Security. We began supplying sensitive pressure measurement instruments, for biological agent detection systems in government facilities. These systems collect and analyze air samples for trace amounts of biological agents. In the third quarter, we also received evaluation orders for our gas analysis technology for other Homeland Security applications.

We positioned the company to expand in other markets with demanding analytical requirements. We entered into an agreement to integrate our multi-varied analysis software with Waters Corporation's analytical instruments, to provide new research tools for the pharmaceutical, chemical, and food industries. Researchers in these industries have struggled to provide data on molecular structures. Our multi-varied analysis software converts process data into useful information. We believe these new tools, could enable researchers to data mine massive amounts of data, in order to find molecular markers for toxicity, and disease.

Another confirmation of our technology leadership is our position as the leader in critical subsystems for semiconductor and thin film processes. According to VLSI Research, we gained share every year since 2002. I'm pleased to announce that the data shows, that in 2006, we gained share in DC Power, reactive gas generation, ozone generation, mass flow control, integrated process diagnostics including residual gas analyzers, and pressure measurement and control. We demonstrate a strong track record at growing faster, and we now have 37% market share, in our process critical subsystems, up from 32% in 2002.

Our technology leadership enables us to integrate technologies, and provide higher value products. One example introduced at Semicon West, is our new delta tube flow ratio controller, that measures, divides, and controls, mixed gas flows to multiple zones or chambers. It combines flow control, digital control, and connectivity, for eDiagnostics in one package, to deliver higher performance and uniformity and increase through-put. We are seeing a lot of interest in this latest integrated subsystem, and we believe our opportunity on this subsystem alone, could be $10 million to $20 million over the next several years.

Turning to our operations, we're going to expand our capacity in Shenzhen, China, by the end of 2007. Our new facility will allow us to transition more products to China, beginning in 2008, which could contribute to gross margin improvement. As we continue to transition products, we could eventually have 50% or more of our global manufacturing capacity in China, and Mexico.

Looking ahead to the third quarter, based on near-term semiconductor market projections, and customers' current order patterns, we anticipate that our sales could be down approximately 10%, and range from $180 million to $188 million. Although visibility is limited, we remain optimistic about longer term prospects for growth, as fabs implement more high performance 300-millimeter equipment. We are well positioned with process control and analysis technologies, that improve fab productivity, and reduce costs. And we are seeing more opportunities for our broad technology portfolio, and other markets, with favorable growth dynamics. Now I'll turn it over to Ron, to discuss our financial results, and to expand on our guidance.

Thank you, Leo, and good morning, everyone. Our second quarter sales remain strong at $204 million, after record sales of $211 million, in the first quarter. As Leo said, although semiconductor related sales decreased by 10% sequentially, we saw a 13% increase in our non-semiconductor related business.

We continue to provide solutions across our markets. Our semiconductor business represented 68% of second-quarter sales. As we have discussed sales to OEMs decreased by 4% sequentially to 57% of sales, and sales to semiconductor fabs decreased by 32% sequentially, to 11% of sales.

In our non-semi business, sales of thin film markets which include flat panel, data storage applications increased by 23% sequentially, to 8% of sales. And sales to other non-semiconductor markets increased by 9% sequentially, and totaled 24% of sales. Our top 10 customers represented 48% of sales. Applied Materials, our largest customer, increased 13% sequentially, and represented 21% of sales, compared to 18% in the first quarter. Sales to contract manufacturers of Applied and other semiconductor OEMs, decreased by 23%, and totaled 5% of total sales. We believe that contract manufacturers have not been as successful as managing inventories as OEMs have been.

Geographically, our sales to Asia decreased by 9% sequentially, on lower sales in Korea, and represented 27% of total sales. Sales in the US decreased by 2% sequentially, and represented 63% of sales and sales to Europe increased by 5% sequentially, primarily because of increased sales to thin film and solar customers, and represented 10% of our sales.

Second-quarter gross margin decreased sequentially to 42.2% from 43.9% as a result of change in mix, lower sales volume, and other costs that were higher, than in the normal quarter due to unique, or nonrecurring reasons. Operating expenses excluding amortization increased by $1.4 million sequentially. This was primarily attributable to investment in IT capability, to support and maintain the implementation of our new ERP system. We expect IT spending to increase moderately in the third quarter, as we reach our planned spending levels for IT.

The tax rate in the second quarter decreased to 27.9%, primarily as a result of adjusting our annual tax rate, to reflect the lower percentage of 2007 income in higher tax countries. As a result of these factors, net income decreased 17% sequentially, to $22.5 million, or $0.39 per diluted share. Non-GAAP net earnings which exclude amortization of intangibles, of acquired assets and special items decreased 16% sequentially to $25.1 million or $0.43 per diluted share.

Our worldwide work force totaled 3,015 people. Cash and investments increased by $27 million, to $343 million at the end of June, and totaled $300 million net of debt. We continue to generate cash from operations which totaled $18 million, in the second quarter.

During the quarter, MKS repurchased approximately 690,000 shares of common stock for $18.8 million in cash, at an average purchase price of $27.28 per share. Year to date, we have repurchased 1.2 million shares or $31.7 million, at an average price of $26.42 per share, under the two year, 300 million share repurchase program authorized by the Board of Directors on February 12, 2007. We expect to continue to generate cash, and to be opportunistic about our future use of cash. The timing and amount of any shares repurchased under this program, will depend on a variety of factors including price, corporate and regulatory requirements, capital availability, and other market conditions, and the program may be discontinued at any time.

Day sales outstanding totaled 56 days, and inventory turns decreased to 2.9 times in the second quarter. The increase in the inventory was primarily a buffer as we prepare to relocate to our new Shenzhen manufacturing facility in the fourth quarter. Capital expenditures of $4.6 million in the quarter were primarily for our Shenzhen facility, and other building improvements, and depreciation totaled $3.7 million. As I mentioned last quarter, we expect capital expenditures to total between $18 million to $20 million in 2007. These expenditures include resold improvements for our new facility in Shenzhen, China, that we expect to occupy in the fourth quarter of 2007. This facility will expand our manufacturing capacity in China by 35%, to approximately 190,000 square feet and will enable us over time, to transition additional products there to support future growth.

Looking ahead to the third quarter, as Leo said, we expect that sales could range from $180 million to $188 million. In order to somewhat mitigate the effect of these lower sales, we are shutting down all U.S. locations for one week in the third quarter, and we are taking other appropriate actions to reduce discretionary spending. At this lower volume, we anticipate that gross margin could range from 41% to 42%, as we continue to work on reducing our material costs, and other manufacturing costs. We expect operating expenses could decrease slightly. R&D expenses could range from $18.2 million to $18.6 million, and SG&A expenses could range from $34.9 million to $35.5 million.

Amortization of acquired intangible assets is estimated to remain at approximately $4 million. Our tax rate for the remainder of 2007 is estimated at 29%. Given these assumptions, second quarter net-- third quarter income could range from $14.6 million to $18.1 million, or $0.25 to $0.31 per diluted share, assuming 58.5 million shares outstanding. Non-GAAP net earnings could range from $17 million to $20.5 million, or $0.29 to $0.35 per diluted share. This concludes our financial discussion, and now we'll take your questions.

Thank you. We'll now begin the Q&A session. (OPERATOR INSTRUCTIONS). One moment. Our first question comes from Brett Hodess, from Merrill Lynch.

Typically at the beginning of a shipment slowdown for your big semi OEM customers, they might be reducing their inventory, and that sometimes can put extra pressure on your revenues. Do you think that's going on at this point in time? If so, how long do you think that typically might last?

Hi, Brett, good morning, this is Leo. I guess-- I think things change, it's dynamic. As we talked about in several calls. I think the OEMs have been doing a good job at reducing cycle time and inventory. I can't go back to previous cycles, or changes and be able to predict it as much. I think we see that maybe the contract manufacturers, have maybe done less of that. I think that's why we saw probably, a larger drop in the contract manufacturing portion of the business.

But I think with our lead times being fairly short, there's not a lot of need to keep a lot of inventory although we've talked about the dynamics of both an upturn and downturn, of the natural build-up if you keep the number of days of inventory constant at different rates. So there is a natural increase going up, of inventory and a natural increase going down. It's impossible to predict exactly what that is.

And a quick follow-on if I might. If you look at the move to Shenzhen, which, you know, largely I guess is completed by year end, and you're well into the new year, if the revenues were to stay in this range for a couple quarters, and you start to move into Shenzhen in the first quarter, would the gross margin still move up at this lower revenue level?

It certainly would be some improvement in gross margin as we continue to transfer products to Shenzhen, and other low-cost countries. But this is an ongoing process. And, you know, as I mentioned earlier, we're still-- when you look at the transfer of manufacturing to low-cost countries, we're still making progress, and reducing our purchase material costs. We're working on reducing other costs such as warranty, and other costs in-- cost of goods sold. When put that together, we're trying to achieve about 100 basis point improvement, over the current gross margins as a result of all those actions put together.

Got it. Thank you.

Thank you. Our next question comes from Jay Deahna, from JPMorgan.

Thank you. Good morning. Leo, how do you explain the jump in the applied material sales in the quarter given the general trends, and I got a follow-on from there.

Yeah. Hi, Jay. I think, you know, the encouraging piece was-- it was not all semi, it was a significant portion also of solar and flat panel. And certainly the last four quarters, or three or four quarters, have sent semi of 2006, you know, the flat panel business in general. The market's been down. It's been anticipated to come back up. So maybe this is a sign that it's coming back up, and there's some, you know, getting orders back in the pipe to get production up. But I think that was, you know, our understanding of a good chunk of that.

So did that particular --

Excuse me. And it was primarily around the power and reactive gas products, which is typically a little longer in lead time. So that may reflect why it's not across the board.

So your overall semi was down, and your other businesses were up. Was that sort of indicative of what you saw at your big customers, as well?

I'm not sure I understand the question.

Were your sales to Applied Semiconductor business down, but the other stuff was up strong enough to offset it? Like your overall business was?

I'm not sure that was the case. I think we didn't get into lots of detail in previous quarters, but I think, you know, it may be that if one quarter is down, the quarter before-- if they were reducing-- these are all hypothetical things because you can't-- I don't have the data in front of me. But basically, you have to look over multiple quarters, you know, in terms of something being down or up. I don't have the exact information. But I know that the solar piece in flat panel is absolutely up.

Okay. And then the other question is, you had a pretty big hiccup in your sales to fabs in 2Q. You mentioned something about Korea. I was wondering if you could explain that a little bit more. And does that look like a bottom for the sales directly to fabs in 2Q, or not?

Well, there's a few things that the dynamics of fabs. That is, you know, some products are continuous spare parts. Some of what we've talked about a lot, in terms of process solutions, of productivity solutions, where they upgrade existing equipment for new processes, improved productivity on existing processes. And then the third category, is actual products, that are targeted for the fabs themselves. Those type of sales tend to be lumpy sales. And so when they tend to be more of, you know, we'll do a couple million dollars of RGAs, and that won't happen with the same fab, quarter after quarter.

So I think that what we saw, is a significantly large order in Q1, and not seeing a repeat of that order, in Q2. And there had been some discussion that, over the course of the year, we would see repeat of that size order. But it certainly didn't happen in Q2. So that of half of the drop that we saw. And that's why Q1, was significantly higher than Q4.

Does Q2 feel like a low for the year for your fab sales, or is that hard to call at this point?

That's hard to call. I don't know -- I don't see anything in the activity level, that would suggest thing are changing at the fabs.

Okay. Thank you.

Thank you. Our next question comes from Robert Maire, from Needham & Company.

Yeah. First question. We've seen some other companies transition to Shenzhen, or lower cost regions. And typically there's a period of double expenses, during the move period, that negatively impacts gross margin. Is there any of that going on, and if so, is that like a two, three-quarter thing, or could you give us a little more on that, please.

Yeah. Let me start, then I'll let Ron get into the details. But just so we're clear, we are in Shenzhen, and have been in there since we did the acquisition of E&I.

I mean for the transition, obviously.

The transition is just expanding, what's going on there to a larger facility, with more capabilities. I'll let Ron get into it --

No, that's true what you say, Robert, because you due tend to have some duplicate overhead expenses in the transition period. And over time as we move more products from one location over there, it may be possible to reduce some of those duplicate overhead expenses, that we would have in the United States. So that would also -- I'm also including that in the expected-- the goal of improving margins by about 100 basis points.

Okay. So -- so whatever is related to that transition and so the double expenses is about 100 basis--

Yeah, as Leo says we're already there. It's not like it's a first-time move where the effect of that would be exaggerated.

No. Understood. In terms, Leo, a more long-term strategic question for you. In terms of your mix of semi versus non-semi, are you currently putting in more R&D, or more sales effort, or more strategic opportunity, investigation efforts, at non-semi business currently, to try and perhaps, continue to bring the percentage of non-semi business up? Is that sort of a goal, or is it just opportunistic, whatever shows up in whatever sectors currently?

No. I would say it's not just of whatever shows up. We've actually either added resources, allocated resources differently to focus on these non-semi markets. Both in the marketing side, the sales side, and on the R&D efforts. And so we-- we've done that. I'd say over the past couple of years. And you know, we can keep transitioning that as we see opportunities. You know, we do work relative to studying the market, the non-semi market more today, than we did in the past. And we put some -- you know, additional plans together to address it. So I'd absolutely say that probably the last few years are more focused around non-semi, and resources allocation, shifts more toward non-semi in order to do that.

Do you have any sort of internal goal of like 50/50, or anything that you would care to share with us over the next couple of years, that you're trying to get to, or is it just pushing it?

Well, I would say that over several years, you know, we've talked internally that just from a-- from a semi cycle standpoint, a 60/40 mix, semi, non-semi, would allow you to take a 50% hit in a semi cycle, and if you're at your peak operating profits, at a peak, you would be pretty healthy in the trough. So I think that's-- you know that's sort, of a long-term objective. You know, that may be achievable organically, acquisitioned-- it might be a combination of things to get there.

Okay. Thank you very much.

You're welcome.

Thank you. Our next question comes from Jim Covello, from Goldman Sachs.

Hi, this is Kate Kotlarsky, on behalf of Jim Covello. I had a couple of questions. My first question is on your gross margin this quarter. You mentioned that there were some one time items in the gross margin line. I was wondering if maybe you could expand on that, and maybe quantify what those items were. And then just curious, if there's also a way to quantify the margin impact from some of the things you're doing to improve your costs over the next couple of quarters. And I have a couple of follow-ups.

Yeah. You know, on the gross margin change this quarter, about half of it really, was due to mix. Volume and mix. And some of that you could see was customer mix. Could have affected the gross margin. The other half was about nine or ten different items, that were a little bit sequentially higher. Some of these will not recur in the third quarter. So we had a small increase in our-- for excess inventory costs. We had a lesser, for example, foreign exchange gain. We recorded some additional expense, which really just related to the timing of some fringe benefit expense that we occurred. And about six or seven other items that by themselves were not sequentially significant. But in the aggregate, probably accounted for half of the gross margin decrease.

As I said, going forward, I expect not all of those items to recur. And as I mentioned going forward, you know, as we start looking into next year and, over the next four quarters or so, we're targeting about 100 basis points gross margin improvement, for the reasons I already mentioned.

Okay. And then just a quick question on your R&D expenses. There is, you know, if expenses are going to stay at similar levels going forward over the next couple of quarters, or if we can expect them to trend down a little bit. And also a question on the tax rate. Should we expect the tax rate to be a little lower in 2008, as well, or is it going to pick up to kind of more 30%, 31% level?

Well, on the R&D expenses, you know, they can vary quarter by quarter. But as Leo said, certainly we're committed to invest in R&D, for solutions that certainly are going to generate differentiated products for us, for our customers. The reason the R&D fluctuates really, quarter by quarter is -- is more dependent upon how much we expend for project materials in development. But I think you could expect that R&D could go up slightly in the future. As far the tax rate is concerned, a lot depends on where -- what the year is going to look like, and where and how much business is going to be done in the US, and how much is going to be done in low-cost countries. So, all things being equal, the rate would stay the same. But if the US business picks up in 2008, then you might see the tax rates not being quite as favorable.

Okay. And then just a final, more big picture question, on your acquisition strategy. Just curious if there are specific market segments or end markets, that you're thinking about, as you think about, some of the future potential acquisitions.

Well, I think what would probably be the most likely, or obvious, is in those markets that we talk about. You know, you know the markets better, you know the customers in those markets. When you're looking at a potential acquisition, you can understand how they play in that market, how their technology is accepted in that market. So I would say that we talk about three or four of them. We talk about solar, we talk about alternative energy, and emissions. We talk about medical.

So I think, you know, those are the markets in addition to semiconductor and flat panel and other thin film, that we're most accustomed to. It's likely that if something were to happen -- it's not out of the question it would happen somewhere else. I think it's likely to happen in the areas that we discuss, that we're trying to grow in or have grown in.

Okay. This is very helpful. Thank you very much.

You're welcome.

Thank you. Our next question comes from Vishal Shah, from Lehman Brothers.

Hi. Good morning, guys. In the past, your semiconductor OEM revenues, have bottomed around $17 million or so. Obviously you've gained share, and you've done some acquisition since then. So if we were to see a similar cycle this time around, would it be fair to assume that you could draw, say, $10 million above the prior trough--

Your $70 million comment was-- I'm just trying to equate the $70 million number and probably we can--

I Think I know what the rest of your question was, which is, it is up higher, therefore at a trough, a similar type of down cycle. Should you model it higher than a previous one? And I guess there are acquisitions as you said. I would expect it would be higher. Just as the peak has been higher.

So what would that be, like $10 million, or more than that?

I -- off the top of my head, I couldn't tell.

Okay. All right. So then in general, I mean, how many fab projects do you have ongoing at any given time? It looks like, one particular project would cause a $10 million impact on your revenues. So are you looking at only three, four projects, or more than that?

No. Let me just clarify one thing, Shah. That project affected $5 million of revenue. No, at any one time, we have probably somebody at every major fab having some activity. So, there may be -- I'd say big projects. There would be at least a couple of dozen in different stages of the pipeline, that could be to the tune of, you know, multiple millions of dollars. And then there are, probably hundreds of smaller ones. So I mean, that's how I would look at it. Not three, or four, at all.

Finally can you look at competition in the solar market. It looks like you gained some share there. And, you know, who are the competitors? Are you competing with regional players, and you talk about some design wins in that market. Thanks.

In the solar market, I -- I think you have to lock at it very similar to the way we compete in semiconductor or other markets. I think what you would look at is the product portfolio. And then based on that product or technology portfolio, we actually had different competitors. Relative to that. Obviously if it's flow controllers, because we sell that into solar and alternative energy, that's a set of competitors. If it's gauging, that's another set of competitors. If it's in ozone, that's a different set of competitors. If it's in power and reactive gas, that's a different set-- you know, power supply, that's a different competitor. I mean, literally I think one of the things that are, that there are different competitors depending on the technology that you're talking about.

Okay. So the AMAT design win, was it in reactive gas, I think you said, or was it --

I don't know if we referred to anything relative to an AMAT design win in solar. I think we talked about an Asian solar equipment supplier, and related to I think reactive gas.

Okay, great. Thank you.

You're welcome.

Thank you. We have time for one final question. Our last question is from Tim Summers, from the Stanford Group.

Hi, yeah, Leo, you talked about the combustion and emissions market. And I was wondering if you could quantify for us, your either second quarter, or first half '07, sales in that market. And can you give us an idea of what the size, and the growth rate opportunity, for MKS might be longer term?

Okay. Again, it's not always possible to get to the exact number, but I think you could think of it, similar to solar. You know, it's not -- it's not $1 million or $2 million, and it's not $30 million, but it's in the $6 million or $7 million range, for a half year.

Okay. Great. Thanks.

You're welcome.

And I'd like to turn it back to management for concluding comments.

Well, thank you for joining us on the call this morning. As you can see, we continue to open up new opportunities in many markets with our market-leading technology. We look forward to speaking with you at the upcoming investor events, including the Canaccord Adams Growth Conference on August 7, in Boston. Thanks for your interest in MKS, and this concludes our comments.

Thank you. Ladies and gentlemen, this does conclude the MKS Instruments second quarter earning conference call. You may now disconnect. Thank you for your participation, and please have a pleasant day.