萬機儀器 (MKSI) 2007 Q3 法說會逐字稿

Welcome to the MKS Instruments third quarter earnings conference call. (OPERATORS INSTRUCTIONS) This conference is being recorded Thursday, October 25, 2007.

I would now like to turn the conference over to Donna [Manes], Director Investor RElations. Please go ahead, Ms. [Mane].

Thank you. Good morning and thank you for joining our earnings conference call. Earlier this morning, we released our financial results for the third quarter of 2007. You can see this release at our website, www.mksinstruments.com. 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 Security Litigation Reform Act of 1995, Section 27A of the Securities Act, and Section 21E 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 Form 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 statements 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 questions to two per firm, and we will circle back as time allows, and now I'll turn the call over to Leo Berlinghieri, Chief Executive Officer and President of MKS.

Thanks, Donna, and good morning everyone. Thanks for joining us on the call this morning. I'll give an overview of the third quarter strategies and outlook. Ron Weigner, our Chief Financial Officer, will review our financial results and guidance, and then Ron and I will open the call for your questions. After we achieve double digit year-over-year sales growth in the first half of 2007, our business declined in the third quarter, primarily as a result of the industry-wide slowdown in semiconductor capital equipment spending. The third quarter sales of 181 million were at the low end of our guidance. Despite lower sales, we delivered stronger than expected financial results. Our non-GAAP earnings of $0.38 per share exceeded our guidance. We adjusted our cost to the changing business environment, and had other favorable items in the quarter. Ron will discuss the details of the quarter in a few minutes.

Sales to semiconductor OEMs were 12% lower sequentially in the third quarter, and were down slightly for the nine months. We've been through semiconductor cycles before, and we plan to stay nimble and aligned with market conditions; however, technology transitions don't stop in a softer business environment. During these transitions, we focus on developing innovative products for next generation tools. We'll continue to invest in key technology and product development to ensure or customer's success and maximize our future growth. Our goal is to continue to grow faster than our core serve market in semiconductor wafer fab equipment, Over the past five years, we've demonstrates our success and grown about 5% faster.

Three growth strategies are unchanged. The first is to increase our content on OEM tools and gain share with differentiated solutions. Second, increase our sales to fabs with solutions for improving productivity and yield. Finally, third, leverage our technology portfolio in other markets with emerging applications. On OEM tools, we have a track record for gaining share with critical subsystems around the process chamber. New and more complex processes require new materials and more precise control, and we see opportunities to leverage our technologies to address these needs.

One area of focus is improving process efficiency. For example, we are enabling faster processing with new features for power management, and we are improving chamber cleaning efficiency and increasing throughput with our Atomic Flooring generators. We also integrate our technologies into subsystems to increase functionality and optimize performance. For example, we are increasing accuracy and repeatability by integrating gas delivery and flow management technologies, and we expect to see increased demand for this type of subsystem. While our third quarter sales to fabs were down quarter-over-quarter, nine-month sales were up 14% year-over-year. We see growth opportunities ahead as fabs face tougher manufacturing challenges. Transitions to smaller device geometries require new processes and materials. Fabs need to improve yield to meet production cost targets.

We're adding value with a range of productivity improvement solutions as these processes change. We're enabling higher productivity with technology for gas analysis, affluent management, ionization and data management and analysis. These technologies items help fabs detect and reduce process cop familiar nation, analyze process variation, resolve process problems, and improve tool uptime yield and throughput. For example, our gas analyzers monitor processes and detect contamination to prevent scrap and yield loss. Effluent management subsystems reduce particle backflow and contamination to improve uptime and yield. Ionization systems reduce electrostatic attraction and particle contamination to prevent yield losses. Data management and analysis technology integrates data from process sensors, detects and characterizes those process faults, and improves process consistency and yield. With these productivity improvement solutions, we expect to increase our direct sales to fabs and our sales to OEMs as these fabs specify MKS.

In the third quarter, we saw some softness in thin film applications for flat panel data storage and architectural glass coating, and our nine-month sales were essentially flat year-over-year. Our broad technology portfolio provides a lot of opportunity and in other non-semimarkets with emerging applications. These markets non-semimarkets include solar and other alternative energy generation processes, gas emissions monitoring to meet combustion engine, smokestack and Homeland Security requirements, pharmaceutical and medical equipment manufacturing, as well as other analytical and industrial processes. In these markets, we saw some lumpiness in the medical equipment market in the third quarter, while nine-month sales are up 12% year-over-year.

The solar market represents a large long-term opportunity, although it's a small percentage of our business today. We're on track to double our 2006 solar revenues in 2007, and we are working with more than two dozen solar companies and with new companies who are entering into the market. Solar shot ups with roots in the semiconductor industry see the value of using our technology to improve process performance and productivity. We're providing solution to complex problems that range from chamber cleaning to process monitoring. Much of our technology can be leveraged from semi to solar. In the quarter, a major U.S. solar customer selected our mass flow controllers for gas boxes on multiple PECVD and PVD tools.

We see an evolving need for our technology to enable solar processes and improve yield to help drive down process costs at the module level which could eventually help make solar economically viable. In other non-semimarkets, we're gaining market share with our gas analysis technology. We're having success in applications where it's essential to measure and monitor multiple gases in real time. We're capturing opportunities that range from measuring multiple greenhouse gas emissions in diesel engines to monitoring gas emissions in different environments for Homeland Security requirements. Diesel engines need to meet new emission standards that take effect in 2010, which translates to a 30% growth rate from 2006 to 2009 in this area.

While this market also represents a small percentage of our total sales, we're on track to double our 2006 sales in 2007. We also see opportunities in many other markets where manufactures need to improve yield as process complexity increases. They may need higher performance and more precise control for next generation products or more analysis to meet tougher standards or regulatory requirements. For example, we're working wait major MRI manufacturer to provide higher levels of power for better imaging and more accurate patient diagnosis. We're working with a major drug manufacturer to provide more process analysis to reduce variability.

Our core process technologies and expertise are transferable to new markets and we see opportunities for our yield improvement technology and many thin film processes such as flat panel display, data storage, codings, and solar. I'm pleased to welcome Dr. John Lee to the MKS team. John is leading our business unit that helps fabs improve yield with analytical instruments. He joins us from the Solar Business Group at Applied Materials where he was managing director of factory technology. Earlier, he was general manager of the Cleans Product Group in the Maydan Technology Center. John brings deep experience to next generation processes technologies and a broadened understanding of thin film process requirements. While we are quite optimistic about our long-term growth opportunities, we remain cautious about the near-term outlook.

Looking ahead to the fourth quarter, several semiconductor industry forecasts call for the softness to continue. Based on these projections and current order patterns, we expect that the fourth quarter sales could range from 165 to 173 million. Our visibility is limited, and we will continue to monitor semiconductor market conditions and manage our costs. However, we're not going to veer from our strategies. We have demonstrated that we can grow faster, and our goal is to continue to grow faster. We plan to continue to invest in R&D to bring products to market and capture growth opportunities in the near term and farther out. We're confident that we can take advantage of the opportunities ahead of us with our track record of share gains, new products in the pipeline, and investment in technology leadership. Now, I'll turn the call over to Ron to discuss our financial results and expand on our guidance.

Thanks, Leo, and good morning, everywhere. Third quarter sales were down 11% sequentially to 181 million, which reflects the slowdown if the semiconductor industry. Non-GAAP earnings of $0.38 per share were higher than expected on anticipated lower volume and reflected higher gross margins and lower operating expenses. GAAP net income of $0.37 per share included a 1.8 million tax benefit in the quarter related to a discrete tax benefit for R&D credits which is excluded from non-GAAP earnings. Our top 10 customers represented 47% of our sales. Our position with Applied remains strong and after a double digit increase in sales to Applied in the second quarter, our third quarter sales to Applied were down 17% sequentially represented 20% of our total sales.

Looking at our business by market, our sales with semiconductor OEMs represented 56% of third quarter sales, and were down 12% sequentially. We've applied accounting for approximately half of this decrease. Sales to fabs were down 16% sequentially, primarily as a result of lower sales to Asian fabs, and represented 10% of total sales. Our year-to-date sales to fabs are up 14% compared to last year, so the sequential decrease in the third quarter may reflect the unevenness of fab project-based spending. Thin film sales, including flat panel, data storage, and architectural glass coatings were down 7% sequentially, and represented 9% of sales. Sales to other non-semiconductor markets were down 8% sequentially and represented 25% of total sales.

Primarily as a result of lower spending for spares by medical imaging equipment customers following six months of strong orders for spares. Geographically, sales in the U.S. decreased by 12% to 62% of sales. Sales to Asia decreased by 17% sequentially, primarily as a result of lower sales to fabs, and represented 25% of total sales, and sales to Europe increased by 5% and represented 13% of sales. Even though we experienced 11% lower volume, gross margin was essentially unchanged at 42.3%. The expected decrease in gross margin on expected lower volume was offset by reduced inventory-related charges and lower overhead spending, which include the effect of a one-week shutdown taken during the quarter.

Operating expenses, including amortization, were approximately 4.6 million, or 9% lower sequentially. A portion of this reduction reflects the shutdown week in addition to vacations taken in the third quarter. R&D expenses were 1.2 million lower due to the timing of spending for engineering projects and staffing. SG&A expenses were 3.4 million lower sequentially, 1.9 million of the reduction was primarily due to lower discretionary spending, including lower IT consulting costs as we completed the conversion of two major locations to our global ERP system. 1.5 million of the reduction was related to favorable foreign exchange and a favorable one-time adjustment for stock-based compensation expense. In the quarter, we reported 1.8 million discrete tax benefit related to R&D tax credits.

Our work force reduced to 2,886 people worldwide from 3,015. We continue to generate cash from operations which totaled $40 million in the third quarter, and $85 million for the nine months. Cash and investments totaled 363 million in the -- at the end of September, or 333 million net-of-debt. During the quarter, MKS repurchased approximately 750,000 shares of common stock at an average price of $23.06 per share. Through September, we have repurchased 1.95 million shares at an average price of $25.13 per share, for $49 million under the two-year 300 million buyback program authorized by the board in February 2007. The timing amount of any shares to be repurchased under this program will depend on a variety of factors, including price, corporate and regulatory requirements, capital availability and other market conditions.

Day sales outstanding total 58 days, and inventory turns were at 2.6 times in the third quarter. Capital expenditures are 5.8 million in the quarter were primarily for our new larger facility in (inaudible) China as we expand capacity to satisfy future needs. This capacity will help us compete in a global market and fulfill our long-range requirement as we grow. Depreciation totaled 3.5 million. As a result of our facility expansion, we expect 2007 capital expenditures to total approximately $18 to $20 million. We see growth opportunity for reactive gas generators for the solar market and for 45 nanometer tools that use different chemistries and have different power requirements.

In order to provide for expansion of our engineering laboratory space in Wilmington, Massachusetts, to support these opportunities, we will relocate our corporate function currently located in Wilmington to 36,000 square feet of lease space near our Andover manufacturing facility. We expect this move to take place around the end of the year. Looking made to the fourth quarter, as Leo said, we expect the sales could range from 165 million to 173 million. Gross margin could range from 40.5% to 41.5%, which primarily reflects the effect of lower volume.

We're going to continue to manage our costs in the fourth quarter and take the equivalent of a week of shutdown, maintain reductions in overtime and temporary help, delay noncritical hires, and reduce other discretionary spending. As Lee go commented, R&D expenses could increase slightly compared to the third quarter, and could range from 17.8 to 18.2 million, reflecting costs for planned staffing levels and project spending. SG&A expenses could be slightly lower sequentially after excluding the 1.5 million from the favorable effect of foreign exchange and stock-based compensation that was reported in the third quarter and could range from 33.4 million to 34 million. Amortization of acquired intangible assets is estimated to remain at approximately 4 million.

Our tax rate for 2007 and for the fourth quarter is estimated at 29%. Given these assumptions, fourth quarter non-GAAP earnings could range from 13.3 million to 16.2 million, or $0.23 to $0.28 per diluted share, assuming 58 million shares outstanding. GAAP net income could range from 11 million to 13.9 million or $0.19 to $0.24 per diluted share. Assuming fourth quarter results are at the mid range of the guidance, our net sales for 2007 could be approximately 765 million, and non-GAAP EPS could be approximately $1.59 and GAAP EPS approximately $1.46. This concludes our discussion, and I will take your questions.

Ladies and gentlemen, at this time, we will begin the question-and-answer session. (OPERATORS INSTRUCTIONS) Our first question comes from Brett Hodess with Merrill Lynch. Please go ahead.

Good morning. Congratulations on the excellent cost controls in this tough environment and getting the upside. Leo, I'm wondering if you can talk about two items. First, if you look at the semiconductor side of the business, the big drop at Applied Materials, how much of that, in general, applied in the other OEM do you think is them reducing inventories in the short-term versus the actual drop off in shipments? And, do you think that they're cutting inventory too much and they'll have to start restocking at some point? Or do you think the demand will have to wait until their shipments actually pick up from here?

Okay. So, it sounded like one question, but I'll try to answer it, and then if I didn't answer it, you can come back with the second one. Related to the semiconductor OEMs being down and whether we think it's more of inventory reduction, less of demand for tool reduction, I think there's always an effect of when we go up, the basic inventory levels increase to keep even the same number of days or turns. So, we do get benefits coming up, and I've always said we see the opposite of that when thing goes down, so they get to consume some of that. I don't anticipate, Brett, that we're seeing anything unusual, though. I don't see an overdriving -- I don't hear customers complaining that they're in serious inventory situations.

I think the short cycle times that people have done have made that affect a little bit less. That's just a guesstimate on that because there's no inspiration to actually tell that unless I look at every inventory of every part in these companies, but there's always some affect on the downside of using up inventory and there's always some affect of having to build some material as you full the pipeline on the upside, but I don't anticipate that it's very unusual. The only place that -- as I said, I think the OEMs have done a good job of driving cycle times down, the suppliers like us have done a good job of shortening our lead time so that we minimize that affect. The only area that may be have been a little more would be in the contract manufacturers, because that's another level that's put in the supply chain. So, that's about the only place that I could see where we may have been bleeding a lit more the inventory off than in the past.

Excellent. And if I could ask a quick follow-on. Ron, could you just walk through just quickly again the one time or basically the tax benefit and the foreign exchange benefit and what you saw as the overall benefit from those on an operating basis?

Yes. On the tax benefit for the R&D, that was only included in our GAAP earnings, EPS, and going I forward, obviously, the reason that adjustment came about is we refined our estimate of R&D expenses eligible for the tax credit, so that credit does does apply to past periods. So, obviously after refining that calculation, we should get some additional benefit in our tax rate going forward into 2008.

So as far as -- so, when you look at the SG&A, I mentioned that about 1.5 million of that was the reduction SG&A was related to the -- a favorable foreign exchange adjustment. That's because the dollar significantly weakened, especially compared to the Yen in the third quarter compared to the second quarter, and that was unusual decrease. And the balance was an adjustment of our estimate for stock-based compensation expense, so it was kind of a catch up to adjust overexpensing in the prior quarter. So that 1.5 million reduction will not necessarily reoccur in the fourth quarter. It's unclear yet what the foreign exchange effect would be in the fourth quarter.

Yet, still SG&A is still going to be down just because of your expense controls and your one-week shutdown?

That's right. After excluding that 1.5 million benefit.

Got it. Thank you.

Our next comes from Jay Deahna with J.P. Morgan. Morgan. Please go ahead.

Okay. Thanks. Can you hear me okay?

Yes.

Okay. Good morning.

Good morning.

In the fourth quarter, it looks like you're guiding your share count to come up a tad. Does that assume no buybacks, and is it possible that buybacks could occur? And then, secondly, can you give us a sense as to what's happening with your sales directly to fabs, and where you expect that to be going forward relative to utilization rate trends in the industry?

First, Jay, I'll answer on the buyback. First part of the question is the guidance is giving assuming that there will be new buybacks, but that does not -- as I said, we will be opportunistic when we do buy back the stock.

How much do you have left in your current authorization?

Well, we spent about -- the authorization was for 300 million, and through the three months, we spent about 49 million.

You've got a lot of room?

Yes.

Okay.

Jay, I'll answer the second one.

Okay.

I think related to business directly, the fabs, I look at that business really three ways, a three-pronged approach to what we sell to fabs. One is the obvious, we sell spares as a fab utilizes their tool and replaces instrumentation or subsystems. We sell some capital equipment, some of these gas analysis products are more like capital equipment, they're a major subsystem, some of the ozone products are -- stand alone generators are major subsystems that would almost look like capital. Third, we do the this upgrade work. I think where you see the softening first is in the capital side.

If there's -- those buys could be anywhere from a million to $3 million to outfit a fab in a particular line with process monitors, and so we see sometimes those slide, like the equipment companies would, so that would affect -- softening of the market tends to affect that. I think that the spare sales, they continue to use spares, but if they're not utilizing tools at the same level, then probably the frequency of spares can tend to get reduced. But the upgrade aspect seems to go on and on. The challenges of getting a product either to yield properly and costs in line, or the throughput that's need for new device and a new process, so I would say that the process solutions that we do that are upgrading process areas, those continue to move at the same pace or higher. The capital buys could get delayed, and I think we've seen a few of those over the last couple of quarters. And then the spares, they get reduced sometimes, but I don't -- not significantly.

If I could, one quick follow-up. I seem to recall over the last year and a half or so, you sold a lot of fab connectivity subsystems. Just wondering if that came up the way you expected and that kind of remote monitoring, if you will, of tools have sort of tracked the trend that you would have expected it to, in terms of adoption?

As far as -- I think we've talked about the potential related to data analysis, data collection, integration. A lot of that is done with some of these process monitors, how we integrate a stand alone process monitor that wasn't purchased with a tool so the fab can actually correlate the wafer data related to that process monitor, but I think the trend that we've always talked about as the geometry shrink, we really see that as a future growth opportunity because as geometries get smaller the fab can justify an investment in analyzing the data and taking preventive actions. One of this -- one is data integration, the other is analysis and basically fingerprinting a good process. And so what we see is as the geometry shrink, the opportunity should grow because there will be justification to invest in preventing defects and predicting them rather than inspecting them.

Right. Thank you very much.

You're welcome.

Our next question comes from Robert Maire with Needham. Please go ahead.

Congratulations on nice management, by the way. You saw a fairly sharp drop off from your largest customer, [AMAT], and we've heard from several other equipment companies that they're expecting sort of a turnup in the first half of the year. Obviously, haven't heard from [AMAT] yet. Maybe if you could give us what you can, in terms of your guidance that you're seeing out of your customers, and my assumption is, as you've indicated before, there isn't an inventory issue that would prevent you from seeing sort of a similar step up, and given your typical relationship with the OEMs, would it be going too far out on a limb to suggest that you could see a marked turn up in Q1?

Yes, I think it would -- we don't have that visibility, Robert. I would say that at least what we read is that -- if we talk to those equipment companies that we have good relationships with three months ago or six months ago, I think they would have thought the third and fourth quarter would have been up. So, I think from a visibility standpoint, with the short lead times we have, I would say this, I have heard some calls and I know that some of them have talked about order rates being up in the fourth quarter, and I think it was a couple of years ago we were sitting here and I think you may have even asked the question, what we thought -- we had thought that the first quarter back a few years ago would be relatively flat, and I said if the order rate continued to pick up, then that typical means they have to build more tools and work closely related to the build rates more than anything else. So I would say -- I can't tell you what will happen in the first quarter, but if -- I would imagine if the order rates do go up, as some have said, and if it continues to go up, then it has to reflect in higher shipments for us, ultimately.

Okay. Thanks.

You're welcome.

Next question comes from Tim Summers with Stanford Financial Group. Please go ahead.

Yes. Thanks for taking my question. Just a couple of things here. Ron, on the expense side, how much do you save from a one-week company-wide shutdown?

Well, it -- when we say it's a shutdown, it's not always a full shutdown, and we always keep critical people on hand to service our customers, but it's -- it was -- it's throughout the operation and that reduction expense is included in the results for the quarter.

Okay. Great. We know you work seven days a week, so we don't count you.

Right.

On the -- just as a follow-up, housekeeping item, on the flat panel and data storage revenue line item, how much of that is flat panel, and what kind of expectations are you building for that business over the next six months because we're hearing some things that might suggest a turnup in that business?

Well, I'm not sure I can give you any of the details for each element of that, but that whole category, flat panel, data storage and architectural gas coating and thin film represented about 9%. It's run between 9% and 11% depending on the activity in that market place. So, all I can say is you could probably get an idea that it's certainly not 9 or 10% of our business, it's got to be a subset of that if the whole category for all three are in that range. So I -- I think that's the best way to look at it. It's a subset of a 9 or 10% share within MKS. If that goes up, then we should have some effect. When it goes down, we have some effect in it, but it's not a huge impact either way.

Okay. Great. Thanks, Leo. You're welcome.

Our next question comes from C.J. [Muse] with Lehman Brothers. Please go ahead.

Yes. Good morning. Thank you for taking my question. I was hoping to go back to, I guess, another question where you're talking about your direct sales and the three moving parts to that, and I guess the question is if we pull out the equipment and we feel pretty good about utilization rates, what do you think that business looks like 2008?

If you exclude the capital that we sell directly to the fabs?

Well, I guess a two-part question here. What's the breakdown between those three areas for that category, and then if we were to assume weakness on the cap equipment side, what could that business look like next year relative to this year?

Well, we don't break then down that way. There's really -- if you look at it, about 20% of our business would be in spares, service, and upgrades, and that doesn't count the capital piece that we talked about.

But I'm referring to your direct sales under the chip maker part of your business.

Yes. That runs about 10%. It ran in 2006, it ran about 10% of total sales.

Right, but earlier you said that that's made up of three things, spares, some cap equipment and upgrade work.

And service, I guess that's another thing.

So, what I'm trying to understand is if I'm comfortable with utilization rates but I think the capital equipment is weaker, the upgrade work continues as you suggested, how should we think about the growth dynamic for that business?

Okay. Well, that's primarily around process monitors and ozone generators, and the only thing I would say that would to be cautious because these not solely utilization dependent. Some of them are actually process technology dependent. They're adding RGA's subsystems to critical processes to be able to manage yield. So, when their spending goes down, they may have a harder time getting a $2 million PO through the process, and it may get pushed out as spending is being scrutinized just as we would internally, but I wouldn't necessarily relate that to utilization. There's obviously a content to that, but I don't think we could give you enough detail that would bring enough color what that impact would be.

Well, I guess, within that roughly 20-plus million here in the September quarter, can you break that down between the three components?

No, I can't.

Okay. Second and last question from me. On the R&D line, you came in about a million, million and a half below your guide. Is that a sustainable level for you guys?

No. As Leo suggested, we're going to be opportunistic in our development and working on solutions for next generation equipment, so we said most of that reduction this quarter, C.J., was due to just the timing of when we are spending on project material, and there was some reduction in staffing levels in engineering in the third quarter as a result of of attrition. So in the fourth quarter, we're planning to increase our engineering headcount and based on what we plan to spend for project materials, it should go up slightly in the fourth quarter. Yes. The range -- if you didn't catch the range in the guidance, it was 17.8 to 18.2.

Generally speaking, we've been running around 18 million a quarter for the past six or seven quarters.

All right. Thank you very much.

(OPERATORS INSTRUCTIONS) And at this time, I'm showing no additional questions in the queue. I would like to turn the call back over to management for any concluding remarks they may have.

Great. Thank you. Thank you for joining us on the call this morning. We look forward to speaking with you at the upcoming investor events, including AEA conference in early November. This concludes our comments.

Ladies and gentleman, this does conclude the MKS Instruments third quarter earnings conference call. You may now disconnect and we thank you for using ACT teleconferencing.