Gerry Colella - CEO & President Seth Bagshaw - CFO.

Tom Diffely - D.A. Davidson Josh Baribeau - Canaccord Patrick Ho - Stifel Nicolaus Jairam Nathan - Sidoti.

Good day ladies and gentlemen and welcome to MKS Instruments Third Quarter 2014 Earnings Conference Call. (Operator Instructions). As a reminder this conference is being recorded and I would now like to introduce your host for today's conference Vice President and Chief Financial Officer, Seth Bagshaw. You may begin..

Thank you. Good morning everyone. I'm Seth Bagshaw, Vice President and Chief Financial Officer and I'm joined this morning by Gerry Colella, our Chief Executive Officer and President. Thank you for joining our earnings conference call. Yesterday aftermarket closed released our financial results for the third quarter of 2014.

You can access this release at our website www.mksinstruments.com. As a reminder various remark that we may make about future expectations plans and prospects for MKS comprise forward-looking statements.

Actual results may differ materially from those indicated, by these forward-looking statements as a result as a result there are various important factors including those discussed in yesterday's press release and in the company's most recent Annual Report on Form 10-K and the most recent quarterly report on Form 10-Q which are 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.

A forward-looking statements should not be relied upon as a representing the company's estimates or views as of any date subsequent to today. Now, I will turn the call over to Gerry..

Thanks, Seth. Good morning everyone and thank you for joining us on the call today.

As in recent calls I would like to start with an overview of the third quarter then I will give a brief update on the progress we've been making against our strategic initiatives and some highlights on our business in the third quarter of 2014 and finally I will provide our outlook for the fourth quarter.

Following me Seth will give further details of our financial results and then we will open the call for your questions. The third quarter was another strong one with sales of $187 million, which was up the high-end of our guidance while non-GAAP earnings of $23 million or $0.43 per share were also above our expectations.

Semiconductor sales both with OEM and device manufacturers continued to remain strong and sales through all the other markets further increased sequentially a reflection of the contribution from Granville-Phillips as well as our continued emphasis on these adjacent marketing I am pleased with these results and anticipate continued strength as we exit the year.

Seth will have more details on this quarter as well as Q4 later in the call.

When I assumed the role In January, the team and I focused on strategic initiatives with specific goals to continue to broaden especially our leadership in vacuum processing, measurably improve our profitability throughout the cycle, efficiently deploy capital to increase shareholder value and aggressively pursue opportunities created by current technology inflections.

In the third quarter we made additional progress towards achieving these goals. Starting with first with our goal to improve leadership in vacuum processing we continue to integrate Granville-Phillips or GP operationally and technically into MKS.

Product lines have been combined and rationalized, operations have been consolidated and the union has progressed very well. The integration is effectively complete and GP is now fully part of MKS and has been immediately accretive. We are now the leading global provider in our served markets of indirect gauges.

In addition, we estimate we remain number one overall in our core served markets and that we gain share organically in 2013. Going forward we have additional initiatives to further broaden our technology leadership and continue to explore M&A that have a strategic fit with MKS.

We have a robust M&A pipeline and I'm confident that we will continually successfully identify, acquire and integrate other technology based companies.

We have remained dedicated to our goal to improve our profitability and in the quarter we took certain additional actions to streamline activities and improve our execution and with these changes our performing to our new model our goal is continued improvement in our profitability and we will monitor progress against our model and make adjustments to refine it as business conditions warrant.

In addition to our profitability goal we are committed to returning capital to shareholders. In the third quarter we paid dividends of approximately $9 million.

Since 2007 the combined return of capital from dividends and share buybacks totaled $379 million and year-to-date we have deployed nearly $135 million in capital through the acquisition of GP, shareholder dividends and share repurchase. Technology leadership is a core aspect of our strategy.

In the semiconductor market we continue to target opportunities arising from the significant technology changes facing the industry. The shift from plain to 3D device is progressing and device makers are integrating additional deposition, etch and process control steps in order to continue scaling while EUV remains slowed.

The complexities of conformal films, high aspect ratio etch (indiscernible), atomic layer films continue to challenge the industry. MKS is well-positioned to provide solutions to address these challenges.

For example, our industry-leading RF generators provide the position control required for the fine lines in high aspect ratio holes in leading-edge 2D and 3D devices and we continue to increase penetration with these new products. In the quarter we also achieved design wins at two major etch OEMs for our flow ratio and pressure control product.

Both of these technologies provide accurate delivery and precise control of process gases which are required for advanced etch We were also selected to provide process to heat and control gas delivery and to manage affluent to ensure process consistency and productivity. We work closely with all OEMs across the globe.

However, we are seeing increasing demand coming from Asia as new OEMs emerge and production continues to shift east. Over the past decade we have made significant investments in Asia (indiscernible) OEM customers and device makers in this growing region.

This is especially true in Korea where we have invested in regional offices, local application engineering and repair capabilities as well as acquiring Plasmart, our Korean product line designing RF matches.

Our localization strategy continues to pay dividends as these have investments have allowed us to develop relationships and provide solutions to OEMs in the region and I'm pleased to report that this quarter we received another significant design win this time for a R*evolution III Remote RF Plasma Source for On-Wafer Processing.

This is a significant win with a growing Korean strip OEM with two slated for advanced memory production. We anticipate that shipments will begin in the fourth quarter and continue into early 2015. Additionally in Korea we received follow-on following orders for our CVD Chamber Clean as well as flow, pressure, ozone, microwave and other products.

While Korea was a good example of how focusing resources improves results, we continue to work closely with all of our customers across the globe.

For example, recently a major device manufacturer in North America selected our new Liquozone reclaim system due to the significant savings it provided and this quarter it was designated as parts of the process of records for future production.

Elsewhere this quarter because of our superior performance we received additional orders for advanced residual gas analysis products which monitor conditions during physical wafer deposition in other critical processes. This is an especially important win since we once again displaced an incumbent supplier.

These are just a few financial of recent activities and design wins but they demonstrate how we support the semiconductor industry around the world and we are optimistic and excited about our future growth and the future of this exciting industry. Moving to other advanced markets, sales increased for the fourth consecutive quarter.

These adjacent markets include medical, thin films, bio and pharmaceutical manufacturing, LEDs, flat panel displays and other diverse applications. In the past calls I’ve spoken about the success of our multi-varied and now software in the biopharmaceutical market.

This quarter we saw an expansion of our real-time process monitoring software in another important and growing market, specialty chemical manufacturing. This win fall successful implementation of the product in the U.S. with a customer quantified to value the software and improving their production process.

This customer has now started implementation at their other facilities outside of the U.S. We continue to have additional follow-on orders for many MKS products. For example this quarter we received additional demand for pressure control products used in advanced plasma sterilization for dental and medical instruments.

Additionally we continue to gain acceptance to take share in the general industrial applications with our G-Series multi-gas, multi-range mass flow controllers.

I'm pleased to report that this quarter we achieved a milestone of over 12,000 G-Series MSCs shipped to more than 650 customers significant indication of the success we have seen with this design. In the last call I’ve mentioned that we have identified several key megatrends which we’re pursuing to drive future growth.

One of these megatrends is environmental monitoring which includes examining ambient air safety as well as quality. I reported in the past calls that the AIRGARD has been installed in major government facilities with multiple follow-on orders projected.

This quarter I'm proud to report that we have made in-roads into the non-government sector as a major U.S. municipal transportation system purchased AIRGARD detectors to monitor (indiscernible) throughout their system.

This is the first major AIRGARD sale outside of core government activities and is part of our strategy to expand our sales in environmental monitoring.

This win is significant and the potential opportunity it represents for MKS but above that this success is validation of our capability to develop advanced solutions which can help protect the general public which we expect will open future opportunities for MKS.

These are just a few examples of how our technologies are solving challenges in the many diverse and growing applications in market we serve which provide growth for MKS.

Looking ahead to the fourth quarter, business in the semiconductor market remains solid and several major OEMs have recently placed large orders with shipments in the fourth quarter and into the first part of next year.

In our other markets we continue to leverage our breadth of technologies as we strategically search out additional opportunities and we anticipate that this is an easier as we will grow.

Based on these factors and looking at current business levels we anticipate the sales in the fourth quarter may range from a $185 million to $200 million at these volumes our non-GAAP net earnings could range from $0.42 to $0.53 per share. At this point I will turn the call over to Seth to discuss our results and expand upon our guidance. .

Thank you, Gerry. I will first discuss the Q3, 2014 financial results before providing further details on our Q4, 2014 guidance. Revenue for the quarter was $187 million increase of 1% compared to Q2 revenue of $185 million and increase of 12% from $166 million a year-ago.

Our Q3 revenue at the higher end of our guidance range due to bad anticipated sales in the semiconductor market continued growth in our other advanced markets which were up 5% sequentially in over 17% from Q3, 2013.

Non-GAAP gross margin was 43.3%, which was slightly above our expectations at this sales volume primarily due it more favorable product mix. On a GAAP basis our gross margin was 42.5% it included $1.6 million of amortization of the inventory step-up related to the GP acquisition.

Non-GAAP operating expenses were $48.2 million which was also favorable to our guidance range due to lower employee related costs, the timing of R&D, IT and other project spending. GAAP operating expenses were $51.2 million included $1.8 million of amortization of intangible assets as well as $1.2 million of restructuring charges.

Our non-GAAP operating margin was 17.5% of sales which remains ahead of our target model at these volumes. Non-GAAP net earnings were $22.8 million or $0.43 per share compared to $22.6 million in the second quarter and $13.3 million in the third quarter of 2013. Our non-GAAP tax rate was 31% as expected.

GAAP net income was $29.1 million or $0.55 per share including GAAP net income with discrete tax credits totaling $9.5 million related to favorable settlements of both domestic and international tax audits as well as a tax credit from and intercompany dividend from a foreign subsidiary.

As we mentioned before we’re committed to making continuous improvements in our financial performance over the operating cycle. In the first quarter earnings call, we discussed a reduction workforce that is now substantially complete.

In the third quarter we completed further reduction of workforce in our international operations that along with other cost reduction activities resulted in a $1.2 million restructuring charge. We anticipate reinvesting the annualized savings related to this Q3 activity into other high growth opportunities.

To recap the combined impact of the 2014 restructuring activities reduce our permanent [ph] cost structure by close to $10 million on annualized basis and we have what will be reinvesting almost $4 million of this back into key initiatives and functions to further strengthen our core competencies.

The result of the net improvement in our long term offering model while providing key funding in resources for long term growth initiatives.

As we discussed in previous calls, these actions in connection with other opportunities have improved our target operating model throughout the semiconductor cycle and our previous and current financial models posted in the investor section of our website.

Now turning to the balance sheet, cash and investments increased by $24 million in the quarter to $570 million or approximately $10.75 per share. The increase in cash and investments was due to continued strong cash flow from operations. In the quarter we also made a dividend to shareholders of $8.8 million or $0.165 per share.

At the end of Q3 approximately 53% of our catch investments were in the U.S. and the balance located throughout our international operations. Total book value net of goodwill intangibles was $817 million or $15.39 per share.

In terms of working capital days sales outstanding were 52 days at the end of the third quarter compared to 50 days at the end of the second quarter and inventory churns were 2.8 compared to 2.7 in the second quarter.

Capital additions for the quarter were $2.1 million, depreciation and amortization expenses were $5.8 million and non-cash stock compensation was $2.8 million.

The total deployment of capital for share repurchases, dividends and the acquisition of Granville-Phillips was nearly $135 million year-to-date, more than 1/3rd of our cash balances in the U.S. when we started the year. We have therefore deployed more than half of our excess cash in the U.S. during 2014.

We will continue seek ways to deploy capital in the long term interest of our shareholders. Now I will go through more detail regarding the composition of revenues for the third quarter. Sales to semiconductor market were $126 million compared to $127 million in Q2 and represented 67% of third quarter revenue.

Sales to semiconductor OEMs were $102 million or 54% of total revenue and sales to semiconductor fabs were $24 million and comprised 13% of total sales, both of these comparable to last quarter. Sales in our other advanced markets were $61 million, up 5% from the second quarter of 2014 and up 17% from the third quarter of 2013.

This increase was the fourth consecutive quarterly increase in revenue in our other advanced markets and reflects the impact of a full quarter's revenue from GP. Sales of these markets comprise 33% of total revenue in the quarter and vary from quarter-to-quarter depending on specific projects. Geographically sales in the U.S.

were 58% of total sales, sales in Asia were 31% and sales in Europe were 11% of total sales. Sales to our Top 10 customers represented 46% of total sales, sales to Applied Materials and Lam Research comprised 20% and 11% of third quarter sales respectively.

Our headcount at the end of the third quarter was 2350 down from 2421 at the end of the second quarter due to restructuring activities described earlier, the inclusion of temporary headcount additions related to seasonal summer (indiscernible) in the U.S. and minor attrition our direct label workforce in China. Now I will turn to Q4 2014 guidance.

Based upon current business levels we estimate that our sales in the fourth quarter could range from $185 million to $200 million, based upon the expected sales range our Q4 gross margin could range from 44% to 45% reflecting these volumes and expected product mix. Q4 non-GAAP operating expenses could range from $49 million to $50 million.

In the fourth quarter R&D expenses could range from $16.1 million to $16.5 million. In SG&A expenses it could range from $32.9 million to $33.5 million. The range of operating expense in the fourth quarter reflects certain R&D and other projects expenses that have moved from Q3 into Q4 and higher employee related costs.

As I mentioned in previous calls, the timing of project expenses depends upon a variety of factors and could vary from quarter-to-quarter. In the fourth quarter, amortization and intangible assets is expected to be approximately $1.8 million and net interest income is estimated to be approximately $400,000.

We expect our fourth quarter income tax rate to be approximately 31% reflecting anticipated geographical mix of taxable income.

Given these assumptions fourth quarter non-GAAP net earnings could range from $22.3 million to $28.2 million or $0.42 to $0.53 per share and GAAP net income could range from $21 million to $27 million or $0.39 to $0.50 per share or approximately 53.5 million shares outstanding.

This concludes our prepared remarks and now will open the call for questions..

(Operator Instructions) Our first question comes from Tom Diffely with D.A. Davidson. Your line is now open..

Maybe first couple questions on just the business trends today. It sounds like, based on your comments, there were some nice orders placed for the fourth quarter going into the first quarter.

So do you view this as kind of a multi quarter ramp in your business on the semiconductor side?.

And part of the problem we have is our lead times are so short our visibility is relatively modest.

But if you -- if we look at what the range of growth in the equipment spending is supposed to be on the average is 7%, and the shift to more favorable mix for MKS to 3D NAND and FinFET and multi patenting, it would tend to lead us to believe that yes, it would be something we'd expect to see continued growth.

So we think it's a positive trend for us, yes..

Okay.

And then the range of your guidance is based just on timing then of those projects?.

Yes..

Whether they hit in the fourth quarter or first quarter?.

Exactly..

And then, Gerry, you talked a lot about Korea being a nice kind of a growth area for you, assuming your relationships with the local guys. What about China? We know we hear a lot of chatter, lately, about the Chinese government trying to support their own industry.

Are you positioned there? Are you seeing any activity there?.

We actually have had a large presence in China for some time, both operationally in sales and service. We continue to see significant growth in our Chinese operation. Actually second only, primarily, to Korea and we're very well-positioned with OEMs there across-the-board. Whether primarily things like LED, (indiscernible) it continues to bounce back.

Semi as well. So yes, our Chinese business is very strong and we have a good, solid operations over there. We're very happy with what's going on there. You know, we highlighted Korea because it's such a growth in the semiconductor equipment space there and again with the device makers. But we certainly are just as focused in Taiwan.

We've seen good growth there. China, solid positioning in Japan. It just happens to be that Korea has really accelerated in its growth..

Are you getting the sense that the Chinese government is really trying to grow equipment companies or is it more on the design side?.

Well we really don't have a lot of visibility into the Chinese government. Just the OEMs themselves and on the equipment, it looks like that what we're seeing is a lot of really capable people in China now. Actually, some people that came from the equipment industry in the U.S., and in Japan are now in China.

We have faith and confidence in these people. We've worked with them in the past. So they are very entrepreneurial. So if the government is assisting them they still have really strong people that know what they're doing and we're pleased with that..

And, Seth, when you look at the $10 million per year savings or cost reduction that you have done, should we look at the model a little differently now? We are we moving some of those costs now from COGS and SG and (indiscernible) for the reinvestments?.

Yes. I would say you're right, Tom. So $10 million -- the $6 million net savings on $10 million gross we're going to reinvest $4 million back in other areas. Most of that reinvestment will be in the R&D or really market based either sales, application (indiscernible) or business development functions.

Yes, not in manufacturing and certainly not in the back ops operations. So it's really targeted to really expand the opportunities we see in other advanced markets even semi as well..

And then, finally, Gerry, when you look at some of these air quality programs that you've talked about in the last few calls, what are kind of the relative size of the opportunities for you per project and how many projects are there out there potentially?.

Well, it really varies by application. You've got engine testing. You've got emissions stack monitoring. In this particular case, chemical weapon detection.

I would probably say that the one with the biggest area of growth for us could be chemical weapon detection and that business was relatively small by our standards but the growth potential is very significant. So I really can't get into specific details of what each project could entail because there's still a lot of things we have to keep discreet.

And we have to use discretion in discussing it because of the sensitivity of it but they could be very significant. I don't mean to be evasive but we just have to be careful what we say..

Thank you. Our next question comes from Josh Baribeau with Canaccord. Your line is now open..

Did you guys ever think -- I'm sure you do.

Can you share with us the ideal mix that you'd like between semi and let's call it, the other markets?.

Well, I would like during a peak, if we were more like 60:40 or 55:45 during a semi peak which means we really grow in the other advanced markets without turning our back on our semiconductor industry, which we think is a great place for our continued growth and strength. But it would be nice to have in case there's some modifying cycle.

We would have a strong basement for our business by having grown the other advanced markets. So that'd be a nice mix. It may take us a while but I think that would be a great mix, if we could do that.

And you're looking at things like industrial, more in the industrial markets where it's more steady in terms of the business that we see, those types of things..

And then as you kind of look around at valuations across-the-board in a lot of sectors, as of the past couple weeks and months, has your appetite increased or has your quoting activity potentially increased for acquisitions with some of your potential targets maybe looking a little bit more attractive?.

Well, I think what we're trying to do is keep a steady hand on our acquisition strategy and I think what we'll do is we would pay a fair value for a company that we think it fits our model that's accretive, our growth strategy and our markets. So we continue to look on a continuous basis.

I've got M&A [ph] team that we're looking throughout the world, being proactive rather than waiting for things to come to us. And we see things that are of a decent value. And if we think things are overvalued then I'm not so sure we would act on them.

I think we paid a good price for GP but I think we think, based on the business growth and on the tax advantage of it, that it was a good deal. So I think we would be very careful and good stewards of the Company's money but make sure we invested for good, high growth opportunities..

Thank you. And our next question comes from Patrick Ho with Stifel Nicolaus. Your line is now open..

Gerry, can you give a little bit more color in terms of the strength in your semi business, particularly in Q3. It held up it appears better during this industry pause than a lot of your peers.

Can you comment whether it's the exposure to some of the key process segments that are increasing capital intensity like etch and deposition? Or were new design wins a contributor to, I guess, the better than expected performance?.

I think it's actually a combination of all three. I think the shift in the technology is good for MKS and I think we're seeing great benefit from that. I think our position in Korea has helped us a lot. We’ve got good business with Korean OEMs over there and we've seen some significant orders coming our way.

And I think that's helped a lot maybe compared to others. And also the other thing is we're kind of first in line in the food chain, Patrick. So sometimes we'll call the downturn and people will think that we're kind of Debbie Downer because we say it first, but it's based on where we are.

So I think a little bit of it is because we're so early on in the supply chain. And I think there's some significant design wins, like the Liquozon and other things that we got in our technology shifting to the 3D NAND and FinFET multi-patenting and I think our strength in Asia has contributed to all of that..

Maybe going to the non-semi side for a second, excluding the Granville-Phillips, what other markets are you seeing kind of emerging strength or building momentum, particularly as we head into the end of the year as well into 2015? Are you seeing any more activity in some of your traditional markets, like flat panel display or LEDs? What are some of the other markets you're starting to see strengthen?.

Yes. Well, the medical was a nice business in the quarter, which is a nice part of our business. So we saw some strengthening there. The biopharm is also starting to see some good strengthening there and the LED, we talked about it being off life support.

We think maybe the patient is now taken its first step out of the hospital bed because we've seen a little better increase on the LED side as well. So I think those three markets kind of led a good strengthening for the company and we're well-positioned there. And those are places we are really trying to penetrate further.

And as well as air quality, air safety emissions control..

And the final question from me for Seth. In terms of the inventory levels, you guys did a pretty good job in Q3, especially as orders were building.

How do you see that trending in Q4 and maybe even a little bit of color early parts of Q1, 2015 given some of the comments by your customers?.

Yes. I think, Patrick, what's going to drive inventory levels is really our sales guidance, I would say. So it'll move by a little bit but I wouldn't expect a major change in inventory volumes by the end of the fourth quarter. And it more correlates with the revenue guidance we gave.

If that were to move, obviously, that would probably drive inventory levels and it can be a little lumpy sometimes. We don't instruct the teams in manufacturing to do anything that's unnatural. They'll do sort of the normal cadence on the buys.

You might see a lumpiness there, which is better for them to really level out the factory and get the best pricing from the suppliers. But I would say, it would be fairly consistent right now based on the guidance we gave and revenue in the fourth quarter..

(Operator Instructions). Our next question comes from Jairam Nathan with Sidoti. Your line is now open..

My first question was on the Korea wins. The significant end customer there seems to be having some trouble.

So in light of that -- would you kind of -- could the wins in Korea, are they mostly memory related where you are seeing more spending? Or can you give us some more idea there?.

Well, I think that, generally, across the board. There are also multiple end-users there other than just one that people talk about, which we have strength with and I think that the Korean OEMs we work with are very close to the device makers, the end-users.

And so I know -- I don't think that they would be strengthening their position with us if they were skittish about the long term outlook for work with their end customers. I know these customers well and I know how they order and I think they see confidence in the business going forward.

And I think -- and I also think it's basically across the board..

Just more broadly on design wins.

How long does it typically take once you win a design to kind of start seeing it in revenue?.

Well, it really depends on the individual OEM. Some can be a quarter or two out. Some might take 7 or 8 months out on the design cycle. So it really depends and it depends on where their product is in their release cycle too. So it's really kind of hard to say. Some could be -- almost be immediately, as an immediate replacement. And we've seen that.

And some could be a matter of their acceptance of their tool into the market and how they go from pilot to production release. So it really kind of varies..

And my last question on -- you mentioned in your press release about redeploying resources, refining the cost structures.

Do you see more opportunities on the efficiency front on OpEx?.

I think that we're dedicated to continuing to look at the cost to run this business and where our money is being invested. And I think the thing that you've seen us do in the last number of months, the last three quarters is to evaluate where we're spending and the return we're getting on it.

I think MKS has always been seen as operationally excellent and financially prudent. We don't expect to do that. But we do think that there is -- as we continue to look at the business that's growing, if we have to shift or reduce costs in order to strengthen investments elsewhere, we'll continue to do that.

So it's something my team is continually looking at on a monthly basis, absolutely..

Thank you. And, at this time, I'm showing no further questions. I would like to turn the call back over to Gerry Colella for further remarks..

Thank you. This quarter was another strong quarter for us and I'm very pleased about our performance. We have targeted specific goals and focused our actions to achieve them and are now seeing the results.

The fourth quarter has started strong with several semiconductor OEMs placing orders to satisfy the increasing capital intensity requirements facing the industry. We continue to leverage our technologies into adjacent markets and to address megatrends such as air quality and safety.

I'm very optimistic about future opportunities and I look forward to updating you on our continued progress in January. Thank you for joining us on the call today..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day..