Note: All new or revised material since the last update is highlighted.
Reason for Report: 4Q07 & FY07 Earnings Preview
Prev. Ed.: December 03, 2007; Minor Changes in Target Price & Estimates
Brokers' Recommendations: Neutral: 85.7% (6 firms); Positive: 14.3% (1); Negative: 0.0% Prev. Ed.: 6; 1; 0
Brokers' Target Price: $21.75 (↔ from the last edition; 4 firms) Brokers’ Avg. Expected Return: 28.9%
Recent Event
On October 25, 2007, MKSI announced 3Q07 financial results. The Zacks Digest total revenue in 3Q07 was $181.0 million, down 11.9% y/y and 11.3% q/q. The 3Q07 pro forma EPS was $0.38, down 26.9% y/y and 11.6% q/q.
Overview
Key investment considerations as identified by analysts are as follows:
Key Positive Arguments / Key Negative ArgumentsNon-Semi Strength: MKSI continues to see strong momentum building in solar and other alternative energy markets. Sales in these markets are expected to double in 2007, which could continue contributing to a larger portion of revenue and earnings in 2008.
New Products and Diversification: According to analysts, new product development efforts will continue to grow the non-semiconductor business.
Applied Materials relationship pays Dividend: MKSI continues to benefit from a healthy customer relationship with Applied Materials (AMAT), which accounted for approximately 20% of 3Q07 sales. / AMAT Dependencies: The Company derives a significant portion of its revenue from the highly-cyclical semiconductor industry, and AMAT is its largest customer, providing a degree of client concentration risk.
Semi Business slowing Near Term: The semi business could show slow growth as MKSI increases penetration in other end markets.
Headquartered in Wilmington, Massachusetts, MKS Instruments, Inc. (MKSI or the Company) engages in the development, manufacture, sale, and servicing of instruments, components, subsystems, and process control solutions that measure, control, power, and monitor parameters of semiconductor and manufacturing processes. MKSI serves manufacturers of semiconductor capital equipment, semiconductor devices, data storage equipment, medical equipment and flat panel displays, as well as industrial and biopharmaceutical manufacturing companies, and university, government, and industrial research laboratories primarily in the United States, Japan, Europe, and Asia. For more information about the Company, please visit its website at www.mksinst.com.
Note: MKSI’s fiscal year coincides with the calendar year.
January 18, 2008
Revenue
Provided below is a summary of total revenue as provided by Zacks Research Digest:
Total Revenue ($M) / 3Q06A / 2Q07A / 3Q07A / 4Q07E / 2007E / 1Q08E / 2Q08E / 3Q08E / 2008E / 2009EZacks Consensus / $169.0 / $772.0 / $175.0 / $767.0
Digest Average / $205.5 / $204.0 / $181.0 / $169.0 / $765.5 / $174.6 / $182.0 / $175.3 / $724.3 / $835.0
Digest Low / $205.5 / $204.0 / $181.0 / $166.0 / $762.4 / $160.0 / $155.0 / $145.0 / $620.0 / $820.0
Digest High / $205.5 / $204.0 / $181.0 / $172.0 / $768.4 / $187.0 / $206.0 / $200.0 / $852.0 / $850.0
Y-o-Y Growth / 2.8% / -11.9% / -15.4% / -2.2% / -17.4% / -10.8% / -3.1% / -5.4% / 15.3%
Seq. Growth / 3.6% / -3.5% / -11.3% / -6.6% / 3.3% / 4.2% / -3.7%
As per Zacks Digest, revenue in 3Q07 was $181.0 million, down 11.9% y/y and 11.3% q/q from $205.5 million in 3Q06 and $204.0 million in 2Q07. The 3Q07 revenue was at the lower end of the guidance range of $180.0-$188.0 million, but came in below the Street consensus of $184.0 million. The softness in the quarter was attributed to the timing of customer spending and the semiconductor revenue and the normal fluctuations of the other aggregate businesses.
Semiconductor related revenue declined 10% sequentially, and non-semiconductor revenue increased 13%. In 3Q07, the semiconductor business represented 66.0% of sales, of which OEM (original equipment manufactures) revenue represented 56.0% of sales (down 12.0% sequentially) and sales to semiconductor fabs represented 10.0% of sales (down 16.0% sequentially). In the non-semi conductor business, sales of thin film markets (flat panel, data storage applications) decreased 7.0% sequentially and accounted for 9.0% of sales. Other non-semiconductor markets sales decreased by 8.0% sequentially, totaling to 25.0% of sales.
Applied Materials (AMAT), the largest customer, accounted for 20.0% of sales versus 21.0% in 2Q07, thereby decreasing sales by 17.0% sequentially. In 3Q07, the top 10 customers accounted for 40.0% of revenue versus 48.0% in 2Q07.
Revenue breakdown by region: Sales in Asia in 3Q07 decreased 18.0% q/q to $45.3 million and comprised 25.0% of the total revenue, primarily due to decreased demand at Fabs. Sales in the United States accounted for 62.0% and decreased 13.0% q/q to $112.23 million, while Europe accounted for 13.0% of total sales, increasing 15.0% q/q to $23.5 million.
Outlook
Considering variations in major customers' order patterns in semiconductor and non-semiconductor markets offsetting the OEM shipment growth, the Company guided 4Q07 revenue in a range of $165.0-$173.0 million against a consensus of $178.0 million. Management expects weak revenue from semiconductors in the near term.
One analyst (Stanford) believes that MKSI with its acquisition strategy will change its semiconductor/non-semiconductor revenue mix from 70%/30% at present to 60%/40% in the next 4-5 years. The analyst also feels the changed revenue mix would help diminish the effect of the semiconductor industry’s cyclicality on MKSI’s financial results and would make internal forecasting and planning easier.
According to one analyst (Merrill), MKSI is strategically well positioned from an increasingly diversified end market stand point and the analyst believes the semiconductor equipment customers to be the driving force for revenues.
For details on individual analyst estimates please see the Consensus tab of the MKSI spreadsheet.
Margins
Provided below is a summary of margins as provided by Zacks Research Digest:
Margins / 3Q06A / 2Q07A / 3Q07A / 4Q07E / 2007E / 1Q08E / 2Q08E / 3Q08E / 2008E / 2009EGross Margin / 44.2% / 42.2% / 42.3% / 41.3% / 42.5% / 42.0% / 42.5% / 44.1% / 44.3% / 44.1%
Operating Margin / 18.3% / 13.5% / 12.8% / 10.0% / 14.6% / 12.2% / 13.9% / 13.8% / 14.2% / 18.7%
Pre-Tax Margin / 18.6% / 15.3% / 15.0% / 11.4% / 15.8% / 13.4% / 15.2% / 15.4% / 15.5% / 19.7%
Net Margin / 13.8% / 11.6% / 12.0% / 8.4% / 11.5% / 9.7% / 11.0% / 10.8% / 11.2% / 14.0%
Gross margin increased by 10 basis points to 42.3% in 3Q07 from 42.2% in 2Q07 and declined by 190 basis points from 44.2% in 3Q06. The sequential increase in the margin, despite lower sales, was due to reduced inventory charges and lower overhead spending due to one week’s shutdown. Gross profit in 3Q07 was $76.6 million versus $90.7 million in 3Q06 and $86.0 million in 2Q07, with a decline of 15.6% y/y and 10.9% q/q.
MKSI witnessed a decrease in operating expenses during the quarter primarily attributable to the foreign currency adjustments. SG&A expense (18.0% of total revenue) was $32.5 million in 3Q07 compared to $33.0 million in 3Q06 and $35.9 million in 2Q07; representing a decrease of 1.5% y/y and 9.5% q/q. The decrease in the SG&A expense was due to lower discretionary spending including lower IT consulting costs and favorable foreign exchange adjustments and one-time stock-based compensation adjustments. R&D expense (9.5% of total revenue) was $17.2 million in 3Q07 versus $18.4 million in 2Q07 and $17.8 million in 3Q06. The lower R&D expense was due to the timing of spending for engineering projects and staffing. Head count was reduced to 2,886 people worldwide from 3,015 people.
The operating margin was 12.8% in 3Q07 versus 18.3% in 3Q06 and 13.5% in 2Q07. The operating profit in the quarter was $23.1 million, down 38.6% y/y and 16.3% q/q. Pre-tax profit was $27.1 million, down 29.1% y/y and 13.1% q/q. The tax rate in the quarter was 21.0%, compared to 26.1% in 3Q06 and 27.9% in 2Q07.
Outlook
For 4Q07, the Company expects gross margin to be in the range of 40.5% to 41.5%. R&D expense in the quarter is expected to range from $17.8 million-$18.2 million and SGA expense to range from $33.5 million-$34.0 million. Amortization of acquired intangible assets is expected to remain about $4.0 million. The tax rate is estimated to be 29.0%.
One analyst (Needham) believes that MKSI’s initiative to export products in low-cost countries and control costs would result in gross margin expansion. On the other hand, another analyst (Stanford) expects a sequential decline in gross margin and a flat q/q operating expense. Further, according to the analyst, there would be no benefit arising from R&D tax credit.
As per Zacks Digest, COGS is expected to decrease by 0.8% y/y in FY07, 3.3% y/y in FY08 and increase by 9.5% in FY09, as against revenue decrease of 2.2% y/y in FY07, 5.4% in FY08 and increase of 15.3% y/y in FY09. Further, R&D expense is expected to increase by 3.0% y/y in FY07, 1.8% in FY08 and 0.8% y/y in FY09. SG&A expense is also expected to increase by 6.9% y/y in FY07, 6.2% in FY09 and decrease by 4.5% y/y in FY08.
For details on individual analyst estimates please see the Consensus tab of the MKSI spreadsheet.
Earnings per Share
Provided below is a summary of EPS as compiled by Zacks Research Digest:
EPS / 3Q06A / 2Q07A / 3Q07A / 4Q07E / 2007E / 1Q08E / 2Q08E / 3Q08E / 2008E / 2009EZacks Consensus / $0.25 / $1.55 / $0.27 / $1.26
Digest Average / $0.52 / $0.43 / $0.38 / $0.27 / $1.60 / $0.33 / $0.37 / $0.38 / $1.47 / $2.05
Digest Low / $0.49 / $0.43 / $0.38 / $0.25 / $1.59 / $0.26 / $0.25 / $0.21 / $1.10 / $2.00
Digest High / $0.56 / $0.43 / $0.38 / $0.28 / $1.62 / $0.39 / $0.48 / $0.58 / $2.05 / $2.10
Year over Year Growth / -11.0% / -26.9% / -44.2% / -13.1% / -37.5% / -14.0% / -0.9% / -8.3% / 39.8%
Sequential Growth / 7.6% / -17.3% / -11.6% / -30.3% / 22.6% / 13.8% / 1.8%
According to the Zacks Research Digest, EPS in 3Q07 was $0.38, down 26.9% y/y and 11.6% q/q, but was ahead of the Street consensus of $0.30. The 3Q07 EPS outstripped the guidance range of $0.29-$0.35, excluding the effect of amortization of acquired intangible assets and special items. The better-than-expected EPS was primarily due to higher gross margin, lower operating expenses and a benefit related to the R&D tax credit. But the overall decline, both on a y/y and q/q basis, was due to the industry-wide slowdown in semiconductor equipment spending. The Company reported a GAAP EPS of $0.37 in 3Q07.
Outlook
The Company guided non-GAAP EPS within a range of $0.23-$0.28 for 4Q07 versus the consensus of $0.29, on approximately 58.0 million shares outstanding based on the semiconductor market projections and current order patterns of the industry. The guidance excludes expenses for amortization of acquired intangible assets and special items. The GAAP EPS is forecast by the Company to range within $0.19 to $0.24.
The Digest average model projects EPS of $1.60 for FY07, $1.47 for FY08, and $2.05 for FY09 with a y/y decline of 13.1% in FY07 and 8.3% in FY08, but an increase of 39.8% in FY09. The estimated 3-year compounded annual growth rate (CAGR) based on FY05 EPS is 26.8%.
Highlights from the EPS chart are as follows:
· 2007 forecasts (6 analysts) range from $1.59 (Goldman) to $1.62 (Needham); the average is $1.60.
· 2008 forecasts (6 analysts) range from $1.10 (Goldman) to $2.05 (J.P. Morgan); the average is $1.47.
· 2009 forecasts (2 analysts) range from $2.00 (Goldman) to $2.10 (Merrill); the average is $2.05.
Following the 3Q07 earnings release, two analysts (Needham; J.P. Morgan) reduced the EPS estimates for FY07 and FY08 to reflect management’s lowered guidance, whereas three analysts (Goldman; Lehman; Merrill) increased their estimates to reflect MKSI’s better-than-expected 3Q07 results and better share buyback outlook.
One analyst (Stanford) continues to expect a sequential increase in EPS from 2008, but from a lower base.
For details on individual analyst estimates please see the EPS tab of the MKSI spreadsheet.
Target Price/Valuation
Of the 7 firms covering MKSI, 1 firm (Needham) gave a positive rating and 6 gave neutral ratings. There is currently no negative rating on the stock. The average Zacks Digest price target is $21.75 (↔ as the previous report; 28.9% upside from the current price). The price targets range from $17.00 (0.8% upside from the current price) (Goldman) to $34.00 (101.5% upside from the current price) (Needham). The firm (Goldman) with the lowest target price has rated the stock Neutral, while the firm (Needham) with the highest target price has assigned a Buy rating on the stock. Following the 3Q07 earnings results, none of the analysts revised the target price and rating on the stock. In the recent update, analysts have not made any change to the target price and rating.
Provided below is a summary of valuation and ratings as compiled by Zacks Research Digest:
Rating DistributionPositive / 14.3%
Neutral / 85.7%
Negative / 0.0%
Digest High / $34.00
Digest Low / $17.00
Avg. Target Price / $21.75
No. of Analysts with Target Price/Total / 4/7
The major risks to the target price from an industry perspective include potentially slower-than-expected near/mid term semiconductor fundamentals due to a potential deterioration in the macro environment, particularly in the IT sector, and weak consumer spending trends. This was also due to the fact that (a) a significant portion of sales are concentrated among a few OEM customers and (b) intense competition with Advanced Energy in the power supply market. From the company-specific perspective, risks include the inability to maintain market share and/or deteriorating operations and financial management.