Shareholder's Message, Q2 FY05

We enjoyed continued growth in our business in the second quarter driven primarily by continued strong growth in new licensing and services in our enterprise SCM business.

Overall we were quite pleased with growth and satisfied with our level of profitability. Many of the trends we reported on in the first quarter remained intact this quarter. We had many medium sized deals and no large blockbusters – 34 deals over 50k with none larger than 250. We continued to see just over half of license revenue coming from large accounts and an even larger proportion of services. In summary this quarter we executed well against our plan and were pleased to be able to do so without any major transactions.

We continue to invest heavily in our field organizations and are working to balance the need to continue to improve profitability with the need to build our sales and services organizations.

This management challenge is exacerbated by currency movements. MKS has avoided some of the adverse effects of the increasing value of the Canadian dollar on overall profitability chiefly due to the increasing value of the Euro and our positive Euro margin. While this is true from an accounting standpoint, in real terms we had lower shipments in Europe in the 2nd quarter in Europe, and we cannot know how much the higher value of the Euro was to blame for lower sales activity. In general, currency stability would be helpful to our business as we suffer the costs of currency shifts in our operating expense but do not necessarily enjoy the benefits in revenue as demand may be impacted. Nevertheless, we expect that the lower shipments this quarter in Europe will turn out to be lumpiness and not a general decline in demand. Fortunately in the 2nd quarter, continued strong gains in our North American business more than offset European softness. We have strong leadership and sales staff in Europe but we have a much higher degree of variability in results than we have seen in North America due to our higher reliance on large transactions there. We expect to see rebounding European results shortly.

Continuing with that theme of North American resurgence, the efforts that we made in the past few years in rebuilding our North American sales and services organization and the significant price we paid in terms of revenue softness in the second and third quarter of last year are now paying handsome dividends. Our North American sales and services organization posted a 91% increase in license revenue and a 50% increase in overall revenue this quarter compared to the same period last year. We are convinced that the measures that we took, although with some unpleasant side-effects at the time, will continue to bear substantial fruit.

At the mid year point of fiscal 2005, MKS is very much on track towards achieving the goals that we set forth in our business plan. As in the last quarter, our sales of Enterprise SCM solutions increased, particularly to the Global 1000 companies that we have set as our primary focus. Not only were the financial results solid in the quarter, but we continued to see improvements in the underlying dynamics that should promote further growth, not only through the overall pipeline improvement and adoption by new beachhead accounts, but also by the continued maturity of our customer facing teams.

Among many others successes, some of our wins included follow on projects with Citigroup, Continental, Northrop Grumman, SAIC, T-Systems and Verizon Wireless. In the second quarter, we also claimed important Beachhead sales into ADP, Autoliv, Electrolux and Honeywell. Our strategy of continuing to develop our key global accounts, while bringing in new names, continues to progress at a solid rate.

The IO division performed well against plan again, with increases in the maintenance revenue and sales strength across both North America and Europe. The profits delivered from the IO team continue to play an important role in the fueling and growth of the SCM division.

Our focus in the third quarter will remain on the same strategic path as it has been over the past few years. Deploying software sold in the previous quarter in order to promote more immediate value to, and demand from, our current customer base. Growing headcount in the field teams and development organization and being extremely selective in the hiring process. And finally, targeting and developing new Global 1000 organizations that we can claim as beachheads. The progress that we have made in attracting top notch customers and employees over the past few quarters will be a great foundation to build upon.

Across the market for IT management tools is a growing realization that much more highly integrated systems will be required to meet the needs of large corporations.

To manage and optimize the major investments in information technology being made by large corporations, MKS delivers three main benefits – Visibility, Productivity and Compliance.

Visibility allows customers to organize and analyze the myriad of tasks undertaken throughout the development process, to measure costs, to plan investments and to support the critical decision making process that makes sure that development dollars are directed in the most optimal way.

Productivity is the ability of customers to cut the cost of development relative to quality and output, through more effective collaboration, code sharing and much more timely decision making. Key to productivity is doing so at a low cost of ownership and without imposing unnecessary overhead.

Finally compliance, represents the ability to regulate process and track activities, to make sure that an organization has control over its software change, to enforce compliance of quality standards and to provide audit trails for all actions.

IT organizations are currently under significant pressure to meet significantly higher levels of compliance than they have generally met before. But MKS products help them to achieve compliance at the same time as enjoying the benefits of better visibility and productivity. MKS customers who have implemented our solutions to drive productivity are now in a highly advantageous position to meet their compliance obligations without significant additional cost or overhead.

MKS will release a new version of its flagship product line in January. Originally scheduled for release this month, we delayed the release to add substantial additional features to our Requirements Management capability instead of delivering it in a later release as originally planned.

The release places heavy emphasis on the Visibility, Productivity and Compliance themes. Our highly flexible customer dashboard allows customers visibility over all development activities. Our requirements management solutions provide high level decision making support over feature planning while delivering in cost effective highly integrated fashion. Our code re-factoring technology offers new capability to facilitate code sharing and component re-use and our electronic signature support offers new tools to prove process compliance.

Elsewhere in the market, leveraging on those key themes of Visibility, Productivity and Compliance, the market is heating up in sectors variously known as Application Portfolio Management and Product Portfolio Management. Both of these disciplines are focused at providing high level visibility and decision support for software development and IT operations. While MKS does not plan to release point products into these markets, we already provide a substantial set of features in these categories. Due to our enviable position in the management of software development tasks and related source code, we already generate the day to day information that those new products would like to manage. We will continue to add features in these categories, further emphasizing the benefits of a one product, fully-integrated approach, one that is endorsed every day as large organizations continue to select our products in record numbers.

In summary, we have built on our strong start to the year with further growth and profitability and are now looking forward to the release of major new product functionality. We are enthusiastic about our prospects and have re-affirmed our expectation for profitability as a whole in fiscal 2005 based on continued growth driven by SCM licensing.

We thank our shareholders for their continued confidence and look forward to reporting on our progress in the months ahead.

Philip C. Deck
Chairman & CEO, MKS Inc.