Shareholders' Message, Q4 FY04

We are quite satisfied with our financial performance this quarter, reestablishing growth, setting a record for overall SCM revenue, and returning MKS to profitability, but the qualitative aspects were even more important and provided telling evidence that our long-term strategy at MKS is maturing.

Our improved performance in the quarter was very broad based, with every sales region exceeding our internal expectations, very strong service deliveries as well as service backlog improvements, good results in our legacy business, strong maintenance renewals, and steady overall pipeline expansion.

During the second and third quarters of this year, we recorded license revenues well below our own expectations. As we explained to our shareholders at that time, we felt strongly that the primary reason for lower revenue was our increased market focus on very large development organizations and the longer sales cycles that accompany those transactions. We indicated throughout the period that we are confident that our strategy would soon produce stronger revenue as those sales initiatives and customer relationships matured. In the fourth quarter, we fulfilled those expectations.

This quarter we saw strong evidence of improvement to overall licensing and in particular to the largest organizations that we serve. A full 30 percent of license sales came from those accounts with large development and IT organizations where we have significant existing license deployments up from less than 10 percent last quarter; moreover, our large account license wins were broad-based. None accounted for more than half a million in licensing. This is in stark contrast to the fourth quarter of last year where although we had slightly higher license revenue, most of it came from two or three large transactions.

The expansion of our large account revenue is a strong sign of increasing customer base maturity that is essential to achieve higher revenue in margins over the long-term. Most of these large accounts represent significant incremental license opportunities over the next few years.

Our SCM sales for the past quarter finished exactly as anticipated, due in large part to our very focused strategy of expanding business within Global 1000 companies, both current and prospective customers. We had our best ever quarter in terms of deals greater than $50,000, with 25 transactions totaling almost 3.5 million in sales. The largest individual sale for the quarter was $600,000, proving that we are able to attain a good quarterly performance across a broad range of opportunities and accounts.

Our IO team delivered their best performance in the past six quarters, as far as number of transactions larger than $50,000, all to current customers that we believe will continue to make investments in the Toolkit line over the coming years. They exceeded their profitability target for the quarter, further allowing MKS to fuel the continued SCM growth.

Our focus in Q1 will continue to be on developing new customers while building upon our current global accounts base. In line with our Q4 performance, in the next quarter we expect to close transactions with approximately one-third of our largest accounts as well as completing initial Enterprise sales with several new global accounts. These targeted accounts have been developed over the past three quarters and we are very excited about their overall potential. With a few of these soon to be beachhead accounts, we have already identified follow-on business based on successful rollout of this first crucial phase.

We’ve completed our strategic plan and budget for fiscal 2005. Our strategy continues to focus on sales to companies that have large, mission-critical development and IT organizations. We continue to devote a larger proportion of our resources to our field organization, placing even more emphasis on professional services as a critical part of our customer relationship and a product plan that increases the ability of our customers to use our products in more and different ways throughout their development in IT organizations.

We continued our very strong win rate against our competitors among large customers. The Serena and Merant acquisition had a mildly positive effect, by reducing the number of competitors we face, as well as creating sales force instability at Merant and a very substantial uncertainty as to the product direction that the new combined Serena and Merant organization will take.

While we are pleased at the improvement in our results and strongly believe that the underlying factors indicate fundamental business improvements, we are still not at the point where we can be assured that we will not see continued volatility in license results. Development of a broad Global 1000 customer base requires significant investment in time and resources. We also remind our shareholders that the first quarter of our fiscal year is typically a weak quarter for MKS and profitability is unlikely during that quarter; for the full fiscal year 2005 however, we believe that our strong pipeline improvement, particularly among our large customers, indicates continued license revenue growth that will deliver profitability for the full fiscal year.

We thank our shareholders for their continuing support through this challenging and critical period of our growth, we’re very optimistic about the future, and look forward to updating you in the months ahead.

Philip C. Deck
Chairman & CEO, MKS Inc.