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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission file number 0-23621
-------
MKS INSTRUMENTS, INC.
(Exact name of registrant as specified in its charter)
Massachusetts 04-2277512
- --------------------------------------------------------------------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
Six Shattuck Road, Andover, Massachusetts 01810
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (978) 975-2350
------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No __.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No __.
Number of shares outstanding of the issuer's common stock as of July 31, 2003:
51,565,994
MKS INSTRUMENTS, INC.
FORM 10-Q
INDEX
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
Consolidated Balance Sheets -
June 30, 2003 and December 31, 2002
Consolidated Statements of Income -
Three months and six months ended June 30, 2003 and 2002
Consolidated Statements of Cash Flows -
Six months ended June 30, 2003 and 2002
Notes to Consolidated Financial Statements
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
ITEM 4. CONTROLS AND PROCEDURES.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
ITEM 5. OTHER INFORMATION.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MKS INSTRUMENTS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
June 30, 2003 December 31, 2002
------------- -----------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents ................................ $ 68,490 $ 88,820
Short-term investments ................................... 48,706 39,894
Trade accounts receivable, net ........................... 50,904 45,505
Inventories .............................................. 74,570 73,235
Other current assets ..................................... 6,491 6,098
-------- --------
Total current assets ................................. 249,161 253,552
Long-term investments .................................... 18,319 15,980
Property, plant and equipment, net ....................... 78,246 82,595
Goodwill, net ............................................ 259,727 259,781
Acquired intangible assets, net .......................... 60,327 67,720
Other assets ............................................. 5,715 5,995
-------- --------
Total assets ......................................... $671,495 $685,623
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings .................................... $ 12,539 $ 13,877
Current portion of long-term debt ........................ 1,777 4,263
Current portion of capital lease obligations ............. 236 332
Accounts payable ......................................... 18,079 15,301
Accrued compensation ..................................... 6,145 6,117
Other accrued expenses ................................... 18,898 21,654
-------- --------
Total current liabilities ............................ 57,674 61,544
Long-term debt ............................................... 10,614 11,469
Long-term portion of capital lease obligations ............... 153 257
Other liabilities ............................................ 1,526 1,663
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred Stock, $0.01 par value, 2,000,000 shares
authorized; none issued and outstanding .............. -- --
Common Stock, no par value, 200,000,000 shares authorized;
51,507,713 and 51,359,753 issued and outstanding at
June 30, 2003 and December 31, 2002, respectively .... 113 113
Additional paid-in capital ............................... 580,539 579,175
Retained earnings ........................................ 15,723 28,623
Accumulated other comprehensive income ................... 5,153 2,779
-------- --------
Total stockholders' equity ........................... 601,528 610,690
-------- --------
Total liabilities and stockholders' equity ........... $671,495 $685,623
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
3
MKS INSTRUMENTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
-------- -------- --------- ---------
Net Sales .......................................... $ 81,168 $ 85,932 $ 153,945 $ 144,999
Cost of sales ...................................... 53,723 56,217 101,094 96,064
-------- -------- --------- ---------
Gross profit ....................................... 27,445 29,715 52,851 48,935
Research and development ........................... 11,453 12,053 22,685 21,185
Selling, general and administrative ................ 17,459 20,721 35,278 37,779
Amortization of acquired intangible assets ......... 3,617 4,137 7,395 6,342
Restructuring, asset impairment and other charges .. 304 -- 304 --
Purchase of in-process research and development .... -- 2,290 -- 8,390
-------- -------- --------- ---------
Loss from operations ............................... (5,388) (9,486) (12,811) (24,761)
Interest expense ................................... 259 252 547 581
Interest income .................................... 541 608 1,109 1,363
-------- -------- --------- ---------
Loss before income taxes ........................... (5,106) (9,130) (12,249) (23,979)
Provision (benefit) for income taxes ............... 364 (4,436) 651 (7,498)
-------- -------- --------- ---------
Net loss ........................................... $ (5,470) $ (4,694) $ (12,900) $ (16,481)
======== ======== ========= =========
Net loss per share:
Basic and diluted ............................. $ (0.11) $ (0.09) $ (0.25) $ (0.34)
======== ======== ========= =========
Weighted average common shares outstanding:
Basic and diluted ............................. 51,419 51,152 51,399 48,720
======== ======== ========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
4
MKS INSTRUMENTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Six Months Ended
June 30,
2003 2002
-------- ---------
Cash flows from operating activities:
Net loss .................................................................. $(12,900) $ (16,481)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ........................................ 14,971 13,522
Purchase of in-process research and development ...................... -- 8,390
Other ................................................................ (71) 464
Changes in operating assets and liabilities net of effects of
businesses acquired:
Trade accounts receivable ........................................ (5,028) (13,324)
Inventories ...................................................... (984) (8,458)
Other current assets ............................................. (393) 3,063
Accrued expenses and other current liabilities ................... (3,006) (3,048)
Accounts payable ................................................. 2,714 7,345
-------- ---------
Net cash used in operating activities ..................................... (4,697) (8,527)
-------- ---------
Cash flows from investing activities:
Purchases of short-term and long-term investments ..................... (42,347) (49,970)
Maturities and sales of short-term and long-term investments .......... 31,345 33,354
Purchases of property, plant and equipment ............................ (3,002) (3,940)
(Increase) decrease in other assets ................................... 422 (511)
Purchases of businesses, net of cash acquired ......................... -- (16,298)
-------- ---------
Net cash used in investing activities ..................................... (13,582) (37,365)
-------- ---------
Cash flows from financing activities:
Proceeds from short-term borrowings ................................... 23,517 6,968
Payments on short-term borrowings ..................................... (24,734) (9,193)
Principal payments on long-term debt .................................. (3,347) (3,616)
Proceeds from exercise of stock options ............................... 1,364 7,518
Principal payments under capital lease obligations .................... (208) (231)
-------- ---------
Net cash provided by (used in) financing activities ....................... (3,408) 1,446
-------- ---------
Effect of exchange rate changes on cash and cash equivalents .............. 1,357 469
-------- ---------
Decrease in cash and cash equivalents ..................................... (20,330) (43,977)
Cash and cash equivalents at beginning of period .......................... 88,820 120,869
-------- ---------
Cash and cash equivalents at end of period ................................ $ 68,490 $ 76,892
======== =========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest ........................................................... $ 412 $ 442
======== =========
Income taxes ....................................................... $ 212 $ 1,901
======== =========
Noncash transactions during the period:
Stock and options issued for acquisitions .......................... -- $ 282,341
======== =========
The accompanying notes are an integral part of the consolidated financial
statements.
5
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tables in thousands, except per share data)
1) Basis of Presentation
The terms "MKS" and the "Company" refer to MKS Instruments, Inc. and its
subsidiaries. The interim financial data as of June 30, 2003 and for the
three and six months ended June 30, 2003 and 2002 is unaudited; however, in
the opinion of MKS, the interim data includes all adjustments, consisting
only of normal recurring adjustments, necessary for a fair statement of the
results for the interim periods. The unaudited financial statements
presented herein have been prepared in accordance with the instructions to
Form 10-Q and do not include all of the information and note disclosures
required by generally accepted accounting principles. The financial
statements should be read in conjunction with the December 31, 2002 audited
financial statements and notes thereto included in the MKS Annual Report on
Form 10-K filed with the Securities and Exchange Commission on March 31,
2003.
2) Stock-Based Compensation
The Company applies Accounting Principles Board Opinion ("APB") No. 25,
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its stock-based compensation plans. Accordingly, no
compensation expense is recorded for options issued to employees in fixed
amounts and with fixed exercise prices at least equal to the fair market
value of the Company's common stock at the date of grant.
The Company has adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," as
amended by SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure," through disclosure only. All
stock-based awards to non-employees are accounted for at their fair value
in accordance with SFAS No. 123.
The following table illustrates the effect on net loss and net loss per
share if the Company had applied the fair value recognition provisions of
SFAS No. 123 to stock-based employee awards.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
--------- ---------- --------- ----------
Net loss:
Net loss as reported .......................... $ (5,470) $ (4,694) $ (12,900) $ (16,481)
Deduct: Total stock-based employee compensation
expense determined under the fair-value-based
method for all awards, net of tax ........... (5,138) (3,848) (10,040) (6,999)
--------- ---------- --------- ----------
Pro forma net loss ............................ $ (10,608) $ (8,542) $ (22,940) $ (23,480)
========= ========== ========= ==========
Basic net loss per share:
Net loss as reported .......................... $ (0.11) $ (0.09) $ (0.25) $ (0.34)
========= ========== ========= ==========
Pro forma net loss ............................ $ (0.21) $ (0.17) $ (0.45) $ (0.48)
========= ========== ========= ==========
Diluted net loss per share:
Net loss as reported .......................... $ (0.11) $ (0.09) $ (0.25) $ (0.34)
========= ========== ========= ==========
Pro forma net loss ............................ $ (0.21) $ (0.17) $ (0.45) $ (0.48)
========= ========== ========= ==========
There is no tax benefit included in the stock-based employee compensation
expense determined under the fair-value-based method for the three and six
months ended June 30, 2003, as the Company established a full valuation
allowance for its net deferred tax assets.
The weighted average fair value of options at the date of grant was
estimated using the Black-Scholes model. In the three and six months ended
June 30, 2003, the weighted fair value of options at the date of grant was
$10.64 and $10.31, respectively, with the following assumptions: expected
life of 5 years, weighted average interest rate of 2.51% and 2.70%,
respectively, expected volatility of 79% and 80%, respectively, and no
dividend yield. In the three and six months ended June 30, 2002, the
weighted average fair value of options at the date of grant was
6
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
$19.23 and $16.50, respectively, with the following assumptions: expected
life of 5 years, weighted average interest rate of 4.51% and 4.40%,
respectively, expected volatility of 81%, and no dividend yield.
The fair value of purchase rights granted in the six months ended June 30,
2003 and 2002 under the Second Restated 1999 Employee Stock Purchase Plan
was $7.06 and $13.82, respectively. The fair value of the employees'
purchase rights was estimated using the Black-Scholes model with the
following assumptions in 2003: expected life of 6 months, interest rate of
1.31%, expected volatility of 79%, and no dividend yield. In 2002, the
following assumptions were made: expected life of 6 months, interest rate
of 1.81%, expected volatility of 81%, and no dividend yield.
3) Use of Estimates
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States. The
preparation of these financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. On an on-going basis, management evaluates its
estimates and judgments, including those related to revenue recognition,
accounts receivable, inventory, intangible assets, goodwill, other
long-lived assets, in-process research and development, income taxes,
deferred tax valuation allowance, and investments. Management bases its
estimates and judgments on historical experience and on various other
factors that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.
4) Recent Accounting Pronouncements
In April 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 149 ("SFAS 149"), "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities." This statement amends SFAS 133 to
provide clarification on the financial accounting and reporting of
derivative instruments and hedging activities and requires contracts with
similar characteristics to be accounted for on a comparable basis. This
statement is effective for contracts entered into or modified after June
30, 2003 and for hedging relationships designated after June 30, 2003. The
Company is in the process of assessing the effect of SFAS 149 and does not
expect the adoption of the pronouncement to have a material effect on its
consolidated financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150 ("SFAS 150"), "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity." SFAS 150 establishes standards on the classification and
measurement of financial instruments with characteristics of both
liabilities and equity. For all financial instruments entered into or
modified after May 31, 2003, SFAS 150 is effective immediately. For all
other instruments, SFAS 150 goes into effect at the beginning of the first
interim period beginning after June 15, 2003. The Company is in the process
of assessing the effect of SFAS 150 and does not expect the adoption of the
pronouncement to have a material effect on its consolidated financial
position or results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities," which addresses
consolidation by a business of variable interest entities in which it is
the primary beneficiary. FIN 46 is effective immediately for certain
disclosure requirements and variable interest entities created after
January 31, 2003, and periods beginning after June 15, 2003 for variable
interest entities created before February 1, 2003. The Company does not
expect the adoption of FIN 46 to have a material effect on its consolidated
financial position or results of operations.
7
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
In November 2002, the Emerging Issues Task Force reached a consensus on
Issue 00-21, "Revenue Arrangements with Multiple Deliverables" ("EITF
00-21"). EITF 00-21 addresses revenue recognition on arrangements
encompassing multiple elements that are delivered at different points in
time, defining criteria that must be met for elements to be considered to
be a separate unit of accounting. If an element is determined to be a
separate unit of accounting, the revenue for the element is recognized at
the time of delivery. EITF 00-21 is effective for revenue arrangements
entered into in fiscal periods beginning after June 15, 2003. The Company
does not expect that the pronouncement will have a material impact on its
consolidated financial position or results of operations.
5) Goodwill and Intangible Assets
Intangible Assets
Acquired amortizable intangible assets consisted of the following as of
June 30, 2003:
Gross Net Weighted
Carrying Accumulated Carrying Average
Amount Amortization Amount Useful Life
-------- ------------ -------- -----------
Completed technology .................... $ 69,394 $(21,632) $47,762 6 years
Customer relationships .................. 6,640 (2,202) 4,438 7 years
Patents, trademarks, tradenames
and other ............................. 12,394 (4,267) 8,127 7 years
-------- -------- -------
$ 88,428 $(28,101) $60,327 6 years
======== ======== ======= =======
Acquired amortizable intangible assets consisted of the following as of
December 31, 2002:
Gross Net Weighted
Carrying Accumulated Carrying Average
Amount Amortization Amount Useful Life
-------- ------------ -------- -----------
Completed technology .................... $ 69,394 $(15,629) $53,765 6 years
Customer relationships .................. 6,640 (1,743) 4,897 7 years
Patents, trademarks, tradenames
and other ............................. 12,394 (3,336) 9,058 7 years
-------- -------- -------
$ 88,428 $(20,708) $67,720 6 years
======== ======== ======= =======
Aggregate amortization expense related to acquired intangibles for the
three and six months ended June 30, 2003 was $3,617,000 and $7,395,000,
respectively. Aggregate amortization expense related to acquired
intangibles for the three and six months ended June 30, 2002 was $4,137,000
and $6,342,000, respectively. Estimated amortization expense related to
acquired intangibles for each of the five succeeding fiscal years is as
follows:
Year Amount
---- -------
2003 $14,469
2004 14,145
2005 13,244
2006 11,143
2007 10,536
Goodwill
The change in the carrying amount of goodwill during the three and six
months ended June 30, 2003 was not material.
8
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
6) Cash and Cash Equivalents and Investments
Cash and Cash equivalents consist of the following:
June 30, December 31,
2003 2002
-------- ------------
Cash and Money Market Instruments .................. $45,500 $51,538
Commercial Paper ................................... 17,394 31,216
Federal Government and Government Agency
Obligations ...................................... 4,856 6,066
Corporate Obligations .............................. 740 --
------- -------
$68,490 $88,820
======= =======
Short-term available-for-sale investments at market value maturing within
one year consist of the following:
June 30, December 31,
2003 2002
-------- ------------
Commercial Paper ................................... $ 9,003 $10,400
Federal Government and Government Agency
Obligations ...................................... 39,703 28,636
Corporate Obligations .............................. -- 858
------- -------
$48,706 $39,894
======= =======
Long-term available-for-sale investments at market value with maturities of
1 to 5 years consist of the following:
June 30, December 31,
2003 2002
-------- ------------
Commercial Paper ................................... $ 3,063 $ --
Federal Government and Government Agency
Obligations ...................................... 7,078 2,061
Corporate Obligations .............................. 8,178 13,919
------- -------
$18,319 $15,980
======= =======
Gross unrealized gains and losses on available-for-sale investments were
not material at June 30, 2003 and December 31, 2002.
7) Net Loss Per Share
The following table sets forth the computation of basic and diluted net
loss per share:
Three Months Ended June 30,
2003 2002
---------- --------
Numerator
Net loss .................................................. $ (5,470) $ (4,694)
========== ========
Denominator
Shares used in net loss per common share - basic
and diluted .............................................. 51,419 51,152
========== ========
Net loss per common share
Basic and diluted .......................................... $ (0.11) $ (0.09)
========== ========
9
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
Six Months Ended June 30,
2003 2002
----------- --------
Numerator
Net loss .................................................. $ (12,900) $(16,481)
=========== ========
Denominator
Shares used in net loss per common share - basic
and diluted .............................................. 51,399 48,720
=========== ========
Net loss per common share
Basic and diluted .......................................... $ (0.25) $ (0.34)
=========== ========
For purposes of computing diluted earnings per share, weighted average
common share equivalents do not include stock options with an exercise
price greater than the average market price of the common shares during the
period. All options outstanding during the three and six months ended June
30, 2003 and 2002 are excluded from the calculation of diluted net loss per
common share because their inclusion would be anti-dilutive. There were
options to purchase approximately 8,218,000 and 7,203,000 shares of the
Company's common stock outstanding as of June 30, 2003 and 2002,
respectively.
8) Inventories
Inventories consist of the following:
June 30, December 31,
2003 2002
-------- ------------
Raw material................... $ 36,116 $ 36,630
Work in process................ 13,537 11,617
Finished goods................. 24,917 24,988
-------- --------
$ 74,570 $ 73,235
======== ========
9) Stockholders' Equity
Total comprehensive loss was as follows:
Three Months Ended June 30,
2003 2002
-------- ---------
Net loss..................................................... $(5,470) $ (4,694)
Other comprehensive income, net of taxes:
Changes in value of financial instruments designated
as hedges of currency and interest rate exposures..... 258 4
Foreign currency translation adjustment.................. 1,455 2,151
Unrealized gain (loss) on investments.................... (13) 118
------- --------
Other comprehensive income, net of taxes..................... 1,700 2,273
------ --------
Total comprehensive loss..................................... $(3,770) $ (2,421)
======= ========
Six Months Ended June 30,
2003 2002
---------- ----------
Net loss................................................... $(12,900) $ (16,481)
Other comprehensive income, net of taxes:
Changes in value of financial instruments designated
as hedges of currency and interest rate exposures... 161 (152)
Foreign currency translation adjustment................ 2,225 1,811
Unrealized gain (loss) on investments.................. (12) 63
-------- ---------
Other comprehensive income, net of taxes................... 2,374 1,722
-------- ---------
Total comprehensive loss................................... $(10,526) $ (14,759)
======== =========
10
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
10) Income Taxes
The Company records income taxes using the asset and liability method.
Deferred income tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective income tax bases, and operating loss and tax credit
carryforwards. The Company evaluates the realizability of its net deferred
tax assets and assesses the need for a valuation allowance on a quarterly
basis. The future benefit to be derived from its deferred tax assets is
dependent upon its ability to generate sufficient future taxable income to
realize the assets. The Company records a valuation allowance to reduce its
net deferred tax assets to the amount that may be more likely than not to
be realized. To the extent the Company establishes a valuation allowance,
an expense will be recorded within the provision for income taxes line on
the statement of income.
As a result of incurring significant operating losses since 2001, the
Company determined that it is more likely than not that its deferred tax
assets may not be realized, and since the fourth quarter of 2002 has
established a full valuation allowance for its net deferred tax assets.
Accordingly, the Company has not recorded a deferred tax benefit from the
net operating loss incurred in the three and six months ended June 30,
2003. The provision for income taxes for the three and six months ended
June 30, 2003 is comprised of tax expense from foreign operations and state
taxes.
In periods subsequent to establishing a valuation allowance, if the Company
were to determine that it would be able to realize its net deferred tax
assets in excess of their net recorded amount, an adjustment to the
valuation allowance would be recorded as a reduction to income tax expense
in the period such determination was made. Also in future periods, if the
Company were to determine that it would not be able to realize the recorded
amount of its net deferred tax assets, an adjustment to the valuation
allowance would be recorded as an increase to income tax expense in the
period such determination was made.
11) Segment Information and Significant Customer
During 2002, the Company consolidated its product groups to accelerate
product development, rationalize manufacturing operations, and reduce
operating costs. This realignment of operations has organized the Company
into three product groups: Instruments and Control Systems; Power and
Reactive Gas Products; and Vacuum Products. The Company's products are
derived from MKS' core competencies in pressure measurement and control;
materials delivery; gas and thin-film composition analysis; control and
information management; power and reactive gas generation; and vacuum
technology. The Company's operating segments are aggregated into one
reportable segment because the products are manufactured and distributed in
a similar manner, have similar long-term margins and are sold to a similar
customer base. The segment information for the three and six months ended
June 30, 2002 has been reclassified to conform with these internal
organizational changes.
Net sales to unaffiliated customers are based on the location in which the
sale originated. Transfers between geographic areas are at negotiated
transfer prices and have been eliminated from consolidated net sales.
Net sales to unaffiliated customers by geographic area for the three months
ended June 30, 2003 and 2002 were as follows:
United States Far East Europe Total
------------- -------- ------- -------
Net sales to unaffiliated customers 2003 $47,813 $22,504 $10,851 $81,168
2002 58,294 18,773 8,865 85,932
11
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
Net sales to unaffiliated customers for the six months ended June 30, 2003
and 2002 and long-lived assets as of June 30, 2003 and 2002, by geographic
area were as follows:
United States Far East Europe Total
------------- -------- ------- --------
Net sales to unaffiliated customers 2003 $90,938 $42,820 $20,187 $153,945
2002 97,688 30,109 17,202 144,999
Long-lived assets 2003 $341,662 $55,458 $ 6,895 $404,015
2002 368,630 58,625 6,241 433,496
Included in the Far East are Japan, Korea, Singapore, Taiwan, China and
Hong Kong. Included in Europe are Germany, France and the United Kingdom.
Net sales to unaffiliated customers from Japan were $11,962,000 and
$9,151,000 for the three months ended June 30, 2003 and 2002 and
$25,355,000 and $16,441,000 for the six months ended June 30, 2003 and
2002, respectively. Long-lived assets within Japan amounted to $9,986,000
and $11,830,000 at June 30, 2003 and 2002, respectively.
The Company had one customer comprising 18% and 27% of net sales for the
three months ended June 30, 2003 and 2002, respectively, and 17% and 23%
for the six months ended June 30, 2003 and 2002, respectively.
12) Commitments and Contingencies
Legal Matters
On April 3, 2003, Advanced Energy Industries, Inc. ("Advanced Energy")
filed suit against MKS in federal district court in Colorado ("Colorado
Action"), seeking a declaratory judgment that Advanced Energy's Xstream
product does not infringe three patents held by Applied Science and
Technology, Inc. ("ASTeX"), a subsidiary of MKS. MKS has filed a motion to
dismiss Advanced Energy's complaint, and that motion is now pending before
the Colorado court. On May 14, 2003, MKS and ASTeX brought suit in federal
district court in Delaware against Advanced Energy for infringement of five
ASTeX patents, including the three patents at issue in the Colorado Action.
MKS and ASTeX seek injunctive relief and damages for Advanced Energy's
infringement. Advanced Energy has moved to dismiss this suit in favor of
Advanced Energy's Colorado Action, and MKS has opposed Advanced Energy's
motion. Advanced Energy's motion to dismiss is now pending before the
Delaware court. Both of these cases are in the early stages of pre-trial
discovery.
On November 3, 1999, On-Line Technologies, Inc. ("On-Line"), which was
acquired by the Company in April 2001, brought suit in federal district
court in Connecticut against Perkin-Elmer, Inc. and certain other
defendants for infringement of On-Line's patent related to its FTIR
spectrometer product. The suit sought injunctive relief and damages for
infringement. Perkin-Elmer, Inc. filed a counterclaim seeking invalidity of
the patent, costs, and attorneys' fees. In June 2002, the defendants filed
a motion for summary judgment. In April 2003 the court granted the motion
and dismissed the case. The Company has appealed this decision.
The Company is subject to legal proceedings and claims, which have arisen
in the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse
effect on the Company's results of operations, financial condition or cash
flows.
12
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
13) Acquisitions
On January 31, 2002, MKS completed its acquisition of the ENI Business
("ENI") of Emerson Electric Co., a supplier of solid-state radio frequency
(RF) and direct current (DC) plasma power supplies, matching networks and
instrumentation to the semiconductor and thin-film processing industries.
The reasons for the acquisition of ENI were based upon the ability to offer
higher value and more integrated application solutions by combining ENI's
solid-state power conversion technology with the Company's core competency
in plasma and reactive gas solutions. On March 13, 2002, MKS acquired Tenta
Technology Ltd. ("Tenta"), a company that designs and supplies modular,
computer-based process control systems for 300mm semiconductor process tool
applications.
The reasons for the acquisition were based upon the ability to offer higher
value and more integrated application solutions by integrating Tenta's
process controllers with MKS digital network products to provide a more
complete process control solution. On April 5, 2002, MKS acquired IPC Fab
Automation GmbH ("IPC"), a privately held developer and provider of
web-based hardware and software that enables e-diagnostics and advanced
process control for advanced manufacturing applications. The acquisitions
have been accounted for under the purchase method of accounting. The
results of operations of these acquired companies are included in the
Company's consolidated statement of income as of and since the date of
purchase.
The following unaudited pro forma information presents a summary of the
historical results of operations of the Company as if the ENI, Tenta and
IPC acquisitions had occurred at the beginning of each period.
Three Months Ended Six Months Ended
June 30, 2002 June 30, 2002
------------------ ----------------
Net sales........................... $85,932 $149,446
Net loss............................ $(2,404) $(10,671)
Net loss per share:
Basic and diluted.............. $ (0.05) $ (0.21)
The unaudited pro forma results for the three and six months ended June 30,
2002 excludes approximately $1,300,000 of non-recurring charges directly
related to the transactions. Additionally, the charge for purchase of
in-process research and development was not included in the unaudited pro
forma results, because it was non-recurring and directly related to the
transaction.
14) Restructuring, Asset Impairment and Other Charges
During 2002, the Company implemented a consolidation of recent acquisitions
to accelerate product development, rationalize manufacturing operations,
and reduce operating costs. As a result, the Company recorded restructuring
and asset impairment charges of $2,726,000 during 2002. The activity for
the six months ended June 30, 2003 related to the 2002 restructuring
accrual is outlined as follows:
Workforce Facility
Reductions Consolidations Total
---------- -------------- -------
Balance as of December 31, 2002 .. $ 331 $ 1,159 $ 1,490
Cash payments in first quarter ... (75) (21) (96)
----- ------- -------
Balance as of March 31, 2003 ..... 256 1,138 1,394
Cash payments in second quarter .. (35) (21) (56)
----- ------- -------
Balance as of June 30, 2003 ...... $ 221 $ 1,117 $ 1,338
===== ======= =======
During the three months ended June 30, 2003, the Company continued the
consolidation of recent acquisitions and recorded restructuring, asset
impairment and other charges of $304,000. The charges consisted of $112,000
of severance costs related to workforce reductions, an asset impairment
charge of $92,000 primarily for assets to be disposed, and $100,000 of
professional fees related to the consolidation. The severance costs and
professional fees are accrued as of June 30, 2003 and are expected to be
paid by the end of 2003.
13
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
15) Product Warranties
The Company provides for the estimated costs to fulfill customer warranty
obligations upon the recognition of the related revenue. While the Company
engages in extensive product quality programs and processes, including
actively monitoring and evaluating the quality of its component suppliers,
the Company's warranty obligation is affected by product failure rates,
utilization levels, material usage, and supplier warranties on parts
delivered to the Company. Should actual product failure rates, utilization
levels, material usage, or supplier warranties on parts differ from the
Company estimates, revisions to the estimated warranty liability would be
required.
Product warranty activity for the six months ended June 30, 2003 was as
follows:
Balance as of December 31, 2002....................... $ 6,921
Provisions for product warranties..................... 1,064
Direct charges to the warranty liability.............. (1,839)
-------
Balance as of June 30, 2003........................... $ 6,146
=======
14
MKS INSTRUMENTS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
MKS believes that this Quarterly Report on Form 10-Q contains "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. When used herein, the words "believes," "anticipates," "plans,"
"expects," "estimates" and similar expressions are intended to identify
forward-looking statements. These forward-looking statements reflect
management's current opinions and are subject to certain risks and uncertainties
that could cause results to differ materially from those stated or implied. MKS
assumes no obligation to update this information. Risks and uncertainties
include, but are not limited to, those discussed herein in the section entitled
"Factors That May Affect Future Results."
OVERVIEW
MKS develops, manufactures and provides instruments, components and integrated
subsystems used to measure, control, power and monitor critical parameters of
semiconductor and other advanced manufacturing process environments.
On January 31, 2002, MKS completed its acquisition of the ENI Business ("ENI")
of Emerson Electric Co., a supplier of solid-state radio frequency (RF) and
direct current (DC) plasma power supplies, matching networks and instrumentation
to the semiconductor and thin-film processing industries. The reasons for the
acquisition of ENI were based upon the ability to offer higher value and more
integrated application solutions by combining ENI's solid-state power conversion
technology with the Company's core competency in plasma and reactive gas
solutions. The acquisition has been accounted for under the purchase method of
accounting. Also in 2002, MKS acquired three companies that expanded its
position in distributed computer-based process control and data management. On
March 13, 2002, MKS acquired Tenta Technology Ltd. ("Tenta"), a privately held
company that designs and supplies modular, computer-based process control
systems for 300mm semiconductor process tool applications. On April 5, 2002, MKS
acquired IPC Fab Automation GmbH ("IPC"), a privately held developer and
provider of web-based hardware and software that enables e-diagnostics and
advanced process control for advanced manufacturing applications. On October 1,
2002, MKS acquired EquipNet Ltd. ("EquipNet"), a privately held company that
develops web-based connectivity equipment for the semiconductor industry. The
results of operations of these acquired companies are included in the Company's
consolidated statement of income as of and since the date of the purchase.
The Company's customers include semiconductor capital equipment manufacturers,
semiconductor device manufacturers, industrial manufacturing companies and
university, government and industrial research laboratories. During 2002, 2001
and 2000, MKS estimates that approximately 70%, 64% and 76% of its net sales,
respectively, were to semiconductor capital equipment manufacturers and
semiconductor device manufacturers. MKS expects that sales to such customers
will continue to account for a substantial majority of its sales. In 2002, 2001
and 2000, sales to MKS' top ten customers accounted for approximately 49%, 39%
and 52%, respectively, of MKS' net sales. During 2002, 2001 and 2000, Applied
Materials, Inc. accounted for approximately 23%, 18% and 30%, respectively, of
MKS' net sales.
A significant portion of MKS' sales are to operations in international markets.
International sales include sales by MKS' foreign subsidiaries, but exclude
direct export sales, which were less than 10% of MKS' total net sales for each
of the years ended December 31, 2002, 2001 and 2000. International sales
accounted for approximately 36% of net sales in 2002, 31% of net sales in 2001
and 23% of net sales in 2000. Sales by MKS' Japan subsidiary comprised 14%, 12%
and 11% of net sales in 2002, 2001 and 2000, respectively.
15
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of total
net sales of certain line items included in MKS' consolidated statement of
income data.
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
------ ------ ------ ------
Net sales............................................ 100.0% 100.0% 100.0% 100.0%
Cost of sales........................................ 66.2 65.4 65.7 66.3
----- ----- ----- -----
Gross profit......................................... 33.8 34.6 34.3 33.7
Research and development............................. 14.1 14.0 14.7 14.6
Selling, general and administrative.................. 21.5 24.1 22.9 26.1
Amortization of acquired intangible assets........... 4.4 4.8 4.8 4.3
Restructuring, asset impairment and other charges.... 0.4 -- 0.2 --
In-process research and development.................. -- 2.7 -- 5.8
----- ----- ----- -----
Loss from operations................................. (6.6) (11.0) (8.3) (17.1)
Interest income, net................................. 0.3 0.4 0.3 0.6
----- ----- ----- -----
Loss before income taxes............................. (6.3) (10.6) (8.0) (16.5)
Provision (benefit) for income taxes................. 0.4 (5.1) 0.4 (5.1)
----- ----- ----- -----
Net loss............................................. (6.7)% (5.5)% (8.4)% (11.4)%
===== ===== ===== =====
Net Sales. Net sales decreased 5.5% to $81.2 million for the three months
ended June 30, 2003 from $85.9 million for the three months ended June 30, 2002.
International net sales were approximately $33.4 million for the three months
ended June 30, 2003 or 41.1% of net sales and $27.6 million for the same period
of 2002 or 32.2% of net sales. The decline in net sales was due to decreased
domestic demand for the Company's products from the Company's semiconductor
capital equipment manufacturer and semiconductor device manufacturer customers,
as compared to the second quarter of 2002.
Net sales increased 6.2% to $153.9 million for the six months ended June
30, 2003 from $145.0 million for the six months ended June 30, 2002.
International net sales were approximately $63.0 million for the six months
ended June 30, 2003 or 40.9% of net sales and $47.3 million for the same period
of 2002 or 32.6% of net sales. MKS acquired ENI, Tenta and IPC during the six
months ended June 30, 2002, and net sales for the six month period ended June
30, 2002 includes their revenues from the date of acquisition, whereas the
revenues of these companies is included in net sales for the full six months of
2003. The revenues of ENI, Tenta and IPC included in the Company's net sales
increased approximately $5.6 million in 2003, primarily from their inclusion for
the full six months of 2003.
The semiconductor capital equipment market has experienced a significant
downturn since 2001. As a result, since 2001 the Company has experienced a
significant reduction in demand for its products from its semiconductor capital
equipment manufacturer and semiconductor device manufacturer customers. The
semiconductor capital equipment industry has been cyclical, and the Company
cannot determine how long the downturn will last. In the absence of significant
improvement, net sales could continue to decline or remain low, and the amount
of goodwill, other long-lived assets, and inventory considered realizable could
be significantly reduced.
Gross Profit. Gross profit as a percentage of net sales decreased to 33.8%
for the three months ended June 30, 2003 from 34.6% for the three months ended
June 30, 2002. The decrease was primarily due to a shift in product mix to new
products with higher materials costs in initial production runs.
Gross profit as a percentage of net sales increased to 34.3% for the six
months ended June 30, 2003 from 33.7% for the same period of 2002. The increase
in gross profit percent is due to overhead costs for the six months of 2003
being a lower percentage of the higher net sales, and cost savings initiatives,
offset by higher materials costs of the new products in initial production runs.
16
Research and Development. Research and development expense decreased 5.0%
to $11.5 million or 14.1% of net sales for the three months ended June 30, 2003
from $12.1 million or 14.0% of net sales for the three months ended June 30,
2002. The decrease was primarily due to decreased expenses for project
materials. Research and development expense increased 7.1% to $22.7 million or
14.7% of net sales for the six months ended June 30, 2003 from $21.2 million or
14.6% of net sales for the same period of 2002. The increase was due to
increased compensation expense, primarily from including a full six months of
costs in 2003 of the companies acquired during 2002.
Selling, General and Administration. Selling, general and administration
expenses decreased 15.7% to $17.5 million or 21.5% of net sales for the three
months ended June 30, 2003 from $20.7 million or 24.1% of net sales for the
three months ended June 30, 2002. The decrease was due primarily to lower
compensation expense of $0.9 million resulting from cost savings initiatives,
and decreased professional fees of $1.7 million. Selling, general and
administrative expenses decreased 6.6% to $35.3 million or 22.9% of net sales
for the six months ended June 30, 2003 from $37.8 million or 26.1% of net sales
for the same period of 2002. The decrease was due primarily to lower
compensation expense of $0.5 million resulting from cost savings initiatives and
decreased professional fees of $1.7 million.
Amortization of Acquired Intangible Assets. Amortization expense of $3.6
million and $7.4 million for the three and six months ended June 30, 2003
represents the amortization of the identifiable intangibles resulting from the
acquisitions completed by MKS. Amortization of the identifiable intangibles was
$4.1 million and $6.3 million for the three and six months ended June 30, 2002,
respectively. The increase in amortization during 2003 was due to amortization
of intangibles from companies acquired in 2002
Restructuring, Asset Impairment and Other Charges. During the three months
ended June 30, 2003, the Company continued the consolidation of recent
acquisitions and recorded restructuring, asset impairment and other charges of
$0.3 million. The charges consisted of $0.1 million of severance costs related
to workforce reductions, an asset impairment charge of $0.1 million primarily
for assets to be disposed, and $0.1 million of professional fees related to the
consolidation. The severance costs and professional fees are accrued as of June
30, 2003 and are expected to be paid by the end of 2003.
Purchase of In-process Technology. In-process research and development of
$2.3 million for the three months ended June 30, 2002 consisted of $1.4 million
related to the increase in the value of the in-process research and development
resulting from the finalization of the ENI purchase price allocation and $0.9
million from the purchase of Tenta and IPC. In-process research and development
of $8.4 million for the six months ended June 30, 2002 arose from the
acquisitions the Company made in 2002.
Interest Income (Expense), Net. During the three and six months ended June
30, 2003, the Company generated net interest income of $0.3 million and $0.6
million, respectively. Interest income declined $0.3 million for the six months
ended June 30, 2003 as compared to the same period of 2002, primarily from lower
interest rate yields during 2003.
Provision (benefit) for Income Taxes. The Company recorded a provision for
income taxes of $0.4 million and $0.7 million for the three and six months ended
June 30, 2003. As a result of incurring significant operating losses since 2001,
the Company determined that it is more likely than not that its deferred tax
assets may not be realized, and since the fourth quarter of 2002 has established
a full valuation allowance for its net deferred tax assets. Accordingly, the
Company has not recorded a deferred tax benefit from the net operating loss
incurred in the three and six months ended June 30, 2003. The provision for
income taxes in 2003 is comprised of tax expense from foreign operations and
state taxes. Until an appropriate level of profitability is reached, the Company
will not record deferred tax benefits from its net operating losses in future
results of operations.
The effective tax rates for the three and six months ended June 30, 2002
were a benefit of 49% and 31%, respectively, and differed from the statutory
rate of 35% due to favorable tax attributes from its foreign subsidiaries,
partially offset by non-deductible charges associated with acquisitions made in
2002.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations and capital requirements through a
combination of cash provided by operations, long-term real estate financing,
capital lease financing and short-term borrowings.
17
Operations used cash of $4.7 million for the six months ended June 30,
2003. The cash flow from operations for the six months ended June 30, 2003 was
impacted by the net loss of $12.9 million, offset by non-cash charges included
in the net loss for depreciation and amortization of $15.0 million.
Additionally, changes in operating assets and liabilities reduced cash by $6.7
million, primarily from an increase in accounts receivable of $5.0 million and a
decrease in accrued expenses of $3.0 million, partially offset by changes in
accounts payable of $2.7 million. Investing activities utilized cash of $13.6
million for the six months ended June 30, 2003 primarily from purchases of
available-for-sale investments. Financing activities used cash of $3.4 million,
primarily for payments on debt. Working capital was $191.5 million as of June
30, 2003, a decrease of $0.5 million from December 31, 2002. As of June 30, 2003
the Company had a combined $40.0 million unsecured line of credit with two large
domestic banks. There were no borrowings made under the line of credit. The
Company decided not to renew the line of credit upon its expiration on July 31,
2003.
MKS believes that its working capital, together with the cash anticipated
to be generated from operations will be sufficient to satisfy its estimated
working capital and planned capital expenditure requirements through at least
the next 12 months.
FACTORS THAT MAY AFFECT FUTURE RESULTS
MKS' BUSINESS DEPENDS SUBSTANTIALLY ON CAPITAL SPENDING IN THE
SEMICONDUCTOR INDUSTRY WHICH IS CHARACTERIZED BY PERIODIC FLUCTUATIONS THAT MAY
CAUSE A REDUCTION IN DEMAND FOR MKS' PRODUCTS.
MKS estimates that approximately 70% of its sales during 2002, 64% of its
sales during 2001, and 76% of its sales during 2000 were to semiconductor
capital equipment manufacturers and semiconductor device manufacturers, and it
expects that sales to such customers will continue to account for a substantial
majority of its sales. MKS' business depends upon the capital expenditures of
semiconductor device manufacturers, which in turn depend upon the demand for
semiconductors. Periodic reductions in demand for the products manufactured by
semiconductor capital equipment manufacturers and semiconductor device
manufacturers may adversely affect MKS' business, financial condition and
results of operations. Historically, the semiconductor market has been highly
cyclical and has experienced periods of overcapacity, resulting in significantly
reduced demand for capital equipment. For example, in 1996 and 1998, the
semiconductor capital equipment industry experienced significant declines, which
caused a number of MKS' customers to reduce their orders. More recently, in
2001, 2002 and 2003, MKS has experienced a significant reduction in demand from
OEM customers, and lower gross margins due to reduced absorption of
manufacturing overhead. MKS incurred significant charges for excess and obsolete
inventory of $16.6 million in 2001. The charges were primarily caused by a
significant reduction in demand including reduced demand for older technology
products. In addition, many semiconductor manufacturers have operations and
customers in Asia, a region which in recent years has experienced serious
economic problems including currency devaluations, debt defaults, lack of
liquidity and recessions. MKS cannot be certain that semiconductor downturns
will not continue or recur. A decline in the level of orders as a result of any
future downturn or slowdown in the semiconductor capital equipment industry
could have a material adverse effect on MKS' business, financial condition and
results of operations.
MKS' QUARTERLY OPERATING RESULTS HAVE VARIED, AND ARE LIKELY TO CONTINUE TO VARY
SIGNIFICANTLY. THIS MAY RESULT IN VOLATILITY IN THE MARKET PRICE FOR MKS'
SHARES.
A substantial portion of MKS' shipments occur shortly after an order is
received and therefore MKS operates with a low level of backlog. As a result, a
decrease in demand for MKS' products from one or more customers could occur with
limited advance notice and could have a material adverse effect on MKS' results
of operations in any particular period. A significant percentage of MKS'
expenses are relatively fixed and based in part on expectations of future net
sales. The inability to adjust spending quickly enough to compensate for any
shortfall would magnify the adverse impact of a shortfall in net sales on MKS'
results of operations. Factors that could cause fluctuations in MKS' net sales
include:
o the timing of the receipt of orders from major customers;
o shipment delays;
o disruption in sources of supply;
o seasonal variations of capital spending by customers;
18
o production capacity constraints; and
o specific features requested by customers.
For example, MKS was in the process of increasing its production capacity
when the semiconductor capital equipment market began to experience a
significant downturn in 1996. This downturn had a material adverse effect on
MKS' operating results in the second half of 1996 and the first half of 1997.
After an increase in business in the latter half of 1997, the market experienced
another downturn in 1998, which had a material adverse effect on MKS' 1998 and
first quarter 1999 operating results. More recently, the semiconductor capital
equipment market experienced a significant downturn during 2001, 2002 and 2003.
As a result, MKS has experienced a reduction in demand from OEM customers, which
has had a material adverse effect on MKS' operating results. During 2001 gross
margins were negatively affected by significant charges for excess and obsolete
inventory of $16.6 million in 2001. The charges were primarily caused by a
significant reduction in demand including reduced demand for older technology
products. As a result of the factors discussed above, it is likely that MKS will
in the future experience quarterly or annual fluctuations and that, in one or
more future quarters, its operating results will fall below the expectations of
public market analysts or investors. In any such event, the price of MKS' common
stock could decline significantly.
THE LOSS OF NET SALES TO ANY ONE OF MKS' MAJOR CUSTOMERS WOULD LIKELY HAVE A
MATERIAL ADVERSE EFFECT ON MKS.
MKS' top ten customers accounted for approximately 49% of its net sales in
2002, 39% of its net sales in 2001 and 52% of its net sales in 2000. The loss of
a major customer or any reduction in orders by these customers, including
reductions due to market or competitive conditions, would likely have a material
adverse effect on MKS' business, financial condition and results of operations.
During 2002, 2001 and 2000, one customer, Applied Materials, accounted for
approximately 23%, 18% and 30%, respectively, of MKS' net sales. None of MKS'
significant customers, including Applied Materials, has entered into an
agreement requiring it to purchase any minimum quantity of MKS' products. The
demand for MKS' products from its semiconductor capital equipment customers
depends in part on orders received by them from their semiconductor device
manufacturer customers.
Attempts to lessen the adverse effect of any loss or reduction through the
rapid addition of new customers could be difficult because prospective customers
typically require lengthy qualification periods prior to placing volume orders
with a new supplier. MKS' future success will continue to depend upon:
o its ability to maintain relationships with existing key customers;
o its ability to attract new customers; and
o the success of its customers in creating demand for their capital
equipment products which incorporate MKS' products.
AS PART OF MKS' BUSINESS STRATEGY, MKS HAS ENTERED INTO AND MAY ENTER INTO OR
SEEK TO ENTER INTO BUSINESS COMBINATIONS AND ACQUISITIONS THAT MAY BE DIFFICULT
TO INTEGRATE, DISRUPT ITS BUSINESS, DILUTE STOCKHOLDER VALUE OR DIVERT
MANAGEMENT ATTENTION.
MKS acquired Compact Instrument Technology, LLC ("Compact Instrument") in
March 2000, Telvac Engineering, Ltd. ("Telvac") in May 2000, Spectra
Instruments, LLC ("Spectra") in July 2000, D.I.P., Inc. ("D.I.P.") in September
2000, Applied Science and Technology, Inc. ("ASTeX") in January 2001, On-Line
Technologies, Inc. ("On-Line") in April 2001, the ENI Business ("ENI") of
Emerson Electric Co. in January 2002, Tenta Technology Ltd. ("Tenta") in March
2002, IPC Fab Automation GmbH ("IPC") in April 2002 and EquipNet Ltd.
("EquipNet") in October 2002. As a part of its business strategy, MKS may enter
into additional business combinations and acquisitions. Acquisitions are
typically accompanied by a number of risks, including the difficulty of
integrating the operations and personnel of the acquired companies, the
potential disruption of MKS' ongoing business and distraction of management,
expenses related to the acquisition and potential unknown liabilities associated
with acquired businesses.
19
As a result of its recent acquisitions, the Company has added several
different decentralized accounting systems, resulting in a complex reporting
environment. The Company expects that it will need to continue to modify its
accounting policies, internal controls, procedures and compliance programs to
provide consistency across all its operations.
If MKS is not successful in completing acquisitions that it may pursue in
the future, it may be required to reevaluate its growth strategy, and MKS may
have incurred substantial expenses and devoted significant management time and
resources in seeking to complete proposed acquisitions that will not generate
benefits for it.
In addition, with future acquisitions, MKS could use substantial portions
of its available cash as all or a portion of the purchase price. MKS could also
issue additional securities as consideration for these acquisitions, which could
cause significant stockholder dilution. MKS' acquisitions of Compact Instrument,
Telvac, Spectra, D.I.P., ASTeX, On-Line, ENI, Tenta, IPC, and EquipNet and any
future acquisitions may not ultimately help MKS achieve its strategic goals and
may pose other risks to MKS.
AN INABILITY TO CONVINCE SEMICONDUCTOR DEVICE MANUFACTURERS TO SPECIFY THE USE
OF MKS' PRODUCTS TO MKS' CUSTOMERS, WHO ARE SEMICONDUCTOR CAPITAL EQUIPMENT
MANUFACTURERS, WOULD WEAKEN MKS' COMPETITIVE POSITION.
The markets for MKS' products are highly competitive. Its competitive
success often depends upon factors outside of its control. For example, in some
cases, particularly with respect to mass flow controllers, semiconductor device
manufacturers may direct semiconductor capital equipment manufacturers to use a
specified supplier's product in their equipment. Accordingly, for such products,
MKS' success will depend in part on its ability to have semiconductor device
manufacturers specify that MKS' products be used at their semiconductor
fabrication facilities. In addition, MKS may encounter difficulties in changing
established relationships of competitors that already have a large installed
base of products within such semiconductor fabrication facilities.
IF MKS' PRODUCTS ARE NOT DESIGNED INTO SUCCESSIVE NEW GENERATIONS OF ITS
CUSTOMERS' PRODUCTS, MKS WILL LOSE SIGNIFICANT NET SALES DURING THE LIFESPAN OF
THOSE PRODUCTS.
New products designed by semiconductor capital equipment manufacturers
typically have a lifespan of five to ten years. MKS' success depends on its
products being designed into new generations of equipment for the semiconductor
industry. MKS must develop products that are technologically current so that
they are positioned to be chosen for use in each successive new generation of
semiconductor capital equipment. If MKS products are not chosen by its
customers, MKS' net sales may be reduced during the lifespan of its customers'
products. In addition, MKS must make a significant capital investment to develop
products for its customers well before its products are introduced and before it
can be sure that it will recover its capital investment through sales to the
customers in significant volume. MKS is thus also at risk during the development
phase that its products may fail to meet its customers' technical or cost
requirements and may be replaced by a competitive product or alternative
technology solution. If that happens, MKS may be unable to recover MKS'
development costs.
THE SEMICONDUCTOR INDUSTRY IS SUBJECT TO RAPID DEMAND SHIFTS WHICH ARE DIFFICULT
TO PREDICT. AS A RESULT, MKS' INABILITY TO EXPAND ITS MANUFACTURING CAPACITY IN
RESPONSE TO THESE RAPID SHIFTS MAY CAUSE A REDUCTION IN ITS MARKET SHARE.
MKS' ability to increase sales of certain products depends in part upon its
ability to expand its manufacturing capacity for such products in a timely
manner. If MKS is unable to expand its manufacturing capacity on a timely basis
or to manage such expansion effectively, its customers could implement its
competitors' products and, as a result, its market share could be reduced.
Because the semiconductor industry is subject to rapid demand shifts which are
difficult to foresee, MKS may not be able to increase capacity quickly enough to
respond to a rapid increase in demand in the semiconductor industry.
Additionally, capacity expansion could increase MKS' fixed operating expenses
and if sales levels do not increase to offset the additional expense levels
associated with any such expansion, its business, financial condition and
results of operations could be materially adversely affected.
20
SALES TO FOREIGN MARKETS CONSTITUTE A SUBSTANTIAL PORTION OF MKS' NET SALES;
THEREFORE, MKS' NET SALES AND RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED
BY DOWNTURNS IN ECONOMIC CONDITIONS IN COUNTRIES OUTSIDE OF THE UNITED STATES.
International sales include sales by MKS' foreign subsidiaries, but exclude
direct export sales, which were less than 10% of MKS' total net sales for each
of the years ended December 31, 2002, 2001 and 2000. International sales
accounted for approximately 36% of net sales in 2002, 31% of net sales in 2001
and 23% of net sales in 2000.
MKS anticipates that international sales will continue to account for a
significant portion of MKS' net sales. In addition, certain of MKS' key domestic
customers derive a significant portion of their revenues from sales in
international markets. Therefore, MKS' sales and results of operations could be
adversely affected by economic slowdowns and other risks associated with
international sales.
RISKS RELATING TO MKS' INTERNATIONAL OPERATIONS COULD ADVERSELY AFFECT MKS'
OPERATING RESULTS.
MKS has substantial international sales, service and manufacturing
operations in Europe and Asia, which exposes MKS to foreign operational and
political risks that may harm MKS' business. MKS' international operations are
subject to inherent risks, which may adversely affect MKS, including:
o political and economic instability in countries where MKS has sales,
service and manufacturing operations, particularly in Asia;
o fluctuations in the value of currencies and high levels of inflation,
particularly in Asia and Europe;
o changes in labor conditions and difficulties in staffing and managing
foreign operations, including, but not limited to, labor unions;
o greater difficulty in collecting accounts receivable and longer
payment cycles;
o burdens and costs of compliance with a variety of foreign laws;
o increases in duties and taxation;
o imposition of restrictions on currency conversion or the transfer of
funds;
o changes in export duties and limitations on imports or exports;
o expropriation of private enterprises; and
o unexpected changes in foreign regulations.
If any of these risks materialize, MKS' operating results may be adversely
affected.
UNFAVORABLE CURRENCY EXCHANGE RATE FLUCTUATIONS MAY LEAD TO LOWER GROSS MARGINS,
OR MAY CAUSE MKS TO RAISE PRICES WHICH COULD RESULT IN REDUCED SALES.
Currency exchange rate fluctuations could have an adverse effect on MKS'
net sales and results of operations and MKS could experience losses with respect
to its hedging activities. Unfavorable currency fluctuations could require MKS
to increase prices to foreign customers which could result in lower net sales by
MKS to such customers. Alternatively, if MKS does not adjust the prices for its
products in response to unfavorable currency fluctuations, its results of
operations could be adversely affected. In addition, sales made by MKS' foreign
subsidiaries are denominated in the currency of the country in which these
products are sold and the currency it receives in payment for such sales could
be less valuable at the time of receipt as a result of exchange rate
fluctuations. MKS enters into forward exchange contracts and local currency
purchased options to reduce currency exposure arising from intercompany sales of
inventory. However, MKS cannot be certain that its efforts will be adequate to
protect it against significant currency fluctuations or that such efforts will
not expose it to additional exchange rate risks.
KEY PERSONNEL MAY BE DIFFICULT TO ATTRACT AND RETAIN.
MKS' success depends to a large extent upon the efforts and abilities of a
number of key employees and officers, particularly those with expertise in the
semiconductor manufacturing and similar industrial manufacturing industries. The
loss of key employees or officers could have a material adverse effect on MKS'
business, financial condition and
21
results of operations. MKS believes that its future success will depend in part
on its ability to attract and retain highly skilled technical, financial,
managerial and marketing personnel. MKS cannot be certain that it will be
successful in attracting and retaining such personnel.
MKS' PROPRIETARY TECHNOLOGY IS IMPORTANT TO THE CONTINUED SUCCESS OF ITS
BUSINESS. MKS' FAILURE TO PROTECT THIS PROPRIETARY TECHNOLOGY MAY SIGNIFICANTLY
IMPAIR MKS' COMPETITIVE POSITION.
As of December 31, 2002, MKS owned 170 U.S. patents and 128 foreign patents
and had 89 pending U.S. patent applications and 286 pending foreign patent
applications. Although MKS seeks to protect its intellectual property rights
through patents, copyrights, trade secrets and other measures, it cannot be
certain that:
o MKS will be able to protect its technology adequately;
o competitors will not be able to develop similar technology
independently;
o any of MKS' pending patent applications will be issued;
o intellectual property laws will protect MKS' intellectual property
rights; or
o third parties will not assert that MKS' products infringe patent,
copyright or trade secrets of such parties.
PROTECTION OF MKS' INTELLECTUAL PROPERTY RIGHTS MAY RESULT IN COSTLY LITIGATION.
Litigation may be necessary in order to enforce MKS' patents, copyrights or
other intellectual property rights, to protect its trade secrets, to determine
the validity and scope of the proprietary rights of others or to defend against
claims of infringement. MKS has been involved in lawsuits enforcing its
intellectual property rights in the past, and may be involved in such litigation
in the future. Such litigation could result in substantial costs and diversion
of resources and could have a material adverse effect on MKS' business,
financial condition and results of operations.
THE MARKET PRICE OF MKS' COMMON STOCK HAS FLUCTUATED AND MAY CONTINUE TO
FLUCTUATE FOR REASONS OVER WHICH MKS HAS NO CONTROL.
The stock market has from time to time experienced, and is likely to
continue to experience, extreme price and volume fluctuations. Recently, prices
of securities of technology companies have been especially volatile and have
often fluctuated for reasons that are unrelated to the operating performance of
the companies. The market price of shares of MKS' common stock has fluctuated
greatly since its initial public offering and could continue to fluctuate due to
a variety of factors. In the past, companies that have experienced volatility in
the market price of their stock have been the objects of securities class action
litigation. If MKS were the object of securities class action litigation, it
could result in substantial costs and a diversion of MKS' management's attention
and resources.
MKS' DEPENDENCE ON SOLE, LIMITED SOURCE SUPPLIERS, AND INTERNATIONAL SUPPLIERS,
COULD AFFECT ITS ABILITY TO MANUFACTURE PRODUCTS AND SYSTEMS.
MKS relies on sole, limited source suppliers, and international suppliers,
for a few of its components and subassemblies that are critical to the
manufacturing of MKS' products. This reliance involves several risks, including
the following:
o the potential inability to obtain an adequate supply of required
components;
o reduced control over pricing and timing of delivery of components; and
o the potential inability of its suppliers to develop technologically
advanced products to support MKS' growth and development of new
systems.
MKS believes that in time MKS could obtain and qualify alternative sources
for most sole, limited source and international supplier parts. Seeking
alternative sources of the parts could require MKS to redesign its systems,
resulting in increased costs and likely shipping delays. MKS may be unable to
redesign its systems, which could result in further costs and shipping delays.
These increased costs would decrease MKS' profit margins if it could not pass
the costs to its customers. Further, shipping delays could damage MKS'
relationships with current and potential customers and have a material adverse
effect on MKS' business and results of operations.
22
MKS IS SUBJECT TO GOVERNMENTAL REGULATIONS.
MKS is subject to federal, state, local and foreign regulations, including
environmental regulations and regulations relating to the design and operation
of MKS' power supply products. MKS must ensure that these systems meet certain
safety standards, many of which vary across the countries in which MKS' systems
are used. For example, the European Union has published directives specifically
relating to power supplies. MKS must comply with these directives in order to
ship MKS' systems into countries that are members of the European Union. MKS
believes it is in compliance with current applicable regulations, directives and
standards and has obtained all necessary permits, approvals, and authorizations
to conduct MKS' business. However, compliance with future regulations,
directives and standards could require it to modify or redesign certain systems,
make capital expenditures or incur substantial costs. If MKS does not comply
with current or future regulations, directives and standards:
o MKS could be subject to fines;
o MKS' production could be suspended; or
o MKS could be prohibited from offering particular systems in specified
markets.
CERTAIN STOCKHOLDERS HAVE A SUBSTANTIAL INTEREST IN MKS AND MAY BE ABLE TO EXERT
SUBSTANTIAL INFLUENCE OVER MKS' ACTIONS.
As of January 31, 2003, John R. Bertucci, president, chairman and chief
executive officer of MKS, and certain members of his family, in the aggregate,
beneficially owned approximately 22.7% of MKS' outstanding common stock. As a
result, these stockholders, acting together, are able to exert substantial
influence over the actions of MKS. Pursuant to the acquisition of the ENI
Business of Emerson Electric Co. ("Emerson"), MKS issued approximately
12,000,000 shares of common stock to Emerson. As of January 31, 2003, Emerson
beneficially owned approximately 23.4% of MKS' outstanding common stock, and
accordingly, Emerson is able to exert substantial influence over MKS' actions.
SOME PROVISIONS OF MKS' RESTATED ARTICLES OF ORGANIZATION, AS AMENDED, MKS'
AMENDED AND RESTATED BY-LAWS AND MASSACHUSETTS LAW COULD DISCOURAGE POTENTIAL
ACQUISITION PROPOSALS AND COULD DELAY OR PREVENT A CHANGE IN CONTROL OF MKS.
Anti-takeover provisions could diminish the opportunities for stockholders
to participate in tender offers, including tender offers at a price above the
then current market value of the common stock. Such provisions may also inhibit
increases in the market price of the common stock that could result from
takeover attempts. For example, while MKS has no present plans to issue any
preferred stock, MKS' board of directors, without further stockholder approval,
may issue preferred stock that could have the effect of delaying, deterring or
preventing a change in control of MKS. The issuance of preferred stock could
adversely affect the voting power of the holders of MKS' common stock, including
the loss of voting control to others. In addition, MKS' amended and restated
by-laws provide for a classified board of directors consisting of three classes.
The classified board could also have the effect of delaying, deterring or
preventing a change in control of MKS.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Information concerning market risk is contained in the Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission on March 31, 2003. MKS enters into local currency
purchased options and forward exchange contracts to reduce currency exposure
arising from intercompany sales of inventory. There were no material changes in
MKS' exposure to market risk from December 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES.
The Company's management, with the participation of the Company's chief
executive officer and chief financial officer, evaluated the effectiveness of
the Company's disclosure controls and procedures (as defined in Rules 13a-15(e)
and 15d-15(e) under the Exchange Act) as of June 30, 2003. Based on this
evaluation, the Company's chief executive officer and chief financial officer
concluded that, as of June 30, 2003, the Company's disclosure controls and
procedures were (1) designed to ensure that material information relating to the
Company, including its consolidated subsidiaries, is made known to the Company's
chief executive officer and chief financial officer by others within those
entities, particularly during the period in which this report was being prepared
and (2) effective, in that they provide reasonable assurance that information
required to be disclosed by the Company in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the SEC's rules and forms.
No change in the Company's internal control over financial reporting (as
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during
the fiscal quarter ended June 30, 2003 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On April 3, 2003, Advanced Energy Industries, Inc. ("Advanced Energy")
filed suit against MKS in federal district court in Colorado ("Colorado
Action"), seeking a declaratory judgment that Advanced Energy's Xstream product
does not infringe three patents held by Applied Science and Technology, Inc.
("ASTeX"), a subsidiary of MKS. MKS has filed a motion to dismiss Advanced
Energy's complaint, and that motion is now pending before the Colorado court. On
May 14, 2003, MKS and ASTeX brought suit in federal district court in Delaware
against Advanced Energy for infringement of five ASTeX patents, including the
three patents at issue in the Colorado Action. MKS and ASTeX seek injunctive
relief and damages for Advanced Energy's infringement. Advanced Energy has moved
to dismiss this suit in favor of Advanced Energy's Colorado Action, and MKS has
opposed Advanced Energy's motion. Advanced Energy's motion to dismiss is now
pending before the Delaware court. Both of these cases are in the early stages
of pre-trial discovery.
On November 3, 1999, On-Line Technologies, Inc. ("On-Line"), which was
acquired by the Company in April 2001, brought suit in federal district court in
Connecticut against Perkin-Elmer, Inc. and certain other defendants for
infringement of On-Line's patent related to its FTIR spectrometer product. The
suit sought injunctive relief and damages for infringement. Perkin-Elmer, Inc.
filed a counterclaim seeking invalidity of the patent, costs, and attorneys'
fees. In June 2002, the defendants filed a motion for summary judgment. In April
2003 the court granted the motion and dismissed the case. The Company has
appealed this decision.
There have been no other material developments since the filing of MKS'
Quarterly Report on Form 10-Q on May 8, 2003.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(d) Use of Proceeds from Sales of Registered Securities.
The Company has previously provided information on Form 10-Q for the
quarter ended September 30, 2000 relating to the use of proceeds from the sale
of securities by the Company pursuant to the Registration Statement on Form
24
S-1 (Reg. No. 333-71363) that was declared effective by the Securities and
Exchange Commission on March 29, 1999. As of June 30, 2003, approximately $32.2
million of the net proceeds from the securities sold has been used to acquire
businesses. There has been no other change to the information previously
provided.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Company's Annual Meeting of Stockholders held on May 14, 2003 (the
"Annual Meeting"), the following proposals were approved as further specified
below:
1. Election of Directors:
Votes For Votes Withheld
---------- --------------
Hans-Jochen Kahl 46,394,881 830,685
Louis P. Valente 46,136,718 1,088,848
2. Ratification of appointment of PricewaterhouseCoopers LLP as
independent accountants for the fiscal year ending December 31, 2003.
Votes For Votes Against Votes Abstaining Broker Non-Votes
--------- ------------- ---------------- ----------------
46,191,279 1,002,128 32,159 0
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit No. Exhibit Description
10.1 Amended and Restated 1997 Director Stock Option Plan
31.1 Certification of Principal Executive Officer pursuant to
Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act
of 1934, as amended
31.2 Certification of Principal Financial Officer pursuant to
Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act
of 1934, as amended
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
On April 17, 2003, the Company furnished a Current Report on Form 8-K announcing
the Company's financial results for the quarter ended March 31, 2003 under "Item
9. Regulation FD Disclosure" (Information furnished pursuant to Item 12.
"Disclosure of Results of Operations and Financial Condition"). The full text of
the press release issued in connection with the announcement, including
financial statements, was attached as Exhibit 99.1 to this Current Report on
Form 8-K.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MKS INSTRUMENTS, INC.
August 13, 2003 By: /s/ Ronald C. Weigner
--------------------------------------
Ronald C. Weigner
Vice President and Chief Financial
Officer (Principal Financial Officer)
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