MKS INSTRUMENTS INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 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
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MKS INSTRUMENTS, INC.
(Exact Name of Registrant as Specified in Its Charter)

MASSACHUSETTS 04-2277512
(State or other Jurisdiction of (IRS Employer
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

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE.

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, NO PAR VALUE

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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in the Exchange Act Rule 12b-2). Yes [X] No [ ]

Aggregate market value of the voting and non-voting common equity held by
nonaffiliates of the registrant as of June 30, 2003 based on the closing price
of the registrant's Common Stock on such date as reported by the NASDAQ National
Market: $508,588,433; Number of shares outstanding of the issuer's Common Stock,
no par value, as of February 13, 2004: 53,334,520.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for MKS' Annual Meeting of
Stockholders to be held on May 13, 2004 are incorporated by reference into Part
III of this Form 10-K.
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

MKS believes that this Annual Report on Form 10-K 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 actual 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 in the section
entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Factors that May Affect Future Results."

PART I

ITEM 1. BUSINESS

We are a leading worldwide provider of instruments, components, subsystems
and process control solutions that measure, control, power and monitor critical
parameters of semiconductor and other advanced manufacturing processes.

We are managed as one operating segment which is organized around three
product groups: Instruments and Control Systems, Power and Reactive Gas Products
and Vacuum Products. Our products are derived from our 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.

Our products are used in diverse markets and applications including the
manufacture of, among other things:

- semiconductor devices for diverse electronics applications;

- flat panel displays for hand-held devices, laptop computers, desktop
computer monitors and television sets;

- magnetic and optical storage media;

- optical filters and fiber optic cables for data and telecommunications;

- optical coatings for eyeglasses, architectural glass and solar panels;

- magnetic resonance imaging (MRI) medical equipment;

- gas lasers;

- cutting tools; and

- freeze-dried pharmaceuticals.

For over 40 years, we have focused on satisfying the needs of our customers
by establishing long-term, collaborative relationships. We have a diverse base
of customers that include manufacturers of semiconductor capital equipment,
semiconductor devices, data storage equipment, medical equipment and flat panel
displays, as well as industrial manufacturing companies, and university,
government and industrial research laboratories. During the years ended December
31, 2003, 2002 and 2001, we estimate that approximately 69%, 70% and 64% of our
net sales, respectively, were to semiconductor capital equipment manufacturers
and semiconductor device manufacturers. Our top 10 customers for the year ended
December 31, 2003 were Applied Materials, ASM International, Celerity Group, Lam
Research, Micromass UK Ltd., Novellus Systems, Phillips Medical, Toyko Electron,
Ulvac and Unaxis.

We file reports, proxy statements and other documents with the Securities
and Exchange Commission. You may read and copy any document we file at the SEC's
public reference room at Judiciary Plaza Building, 450 Fifth Street, N.W., Room
1024, Washington, D.C. 20549. You should call 1-800-SEC-0330 for more

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information on the public reference room. Our SEC filings are also available to
you on the SEC's Internet site at http://www.sec.gov.

Our internet address is www.mksinst.com. We are not including the
information contained in our website as part of, or incorporating it by
reference into, this annual report on Form 10-K. We make available free of
charge through our web site our annual reports on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K and amendments to these reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act
of 1934, as amended as soon as reasonably practicable after we electronically
file such materials with the Securities and Exchange Commission.

MARKETS AND APPLICATIONS

We are focused on three market sectors: semiconductor manufacturing
applications; thin-film manufacturing applications; and other non-semiconductor
manufacturing applications. We estimate that approximately 69%, 70% and 64% of
our net sales for the years ended December 31, 2003, 2002 and 2001,
respectively, were to semiconductor capital equipment manufacturers and
semiconductor device manufacturers. Approximately 10%, 8% and 11% of our net
sales in the years ended December 31, 2003, 2002 and 2001, respectively, were
for thin-film processing equipment applications, including compact disks,
digital video disks (DVDs) and other digital storage media; flat panel displays
for computer and television screens; and thin-film coatings for architectural
glass and optics. Approximately 21%, 22% and 25% of our net sales in the years
ended December 31, 2003, 2002 and 2001, respectively, were for other
non-semiconductor manufacturing applications. These include, but are not limited
to, industrial manufacturing, magnetic resonance imaging (MRI) medical
equipment, biopharmaceutical manufacturing, and university, government and
industrial research laboratories.

We estimate that approximately 41%, 36% and 31% of our net sales for the
years ended December 31, 2003, 2002 and 2001, respectively, were to customers
located in international markets. International sales include sales by our
foreign subsidiaries, but exclude direct export sales, which were less than 10%
of our total net sales for the years ended December 31, 2003, 2002 and 2001.

SEMICONDUCTOR MANUFACTURING APPLICATIONS

Our products are sold to semiconductor capital equipment manufacturers and
semiconductor device manufacturers. Our products are used in the major
semiconductor processing steps such as:

- depositing materials onto substrates

- etching and cleaning circuit patterns

- implanting positively charged atoms into a substrate to alter electrical
characteristics

Our products are also used for process facility applications such as gas
distribution, pressure control and vacuum distribution in clean rooms where
semiconductor manufacturing takes place. In addition, we provide specialized
instruments that monitor the performance of manufacturing equipment and products
that distribute and manage process control information. We anticipate that the
semiconductor manufacturing market will continue to account for a substantial
portion of our sales. While the semiconductor device manufacturing market is
global, major semiconductor capital equipment manufacturers are concentrated in
Europe, Japan and the United States.

THIN-FILM MANUFACTURING APPLICATIONS

Flat Panel Display Manufacturing.

Our products are used in the manufacture of flat panel displays, which
require the same or similar fabrication processes as semiconductor
manufacturing. Flat panel displays are used in electronic hand-held devices,
laptop computers, desktop computer monitors, and television sets. Computer
monitors and television sets with flat panel display technology are designed to
replace bulkier cathode ray tube (CRT) technology in computer monitors and
television sets. We sell products to flat panel equipment manufacturers and to
end-

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users in the flat panel display market. The transition to larger panel sizes and
higher display resolution is driving the need for tighter process controls to
reduce defects. The major manufacturers for flat panel displays are concentrated
in Japan, Korea and Taiwan, and the major manufacturers for flat panel display
equipment are concentrated in Japan and the United States.

Magnetic and Optical Storage Media.

Our products are used to manufacture:

- magnetic storage media which store and read data magnetically;

- optical storage media which store and read data using laser technology;

- compact disks;

- hard disks;

- data storage devices; and

- digital video or versatile disks (DVDs).

The transition to higher density storage capacity requires manufacturing
processes incorporating tighter process controls. The major manufacturers of
storage media are concentrated in Japan and the Asia Pacific region, and the
major manufacturers of storage media capital equipment are concentrated in
Europe, Japan and the United States.

Optical Filters, Optical Fibers and Other Coating Processes

Our products are used in optical filter, optical fiber and other optical
thin-film coating processes. Our products are sold both to coating equipment
manufacturers and to manufacturers of products made using optical thin-film
coating processes. Optical filters and fibers used for data transmission are
manufactured using processes to deposit chemical vapors which are similar to
those used in semiconductor manufacturing. The requirement for higher data
transmission rates is driving the need for tighter control of optical filters
and fiber coating processes. Optical thin films for eyeglasses, solar panels and
architectural glass are deposited using processes to deposit chemical vapors and
gaseous metals similar to those used in semiconductor manufacturing. Optical
filter, optical fiber and other optical thin-film processing are concentrated in
Europe, Japan and the United States.

Our products are also used in processes for the application of thin films
to harden tool bit surfaces, for the application of diamond thin films to
enhance surface hardness and durability and for coatings used for food container
packaging, jewelry and ornaments. The major equipment and process providers are
concentrated in Europe, Japan and the United States.

OTHER NON-SEMICONDUCTOR MANUFACTURING APPLICATIONS

Our products are used in plasma processes used to sterilize medical
instruments, in vacuum freeze drying of pharmaceuticals, foods and beverages,
and in vacuum processes involved in light bulb and gas laser manufacturing. Our
products are also incorporated into several other end-market products such as
MRI medical equipment, industrial vehicles, and analytical instruments. In
addition, our products are sold to government, university and industrial
laboratories for vacuum applications involving research and development in
materials science, physical chemistry and electronics materials. The major
equipment and process providers and research laboratories are concentrated in
Europe, Japan and the United States.

PRODUCTS

During 2002, we consolidated our product groups to accelerate product
development, rationalize manufacturing operations, and reduce operating costs.
This realignment of operations has organized us into three product groups:
Instruments and Control Systems, Power and Reactive Gas Products and Vacuum
Products.

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1. INSTRUMENTS AND CONTROL SYSTEMS

PRESSURE MEASUREMENT AND CONTROL PRODUCTS. Each of our Pressure
Measurement and Control product lines consists of products that are designed for
a variety of pressure ranges and accuracies.

Baratron Pressure Measurement Products. Our Baratron products are
high-precision pressure measurement instruments. We have five Baratron product
families that range from high accuracy digital output instruments to simple
electronic switches. These products are typically used to measure the pressure
of the gases being distributed upstream of the process chambers, to measure
process chamber pressures and to measure pressures between process chambers,
vacuum pumps and exhaust lines. Baratron instruments measure pressures at ranges
from two hundred times atmospheric pressure to one billionth of atmospheric
pressure. We believe we offer the widest range of gas pressure measurement
instruments in the semiconductor and advanced thin-film materials processing
industries.

Automatic Pressure and Vacuum Control Products. Automatic pressure control
products consist of analog and digital automatic pressure and vacuum control
electronic instruments and valves. These products enable precise control of
process pressure by electronically actuating valves that control the flow of
gases in and out of the process chamber to minimize the difference between
desired and actual pressure in the chamber. The electronic controllers vary from
simple analog units with precise manual tuning capability to state-of-the-art
self-tuning, digital signal processing controllers. The valve products vary from
small gas inlet valves to large exhaust valves.

In most cases, Baratron pressure measurement instruments provide the
pressure input to the automatic pressure control device. Together, these
components create an integrated automatic pressure control subsystem. Our
pressure control products can also accept inputs from other measurement
instruments, enabling the automatic control of gas input or exhaust based on
parameters other than pressure.

MATERIALS DELIVERY PRODUCTS. Each of our Materials Delivery product lines
consists of products that are designed for a variety of flow ranges and
accuracies.

Flow Measurement and Control Products. Flow measurement products include
gas, vapor and liquid flow measurement products based upon thermal conductivity,
pressure and direct liquid injection technologies. The flow control products
combine the flow measurement device with valve control elements based upon
solenoid, piezo-electric and piston pump technologies. The products measure and
automatically control the mass flow rate of gases and vapors into the process
chamber. Our line of thermal-based mass flow controllers, which control gas flow
based on the molecular weight of gases, includes all-metal-sealed designs and
ultra-clean designs for semiconductor applications, as well as general-purpose
controllers for applications where all-metal-sealed construction is not
required. We have also developed pressure-based mass flow controllers, based on
Baratron pressure instrument measurement and control technology, which restrict
flow in the gas line to transform pressure control into mass flow control.

Our flow measurement products also include a calibration system which
independently measures mass flow and compares this measurement to that of the
process chamber mass flow controller. The demand for our calibration system is
driven by the increasingly stringent process control needs of the semiconductor
industry and the need to reduce costly downtime resulting from stopping
operations to address mass flow controller problems.

GAS AND THIN-FILM COMPOSITION ANALYSIS PRODUCTS. The technologies used in
these products include mass spectrometry and infrared spectroscopy. Gas and
thin-film composition analysis instruments are sold to a variety of industries
including the semiconductor industry.

Mass Spectrometry-based Gas Composition Analysis Instruments. These
products are based on quadruple mass spectrometer sensors that separate gases
based on molecular weight. These sensors include built-in electronics and are
provided with software that analyzes the composition of background and process
gases in the process chamber. These instruments are provided both as portable
laboratory systems and as process gas monitoring systems used in the diagnosis
of semiconductor manufacturing process systems.

Fourier Transform Infra-Red (FTIR) Based Gas and Thin-Film Composition
Analysis Products. FTIR-based products provide information about the composition
of gases and thin-films by measuring the
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absorption of infra-red light as it passes through the sample being measured.
Gas analysis applications include measuring the compositions of mixtures of
reactant gases; measuring the purity of individual process gases; measuring the
composition of process exhaust gas streams to determine process health;
monitoring gases to ensure environmental health and safety; and monitoring
combustion exhausts. These instruments are provided as portable laboratory
systems and as process gas monitoring systems used in the diagnosis of
manufacturing processes.

Mass spectrometry-based and FTIR-based gas monitoring systems can indicate
out-of-bounds conditions -- such as the presence of undesirable contaminant
gases and water vapor or out-of-tolerance amounts of specific gases in the
process -- which alert operators to diagnose and repair faulty equipment.

Leak Detection Products. We manufacture a range of mass spectrometer-based
helium leak detection products. Helium leak detection is used in a variety of
industries including semiconductor, HVAC, automotive and aerospace to ensure the
leak integrity of both manufactured products and manufacturing equipment. We
believe that our product is the smallest mass spectrometer-based leak detector
currently available.

Optical Monitoring Instruments. We manufacture a range of optical
monitoring instruments that are sold primarily for thin-film coating
applications such as the manufacture of optical filters. The optical monitors
measure the thickness and optical properties of a film being deposited, allowing
the user to better control the process.

CONTROL AND INFORMATION TECHNOLOGY PRODUCTS. We design and manufacture a
suite of products that allow customers to better control their processes through
computer-controlled automation. The products include digital control network
products, process chamber and system controllers and connectivity products.
Digital control network products are used to connect sensors, actuators and
subsystems to the chamber and system control computers. They support a variety
of industry-standard connection methods including DeviceNet, Profibus, ethernet
and conventional discrete digital and analog signals. Chamber and system control
computers process these signals in real time and allow the customer to precisely
manage the process conditions. Connectivity products allow information to flow
from the process sensors and subsystems and from the process tool control
computer to the factory network. By enabling this information flow, customers
can better optimize their processes through new techniques known as Advanced
Process Control (APC), and diagnose problems with the equipment and process from
a remote location (e-diagnostics).

2. POWER AND REACTIVE GAS PRODUCTS

In the Power and Reactive Gas Products group, we design and manufacture a
wide variety of power supplies and reactive gas generation modules used in
semiconductor device manufacturing and medical equipment markets.

Power Delivery Products. Our power delivery products are used in the
semiconductor, flat panel display, data storage and medical markets. In the
semiconductor, flat panel and data storage markets, our microwave, RF and DC
power supplies are used to provide energy to various etching, stripping and
deposition processes. In the medical market, our power delivery products are
used to provide power for MRI equipment. Our power delivery products cover
frequencies ranging from DC to 2.45GHZ (gigahertz) at power levels from tens of
watts to over 100 kilowatts. A range of impedance matching units transfer power
from the power supplies to the customer's process. They are automated with
modern digital control electronics that ensure optimum power transfer and rapid
response to changing process conditions. Our MRI power amplifiers are used in
the most advanced MRI systems including the 3T (three Tesla) machines. These
machines provide higher resolution images to medical professionals, allowing
better diagnosis and treatment. Our high power and high frequency technology is
particularly well suited to these applications.

Reactive Gas Generation Products. Reactive gases are used in many of the
process steps in chip fabrication. Reactive gases are used to etch, strip and
deposit films on wafers, to clean wafers during processing, and to clean process
chambers to reduce particle contamination. A reactive gas is created when energy
is added to a stable gas to break apart its molecules. The resulting dissociated
gas produces rapid chemical reactions when it comes into contact with other
matter. Reactive gas processes have important

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advantages relative to other types of chemical processes. These advantages
include: greater precision in etch, strip and deposition process steps; lower
temperatures that protect materials involved in the process from heat damage;
greater efficiency and shorter reaction times to improve manufacturing yields;
and lower cost. Examples of our reactive gas products include ozone generators
and subsystems used for deposition of insulators on to semiconductor devices,
ozonated water delivery systems for advanced semiconductor wafer and flat panel
display cleaning, atomic fluorine generators for process chamber cleaning, and
microwave plasma based products for photo resist removal.

3. VACUUM PRODUCTS

In the Vacuum Products group, we design and manufacture a wide variety of
vacuum technology products, including vacuum gauges, valves and components.

Vacuum Gauging Products. We offer a wide range of vacuum instruments
consisting of vacuum measurement sensors and associated power supply and readout
units. These vacuum gauges measure phenomena that are related to the level of
pressure in the process chamber and downstream of the process chamber between
the chamber and the pump. These gauges are used to measure vacuum at pressures
lower than those measurable with a Baratron instrument or to measure vacuum in
the Baratron instrument range where less accuracy is required. Our indirect
pressure gauges use thermal conductivity and ionization gauge technologies to
measure pressure from atmospheric pressure to one trillionth of atmospheric
pressure.

Vacuum Valves and Components. Our vacuum valves are used on the gas lines
between the process chamber and the pump downstream of the process chamber. Our
vacuum components consist of flanges, fittings, traps and heated lines that are
used downstream from the process chamber to provide leak free connections and to
prevent condensable materials from depositing particles near or back into the
chamber. The manufacture of devices with small circuit patterns cannot tolerate
contamination from atmospheric leaks or particles. Our vacuum components are
designed to minimize such contamination and thus increase yields and uptimes.

APPLICATION-SPECIFIC INTEGRATED SUBSYSTEMS

We also combine products and technologies to provide application-specific
integrated subsystems. Integrated subsystems are made by each product group,
depending upon the application of the subsystem. Our integrated subsystems
represented approximately 20% of revenues for the year ended December 31, 2003.

For example, we have a line of integrated flow and pressure control
subsystems that combine two or more of our products and technologies into
products for specific process applications. We have developed a range of
Back-Side Wafer Cooling Subsystems which are needed to control the flow and
pressure of the helium used to effect the cooling of wafers in semiconductor
manufacturing. By combining the functions of our Baratron pressure measurement
instruments, flow measurement instruments, control electronics and valves into a
range of compact instruments, this product line addresses the need for smaller
components that save valuable clean room space.

CUSTOMERS

Each of our product groups' largest customers are leading semiconductor
capital equipment manufacturers such as Applied Materials, Lam Research,
Novellus Systems and Tokyo Electron, and semiconductor device manufacturers such
as IBM and Taiwan Semiconductor Manufacturing Company. Sales to our top ten
customers accounted for approximately 42%, 49% and 39% of net sales for the
years ended December 31, 2003, 2002 and 2001, respectively. Applied Materials
accounted for approximately 18%, 23% and 18% of our net sales for the years
ended December 31, 2003, 2002 and 2001, respectively.

SALES, MARKETING AND SUPPORT

Our worldwide sales, marketing and support organization is critical to our
strategy of maintaining close relationships with semiconductor capital equipment
manufacturers and semiconductor device manufacturers.

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We sell our products primarily through our direct sales force. As of December
31, 2003, we had 172 sales employees worldwide in China, France, Germany, Japan,
Korea, the Netherlands, Singapore, Taiwan, the United Kingdom and the United
States. Sales representatives and agents in countries including Canada, China,
India, Israel, and Italy and in select U.S. cities supplement this direct sales
force. We maintain a marketing staff that identifies customer requirements,
assists in product planning and specifications, and focuses on future trends in
the semiconductor and other markets.

As semiconductor device manufacturers have become increasingly sensitive to
the significant costs of system downtime, they have required that suppliers
offer comprehensive local repair service and close customer support.
Manufacturers require close support to enable them to repair, modify, upgrade
and retrofit their equipment to improve yields and adapt new materials or
processes. To meet these market requirements, we maintain a worldwide sales and
support organization in 10 countries. Technical support is provided by
applications engineers located at offices in China, France, Germany, Japan,
Korea, the Netherlands, Singapore, Taiwan, the United Kingdom and the United
States. Repair and calibration services are provided at 22 service depots
located worldwide. We provide warranties from one to three years, depending upon
the type of product.

RESEARCH AND DEVELOPMENT

Our products incorporate sophisticated technologies to power, measure,
control and monitor increasingly complex gas-related semiconductor manufacturing
processes, thereby enhancing uptime, yield and throughput for our semiconductor
device manufacturing customers. Our products have continuously advanced as our
customers' needs have evolved. We have developed, and continue to develop, new
products to address emerging industry trends such as the transition from the use
of 200mm wafers to 300mm wafers and the shrinking of integrated circuit
line-widths from 0.18 micron to 0.13 micron and smaller. In addition, we have
developed, and continue to develop, products that support the migration to new
classes of materials, such as copper for low resistance conductors, high-k
dielectric materials for capacitors and gates and low-k dielectric materials for
low loss insulators that are used in small geometry manufacturing. We have
undertaken an initiative to involve our marketing, engineering, manufacturing
and sales personnel in the concurrent development of new products in order to
reduce the time to market for new products. Our employees also work closely with
customers' development personnel. These relationships help us identify and
define future technical needs on which to focus research and development
efforts. We support research at academic institutions targeted at advances in
materials science and semiconductor process development. At December 31, 2003,
we had 326 research and development employees, primarily located in the United
States. Our research and development expense was $47.7 million, $46.0 million
and $38.0 million for the years ended December 31, 2003, 2002 and 2001,
respectively. Our research and development efforts include numerous projects
that generally have a duration of 18 to 30 months. In addition, we acquired
in-process technology of $8.4 million in 2002 and $2.3 million in 2001.

MANUFACTURING

Our manufacturing facilities are located in China, Germany, Israel, Japan,
Mexico, the United Kingdom and the United States. Manufacturing activities
include the assembly and testing of components and subassemblies, which are
integrated into products. We outsource some of our subassembly work. We purchase
a wide range of electronic, mechanical and electrical components, some of which
are designed to our specifications. We consider our ability to flexibly respond
to customers' significantly fluctuating product demands by using lean
manufacturing techniques to be a distinct competitive advantage.

COMPETITION

The market for our products is highly competitive. Principal competitive
factors include:

- historical customer relationships;

- product quality, performance and price;

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- breadth of product line;

- manufacturing capabilities; and

- customer service and support.

Although we believe that we compete favorably with respect to these
factors, there can be no assurance that we will continue to do so.

We encounter substantial competition in most of our product lines, although
no one competitor competes with us across all product lines. Certain of our
competitors may have greater financial and other resources than us. In some
cases, competitors are smaller than we are, but well established in specific
product niches. Mykrolis offers products that compete with our pressure and
materials delivery products. Advanced Energy, Horiba/STEC and Celerity/Unit
Instruments, each offer materials delivery products that compete with our
product line of mass flow controllers. Nor-Cal Products, Inc. and MDC Vacuum
Products, Inc., each offer products that compete with our vacuum components.
Inficon offers products that compete with our vacuum measurement and gas
analysis products. Helix Technology offers products that compete with our vacuum
gauging products. Advanced Energy offers products that compete with our power
delivery and reactive gas generator products and with certain data management
and information products.

PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS

We rely on a combination of patent, copyright, trademark and trade secret
laws and license agreements to establish and protect our proprietary rights. As
of December 31, 2003, we owned 194 U.S. patents, 123 foreign patents and had 84
pending U.S. patent applications. Foreign counterparts of certain of these
applications have been filed or may be filed at the appropriate time. Although
we believe that certain patents may be important for certain aspects of our
business, we believe that our success also depends upon close customer contact,
innovation, technological expertise, responsiveness and worldwide distribution.

We require each of our employees, including our executive officers, to
enter into standard agreements pursuant to which the employee agrees to keep
confidential all of our proprietary information and to assign to us all
inventions while they are employed by us.

For a discussion of litigation relating to our intellectual property, see
"Item 3. Legal Proceedings."

EMPLOYEES

As of December 31, 2003, we employed approximately 2,144 persons. We
believe that our ongoing success depends upon our continued ability to attract
and retain highly skilled employees for whom competition is intense. None of our
employees are represented by a labor union or are party to a collective
bargaining agreement. We believe that our employee relations are good.

ITEM 2. PROPERTIES

As of December 31, 2003, the following table provides information
concerning MKS' principal and certain other owned and leased facilities:

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(1) This facility is owned by MKS.

(2) MKS leases two facilities, one has 8,000 square feet of space and a lease
term which expired December 31, 2003 and we currently lease the facility on
a month to month basis and the second has 6,000 square feet of space and a
lease term which expires December 31, 2004.

(3) MKS leases two facilities, one has 39,000 square feet of space and a lease
term which expires October 31, 2004 and the second has 33,000 square feet
of space and a lease term which expires August 31, 2005. MKS also owns a
third and fourth facility with 27,000 and 20,000 square feet of space,
respectively.

(4) MKS leases two facilities, one has 2,000 square feet of space and a lease
term which expires October 5, 2009 and the second has 11,000 square feet of
space and a lease term which expires November 30, 2009.

(5) MKS leases one facility with 16,600 square feet of space and a lease term
which expires on February 28, 2005. MKS owns another facility with 24,000
square feet.

(6) MKS is subleasing this facility which lease term expires on July 31, 2004.

(7) In December 2003, MKS exited this facility as part of its consolidation
plan and is currently negotiating to sublease portions of this facility.
The lease term expires on June 30, 2007.

(8) MKS owns this facility and has an Industrial Development Revenue Bond of
$5.0 million, due in 2014, that is collateralized by the building.

(9) MKS leases 4,000 square feet of space with a lease term which expires April
30, 2005. MKS owns another facility with 5,000 square feet of space.

(10) MKS leases two facilities, one has 10,300 square feet of space and a lease
term which expires October 31, 2004 and the second has 3,400 square feet of
space and a lease term which expires August 25, 2004.

(11) MKS leases two facilities, one has 14,500 square feet of space and a lease
term which expires April 30, 2005 and the second has 10,500 square feet of
space and a lease term which expires on September 30, 2006. MKS owns a
third facility of 6,000 square feet.

(12) MKS owns this facility and has a mortgage note payable of approximately
$4.6 million outstanding at December 31, 2003.

In addition to manufacturing and other operations conducted at the
foregoing leased or owned facilities, MKS provides worldwide sales, customer
support and services from various other leased facilities throughout the world
not listed in the table above. See "Business -- Sales, Marketing and Support."

ITEM 3. LEGAL PROCEEDINGS

On January 12, 2004, Gas Research Institute ("GRI") brought suit in federal
district court in Illinois against us, On-Line Technologies, Inc., which was
acquired by us in April 2001, and another defendant for breach of contract,
misappropriation of trade secrets and related claims relating to certain
infra-red gas

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analysis technology allegedly developed under a January 1995 Contract for
Research and incorporated into certain of our products. GRI has made claims for
unspecified damages, attorney's fees and injunctive relief. We are currently
evaluating the merits of the claims. We cannot be certain of the outcome of this
litigation, but we plan to oppose the claims against us vigorously.

On April 3, 2003, Advanced Energy Industries, Inc. ("Advanced Energy")
filed suit against us 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 our subsidiary Applied Science and Technology,
Inc. ("ASTeX"). On May 14, 2003, we 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. We seek injunctive
relief and damages for Advanced Energy's infringement. On December 24, 2003, the
Colorado court granted our motion to transfer Advanced Energy's Colorado suit to
Delaware and on February 9, 2004, the Delaware court denied Advanced Energy's
motion to dismiss or transfer our Delaware case back to Colorado. The case is in
the early stages of pre-trial discovery.

On November 30, 2000, ASTeX, which we acquired in January 2001, brought
suit in federal district court in Delaware against Advanced Energy for
infringement of ASTeX's patent related to its Astron product. On May 17, 2002, a
jury affirmed the validity of our patent and found that Advanced Energy
infringed the patent. On May 31, 2002, based on the jury's findings, the Court
entered a judgment on the infringement claim in favor of us and against Advanced
Energy, and awarded $4.2 million in damages to compensate us for Advanced
Energy's infringing activity. Advanced Energy filed motions to overturn the
verdict. During August of 2002, we entered into an agreement with Advanced
Energy whereby Advanced Energy agreed to pay the awarded damages amount to us
and withdraw its motions to overturn the verdict. We received the $4.2 million
in September 2002, and recorded the amount as Income from litigation settlement.

On November 3, 1999, On-Line Technologies, Inc. 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 seeks injunctive relief and damages for infringement.
Perkin-Elmer, Inc. has filed a counterclaim seeking invalidity of the patent,
costs, and attorneys' fees. We believe that the counterclaim is without merit.
We cannot be certain of the outcome of this litigation, but we plan to assert
our claims and oppose the counterclaims against us vigorously.

We are subject to other 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 our results of operations, financial
condition or cash flows.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter of 2003 through the solicitation of proxies or otherwise.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

PRICE RANGE OF COMMON STOCK

Our common stock is traded on the Nasdaq National Market under the symbol
MKSI. On February 13, 2004, the closing price of our common stock, as reported
on the Nasdaq National Market, was $24.85 per

11

share. The following table sets forth for the periods indicated the high and low
bid prices per share of our common stock as reported by the Nasdaq National
Market.

On February 13, 2004, we had approximately 205 stockholders of record.

DIVIDEND POLICY

We have never declared or paid any cash dividends. We currently intend to
retain earnings, if any, to support our growth strategy and do not anticipate
paying cash dividends in the foreseeable future. Payment of future dividends, if
any, will be at the discretion of our board of directors after taking into
account various factors, including our financial condition, operating results,
current and anticipated cash needs, plans for expansion, and changes in tax and
regulatory rulings.

ITEM 6. SELECTED FINANCIAL DATA

SELECTED CONSOLIDATED FINANCIAL DATA

- ---------------

(1) Amounts have been restated to reflect the acquisition of Applied Science and
Technology, Inc. ("ASTeX") in a pooling of interests transaction effective
January 26, 2001.

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(2) Gross profit for the year ended December 31, 2001 includes significant
charges for excess and obsolete inventory of $16.6 million. These charges
were primarily caused by a significant reduction in demand, including
reduced demand for older technology products.

(3) Loss from operations, historical net loss and historical net loss per share
for the year ended December 31, 2003 include restructuring, asset impairment
and other charges of $1.6 million. Loss from operations, historical net loss
and historical net loss per share for the year ended December 31, 2002
include restructuring and asset impairment charges of $2.7 million and
purchase of in-process technology of $8.4 million. Loss from operations,
historical net loss and historical net loss per share for the year ended
December 31, 2001 include restructuring and asset impairment charges of $3.7
million, merger expenses of $7.7 million and purchase of in-process
technology of $2.3 million.

(4) The historical net income (loss) per share data does not include provisions
for federal income taxes prior to our initial public offering in 1999,
because we were treated as an S corporation for federal income tax purposes.
The pro forma statement of income data presents net income and net income
per share data as if we had been subject to federal income taxes as a C
corporation during the periods presented. No pro forma presentation is
necessary for the fiscal years ended December 31, 2003, 2002, 2001 and 2000
because we were subject to income taxes as a C corporation for these
periods. Management believes this pro forma presentation is useful because
it provides for consistent federal income tax treatment for all years
presented.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

We are a leading worldwide provider of instruments, components, subsystems
and process control solutions that measure, control, power and monitor critical
parameters of semiconductor and other advanced manufacturing processes.

We are organized into three product groups: Instruments and Control
Systems, Power and Reactive Gas Products and Vacuum Products. Our products are
derived from our 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.
Our products are used to manufacture semiconductors; thin film coatings for
diverse markets such as flat panel displays, optical and magnetic storage media,
architectural glass and electro-optical products. We also provide technologies
for medical imaging equipment.

We have a diverse base of customers that include manufacturers of
semiconductor capital equipment, semiconductor devices, data storage equipment,
medical equipment and flat panel displays, as well as industrial manufacturing
companies, and university, government and industrial research laboratories.
During the years ended December 31, 2003, 2002 and 2001, we estimate that
approximately 69%, 70% and 64% of our net sales, respectively, were to
semiconductor capital equipment manufacturers and semiconductor device
manufacturers. We expect that sales to such customers will continue to account
for a substantial majority of our sales.

The semiconductor capital equipment market experienced a significant
downturn in 2001, 2002 and the first nine months of 2003. As a result, we
experienced a significant reduction in demand for products from our
semiconductor capital equipment manufacturer and semiconductor device
manufacturer customers during these periods. In the fourth quarter of 2003, we
experienced a significant increase in orders and shipments compared to the third
quarter of 2003. The semiconductor capital equipment industry has been very
cyclical, and we cannot determine how long this recent improvement will last. In
the absence of a significant long-term improvement, net sales could decline or
remain low, and the amount of goodwill, other long-lived assets, and inventory
considered realizable could be impaired.

A significant portion of our net sales are to operations in international
markets. International net sales include sales by our foreign subsidiaries, but
exclude direct export sales, which were less than 10% of our total net sales for
each of the years ended December 31, 2003, 2002 and 2001. International net
sales accounted for

13

approximately 41%, 36% and 31% of net sales for the years ended December 31,
2003, 2002 and 2001, respectively, a significant portion of which were sales in
Japan. We expect that international net sales will continue to represent a
significant percentage of our net sales.

RECENT ACQUISITIONS

On September 30, 2003, we acquired Wenzel Instruments, a privately held
developer of solid state MicroElectroMechanical System (MEMS) based vacuum
sensor technology for advanced manufacturing processes.

On January 31, 2002, we completed the acquisition of the ENI Business
("ENI") of Emerson Electric Co. ("Emerson"), 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. We
acquired ENI in order to offer higher value and more integrated application
solutions by combining ENI's solid-state power conversion technology with our
core competency in plasma and reactive gas solutions. The acquisition has been
accounted for under the purchase method of accounting.

Also in 2002, we acquired three companies that expanded our position in
distributed computer-based process control and data management. On March 13,
2002, we 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, we 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, we acquired
EquipNet Ltd., 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 our
consolidated statement of operations as of and since the respective dates of
purchase.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses our consolidated financial statements, which 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, we evaluate our estimates and
judgments, including those related to revenue recognition, inventory, warranty
costs, intangible assets, goodwill and other long-lived assets, in-process
research and development and income taxes. We base our 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.

We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:

Revenue recognition. Revenue from product sales is recorded upon transfer
of title and risk of loss to the customer provided that there is evidence of an
arrangement, the sales price is fixed or determinable, and collection of the
related receivable is reasonably assured. In most transactions, we have no
obligations to our customers after the date products are shipped other than
pursuant to warranty obligations. In some instances, we provide installation and
training to customers after the product has been shipped. In accordance with the
Emerging Issues Task Force ("EITF") 00-21 "Accounting For Revenue Arrangements
With Multiple Deliverables", we defer the fair value of any undelivered elements
until the installation or training is complete. Fair value is the price charged
when the element is sold separately. Shipping and handling fees billed to

14

customers, if any, are recognized as revenue. The related shipping and handling
costs are recognized in cost of sales.

We monitor and track the amount of product returns, provide for accounts
receivable allowances and reduce revenue at the time of shipment for the
estimated amount of such future returns, based on historical experience. While
product returns have historically been within our expectations and the
provisions established, there is no assurance that we will continue to
experience the same return rates that we have in the past. Any significant
increase in product return rates could have a material adverse impact on our
operating results for the period or periods in which such returns materialize.
While we maintain a credit approval process, significant judgments are made by
management in connection with assessing our customers' ability to pay at the
time of shipment. Despite this assessment, from time to time, our customers are
unable to meet their payment obligations. We continuously monitor our customers'
credit worthiness, and use our judgment in establishing a provision for
estimated credit losses based upon our historical experience and any specific
customer collection issues that we have identified. While such credit losses
have historically been within our expectations and the provisions established,
there is no assurance that we will continue to experience the same credit loss
rates that we have in the past. A significant change in the liquidity or
financial position of our customers could have a material adverse impact on the
collectability of accounts receivable and our future operating results.

Inventory. We value our inventory at the lower of cost (first-in,
first-out method) or market. We regularly review inventory quantities on hand
and record a provision to write down excess and obsolete inventory to our
estimated net realizable value, if less than cost, based primarily on our
estimated forecast of product demand. Demand for our products can fluctuate
significantly, as demonstrated during 2001 when we recorded charges for excess
and obsolete inventory of $16.6 million. The charges were primarily caused by a
significant reduction in demand including reduced demand for older technology
products. A significant increase in the demand for our products could result in
a short-term increase in the cost of inventory purchases from supply shortages
or a decrease in the cost of inventory purchases as a result of volume
discounts, while a significant decrease in demand could result in an increase in
the charges for excess inventory quantities on hand. In addition, our industry
is subject to technological change, new product development, and product
technological obsolescence that could result in an increase in the amount of
obsolete inventory quantities on hand. Therefore, any significant unanticipated
changes in demand or technological developments could have a significant impact
on the value of our inventory and our reported operating results.

Warranty Costs. We provide for the estimated costs to fulfill customer
warranty obligations upon the recognition of the related revenue. We provide
warranty coverage for our products ranging from 12 to 36 months, with the
majority of our products ranging from 12 to 24 months. We estimate the
anticipated costs of repairing our products under such warranties based on the
historical costs of the repairs and any known specific product issues. The
assumptions we use to estimate warranty accruals are reevaluated periodically in
light of actual experience and, when appropriate, the accruals are adjusted. Our
determination of the appropriate level of warranty accrual is based upon
estimates. Should product failure rates differ from our estimates, actual costs
could vary significantly from our expectations.

Intangible assets, goodwill and other long-lived assets. We review
intangible assets and other long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of these assets may
not be recoverable. Factors we consider important which could indicate an
impairment include significant under performance relative to expected historical
or projected future operating results, significant changes in the manner of our
use of the asset or the strategy for our overall business and significant and
negative industry or economic trends. When we determine that the carrying value
of the asset may not be recoverable based upon the existence of one or more of
the above indicators of impairment, we compare the undiscounted cash flows to
the carrying value of the asset. If an impairment is indicated, the asset is
written down to its estimated fair value. Intangible assets, such as purchased
technology, are generally recorded in connection with a business acquisition.
The value assigned to intangible assets is determined based on estimates and
judgment regarding expectations for the success and life cycle of products and
technology acquired. If actual product acceptance differs significantly from the
estimates, we may be required to record an impairment charge to write down the
asset to its net realizable value.
15

We assess goodwill for impairment at least annually, or more frequently
when events and circumstances occur indicating that the recorded goodwill may be
impaired. If the book value of a reporting unit exceeds its fair value, the
implied fair value of goodwill is compared with the carrying amount of goodwill.
If the carrying amount of goodwill exceeds the implied fair value, an impairment
loss is recorded in an amount equal to that excess. The fair value of a
reporting unit is estimated using the discounted cash flow approach, and is
dependent on estimates and judgments related to future cash flows and discount
rates. If actual cash flows differ significantly from the estimates used by
management, we may be required to record an impairment charge to write down the
goodwill to its net realizable value.

In-process research and development. We value tangible and intangible
assets acquired through our business acquisitions, including in-process research
and development ("IPR&D"), at fair value. We determine IPR&D through established
valuation techniques for various projects for the development of new products
and technologies and expenses IPR&D when technical feasibility is not reached.
The value of IPR&D is determined using the income approach, which discounts
expected future cash flows from projects under development to their net present
value. Each project is analyzed and estimates and judgments are made to
determine the technological innovations included; the utilization of core
technology; the complexity, cost and time to complete development; any
alternative future use or current technological feasibility; and the stage of
completion. During 2002 and 2001, we expensed approximately $8.4 million and
$2.3 million, respectively, in IPR&D charges primarily related to the ENI
acquisition and the On-Line acquisition because the technological feasibility of
certain products under development had not been established and no future
alternative uses existed. If we acquire other companies with IPR&D in the
future, we will value the IPR&D through established valuation techniques and
will incur future IPR&D charges if those products under development have not
reached technical feasibility.

Income taxes. We evaluate the realizability of our net deferred tax assets
and assess the need for a valuation allowance on a quarterly basis. The future
benefit to be derived from our deferred tax assets is dependent upon our ability
to generate sufficient future taxable income to realize the assets. We record a
valuation allowance to reduce our net deferred tax assets to the amount that may
be more likely than not to be realized. To the extent we established a valuation
allowance, an expense is recorded within the provision for income taxes line on
the statement of income. During the year ended December 31, 2002, we established
a full valuation allowance for our net deferred tax assets and have maintained
this valuation allowance through December 31, 2003. In periods subsequent to
establishing a valuation allowance, if we were to determine that we would be
able to realize our 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 we were to determine that we would not be able to realize
the recorded amount of our remaining 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.

16

RESULTS OF OPERATIONS

The following table sets forth for the periods indicated the percentage of
total net sales of certain line items included in our consolidated statement of
operations data:

YEAR ENDED 2003 COMPARED TO 2002

Net Sales. Net sales increased $22.5 million or 7.2% to $337.3 million for
the year ended December 31, 2003 from $314.8 million for the year ended December
31, 2002. International net sales were approximately $138.1 million for the year
ended December 31, 2003 or 41.0% of net sales and $114.6 million for the year
ended December 31, 2002 or 36.4% of net sales. During the year ended December
31, 2002, we acquired ENI, Tenta and IPC. These acquisitions increased our net
sales by $9.9 million for the year ended December 31, 2003, as they were
included in net sales for the full period in 2003 while net sales for the year
ended December 31, 2002 includes their revenues only from the date of
acquisition. The remaining increase in 2003 was the result of increased service
revenues as well as increased demand for our products from our semiconductor
capital equipment manufacturer customers, particularly in the fourth quarter, as
compared to the year ended December 31, 2002. The increase in service revenues,
which represents less than 10% of total net sales, has been driven by the
prolonged slow-down in the semiconductor capital equipment market, as customers
tried to maintain equipment rather than invest in new capital.

Gross Profit. Gross profit as a percentage of net sales increased to 35.0%
for the year ended December 31, 2003 from 33.6% for the year ended December 31,
2002. The increase in gross profit percent is mainly due to a slight increase in
volumes that increased our fixed cost absorption and a favorable foreign
exchange impact, offset by higher materials costs of new products in initial
production runs.

Research and Development. Our research and development efforts are
directed toward developing and improving our instruments, components, subsystems
and process control solutions for semiconductor and advanced thin-film
processing applications and identifying and developing products for new
applications for which gas management plays a critical role. Although overall
business activity was down throughout most of 2003, and we implemented
initiatives to reduce costs, we continued to invest in research and development
activities. Research and development expense increased $1.7 million or 3.6% to
$47.7 million or 14.1% of net sales for the year ended December 31, 2003 from
$46.0 million or 14.6% of net sales for the year ended

17

December 31, 2002. The increase was due mainly to increased compensation expense
of $1.0 million, as a result of including a full year of costs in 2003 of the
companies acquired during 2002 and an increase in project material costs of $0.7
million. Our research and development efforts include numerous projects which
generally have a duration of 18 to 30 months.

Selling, General and Administrative. Selling, general and administrative
expenses decreased $7.9 million or 10.2% to $69.9 million or 20.7% of net sales
for the year ended December 31, 2003 from $77.8 million or 24.7% of net sales
for the year ended December 31, 2002. The decrease was due primarily to lower
compensation expense, as a result of lower headcount, of $3.5 million resulting
from cost savings initiatives and decreased professional fees of $2.5 million.

Amortization of Acquired Intangible Assets. For the year ended December
31, 2003, amortization expense was $14.7 million, an increase of $0.8 million or
5.7% from the $13.9 million for the year ended December 31, 2002. The increase
in amortization was due to a full year of amortization of intangibles in 2003
from companies acquired in 2002.

Restructuring, Asset Impairment and Other Charges. During 2003, we
continued the consolidation to accelerate product development, rationalize
manufacturing operations, and reduce operating costs of prior acquisitions that
was started in 2002. In 2003, we recorded restructuring, asset impairment and
other charges of $1.6 million, consisting of $0.4 million of severance costs
related to workforce reductions, $1.1 million of lease cost, professional fees
and other costs related to facility consolidations and an asset impairment
charge of $0.1 million. The workforce reduction was across all functional
groups.

In 2002, this consolidation of prior acquisitions resulted in recording
restructuring and asset impairment charges of $2.7 million. The charges
consisted of $0.6 million of severance costs related to a workforce reduction,
$1.2 million related to consolidation of leased facilities, and an asset
impairment charge of $0.9 million primarily related to the impairment of an
intangible asset from the discontinuance of certain product development
activities. The workforce reduction was across all functional groups and
consisted of 225 employees.

We anticipate incurring additional restructuring charges in 2004, related
to prior year initiatives, of up to $2.0 million as we complete the
consolidation of leased facilities.

A summary of the restructuring charges, asset impairments and other charges
during 2002 and 2003, and the related accrual balance is outlined as follows:

The remaining accrual for workforce reductions is expected to be paid by
the second quarter of 2004. The facilities consolidation charges will be paid
over the respective lease terms, the latest of which ends in 2007. The accrual
for severance costs and lease payments is recorded in Other accrued expenses and
Other liabilities.

Purchase of In-process Technology. There was no purchase of in-process
research and development expenses in 2003. In-process research and development
of $8.4 million for the year ended December 31, 2002 arose from the acquisitions
we made in 2002.

18

In January 2002, we acquired ENI in a transaction accounted for under the
purchase method. The purchase price was allocated to the assets acquired,
including intangible assets, based on their estimated fair values. The
intangible assets include approximately $7.5 million for acquired in-process
technology for projects, generally expected to have durations of 12 months, that
did not have future alternative uses. The value of the purchased in-process
technology was determined using the income approach, which discounts expected
future cash flows from projects under development to their net present value.
Each project was analyzed to determine the technological innovations included;
the utilization of core technology; the complexity, cost and time to complete
development; any alternative future use or current technological feasibility;
and the stage of completion. The cash flows derived from the in-process
technology projects were discounted at rates ranging from 25% to 30%. We believe
these rates were appropriate given the risks associated with the technologies
for which commercial feasibility had not been established. The percentage of
completion for each in-process project was determined by identifying the cost
incurred to date of the project as a ratio of the total cost required to bring
the project to technical and commercial feasibility. The percentage completion
for in-process projects acquired ranged from 65% to 80% complete, based on our
estimates of tasks completed and the tasks to be completed to bring the projects
to technological and commercial feasibility. At the date of the acquisition, the
development of these projects had not yet reached technological feasibility, and
the technology in progress had no alternative future uses. Accordingly, these
costs were expensed in 2002.

Interest Income (Expense), Net. For the year ended December 31, 2003, net
interest income was $1.1 million, a decrease of $0.4 million from the $1.5
million for the year ended December 31, 2002. The decrease in net interest
income in 2003 is mainly related to slightly lower investment balances and lower
interest rates in 2003.

Income from Litigation Settlement. On November 30, 2000, Applied Science
and Technology, Inc. ("ASTeX"), which we acquired in January 2001, brought suit
in federal district court in Delaware against Advanced Energy Industries, Inc.
for infringement of ASTeX's patent related to its Astron product. On May 17,
2002, a jury affirmed the validity of our patent and found that Advanced Energy
infringed the patent. On May 31, 2002, based on the jury's findings, the Court
entered a judgment on the infringement claim in favor of us and against Advanced
Energy, and awarded $4.2 million in damages to compensate us for Advanced
Energy's infringing activity. Advanced Energy filed motions to overturn the
verdict. During August of 2002, we entered into an agreement with Advanced
Energy whereby Advanced Energy agreed to pay the awarded damages amount to us
and withdraw its motions to overturn the verdict. We received the $4.2 million
in September 2002, and recorded the amount as Income from litigation settlement.

Other (Income) Expense. During the fourth quarter of 2003, we recorded a
gain of $0.9 million from the early repayment of premiums related to a split
dollar life insurance policy covering the Chairman and CEO of the Company.

During 2001, we sold certain assets for proceeds of approximately $9.0
million, including a note receivable of approximately $3.9 million and warrants
of $0.2 million. During 2002, due to the downturn in the semiconductor industry
and its result on the acquirer's operations, and the acquirer's inability to
raise financing, we considered the value of the note and warrants to be
impaired. Accordingly, during 2002, we recorded a charge of $4.1 million to
other expense for our estimate of the impairment on the note receivable and
warrants.

Provision (Benefit) for Income Taxes. We recorded a provision for income
taxes of $2.7 million for the year ended December 31, 2003, as compared to a tax
benefit of $2.0 million for the year ended December 31, 2002. As a result of
incurring significant operating losses since 2001, we determined that it is more
likely than not that our deferred tax assets may not be realized, and since the
fourth quarter of 2002 have established a full valuation allowance for our net
deferred tax assets. Accordingly, we have not recorded a deferred tax benefit
from the net operating loss incurred in the year ended December 31, 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, we will not record deferred tax benefits from our net operating losses
in future results of operations.

19

YEAR ENDED 2002 COMPARED TO 2001

Net Sales. Net sales increased 9.8% to $314.8 million for the year ended
December 31, 2002 from $286.8 million for the year ended December 31, 2001.
International net sales were approximately $114.6 million for the year ended
December 31, 2002 or 36.4% of net sales and $90.0 million for the year ended
December 31, 2001 or 31.4% of net sales. The increase in worldwide net sales in
2002 is from the partial year revenues of $58.5 million from ENI, Tenta and IPC,
companies which were acquired during the year. This increase was offset by a
decline of $30.5 million or 10.6%, due to the worldwide slowdown in demand for
our products from our semiconductor capital equipment manufacturer and
semiconductor device manufacturer customers, which began in the first quarter of
2001 and continued through 2002.

Gross Profit. Gross profit as a percentage of net sales increased to 33.6%
for the year ended December 31, 2002 from 29.8% for the year ended December 31,
2001. The increase in gross margin was primarily due to lower provisions for
excess and obsolete inventory in 2002 compared to 2001. In 2001, we recorded
significant charges for excess and obsolete inventory of $16.6 million, or 5.8%
of net sales. These charges were primarily caused by a significant reduction in
demand, including demand for older technology products. During 2002, we realized
a benefit of $1.4 million in cost of sales, or 0.4% of net sales, from sales of
inventory which were included as part of the excess and obsolete inventory
charges in 2001. The lower excess and obsolete inventory charges in 2002 were
offset by the addition of manufacturing overhead costs from the companies
acquired in 2002, which resulted in a decrease in gross margin of approximately
2%.

Research and Development. Research and development expense increased 21.2%
to $46.0 million or 14.6% of net sales for the year ended December 31, 2002 from
$38.0 million or 13.2% of net sales for the year ended December 31, 2001.
Compensation expense increased by $2.7 million during 2002, which was comprised
of an increase of $6.5 million from the companies acquired during the year,
offset by a $3.8 million decrease resulting from cost saving programs including
workforce reductions, salary reductions, and furloughs. Also, expenses for
project materials increased $3.5 million during 2002, primarily from the
companies acquired during the year.

Selling, General and Administrative. Selling, general and administrative
expenses increased 10.9% to $77.8 million or 24.7% of net sales for the year
ended December 31, 2002 from $70.2 million or 24.5% of net sales for the year
ended December 31, 2001. The increase was due to increased compensation expense
of $4.8 million primarily from the companies acquired during the year, increased
professional fees of $1.1 million and other selling, general and administrative
expenses.

Amortization of Goodwill and Acquired Intangible Assets. Amortization
expense of $13.9 million for the year ended December 31, 2002, represents the
amortization of the identifiable intangibles resulting from the acquisitions
completed by us. In accordance with SFAS No. 142, we ceased amortizing goodwill
on January 1, 2002. Amortization of goodwill and acquired intangible assets of
$11.0 million for the year ended December 31, 2001, represents the amortization
of goodwill and other intangibles resulting from the acquisitions completed by
us, of which $5.2 million relates to acquired intangibles and $5.8 million
relates to goodwill.

Merger Costs. On January 26, 2001 we completed our acquisition of ASTeX in
a transaction accounted for under the pooling of interests method of accounting.
Under the pooling of interests method of accounting, fees and expenses related
to the merger are expensed in the period of the merger. During the year ended
December 31, 2001, we expensed approximately $7.7 million of merger related
expenses, consisting of $6.9 million of investment banking, legal, accounting,
printing and other professional fees, and $0.8 million of regulatory and other
costs.

Purchase of In-process Technology. In-process research and development of
$8.4 million and $2.3 million for the years ended December 31, 2002 and 2001
arose from the acquisitions we made in 2002 and 2001, respectively. As discussed
previously above, the $8.4 million of in-process research and development
expenses in 2002 related to our acquisition of ENI in January 2002.

In April 2001, we acquired On-Line in a transaction accounted for under the
purchase method. The purchase price was allocated to the assets acquired,
including intangible assets, based on their estimated fair

20

values. The intangible assets included approximately $2.3 million for acquired
in-process technology for various projects, generally expected to have durations
of 24 to 48 months, that did not have future alternative uses. The value of the
purchased in-process technology was determined using the income approach, which
discounts expected future cash flows from projects under development to their
net present value. Each project was analyzed to determine the technological
innovations included; the utilization of core technology; the complexity, cost
and time to complete development; any alternative future use or current
technological feasibility; and the stage of completion. The cash flows derived
from the in-process technology projects were discounted at a rate of 25%. We
believe this rate was appropriate given the risks associated with the
technologies for which commercial feasibility had not been established. The
percentage of completion for each in-process project was determined by
identifying the elapsed time invested in the project as a ratio of the total
time required to bring the project to technical and commercial feasibility. The
percentage of completion for in-process projects acquired ranged from 55% to
65%, based on management's estimates of tasks completed and the tasks to be
completed to bring the projects to technological and commercial feasibility. At
the date of the acquisition, the development of these projects had not yet
reached technological feasibility, and the technology in progress had no
alternative future uses. Accordingly, these costs were expensed in 2001.

Restructuring and Asset Impairment Charges. During 2002 we implemented a
consolidation of recent acquisitions to accelerate product development,
rationalize manufacturing operations, and reduce operating costs. As a result of
these actions, we recorded restructuring and asset impairment charges of $2.7
million in 2002. The charges consisted of $0.6 million of severance costs
related to a workforce reduction, $1.2 million related to consolidation of
leased facilities, and an asset impairment charge of $0.9 million primarily
related to the impairment of an intangible asset from the discontinuance of
certain product development activities. The fair value of the impaired
intangible asset was determined using the expected present value of future cash
flows. The workforce reduction was across all functional groups and consisted of
225 employees. Severance costs of $0.3 million were paid during 2002. The
facilities consolidation charges will be paid over the respective lease terms,
the latest of which ends in 2007.

When we acquired the Shamrock product line, it was expected that sales of
the existing system design and development of new system designs would generate
future revenues. We had provided potential customers with purchase quotations
for Shamrock systems, including a significant quotation to a potential customer
in January 2001 for the sale of several systems. The potential customer did not
purchase the systems, and the quotation expired in March 2001. We were
unsuccessful in selling any systems of the product line after the acquisition
and, with the expiration of the significant quote in March 2001, we evaluated
the recoverability of the long-lived assets, primarily goodwill. As a result,
based on discounted cash flow analysis we recorded an impairment charge for the
carrying value of the related goodwill of approximately $3.7 million in the
quarter ended March 31, 2001.

Interest Income (Expense), Net. During the year ended December 31, 2002,
we generated net interest income of $1.5 million, primarily from interest on our
invested cash and investments, offset by interest expense of $1.2 million on
outstanding debt. Interest income declined $2.5 million to $2.7 million for the
year ended December 31, 2002 from $5.2 million for the year ended December 31,
2001. The decrease was due to lower interest rate yields on investments during
2002 compared to 2001.

Income from Litigation Settlement. On November 30, 2000, ASTeX, which we
acquired in January 2001, brought suit in federal district court in Delaware
against Advanced Energy for infringement of ASTeX's patent related to its Astron
product. On May 17, 2002, a jury affirmed the validity of our patent and found
that Advanced Energy infringed the patent. On May 31, 2002, based on the jury's
findings, the Court entered a judgment on the infringement claim in favor of us
and against Advanced Energy, and awarded $4.2 million in damages to compensate
us for Advanced Energy's infringing activity. Advanced Energy filed motions to
overturn the verdict. During August of 2002, we entered into an agreement with
Advanced Energy whereby Advanced Energy agreed to pay the awarded damages amount
to us and withdraw its motions to overturn the verdict. We received the $4.2
million and recorded the amount as Income from litigation settlement.

Other Expense, Net. During 2001, we recorded a loss on the sale of an
investment in a company of $1.1 million, which was recorded as other expense.
Also during 2001, we sold certain assets for proceeds of

21

approximately $9.0 million, including a note receivable of approximately $3.9
million and warrants of $0.2 million. The loss on the transaction was $1.2
million and was recorded as other expense in 2001. During 2002, due to the
downturn in the semiconductor industry and its result on the acquirer's
operations, and the acquirer's inability to raise financing, we considered the
value of the note and warrants to be impaired. Accordingly, during 2002, we
recorded a charge of $4.1 million to other expense for our estimate of the
impairment on the note receivable and warrants.

Benefit for Income Taxes. We recorded a benefit for income taxes of $2.0
million for the year ended December 31, 2002, for an effective tax rate of 4.8%.
We recorded a benefit for income taxes of $15.0 million for the year ended
December 31, 2001, for an effective tax rate of 32.6% in 2001. The change in our
effective tax rate from 2001 to 2002 was primarily due to the recording of a
valuation allowance against our net deferred tax assets in 2002. As a result of
incurring significant operating losses during 2001 and 2002, and the continuing
uncertainty in the semiconductor industry, management determined that it is more
likely than not our deferred tax assets may not be realized and, accordingly,
recorded a charge of $13.4 million to establish a full valuation allowance for
our deferred tax assets in the fourth quarter of 2002. The benefit for income
taxes of $2.0 million for the year ended December 31, 2002 is primarily
comprised of an estimated current tax benefit of $3.8 million from 2002 United
States net operating losses offset by $1.6 million of tax expense from foreign
operations and state taxes.

LIQUIDITY AND CAPITAL RESOURCES

Since our initial public offering we have financed our operations and
capital requirements through a combination of cash provided by operations,
long-term real estate financing and short-term borrowings. Cash, cash
equivalents and short-term marketable securities totaled $129.2 million at
December 31, 2003, compared to $128.7 million at December 31, 2002. In addition,
in January 2004, we issued 1,314,286 shares of our common stock at $26.25 per
share in a public offering, which generated net proceeds of approximately $32.8
million.

Net cash used in operating activities of $0.2 million for the year ended
December 31, 2003, was impacted by the net loss of $16.4 million and an increase
in operating assets of $21.7 million, offset by non-cash charges of $28.2
million for depreciation and amortization and an increase in operating
liabilities of $8.8 million. The increase in operating assets consisted mainly
of an increase in accounts receivable of $16.3 million due to the increased
shipments in the fourth quarter of 2003 as compared to the fourth quarter of
2002, which contributed to a slight increase in our days sales outstanding from
53 days at the end of 2002 to 58 days in 2003, and an increase in inventory of
$6.7 million as a result of increased production volumes in the fourth quarter
of 2003. The increase in operating liabilities consisted primarily of an
increase in accounts payable of $9.7 million resulting from increased production
activity in the fourth quarter. Net cash provided by operating activities of
$13.8 million for the year ended December 31, 2002 resulted mainly from non-cash
charges for depreciation and amortization of $28.7 million, purchases of
in-process technology of $8.4 million related mainly to the ENI acquisition,
asset impairment charges of $5.0 million consisting primarily of the write-off
of an impaired note receivable and a decrease in operating assets and
liabilities of $9.6 million, all of which were partially offset by the net loss
of $39.5 million. The decrease in operating assets consisted of a reduction in
other current assets of $12.3 million from the receipt of income tax refunds in
2002 and a decrease in inventory of $6.6 million, offset by decreases in accrued
expenses of $7.3 million.

Net cash used in investing activities of $21.4 million for the year ended
December 31, 2003 resulted mainly from the net purchases of $14.0 million of
available for sale securities, the purchase of property, plant and equipment of
$6.3 million, and the purchase of a small technology business for $2.2 million.
Net cash used in investing activities of $51.9 million for the year ended
December 31, 2002 consisted mainly of net purchases of short-term and long-term
investments of $28.7 million, $17.7 million for the acquisition of businesses
and $7.9 million for the purchases of capital assets, partially offset by $2.5
million in proceeds from the sale of assets.

Net cash provided by financing activities of $5.3 million for the year
ended December 31, 2003 consisted of $8.6 million in proceeds from the exercise
of stock options and purchases under the employee stock

22

purchase plan, net proceeds of $2.2 million from short-term borrowings, offset
by $5.5 million of principal payments on long-term debt and capital lease
obligations. Net cash provided by financing activities of $5.5 million for the
year ended December 31, 2002 consisted mainly of proceeds from the exercise of
stock options and purchases under the employee stock purchase plan of $8.9
million and $2.9 million in net proceeds from short-term borrowings offset by
principal payments of $6.3 million on long-term debt and capital lease
obligations.

On July 30, 2003, our $40.0 million unsecured credit facility with two
domestic banks expired and we elected not to renew this facility. There had been
no borrowings made under this line of credit.

Certain of our foreign subsidiaries have credit lines and short-term
borrowing arrangements with various financial institutions which provide for
aggregate borrowings as of December 31, 2003 of up to $28.0 million, which
generally expire and are renewed in six month intervals. At December 31, 2003,
total borrowings outstanding under these arrangements totaled $17.7 million with
$10.3 million available for future borrowings.

Future payments due under debt, lease and purchase commitment obligations
as of December 31, 2003 (in thousands) are as follows:

- ---------------

(1) Excluded from Other Long-Term Liabilities was $1.1 million of operating
leases related to restructuring charges that have been accrued on our
balance sheet as they are included in the Operating Leases amount above.

We believe that our working capital, together with the cash anticipated to
be generated from operations will be sufficient to satisfy our estimated working
capital and planned capital expenditure requirements through at least the next
12 months.

To the extent permitted by Massachusetts law, our Restated Articles of
Organization, as amended, requires us to indemnify any of our current or former
officers or directors or any person who has served or is serving in any capacity
with respect to any of our employee benefit plans. Because no claim for
indemnification has been made by any person covered by the relevant provisions
of our Restated Articles of Organization, we believe that the estimated exposure
for these indemnification obligations is currently minimal. Accordingly, we have
no liabilities recorded for these requirements as of December 31, 2003.

We also enter into standard indemnification agreements in the ordinary
course of business. Pursuant to these agreements, we indemnify, hold harmless
and agree to reimburse the indemnified party for losses suffered or incurred by
the indemnified party, generally our customers, in connection with any patent,
or any other intellectual property infringement claim by any third party with
respect to our products. The term of these indemnification agreements is
generally perpetual any time after execution of the agreement. The maximum
potential amount of future payments we could be required to make under these
indemnification agreements is, in some instances, unlimited. We have never
incurred costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, we believe the estimated fair value of
these agreements is minimal. Accordingly, we have no liabilities recorded for
these agreements as of December 31, 2003.

23

When as part of an acquisition, we acquire all of the stock or all of the
assets and liabilities of another company, we assume liability for certain
events or occurrences that took place prior to the date of acquisition. The
maximum potential amount of future payments we could be required to make for
such obligations is undeterminable at this time. Other than obligations recorded
as liabilities at the time of the acquisitions, historically we have not made
significant payments for these indemnifications. Accordingly, no liabilities
have been recorded for these obligations.

In conjunction with certain asset sales, we may provide routine
indemnifications whose terms range in duration and often are not explicitly
defined. Where appropriate, an obligation for such indemnifications is recorded
as a liability. Because the amount of liability under these types of
indemnifications are not explicitly stated, the overall maximum amount of the
obligation under such indemnifications cannot be reasonably estimated. Other
than obligations recorded as liabilities at the time of the asset sale,
historically we have not made significant payments for these indemnifications.

DERIVATIVES

We conduct our operations globally. Consequently the results of our
operations are exposed to movements in foreign currency exchange rates. We hedge
a portion of our forecasted foreign currency denominated intercompany sales of
inventory, over a maximum period of fifteen months, using forward exchange
contracts and currency options primarily related to Japanese and European
currencies. These derivatives are designated as cash-flow hedges, and changes in
their fair value are carried in accumulated other comprehensive income until the
hedged transaction affects earnings. When the hedged transaction affects
earnings, the appropriate gain or loss from the derivative designated as a hedge
of the transaction is reclassified from accumulated other comprehensive income
to cost of sales. As of December 31, 2003 the amount that will be reclassified
from accumulated other comprehensive income to earnings over the next twelve
months is an unrealized loss of $2.1 million, net of taxes. The ineffective
portion of the derivatives, primarily related to option premiums, is recorded in
cost of sales and were immaterial in 2003, 2002 and 2001.

We hedge certain intercompany and other payables with foreign exchange
contracts and currency options. Since these derivatives hedge existing amounts
that are denominated in foreign currencies, the derivatives do not qualify for
hedge accounting. The foreign exchange gain or loss on these derivatives was
immaterial in 2003, 2002 and 2001.

Realized and unrealized gains and losses on forward exchange contracts and
local currency purchased option contracts that do not qualify for hedge
accounting are recognized immediately in earnings. The cash flows resulting from
forward exchange contracts and local currency purchased options that qualify for
hedge accounting are classified in the statement of cash flows as part of cash
flows from operating activities. Cash flows resulting from forward exchange
contracts and local currency purchased options that do not qualify for hedge
accounting are classified in the statement of cash flows as investing
activities. We do not hold or issue derivative financial instruments for trading
purposes.

There were forward exchange contracts with notional amounts totaling $41.0
million outstanding at December 31, 2003. Of such forward exchange contracts,
$32.5 million were outstanding to exchange Japanese yen for US dollars. There
were forward exchange contracts with notional amounts totaling $23.3 million
outstanding at December 31, 2002 of which $17.2 million were outstanding to
exchange Japanese yen for US dollars. There were no forward exchange contracts
outstanding at December 31, 2001. Local currency purchased options with notional
amounts totaling $0, $5.1 million and $11.3 million to exchange foreign
currencies for U.S. dollars were outstanding at December 31, 2003, 2002 and
2001, respectively.

Foreign exchange gains and losses on forward exchange contracts and
currency options which did not qualify for hedge accounting were immaterial
during 2003 and 2002. There were no foreign exchange gains or losses on forward
exchange contracts which did not qualify for hedge accounting in 2001. Gains and
losses on forward exchange contracts and local currency purchased options that
qualify for hedge accounting are classified in cost of goods sold and totaled a
loss of $1.4 million for the year ended December 31, 2003 and a gain of $0.5
million and $0.2 million for the years ended December 31, 2002 and 2001,
respectively.

24

The fair values of local currency purchased options at December 31, 2002
and 2001, which were obtained through dealer quotes, were immaterial. There were
no purchased options outstanding at December 31, 2003.

OFF-BALANCE SHEET ARRANGEMENTS

We do not have any financial partnerships with unconsolidated entities,
such as entities often referred to as structured finance, special purpose
entities or variable interest entities which are often established for the
purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes. Accordingly, we are not exposed to any financing,
liquidity, market or credit risk that could arise if we had such relationships.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In January 2003, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 46, as amended by FIN 46R, "Consolidation of Variable
Interest Entities, an Interpretation of ARB 51" ("FIN 46"). The primary
objectives of FIN 46 are to provide guidance on the identification of entities
for which control is achieved through means other than through voting rights
("variable interest entities" or "VIEs") and how to determine when and which
business enterprise should consolidate the VIE. This new model for consolidation
applies to an entity which either: (a) the equity investors (if any) do not have
a controlling financial interest; or (b) the equity investment at risk is
insufficient to finance that entity's activities without receiving additional
subordinated financial support from other parties. In addition, FIN 46 requires
that both the primary beneficiary and all other enterprises with a significant
variable interest in a VIE make additional disclosures. FIN 46 is effective for
all new VIEs created or acquired after January 31, 2003. For VIEs created or
acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for
the first interim or annual period ending after March 15, 2004. We have not
created or acquired any VIEs. The adoption of FIN 46 did not have a material
impact on our financial position or results of operations.

FACTORS THAT MAY AFFECT FUTURE RESULTS

OUR BUSINESS DEPENDS SUBSTANTIALLY ON CAPITAL SPENDING IN THE SEMICONDUCTOR
INDUSTRY WHICH IS CHARACTERIZED BY PERIODIC FLUCTUATIONS THAT MAY CAUSE A
REDUCTION IN DEMAND FOR OUR PRODUCTS.

We estimate that approximately 69%, 70% and 64% of our net sales for the
years ended December 31, 2003, 2002 and 2001, respectively, were to
semiconductor capital equipment manufacturers and semiconductor device
manufacturers, and we expect that sales to such customers will continue to
account for a substantial majority of our sales. Our 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 our 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. Most recently, in 2001 and
2002, we experienced a significant reduction in demand from OEM customers, and
lower gross margins due to reduced absorption of manufacturing overhead. As a
result of this significant reduction in demand, particularly for older
technology products, we incurred significant charges for excess and obsolete
inventory of $16.6 million in 2001. 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. We 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 our business,
financial condition and results of operations.

25

OUR QUARTERLY OPERATING RESULTS HAVE VARIED, AND ARE LIKELY TO CONTINUE TO VARY
SIGNIFICANTLY. THIS MAY RESULT IN VOLATILITY IN THE MARKET PRICE OF OUR COMMON
STOCK.

A substantial portion of our shipments occur shortly after an order is
received and therefore we operate with a low level of backlog. As a result, a
decrease in demand for our products from one or more customers could occur with
limited advance notice and could have a material adverse effect on our results
of operations in any particular period. A significant percentage of our 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 our results of
operations. Factors that could cause fluctuations in our net sales include:

- the timing of the receipt of orders from major customers;

- shipment delays;

- disruption in sources of supply;

- seasonal variations of capital spending by customers;

- production capacity constraints; and

- specific features requested by customers.

For example, the semiconductor capital equipment market experienced a
significant downturn during 2001 and 2002. As a result, we experienced a
reduction in demand from OEM customers, which has had a material adverse effect
on our quarterly operating results during these years. During 2001, gross
margins were negatively affected by significant charges for excess and obsolete
inventory of $2.6 million in the second quarter and $14.0 million in the fourth
quarter. These 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 we may in the future experience
quarterly or annual fluctuations and that, in one or more future quarters, our
operating results may fall below the expectations of public market analysts or
investors. In any such event, the price of our common stock could decline
significantly.

THE LOSS OF NET SALES TO ANY ONE OF OUR MAJOR CUSTOMERS WOULD LIKELY HAVE A
MATERIAL ADVERSE EFFECT ON US.

Our top ten customers accounted for approximately 42%, 49% and 39% of our
net sales for the years ended December 31, 2003, 2002 and 2001, respectively.
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 our business, financial condition and results of
operations. During the years ended December 31, 2003, 2002 and 2001, one
customer, Applied Materials, accounted for approximately 18%, 23% and 18%,
respectively, of our net sales. None of our significant customers, including
Applied Materials, has entered into an agreement requiring it to purchase any
minimum quantity of our products. The demand for our products from our
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 of net sales
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. Our future success will continue to
depend upon:

- our ability to maintain relationships with existing key customers;

- our ability to attract new customers;

- our ability to introduce new products in a timely manner for existing and
new customers; and

- the success of our customers in creating demand for their capital
equipment products which incorporate our products.

26

AS PART OF OUR BUSINESS STRATEGY, WE HAVE ENTERED INTO AND MAY ENTER INTO OR
SEEK TO ENTER INTO BUSINESS COMBINATIONS AND ACQUISITIONS THAT MAY BE DIFFICULT
TO INTEGRATE, DISRUPT OUR BUSINESS, DILUTE STOCKHOLDER VALUE OR DIVERT
MANAGEMENT ATTENTION.

We have made several acquisitions since 2000. As a part of our business
strategy, we 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 our ongoing business and distraction of
management, expenses related to the acquisition and potential unknown
liabilities associated with acquired businesses.

As a result of our recent acquisitions, we have added several different
decentralized accounting systems, resulting in a complex reporting environment.
We expect that we will need to continue to modify our accounting policies,
internal controls, procedures and compliance programs to provide consistency
across all our operations.

If we are not successful in completing acquisitions that we may pursue in
the future, we may be required to reevaluate our growth strategy, and we may
incur substantial expenses and devote significant management time and resources
in seeking to complete proposed acquisitions that will not generate benefits for
us.

In addition, with future acquisitions, we could use substantial portions of
our available cash as all or a portion of the purchase price. We could also
issue additional securities as consideration for these acquisitions, which could
cause significant stockholder dilution. Our recent acquisitions and any future
acquisitions may not ultimately help us achieve our strategic goals and may pose
other risks to us.

WE HAVE HAD SIGNIFICANT OPERATING AND NET LOSSES, AND WE MAY HAVE FUTURE LOSSES.

We have not reported an annual operating profit or annual net income since
2000. We cannot predict whether we will experience operating losses and net
losses in the future.

AN INABILITY TO CONVINCE SEMICONDUCTOR DEVICE MANUFACTURERS TO SPECIFY THE USE
OF OUR PRODUCTS TO OUR CUSTOMERS, THAT ARE SEMICONDUCTOR CAPITAL EQUIPMENT
MANUFACTURERS, WOULD WEAKEN OUR COMPETITIVE POSITION.

The markets for our products are highly competitive. Our competitive
success often depends upon factors outside of our 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,
our success will depend in part on our ability to have semiconductor device
manufacturers specify that our products be used at their semiconductor
fabrication facilities. In addition, we may encounter difficulties in changing
established relationships of competitors that already have a large installed
base of products within such semiconductor fabrication facilities.

IF OUR PRODUCTS ARE NOT DESIGNED INTO SUCCESSIVE GENERATIONS OF OUR CUSTOMERS'
PRODUCTS, WE 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. Our success depends on our
products being designed into new generations of equipment for the semiconductor
industry. We must develop products that are technologically current so that they
are positioned to be chosen for use in each successive generation of
semiconductor capital equipment. If our products are not chosen by our
customers, our net sales may be reduced during the lifespan of our customers'
products. In addition, we must make a significant capital investment to develop
products for our customers well before our products are introduced and before we
can be sure that we will recover our capital investment through sales to the
customers in significant volume. We are thus also at risk during the development
phase that our products may fail to meet our customers' technical or cost
requirements and may be replaced by a competitive product or alternative
technology solution. If that happens, we may be unable to recover our
development costs.

27

THE SEMICONDUCTOR INDUSTRY IS SUBJECT TO RAPID DEMAND SHIFTS WHICH ARE DIFFICULT
TO PREDICT. AS A RESULT, OUR INABILITY TO EXPAND OUR MANUFACTURING CAPACITY IN
RESPONSE TO THESE RAPID SHIFTS MAY CAUSE A REDUCTION IN OUR MARKET SHARE.

Our ability to increase sales of certain products depends in part upon our
ability to expand our manufacturing capacity for such products in a timely
manner. If we are unable to expand our manufacturing capacity on a timely basis
or to manage such expansion effectively, our customers could implement our
competitors' products and, as a result, our market share could be reduced.
Because the semiconductor industry is subject to rapid demand shifts which are
difficult to foresee, we 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 our fixed operating expenses and
if sales levels do not increase to offset the additional expense levels
associated with any such expansion, our business, financial condition and
results of operations could be materially adversely affected.

WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY.

The market for our products is highly competitive. Principal competitive
factors include:

- historical customer relationships;

- product quality, performance and price;

- breadth of product line;

- manufacturing capabilities; and

- customer service and support.

Although we believe that we compete favorably with respect to these
factors, there can be no assurance that we will continue to do so. We encounter
substantial competition in most of our product lines. Certain of our competitors
may have greater financial and other resources than we have. In some cases,
competitors are smaller than we are, but well established in specific product
niches. We may encounter difficulties in changing established relationships of
competitors with a large installed base of products at such customers'
fabrication facilities. In addition, our competitors can be expected to continue
to improve the design and performance of their products. There can be no
assurance that competitors will not develop products that offer price or
performance features superior to those of our products.

SALES TO FOREIGN MARKETS CONSTITUTE A SUBSTANTIAL PORTION OF OUR NET SALES;
THEREFORE, OUR 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 our foreign subsidiaries, but exclude
direct export sales, which were less than 10% of our total net sales for each of
the years ended December 31, 2003, 2002 and 2001. International sales accounted
for approximately 41%, 36% and 31% of net sales for the years ended December 31,
2003, 2002 and 2001, respectively, a significant portion of which were sales to
Japan.

We anticipate that international sales will continue to account for a
significant portion of our net sales. In addition, certain of our key domestic
customers derive a significant portion of their revenues from sales in
international markets. Therefore, our sales and results of operations could be
adversely affected by economic slowdowns and other risks associated with
international sales.

RISKS RELATING TO OUR INTERNATIONAL OPERATIONS COULD ADVERSELY AFFECT OUR
OPERATING RESULTS.

We have substantial international sales, service and manufacturing
operations in Europe and Asia, which exposes us to foreign operational and
political risks that may harm our business. Our international operations are
subject to inherent risks, which may adversely affect us, including:

- political and economic instability in countries where we have sales,
service and manufacturing operations, particularly in Asia;

28

- fluctuations in the value of currencies and high levels of inflation,
particularly in Asia and Europe;

- changes in labor conditions and difficulties in staffing and managing
foreign operations, including, but not limited to, labor unions;

- greater difficulty in collecting accounts receivable and longer payment
cycles;

- burdens and costs of compliance with a variety of foreign laws;

- increases in duties and taxation;

- imposition of restrictions on currency conversion or the transfer of
funds;

- changes in export duties and limitations on imports or exports;

- expropriation of private enterprises; and

- unexpected changes in foreign regulations.

If any of these risks materialize, our operating results may be adversely
affected.

UNFAVORABLE CURRENCY EXCHANGE RATE FLUCTUATIONS MAY LEAD TO LOWER GROSS MARGINS,
OR MAY CAUSE US TO RAISE PRICES WHICH COULD RESULT IN REDUCED SALES.

Currency exchange rate fluctuations could have an adverse effect on our net
sales and results of operations and we could experience losses with respect to
our hedging activities. Unfavorable currency fluctuations could require us to
increase prices to foreign customers which could result in lower net sales by us
to such customers. Alternatively, if we do not adjust the prices for our
products in response to unfavorable currency fluctuations, our results of
operations could be adversely affected. In addition, sales made by our foreign
subsidiaries are denominated in the currency of the country in which these
products are sold and the currency they receive in payment for such sales could
be less valuable at the time of receipt as a result of exchange rate
fluctuations. We enter into forward exchange contracts and local currency
purchased options to reduce currency exposure arising from intercompany sales of
inventory. However, we cannot be certain that our efforts will be adequate to
protect us against significant currency fluctuations or that such efforts will
not expose us to additional exchange rate risks.

KEY PERSONNEL MAY BE DIFFICULT TO ATTRACT AND RETAIN.

Our 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 our
business, financial condition and results of operations. We believe that our
future success will depend in part on our ability to attract and retain highly
skilled technical, financial, managerial and marketing personnel. We cannot be
certain that we will be successful in attracting and retaining such personnel.

OUR PROPRIETARY TECHNOLOGY IS IMPORTANT TO THE CONTINUED SUCCESS OF OUR
BUSINESS. OUR FAILURE TO PROTECT THIS PROPRIETARY TECHNOLOGY MAY SIGNIFICANTLY
IMPAIR OUR COMPETITIVE POSITION.

As of December 31, 2003, we owned 194 U.S. patents, 123 foreign patents and
had 84 pending U.S. patent applications. Although we seek to protect our
intellectual property rights through patents, copyrights, trade secrets and
other measures, we cannot be certain that:

- we will be able to protect our technology adequately;

- competitors will not be able to develop similar technology independently;

- any of our pending patent applications will be issued;

- intellectual property laws will protect our intellectual property rights;
or

- third parties will not assert that our products infringe patent,
copyright or trade secrets of such parties.

29

PROTECTION OF OUR INTELLECTUAL PROPERTY RIGHTS MAY RESULT IN COSTLY LITIGATION.

Litigation may be necessary in order to enforce our patents, copyrights or
other intellectual property rights, to protect our trade secrets, to determine
the validity and scope of the proprietary rights of others or to defend against
claims of infringement. We have been in the past, and currently are, involved in
lawsuits enforcing and defending, our intellectual property rights, 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 our business, financial condition and results of operations.

We may need to expend significant time and expense to protect our
intellectual property regardless of the validity or successful outcome of such
intellectual property claims. If we lose any litigation, we may be required to
seek licenses from others or change, stop manufacturing or stop selling some of
our products.

THE MARKET PRICE OF OUR COMMON STOCK HAS FLUCTUATED AND MAY CONTINUE TO
FLUCTUATE FOR REASONS OVER WHICH WE HAVE NO CONTROL.

The stock market has from time to time experienced, and is likely to
continue to experience, extreme price and volume fluctuations. 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 our common stock has fluctuated greatly
since our 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 we were the object of securities class action litigation, it
could result in substantial costs and a diversion of our management's attention
and resources.

OUR DEPENDENCE ON SOLE, LIMITED SOURCE SUPPLIERS, AND INTERNATIONAL SUPPLIERS,
COULD AFFECT OUR ABILITY TO MANUFACTURE PRODUCTS AND SYSTEMS.

We rely on sole, limited source suppliers, and international suppliers, for
a few of our components and subassemblies that are critical to the manufacturing
of our products. This reliance involves several risks, including the following:

- the potential inability to obtain an adequate supply of required
components;

- reduced control over pricing and timing of delivery of components; and

- the potential inability of our suppliers to develop technologically
advanced products to support our growth and development of new systems.

We believe that in time we could obtain and qualify alternative sources for
most sole, limited source and international supplier parts. Seeking alternative
sources of the parts could require us to redesign our systems, resulting in
increased costs and likely shipping delays. We may be unable to redesign our
systems, which could result in further costs and shipping delays. These
increased costs would decrease our profit margins if we could not pass the costs
to our customers. Further, shipping delays could damage our relationships with
current and potential customers and have a material adverse effect on our
business and results of operations.

WE ARE SUBJECT TO GOVERNMENTAL REGULATIONS. IF WE FAIL TO COMPLY WITH THESE
REGULATIONS, OUR BUSINESS COULD BE HARMED.

We are subject to federal, state, local and foreign regulations, including
environmental regulations and regulations relating to the design and operation
of our power supply products. We must ensure that these systems meet certain
safety standards, many of which vary across the countries in which our systems
are used. For example, the European Union has published directives specifically
relating to power supplies. We must comply with these directives in order to
ship our systems into countries that are members of the European Union. We
believe we are in compliance with current applicable regulations, directives and
standards and have obtained all necessary permits, approvals, and authorizations
to conduct our business. However, compliance with future regulations, directives
and standards could require us to modify or redesign certain systems, make

30

capital expenditures or incur substantial costs. If we do not comply with
current or future regulations, directives and standards:

- we could be subject to fines;

- our production could be suspended; or

- we could be prohibited from offering particular systems in specified
markets.

CERTAIN STOCKHOLDERS HAVE A SUBSTANTIAL INTEREST IN US AND MAY BE ABLE TO EXERT
SUBSTANTIAL INFLUENCE OVER OUR ACTIONS.

As of January 31, 2004, John R. Bertucci, our Chairman, Chief Executive
Officer and President, and certain members of his family, in the aggregate,
beneficially owned approximately 18% of our outstanding common stock. As a
result, these stockholders, acting together, are able to exert substantial
influence over our actions. Pursuant to the acquisition of the ENI Business of
Emerson Electric Co. ("Emerson"), we issued approximately 12,000,000 shares of
common stock to Emerson and its wholly owned subsidiary, Astec America, Inc.
Emerson owned approximately 19% of our outstanding common stock as of January
31, 2004, and James G. Berges, the President and a director of Emerson, is a
member of our board of directors. Accordingly, Emerson is able to exert
substantial influence over our actions.

SOME PROVISIONS OF OUR RESTATED ARTICLES OF ORGANIZATION, AS AMENDED, OUR
AMENDED AND RESTATED BY-LAWS AND MASSACHUSETTS LAW COULD DISCOURAGE POTENTIAL
ACQUISITION PROPOSALS AND COULD DELAY OR PREVENT A CHANGE IN CONTROL OF US.

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 price 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 we have no present plans to issue any
preferred stock, our 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 us. The issuance of preferred stock could
adversely affect the voting power of the holders of our common stock, including
the loss of voting control to others. In addition, our 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 us.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

MARKET RISK AND SENSITIVITY ANALYSIS

Our primary exposures to market risks include fluctuations in interest
rates on our investment portfolio, short and long term debt as well as
fluctuations in foreign currency exchange rates.

FOREIGN EXCHANGE RATE RISK

We enter into local currency purchased options and forward exchange
contracts to reduce currency exposure arising from intercompany sales of
inventory. The potential fair value loss for a hypothetical 10% adverse change
in currency exchange rates on our local currency purchased options at December
31, 2002 was immaterial. There were no local currency purchased options
outstanding at December 31, 2003. The potential loss in 2002 was estimated by
calculating the fair value of the local currency purchased options at December
31, 2002 and comparing that with those calculated using the hypothetical
currency exchange rates.

There were forward exchange contracts with notional amounts totaling $41.0
million and $23.3 million outstanding at December 31, 2003 and 2002,
respectively. Of such forward exchange contracts, $32.5 million and $17.2
million, respectively, were outstanding to exchange Japanese yen for US dollars
with the remaining amounts relating to the British pound and Euro. The potential
fair value loss for a hypothetical 10% adverse change in the forward currency
exchange rate on our forward exchange contracts at December 31, 2003 and 2002
would be $4.8 million and $2.7 million, respectively. The potential losses in
2003 and 2002 were

31

estimated by calculating the fair value of the forward exchange contracts at
December 31, 2003 and 2002 and comparing that with those calculated using the
hypothetical forward currency exchange rates.

At December 31, 2003, MKS had $18,669,000 related to short-term borrowings
and current portion of long-term debt denominated in Japanese yen. The carrying
value of these short-term borrowings approximates fair value due to their short
period to maturity. Assuming a hypothetical 10% adverse change in the Japanese
yen to U.S. dollar year end exchange rate, the fair value of these short-term
borrowings would increase by $2,074,000. The potential increase in fair value
was estimated by calculating the fair value of the short-term borrowings at
December 31, 2003 and comparing that with the fair value using the hypothetical
year end exchange rate.

At December 31, 2002, MKS had $13,877,000 related to short-term borrowings
denominated in Japanese yen. The carrying value of these short-term borrowings
approximates fair value due to their short period to maturity. Assuming a
hypothetical 10% adverse change in the Japanese yen to U.S. dollar year end
exchange rate, the fair value of these short-term borrowings would increase by
$1,542,000. The potential increase in fair value was estimated by calculating
the fair value of the short-term borrowings at December 31, 2002 and comparing
that with the fair value using the hypothetical year end exchange rate.

INTEREST RATE RISK

Due to its short-term duration, the fair value of our cash and investment
portfolio at December 31, 2003 and 2002 approximated its carrying value.
Interest rate risk was estimated as the potential decrease in fair value
resulting from a hypothetical 10% increase in interest rates for securities
contained in the investment portfolio. The resulting hypothetical fair value was
not materially different from the year-end carrying values.

Our total long-term debt outstanding, including the current portion, at
December 31, 2003 and 2002, was $11.2 million and $15.7 million, respectively,
and consisted mainly of a mortgage note and industrial development revenue bond.
The interest rates on these debt instruments are variable and range from 1.2% to
2.6% at December 31, 2003 and 2.1% to 3.1% at December 31, 2002. Due to the
immaterial amounts of the outstanding debt, a hypothetical change of 10% in
interest rates would not have a material effect on our near-term financial
condition or results of operations.

The Company from time to time has outstanding short-term borrowings with
variable interest rates, primarily denominated in Japanese yen. At December 31,
2003 and 2002, we had $17.7 million and $13.9 million, respectively, outstanding
related to these short-term borrowings at interest rates ranging from 1.13% to
1.50%. Due to the short-term nature and amount of this short-term debt, a
hypothetical change of 10% in interest rates would not have a material effect on
our near-term financial condition or results of operations.

32

ITEM 8. FINANCIAL STATEMENTS

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders of
MKS Instruments, Inc.:

In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) present fairly, in all material respects, the
financial position of MKS Instruments, Inc. and its subsidiaries at December 31,
2003 and 2002 and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 2003 in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the index
appearing under Item 15(a)(2) presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

As discussed in Notes 2 and 15 to the consolidated financial statements,
the Company changed its method of accounting for goodwill and other intangible
assets upon adoption of Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" on January 1, 2002.

PricewaterhouseCoopers LLP

Boston, Massachusetts
January 30, 2004

33

MKS INSTRUMENTS, INC.

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of the consolidated financial
statements.
34

MKS INSTRUMENTS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of the consolidated financial
statements.
35

MKS INSTRUMENTS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

The accompanying notes are an integral part of the consolidated financial
statements.
36

MKS INSTRUMENTS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of the consolidated financial
statements.
37

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

1) DESCRIPTION OF BUSINESS

MKS Instruments, Inc. was founded in 1961 and is a leading worldwide
provider of instruments, components, subsystems and process control solutions
that measure, control, power and monitor critical parameters of semiconductor
and other advanced manufacturing processes. MKS is managed as one operating
segment which is organized around three product groups: Instruments and Control
Systems, Power and Reactive Gas Products and Vacuum Products. MKS' products are
derived from its 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.

2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

All significant intercompany accounts and transactions have been eliminated
in consolidation. On January 26, 2001, MKS Instruments, Inc. completed its
acquisition of Applied Science and Technology, Inc. ("ASTeX") in a transaction
accounted for under the pooling of interests method of accounting and,
accordingly, the consolidated financial statements reflect the combined
financial position, results of operations and cash flows of MKS Instruments,
Inc., ASTeX and their respective subsidiaries (together, the "Company" or
"MKS"), for all periods presented. These consolidated financial statements
combine the historical consolidated financial statements of the Company for all
periods presented and the ASTeX share information has been converted to the MKS
share equivalent.

NET INCOME PER SHARE

Basic earnings per share is based on the weighted average number of common
shares outstanding, and diluted earnings per share is based on the weighted
average number of common shares outstanding and all dilutive potential common
equivalent shares outstanding. The dilutive effect of options is determined
under the treasury stock method using the average market price for the period.
Common equivalent shares are included in the per share calculations when the
effect of their inclusion would be dilutive.

The following is a reconciliation of basic to diluted net income per share:

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.
Options outstanding of 8,897,899, 8,284,693 and 5,958,735 during the years ended
December 31, 2003, 2002 and 2001, respectively, are excluded from the
calculation of diluted net loss per common share because their inclusion would
be anti-dilutive.

38

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

STOCK-BASED COMPENSATION

The Company has several stock-based employee compensation plans. The
Company accounts for stock-based awards to employees using the intrinsic value
method as prescribed by Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, no compensation expense is recorded for options issued to employees
in fixed amounts 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 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.

The following table illustrates the effect on net income and net income per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee awards:

There is no tax benefit included in the stock-based employee compensation
expense determined under the fair-value-based method for the years ended
December 31, 2003 and 2002, as the Company established a full valuation
allowance for its net deferred tax assets during 2002.

The weighted average grant date fair value of options granted during 2003,
2002 and 2001 was $15.91, $14.22 and $14.65 per option, respectively. The fair
value of options at the date of grant was estimated using the Black-Scholes
option-pricing model with the following weighted average assumptions:

The weighted average fair value of employee stock purchase rights granted
in 2003, 2002 and 2001 under the Purchase Plan was $7.08, $9.35, and $7.19,
respectively. The fair value of the employees' purchase rights was estimated
using the Black-Scholes option-pricing model with the following weighted average
assumptions:

39

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

FOREIGN EXCHANGE

The functional currency of the majority of the Company's foreign
subsidiaries is the applicable local currency. For those subsidiaries, assets
and liabilities are translated to U.S. dollars at year-end exchange rates.
Income and expense accounts are translated at the average exchange rates
prevailing for the year. The resulting translation adjustments are included in
accumulated other comprehensive income in consolidated stockholders' equity.
Foreign exchange transaction gains and losses were immaterial in 2003, 2002 and
2001.

REVENUE RECOGNITION

Revenue from product sales is recorded upon transfer of title and risk of
loss to the customer provided that there is evidence of an arrangement, the
sales price is fixed or determinable, and collection of the related receivable
is reasonably assured. In most transactions, the Company has no obligations to
customers after the date products are shipped other than pursuant to warranty
obligations. In some instances, the Company provides installation and training
to customers after the product has been shipped. In accordance with the Emerging
Issues Task Force ("EITF") 00-21 "Accounting For Revenue Arrangements With
Multiple Deliverables," the Company allocates the revenue between the multiple
elements based upon fair value and defers the revenue related to the undelivered
elements until the installation or training is complete. Fair value is the price
charged when the element is sold separately. The Company provides for the
estimated costs to fulfill customer warranty obligations upon the recognition of
the related revenue. Shipping and handling fees, if any, billed to customers are
recognized as revenue. The related shipping and handling costs are recognized in
cost of sales. Accounts receivable allowances include sales returns and bad debt
allowances. The Company monitors and tracks the amount of product returns and
reduces revenue at the time of shipment for the estimated amount of such future
returns, based on historical experience. The Company makes estimates evaluating
its allowance for doubtful accounts. The Company continuously monitors
collections and payments from its customers and maintains a provision for
estimated credit losses based upon its historical experience and any specific
customer collection issues that it has identified.

CASH AND CASH EQUIVALENTS AND INVESTMENTS

All highly liquid investments with an original maturity of three months or
less at the date of purchase are considered to be cash equivalents.

Cash and cash equivalents consists of the following:

40

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The fair value of short-term available-for-sale investments maturing within
one year consists of the following:

The fair value of long-term available-for-sale investments with maturities
of 1 to 5 years consists of the following:

The appropriate classification of investments in securities is determined
at the time of purchase. Debt securities that the Company does not have the
intent and ability to hold to maturity are classified as "available-for-sale"
and are carried at fair value. Unrealized gains and losses on securities
classified as available-for-sale are included in accumulated other comprehensive
income in consolidated stockholders' equity. Gross unrealized gains and gross
unrealized losses on available-for-sale investments were not material at
December 31, 2003 and 2002. Realized gains (losses) on securities were
immaterial in 2003, 2002 and 2001. The cost of securities sold is based on the
specific identification method.

INVENTORIES

The Company values its inventory at the lower of cost (first-in, first-out
method) or market. The Company regularly reviews inventory quantities on hand
and records a provision to write down excess and obsolete inventory to its
estimated net realizable value, if less than cost, based primarily on its
estimated forecast of product demand.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are stated at cost. Equipment acquired under
capital leases is recorded at the present value of the minimum lease payments
required during the lease period. Expenditures for major renewals and
betterments that extend the useful lives of property, plant and equipment are
capitalized. Expenditures for maintenance and repairs are charged to expense as
incurred. When assets are sold or otherwise disposed of, the cost and related
accumulated depreciation are eliminated from the accounts and any resulting gain
or loss is recognized in earnings.

Depreciation is provided on the straight-line method over the estimated
useful lives of twenty to thirty-one and one-half years for buildings and three
to seven years for machinery and equipment and furniture and fixtures. Leasehold
improvements are amortized over the shorter of the lease term or the estimated
useful life of the leased asset.

41

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

INTANGIBLE ASSETS

Intangible assets resulting from the acquisitions of entities accounted for
using the purchase method of accounting are estimated by management based on the
fair value of assets received. These include acquired customer lists,
technology, patents, trade name, and covenants not to compete. Intangible assets
are amortized from three to eight years on a straight-line basis which
represents the estimated periods of benefit.

GOODWILL

Goodwill is the amount by which the cost of acquired net assets exceeded
the fair value of those net assets on the date of acquisition. Through December
31, 2001, the Company amortized goodwill on a straight-line basis over its
expected useful life of 5 to 7 years. As of January 1, 2002 the Company ceased
amortizing goodwill in compliance with Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142").

The Company assesses goodwill for impairment on an annual basis during the
fourth quarter of each fiscal year, or more frequently when events and
circumstances occur indicating that the recorded goodwill may be impaired. If
the book value of a reporting unit exceeds its fair value, the implied fair
value of goodwill is compared with the carrying amount of goodwill. If the
carrying amount of goodwill exceeds the implied fair value, an impairment loss
is recorded equal to that excess.

IMPAIRMENT OF LONG-LIVED ASSETS

The Company evaluates the recoverability of its long-lived assets which
include acquired amortizable intangible assets, in accordance with Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 requires recognition of
impairment of long-lived assets in the event the net book value of such assets
exceeds the future undiscounted cash flows attributable to such assets. If an
impairment is indicated, the assets are written down to their estimated fair
value.

RESEARCH AND DEVELOPMENT

Research and development costs are expensed as incurred and consist mainly
of compensation related expenses and project materials. The Company's research
and development efforts include numerous projects which generally have a
duration of 18 to 30 months.

IN-PROCESS RESEARCH AND DEVELOPMENT

The Company values tangible and intangible assets acquired through its
business acquisitions at fair value including in-process research and
development ("IPR&D"). The Company determines IPR&D through established
valuation techniques for various projects for the development of new products
and technologies and expenses IPR&D when technical feasibility is not reached.

ADVERTISING COSTS

Advertising costs are expensed as incurred. Advertising costs were
immaterial in 2003, 2002 and 2001.

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
42

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

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. During the year
ended December 31, 2002 the Company established a full valuation allowance for
its net deferred tax assets and maintained this valuation allowance through
December 31, 2003. 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.

The Company does not provide for a U.S. income tax liability on
undistributed earnings of its foreign subsidiaries. The earnings of non-U.S.
subsidiaries, which reflect full provision for non-U.S. income taxes, are
indefinitely reinvested in non-U.S. operations or will be remitted substantially
free of additional tax.

NEW ACCOUNTING PRONOUNCEMENTS

In December 2003, the SEC issued Staff Accounting Bulletin ("SAB") No. 104,
Revenue Recognition, which supersedes SAB No. 101, Revenue Recognition in
Financial Statements. SAB No. 104 rescinds accounting guidance in SAB No. 101
related to multiple-element arrangements as this guidance has been superseded as
a result of the issuance of EITF 00-21, "Accounting for Revenue Arrangements
with Multiple Deliverables" ("EITF 00-21"). The adoption of SAB No. 104 did not
have a material impact on the Company's financial position, results of
operations or cash flows.

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 was effective for contracts entered
into or modified after June 30, 2003 and for hedging relationships designated
after June 30, 2003. The Company adopted SFAS 149 on July 1, 2003 and the
adoption did not have a material effect on its consolidated financial position
or results of operations.

In January 2003, the FASB issued FASB Interpretation No. 46, as amended by
FIN 46R, "Consolidation of Variable Interest Entities, an Interpretation of ARB
51" ("FIN 46"). The primary objectives of FIN 46 are to provide guidance on the
identification of entities for which control is achieved through means other
than through voting rights ("variable interest entities" or "VIEs") and how to
determine when and which business enterprise should consolidate the VIE. This
new model for consolidation applies to an entity which either: (a) the equity
investors (if any) do not have a controlling financial interest; or (b) the
equity investment at risk is insufficient to finance that entity's activities
without receiving additional subordinated financial support from other parties.
In addition, FIN 46 requires that both the primary beneficiary and all other
enterprises with a significant variable interest in a VIE make additional
disclosures. FIN 46 is effective for all new VIEs created or acquired after
January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
ending after March 15, 2004. The Company has not created or acquired any VIEs.
The adoption of FIN 46 did not have a material impact on the Company's financial
position or results of operations.

In November 2002, the EITF reached a consensus on issue 00-21, "Accounting
for Revenue Arrangements with Multiple Deliverables." EITF 00-21 addresses
revenue recognition on arrangements encompassing

43

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

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 adopted EITF 00-21 on July 1, 2003 and the
adoption did not have a material effect on its consolidated financial position
or results of operations.

In June 2002, Statement of Financial Accounting Standards No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146")
was issued. This Statement addresses financial accounting and reporting for
costs associated with exit or disposal activities and nullifies EITF Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The provisions of SFAS 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. The Company adopted SFAS
146 on January 1, 2003 and the adoption did not have a material effect on its
consolidated financial position or results of operations.

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, inventory, intangible assets, goodwill,
and other long-lived assets, in-process research and development, merger
expenses, income taxes 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.

RECLASSIFICATIONS

Certain prior year amounts have been reclassified to be consistent with the
current year classifications.

3) FINANCIAL INSTRUMENTS AND RISK MANAGEMENT

FOREIGN EXCHANGE RISK MANAGEMENT

The Company hedges a portion of its forecasted foreign currency denominated
intercompany sales of inventory, over a maximum period of fifteen months, using
forward exchange contracts and currency options primarily related to Japanese
and European currencies. These derivatives are designated as cash-flow hedges,
and changes in their fair value are carried in accumulated other comprehensive
income until the hedged transaction affects earnings. When the hedged
transaction affects earnings, the appropriate gain or loss from the derivative
designated as a hedge of the transaction is reclassified from accumulated other
comprehensive income to cost of sales. As of December 31, 2003 the amount that
will be reclassified from accumulated other comprehensive income to earnings
over the next twelve months is an unrealized loss of $2,081,000, net of taxes.
The ineffective portion of the derivatives is primarily related to option
premiums, is recorded in cost of sales, and was immaterial in 2003, 2002 and
2001.

The Company hedges certain intercompany and other payables with foreign
exchange contracts and currency options. Since these derivatives hedge existing
amounts that are denominated in foreign currencies, the derivatives do not
qualify for hedge accounting under SFAS No. 133. The foreign exchange gain on
these derivatives was immaterial in 2003, 2002 and 2001.
44

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Realized and unrealized gains and losses on forward exchange contracts and
local currency purchased option contracts that do not qualify for hedge
accounting are recognized immediately in earnings. The cash flows resulting from
forward exchange contracts and local currency purchased options that qualify for
hedge accounting are classified in the statement of cash flows as part of cash
flows from operating activities. Cash flows resulting from forward exchange
contracts and local currency purchased options that do not qualify for hedge
accounting are classified in the statement of cash flows as investing
activities. The Company does not hold or issue derivative financial instruments
for trading purposes.

There were forward exchange contracts with notional amounts totaling
$41,018,000 outstanding at December 31, 2003. Of such forward exchange
contracts, $32,488,000 were outstanding to exchange Japanese yen for U.S.
dollars. There were forward exchange contracts with notional amounts totaling
$23,287,000 outstanding at December 31, 2002 of which $17,213,000 were
outstanding to exchange Japanese yen for U.S. dollars. There were no forward
exchange contracts outstanding at December 31, 2001. Local currency purchased
options with notional amounts totaling $0, $5,053,000 and $11,349,000 to
exchange foreign currencies for U.S. dollars were outstanding at December 2003,
2002 and 2001, respectively.

Foreign exchange gains on forward exchange contracts which did not qualify
for hedge accounting were immaterial during 2003 and 2002. There were no foreign
exchange gains or losses on forward exchange contracts which did not qualify for
hedge accounting in 2001. Gains and losses on forward exchange contracts and
local currency purchased options that qualify for hedge accounting are
classified in cost of goods sold and totaled a loss of $1,411,000 for the year
ended December 31, 2003 and a gain of $452,000 and $175,000 for the years ended
December 31, 2002 and 2001, respectively.

The fair values of forward exchange contracts at December 31, 2003 and
2002, determined by applying period end currency exchange rates to the notional
contract amounts, amounted to an unrealized loss of $2,081,000 and $407,000,
respectively. The fair values of local currency purchased options at December
31, 2002 and 2001, which were obtained through dealer quotes were immaterial.
There were no purchased options outstanding at December 31, 2003.

CONCENTRATIONS OF CREDIT RISK

The Company's significant concentrations of credit risk consist principally
of cash and cash equivalents, investments, forward exchange contracts, and trade
accounts receivable. The Company maintains cash and cash equivalents with
financial institutions including the bank with which it has borrowings. The
Company maintains investments primarily in U.S. Treasury and government agency
securities and corporate debt securities, rated AA or higher. The Company places
forward currency contracts with high credit-quality financial institutions in
order to minimize credit risk exposure. Concentrations of credit risk with
respect to accounts receivable are limited due to the large number of diverse
and geographically dispersed customers. Credit is extended for all customers
based on financial condition and collateral is not required.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value of the term loans, including the current portion,
approximates its carrying value given its variable rate interest provisions. The
fair value of marketable securities is based on quoted market prices. The fair
value of mortgage notes is based on borrowing rates for similar instruments and
approximates its carrying value. For all other balance sheet financial
instruments, the carrying amount approximates fair value because of the short
period to maturity of these instruments.

45

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

4) INVENTORIES

Inventories consist of the following:

5) PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of the following:

Depreciation and amortization of property, plant and equipment totaled
$13,508,000, $14,830,000 and $11,905,000 for the years ended December 31, 2003,
2002 and 2001, respectively.

6) DEBT

CREDIT AGREEMENTS AND SHORT-TERM BORROWINGS

On July 31, 2002, the Company entered into a loan agreement with two banks,
which provided access to a revolving credit facility. The revolving credit
facility provided for borrowings up to $40,000,000 and expired on July 30, 2003.
The Company decided not to renew the credit facility.

Additionally, the Company's Japanese subsidiary has lines of credit and
short-term borrowing arrangements with various financial institutions which
provide for aggregate borrowings as of December 31, 2003 of up to $28,003,000,
which generally expire and are renewed at six month intervals. At December 31,
2003 and 2002, total borrowings outstanding under these arrangements were
$17,736,000 and $13,877,000, respectively, at interest rates ranging from 1.23%
to 1.50% and 1.13% to 1.50%, respectively.

46

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

LONG-TERM DEBT

Long-term debt consists of the following:

In connection with the purchase of On-Line Technologies, Inc., the Company
assumed term loans of $4,728,000. The principal and interest accrued were due in
two installments, the first installment on April 27, 2002, and the second
installment on April 27, 2003. This loan was paid off in full in 2003.

In connection with the purchase of Telvac Engineering, Ltd., the Company
issued term loans of $752,000. Principal payments of $61,000 are due on an
annual basis through December 1, 2004 with the remaining principal due on May 1,
2005. Interest is payable semi-annually at the UK base rate. The fixed interest
rate for the term loan is 4.0% and the remaining principal due as of December
31, 2003 was $657,000.

The Company has an outstanding term loan from a foreign bank, with
principal due on April 2, 2004. The interest rate in effect for this term loan
at December 31, 2003 was 1.19%. The remaining principal balance outstanding at
December 31, 2003 was $933,000 and is included in current portion of long-term
debt.

In connection with the acquisition of ENI, the Company assumed a long-term
debt agreement with the County of Monroe Industrial Development Agency (COMIDA)
for a manufacturing facility located in Rochester, New York. The terms are the
same as that of the underlying Industrial Development Revenue Bond which calls
for payments of interest only through July 1, 2014, at which time the Bond is
repayable in a lump sum of $5,000,000. Interest is reset annually based on bond
remarketing, with an option by the Company to elect a fixed rate, subject to a
maximum rate of 13% per annum. At December 31, 2003 the interest rate was 1.2%.
The bond is collateralized by the building. The remaining principal balance
outstanding at December 31, 2003 was $5,000,000. The net book value of the
building at December 31, 2003 was approximately $10,804,000.

On March 6, 2000, the Company entered into a mortgage note payable with a
bank to borrow $10,000,000 to finance the purchase of land and a building.
Principal and interest of $119,000 is being paid in monthly installments with
final payments due in March 2007. The remaining principal as of December 31,
2003 was $4,643,000 with a variable interest rate of 2.61%. The net book value
of the land and building at December 31, 2003 was approximately $18,292,000.

The Company had a loan outstanding from a foreign bank in the form of a
mortgage note at December 31, 2002 with a balance of $687,000 and an interest
rate of 1.88%. Principal and interest were payable in monthly installments
through 2005. The loan was collateralized by mortgages on certain of the
Company's foreign properties. This remaining principal balance was repaid in
full during 2003.

47

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Aggregate maturities of long-term debt over the next five years are as
follows:

7) COMMITMENTS AND CONTINGENCIES

On April 3, 2003, Advanced Energy Industries, Inc. ("Advanced Energy")
filed suit against the Company 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 the Company's subsidiary Applied Science
and Technology, Inc. ("ASTeX"). On May 14, 2003, MKS 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. The
Company seeks injunctive relief and damages for Advanced Energy's infringement.
On December 24, 2003, the Colorado court granted the Company's motion to
transfer Advanced Energy's Colorado suit to Delaware and on February 9, 2004,
the Delaware court denied Advanced Energy's motion to dismiss or transfer the
Company's Delaware case back to Colorado. The case is in the early stages of
pre-trial discovery.

On November 30, 2000, ASTeX, which was acquired by MKS in January 2001,
brought suit in federal district court in Delaware against Advanced Energy for
infringement of ASTeX's patent related to its Astron product. On May 17, 2002, a
jury affirmed the validity of the Company's patent and found that Advanced
Energy infringed the patent. On May 31, 2002, based on the jury's findings, the
Court entered a judgement on the infringement claim in favor of the Company and
against Advanced Energy, and awarded $4,200,000 in damages to compensate the
Company for Advanced Energy's infringing activity. Advanced Energy filed motions
to overturn the verdict. During August of 2002, the Company and Advanced Energy
entered into an agreement whereby Advanced Energy agreed to pay the awarded
damages amount to the Company and withdraw its motions to overturn the verdict.
The Company received the $4,200,000 in September 2002, and recorded the amount
as Income from litigation settlement.

On November 3, 1999, On-Line Technologies, Inc., 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 seeks
injunctive relief and damages for infringement. Perkin-Elmer, Inc. has filed a
counterclaim seeking invalidity of the patent, costs, and attorneys' fees. The
Company believes that the counterclaim is without merit. The Company cannot be
certain of the outcome of this litigation, but does plan to assert its claims
and oppose the counterclaims against it vigorously.

The Company is subject to other 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.

The Company leases certain of its facilities and machinery and equipment
under capital and operating leases expiring in various years through 2003 and
thereafter. Generally, the facility leases require the Company

48

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

to pay maintenance, insurance and real estate taxes. Rental expense under
operating leases totaled $7,253,000, $6,278,000 and $5,122,000, for the years
ended December 31, 2003, 2002 and 2001, respectively.

Minimum lease payments under operating and capital leases are as follows:

As of December 31, 2003, the Company has entered into non-cancelable
purchase commitments for certain inventory components and other equipment and
services used in its normal operations. The purchase commitments covered by
these arrangements are for periods of less than one year and aggregate
approximately $50,152,000.

To the extent permitted by Massachusetts law, the Company's Restated
Articles of Organization, as amended, requires the Company to indemnify any
current or former officer or director of the Company or any person who has
served or is serving in any capacity with respect to any employee benefit plan
of the Company. Because no claim for indemnification has been made by any person
covered by the relevant provisions of the Company's Restated Articles of
Organization, the Company believes that its estimated exposure for these
indemnification obligations is currently minimal. Accordingly, the Company has
no liabilities recorded for these requirements as of December 31, 2003.

The Company enters into standard indemnification agreements in the ordinary
course of business. Pursuant to these agreements, the Company indemnifies, holds
harmless and agrees to reimburse the indemnified party for losses suffered or
incurred by the indemnified party, generally the Company's customers, in
connection with any patent, or any other intellectual property infringement
claim by any third party with respect to the Company's products. The term of
these indemnification agreements is generally perpetual any time after execution
of the agreement. The maximum potential amount of future payments the Company
could be required to make under these indemnification agreements is unlimited.
The Company has never incurred costs to defend lawsuits or settle claims related
to these indemnification agreements. As a result, the Company believes the
estimated fair value of these agreements is minimal. Accordingly, the Company
has no liabilities recorded for these agreements as of December 31, 2003.

When as part of an acquisition, the Company acquires all of the stock or
all of the assets and liabilities of another company, the Company assumes
liability for certain events or occurrences that took place prior to the date of
acquisition. The maximum potential amount of future payments the Company could
be required to make for such obligations is undeterminable at this time. Other
than obligations recorded as liabilities at the time of the acquisition,
historically the Company has not made significant payments for these
indemnifications. Accordingly, no liabilities have been recorded for these
obligations.

49

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

In conjunction with certain asset sales, the Company may provide routine
indemnifications whose terms range in duration and often are not explicitly
defined. Where appropriate, an obligation for such indemnifications is recorded
as a liability. Because the amount of liability under these types of
indemnifications are not explicitly stated, the overall maximum amount of the
obligation under such indemnifications cannot be reasonably estimated. Other
than obligations recorded as liabilities at the time of the asset sale,
historically the Company has not made significant payments for these
indemnifications.

8) STOCKHOLDERS' EQUITY

COMMON STOCK

In May 2002, the Company amended its Restated Articles of Organization to
increase the authorized number of shares of Common Stock to 200,000,000 shares
from 75,000,000 shares.

STOCK PURCHASE PLANS

The Company's 1999 Second Restated Employee Stock Purchase Plan (the
"Purchase Plan") authorizes the issuance of up to an aggregate of 700,000 shares
of Common Stock to participating employees. Offerings under the Purchase Plan
commence on June 1 and December 1 and terminate, respectively, on November 30
and May 31. Under the Purchase Plan, eligible employees may purchase shares of
Common Stock through payroll deductions of up to 10% of their compensation. The
price at which an employee's option is exercised is the lower of (1) 85% of the
closing price of the Common Stock on the Nasdaq National Market on the day that
each offering commences or (2) 85% of the closing price on the day that each
offering terminates. During 2003 and 2002 the Company issued 101,102 and 110,947
shares, respectively, of Common Stock to employees who participated in the
Purchase Plan at exercise prices of $16.16 and $16.49 in 2003, and $18.33 and
$16.18 in 2002. As of December 31, 2003 there were 256,479 shares reserved for
issuance under the Purchase Plan.

The Company's Second Restated International Employee Stock Purchase Plan
(the "Foreign Purchase Plan") authorizes the issuance of up to an aggregate of
75,000 shares of Common Stock to participating employees. Offerings under the
Foreign Purchase Plan commence on June 1 and December 1 and terminate,
respectively, on November 30 and May 31. Under the Foreign Purchase Plan,
eligible employees may purchase shares of Common Stock through payroll
deductions of up to 10% of their compensation. The price at which an employee's
option is exercised is the lower of (1) 85% of the closing price of the Common
Stock on the Nasdaq National Market on the day that each offering commences or
(2) 85% of the closing price on the day that each offering terminates. During
2003 and 2002, the Company issued 25,809 and 18,435 shares of Common Stock to
employees who participated in the Foreign Purchase Plan at exercise prices of
$16.16 and $16.49, and $18.33 and $16.18 per share, respectively. As of December
31, 2003 there were 10,175 shares reserved for issuance under the Foreign
Purchase Plan.

STOCK OPTION PLANS

In April 2001, the Company's Board of Directors approved an annual increase
in the number of shares that may be granted under the Second Restated 1995 Stock
Incentive Plan of 5% of the total shares of the Company's stock on July 1 of
each year. In March 2002, the Board of Directors approved, and in May 2002, the
stockholders of the Company approved an increase in the number of shares that
may be granted under the Second Restated 1995 Stock Incentive Plan to 15,000,000
shares. The annual increase will occur until such time as the aggregate number
of shares which may be issued under the Plan is 15,000,000 shares, subject to
adjustment for certain changes in MKS' capitalization.

The Company has granted options to employees under the 1995 Stock Incentive
Plan and the 1993 Stock Option Plan and to directors under the 1996 Director
Stock Option Plan and the 1997 Director Stock Option Plan (the "Plans"). The
Plans are administered by the Company's board of directors.
50

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

At December 31, 2003, 1,863,186 options to purchase shares of the Company's
common stock were reserved for issuance under the Plans. Stock options are
granted at 100% of the fair value of the Company's common stock. Generally,
stock options granted to employees under the Plans in 2003, 2002 and 2001 vest
25% after one year and 6.25% per quarter thereafter and expire 10 years after
the grant date. Generally, stock options granted under the Plans prior to 2000
vest 20% after one year and 5% per quarter thereafter, and expire 10 years after
the grant date. Generally, options granted to directors vest at the earlier of
(1) the next annual meeting, (2) 13 months from date of grant, or (3) the
effective date of an acquisition.

The following table presents the activity for options under the Plans:

The following table summarizes information with respect to options
outstanding and exercisable under the Plans at December 31, 2003:

51

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

ACCUMULATED OTHER COMPREHENSIVE INCOME

The balance of accumulated other comprehensive income (loss) was comprised
of the following:

9) INCOME TAXES

A reconciliation of the Company's 2003, 2002 and 2001 effective tax rate to
the U.S. federal statutory rate follows:

52

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The components of income before income taxes and the related provision
(benefit) for income taxes consist of the following:

At December 31, 2003 and 2002 the components of the deferred tax asset and
deferred tax liability were as follows:

During 2002 the Company recorded a valuation allowance of $12,590,000
against all of its United States and foreign net deferred tax assets. This
valuation allowance was recorded against deferred tax assets because the Company
determined that it is more likely than not that all of the deferred tax assets
may not be realized.

53

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

In 2003, the Company increased the valuation allowance by $10,343,000 to
$22,933,000 primarily as a result of additional net operating losses and tax
credits.

The Company incurred significant operating losses in 2003, 2002 and 2001.
At December 31, 2003 and 2002, these cumulative factors resulted in the
Company's decision that it is more likely than not that all of its deferred tax
assets may not be realized. If the Company generates sustained future taxable
income against which these tax attributes may be applied, some portion or all of
the valuation allowance would be reversed. If the valuation allowance were
reversed, approximately $4,000,000 would be recorded as a reduction of goodwill,
approximately $1,800,000 would be recorded as an increase to additional paid in
capital, and the remainder would be recorded as a reduction to income tax
expense.

At December 31, 2003, the Company had approximately $49,294,000 of federal
net operating losses including approximately $6,800,000 the utilization of which
may be limited by the change in ownership rules under Section 382 of the
Internal Revenue Code. The remaining $42,494,000 of net operating losses may be
further limited should a change in ownership occur as defined by section 382. In
addition, at December 31, 2003, the Company also had approximately $57,276,000
of state net operating losses. The federal and state net operating losses begin
to expire in 2009 and 2006, respectively.

The Company does not provide for a U.S. income tax liability on
undistributed earnings of its foreign subsidiaries. The earnings of non-U.S.
subsidiaries, which reflect full provision for non-U.S. incomes taxes, are
indefinitely reinvested in non-U.S. operations or will be remitted substantially
free of additional tax. As of December 31, 2003, the unrecognized deferred tax
liability associated with these unremitted earnings was approximately
$3,300,000.

10) EMPLOYEE BENEFIT PLANS

The Company has a 401(k) profit-sharing plan for U.S. employees meeting
certain requirements in which eligible employees may contribute between 1% and
20% of their annual compensation to this plan, limited by an annual maximum
amount determined by the Internal Revenue Service. The Company, at its
discretion, may provide a matching contribution which will generally match up to
the first 2% of each participant's compensation, plus 25% of the next 4% of
compensation. At the discretion of the board of directors, the Company may also
make additional contributions for the benefit of all eligible employees. The
Company's contributions were $1,503,000, $1,938,000 and $1,419,000 for 2003,
2002 and 2001, respectively.

The Company maintains a bonus plan which provides cash awards to key
employees, at the discretion of the compensation committee of the board of
directors, based upon operating results and employee performance. The bonus
expense in 2003 was immaterial and there was no bonus expense in 2002 and 2001.

11) SEGMENT AND GEOGRAPHICAL INFORMATION AND SIGNIFICANT CUSTOMER

The Company operates in one segment for the development, manufacturing,
sales and servicing of products that measure, control, power and monitor
critical parameters of advanced manufacturing processes. The Company's chief
decision-maker reviews operating results to make decisions about allocating
resources and assessing performance for the entire Company.

Information about the Company's operations in different geographic regions
is presented in the tables below. 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.

54

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The Company had one customer comprising 18%, 23% and 18% of net sales for
the years ended December 31, 2003, 2002 and 2001, respectively. During the years
ended December 31, 2003, 2002 and 2001, the Company estimates that approximately
69%, 70% and 64% of its net sales, respectively, were to semiconductor capital
equipment manufacturers and semiconductor device manufacturers.

12) ACQUISITIONS

On September 30, 2003, the Company acquired Wenzel Instruments, a privately
held developer of solid state MicroElectroMechanical System (MEMS) based vacuum
sensor technology for advanced manufacturing processes. This acquisition expands
our vacuum gauge product line offering to help meet current demand for process
control sensors with higher accuracy and a faster response in a smaller
footprint. The purchase price was $2,150,000 and was accounted for under the
purchase method of accounting. The purchase price was primarily allocated to the
assets acquired based upon their estimated fair values, with the full purchase
price being allocated to intangible assets as completed technology. This
intangible asset is being amortized over its estimated useful life of 5 years.
The results of operations are included in the Company's consolidated statement
of income as of and since the date of the purchase.

On January 31, 2002, MKS completed its acquisition of the ENI Business
("ENI") of Emerson Electric Co., a supplier of solid-state RF and 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. The purchase
price was approximately $266,530,000 and consisted of approximately 12,000,000
shares of MKS common stock valued at approximately $261,264,000 and transaction
expenses of approximately $5,266,000. The value of MKS common stock was
approximately $21.7720 per share based on the average closing price of MKS'
common stock for the five-day period including the date of the announcement of
the signing of the merger agreement and the two days preceding and succeeding
such date.

55

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The purchase price was allocated to the assets acquired based upon their
estimated fair values and resulted in an allocation of approximately
$197,123,000 to goodwill. The results of operations are included in the
Company's consolidated statement of income as of and since the date of the
purchase. The allocation of the purchase price is as follows:

Current assets.............................................. $ 31,038
Other assets................................................ 2,123
Fixed assets................................................ 18,882
Completed technology........................................ 39,600
Patents..................................................... 6,500
Customer relationships...................................... 2,600
In-process research and development......................... 7,500
Goodwill.................................................... 197,123
Other current liabilities................................... (13,883)
Deferred tax liabilities.................................... (19,480)
Other long term liabilities................................. (5,473)
--------
$266,530
========

The amounts allocated to acquired intangible assets are being amortized
using the straight-line method over their respective estimated useful lives: six
years for completed technology, eight years for patents, and eight years for
customer relationships. The total weighted average amortizable life of the
acquired intangible assets is six years. Approximately $9,700,000 of the
goodwill is tax deductible.

In connection with the acquisition of ENI, the Company obtained an
appraisal from an independent appraiser of the fair value of its intangible
assets. This appraisal valued purchased in-process research and development
("IPR&D") of various projects for the development of new products and
technologies at approximately $7,500,000. Because the technological feasibility
of products under development had not been established and no future alternative
uses existed, the purchased IPR&D was expensed during the six months ended June
30, 2002. The value of the purchased IPR&D was determined using the income
approach, which discounts expected future cash flows from projects under
development to their net present value. Each project was analyzed to determine
the technological innovations included; the utilization of core technology; the
complexity, cost and time to complete development; any alternative future use or
current technological feasibility; and the stage of completion. The cash flows
derived from the IPR&D projects were discounted at rates ranging from 25% to
30%. The Company believes these rates were appropriate given the risks
associated with the technologies for which commercial feasibility had not been
established. The percentage of completion for each in-process project was
determined by identifying the cost incurred to date of the project as a ratio of
the total estimated cost required to bring the project to technical and
commercial feasibility. The percentage of completion for in-process projects
acquired ranged from 65% to 80%, based on management's estimates of tasks
completed and the tasks to be completed to bring the projects to technological
and commercial feasibility. The projects were generally expected to have
durations of up to 12 months.

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.
The acquisition has been accounted for under the purchase method of accounting.
The purchase price was approximately $26,400,000 and consisted of 700,000 shares
of MKS common stock valued at approximately $21,100,000, cash of $5,000,000 and
transaction expenses of

56

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

approximately $300,000. The value of MKS common stock was based on the average
closing price of MKS' common stock for the five-day period including the date of
the announcement of the signing of the merger agreement and the two days
preceding and succeeding such date. The purchase price was allocated to the
assets acquired based upon their estimated fair values. The results of
operations are included in the Company's consolidated statement of income as of
and since the date of the purchase. The allocation of the purchase price was as
follows:

Current assets.............................................. $ 5,051
Completed technology........................................ 10,400
Other acquired intangibles.................................. 540
In-process research and development......................... 180
Goodwill.................................................... 18,899
Other net liabilities assumed............................... (8,670)
-------
$26,400
=======

Completed technology and other acquired intangibles are being amortized on
a straight-line basis over 6 to 8 years. None of the goodwill is tax deductible.

In 2002, the Company acquired two other businesses for a total purchase
price of $12,200,000, including IPC Fab Automation GmbH, a developer and
provider of web-based hardware and software that enable e-diagnostics and
advanced process control for advanced manufacturing applications. There were no
shares of MKS common stock issued for these acquisitions. Goodwill recognized in
these transactions was approximately $11,000,000 and acquired intangible assets
were approximately $2,800,000.

On April 27, 2001, MKS completed its acquisition of On-Line Technologies,
Inc. ("On-Line"), a company that designs and manufactures products used for gas
analysis, wafer metrology and complementary analysis and control software. The
reasons for the acquisition of On-Line were to expand our range of products for
monitoring the composition of process gases and thin-films, and to provide our
customers with integrated products that help them to increase their
manufacturing yield. The acquisition has been accounted for under the purchase
method of accounting. The purchase price was approximately $23,829,000 and
consisted of approximately 660,000 shares of MKS common stock valued at
approximately $12,110,000, cash payments of $6,295,000, assumption of On-Line
debt of approximately $4,728,000 and transaction expenses of approximately
$696,000. The value of MKS common stock was based on the average closing price
of MKS' common stock for the five-day period including the date of the
announcement of the signing of the merger agreement and the two days preceding
and succeeding such date. The purchase price was allocated to the assets
acquired based upon their estimated fair values and resulted in an allocation of
approximately $16,050,000 to goodwill. The results of operations are included in
the Company's consolidated statement of income (loss) as of and since the
effective date of the purchase. The allocation of the purchase price was as
follows:

Net tangible assets acquired................................ $ (971)
In-process research and development......................... 2,340
Completed technology........................................ 4,710
Other acquired intangibles.................................. 1,700
Goodwill.................................................... 16,050
-------
$23,829
=======

The completed technology and other intangibles are being amortized on a
straight-line basis over 5 to 7 years. None of the goodwill is tax deductible.

57

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

In connection with the acquisition of On-Line, the Company obtained an
appraisal from an independent appraiser of the fair value of its intangible
assets. This appraisal valued purchased IPR&D of various projects for the
development of new products and technologies at approximately $2,340,000. The
projects were generally expected to have durations of 24 to 48 months. Because
the technological feasibility of products under development had not been
established and no future alternative uses existed, the purchased IPR&D was
expensed during the quarter ended June 30, 2001. The value of the purchased
IPR&D was determined using the income approach, which discounts expected future
cash flows from projects under development to their net present value.

Each project was analyzed to determine the technological innovations
included; the utilization of core technology; the complexity, cost and time to
complete development; any alternative future use or current technological
feasibility; and the stage of completion. The cash flows derived from the
in-process technology projects were discounted at a rate of 25%. The Company
believes this rate was appropriate given the risks associated with the
technologies for which commercial feasibility had not been established. The
percentage of completion for each in-process project was determined by
identifying the elapsed time invested in the project as a ratio of the total
time required to bring the project to technical and commercial feasibility. The
percentage of completion for in-process projects acquired ranged from 55% to
65%, based on management's estimates of tasks completed and the tasks to be
completed to bring the projects to technological and commercial feasibility.

The following unaudited pro forma results of operations of the Company for
2002 and 2001 give effect to the acquisitions made in 2002 and 2001 as if the
acquisitions had occurred at the beginning of 2001.

These unaudited pro forma results have been prepared for comparative
purposes only and do not purport to be indicative of the results of operations
which actually would have resulted had the acquisitions occurred at the
beginning of the period, or which may result in the future. Additionally, the
charges for purchased IPR&D were not included in the unaudited pro forma
results, because they were non-recurring and directly related to the
transactions.

POOLING OF INTEREST COMBINATIONS

On January 26, 2001, the Company acquired ASTeX. Each outstanding share of
ASTeX common stock was exchanged for 0.7669 newly issued shares of common stock
of the Company, resulting in the issuance of approximately 11,200,000 shares of
common stock. The acquisition was accounted for under the pooling of interests
method of accounting, and accordingly, the consolidated financial statements
reflect the combined financial position and results of operations and cash flows
of MKS Instruments, Inc. and ASTeX, for all periods presented.

13) SALE OF ASSETS

During 2002, the Company sold an investment in a company for approximately
$2,500,000. The gain on the transaction was not material.

58

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

In August 2001, the Company sold certain assets for proceeds of
approximately $9,000,000, consisting of approximately $4,700,000 in cash,
$3,900,000 in a note receivable, and $200,000 of warrants. The note receivable
matures August 7, 2004, and bears an annual interest rate of 9.0%. The loss on
the transaction was $1,246,000 before taxes. During 2002, due to the downturn in
the semiconductor industry and its result on the acquirer's operations, and the
acquirer's inability to raise financing, the Company considered the value of the
note and warrants to be impaired. Accordingly, during 2002, MKS recorded a
charge of $4,121,000 to other expense for the Company's estimate of the
impairment on the note receivable and warrants.

In December 2001, the Company sold an investment in a company for
approximately $367,000. The loss on the transaction was $1,133,000 before taxes.

14) RESTRUCTURING AND ASSET IMPAIRMENT CHARGES

During 2003, the Company continued its consolidation of recent acquisitions
that it initiated in 2002, and recorded restructuring, asset impairment and
other charges of $1,593,000. The charges in 2003 consisted of $356,000 of
severance costs related to workforce reductions, $1,145,000 of lease cost,
professional fees and other costs related to facility consolidations and an
asset impairment charge of $92,000. The workforce reduction was across all
functional groups.

During 2002 the Company implemented a consolidation of recent acquisitions
to accelerate product development, rationalize manufacturing operations, and
reduce operating costs. As a result of these actions, the Company recorded
restructuring and asset impairment charges of $2,726,000 in 2002. The charges
consisted of $631,000 of severance costs related to a workforce reduction,
$1,228,000 related to consolidation of leased facilities, and an asset
impairment charge of $867,000 primarily related to the impairment of an
intangible asset from the discontinuance of certain product development
activities. The fair value of the impaired intangible asset was determined using
the expected present value of future cash flows. The workforce reduction was
across all functional groups and consisted of 225 employees.

The following table sets forth the components of the restructuring
activities initiated during 2003 and 2002, and the related accruals remaining at
December 31, 2003:

The remaining accruals for workforce reductions are expected to be paid by
the second quarter of 2004. The facilities consolidation charges will be paid
over the respective lease terms, the latest of which ends in 2007. The accrual
for severance costs and lease payments is recorded in Other accrued expenses and
Other liabilities.

59

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Inventory Reserves

During the second quarter and fourth quarter of 2001, the Company recorded
significant charges to reserve for excess and obsolete inventory. The following
is a summary of the changes in these inventory reserves during 2001, 2002 and
2003:

When the Company acquired the Shamrock product line, it was expected that
sales of the existing system design and development of new system designs would
generate future revenues. Since the acquisition, the Company had provided
potential customers with purchase quotations for Shamrock systems, including a
significant quotation to a potential customer in January 2001 for the sale of
several systems. The potential customer did not purchase the systems, and the
quotation expired in March 2001. The Company had been unsuccessful in selling
any systems of the product line since the acquisition and, with the expiration
of the significant quote in March 2001, the Company evaluated the recoverability
of the long-lived assets, primarily goodwill. As a result, based on discounted
cash flow analysis, the Company recorded an impairment charge for the carrying
value of the related goodwill of approximately $3,720,000 in the quarter ended
March 31, 2001.

15) GOODWILL AND INTANGIBLE ASSETS

The Company adopted the provisions of SFAS 142 on January 1, 2002.
Accordingly, the Company ceased the ratable amortization of goodwill on that
date. In addition, the Company reassessed the classification of its goodwill and
intangible assets. This analysis, which was completed during the quarter ended
March 31, 2002, resulted in the reclassification of workforce related intangible
assets of $2,023,000 to goodwill. Also, in accordance with this statement, the
Company reassessed the useful lives of its amortizable intangible assets and
determined that the lives were appropriate.

The Company is required to perform an annual impairment test of its
goodwill under the provisions of FAS 142. The Company compares the fair value of
each reporting unit to its recorded book value. An excess of book value over
fair value indicates that an impairment of goodwill exists. Fair value is based
on a discounted cash flow analysis of expectations of future earnings for each
of the reporting units with goodwill. The Company completed its annual
impairment for 2003 in the fourth quarter. No adjustment to goodwill was
necessary.

60

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

The changes in the carrying amount of goodwill during the years ended
December 31, 2003 and 2002 were as follows:

The following is the pro forma effect on net income and net income per
share had SFAS 142 been in effect for the year ended December 31, 2001:

Components of the Company's acquired intangible assets are comprised of the
following:

61

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

Aggregate amortization expense related to acquired intangibles for the
years ended December 31, 2003, 2002 and 2001 were $14,692,000, $13,897,000 and
$5,200,000, respectively. Estimated amortization expense related to acquired
intangibles for each of the five succeeding years is as follows:

16) 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's estimates, revisions to
the estimated warranty liability would be required.

Product warranty activity for the years ended December 31, were as follows:

17) OTHER ACCRUED EXPENSES

Other accrued expenses consist of:

18) RELATED PARTY TRANSACTIONS

In December 2003, the Company recorded a gain of $927,000 from the early
repayment of premiums related to a split dollar life insurance policy covering
the Chairman and CEO of the Company. This gain was recorded in Other expense
(income) in the consolidated statement of operations.

62

MKS INSTRUMENTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(TABLES IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

19) SUBSEQUENT EVENTS

Litigation

On January 12, 2004, Gas Research Institute ("GRI") brought suit in federal
district court in Illinois against the Company, On-Line Technologies, Inc.,
which was acquired by the Company in April 2001, and another defendant for
breach of contract, misappropriation of trade secrets and related claims
relating to certain infra-red gas analysis technology allegedly developed under
a January 1995 Contract for Research and incorporated into certain of the
Company's products. GRI has made claims for unspecified damages, attorney's fees
and injunctive relief. The Company is currently evaluating the merits of the
claims. The Company cannot be certain of the outcome of this litigation, but
plans to oppose the claims against it vigorously.

Issuance of Common Stock

On January 21, 2004, the Company issued 1,142,857 shares of its common
stock at $26.25 per share through a public offering. Estimated proceeds of the
offering, net of underwriters discount and estimated offering expenses, were
approximately $28,500,000. On January 23, 2004, the underwriters exercised their
over-allotment option and therefore, the Company issued an additional 171,429
shares of its common stock, which generated net proceeds of approximately
$4,298,000.

63

MKS INSTRUMENTS, INC.

SUPPLEMENTAL FINANCIAL DATA

- ---------------

(1) Income (loss) from operations for the quarter ended December 31, 2003
includes restructuring charges of $1.0 million and an adjustment of $0.8
million to reduce depreciation expense.

(2) Net income (loss) for the quarter ended December 31, 2003 includes a gain of
$0.9 million from the early repayment of premiums related to a split dollar
life insurance policy covering the Chairman and CEO of the Company.

(3) Income (loss) from operations for the quarter ended September 30, 2002
includes restructuring and asset impairment charges of $2.4 million.

(4) Net income (loss) for the quarter ended December 31, 2002 includes a
deferred tax charge of $13.4 million to establish a valuation allowance for
the Company's net deferred tax assets. These assets remain available for use
as deductions against future taxable income.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

ITEM 9A. 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 December 31, 2003. Based on this
evaluation, the Company's chief executive officer and chief financial officer
concluded that, as of December 31, 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.

64

The Company's management, including the chief executive officer and chief
financial officer, recognizes that our disclosure controls and our internal
controls cannot prevent all error or all attempts at fraud. Any controls system,
no matter how well crafted and operated, can only provide reasonable, and not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints that affect the operation of any such system and that the benefits
of controls must be considered relative to their costs. Because of the inherent
limitations in any control system, no evaluation or implementation of a control
system can provide complete assurance that all control issues and all possible
instances of fraud have been or will be detected. These inherent limitations
include the realities that judgments in decision-making can be faulty and that
breakdowns can occur because of simple error or mistake.

As a result of 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.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item is set forth under the captions
"Election of Directors", "Executive Officers", "Code of Ethics" and "Audit
Committee Financial Expert" in our definitive proxy statement for the 2004
Annual Meeting of Stockholders, is incorporated herein by reference.

We are also required under Item 405 of Regulation S-K to provide
information concerning delinquent filers of reports under Section 16 of the
Securities and Exchange Act of 1934, as amended. This information is listed
under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in
our definitive proxy statement for the 2004 Annual Meeting of Stockholders to be
filed with the Securities and Exchange Commission no later than 120 days after
the end of our fiscal year. This information is incorporated herein by
reference.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is set forth under the caption
"Executive Compensation" in our definitive proxy statement for the 2004 Annual
Meeting of Stockholders to be filed with the Securities and Exchange Commission
not later than 120 days after the end of our fiscal year. This information is
incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

The information required by Item 403 of Regulation S-K is set forth under
the caption "Security Ownership of Certain Beneficial Owners and Management" in
our definitive proxy statement for the 2004 Annual Meeting of Stockholders to be
filed with the Securities and Exchange Commission not later than 120 days after
the end of our fiscal year. This information is incorporated herein by
reference.

The information required by Item 201(d) of Regulation S-K is set forth
under the caption "Equity Compensation Plan Information" in our definitive proxy
statement for the 2004 Annual Meeting of Stockholders, to be filed with the
Securities and Exchange Commission not later than 120 days after the end of our
fiscal year. This information is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is set forth under the caption
"Certain Relationships and Related Transactions" in our definitive proxy
statement for the 2004 Annual Meeting of Stockholders to be filed with

65

the Securities and Exchange Commission not later than 120 days after the end of
our fiscal year. This information is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The information required by this item is set forth under the caption
"Report of the Audit Committee of the Board of Directors" in our definitive
proxy statement for the 2004 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission not later than 120 days after the end of our
fiscal year. This information is incorporated herein by reference.

PART IV

ITEM 15. EXHIBITS, FINANCIAL SCHEDULES AND REPORTS ON FORM 8-K

(a) The following documents are filed as a part of this Report:

1. Financial Statements. The following Consolidated Financial
Statements are included under Item 8 on this Annual Report on Form 10-K.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

FINANCIAL STATEMENTS:
Report of Independent Auditors.............................. 33
Consolidated Balance Sheets at December 31, 2003 and 2002... 34
Consolidated Statements of Operations for the years ended
December 31, 2003, 2002 and 2001.......................... 35
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 2003, 2002 and 2001.............. 36
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001.......................... 37
Notes to Consolidated Financial Statements.................. 38-63

2. Financial Statement Schedules

The following consolidated financial statement schedule is included in
this Annual Report on Form 10-K of Item 15(d):

Schedule II -- Valuation and Qualifying Accounts

Schedules other than those listed above have been omitted since they are
either not required or information is otherwise included.

3. Exhibits. The following exhibits are filed as part of this Annual
Report on Form 10-K pursuant to Item 15(c).

- ---------------

+ Previously filed

* Management contract or compensatory plan arrangement filed as an Exhibit to
this Form 10-K pursuant to Item 15(c) of this report.

(1) Incorporated by reference to the Registration Statement on Form S-4 (File
No. 333-49738) filed with the Securities and Exchange Commission on
November 13, 2000.

(2) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
(File No. 000-23621) for the quarter ended June 30, 2001.

67

(3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
(File No. 000-23621) for the quarter ended June 30, 2002.

(4) Incorporated by reference to the Registration Statement on Form S-1 (File
No. 333-71363) filed with the Securities and Exchange Commission on January
28, 1999, as amended.

(5) Incorporated by reference to the Registration Statement on Form S-8 (File
No. 333-54486) filed with the Securities and Exchange Commission on January
29, 2001.

(6) Incorporated by reference to the Registration Statement on Form S-8 (File
No. 333-54488) filed with the Securities and Exchange Commission on January
29, 2001.

(7) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
(File No. 000-23621) for the quarter ended June 30, 2003.

(8) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
(File No. 000-23621) for the quarter ended September 30, 2002.

(9) Incorporated by reference to the Registrant's Annual Report on Form 10-K
(File No. 000-23621) for the fiscal year ended December 31, 1999.

(10) Incorporated by reference to the Registrant's Annual Report on Form 10-K
(File No. 000-23621) for the fiscal year ended December 31, 2002.

(11) Incorporated by reference to Applied Science and Technology, Inc.'s
Quarterly Report on Form 10-Q (File No. 333-71467) for the quarter ended
March 25, 2000.

(12) Incorporated by reference to the Registrant's Definitive Proxy Statement on
Schedule 14A (Commission File No. 000-23621) filed with the Securities and
Exchange Commission on December 4, 2001.

(13) Incorporated by reference to the Registrant's Report on Form 8-K (File No.
000-23621) filed with the Securities and Exchange Commission on February
12, 2002.

(b) Reports on Form 8-K.

On October 21, 2003, the Company furnished a Current Report on Form
8-K dated October 21, 2003 under Item 12 (Results of Operations and
Financial Condition) containing a copy of its earnings release for the
quarter ended September 30, 2003.

On October 16, 2003, the Company filed a Current Report on Form 8-K
for the purpose of filing under Item 7 (Financial Statements, Pro Forma
Financial Information and Exhibits) as an exhibit thereto, certain pro
forma financial data related to the acquisition on January 31, 2002 by the
Company of the ENI business of Emerson Electric Co.

(c) Exhibits.

The Company hereby files as exhibits to our Annual Report on Form 10-K
those exhibits listed in Item 15 above.

(d) Financial Statement Schedules.

68

MKS INSTRUMENTS, INC.

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

69

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

By: /s/ JOHN R. BERTUCCI
------------------------------------
John R. Bertucci
President, Chairman of the Board of
Directors
and Chief Executive Officer
(Principal Executive Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.