1
20
Selected Consolidated Financial Data
(in thousands, except per share data)
Year Ended December 31
--------------------------------------------------------------------
1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------
Statement of Income Data
Net sales $187,083 $139,763 $188,080 $170,862 $157,164
Gross profit 79,855 55,979 80,474 68,854 69,461
Income from operations 27,611 9,135 23,963 16,068 24,106
Net income $ 24,037 $ 7,186 $ 20,290 $ 12,503 $ 21,658
Historical net income per share - Diluted $ 1.00 $ 0.38 $ 1.10 $ 0.69 $ 1.20
Pro Forma Statement of Income Data (1)
Pro forma net income $ 18,412 $ 5,044 $ 13,806 $ 8,248 $ 13,821
Pro forma net income per share - Diluted $ 0.77 $ 0.27 $ 0.76 $ 0.46 $ 0.77
Balance Sheet Data
Cash and cash equivalents $ 35,714 $ 11,188 $ 2,511 $ 3,815 $ 3,650
Working capital 87,088 31,493 30,321 22,404 32,202
Total assets 174,605 96,232 106,536 95,000 104,511
Short-term obligations 20,828 12,819 13,852 16,124 15,192
Long-term obligations, less current portion 5,662 13,786 15,624 18,899 20,462
Stockholders' equity 119,169 54,826 52,848 45,498 48,392
Quarter Ended
--------------------------------------------------
Mar 31 Jun 30 Sep 30 Dec 31
- -------------------------------------------------------------------------------------------------
1998
Statement of Income Data
Net sales $46,163 $34,026 $28,834 $30,740
Gross profit 19,406 13,761 10,694 12,118
Income from operations 5,500 1,609 318 1,708
Net income 4,279 1,232 142 1,533
Historical net income per share - Diluted $ 0.23 $ 0.07 $ 0.01 $ 0.08
Pro Forma Statement of Income Data (1)
Pro forma net income $ 3,003 $ 865 $ 100 $ 1,076
Pro forma net income per share - Diluted $ 0.16 $ 0.05 $ 0.01 $ 0.06
1999
Statement of Income Data
Net sales $37,910 $44,209 $50,621 $54,343
Gross profit 15,353 18,659 21,745 24,098
Income from operations 3,541 5,907 7,999 10,164
Net income 3,129 7,576 6,037 7,295
Historical net income per share - Diluted $ 0.16 $ 0.30 $ 0.24 $ 0.28
Pro Forma Statement of Income Data (1)
Pro forma net income $ 2,150 $ 3,806 $ 5,677 $ 6,779
Pro forma net income per share - Diluted $ 0.11 $ 0.15 $ 0.22 $ 0.26
(1) Data is computed on the same basis as Note 2 of Notes to Consolidated
Financial Statements. The historical net income per share data does not
include provisions for federal income taxes because prior to its
initial public offering in 1999, MKS was 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 MKS had been
subject to federal income taxes as a C corporation during the periods
presented.
2
21 MKS Instruments 1999
Management's Discussion and Analysis of Financial Condition and Results of
Operations
When used in this Annual Report, including this Management's Discussion and
Analysis, the words "believes," "anticipates," "plans," "expects" 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 Instruments, Inc. (the "Company" or
"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 - Trends, Risks and
Uncertainties."
Overview
MKS was founded in 1961. MKS develops, manufactures and supplies instruments and
components used to measure, control and analyze gases in semiconductor
manufacturing and similar industrial manufacturing processes. During 1999, MKS
estimates that approximately 66% of its net sales were to semiconductor capital
equipment manufacturers and semiconductor device manufacturers. MKS expects that
sales to such customers will continue to account for a substantial majority of
its sales. MKS's customers include semiconductor capital equipment
manufacturers, semiconductor device manufacturers, industrial manufacturing
companies and university, government and industrial research laboratories. In
1999, 1998 and 1997, sales to MKS's top five customers accounted for
approximately 33%, 24% and 32%, respectively, of MKS's net sales. During 1999,
Applied Materials, Inc. accounted for approximately 22% of MKS's net sales. MKS
typically enters into contracts with its semiconductor equipment manufacturer
customers that provide for quantity discounts. MKS recognizes revenue, and
accrues for anticipated returns and warranty costs, upon completion of delivery
obligations.
A significant portion of MKS's sales are to operations in international markets.
International sales by MKS's foreign operations, located in Japan, Korea,
Europe, Singapore and Taiwan, were 31.3% and 32.4% of net sales for 1999 and
1998, respectively. Sales by MKS's Japan subsidiary comprised 16.4% and 15.1% of
net sales in 1999 and 1998, respectively. MKS does not classify export sales
made directly by MKS as international sales. Such export sales have generally
been less than 10% of net sales. MKS currently uses, and plans to continue to
use, forward exchange contracts and local currency purchased options to reduce
currency exposure arising from foreign currency denominated intercompany sales
of inventory. Gains and losses on derivative financial instruments that qualify
for hedge accounting are classified in cost of sales. Gains and losses on
derivative financial instruments that do not qualify for hedge accounting are
marked-to-market and recognized immediately in other income. See Note 3 of Notes
to Consolidated Financial Statements.
MKS was treated as an S corporation for federal income tax purposes prior to its
initial public offering in 1999. MKS's S corporation status terminated upon the
closing of the offering, at which time MKS became subject to federal, and
certain state, income taxation as a C corporation. The pro forma net income
reflects a pro forma effective tax rate of 38.0% in 1997 and 1998, and 37.1% in
1999 to reflect federal and state income taxes which would have been payable had
MKS been taxed as a C corporation for each period.
On April 5, 1999 MKS closed the initial public offering of its Common Stock. In
connection with this offering and the exercise of an over-allotment option by
the underwriters, the Company sold 6,375,000 shares of Common Stock at a price
of $14.00 per share. The net proceeds to the Company were approximately
$82,000,000. Offering costs were approximately $1,000,000.
On April 5, 1999 MKS distributed $40,000,000, which was the estimated amount of
the Company's undistributed S Corporation earnings as of the day prior to the
closing of the offering.
Results of Operations
The following table sets forth for the periods indicated the percentage of total
net sales of certain line items included in MKS's consolidated statement of
income data:
Year Ended December 31
1999 1998 1997
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of sales 57.3 59.9 57.2
------ ------ ------
Gross profit 42.7 40.1 42.8
Research and development 7.1 8.7 7.8
Selling, general and administrative 20.8 24.9 22.3
------ ------ ------
Income from operations 14.8 6.5 12.7
Interest income (expense), net 0.4 (0.8) (1.0)
Other income, net 0.4 0.1 0.1
------ ------ ------
Income before income taxes 15.6 5.8 11.8
Provision for income taxes 2.8 0.7 1.0
------ ------ ------
Net income 12.8% 5.1% 10.8%
====== ====== ======
Pro forma data:
Historical income before income taxes 15.6 5.8 11.8
Pro forma provision for income taxes 5.8 2.2 4.5
------ ------ ------
Pro forma net income 9.8% 3.6% 7.3%
====== ====== ======
3
22
Year Ended 1999 Compared to 1998
Net Sales
Net sales increased 33.9% to $187.1 million for 1999 from $139.8 million for
1998. International net sales were approximately $58.5 million in 1999 or 31.3%
of net sales and $45.3 million in 1998 or 32.4% of net sales. The increase in
net sales was primarily due to increased sales volume of MKS's existing products
in the United States and in Asia which resulted primarily from increased sales
to the Company's semiconductor capital equipment manufacturing and semiconductor
device manufacturer customers.
Gross Profit
Gross profit as a percentage of net sales increased to 42.7% for 1999 from 40.1%
in 1998. The increase was primarily due to fuller utilization of existing
manufacturing capacity as a result of increased net sales.
Research and Development
Research and development expenses increased 9.0% to $13.2 million or 7.1% of net
sales for 1999 from $12.1 million or 8.7% of net sales for 1998. The increase
was due to increased spending for development materials.
Selling, General and Administrative
Selling, general and administrative expenses increased 12.4% to $39.0 million or
20.8% of net sales from $34.7 million or 24.9% of net sales for 1998. The
increase was due primarily to increased incentive compensation expense of $3.3
million, professional fees, and other selling expenses.
Interest Income (Expense), Net
During 1999, the Company generated net interest income of $0.8 million primarily
from the invested net proceeds of the initial public offering, offset by
interest expense on outstanding debt. Net interest expense of $1.2 million for
1998 represents interest on outstanding loans, offset by interest income earned
on cash and cash equivalents and short-term investments.
Other Income (Expense), Net
Other income of $0.8 million for 1999 includes a distribution of $0.7 million
from one of MKS's mutual insurance carriers upon the initial public offering of
the insurance carrier, and also includes gains recorded from foreign exchange
contracts which did not qualify for hedge accounting. Other income of $0.2
million in 1998 primarily represents foreign exchange translation gains on
intercompany payables of $1.0 million offset by $0.7 million for costs
associated with MKS's planned initial public offering in early 1998.
Effective April 1, 1999 MKS adopted Statement of Financial Accounting Standards
(SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities."
SFAS No. 133 requires that all derivative instruments be recorded on the balance
sheet at their fair value. Changes in the fair value of derivatives are recorded
each period in current earnings or other comprehensive income, depending on
whether a derivative is designated as part of a hedge transaction and, if it is,
the type of hedge transaction. The adoption of SFAS No. 133 did not have a
material impact on MKS's financial position or results of operations. The
derivative instruments currently held by MKS which have been designated as
hedges, including forward exchange contracts, local currency purchased options,
and an interest rate swap, qualify for hedge accounting under SFAS No. 133, and
changes in their fair value will be recorded as a component of other
comprehensive income until the hedged transaction occurs.
Pro Forma Provision for Income Taxes
Prior to the closing of its initial public offering in April, 1999 MKS was
treated as an S corporation for tax purposes. As an S corporation, MKS was not
subject to federal, and certain state, income taxes. Upon the closing of its
initial public offering on April 5, 1999, MKS's status as an S corporation was
terminated and it became subject to taxes as a C corporation. The pro forma
provision for income taxes reflects the estimated tax expense MKS would have
incurred had it been subject to federal and state income taxes as a C
corporation. The pro forma provision differs from the federal statutory rate due
primarily to the effects of state and foreign taxes and certain tax credits. The
pro forma provision for 1999 reflects a pro forma tax rate of 37.1%. This rate
differs from the pro forma tax rate of 38% for 1998 due to increased tax credits
and lower nondeductable expenses in 1999.
Year Ended 1998 Compared to 1997
Net Sales
Net sales decreased 25.7% to $139.8 million for 1998 from $188.1 million for
1997. International net sales were approximately $45.3 million in 1998 or 32.4%
of net sales and $51.4 million in 1997 or 27.3% of net sales. The decrease in
net sales was primarily due to decreased sales volume of MKS's existing products
in the United States and in Asia caused by the 1998 downturn in the
semiconductor capital equipment market.
Gross Profit
Gross profit as a percentage of net sales decreased to 40.1% for 1998 from 42.8%
in 1997. The change was primarily due to manufacturing overhead costs being a
higher percentage of net sales due to lower sales volume in 1998.
Research and Development
Research and development expenses decreased 17.3% to $12.1 million or 8.7% of
net sales for 1998 from $14.7 million or 7.8% of net sales for 1997. The
decrease was due to reduced spending for development materials primarily related
to certain projects that were completed during 1998.
Selling, General and Administrative
Selling, general and administrative expenses decreased 17.0% to $34.7 million or
24.9% of net sales for 1998 from $41.8 million or 22.3% of net sales for 1997.
The decrease was due primarily to a decrease of approximately $4.2 million in
compensation expense resulting from the reduction in personnel during 1998 and
reduced incentive compensation. Additionally, expenses were reduced as a result
of lower spending on advertising, travel, and other selling and administrative
costs.
Interest Expense, Net
Net interest expense decreased to $1.2 million for 1998 from $1.9 million for
1997 primarily due to lower debt outstanding during 1998.
4
23 MKS Instruments 1999
Other Income (Expense), Net
Other income of $0.2 million in 1998 primarily represents foreign exchange
translation gains on intercompany payables of $1.0 million offset by $0.7
million for costs associated with MKS's planned initial public offering in early
1998 which was postponed at that time. Other income of $0.2 million in 1997
represents gains of $1.2 million from foreign exchange contracts that did not
qualify for hedge accounting, offset by a foreign exchange translation loss on
an intercompany payable.
Pro Forma Provision for Income Taxes
The pro forma provision for income taxes for 1998 reflects the estimated tax
expense MKS would have incurred had it been subject to federal and state income
taxes as a C corporation under the Internal Revenue Code. The pro forma
provision reflects a pro forma tax rate of 38.0%, which differs from the federal
statutory rate due primarily to the effects of state and foreign taxes and
certain tax credits.
Liquidity and Capital Resources
MKS has financed its operations and capital requirements through a combination
of cash provided by operations, long-term real estate financing, capital lease
financing and short-term lines of credit. On April 5, 1999 the Company completed
the initial public offering of its Common Stock. In connection with this
offering and the exercise of an over-allotment option by the underwriters, the
Company sold 6,375,000 shares of Common Stock at a price of $14.00 per share.
The net proceeds to the Company were approximately $82,000,000 and were received
in the second quarter of 1999. Underwriting discounts and commissions were
approximately $6,200,000, and other offering costs were approximately
$1,000,000. On April 5, 1999 MKS distributed $40,000,000, which was the
estimated amount of its undistributed S Corporation earnings as of the day prior
to the closing of the offering.
Operations provided cash of $17.1 million for 1999 primarily from generating net
income. This cash flow was impacted by depreciation and changes in the levels of
accounts payable, accrued expenses, accounts receivable and a non-cash deferred
tax credit. Investing activities utilized cash of $33.4 million for 1999
primarily from purchasing short-term investments with the net proceeds from the
initial public offering and for the purchase of property and equipment.
Financing activities provided cash of $41.2 million, with net proceeds from the
initial public offering of $82.1 million offset by the distribution to
stockholders of $40.0 million.
Working capital was $87.1 million as of December 31, 1999, an increase of $55.6
million from December 31, 1998. MKS has a combined $30.0 million line of credit
with two banks, expiring December 31, 2000, all of which is available.
Prior to its initial public offering, the Company entered into a Tax
Indemnification and S Corporation Distribution Agreement with its then existing
stockholders (the "Pre-IPO stockholders"). The agreement includes provisions for
the payment, with interest, by the Pre-IPO stockholders or MKS, as the case may
be, for the difference between the $40,000,000 distributed as an estimate of the
amount of the accumulated adjustments account as of April 4, 1999, which is the
date the Company's S Corporation status was terminated, and the actual amount of
the accumulated adjustments account on that day. The actual amount of the
accumulated adjustments account cannot be determined until MKS calculates the
amount of its taxable income for the year ending December 31, 1999. Based on the
Company's estimate of the taxable income for the year ending December 31, 1999,
MKS believes that an additional distribution to the Pre-IPO stockholders will be
required under this agreement. The amount of the additional distribution, prior
to interest, is currently estimated to be $3,350,000. The amount of the
additional distribution payable has been charged directly to retained earnings
and had no impact on net income or earnings per share. No shareholders, other
than the Pre-IPO stockholders, are parties to the Tax Indemnification and S
Corporation Distribution Agreement.
Recently Issued Accounting Pronouncements
See Note 2 of Notes to Consolidated Financial Statements for a discussion of the
impact of recently issued accounting pronouncements.
MKS believes that its working capital, together with the cash anticipated to be
generated from operations and funds available from existing credit facilities,
will be sufficient to satisfy its estimated working capital and planned capital
expenditure requirements through at least the next 24 months.
Trends, Risks and Uncertainties
Year 2000 Compliance
The Year 2000 problem stems from the fact that many currently installed computer
systems include software and hardware products that are unable to distinguish
21st century dates from those in the 20th century. As a result, computer
software and/or hardware used by many companies and governmental agencies may
need to be upgraded to comply with Year 2000 requirements or risk system failure
or miscalculations causing disruptions to normal business activities. In
addition, despite the fact that many computer systems are currently processing
21st century dates correctly, companies, including MKS, could experience future
Year 2000 problems.
During the past few years, MKS designed and implemented a multi-phase Year 2000
project. MKS believes it has taken steps in its multi-phase Year 2000 project to
identify and remediate material Year 2000 related issues. MKS has not
experienced any significant disruption to normal business activities or product
noncompliance related to the Year 2000 problem. However, there can be no
assurance that MKS has identified and remediated all material Year 2000 related
issues. Additionally, there can be no assurance that unexpected delays or
problems will not occur that would have a material adverse effect on the
Company's financial condition or results of operations.
5
24
MKS's multi-phase Year 2000 project consisted of:
- - assessment of the corporate systems and operations including both
information technology and non-information technology that could be
affected by the Year 2000 problem
- - remediation of non-compliant systems and components
- - testing of systems and components following remediation
MKS, under the guidance of its Information Technology Steering Committee,
focused its Year 2000 review on four areas:
- - internal computer software and hardware
- - product compliance
- - facilities and manufacturing equipment
- - third-party compliance
Internal Computer Software and Hardware. MKS uses information technology for its
internal infrastructure, which consists of its main enterprise systems which
include the systems used, in part, for purchase orders, invoicing, shipping and
accounting, and individual workstations, including personal computers, and its
network systems.
Because MKS's business and manufacturing systems, such as its main enterprise
systems, are essential to its business, financial condition and results of
operations, MKS began its assessment of these systems prior to its other
non-critical information technology systems. MKS began its assessment in the
fall of 1997, and in November 1997, MKS developed a remediation plan for all
identified noncompliant business and manufacturing systems. This remediation
plan was implemented in January 1998. By July 1998, MKS had installed new
systems or upgraded existing systems. Based upon post-implementation testing and
review, management believes that all business and manufacturing systems are Year
2000 compliant.
MKS's personal computer based systems were assessed in early 1998. MKS believes
that all non-compliant hardware and software was identified by March 1998, at
which time it made a list prioritizing databases to be remedied. Critical
databases were identified and were scheduled for remediation prior to other
databases. Remediation plans to convert the databases were initiated in November
1998. MKS believes its critical and non-critical personal computer based systems
are Year 2000 compliant.
Product Compliance. Throughout 1998, MKS assessed and addressed the Year 2000
compliance of its products. This assessment resulted in the identification of
MKS's products that were compliant and non-compliant. The substantial majority
of MKS's products were deemed to be compliant.
The date related functions of all non-compliant products, other than certain
residual gas analysis products, are believed by MKS to be non-critical in that
such noncompliance would not affect the independent performance of the product;
would not cause the MKS product to cease operating on any particular date; and
independently would not pose a safety risk. MKS believes that Year 2000 problems
associated with non-compliant residual gas analysis products will also be
non-critical. However, these products contain components of other manufacturers
and cannot be tested and therefore it is possible that such products could cause
unanticipated performance problems. MKS made available to its customers a list
which describes Year 2000 readiness of its products.
Facilities and Manufacturing Equipment. Some aspects of MKS's facilities and
manufacturing equipment may include embedded technology, such as
microcontrollers. The Year 2000 problem could cause a system failure or
miscalculation in such facilities or manufacturing equipment which could disrupt
MKS's operations. Affected areas include security systems, elevator controls,
voice mail and phone systems, cleanroom environmental controls, numerically
controlled production machinery and computer based production equipment. MKS
organized a team of experienced managers in November 1998 to assess the
potential problems in these areas. An assessment of all facilities and
manufacturing equipment was conducted through December 1998, and a remediation
plan was developed in January 1999. MKS believes its facilities and
manufacturing equipment are Year 2000 compliant.
Third-Party Compliance. MKS has relationships with third-parties including
customers and vendors and suppliers of goods, services and computer interfaces.
The failure of such persons to implement and execute Year 2000 compliance
measures in a timely manner, if at all, could, among other things:
- - adversely affect MKS's ability to obtain components in a timely manner
- - cause a reduction in the quality of components obtained by MKS
- - cause a reduction, delay or cancellation of customer orders received by
MKS or a delay in payments by its customers for products shipped
- - result in the loss of services that would be necessary for MKS to
operate in the normal course of business
MKS assessed which of these third-party goods, services and interfaces were
critical to its operations and developed and mailed a standard survey to each
third-party deemed critical in January 1998. Based on this survey and its review
of survey data, MKS believes all critical third-parties have achieved
satisfactory compliance.
6
25 MKS Instruments 1999
Costs
MKS's costs to date associated with assessment, remediation and testing
activities concerning the Year 2000 problem have been approximately $3.1
million. MKS has funded these activities principally through cash provided by
operations and existing leasing lines of credit. It is not possible for MKS to
completely estimate the costs incurred in its remediation effort as many of its
employees have focused significant efforts in evaluating MKS's Year 2000 state
of readiness and in remediating problems that have arisen from such evaluation.
Contingency Plan
MKS has not formulated contingency plans related to the failure of its or a
third-party's Year 2000 remediation efforts. Contingency plans for the failure
to implement compliance procedures have not been completed because MKS believes
it completed all required modifications and tested the modifications thoroughly
prior to December 31, 1999.
MKS believes it has taken steps in its multi-phase Year 2000 project to identify
and remediate material Year 2000 related issues. MKS has not experienced any
significant disruption to normal business activities or product noncompliance
related to the Year 2000 problem. However, there can be no assurance that MKS
has identified and remediated all material Year 2000 related issues.
Additionally, there can be no assurance that unexpected delays or problems will
not occur that would have a material adverse effect on the Company's financial
condition or results of operations.
Factors That May Affect Future Results
Cyclicality of the Semiconductor Industry
MKS estimates that approximately 66% of its sales during 1999 were to
semiconductor capital equipment manufacturers and semiconductor device
manufacturers, and MKS expects that sales to such customers will continue to
account for a substantial majority of its sales. MKS's business depends
substantially upon the capital expenditures of semiconductor device
manufacturers, which in turn depend upon the demand for semiconductors and other
products utilizing semiconductors. Periodic reductions in demand for the
products manufactured by semiconductor capital equipment manufacturers and
semiconductor device manufacturers may adversely affect MKS's business,
financial condition and results of operations. Historically, the semiconductor
market has been highly cyclical and has experienced periods of overcapacity,
resulting in significantly reduced demand for capital equipment. For example, in
1996 and 1998 the semiconductor industry experienced a significant decline,
which caused a number of MKS's customers to reduce their orders. MKS cannot be
certain that semiconductor downturns will not recur. A decline in the level of
orders as a result of any future downturn or slowdown in the semiconductor
industry could have a material adverse effect on MKS's business, financial
condition and results of operations.
Fluctuations in Operating Results
A substantial portion of MKS's shipments occur shortly after an order is
received and therefore MKS operates with a low level of backlog. As a
consequence of the just-in-time nature of shipments and the low level of
backlog, a decrease in demand for MKS's products from one or more customers
could occur with limited advance notice and could have a material adverse effect
on MKS's results of operations in any particular period.
A significant percentage of MKS's expenses are relatively fixed and based in
part on expectations of future net sales. The inability to adjust spending
quickly enough to compensate for any shortfall would magnify the adverse impact
of a shortfall in net sales on MKS's results of operations. Factors that could
cause fluctuations in MKS's 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
- - Specific features requested by customers
For example, MKS was in the process of increasing production capacity when the
semiconductor capital equipment market began to experience a significant
downturn in 1996. This downturn had a material adverse effect on MKS's operating
results in the second half of 1996 and the first half of 1997. After an increase
in business in the latter half of 1997, the market experienced another downturn
in 1998, which had a material adverse effect on MKS's 1998 and first quarter
1999 operating results. As a result of the factors discussed above, it is likely
that MKS will in the future experience quarterly or annual fluctuations and
that, in one or more future quarters, MKS's operating results will fall below
the expectations of public market analysts or investors. In any such event, the
price of MKS's common stock could decline significantly.
Customer Concentration
MKS's five largest customers in 1999 and 1998 accounted for approximately 33%
and 24%, respectively, of its net sales. The loss of a major customer or any
reduction in orders by such customers, including reductions due to market or
competitive conditions, would likely have a material adverse effect on MKS's
business, financial condition and results of operations. During 1999, one
customer, Applied Materials, Inc., accounted for approximately 22% of MKS's net
sales. While the Company has entered into a purchase contract with Applied
Materials, Inc. that expires in 2000 unless it is extended by mutual agreement,
none of MKS's significant customers, including Applied Materials, Inc., has
entered into an agreement requiring it to purchase any minimum quantity of MKS's
products. The demand for MKS's products from its semiconductor capital equipment
customers depends in part on orders received by them from their semiconductor
device manufacturer customers.
7
26
Attempts to lessen the adverse effect of any loss or reduction through the rapid
addition of new customers could be difficult because prospective customers
typically require lengthy qualification periods prior to placing volume orders
with a new supplier. The Company's future success will continue to depend upon
MKS's ability to maintain relationships with existing key customers, MKS's
ability to attract new customers, and the success of MKS's customers in creating
demand for their capital equipment products which incorporate MKS's products.
Competition
The markets for MKS's products are highly competitive. The Company's competitive
success often depends upon factors outside of its control. For example, in some
cases, particularly with respect to mass flow controllers, semiconductor device
manufacturers may direct semiconductor capital equipment manufacturers to use a
specified supplier's product in their equipment. Accordingly, for such products,
the Company's success will depend in part on its ability to have semiconductor
device manufacturers specify that the Company's products be used at their
semiconductor fabrication facilities. In addition, MKS may encounter
difficulties in changing established relationships of competitors that already
have a large installed base of products within such semiconductor fabrication
facilities.
Technological Changes
New products designed by semiconductor capital equipment manufacturers typically
have a lifespan of five to ten years. MKS's success depends on its products
being designed into new generations of equipment for the semiconductor industry.
The Company must develop products that are technologically current so that they
are positioned to be chosen for use in each successive new generation of
semiconductor equipment. If its products are not chosen by its customers, the
Company's net sales may be reduced during the lifespan of its customers'
products.
Expansion into New Markets
MKS plans to build upon its experience in manufacturing and selling gas
measurement, control and analysis products used by the semiconductor industry by
designing and selling such products for applications in other industries which
use production processes similar to those used in the semiconductor industry.
For example, MKS plans to expand its business to the manufacture of, among other
things, hard coatings to minimize wear on cutting tools. Any failure by the
Company to penetrate additional markets would limit its ability to reduce its
vulnerability to downturns in the semiconductor industry and could have a
material adverse effect on MKS's business, financial condition and results of
operations.
MKS has limited experience selling its products in certain markets outside the
semiconductor industry. The Company cannot be certain that it will be successful
in the expansion of its business outside the semiconductor industry. MKS's
future success will depend in part on its ability to:
- - identify new applications for MKS's products
- - adapt MKS's products for such applications
- - market and sell such products to customers
Expansion of Manufacturing Capacity
MKS's ability to increase sales of certain products depends in part upon its
ability to expand manufacturing capacity for such products in a timely manner.
If the Company is unable to expand manufacturing capacity on a timely basis or
to manage such expansion effectively, its customers could seek such products
from others and its market share could be reduced. Because the semiconductor
industry is subject to rapid demand shifts which are difficult to foresee, MKS
may not be able to increase capacity quickly enough to respond to a rapid
increase in demand in the semiconductor industry. Additionally, capacity
expansion could increase the Company's fixed operating expenses and if sales
levels do not increase to offset the additional expense levels associated with
any such expansion, the Company's business, financial condition and results of
operations could be materially adversely affected.
International Operations and Sales
International sales, which include sales by MKS's foreign subsidiaries, but
exclude direct export sales which were less than 10% of total net sales,
accounted for approximately 31% of net sales in 1999, and 32% of net sales in
1998. MKS anticipates that international sales will continue to account for a
significant portion of net sales. In addition, certain of MKS's key domestic
customers derive a significant portion of their revenues from sales in
international markets. Therefore, MKS's sales and results of operations could be
adversely affected by economic slowdowns and other risks associated with
international sales.
Exchange rate fluctuations could have an adverse effect on MKS's net sales and
results of operations and the Company could experience losses with respect to
its hedging activities. Unfavorable currency fluctuations could require MKS to
increase prices to foreign customers which could result in lower net sales to
such customers. Alternatively, if MKS does not adjust the prices for its
products in response to unfavorable currency fluctuations, its results of
operations could be adversely affected. In addition, sales made by MKS's foreign
subsidiaries are denominated in the currency of the country in which these
products are sold and the currency MKS receives in payment for such sales could
be less valuable at the time of receipt as a result of exchange rate
fluctuations. While MKS enters into forward exchange contracts and local
currency purchased options to reduce currency exposure arising from intercompany
sales of inventory, MKS cannot be certain that its efforts will be adequate to
protect the Company against significant currency fluctuations or that such
efforts will not expose MKS to additional exchange rate risks.
8
27 MKS Instruments 1999
Need to Retain and Attract Key Employees
MKS's 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 and adverse effect on
MKS's business, financial condition and results of operations. MKS believes that
its future success will depend in part on its ability to attract and retain
highly skilled technical, financial, managerial and marketing personnel.
Competition for such personnel is intense, and MKS cannot be certain that it
will be successful in attracting and retaining such personnel.
Intellectual Property Matters
Although MKS seeks to protect its intellectual property rights through patents,
copyrights, trade secrets and other measures, MKS cannot be certain that:
- - it will be able to protect its technology adequately
- - competitors will not be able to develop similar technology
independently
- - any of its pending patent applications will be issued
- - intellectual property laws will protect its intellectual property
rights
- - third parties will not assert that MKS's products infringe patent,
copyright or trade secrets of such parties
Litigation may be necessary in order to enforce MKS's patents, copyrights or
other intellectual property rights, to protect its trade secrets, to determine
the validity and scope of the proprietary rights of others or to defend against
claims of infringement. Such litigation could result in substantial costs and
diversion of resources and could have a material adverse effect on the Company's
business, financial condition and results of operations.
Market Risk and Sensitivity Analysis
Foreign Exchange Rate Risk
MKS enters into forward exchange contracts and local currency purchased options
to reduce currency exposure arising from intercompany sales of inventory. The
potential fair value loss for a hypothetical 10% adverse change in forward
currency exchange rates on MKS's forward exchange contracts at December 31, 1999
would be $502,000. The potential loss was estimated by calculating the fair
value of the forward exchange contracts at December 31, 1999 and comparing that
with those calculated using the hypothetical forward currency exchange rates.
The value of the local currency purchased options at December 31, 1999 was
immaterial.
At December 31, 1999, MKS had $12,423,000 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
$1,381,000. The potential increase in fair value was estimated by calculating
the fair value of the short-term borrowings at December 31, 1999 and comparing
that with the fair value using the hypothetical year end exchange rate.
Interest Rate Risk
MKS is exposed to fluctuations in interest rates in connection with its variable
rate term loans. In order to minimize the effect of changes in interest rates on
earnings, MKS entered into an interest rate swap that fixed the interest rate on
its variable rate term loans. Under the swap agreement, MKS pays a fixed rate of
5.85% on the notional amount and receives LIBOR. At December 31, 1999, the
notional amount of the interest rate swap was equal to the principal amount of
the variable rate term loans. The potential increase in the fair value of term
loans when adjusting for the interest rate swap paying at a fixed rate resulting
from a hypothetical 10% decrease in interest rates was not material.
Due to its short-term duration the fair value of the Company's cash and
investment portfolio at December 31, 1999 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 value.
9
28
Supplemental Stockholder Information
Price Range of Common Stock
The Common Stock of MKS is traded on the Nasdaq National Market under the symbol
MKSI. On February 11, 2000, the closing price of the Company's Common Stock, as
reported on the Nasdaq National Market, was $38.00 per share. The following
table sets forth for the periods indicated the high and low closing sales prices
per share of the Common Stock as reported by the Nasdaq National Market.
1999 High Low
- -------------------------------------------------------------
First Quarter 14.0625 13.3750
Second Quarter 19.3750 12.0000
Third Quarter 22.2500 18.1250
Fourth Quarter 36.1250 19.3750
On February 11, 2000, MKS had approximately 1800 stockholders of record.
Dividend Policy
We currently intend, subject to our contractual obligations under the Tax
Indemnification and S Corporation Distribution Agreement, to retain earnings for
the continued development of our business. Restrictions or limitations on the
payment of dividends may be imposed in the future under the terms of credit
agreements or under other contractual provisions. In the absence of such
restrictions or limitations, the payment of any dividends will be at the
discretion of our Board of Directors.
10
29 MKS Instruments 1999
Report of Independent Accountants
To the Board of Directors and Stockholders of
MKS Instruments, Inc.:
In our opinion, the accompanying consolidated balance sheets and related
consolidated statements of income, stockholders' equity and cash flows present
fairly, in all material respects, the financial position of MKS Instruments,
Inc. and its subsidiaries at December 31, 1999 and 1998, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1999 in conformity with accounting principles generally
accepted in the United States. These financial statements are the responsibility
of the Company's management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States 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 the opinion expressed above.
As discussed in Note 2 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No.133, "Accounting for
Derivative Instruments and Hedging Activities" in 1999.
PRICEWATERHOUSECOOPERS LLP
Boston, Massachusetts
January 28, 2000
11
30
Consolidated Balance Sheets
December 31
--------------------------
(in thousands, except share data) 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 35,714 $ 11,188
Short-term investments 28,132 538
Trade accounts receivable, net of allowance for doubtful accounts of $934 and
$656 at December 31, 1999 and 1998, respectively 36,857 20,674
Inventories 27,650 24,464
Deferred tax asset 4,119 698
Other current assets 3,378 971
--------- ---------
Total current assets 135,850 58,533
Property, plant and equipment, net 32,826 32,725
Long-term investments 1,063 --
Other assets 4,866 4,974
--------- ---------
Total assets $ 174,605 $ 96,232
========= =========
Liabilities and Stockholders' Equity
Current liabilities:
Short-term borrowings $ 12,423 $ 9,687
Current portion of long-term debt 7,346 2,058
Current portion of capital lease obligations 1,059 1,074
Accounts payable 7,683 3,677
Accrued compensation 9,202 3,985
Other accrued expenses 6,314 5,280
Income taxes payable 1,385 1,279
Distribution payable 3,350 --
--------- ---------
Total current liabilities 48,762 27,040
Long-term debt 4,340 12,042
Long-term portion of capital lease obligations 1,322 1,744
Deferred tax liability 522 117
Other liabilities 490 463
Commitments and contingencies (Note 7)
Stockholders' equity:
Preferred Stock, $0.01 par value, 2,000,000 shares authorized; none issued and outstanding -- --
Common Stock, no par value, 50,000,000 shares authorized; 24,632,849 shares issued and
outstanding at December 31, 1999 113 --
Common Stock, Class A, no par value; 11,250,000 shares authorized;
7,766,910 shares issued and outstanding at December 31, 1998 -- 40
Common Stock, Class B (non voting) no par value; 18,750,000 shares authorized; 10,286,257
shares issued and outstanding at December 31, 1998 -- 73
Additional paid-in capital 84,713 48
Retained earnings 33,166 52,479
Shareholder receivable (856) --
Accumulated other comprehensive income 2,033 2,186
--------- ---------
Total stockholders' equity 119,169 54,826
--------- ---------
Total liabilities and stockholders' equity $ 174,605 $ 96,232
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
12
31 MKS Instruments 1999
Consolidated Statements of Income
Year Ended December 31
--------------------------------------
(in thousands, except per share data) 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------
Net sales $187,083 $139,763 $188,080
Cost of sales 107,228 83,784 107,606
-------- -------- --------
Gross profit 79,855 55,979 80,474
Research and development 13,230 12,137 14,673
Selling, general and administrative 39,014 34,707 41,838
-------- -------- --------
Income from operations 27,611 9,135 23,963
Interest expense 1,346 1,483 2,132
Interest income 2,154 296 271
Other income, net 849 187 166
-------- -------- --------
Income before income taxes 29,268 8,135 22,268
Provision for income taxes (Note 9) 5,231 949 1,978
-------- -------- --------
Net income $ 24,037 $ 7,186 $ 20,290
======== ======== ========
Historical net income per share:
Basic $ 1.05 $ 0.40 $ 1.12
-------- -------- --------
Diluted $ 1.00 $ 0.38 $ 1.10
-------- -------- --------
Historical weighted average common shares outstanding:
Basic 22,784 18,053 18,053
-------- -------- --------
Diluted 23,954 18,720 18,388
-------- -------- --------
Pro forma data (unaudited):
Historical income before income taxes $ 29,268 $ 8,135 $ 22,268
Pro forma provision for income taxes assuming C corporation tax 10,856 3,091 8,462
-------- -------- --------
Pro forma net income $ 18,412 $ 5,044 $ 13,806
======== ======== ========
Pro forma net income per share:
Basic $ 0.81 $ 0.28 $ 0.76
-------- -------- --------
Diluted $ 0.77 $ 0.27 $ 0.76
-------- -------- --------
Pro forma weighted average common shares outstanding:
Basic 22,784 18,053 18,053
-------- -------- --------
Diluted 23,786 18,538 18,262
-------- -------- --------
The accompanying notes are an integral part of the consolidated financial
statements.
13
32
Consolidated Statements of Stockholders'
Equity For the years ended December 31, 1999, 1998 and 1997 (in thousands,
except share data)
Common Stock Additional
-------------------------------------------------------
Class A Class B Common Stock Paid-In
-------------------------- ------------------------- --------------------------
Shares Amount Shares Amount Shares Amount Capital
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 7,766,910 $ 40 10,286,255 $ 73 $ 48
Distributions to stockholders
Comprehensive income
Net income
Other comprehensive income,
net of taxes:
Foreign currency translation
adjustment
Unrealized gain on investments
Comprehensive income
------------------------------------------------------------------------------------------------
Balance at December 31, 1997 7,766,910 40 10,286,255 73 48
Distributions to stockholders
Issuance of common stock 2
Comprehensive income
Net income
Other comprehensive income,
net of taxes:
Foreign currency translation
adjustment
Unrealized loss on investments
Comprehensive income
------------------------------------------------------------------------------------------------
Balance at December 31, 1998 7,766,910 40 10,286,257 73 48
Distributions to stockholders
Distributions payable
to stockholders
Conversion to Common Stock (7,766,910) (40) (10,286,257) (73) 18,053,167 113
Issuance of common stock from
Initial Public Offering 6,375,000 82,062
Issuance of common stock from
exercise of stock options and
Employee Stock Purchase Plan 204,682 1,230
Tax benefit from exercise of
stock options 1,112
Stock option compensation 261
Shareholder receivable
Comprehensive income:
Net income
Other comprehensive income,
net of taxes:
Non-recurring deferred tax
charge to comprehensive
income (Note 9)
Impact of adopting
SFAS No. 133
Changes in value of financial
instruments designated as
cash flow hedges
Foreign currency translation
adjustment
Unrealized gain (loss) on
investments
Comprehensive income
------------------------------------------------------------------------------------------------
Balance at December 31, 1999 -- $ -- -- $ -- 24,632,849 $ 113 $ 84,713
================================================================================================
Accumulated
Other Total
Retained Shareholder Comprehensive Comprehensive Stockholders'
Earnings Receivable Income Income Equity
- --------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 $ 43,553 $ 1,784 $ 45,498
Distributions to stockholders (12,400) (12,400)
Comprehensive income
Net income 20,290 20,290 20,290
Other comprehensive income,
net of taxes:
Foreign currency translation
adjustment (786) (786) (786)
Unrealized gain on investments 246 246 246
-----------
Comprehensive income $ 19,750
------------------------------------------------===========---------------
Balance at December 31, 1997 51,443 1,244 52,848
Distributions to stockholders (6,150) (6,150)
Issuance of common stock
Comprehensive income
Net income 7,186 7,186 7,186
Other comprehensive income,
net of taxes:
Foreign currency translation
adjustment 992 992 992
Unrealized loss on investments (50) (50) (50)
-----------
Comprehensive income $ 8,128
------------------------------------------------===========---------------
Balance at December 31, 1998 52,479 2,186 54,826
Distributions to stockholders (40,000) (40,000)
Distributions payable
to stockholders (3,350) (3,350)
Conversion to Common Stock
Issuance of common stock from
Initial Public Offering 82,062
Issuance of common stock from
exercise of stock options and
Employee Stock Purchase Plan 1,230
Tax benefit from exercise of
stock options 1,112
Stock option compensation 261
Shareholder receivable (856) (856)
Comprehensive income:
Net income 24,037 24,037 24,037
Other comprehensive income,
net of taxes:
Non-recurring deferred tax
charge to comprehensive
income (Note 9) (660) (660) (660)
Impact of adopting
SFAS No. 133 (16) (16) (16)
Changes in value of financial
instruments designated as
cash flow hedges (212) (212) (212)
Foreign currency translation
adjustment (80) (80) (80)
Unrealized gain (loss) on
investments 815 815 815
-----------
Comprehensive income $ 23,884
------------------------------------------------===========---------------
Balance at December 31, 1999 $ 33,166 $ (856) $ 2,033 $ 119,169
================================================ ===============
The accompanying notes are an integral part of the consolidated financial
statements.
14
33 MKS Instruments 1999
Consolidated Statements of Cash Flows
Year Ended December 31
----------------------------------------
(in thousands) 1999 1998 1997
- -------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 24,037 $ 7,186 $ 20,290
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization of property, plant, and equipment 6,209 6,242 5,712
(Gain) loss on disposal of property, plant and equipment (181) 48 552
Deferred taxes (266) (32) (145)
Non-recurring deferred tax credit (3,770) -- --
Provision for doubtful accounts 257 253 258
Forward exchange contract loss (gain) realized 9 (1,211) 132
Stock option compensation 261 -- 95
Changes in operating assets and liabilities:
Trade accounts receivable (15,922) 12,908 (12,509)
Inventories (2,908) 6,479 (5,930)
Other current assets (1,000) 554 (1,261)
Accrued compensation 5,217 (3,516) 2,386
Accrued expenses 1,019 (1,602) 3,312
Accounts payable 4,022 (3,682) 2,638
Income taxes payable 106 (647) 1,283
-------- -------- --------
Net cash provided by operating activities 17,090 22,980 16,813
-------- -------- --------
Cash flows from investing activities:
Purchases of short-term and long-term investments (45,999) -- --
Maturities and sales of short-term and long-term investments 18,654 -- --
Purchases of property, plant and equipment (5,505) (3,137) (3,269)
Proceeds from sale of property, plant and equipment 318 60 203
Increase in other assets (853) (270) (123)
Cash received (used) to settle forward exchange contracts (9) 1,211 (132)
-------- -------- --------
Net cash used in investing activities (33,394) (2,136) (3,321)
-------- -------- --------
Cash flows from financing activities:
Net payments on demand notes payable -- -- (1,875)
Proceeds from short-term borrowings 11,250 15,242 24,110
Payments on short-term borrowings (9,825) (17,569) (22,938)
Principal payments on long-term debt (2,424) (2,057) (2,217)
Proceeds from issuance of common stock, net of issuance costs 82,062 -- --
Proceeds from exercise of stock options and Employee Stock
Purchase Plan 1,230 -- --
Cash distributions to stockholders (40,000) (6,150) (12,400)
Principal payments under capital lease obligations (1,050) (1,257) (870)
-------- -------- --------
Net cash provided by (used in) financing activities 41,243 (11,791) (16,190)
-------- -------- --------
Effect of exchange rate changes on cash and cash equivalents (413) (376) 1,394
-------- -------- --------
Increase (decrease) in cash and cash equivalents 24,526 8,677 (1,304)
Cash and cash equivalents at beginning of period 11,188 2,511 3,815
-------- -------- --------
Cash and cash equivalents at end of period $ 35,714 $ 11,188 $ 2,511
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 1,377 $ 1,526 $ 2,030
======== ======== ========
Income taxes $ 10,017 $ 1,608 $ 1,078
======== ======== ========
Noncash transactions during the period:
Equipment acquired under capital leases $ 762 $ 1,138 $ 145
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
15
Notes to Consolidated Financial Statements
(Tables in thousands, except per share data)
1} Description of Business
MKS Instruments, Inc. (the "Company" or "MKS") is a worldwide developer,
manufacturer, and supplier of instruments and components that are used to
measure, control and analyze gases in semiconductor manufacturing and similar
industrial manufacturing processes. The Company's products include pressure and
flow measurement and control instruments; vacuum gauges, valves and components;
and gas analysis instruments. The Company is subject to risks common to
companies in the semiconductor industry including, but not limited to, the
highly cyclical nature of the semiconductor industry leading to recurring
periods of over supply, development by the Company or its competitors of new
technological innovations, dependence on key personnel and the protection of
proprietary technology.
2} Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant intercompany accounts and transactions have
been eliminated in consolidation.
Historical and Pro Forma (Unaudited) Net Income Per Share
The Company computes basic and diluted earnings per share in accordance with
Statement of Financial Accounting Standards No. 128 ("SFAS 128") "Earnings per
Share." SFAS 128 requires both basic earnings per share, which is based on the
weighted average number of common shares outstanding, and diluted earnings per
share, which 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 where the effect of their inclusion would be
dilutive.
Historical net income per share is not meaningful because of the Company's
conversion from an S corporation to a C corporation upon the closing of its
initial public offering. Historical net income has been adjusted for the pro
forma provision for income taxes calculated assuming the Company was subject to
income taxation as a C corporation, at a pro forma tax rate of 38.0% in 1998 and
1997, and at a pro forma tax rate of 37.1% in 1999.
The following is a reconciliation of basic to diluted pro forma and historical
net income per share:
For the Year Ended December 31
--------------------------------------------------------------------------
1999 1998 1997
---------------------- ---------------------- ----------------------
Pro forma Historical Pro forma Historical Pro forma Historical
- ---------------------------------------------------------------------------------------------------------------------------
Net income $18,412 $24,037 $5,044 $7,186 $13,806 $20,290
Shares used in net income per
common share-- basic 22,784 22,784 18,053 18,053 18,053 18,053
Effect of dilutive securities:
Employee and director stock options 1,002 1,170 485 667 209 335
-------------------------------------------------------------------------
Shares used in net income per
common share-- diluted 23,786 23,954 18,538 18,720 18,262 18,388
=========================================================================
Net income per common share-- basic $0.81 $1.05 $0.28 $0.40 $0.76 $1.12
=========================================================================
Net income per common share-- diluted $0.77 $1.00 $0.27 $0.38 $0.76 $1.10
=========================================================================
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 to
purchase 33,500, 24,643 and zero shares of common stock were outstanding during
1999, 1998, and 1997, respectively, but were not included in the calculation of
diluted net income per common share because the option price was greater than
the average market price of the common shares during the period.
Foreign Exchange
The functional currency 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.
Revenue Recognition
The Company recognizes revenue, and accrues for anticipated returns and warranty
costs, upon completion of delivery obligations.
16
35 MKS Instruments 1999
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 equivalents
consist of the following:
December 31,
1999 1998
- ----------------------------------------------------------------------------------------------------------------------------
Cash and Money Market Instruments $22,156 $11,188
Commercial Paper 5,558 --
Federal Government and Government Agency Obligations 6,000 --
Corporate Obligations 2,000 --
---------------------
$35,714 $11,118
====================
Short-term available-for-sale investments maturing within one year consist of
the following:
December 31,
1999 1998
- ----------------------------------------------------------------------------------------------------------------------------
Federal Government and Government Agency Obligations $16,245
Corporate Obligations 5,501
Commercial Paper 4,641
Equity Securities 1,745 $538
--------------------
$28,132 $538
====================
Long-term available-for-sale investments maturing within two years consist of
the following at December 31, 1999:
Federal Government and Government Agency Obligations $1,063
======
The appropriate classification of investments in debt and equity securities is
determined at the time of purchase. Debt securities that the Company has both
the intent and ability to hold to maturity are carried at amortized cost. Debt
securities that the Company does not have the intent and ability to hold to
maturity or equity securities are classified either as "available-for-sale" or
as "trading" and are carried at fair value. Marketable equity securities are
carried at fair value and classified either as available-for-sale or trading.
Unrealized gains and losses on securities classified as available-for-sale are
included in accumulated other comprehensive income in consolidated stockholders'
equity. Unrealized gains and losses on securities classified as trading are
reported in earnings. The cost of securities sold is based on the specific
identification method.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined on the
first-in, first-out method.
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 20 years for buildings and three to five years for machinery and
equipment. Leasehold improvements are amortized over the shorter of the lease
term or the estimated useful life of the leased asset.
Research and Development
Research and development costs are expensed as incurred.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and, if it is, the type of hedge transaction. The Company
adopted the provisions of SFAS No. 133 effective April 1, 1999. The impact of
adopting SFAS No. 133 was the recording of an unrealized loss of $16,000, net of
taxes, in other comprehensive income.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No 101 ("SAB 101"), "Revenue Recognition". SAB 101 summarizes the
staff's view in applying generally accepted accounting principles to revenue
recognition. The application of the guidance in SAB 101 will be required in the
Company's first quarter of the fiscal year 2000. Any effect of applying this
guidance will be reported as a cumulative effect adjustment resulting from a
change in accounting principle. The Company does not expect the application to
have a material affect on its financial statements.
17
36
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the dates of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
3} Financial Instruments and Risk Management
Foreign Exchange Risk Management
The Company adopted the provisions of SFAS No. 133 effective April 1, 1999. 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 underlying forecasted transaction occurs. Once the underlying
forecasted transaction is realized, 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. The Company utilizes an
interest rate swap to fix the interest rate on certain variable term loans in
order to minimize the effect of changes in interest rates on earnings. Since the
adoption of SFAS No. 133 on April 1, 1999, net realized losses recorded in
earnings were $104,000. As of December 31, 1999 the amount that will be
reclassified from accumulated other comprehensive income to earnings over the
next twelve months is an unrealized loss of $228,000, net of taxes. The
ineffective portion of the derivatives is primarily related to option premiums,
and was $307,000 in 1999.
Prior to the adoption of SFAS No. 133, the Company entered into forward exchange
contracts and local currency purchased options to hedge a portion of its
probable anticipated, but not firmly committed transactions. The anticipated
transactions whose risks were being hedged were the intercompany sales of
inventory by the U.S. parent to the foreign subsidiary payable in the foreign
subsidiary's local currency. The time period of the anticipated transactions
that were hedged generally approximated one year. The Company also used forward
exchange contracts to hedge firm commitments. Market value gains and losses on
forward exchange contracts were recognized immediately in earnings unless a firm
commitment existed. Market value gains and premiums on local currency purchased
options on probable anticipated transactions and market value gains and losses
on forward exchange contracts hedging firm commitments were recognized when the
hedged transaction occurred. These contracts, which related primarily to
Japanese and European currencies generally had terms of twelve months or less.
Forward exchange contracts received hedge accounting on firmly committed
transactions when they were designated as a hedge of the designated currency
exposure and were effective in minimizing such exposure. Options received hedge
accounting on probable anticipated transactions when they were designated as a
hedge of the currency exposure and were effective in minimizing such exposure.
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.
Forward exchange contracts with notional amounts totaling $4,000,000,
$8,000,000, and $9,800,000 to exchange foreign currencies for U.S. dollars were
outstanding at December 31, 1999, 1998, and 1997, respectively. Of such forward
exchange contracts, $4,000,000, $7,800,000 and $6,900,000 to exchange Japanese
yen for U.S. dollars, were outstanding at December 31, 1999, 1998, and 1997,
respectively. Local currency purchased options with notional amounts totaling
$11,800,000, $10,221,000, and $12,738,000 to exchange foreign currencies for
U.S. dollars were outstanding at December 31, 1999, 1998, and 1997,
respectively.
Foreign exchange gains of $415,000, foreign exchange losses of $168,000, and
foreign exchange gains of $1,166,000 on forward exchange contracts which did not
qualify for hedge accounting were recognized in earnings during 1999, 1998, and
1997, respectively, and are classified in Other income, net. 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
$104,000 and gains of $310,000 and $1,178,000 for the years ended December 31,
1999, 1998, and 1997, respectively.
The fair values of forward exchange contracts at December 31, 1999 and 1998,
determined by applying period end currency exchange rates to the notional
contract amounts, amounted to an unrealized loss of $547,000 and $349,000,
respectively. The fair values of local currency purchased options at December
31, 1999 and 1998, which were obtained through dealer quotes were immaterial.
The Company recorded a foreign exchange translation gain on intercompany
payables of $1,000,000 and a foreign exchange translation loss on intercompany
payables of $1,000,000 in Other income, net in 1998 and 1997, respectively.
During 1999 the Company has hedged certain intercompany payables with currency
options. Since these derivatives hedge existing amounts that are denominated in
foreign currencies, the options do not qualify for hedge accounting under SFAS
No. 133.
18
37 MKS Instruments 1999
The market risk exposure from forward exchange contracts is assessed in light of
the underlying currency exposures and is controlled by the initiation of
additional or offsetting foreign currency contracts. The market risk exposure
from options is limited to the cost of such investments.
Interest Rate Risk Management
The Company utilizes an interest rate swap to fix the interest rate on certain
variable rate term loans in order to minimize the effect of changes in interest
rates on earnings. In 1998, the Company entered into a four-year interest rate
swap agreement on a declining notional amount basis which coincides with the
scheduled principal payments with a major financial institution for the notional
amount of $10,528,000 equal to the term loans described in Note 6. Under the
agreement, the Company pays a fixed rate of 5.85% on the notional amount and
receives LIBOR. The interest differential payable or accruable on the swap
agreement is recognized on an accrual basis as an adjustment to interest
expense. The criteria used to apply hedge accounting for this interest rate swap
is based upon management designating the swap as a hedge against the variable
rate debt combined with the terms of the swap matching the underlying debt
including the notional amount, the timing of the interest reset dates, the
indices used and the paydates. At December 31, 1999, the fair value of this
interest rate swap, which represents the amount the Company would receive or pay
to terminate the agreement, is a net receivable of $49,000, based on dealer
quotes. The variable rate received on the swap at December 31, 1999 was 6.48%.
The market risk exposure from the interest rate swap is assessed in light of the
underlying interest rate exposures. Credit risk exposure from the swap is
minimized as the agreement is with a major financial institution. The Company
monitors the credit worthiness of this financial institution and full
performance is anticipated.
Concentrations of Credit Risk
The Company's significant concentrations of credit risk consist principally of
cash and cash investments, forward exchange contracts, and trade accounts
receivable. The Company maintains cash and cash equivalents with financial
institutions including the bank it has borrowings with. The Company maintains
cash investments primarily in U.S. Treasury and government agency securities and
corporate debt securities, rated AA or higher, which have minimal credit risk.
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.
4} Inventories
Inventories consist of the following:
December 31
-------------------
1999 1998
- ---------------------------------------------------------------------------------------------------------------------------
Raw material $6,644 $7,544
Work in process 7,026 5,718
Finished goods 13,980 11,202
--------------------
$27,650 $24,464
====================
5} Property, Plant and Equipment
Property, plant and equipment consist of the following:
December 31
1999 1998
- ---------------------------------------------------------------------------------------------------------------------------
Land $9,100 $8,834
Buildings 26,081 26,020
Machinery and equipment 30,175 27,394
Furniture and fixtures 12,968 10,578
Leasehold improvements 1,966 1,814
--------------------
80,290 74,640
Less: accumulated depreciation and amortization 47,464 41,915
--------------------
$32,826 $32,725
====================
6} Debt
Credit Agreements and Short-Term Borrowings
In February 1996, the Company entered into loan agreements with two banks, which
provided access to a revolving credit facility. The revolving credit facility
provided for uncollateralized borrowings up to $30,000,000, and expired on
December 31, 1999. Interest on borrowings was payable quarterly at either the
banks' base rate or the LIBOR Rate, as defined in the agreement, at the
Company's option. At December 31, 1999 and 1998, the Company had no borrowings
under this revolving credit facility.
19
38
Effective January 1, 2000, the Company entered into a loan agreement with the
same two banks, which provides access to a revolving credit facility. The
revolving credit facility provides for uncollateralized borrowings up to
$30,000,000, and expires December 31, 2000. Interest on borrowings is payable
quarterly at either the banks' base rate, or the LIBOR Rate, as defined in the
agreement.
Additionally, certain of the Company's foreign subsidiaries have lines of credit
and short-term borrowing arrangements with various financial institutions which
provide for aggregate borrowings as of December 31, 1999 of up to $17,289,000,
which generally expire and are renewed at six month intervals. At December 31,
1999 and 1998, total borrowings outstanding under these arrangements were
$12,423,000, and $9,687,000, respectively, at interest rates ranging from 1.2%
to 1.7%, and 1.3% to 1.7%, respectively. Foreign short-term borrowings are
generally collateralized by certain trade accounts receivable and are guaranteed
by a domestic bank.
Long-Term Debt
Long-term debt consists of the following:
December 31
-------------------
1999 1998
- ---------------------------------------------------------------------------------------------------------------------------
Term loans $8,862 $10,528
Mortgage notes 2,824 3,572
-------------------
Total long-term debt 11,686 14,100
Less: current portion 7,346 2,058
-------------------
Long-term debt less current portion $4,340 $12,042
===================
On November 1, 1993, the Company entered into a term loan agreement with a bank,
which provided for borrowings of $10,000,000. Principal payments are payable in
equal monthly installments of $56,000 through October 1, 2000, with the
remaining principal payment due on November 1, 2000. The loan is collateralized
by certain land, buildings, and equipment. Interest is payable monthly at either
the bank's base rate, at a rate based on the long-term funds rate, or at the
LIBOR Rate, as defined in the agreement, at the Company's option. On October 31,
1995, the Company also entered into a term loan agreement with the same bank,
which provided additional uncollateralized borrowings of $7,000,000. Principal
payments are payable in equal monthly installments of $83,000 through June 1,
2002, with the remaining principal payment due on June 30, 2002. Interest is
payable monthly at either the bank's base rate or at the LIBOR Rate, as defined
in the agreement, at the Company's option.
At December 31, 1999 and 1998, the interest rates in effect for the term loan
borrowings were 7.40% and 7.131%, respectively.
The terms of the revolving credit facility and term loan agreements, as amended,
contain, among other provisions, requirements for maintaining certain levels of
tangible net worth and other financial ratios. The agreement also contains
restrictions with respect to acquisitions. Under the most restrictive covenant,
the operating cash flow to debt service ratio for a fiscal quarter shall not be
less than 1.25 to 1.0. In the event of default of these covenants or
restrictions, any obligation then outstanding under the loan agreement shall
become payable upon demand by the bank.
The Company has loans outstanding from various foreign banks in the form of
mortgage notes at interest rates ranging from 1.9% to 6.2%. Principal and
interest are payable in monthly installments through 2010. The loans are
collateralized by mortgages on certain of the Company's foreign properties.
Aggregate maturities of long-term debt over the next five years are as follows:
Year ending December 31 Aggregate Maturities
- ---------------------------------------------------------------------------------------------------------------------------
2000 $7,346
2001 1,406
2002 1,327
2003 414
2004 419
Thereafter 774
-------
$11,686
=======
7} Commitments and Contingencies
The Company leases certain of its facilities and machinery and equipment under
capital and operating leases expiring in various years through 2002 and
thereafter. Generally, the facility leases require the Company to pay
maintenance, insurance and real estate taxes. Rental expense under operating
leases totaled $2,950,000, $2,388,000, and $2,478,000 for the years ended
December 31, 1999, 1998, and 1997, respectively.
20
39 MKS Instruments 1999
Minimum lease payments under operating and capital leases are as follows:
Capital
Operating Leases Leases
------------------------ ---------
Year ending December 31, Real Estate Equipment Equipment
- ---------------------------------------------------------------------------------------------------------------------------
2000 $1,875 $515 $1,203
2001 1,062 329 684
2002 207 176 450
2003 130 78 234
2004 52 45 86
Thereafter -- 41 --
-----------------------------------
Total minimum lease payments $3,326 $1,184 $2,657
===================================
Less: amounts representing interest 276
Present value of minimum lease payments 2,381
Less: current portion 1,059
------
Long-term portion $1,322
======
Prior to its initial public offering, the Company entered into a Tax
Indemnification and S Corporation Distribution Agreement with its then existing
stockholders (the "Pre-IPO stockholders"). The agreement includes provisions for
the payment, with interest, by the pre-IPO stockholders or MKS, as the case may
be, for the difference between the $40,000,000 distributed as an estimate of the
amount of the accumulated adjustments account as of April 4, 1999, which is the
date the Company's S Corporation status was terminated, and the actual amount of
the accumulated adjustments account on that day. The actual amount of the
accumulated adjustments account cannot be determined until MKS calculates the
amount of its taxable income for the year ending December 31, 1999. Based on the
Company's estimate of the taxable income for the year ending December 31, 1999,
MKS believes that an additional future distribution to the Pre-IPO stockholders
will be required under this agreement. The amount of the additional
distribution, prior to interest, is currently estimated to be $3,350,000. The
amount of the additional distribution payable has been charged directly to
retained earnings and had no impact on net income or earnings per share. No
shareholders, other than the Pre-IPO stockholders, are parties to the Tax
Indemnification and S Corporation Distribution Agreement.
8} Stockholders' Equity
Common Stock
In March 1999, the Company amended its Articles of Organization to: i) eliminate
the authorized shares of Class A Common Stock and Class B Common Stock; ii)
increase the authorized number of shares of Common Stock to 50,000,000 shares;
iii) authorize 2,000,000 shares of Preferred Stock, $0.01 par value per share;
and iv) provide that each outstanding share of Class A Common Stock and Class B
Common Stock be converted into one share of Common Stock.
On April 5, 1999 the Company closed the initial public offering of its Common
Stock. In connection with this offering and the exercise of an over-allotment
option by the underwriters, the Company sold 6,375,000 shares of Common Stock at
a price of $14.00 per share. The net proceeds to the Company were approximately
$82,000,000. Underwriting discounts and commissions were approximately
$6,200,000 and other offering costs were approximately $1,000,000.
On April 5, 1999 the Company distributed $40,000,000, which was the estimated
amount of the Company's undistributed S corporation earnings as of the day prior
to the closing of the offering.
Stock Purchase Plan
The Company's Amended and Restated 1999 Employee Stock Purchase Plan (the
"Purchase Plan") authorizes the issuance of up to an aggregate of 450,000 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. On November 30, 1999 the Company issued 36,520 shares of
Common Stock to employees who participated in the Purchase Plan, at an exercise
price of $12.94 per share. As of December 31, 1999 there were 413,480 shares
reserved for issuance.
Stock Option Plans
On January 9, 1998, the stockholders of the Company approved the following: (1)
an increase in the number of shares that may be granted under the 1995 Stock
Incentive Plan to 3,750,000 shares of common stock; (2) the adoption of the 1997
Director Stock Option Plan pursuant to which options may be granted to purchase
up to an aggregate of 300,000 shares of common stock; (3) the adoption of the
1997 Employee Stock Purchase Plan pursuant to which the Company may issue up to
an aggregate of 450,000 shares of common stock; and (4) that 3,750,000 shares,
300,000 shares, and 450,000 shares of common stock be reserved for issuance
under the 1995 Stock Incentive Plan, the 1997 Director Stock Option Plan, and
the 1997 Employee Stock Purchase Plan, respectively. The 1997 Employee Stock
Purchase Plan was amended and restated on April 22, 1999, and the Plan's name
was changed to the Amended and Restated 1999 Employee Stock Purchase Plan.
21
40
The Company grants options to employees under the 1995 Stock Incentive Plan (the
"Plan") and to directors under the 1996 Director Stock Option Plan and the 1997
Director Stock Option Plan (the "Director Plans").
At December 31, 1999, 1,029,613 options to purchase shares of the Company's
common stock were reserved for issuance under the Plan. At December 31, 1999,
under the Director Plans, options to purchase 234,000 shares of common stock
were reserved for issuance. Stock options are granted at 100% of the fair value
of the Company's common stock. Generally, stock options under the Plan vest 20%
after one year and 5% per quarter thereafter, and expire 10 years after the
grant date. Under the Director Plans, certain options granted in 1999 vest
immediately. The remainder of the options granted in 1997 and later 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 as defined in the Director Plans.
The following table presents the activity for options under the Plan.
Year Ended December 31
-----------------------------------------------------------------------------------
1999 1998 1997
-----------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding-- beginning of period 2,098,207 $5.20 1,564,449 $4.50 810,442 $4.43
Granted 678,971 16.40 629,969 6.80 785,657 4.57
Exercised (168,162) 4.56 (2) 4.43 -- --
Forfeited or Expired (56,793) 5.76 (96,209) 4.43 (31,650) 4.43
-----------------------------------------------------------------------------------
Outstanding-- end of period 2,552,223 $8.21 2,098,207 $5.20 1,564,449 $4.50
Exercisable at end of period 1,047,748 $4.82 778,473 $4.46 476,451 $4.43
The following table summarizes information with respect to options outstanding
and exercisable under the Plan at December 31, 1999:
Options Outstanding Options Exercisable
---------------------------------------------- ------------------------
Weighted
Weighted Average Weighted
Average Remaining Average
Number of Exercise Contractual Life Number of Exercise
Range of Exercise Prices Shares Price (In Years) Shares Price
- ------------------------------------------------------------------------------------------------------------------------------------
$4.43 - $8.00 1,881,152 $5.27 7.45 1,047,748 $4.82
$13.56 - $14.50 524,571 $14.13 9.28 -- --
$19.00 - $27.25 146,500 $24.63 9.81 -- --
------------------------------------------------------------------------
2,552,223 $8.21 7.96 1,047,748 $4.82
The following table presents activity for options under the Director Plans:
Year Ended December 31
---------------------------------------------------------------------------------
1999 1998 1997
---------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
- ------------------------------------------------------------------------------------------------------------------------------------
Outstanding-- beginning of period 34,368 $4.81 30,748 $4.43 27,128 $4.43
Granted 66,000 14.15 3,620 8.00 3,620 4.43
---------------------------------------------------------------------------------
Outstanding-- end of period 100,368 $10.95 34,368 $4.81 30,748 $4.43
Exercisable at end of period 76,368 $9.86 26,228 $4.43 13,564 $4.43
The following table summarizes information with respect to options outstanding
and exercisable under the Director Plans at December 31, 1999
Options Outstanding Options Exercisable
-------------------------------------------------------------------
Weighted
Weighted Average Weighted
Average Remaining Average
Number of Exercise Contractual Life Number of Exercise
Range of Exercise Prices Shares Price (In Years) Shares Price
- ----------------------------------------------------------------------------------------------------------------------------------
$4.43 - $8.00 34,368 $4.81 6.86 34,368 $4.81
$14.00 - $14.40 66,000 $14.15 9.20 42,000 $14.00
-------------------------------------------------------------------
100,368 $10.95 8.40 76,368 $9.86
22
41 MKS Instruments 1999
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123 (SFAS No. 123), "Accounting for Stock-Based
Compensation." The Company has chosen to continue to account for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and
related interpretations. The Company is required to disclose pro forma net
income and net income per common share amounts had compensation cost for the
Company's stock based compensation plans been determined based on the fair value
at the grant date for awards under the plans. Had compensation expense for the
stock based compensation plans been consistent with the method of SFAS No.
123, the amounts reported for 1999 would have been:
Pro forma for
As Reported SFAS No. 123
- -----------------------------------------------------------------------------------
Historical net income $24,037 $23,098
Historical net income per share:
Basic $1.05 $1.01
Diluted $1.00 $0.96
Pro forma net income $18,412 $17,559
Pro forma net income per share:
Basic $0.81 $0.77
Diluted $0.77 $0.74
The weighted average fair value of options at the date of grant was estimated
using the Black-Scholes model and was $9.54 with the following assumptions in
1999: expected life of 5 years, weighted average interest rate of 5.49%,
expected volatility of 64%, and no dividend yield. Had the fair value based
method prescribed in SFAS No. 123 been used to account for stock-based
compensation cost in 1998 and 1997, there would have been no change in net
income and net income per share from that reported based on the following
assumptions: dividend yield of 8%, interest rate of 5.44% and an expected life
of 8 years.
The fair value of purchase rights granted in 1999 under the Purchase Plan was
$5.11. The fair value of the employees' purchase rights was estimated using the
Black-Scholes model with the following assumption in 1999: expected life of 6
months, interest rate of 4.87%, expected volatility of 64%, and no dividend
yield.
Accumulated Other Comprehensive Income
The balance of accumulated other comprehensive income was comprised of the
following:
Financial
Cumulative Unrealized Instruments Accumulated
Translation Gain on Designated as Other Comprehensive
Adjustments Investments Cash Flow Hedges Income
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 $1,875 $311 -- $2,186
Non-recurring deferred tax charge (497) (163) -- (660)
Foreign currency translation adjustment, net of taxes of $(55) (80) -- -- (80)
Unrealized gain on investments, net of taxes of $377 -- 815 -- 815
Changes in value of financial instruments designated as cash
flow hedges, net of taxes of $(232) -- -- (228) (228)
--------------------------------------------------------------
Balance at December 31, 1999 $1,298 $963 $(228) $2,033
==============================================================
Shareholder Receivable
The Company has an agreement with certain shareholders whereby the Company has
paid the premiums for life insurance policies of the shareholders. The agreement
provides for the reimbursement of the premiums to the Company upon receipt of
proceeds from the policies. The present value discount related to the premiums
is $856,000.
9} Income Taxes
Prior to its initial public offering, the Company was treated as an S
corporation for federal income tax purposes. As an S corporation, the Company
was not subject to federal, and certain state, income taxes. The Company
terminated its S corporation status upon the closing of its initial public
offering in 1999 and became subject to taxes at C corporation tax rates. This
change in tax status and tax rates resulted in a non-recurring, non-cash
deferred tax credit to net income of $3,770,000 and a deferred tax charge to
other comprehensive income of $660,000.
23
42
The Pre-IPO stockholders are liable for individual Federal, and certain state,
income taxes on their allocated portions of the Company's taxable income as an S
corporation. For the tax year ending December 31, 1999, the Pre-IPO stockholders
will be allocated a portion of the Company's 1999 taxable income. A
reconciliation of the Company's 1999 effective tax rate to the U.S. federal
statutory rate follows:
U.S. Federal income tax statutory rate 35.0%
Non-recurring deferred tax credit (12.8)
Pre-IPO stockholder 1999 allocated taxable income (6.8)
State income taxes, net of federal benefit 2.5
Effect of foreign operations taxed at various rates 2.1
Foreign sales corporation tax benefit (1.6)
Other (0.5)
------
17.9%
======
As the Company was not subject to Federal income taxes in 1998 and 1997, a
reconciliation of the effective tax rate to the Federal statutory rate is not
meaningful for those years.
The components of income before income taxes and the historical related
provision for income taxes consist of the following:
Year Ended December 31
---------------------------------
1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
Income before income taxes:
United States $25,590 $6,169 $21,858
Foreign 3,678 1,966 410
--------------------------------
29,268 8,135 22,268
Current taxes:
United States Federal 6,269 -- --
State 1,192 197 1,331
Foreign 1,806 784 792
--------------------------------
9,267 981 2,123
--------------------------------
Deferred taxes:
United States Federal (4,025) -- --
State (27) (39) (72)
Foreign 16 7 (73)
--------------------------------
(4,036) (32) (145)
--------------------------------
Provision for income taxes $5,231 $949 $1,978
================================
At December 31, 1999, 1998, and 1997 the components of the deferred tax asset
and deferred tax liability were as follows:
1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
Deferred tax assets (liabilities):
Inventories $1,434 $265 $344
Intercompany profits 1,362 152 214
Depreciable assets 746 (234) (20)
Compensation 362 127 77
Investment booked under the equity method (557) (59) (41)
Other 250 330 (25)
--------------------------------
Total $3,597 $581 $549
================================
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 from 1% up to 12% of
their compensation. 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 are generally
paid annually, and were $1,182,000 and $2,500,000 for the years ended December
31, 1998 and 1997. Approximately $2,316,000 has been accrued as the estimated
Company contribution for the year ended December 31, 1999 and is included in
accrued compensation.
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. Bonus expense to key employees
was $3,213,000, none and $1,425,000, for the years ended December 31, 1999,
1998, and 1997, respectively.
11} Geographic Financial Information and Significant Customer
See Note 1 for a brief description of the Company's business. The Company is
organized around two similar product lines domestically and by geographic
locations internationally and has three reportable segments: North America, Far
East, and Europe. Net sales to unaffiliated
24
43 MKS Instruments 1999
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. Income from operations consists of total
net sales less operating expenses and does not include either interest income,
interest expense or income taxes. The Company had one customer comprising 22%,
16% and 22% of net sales for the years ended December 31, 1999, 1998, and 1997,
respectively. This data is presented in accordance with SFAS 131, "Disclosures
About Segments of an Enterprise and Related Information," which the Company has
retroactively adopted for all periods presented.
Year Ended December 31, 1999
----------------------------------------------------
North America Far East Europe Total
- ---------------------------------------------------------------------------------------------------------------------------
Net sales to unaffiliated customers $128,562 $38,734 $19,787 $187,083
Intersegment net sales 36,884 706 986 38,576
Depreciation and amortization 5,543 252 414 6,209
Income from operations 24,608 1,413 1,590 27,611
Segment assets 132,971 31,272 10,362 174,605
Long-lived assets 29,656 6,524 2,575 38,755
Capital expenditures 5,013 241 251 5,505
Year Ended December 31, 1998
----------------------------------------------------
North America Far East Europe Total
- ---------------------------------------------------------------------------------------------------------------------------
Net sales to unaffiliated customers $95,607 $23,902 $20,254 $139,763
Intersegment net sales 26,657 290 1,015 27,962
Depreciation and amortization 5,627 210 405 6,242
Income from operations 6,319 1,298 1,518 9,135
Segment assets 65,560 20,768 9,904 96,232
Long-lived assets 28,960 5,655 3,084 37,699
Capital expenditures 2,635 179 323 3,137
Year Ended December 31, 1997
----------------------------------------------------
North America Far East Europe Total
- ---------------------------------------------------------------------------------------------------------------------------
Net sales to unaffiliated customers $138,186 $31,559 $18,335 $188,080
Intersegment net sales 35,429 225 749 36,403
Depreciation and amortization 5,096 259 357 5,712
Income from operations 22,847 886 230 23,963
Segment assets 77,302 19,906 9,328 106,536
Long-lived assets 30,738 4,904 3,015 38,657
Capital expenditures 2,899 128 242 3,269
Included in North America are the United States and Canada. Net sales to
unaffiliated customers from the United States were $128,560,000, $94,449,000 and
$136,653,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
Long-lived assets within the United States amounted to $28,729,000, $28,902,000
and $30,667,000 at December 31, 1999, 1998, and 1997, respectively.
Included in the Far East are Japan, Korea, Singapore and Taiwan. Included in
Europe are Germany, France and the United Kingdom. Net sales to unaffiliated
customers from Japan were $30,696,000, $21,153,000 and $28,184,000 for the years
ended December 31, 1999, 1998 and 1997, respectively. Long-lived assets within
Japan amounted to $6,266,000, $5,431,000 and $4,792,000 at December 31, 1999,
1998 and 1997, respectively.
25
44
Corporate Information
Board of Directors
John R. Bertucci, Chairman and Chief Executive Officer
MKS Instruments, Inc.
Richard S. Chute, Esquire
Hill & Barlow
Owen W. Robbins, Executive Vice President (retired)
Teradyne, Inc.
Robert J. Therrien, President and Chief Executive Officer
Brooks Automation, Inc.
Louis P. Valente, Chairman and Chief Executive Officer
Palomar Medical Technologies, Inc.
Management
John R. Bertucci, Chairman of the Board and Chief
Executive Officer
Dr. Peter R. Younger, President and Chief Operating Officer
Ronald C. Weigner, Vice President and Chief Financial Officer
John J. Sullivan, Executive Vice President, Technology
William D. Stewart, Corporate Vice President and General Manager, Vacuum
Products
Joseph A. Maher, Jr., Corporate Vice President and General Manager, Pressure
Measurement and Control Products
Robert L. Klimm, Corporate Vice President and General Manager, Materials
Delivery and Analysis Products
Leo Berlinghieri, Corporate Vice President,
Customer Support Operations
Paul A. Blackborow, Corporate Vice President, Marketing
Gerald G. Colella, Corporate Vice President,
Business Operations
George E. Manning, Corporate Vice President,
Human Resources
William P. Donlan, Treasurer and Corporate Controller
Business Operations
MKS Instruments, Inc.
Pressure Measurement and Control Products Group
Andover, Massachusetts
MKS Instruments, Inc.
Materials Delivery and Analysis Products Group
Methuen, Massachusetts
MKS Instruments, Inc.
Vacuum Products Group
Boulder, Colorado
MKS Instruments, Inc.
Austin, Texas
MKS Instruments, Inc.
Santa Clara, California
MKS Instruments France s.a.
Le Bourget, France
MKS Instruments Deutschland GmbH
Munich, Germany
MKS Instruments Benelux
Delft, The Netherlands
MKS Instruments, U.K. Ltd.
Altricham, England
Livingston, Scotland
Kildare, Republic of Ireland
MKS Japan, Inc.
Tokyo, Japan
MKS Korea Co., Ltd.
Seoul, Korea
MKS Instruments, Inc. Singapore
Singapore
MKS Instruments, Inc. Taiwan
Hsinchu, Taiwan
Shareholder Information
Stock Listing
NASDAQ National Market, Symbol: MKSI
Transfer Agent and Registrar
BankBoston, N.A.
Boston, Massachusetts
Independent Auditors
PricewaterhouseCoopers LLP
Boston, Massachusetts
Outside Counsel
Hale and Dorr LLP
Boston, Massachusetts
Hill and Barlow
Boston, Massachusetts
Inquiries Concerning the Company
Stockholder inquiries about MKS Instruments may be addressed to Ronald Weigner,
Vice President and Chief Financial Officer, Six Shattuck Road, Andover, MA
01810; or inquiries may be sent through the MKS website at
http://www.mksinst.com.
Licensed Trademarks
Baratron,(R) Mass-Flo,(R) and Orion(R) are registered trademarks of MKS
Instruments, Inc., Andover, MA and are used under license. HPS(TM) is a
trademark of MKS Instruments, Inc., Andover, MA and is used under license.
DeviceNet(TM) is a trademark of the Open DeviceNet Vendor Association. SDS(R) is
a registered trademark of Matheson Tri-Gas and ATMI, Inc.
Annual Meeting
The Company's 2000 Annual Meeting of the shareholders will be held at 10:00 A.M.
on May 17, 2000 at the Andover Country Club, 60 Canterbury Street, Andover,
Massachusetts 01810.