UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(MARK ONE)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission file number 0-23621
MKS INSTRUMENTS, INC.
(Exact name of registrant as specified in its charter)
Massachusetts 04-2277512
- --------------------------------------------------------------------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
90 Industrial Way, Wilmington, Massachusetts 01887
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (978) 284-4000
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ].
Number of shares outstanding of the issuer's common stock as of July 27, 2004:
53,599,846
MKS INSTRUMENTS, INC.
FORM 10-Q
INDEX
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
Consolidated Balance Sheets -
June 30, 2004 and December 31, 2003
Consolidated Statements of Operations -
Three and six months ended June 30, 2004 and 2003
Consolidated Statements of Cash Flows -
Six months ended June 30, 2004 and 2003
Notes to Consolidated Financial Statements
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.
ITEM 4. CONTROLS AND PROCEDURES.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MKS INSTRUMENTS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
June 30, 2004 December 31, 2003
------------- -----------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents ................................ $117,540 $ 74,660
Short-term investments ................................... 72,573 54,518
Trade accounts receivable, net ........................... 89,251 65,454
Inventories .............................................. 105,681 82,013
Other current assets ..................................... 9,286 5,631
-------- --------
Total current assets ................................. 394,331 282,276
Long-term investments .................................... 8,865 13,625
Property, plant and equipment, net ....................... 78,003 76,121
Goodwill, net ............................................ 259,818 259,924
Acquired intangible assets, net .......................... 48,732 56,192
Other assets ............................................. 4,075 4,724
-------- --------
Total assets ......................................... $793,824 $692,862
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings .................................... $ 21,932 $ 17,736
Current portion of long-term debt ........................ 2,134 2,460
Accounts payable ......................................... 31,003 25,302
Accrued compensation ..................................... 12,484 7,711
Income taxes payable ..................................... 12,324 --
Other accrued expenses ................................... 23,519 18,599
-------- --------
Total current liabilities ............................ 103,396 71,808
Long-term debt ............................................... 7,477 8,924
Other liabilities ............................................ 4,047 3,820
Commitments and contingencies (Note 10)
Stockholders' equity:
Preferred Stock, $0.01 par value, 2,000,000 shares
authorized; none issued and outstanding .............. -- --
Common Stock, no par value, 200,000,000 shares authorized;
53,596,907 and 52,040,019 issued and outstanding at
June 30, 2004 and December 31, 2003, respectively .... 113 113
Additional paid-in capital ............................... 624,347 587,910
Retained earnings ........................................ 45,812 12,238
Accumulated other comprehensive income ................... 8,632 8,049
-------- --------
Total stockholders' equity ........................... 678,904 608,310
-------- --------
Total liabilities and stockholders' equity ........... $793,824 $692,862
======== ========
The accompanying notes are an integral part of the consolidated
financial statements.
3
MKS INSTRUMENTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
--------- --------- --------- ---------
Net sales .......................................... $ 151,585 $ 81,168 $ 284,570 $ 153,945
Cost of sales ...................................... 90,192 53,723 168,948 101,094
--------- --------- --------- ---------
Gross profit ....................................... 61,393 27,445 115,622 52,851
Research and development ........................... 14,620 11,453 28,956 22,685
Selling, general and administrative ................ 22,661 17,459 42,813 35,278
Amortization of acquired intangible assets ......... 3,691 3,617 7,384 7,395
Restructuring, asset impairment and other charges .. -- 304 437 304
--------- --------- --------- ---------
Income (loss) from operations ...................... 20,421 (5,388) 36,032 (12,811)
Interest expense ................................... 132 259 284 547
Interest income .................................... 458 541 882 1,109
Other income ....................................... 5,402 -- 5,402 --
--------- --------- --------- ---------
Income (loss) before income taxes .................. 26,149 (5,106) 42,032 (12,249)
Provision for income taxes ......................... 5,281 364 8,458 651
--------- --------- --------- ---------
Net income (loss) .................................. $ 20,868 $ (5,470) $ 33,574 $ (12,900)
========= ========= ========= =========
Net income (loss) per share:
Basic ......................................... $ 0.39 $ (0.11) $ 0.63 $ (0.25)
========= ========= ========= =========
Diluted ....................................... $ 0.38 $ (0.11) $ 0.61 $ (0.25)
========= ========= ========= =========
Weighted average common shares outstanding:
Basic ......................................... 53,540 51,419 53,398 51,399
========= ========= ========= =========
Diluted ....................................... 54,967 51,419 55,026 51,399
========= ========= ========= =========
The accompanying notes are an integral part of the consolidated
financial statements.
4
MKS INSTRUMENTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Six Months Ended
June 30,
2004 2003
--------- ---------
Cash flows from operating activities:
Net income (loss) .................................................................... $ 33,574 $ (12,900)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization ................................................... 13,900 14,971
Gain on collection of a note receivable ......................................... (5,042) --
Gain on the sale of assets ...................................................... (371) --
Other ........................................................................... 290 (71)
Changes in operating assets and liabilities:
Trade accounts receivable ................................................... (24,257) (5,028)
Inventories ................................................................. (23,904) (984)
Other current assets ........................................................ (3,655) (393)
Accrued expenses and other current liabilities .............................. 11,265 (3,178)
Accounts payable ............................................................ 5,712 2,714
Income taxes payable ........................................................ 12,343 172
--------- ---------
Net cash provided by (used in) operating activities .................................. 19,855 (4,697)
--------- ---------
Cash flows from investing activities:
Purchases of short-term and long-term available for sale investments ............. (61,722) (42,347)
Maturities and sales of short-term and long-term available for sale investments .. 48,510 31,345
Purchases of property, plant and equipment ....................................... (9,189) (3,002)
Proceeds from sale of property, plant and equipment .............................. 1,202 --
Proceeds from collection of a note receivable .................................... 5,042 --
Other ............................................................................ 750 422
--------- ---------
Net cash used in investing activities ................................................ (15,407) (13,582)
--------- ---------
Cash flows from financing activities:
Proceeds from short-term borrowings .............................................. 46,271 23,517
Payments on short-term borrowings ................................................ (41,644) (24,734)
Principal payments on long-term debt ............................................. (1,778) (3,555)
Proceeds from issuance of common stock, net of issuance costs .................... 32,550 --
Proceeds from exercise of stock options and employee stock purchase plan ......... 3,887 1,364
--------- ---------
Net cash provided by (used in) financing activities .................................. 39,286 (3,408)
--------- ---------
Effect of exchange rate changes on cash and cash equivalents ......................... (854) 1,357
--------- ---------
Increase (decrease) in cash and cash equivalents ..................................... 42,880 (20,330)
Cash and cash equivalents at beginning of period ..................................... 74,660 88,820
--------- ---------
Cash and cash equivalents at end of period ........................................... $ 117,540 $ 68,490
========= =========
The accompanying notes are an integral part of the consolidated
financial statements.
5
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tables in thousands, except per share data)
1) Basis of Presentation
The terms "MKS" and the "Company" refer to MKS Instruments, Inc. and
its subsidiaries. The interim financial data as of June 30, 2004 and
for the three and six months ended June 30, 2004 and 2003 is unaudited;
however, in the opinion of MKS, the interim data includes all
adjustments, consisting only of normal recurring adjustments, necessary
for a fair statement of the results for the interim periods. The
unaudited consolidated financial statements presented herein have been
prepared in accordance with the instructions to Form 10-Q and do not
include all of the information and note disclosures required by
generally accepted accounting principles. The consolidated financial
statements should be read in conjunction with the December 31, 2003
audited consolidated financial statements and notes thereto included in
the MKS Annual Report on Form 10-K filed with the Securities and
Exchange Commission on March 11, 2004.
The preparation of these consolidated financial statements requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent
liabilities at the date of the consolidated financial statements and
the reported amounts of revenues and expenses during the reporting
period. On an on-going basis, management evaluates its estimates and
judgments, including those related to revenue recognition, accounts
receivable, inventory, intangible assets, goodwill, other long-lived
assets, income taxes, deferred tax valuation allowance, and
investments. Management bases its estimates and judgments on historical
experience and on various other factors that are believed to be
reasonable under the circumstances, the results of which form the basis
for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions.
2) Stock-Based Compensation
The Company has several stock-based employee compensation plans. The
Company accounts for stock-based awards to employees using the
intrinsic value method as prescribed by Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. Accordingly, no compensation expense is
recorded for options issued to employees in fixed amounts with fixed
exercise prices at least equal to the fair market value of the
Company's common stock at the date of grant. The Company has adopted
the provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS
No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure," through disclosure only.
The following table illustrates the effect on net income (loss) and net
income (loss) per share if the Company had applied the fair value
recognition provisions of SFAS No. 123 to stock-based employee awards.
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
------- -------- ---------- ----------
Net income (loss):
Net income (loss) as reported .................. $20,868 $ (5,470) $ 33,574 $ (12,900)
Deduct: Total stock-based employee compensation
expense determined under the fair-value-based
method for all awards, net of tax ............ (5,876) (5,138) (11,950) (10,040)
------- -------- ---------- ----------
Pro forma net income (loss) .................... $14,992 $(10,608) $ 21,624 $ (22,940)
======= ======== ========== ==========
Basic net income (loss) per share:
Net income (loss) as reported .................. $ 0.39 $ (0.11) $ 0.63 $ (0.25)
======= ======== ========== ==========
Pro forma net income (loss) .................... $ 0.28 $ (0.21) $ 0.40 $ (0.45)
======= ======== ========== ==========
Diluted net income (loss) per share:
Net income (loss) as reported .................. $ 0.38 $ (0.11) $ 0.61 $ (0.25)
======= ======== ========== ==========
Pro forma net income (loss) .................... $ 0.27 $ (0.21) $ 0.39 $ (0.45)
======= ======== ========== ==========
6
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
There is no tax benefit included in the stock-based employee
compensation expense determined under the fair-value-based method for
the three and six months ended June 30, 2004 and 2003, respectively, as
the Company established a full valuation allowance for its net deferred
tax assets.
3) Goodwill and Intangible Assets
Intangible Assets
Acquired amortizable intangible assets consisted of the following as of
June 30, 2004:
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
------ ------------ ------
Completed technology ....................... $ 72,484 $(33,812) $ 38,672
Customer relationships ..................... 6,640 (3,122) 3,518
Patents, trademarks, tradenames and other .. 12,394 (5,852) 6,542
-------- -------- --------
$ 91,518 $(42,786) $ 48,732
======== ======== ========
Acquired amortizable intangible assets consisted of the following as of
December 31, 2003:
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
------ ------------ ------
Completed technology ....................... $ 72,563 $(27,654) $ 44,909
Customer relationships ..................... 6,640 (2,663) 3,977
Patents, trademarks, tradenames and other .. 12,394 (5,088) 7,306
-------- -------- --------
$ 91,597 $(35,405) $ 56,192
======== ======== ========
Aggregate amortization expense related to acquired intangibles for the
three and six months ended June 30, 2004 was $3,691,000 and $7,384,000,
respectively. Aggregate amortization expense related to acquired
intangibles for the three and six months ended June 30, 2003 was
$3,617,000 and $7,395,000, respectively. Estimated amortization expense
related to acquired intangibles for the remainder of 2004 and each of
the four succeeding fiscal years is as follows:
Year Amount
---- ------
2004 $ 7,382
2005 13,864
2006 11,763
2007 11,129
2008 2,759
Goodwill
The change in the carrying amount of goodwill during the three and six
months ended June 30, 2004 was not material.
7
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
4) Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net
income (loss) per share:
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
---------- ---------- ---------- --------
Numerator
Net income (loss) .................................. $ 20,868 $ (5,470) $ 33,574 $(12,900)
========== ========== ========== ========
Denominator
Shares used in net loss per common share - basic ..... 53,540 51,419 53,398 51,399
Effect of dilutive securities:
Stock options and employee stock purchase plan .. 1,427 -- 1,628 --
========== ========== ========== ========
Shares used in net income (loss) per common share -
diluted ............................................ 54,967 51,419 55,026 51,399
========== ========== ========== ========
Net income (loss) per common share
Basic ............................................. $ 0.39 $ (0.11) $ 0.63 $ (0.25)
========== ========== ========== ========
Diluted ........................................... $ 0.38 $ (0.11) $ 0.61 $ (0.25)
========== ========== ========== ========
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, as
the effect would be anti-dilutive. All options outstanding during the
three and six months ended June 30, 2003 are excluded from the
calculation of diluted net loss per common share because their
inclusion would be anti-dilutive. There were options to purchase
approximately 8,862,000 and 8,218,000 shares of the Company's common
stock outstanding as of June 30, 2004 and 2003, respectively.
5) Cash and Cash Equivalents and Investments
All highly liquid investments with an original maturity of three months
or less at the date of purchase are considered to be cash equivalents.
Cash and cash equivalents consists of the following:
June 30, December 31,
2004 2003
-------- --------
Cash and money market instruments ..................... $ 73,764 $ 60,869
Commercial paper ...................................... 40,897 12,645
Federal government and government agency obligations .. 2,879 876
Corporate obligations ................................. -- 270
-------- --------
$117,540 $ 74,660
======== ========
The fair value of short-term available-for-sale investments maturing
within one year consists of the following:
June 30, December 31,
2004 2003
------- -------
Federal government and government agency obligations .. $58,420 $41,566
Commercial paper ...................................... 1,953 10,449
Corporate obligations ................................. 12,200 2,503
------- -------
$72,573 $54,518
======= =======
8
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
The fair value of long-term available-for-sale investments with
maturities greater than 1 year consists of the following:
June 30, December 31,
2004 2003
------- -------
Corporate obligations ................................. $ 5,625 $ 5,499
Federal government and government agency obligations .. 3,240 4,807
Commercial paper ...................................... -- 3,319
------- -------
$ 8,865 $13,625
======= =======
The appropriate classification of investments in securities is
determined at the time of purchase. Debt securities that the Company
does not have the intent and ability to hold to maturity are classified
as "available-for-sale" and are carried at fair value. Unrealized gains
and losses on securities classified as available-for-sale are included
in accumulated other comprehensive income in consolidated stockholders'
equity. Gross unrealized gains and gross unrealized losses on
available-for-sale investments were not material at June 30, 2004 and
December 31, 2003.
6) Inventories
Inventories consist of the following:
June 30, December 31,
2004 2003
-------- --------
Raw material ............... $ 45,274 $ 36,834
Work in process ............ 24,017 15,786
Finished goods ............. 36,390 29,393
-------- --------
$105,681 $ 82,013
======== ========
7) Stockholders' Equity
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
-------- -------- -------- --------
Net income (loss) ...................................... $ 20,868 $ (5,470) $ 33,574 $(12,900)
Other comprehensive income, net of taxes of $0:
Changes in value of financial instruments designated
as hedges of currency ............................ 1,398 258 1,908 161
Foreign currency translation adjustment ............ (1,406) 1,455 (1,352) 2,225
Unrealized gain (loss) on investments .............. 1 (13) 27 (12)
-------- -------- -------- --------
Other comprehensive income (loss), net of taxes ........ (7) 1,700 583 2,374
-------- -------- -------- --------
Total comprehensive income (loss) ...................... $ 20,861 $ (3,770) $ 34,157 $(10,526)
======== ======== ======== ========
Common Stock Offering
On January 21, 2004, the Company issued 1,142,857 shares of its common
stock at $26.25 per share through a public offering. Proceeds of the
offering, net of underwriters' discount and offering expenses, were
approximately $28,252,000. On January 23, 2004, the underwriters
exercised their over-allotment option and therefore, the Company issued
an additional 171,429 shares of its common stock, which generated net
proceeds of approximately $4,298,000.
9
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
8) Income Taxes
The Company records income taxes using the asset and liability method.
Deferred income tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
consolidated financial statement carrying amounts of existing assets
and liabilities and their respective income tax bases, and operating
loss and tax credit carryforwards. The Company evaluates the
realizability of its net deferred tax assets and assesses the need for
a valuation allowance on a quarterly basis. The future benefit to be
derived from its deferred tax assets is dependent upon its ability to
generate sufficient future taxable income to realize the assets. The
Company records a valuation allowance to reduce its net deferred tax
assets to the amount that may be more likely than not to be realized.
To the extent the Company establishes a valuation allowance, an expense
will be recorded within the provision for income taxes line on the
consolidated statements of operations.
As a result of incurring significant operating losses from 2001 through
2003, the Company determined that it is more likely than not that its
deferred tax assets may not be realized. During the fourth quarter of
2002, the Company established a full valuation allowance for its net
deferred tax assets. At June 30, 2004 and December 31, 2003, the
Company continued to believe that it is more likely than not that all
of its deferred tax assets may not be realized. If the Company
generates sustained future taxable income against which these tax
attributes may be applied, some portion or all of the valuation
allowance would be reversed. If the valuation allowance were reversed,
a portion would be recorded as a reduction of goodwill, an additional
amount would be recorded as an increase to additional paid in capital
and the remainder would be recorded as a reduction to income tax
expense. During the three and six months ended June 30, 2004, the
Company's estimated U.S. federal tax liability has been offset by the
benefit from U.S. net operating loss carryforwards. The tax rate for
the three and six months ended June 30, 2004 differs from the U.S.
statutory rate primarily due to the release of the valuation allowance
associated with the utilization of the prior federal net operating
loss.
9) Segment Information and Significant Customer
The Company operates in one segment for the development, manufacturing,
sales and servicing of instruments, components, subsystems and process
control solutions that measure, control, power and monitor critical
parameters of semiconductor and other advanced manufacturing processes.
The Company's chief decision-maker reviews operating results to make
decisions about allocating resources and assessing performance for the
entire Company.
Information about the Company's operations in different geographic
regions is presented in the tables below. Net sales to unaffiliated
customers are based on the location in which the sale originated.
Transfers between geographic areas are at negotiated transfer prices
and have been eliminated from consolidated net sales.
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
-------- -------- -------- --------
Geographic net sales
United States ... $102,943 $ 47,813 $187,919 $ 90,938
Japan ........... 21,443 11,962 42,798 25,355
Europe .......... 13,542 10,851 25,063 20,187
Asia ............ 13,657 10,542 28,790 17,465
-------- -------- -------- --------
$151,585 $ 81,168 $284,570 $153,945
======== ======== ======== ========
10
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
June 30, December 31,
2004 2003
------- -------
Long-lived assets:
United States ............ $68,165 $65,977
Japan .................... 5,791 5,978
Europe ................... 4,778 5,541
Asia ..................... 3,344 3,349
------- -------
$82,078 $80,845
======= =======
The Company had one customer comprising 22% and 18% of net sales for
the three months ended June 30, 2004 and 2003, respectively, and 21%
and 17% for the six months ended June 30, 2004 and 2003, respectively.
10) Commitments and Contingencies
On July 12, 2004, Advanced Energy Industries, Inc. ("Advanced Energy")
filed suit against MKS in federal district court in Delaware, seeking
injunctive relief and damages for alleged infringement of a patent held
by Advanced Energy. The Company is currently evaluating the merits of
the claim. The Company cannot be certain of the outcome of this
litigation, but does plan to oppose the claims vigorously.
On January 12, 2004, Gas Research Institute ("GRI") brought suit in
federal district court in Illinois against the Company, On-Line
Technologies, Inc. ("On-Line") which we acquired in 2001, and another
defendant, Advanced Fuel Research, Inc. ("AFR"), for breach of
contract, misappropriation of trade secrets and related claims relating
to certain infra-red gas analysis technology allegedly developed under
a January 1995 Contract for Research between GRI and AFR. The
technology is alleged to have been incorporated into certain of the
Company's products. GRI has made claims for damages, exemplary damages,
attorney's fees and costs and injunctive relief. The Company has filed
an answer, denying liability and asserting various defenses to GRI's
claims. The Company has also asserted a cross-claim against
co-defendant AFR, alleging misrepresentation, breach of contract and
breach of various duties owed by AFR, and alleging that in the event
the Company and On-Line are held liable to GRI, AFR would be required
to reimburse, indemnify, and hold harmless On-Line and the Company for
any such liability. AFR has filed a motion to dismiss the action for
lack of personal jurisdiction or, in the alternative, to transfer the
case to another federal court, which motion is pending. The case is in
its initial stages and the Company is unable to predict its outcome.
On April 3, 2003, Advanced Energy filed suit against MKS in federal
district court in Colorado ("Colorado Action"), seeking a declaratory
judgment that Advanced Energy's Xstream product does not infringe three
patents held by the Company's subsidiary Applied Science and
Technology, Inc. ("ASTeX"). On May 14, 2003, MKS brought suit in
federal district court in Delaware against Advanced Energy for
infringement of five ASTeX patents, including the three patents at
issue in the Colorado Action. The Company sought injunctive relief and
damages for Advanced Energy's infringement. On December 24, 2003, the
Colorado court granted the Company's motion to transfer Advanced
Energy's Colorado Action to Delaware. In connection with the jury
trial, the parties agreed to present the jury with representative
claims from three of the five ASTeX patents. On July 23, 2004, the jury
found that Advanced Energy infringed all three patents. The Company has
filed a motion for a permanent injunction, which is pending before the
court. The parties are awaiting the court to set a trial date with
respect to damages.
11
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
On November 3, 1999, On-Line brought suit in federal district court in
Connecticut against Perkin-Elmer, Inc. and certain other defendants for
infringement of On-Line's patent related to its FTIR spectrometer
product. The suit sought injunctive relief and damages for
infringement. Perkin-Elmer, Inc. filed a counterclaim seeking
invalidity of the patent, costs, and attorneys' fees. In June 2002, the
defendants filed a motion for summary judgment. In April 2003, the
court granted the motion and dismissed the case. On August 5, 2004, we
argued our appeal of this decision before the federal circuit court of
appeals and are awaiting a decision.
The Company is subject to other legal proceedings and claims, which
have arisen in the ordinary course of business.
In the opinion of management, the ultimate disposition of these matters
will not have a material adverse effect on the Company's results of
operations, financial condition or cash flows.
11) Restructuring, Asset Impairment and Other Charges
During the first quarter of 2004, the Company completed its
consolidation of acquisitions, which was initiated in 2002 to
accelerate product development, rationalize manufacturing operations
and reduce operating costs. The Company recorded restructuring charges
of $437,000 related to lease costs of exited facilities.
During the three months ended June 30, 2003, the Company recorded
restructuring, asset impairment and other charges of $304,000 related
to the consolidation of previous acquisitions. The charges consisted of
$112,000 of severance costs related to workforce reductions, an asset
impairment charge of $92,000 primarily for assets to be disposed and
$100,000 of professional fees related to the consolidation.
The following table sets forth the activity in the restructuring
accruals from December 31, 2003 to June 30, 2004:
Workforce Facility
Reductions Consolidations Total
---------- -------------- -----
Balance as of December 31, 2003 ........ $ 199 $ 1,831 $ 2,030
Restructuring provision in
first quarter ....................... -- 437 437
Charges utilized in first quarter ...... (15) (226) (241)
------- ------- -------
Balance as of March 31, 2004 ........... 184 2,042 2,226
Charges utilized in second quarter ..... (95) (276) (371)
------- ------- -------
Balance as of June 30, 2004 ............ $ 89 $ 1,766 $ 1,855
======= ======= =======
The remaining accruals for workforce reductions are expected to be paid
by the end of 2004. The facilities consolidation charges will be paid
over the respective lease terms, the latest of which ends in 2008. The
accruals for severance costs and lease payments is recorded in Other
accrued expenses and Other liabilities in the consolidated balance
sheets.
12) Product Warranties
The Company provides for the estimated costs to fulfill customer
warranty obligations upon the recognition of the related revenue. While
the Company engages in extensive product quality programs and
processes, including actively monitoring and evaluating the quality of
its component suppliers, the Company's warranty obligation is affected
by product failure rates, utilization levels, material usage, and
supplier warranties on parts delivered to the Company. Should actual
product failure rates, utilization levels, material usage, or supplier
warranties on parts differ from the Company's estimates, revisions to
the estimated warranty liability would be required.
12
MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Tables in thousands, except per share data)
Product warranty activity for the six months ended June 30 was as
follows:
2004 2003
------- -------
Balance at beginning of year ............................. $ 5,804 $ 6,921
Provisions for product warranties during the period ...... 4,509 1,064
Direct charges to the warranty liability during
the period ............................................ (2,726) (1,839)
------- -------
Balance as of June 30 .................................... $ 7,587 $ 6,146
======= =======
13) Other Income
During the second quarter of 2004, the Company received $5,042,000
related to the collection of a note receivable that had been written
off in the third quarter of 2002. This amount was recorded as a gain
and included in Other income in the consolidated statements of
operations for the three and six months ended June 30, 2004,
respectively.
13
MKS INSTRUMENTS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
We believe that this Quarterly Report on Form 10-Q contains
"forward-looking statements" within the meaning of The Private Securities
Litigation Reform Act of 1995. When used herein, the words "believes,"
"anticipates," "plans," "expects," "estimates" and similar expressions are
intended to identify forward-looking statements. These forward-looking
statements reflect management's current opinions and are subject to certain
risks and uncertainties that could cause results to differ materially from those
stated or implied. We assume no obligation to update this information. Risks and
uncertainties include, but are not limited to, those discussed in the section in
this Report entitled "Factors That May Affect Future Results."
OVERVIEW
We are a leading worldwide provider of instruments, components,
subsystems and process control solutions that measure, control, power and
monitor critical parameters of semiconductor and other advanced manufacturing
processes.
We are managed as one operating segment which is organized around three
product groups: Instruments and Control Systems, Power and Reactive Gas
Products, and Vacuum Products. Our products are derived from our core
competencies in pressure measurement and control, materials delivery, gas and
thin-film composition analysis, control and information management, power and
reactive gas generation and vacuum technology. Our products are used to
manufacture semiconductors and thin film coatings for diverse markets such as
flat panel displays, optical and magnetic storage media, architectural glass,
and electro-optical products. We also provide technologies for medical imaging
equipment.
Our customers include semiconductor capital equipment manufacturers,
semiconductor device manufacturers, industrial manufacturing companies, medical
equipment manufacturers and university, government and industrial research
laboratories. For the six months ended June 30, 2004 and the full year ended
December 31, 2003, we estimate that approximately 79% and 69% of our net sales,
respectively, were to semiconductor capital equipment manufacturers and
semiconductor device manufacturers.
During the latter half of 2003 and continuing into 2004, the
semiconductor capital equipment market experienced a market upturn after almost
a three-year downturn. Starting in the fourth quarter of 2003, we have
experienced an increase in orders and shipments and as a result, have returned
to profitability. The semiconductor capital equipment industry has been very
cyclical, and we cannot determine how long this recent improvement will last.
A portion of our sales is to operations in international markets.
International sales include sales by our foreign subsidiaries, but exclude
direct export sales. For the six months ended June 30, 2004 and full year ended
December 31, 2003, international sales accounted for approximately 34% and 41%
of net sales, respectively.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our consolidated financial statements and related
disclosures in conformity with accounting principles generally accepted in the
United States of America requires management to make judgments, assumptions and
estimates that affect the amounts reported. There have been no material changes
in our critical accounting policies since December 31, 2003. See the discussion
of critical accounting policies in our Annual Report on Form 10-K for the year
ended December 31, 2003.
14
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage
of total net sales of certain line items included in MKS' consolidated
statements of operations data.
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
------ ------ ------ ------
Net sales ....................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales ................................... 59.5 66.2 59.4 65.7
------ ------ ------ ------
Gross profit .................................... 40.5 33.8 40.6 34.3
Research and development ........................ 9.6 14.1 10.2 14.7
Selling, general and administrative ............. 15.0 21.5 15.0 22.9
Amortization of acquired intangible assets ...... 2.4 4.4 2.6 4.8
Restructuring, asset impairment and
other charges ................................ -- 0.4 0.1 0.2
------ ------ ------ ------
Income (loss) from operations ................... 13.5 (6.6) 12.7 (8.3)
Interest income, net ............................ 0.2 0.3 0.2 0.3
Other income (expense), net ..................... 3.6 -- 1.9 --
------ ------ ------ ------
Income (loss) before income taxes ............... 17.3 (6.3) 14.8 (8.0)
Provision for income taxes ...................... 3.5 0.4 3.0 0.4
------ ------ ------ ------
Net income (loss) ............................... 13.8% (6.7)% 11.8% (8.4)%
====== ====== ====== ======
Net Sales. Net sales for the three months ended June 30, 2004 increased
$70.4 million or 87% to $151.6 million from $81.2 million for the three months
ended June 30, 2003. The increase was due mainly to stronger worldwide demand
from our semiconductor capital equipment manufacturer and semiconductor device
manufacturer customers, which increased $67.4 million or 127% compared to the
prior year. International net sales were $48.6 million for the three months
ended June 30, 2004 or 32.1% of net sales compared to $33.4 million for the same
period of 2003 or 41.1% of net sales.
Net sales for the six months ended June 30, 2004 increased $130.6
million or 85% to $284.6 million from $153.9 million for the six months ended
June 30, 2003. The increase was due mainly to stronger worldwide demand from our
semiconductor capital equipment manufacturer and semiconductor device
manufacturer customers, which increased $122.7 million or 121% compared to the
prior year. International net sales were $96.7 million for the six months ended
June 30, 2004 or 34.0% of net sales compared to $63.0 million for the same
period of 2003 or 40.9% of net sales.
Gross Profit. Gross profit as a percentage of net sales increased to
40.5% for the three months ended June 30, 2004 from 33.8% for the three months
ended June 30, 2003. The increase was mainly due to overhead being a lower
percentage of net sales. In addition, the gross profit for the three months
ended June 30, 2004 was positively impacted by approximately $1.0 million from
the sale of inventory previously deemed excess and written down to net
realizable value, and negatively impacted by $2.1 million of increased warranty
charges.
For the six months ended June 30, 2004 gross profit increased to 40.6%
from 34.3% for the six months ended June 30, 2003. The increase was mainly due
to overhead being a lower percentage of net sales. In addition, gross profit for
the six months ended June 30, 2004 was positively impacted by approximately $1.3
million from the sale of inventory previously deemed excess and written down to
net realizable value, and negatively impacted by $3.4 million of increased
warranty charges.
Research and Development. Research and development expense for the
three months ended June 30, 2004 increased $3.2 million or 28% to $14.6 million
or 9.6% of net sales from $11.5 million or 14.1% of net sales for the three
months ended June 30, 2003. The increase was primarily due to increased
compensation expense of $1.6 million as a result of higher staffing levels,
restored compensation levels, salary increases and incentive compensation and
$1.1 million of higher project material expenses.
15
Research and development expense for the six months ended June 30, 2004
increased $6.3 million or 27.6% to $29.0 million or 10.2% of net sales from
$22.7 million or 14.7% of net sales for the six months ended June 30, 2003. The
increase was primarily due to increased compensation expense of $3.2 million as
a result of higher staffing levels, restored compensation levels, salary
increases and incentive compensation, $2.2 million of higher project material
expenses and $0.6 million of increased consulting costs.
Selling, General and Administrative. Selling, general and
administrative expenses for the three months ended June 30, 2004 increased $5.2
million or 29.8% to $22.7 million or 14.9% of net sales from $17.5 million or
21.5% of net sales for the three months ended June 30, 2003. The increase was
primarily due to higher compensation expense of $2.1 million as a result of
restored compensation levels, salary increases, incentive compensation and
higher sales commissions, $1.4 million related to foreign exchange, $0.4 million
increase in advertising and promotional expenses and a $0.4 million increase in
professional fees.
Selling, general and administrative expenses for the six months ended
June 30, 2004 increased $7.5 million or 21.4% to $42.8 million or 15.0% of net
sales from $35.3 million or 22.9% of net sales for the six months ended June 30,
2003. The increase was primarily due to higher compensation expense of $4.6
million as a result of restored compensation levels, salary increases, incentive
compensation and higher sales commissions, $1.1 million increase in professional
fees and a $0.5 million increase in advertising and promotional expenses.
Amortization of Acquired Intangible Assets. Amortization expense of
$3.7 million and $7.4 million for the three and six months ended June 30, 2004,
respectively, represents the amortization of the identifiable intangibles
resulting from our completed acquisitions. Amortization of identifiable
intangibles was $3.6 million and $7.4 million for the three and six months ended
June 30, 2003, respectively.
Restructuring, Asset Impairment and Other Charges. During the first
quarter of 2004, we completed our consolidation of acquisitions, which was
initiated in 2002 to accelerate product development, rationalize manufacturing
operations and reduce operating costs. We recorded restructuring charges of $0.4
million related to lease costs of exited facilities. There were no restructuring
charges during the second quarter of 2004.
During the three months ended June 30, 2003, we recorded restructuring,
asset impairment and other charges of $0.3 million related to the consolidation
of previous acquisitions. The charges consisted of $0.1 million of severance
costs related to workforce reductions, an asset impairment charge of $0.1
million primarily for assets to be disposed and $0.1 million of professional
fees related to the consolidation.
The following table sets forth the activity in the restructuring
accruals from December 31, 2003 to June 30, 2004:
Workforce Facility
Reductions Consolidations Total
---------- -------------- -----
(in thousands)
Balance as of December 31, 2003 ........ $ 199 $ 1,831 $ 2,030
Restructuring provision in
first quarter ....................... -- 437 437
Charges utilized in first quarter ...... (15) (226) (241)
------- ------- -------
Balance as of March 31, 2004 ........... 184 2,042 2,226
Charges utilized in second quarter ..... (95) (276) (371)
------- ------- -------
Balance as of June 30, 2004 ............ $ 89 $ 1,766 $ 1,855
======= ======= =======
The remaining accruals for workforce reductions are expected to be paid
by the end of 2004. The facilities consolidation charges will be paid over the
respective lease terms, the latest of which ends in 2008. The accrual for
severance costs and lease payments is recorded in Other accrued expenses and
Other liabilities.
Interest Income, Net. During the three and six months ended June 30,
2004, the Company generated net interest income of $0.3 million and $0.6
million, respectively, which are comparable to the $0.3 million and $0.6 million
for the three and six months ended June 30, 2003, respectively.
16
Other Income. Other income of $5.4 million for the three and six months
ended June 30, 2004, consisted primarily of a gain of $5.0 million related to
the collection of a note receivable that was written off in 2002.
Provision for Income Taxes. As a result of incurring significant
operating losses from 2001 through 2003, we determined that it is more likely
than not that our deferred tax assets may not be realized, and since the fourth
quarter of 2002 have established a full valuation allowance for our net deferred
tax assets. If we generate sustained future taxable income against which these
tax attributes may be applied, some portion or all of the valuation allowance
would be reversed. If the valuation allowance were reversed, a portion would be
recorded as a reduction of goodwill, an additional amount would be recorded as
an increase to additional paid in capital, and the remainder would be recorded
as a reduction to income tax expense.
We recorded a provision for income taxes of $5.3 million and $8.5
million for the three and six months ended June 30, 2004, respectively, as
compared to a provision of $0.4 million and $0.7 million for the three and six
months ended June 30, 2003, respectively. During the three and six months ended
June 30, 2004, our estimated U.S. federal tax liability has been offset by the
benefit from U.S. net operating loss carryforwards. The tax rate for the three
and six months ended June 30, 2004 differs from the U.S. statutory rate
primarily due to the release of the valuation allowance associated with the
utilization of the prior federal net operating loss.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term marketable securities totaled $190.1
million at June 30, 2004 compared to $129.2 million at December 31, 2003. This
increase is mainly due to net proceeds of approximately $32.6 million from our
public offering of common stock in the first quarter of 2004 and $19.9 million
of cash generated from operations during the six months ended June 30, 2004.
Net cash provided by operating activities of $19.9 million for the six
months ended June 30, 2004, resulted mainly from net income of $33.6 million,
non-cash depreciation and amortization expenses of $13.9 million and an increase
in operating liabilities of $29.3 million, partially offset by an increase in
operating assets of $51.8 million and a $5.0 million gain related to the
collection of a previously written off note receivable. The increase in
operating assets consisted mainly of an increase in accounts receivable of $24.3
million due to the higher shipments in the second quarter of 2004 as compared to
the fourth quarter of 2003, and an increase in inventory of $23.9 million as a
result of higher production volumes in 2004. The increase in operating
liabilities consisted primarily of an increase in accrued expenses and other
current liabilities of $11.3 million resulting mainly from increased accrued
compensation, warranty reserves and non-income related tax accruals, as well as
a $12.3 million increase in income tax payable. Net cash used in operating
activities of $4.7 million for the six months ended June 30, 2003 resulted
mainly from a net loss of $12.9 million, an increase in accounts receivable of
$5.0 million and inventory of $1.0 million and a decrease in accrued expenses of
$3.2 million, partially offset by non-cash charges of $15.0 million for
depreciation and amortization and an increase in accounts payable of $2.7
million.
Net cash used in investing activities of $15.4 million for the six months
ended June 30, 2004 resulted from the net purchases of $13.2 million of
available for sale investments mainly from the net proceeds received from our
stock offering in the first quarter, and the purchase of property, plant and
equipment of $9.2 million for investments in manufacturing equipment and for
consolidation of our IT infrastructure, partially offset by proceeds of $5.0
million received from the collection of a note receivable that was previously
written off. Net cash used in investing activities of $13.6 million for the six
months ended June 30, 2003 consisted mainly of net purchases of short-term and
long-term available for sale investments of $11.0 million and purchases of
property, plant and equipment of $3.0 million.
Net cash provided by financing activities of $39.3 million for the six
months ended June 30, 2004 consisted primarily of $32.6 million in net proceeds
received from our common stock offering, $3.9 million in proceeds from the
exercise of stock options and purchases under the employee stock purchase plan,
and net proceeds of $4.6 million from short-term borrowings, partially offset by
$1.8 million of principal payments on long-term debt. Net cash used in financing
activities of $3.4 million for the six months ended June 30, 2003 consisted of
principal payments of $3.6 million on long-term debt and capital lease
obligations and $1.2 million in net payments on short-term borrowings, partially
offset by $1.4 million in proceeds from the exercise of stock options.
17
We believe that our working capital, together with the cash anticipated
to be generated from operations and funds available from existing credit
facilities, will be sufficient to satisfy our estimated working capital and
planned capital expenditure requirements through at least the next twelve
months.
As of June 30, 2004, we had $76.7 million of purchase obligations
compared to $50.2 million at December 31, 2004. The increase of $26.5 million
is primarily due to increased inventory purchase commitments as a result of
increased production volumes in 2004.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any financial partnerships with unconsolidated entities,
such as entities often referred to as structured finance, special purpose
entities or variable interest entities which are often established for the
purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes. Accordingly, we are not exposed to any financing,
liquidity, market or credit risk that could arise if we had such relationships.
FACTORS THAT MAY AFFECT FUTURE RESULTS
OUR BUSINESS DEPENDS SUBSTANTIALLY ON CAPITAL SPENDING IN THE SEMICONDUCTOR
INDUSTRY WHICH IS CHARACTERIZED BY PERIODIC FLUCTUATIONS THAT MAY CAUSE A
REDUCTION IN DEMAND FOR OUR PRODUCTS.
We estimate that approximately 79% of our net sales for the six months
ended June 30, 2004 and 69%, 70% and 64% of our net sales for the years ended
December 31, 2003, 2002 and 2001, respectively, were to semiconductor capital
equipment manufacturers and semiconductor device manufacturers, and we expect
that sales to such customers will continue to account for a substantial majority
of our sales. Our business depends upon the capital expenditures of
semiconductor device manufacturers, which in turn depend upon the demand for
semiconductors. Periodic reductions in demand for the products manufactured by
semiconductor capital equipment manufacturers and semiconductor device
manufacturers may adversely affect our business, financial condition and results
of operations. Historically, the semiconductor market has been highly cyclical
and has experienced periods of overcapacity, resulting in significantly reduced
demand for capital equipment. Most recently, in 2001, 2002 and the first half of
2003, we experienced a significant reduction in demand from OEM customers, and
lower gross margins due to reduced absorption of manufacturing overhead. In
addition, many semiconductor manufacturers have operations and customers in
Asia, a region that in recent years has experienced serious economic problems
including currency devaluations, debt defaults, lack of liquidity and
recessions. We cannot be certain that semiconductor downturns will not continue
or recur. A decline in the level of orders as a result of any future downturn or
slowdown in the semiconductor capital equipment industry could have a material
adverse effect on our business, financial condition and results of operations.
OUR QUARTERLY OPERATING RESULTS HAVE VARIED, AND ARE LIKELY TO CONTINUE TO VARY
SIGNIFICANTLY. THIS MAY RESULT IN VOLATILITY IN THE MARKET PRICE OF OUR COMMON
STOCK.
A substantial portion of our shipments occurs shortly after an order is
received and therefore we operate with a low level of backlog. As a result, a
decrease in demand for our products from one or more customers could occur with
limited advance notice and could have a material adverse effect on our results
of operations in any particular period. A significant percentage of our expenses
are relatively fixed and based in part on expectations of future net sales. The
inability to adjust spending quickly enough to compensate for any shortfall
would magnify the adverse impact of a shortfall in net sales on our results of
operations. Factors that could cause fluctuations in our net sales include:
- the timing of the receipt of orders from major customers;
- shipment delays;
- disruption in sources of supply;
- seasonal variations of capital spending by customers;
- production capacity constraints; and
18
- specific features requested by customers.
In addition, our quarterly operating results may be adversely affected
due to charges incurred in a particular quarter, for example, relating to
inventory obsolescence, bad debt or asset impairments.
As a result of the factors discussed above, it is likely that we may in
the future experience quarterly or annual fluctuations and that, in one or more
future quarters, our operating results may fall below the expectations of public
market analysts or investors. In any such event, the price of our common stock
could decline significantly.
THE LOSS OF NET SALES TO ANY ONE OF OUR MAJOR CUSTOMERS WOULD LIKELY HAVE A
MATERIAL ADVERSE EFFECT ON US.
Our top ten customers accounted for approximately 51% of our net sales
for the six months ended June 30, 2004, and 42%, 49% and 39% of our net sales
for the years ended December 31, 2003, 2002 and 2001, respectively. The loss of
a major customer or any reduction in orders by these customers, including
reductions due to market or competitive conditions, would likely have a material
adverse effect on our business, financial condition and results of operations.
During the six months ended June 30, 2004 and years ended December 31, 2003,
2002 and 2001, one customer, Applied Materials, accounted for approximately 21%,
18%, 23% and 18%, respectively, of our net sales. None of our significant
customers, including Applied Materials, has entered into an agreement requiring
it to purchase any minimum quantity of our products. The demand for our products
from our semiconductor capital equipment customers depends in part on orders
received by them from their semiconductor device manufacturer customers.
Attempts to lessen the adverse effect of any loss or reduction of net
sales through the rapid addition of new customers could be difficult because
prospective customers typically require lengthy qualification periods prior to
placing volume orders with a new supplier. Our future success will continue to
depend upon:
- our ability to maintain relationships with existing key
customers;
- our ability to attract new customers;
- our ability to introduce new products in a timely manner for
existing and new customers; and
- the success of our customers in creating demand for their capital
equipment products which incorporate our products.
AS PART OF OUR BUSINESS STRATEGY, WE HAVE ENTERED INTO AND MAY ENTER INTO OR
SEEK TO ENTER INTO BUSINESS COMBINATIONS AND ACQUISITIONS THAT MAY BE DIFFICULT
AND COSTLY TO INTEGRATE, DISRUPT OUR BUSINESS, DILUTE STOCKHOLDER VALUE OR
DIVERT MANAGEMENT ATTENTION.
We made several acquisitions in the years 2000 through 2002. As a part
of our business strategy, we may enter into additional business combinations and
acquisitions. Acquisitions are typically accompanied by a number of risks,
including the difficulty of integrating the operations and personnel of the
acquired companies, the potential disruption of our ongoing business and
distraction of management, expenses related to the acquisition and potential
unknown liabilities associated with acquired businesses. If we are not
successful in completing acquisitions that we may pursue in the future, we may
be required to reevaluate our growth strategy, and we may incur substantial
expenses and devote significant management time and resources in seeking to
complete proposed acquisitions that will not generate benefits for us.
In addition, with future acquisitions, we could use substantial
portions of our available cash as all or a portion of the purchase price. We
could also issue additional securities as consideration for these acquisitions,
which could cause significant stockholder dilution. Our recent acquisitions and
any future acquisitions may not ultimately help us achieve our strategic goals
and may pose other risks to us.
As a result of our previous acquisitions, we have added several
different decentralized operating and accounting systems, resulting in a complex
reporting environment. We expect that we will need to continue to modify our
accounting policies, internal controls, procedures and compliance programs to
provide consistency across all our operations. In order
19
to increase efficiency and operating effectiveness and improve corporate
visibility into our decentralized operations, we are currently in the planning
and design phase of implementing a new worldwide Enterprise Resource Planning
("ERP") system. We expect to implement the ERP system by converting our
operations in phases over the next few years, beginning in the first half of
2005. Although we have a detailed plan to accomplish the ERP implementation, we
may risk potential disruption of our operations during the conversion periods,
the implementation could require significantly more management time than
currently estimated and we could incur significantly higher implementation costs
than currently estimated.
AN INABILITY TO CONVINCE SEMICONDUCTOR DEVICE MANUFACTURERS TO SPECIFY THE USE
OF OUR PRODUCTS TO OUR CUSTOMERS, THAT ARE SEMICONDUCTOR CAPITAL EQUIPMENT
MANUFACTURERS, WOULD WEAKEN OUR COMPETITIVE POSITION.
The markets for our products are highly competitive. Our competitive
success often depends upon factors outside of our control. For example, in some
cases, particularly with respect to mass flow controllers, semiconductor device
manufacturers may direct semiconductor capital equipment manufacturers to use a
specified supplier's product in their equipment. Accordingly, for such products,
our success will depend in part on our ability to have semiconductor device
manufacturers specify that our products be used at their semiconductor
fabrication facilities. In addition, we may encounter difficulties in changing
established relationships of competitors that already have a large installed
base of products within such semiconductor fabrication facilities.
IF OUR PRODUCTS ARE NOT DESIGNED INTO SUCCESSIVE GENERATIONS OF OUR CUSTOMERS'
PRODUCTS, WE WILL LOSE SIGNIFICANT NET SALES DURING THE LIFESPAN OF THOSE
PRODUCTS.
New products designed by semiconductor capital equipment manufacturers
typically have a lifespan of five to ten years. Our success depends on our
products being designed into new generations of equipment for the semiconductor
industry. We must develop products that are technologically current so that they
are positioned to be chosen for use in each successive generation of
semiconductor capital equipment. If customers do not choose our products, our
net sales may be reduced during the lifespan of our customers' products. In
addition, we must make a significant capital investment to develop products for
our customers well before our products are introduced and before we can be sure
that we will recover our capital investment through sales to the customers in
significant volume. We are thus also at risk during the development phase that
our products may fail to meet our customers' technical or cost requirements and
may be replaced by a competitive product or alternative technology solution. If
that happens, we may be unable to recover our development costs.
THE SEMICONDUCTOR INDUSTRY IS SUBJECT TO RAPID DEMAND SHIFTS WHICH ARE DIFFICULT
TO PREDICT. AS A RESULT, OUR INABILITY TO EXPAND OUR MANUFACTURING CAPACITY IN
RESPONSE TO THESE RAPID SHIFTS MAY CAUSE A REDUCTION IN OUR MARKET SHARE.
Our ability to increase sales of certain products depends in part upon
our ability to expand our manufacturing capacity for such products in a timely
manner. If we are unable to expand our manufacturing capacity on a timely basis
or to manage such expansion effectively, our customers could implement our
competitors' products and, as a result, our market share could be reduced.
Because the semiconductor industry is subject to rapid demand shifts which are
difficult to foresee, we may not be able to increase capacity quickly enough to
respond to a rapid increase in demand in the semiconductor industry.
Additionally, capacity expansion could increase our fixed operating expenses and
if sales levels do not increase to offset the additional expense levels
associated with any such expansion, our business, financial condition and
results of operations could be materially adversely affected.
WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY.
The market for our products is highly competitive. Principal
competitive factors include:
- historical customer relationships;
- product quality, performance and price;
- breadth of product line;
20
- manufacturing capabilities; and
- customer service and support.
Although we believe that we compete favorably with respect to these
factors, there can be no assurance that we will continue to do so. We encounter
substantial competition in most of our product lines. Certain of our competitors
may have greater financial and other resources than we have. In some cases,
competitors are smaller than we are, but well established in specific product
niches. We may encounter difficulties in changing established relationships of
competitors with a large installed base of products at such customers'
fabrication facilities. In addition, our competitors can be expected to continue
to improve the design and performance of their products. There can be no
assurance that competitors will not develop products that offer price or
performance features superior to those of our products.
SALES TO FOREIGN MARKETS CONSTITUTE A SUBSTANTIAL PORTION OF OUR NET SALES;
THEREFORE, OUR NET SALES AND RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED
BY DOWNTURNS IN ECONOMIC CONDITIONS IN COUNTRIES OUTSIDE OF THE UNITED STATES.
International sales include sales by our foreign subsidiaries, but
exclude direct export sales, which were less than 10% of our total net sales for
each of the years ended December 31, 2003, 2002 and 2001. International sales
accounted for approximately 34% of our net sales for the six months ended June
30, 2004 and 41%, 36% and 31% of net sales for the years ended December 31,
2003, 2002 and 2001, respectively, a significant portion of which were sales to
Japan.
We anticipate that international sales will continue to account for a
significant portion of our net sales. In addition, certain of our key domestic
customers derive a significant portion of their revenues from sales in
international markets. Therefore, our sales and results of operations could be
adversely affected by economic slowdowns and other risks associated with
international sales.
RISKS RELATING TO OUR INTERNATIONAL OPERATIONS COULD ADVERSELY AFFECT OUR
OPERATING RESULTS.
We have substantial international sales, service and manufacturing
operations in Europe and Asia, which exposes us to foreign operational and
political risks that may harm our business. Our international operations are
subject to inherent risks, which may adversely affect us, including:
- political and economic instability in countries where we have
sales, service and manufacturing operations, particularly in
Asia;
- fluctuations in the value of currencies and high levels of
inflation, particularly in Asia and Europe;
- changes in labor conditions and difficulties in staffing and
managing foreign operations, including, but not limited to, labor
unions;
- greater difficulty in collecting accounts receivable and longer
payment cycles;
- burdens and costs of compliance with a variety of foreign laws;
- increases in duties and taxation;
- imposition of restrictions on currency conversion or the transfer
of funds;
- changes in export duties and limitations on imports or exports;
- expropriation of private enterprises; and
- unexpected changes in foreign regulations.
If any of these risks materialize, our operating results may be
adversely affected.
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UNFAVORABLE CURRENCY EXCHANGE RATE FLUCTUATIONS MAY LEAD TO LOWER OPERATING
MARGINS, OR MAY CAUSE US TO RAISE PRICES WHICH COULD RESULT IN REDUCED SALES.
Currency exchange rate fluctuations could have an adverse effect on our
net sales and results of operations and we could experience losses with respect
to our hedging activities. Unfavorable currency fluctuations could require us to
increase prices to foreign customers which could result in lower net sales by us
to such customers. Alternatively, if we do not adjust the prices for our
products in response to unfavorable currency fluctuations, our results of
operations could be adversely affected. In addition, most sales made by our
foreign subsidiaries are denominated in the currency of the country in which
these products are sold and the currency they receive in payment for such sales
could be less valuable at the time of receipt as a result of exchange rate
fluctuations. We enter into forward exchange contracts and local currency
purchased options to reduce currency exposure arising from intercompany sales of
inventory. However, we cannot be certain that our efforts will be adequate to
protect us against significant currency fluctuations or that such efforts will
not expose us to additional exchange rate risks.
KEY PERSONNEL MAY BE DIFFICULT TO ATTRACT AND RETAIN.
Our success depends to a large extent upon the efforts and abilities of
a number of key employees and officers, particularly those with expertise in the
semiconductor manufacturing and similar industrial manufacturing industries. The
loss of key employees or officers could have a material adverse effect on our
business, financial condition and results of operations. We believe that our
future success will depend in part on our ability to attract and retain highly
skilled technical, financial, managerial and marketing personnel. We cannot be
certain that we will be successful in attracting and retaining such personnel.
OUR PROPRIETARY TECHNOLOGY IS IMPORTANT TO THE CONTINUED SUCCESS OF OUR
BUSINESS. OUR FAILURE TO PROTECT THIS PROPRIETARY TECHNOLOGY MAY SIGNIFICANTLY
IMPAIR OUR COMPETITIVE POSITION.
As of December 31, 2003, we owned 194 U.S. patents, 123 foreign patents
and had 84 pending U.S. patent applications. Although we seek to protect our
intellectual property rights through patents, copyrights, trade secrets and
other measures, we cannot be certain that:
- we will be able to protect our technology adequately;
- competitors will not be able to develop similar technology
independently;
- any of our pending patent applications will be issued;
- intellectual property laws will protect our intellectual property
rights; or
- third parties will not assert that our products infringe patent,
copyright or trade secrets of such parties.
PROTECTION OF OUR INTELLECTUAL PROPERTY RIGHTS MAY RESULT IN COSTLY LITIGATION.
Litigation may be necessary in order to enforce our patents, copyrights
or other intellectual property rights, to protect our trade secrets, to
determine the validity and scope of the proprietary rights of others or to
defend against claims of infringement. We have been in the past, and currently
are, involved in lawsuits enforcing and defending our intellectual property
rights and may be involved in such litigation in the future. Such litigation
could result in substantial costs and diversion of resources and could have a
material adverse effect on our business, financial condition and results of
operations.
We may need to expend significant time and expense to protect our
intellectual property regardless of the validity or successful outcome of such
intellectual property claims. If we lose any litigation, we may be required to
seek licenses from others or change, stop manufacturing or stop selling some of
our products.
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THE MARKET PRICE OF OUR COMMON STOCK HAS FLUCTUATED AND MAY CONTINUE TO
FLUCTUATE FOR REASONS OVER WHICH WE HAVE NO CONTROL.
The stock market has from time to time experienced, and is likely to
continue to experience, extreme price and volume fluctuations. Prices of
securities of technology companies have been especially volatile and have often
fluctuated for reasons that are unrelated to the operating performance of the
companies. The market price of shares of our common stock has fluctuated greatly
since our initial public offering and could continue to fluctuate due to a
variety of factors. In the past, companies that have experienced volatility in
the market price of their stock have been the objects of securities class action
litigation. If we were the object of securities class action litigation, it
could result in substantial costs and a diversion of our management's attention
and resources.
OUR DEPENDENCE ON SOLE, LIMITED SOURCE SUPPLIERS, AND INTERNATIONAL SUPPLIERS,
COULD AFFECT OUR ABILITY TO MANUFACTURE PRODUCTS AND SYSTEMS.
We rely on sole, limited source suppliers, and international suppliers,
for a few of our components and subassemblies that are critical to the
manufacturing of our products. This reliance involves several risks, including
the following:
- the potential inability to obtain an adequate supply of required
components;
- reduced control over pricing and timing of delivery of
components; and
- the potential inability of our suppliers to develop
technologically advanced products to support our growth and
development of new systems.
We believe that in time we could obtain and qualify alternative sources
for most sole, limited source and international supplier parts. Seeking
alternative sources of the parts could require us to redesign our systems,
resulting in increased costs and likely shipping delays. We may be unable to
redesign our systems, which could result in further costs and shipping delays.
These increased costs would decrease our profit margins if we could not pass the
costs to our customers. Further, shipping delays could damage our relationships
with current and potential customers and have a material adverse effect on our
business and results of operations.
WE ARE SUBJECT TO GOVERNMENTAL REGULATIONS. IF WE FAIL TO COMPLY WITH THESE
REGULATIONS, OUR BUSINESS COULD BE HARMED.
We are subject to federal, state, local and foreign regulations,
including environmental regulations and regulations relating to the design and
operation of our products. We must ensure that the affected products meet a
variety of standards, many of which vary across the countries in which our
systems are used. For example, the European Union has published directives
specifically relating to power supplies. In addition, the European Union has
issued directives relating to future regulation of recycling and hazardous
substances, which may be applicable to our products. We must comply with these
directives in order to ship affected products into countries that are members of
the European Union. We believe we are in compliance with current applicable
regulations, directives and standards and have obtained all necessary permits,
approvals, and authorizations to conduct our business. However, compliance with
future regulations, directives and standards could require us to modify or
redesign certain systems, make capital expenditures or incur substantial costs.
If we do not comply with current or future regulations, directives and
standards:
- we could be subject to fines;
- our production could be suspended; or
- we could be prohibited from offering particular systems in
specified markets.
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CERTAIN STOCKHOLDERS HAVE A SUBSTANTIAL INTEREST IN US AND MAY BE ABLE TO EXERT
SUBSTANTIAL INFLUENCE OVER OUR ACTIONS.
As of June 30, 2004, John R. Bertucci, our Chairman and Chief Executive
Officer and certain members of his family, in the aggregate, beneficially owned
approximately 18% of our outstanding common stock. As a result, these
stockholders, acting together, are able to exert substantial influence over our
actions. Pursuant to the acquisition of the ENI Business of Emerson Electric Co.
("Emerson"), we issued approximately 12,000,000 shares of common stock to
Emerson and its wholly owned subsidiary, Astec America, Inc. Emerson owned
approximately 19% of our outstanding common stock as of June 30, 2004, and James
G. Berges, the President and a director of Emerson, is a member of our board of
directors. Accordingly, Emerson is able to exert substantial influence over our
actions.
SOME PROVISIONS OF OUR RESTATED ARTICLES OF ORGANIZATION, AS AMENDED, OUR
AMENDED AND RESTATED BY-LAWS AND MASSACHUSETTS LAW COULD DISCOURAGE POTENTIAL
ACQUISITION PROPOSALS AND COULD DELAY OR PREVENT A CHANGE IN CONTROL OF US.
Anti-takeover provisions could diminish the opportunities for
stockholders to participate in tender offers, including tender offers at a price
above the then current market price of the common stock. Such provisions may
also inhibit increases in the market price of the common stock that could result
from takeover attempts. For example, while we have no present plans to issue any
preferred stock, our board of directors, without further stockholder approval,
may issue preferred stock that could have the effect of delaying, deterring or
preventing a change in control of us. The issuance of preferred stock could
adversely affect the voting power of the holders of our common stock, including
the loss of voting control to others. In addition, our amended and restated
by-laws provide for a classified board of directors consisting of three classes.
The classified board could also have the effect of delaying, deterring or
preventing a change in control of us.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Information concerning market risk is contained in the Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in our Annual Report on Form 10-K filed with the Securities and
Exchange Commission on March 11, 2004. We enter into local currency purchased
options and forward exchange contracts to reduce currency exposure arising from
intercompany sales of inventory. There were no material changes in our exposure
to market risk from December 31, 2003.
We have performed an analysis to assess the potential financial effect
of reasonably possible near-term changes in interest and foreign currency
exchange rates. Based upon our analysis, the effect of such rate changes in not
expected to be material to our financial condition, results of operations or
cash flows.
ITEM 4. CONTROLS AND PROCEDURES.
a) Evaluation of disclosure controls and procedures.
Our management, with the participation of our principal executive
officer and principal financial officer, has evaluated the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended) as of the end of the period covered by this Quarterly Report on Form
10-Q. Based on this evaluation, our principal executive officer and principal
financial officer concluded that these disclosure controls and procedures are
effective and designed to ensure that the information required to be disclosed
in our reports filed or submitted under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the requisite time periods.
While our disclosure controls and procedures provide reasonable
assurance that the appropriate information will be available on a timely basis,
this assurance is subject to limitations inherent in any control system, no
matter how well designed and administered.
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b) Changes in internal controls.
There were no changes in our internal control over financial reporting
identified in connection with the evaluation of our internal control performed
during our last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
As a result of various acquisitions, we have added several different
decentralized accounting systems, resulting in a complex reporting environment.
We expect that we will need to continue to modify our accounting policies,
internal controls, procedures and compliance programs to provide consistency
across all of our operations.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On July 12, 2004, Advanced Energy Industries, Inc. ("Advanced Energy")
filed suit against us in federal district court in Delaware, seeking injunctive
relief and damages for alleged infringement of a patent held by Advanced Energy.
We currently evaluating the merits of the claim. We cannot be certain of the
outcome of this litigation, but do plan to oppose the claims vigorously.
On January 12, 2004, Gas Research Institute ("GRI") brought suit in
federal district court in Illinois against us, On-Line Technologies, Inc.
("On-Line") which we acquired in 2001, and another defendant, Advanced Fuel
Research, Inc. ("AFR"), for breach of contract, misappropriation of trade
secrets and related claims relating to certain infra-red gas analysis technology
allegedly developed under a January 1995 Contract for Research between GRI and
AFR. The technology is alleged to have been incorporated into certain of our
products. GRI has made claims for damages, exemplary damages, attorney's fees
and costs and injunctive relief. We have filed an answer, denying liability and
asserting various defenses to GRI's claims. We have also asserted a cross-claim
against co-defendant AFR, alleging misrepresentation, breach of contract and
breach of various duties owed by AFR, and alleging that in the event we and
On-Line are held liable to GRI, AFR would be required to reimburse, indemnify,
and hold harmless On-Line and us for any such liability. AFR has filed a motion
to dismiss the action for lack of personal jurisdiction or, in the alternative,
to transfer the case to another federal court, which motion is pending. The case
is in its initial stages and we are unable to predict its outcome.
On April 3, 2003, Advanced Energy filed suit against us in federal
district court in Colorado ("Colorado Action"), seeking a declaratory judgment
that Advanced Energy's Xstream product does not infringe three patents held by
our subsidiary Applied Science and Technology, Inc. ("ASTeX"). On May 14, 2003,
we brought suit in federal district court in Delaware against Advanced Energy
for infringement of five ASTeX patents, including the three patents at issue in
the Colorado Action. We sought injunctive relief and damages for Advanced
Energy's infringement. On December 24, 2003, the Colorado court granted our
motion to transfer Advanced Energy's Colorado Action to Delaware. In connection
with the jury trial, the parties agreed to present the jury with representative
claims from three of the five ASTeX patents. On July 23, 2004, the jury found
that Advanced Energy infringed all three patents. We have filed a motion for a
permanent injunction, which is pending before the court. The parties are
awaiting the court to set a trial date with respect to damages.
On November 3, 1999, On-Line brought suit in federal district court in
Connecticut against Perkin-Elmer, Inc. and certain other defendants for
infringement of On-Line's patent related to its FTIR spectrometer product. The
suit sought injunctive relief and damages for infringement. Perkin-Elmer, Inc.
filed a counterclaim seeking invalidity of the patent, costs, and attorneys'
fees. In June 2002, the defendants filed a motion for summary judgment. In April
2003, the court granted the motion and dismissed the case. On August 5, 2004, we
argued our appeal of this decision before the federal circuit court of appeals
and are awaiting a decision.
We are subject to other legal proceedings and claims, which have arisen
in the ordinary course of business.
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In the opinion of management, the ultimate disposition of these matters
will not have a material adverse effect on our results of operations, financial
condition or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Company's Annual Meeting of Stockholders held on May 13, 2004 (the
"Annual Meeting"), the following proposals were approved as further specified
below:
1. Election of Directors:
Votes For Votes Withheld
--------- --------------
James G. Berges 44,968,374 1,664,330
Richard S. Chute 38,309,210 8,323,494
Owen W. Robbins 45,226,987 1,405,717
The other members of our Board of Directors whose terms of office continued
after the Annual Meeting were Messrs. Bertucci, Anderson, Kahl and Valente.
2. Approval of the 2004 Stock Incentive Plan
Votes For Votes Against Votes Abstain
--------- ------------- -------------
24,110,155 18,414,150 17,511
3. Approval of Amendment to the Amended and Restated 1997 Director Stock
Option Plan
Votes For Votes Against Votes Abstain
--------- ------------- -------------
34,267,038 8,259,153 15,625
4. Approval of Amendment to the Second Restated 1999 Employee Stock Purchase
Plan
Votes For Votes Against Votes Abstain
--------- ------------- -------------
41,315,451 1,193,409 32,956
5. Approval of Amendment to the Restated International Employee Stock Purchase
Plan
Votes For Votes Against Votes Abstain
--------- ------------- -------------
42,007,893 500,990 32,933
6. Ratification of appointment of PricewaterhouseCoopers LLP as independent
auditors for the fiscal year ending December 31, 2004.
Votes For Votes Against Votes Abstain
--------- ------------- -------------
45,533,465 1,065,028 34,211
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit No. Exhibit Description
----------- -------------------
10.1* 2004 Stock Incentive Plan
10.2* Third Restated 1999 Employee Stock Purchase Plan
10.3* Second Restated International Employee Stock
Purchase Plan
10.4* Second Amended and Restated 1997 Director Stock Option
Plan, and forms of option agreement thereto
26
10.5* Form of Nonstatutory Stock Option Agreement Granted
under the Second Restated 1995 Stock Incentive Plan
10.6* Employment Agreement dated as of July 30, 2004 between
Leo Berlinghieri and the Registrant
10.7* Employment Agreement dated as of July 30, 2004 between
Ronald C. Weigner and the Registrant
10.8* Employment Agreement dated as of July 30, 2004 between
Robert L. Klimm and the Registrant
10.9* Employment Agreement dated as of July 30, 2004 between
John A. Smith and the Registrant
10.10* Employment Agreement dated as of July 30, 2004 between
Gerald G. Colella and the Registrant
31.1 Certification of Principal Executive Officer pursuant to
Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange
Act of 1934, as amended
31.2 Certification of Principal Financial Officer pursuant to
Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange
Act of 1934, as amended
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
- ----------
- Management contract or compensatory plan arrangement.
(b) Reports on Form 8-K
On April 20, 2004, the Company filed a Current Report on Form 8-K under
Item 12 (Results of Operations and Financial Condition) furnishing a press
release announcing its financial results for the quarter ended March 31, 2004.
On April 26, 2004, the Company filed a Current Report on Form 8-K under
Item 5 (Other Events) disclosing that the Board of Directors had appointed Leo
Berlinghieri, the Company's Vice President and Chief Operating Officer, as
President and Chief Operating Officer on April 22, 2004.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MKS INSTRUMENTS, INC.
August 5, 2004 By: /s/ Ronald C. Weigner
-------------------------------------------
Ronald C. Weigner
Vice President and Chief Financial Officer
(Principal Financial Officer)
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