MKS Instruments - 10-Q quarterly report FY

 

     (MARK ONE)

     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 þ     No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ                     Accelerated filer o                    Non-accelerated filer o

     Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act.

     Yes o     No þ

     Number of shares outstanding of the issuer’s common stock as of October 29, 2007: 56,684,135

 

 

MKS INSTRUMENTS, INC.
FORM 10-Q
INDEX

     ITEM 1. FINANCIAL STATEMENTS.

MKS INSTRUMENTS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

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

MKS INSTRUMENTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)

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

MKS INSTRUMENTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)

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

MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tables in thousands, except share and per share data)

MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
(Tables in thousands, except share and per share data)

MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
(Tables in thousands, except share and per share data)

MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
(Tables in thousands, except share and per share data)

MKS INSTRUMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (continued)
(Tables in thousands, except share and per share data)

MKS INSTRUMENTS, INC.

     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, Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. When used herein, the words “believes,” “anticipates,” “plans,” “expects,” “estimates,” “intends,” “may,” “projects,” “will,” “would” 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 entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2006 filed with the Securities and Exchange Commission on February 28, 2007.

     We are a leading worldwide provider of instruments, components, subsystems and process control solutions that measure, control, power, monitor and analyze 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, electrostatic charge control, 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, solar panels and electro-optical products. We also provide technologies for other markets, including the medical imaging equipment and the energy generation and conservation markets.

     Our customers include semiconductor capital equipment manufacturers, semiconductor device manufacturers, capital equipment manufacturers of thin-film coatings used in flat panel displays, optical and magnetic data storage media, architectural glass, solar panels and electro-optical products, industrial and manufacturing companies, medical equipment manufacturers and university, government and industrial research laboratories. For the nine months ended September 30, 2007 and the full year ended December 31, 2006, we estimate that approximately 69% and 70% of our net sales, respectively, were to semiconductor capital equipment manufacturers and semiconductor device manufacturers. We expect that sales to the semiconductor capital equipment manufacturers and semiconductor device manufacturers will continue to account for a substantial majority of our sales.

     During 2006, we experienced significant increases in customer orders, which primarily resulted in an increase in our net sales for 2006 to $782.8 million, which ranged quarterly from $179.1 million to $205.5 million, from 2005 net sales of $509.3 million. Orders and net sales during our first two quarters of 2007 continued at a high level resulting in net sales of $211.4 million and $204.0 million for the first and second quarter, respectively, and declined in the third quarter of 2007 to $181.0. For the fourth quarter of 2007, we expect that our net sales could be approximately 7% lower than our third quarter 2007 net sales. The semiconductor capital equipment industry is subject to rapid demand shifts, which are difficult to predict, and we are uncertain how long these sales levels may be maintained or the timing or extent of any future downturn or upturn in the semiconductor capital equipment industry.

     A portion of our net sales is attributable to operations in international markets. For the nine months ended September 30, 2007 and full year ended December 31, 2006, international sales accounted for approximately 38% and 34% of net sales, respectively.

     On January 3, 2006, we completed our acquisition of Ion Systems, Inc. (“Ion”), a leading provider of electrostatic management solutions located in Alameda, California, pursuant to an Agreement and Plan of Merger dated November 25, 2005. Ion’s ionization technology controls electrostatic charges to reduce process contamination and improve yields, which complements our process monitoring and control technologies. The aggregate purchase price consisted of $68.1 million in cash, net of $5.1 million in cash acquired, and $0.8 million in acquisition related costs.

     Additionally, on January 3, 2006, we completed our acquisition of Umetrics, AB (“Umetrics”), a leader in multivariate data analysis and modeling software located in Umea, Sweden, pursuant to a Sale and Purchase Agreement dated December 15, 2005. Umetrics’ multivariate data analysis and modeling software converts process data into useable information for yield improvement, when linked with our open and modular platform of process sensors and data collection, integration, data storage, and visualization capabilities. The purchase price consisted of $27.4 million in cash, net of $2.6 million in cash acquired, and $0.4 million in acquisition related costs.

     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, 2006. For further information, please see the discussion of critical accounting policies in our Annual Report on Form 10-K for the year ended December 31, 2006.

     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.

     Net sales decreased $24.5 million during the three month period ended September 30, 2007 mainly due to a $22.7 million or 15.9% decrease in worldwide demand from our semiconductor capital equipment manufacturer and semiconductor device manufacturer customers compared to the same period for the prior year and from our thin-film and other non-semiconductor manufacturing applications, which sales decreased $1.7 million or 2.8% compared to the same period for the prior year. International net sales were approximately $68.4 million for the three months ended September 30, 2007 or 37.8% of net sales compared to $72.3 million for the three months ended September 30, 2006 or 35.2% of net sales.

     Net sales increased $13.5 million during the nine month period ended September 30, 2007 mainly due to an increase in worldwide demand during the first half of 2007 from our other non-semiconductor manufacturing applications, which sales increased $14.4 million or 11.6% compared to the same period for the prior year. International net sales were approximately $226.0 million for the nine months ended September 30, 2007 or 37.9% of net sales compared to $191.2 million for the nine months ended September 30, 2006 or 32.8% of net sales.

     Gross profit decreased by approximately 1.8 percentage points during the three months ended September 30, 2007 consisting of approximately 1.5 percentage points from decreased sales volume and 1.4 percentage points from product mix, primarily offset by 0.4 percentage points from reduced overhead spending and 0.7 percentage points from reduced costs related to warranty and excess and obsolete inventory.

     Gross profit decreased by approximately 0.2 percentage points during the nine months ended September 30, 2007 primarily consisting of approximately 0.7 percentage points from higher overhead, 0.5 percentage points from higher costs related to excess and obsolete inventory, primarily offset by 0.9 percentage points from reduced warranty costs.

     Research and development expense decreased $0.8 million during the three months ended September 30, 2007 mainly from decreased project materials spending of $0.8 million due to the timing of various projects.

     Research and development expense increased $2.1 million during the nine months ended September 30, 2007 mainly due to increased compensation expense of $1.5 million, as a result of higher staffing and compensation levels.

     Our research and development is primarily focused on developing and improving our instruments, components, subsystems and process control solutions to improve process performance and productivity.

     We have hundreds of products and our research and development efforts primarily consist of a large number of projects related to these products, none of which is individually material to us. Current projects typically have a duration of 12 to 30 months depending upon whether the product is an enhancement of existing technology or a new product. Our current initiatives include projects to enhance the performance characteristics of older products, to develop new products and to integrate various technologies into subsystems. These projects support in large part the transition in the semiconductor industry to larger wafer sizes and smaller integrated circuit geometries, which require more advanced process control technology. Research and development expenses consist primarily of salaries and related expenses for personnel engaged in research and development, fees paid to consultants, material costs for prototypes and other expenses related to the design, development, testing and enhancement of our products.

     We believe that the continued investment in research and development and ongoing development of new products are essential to the expansion of our markets, and expect to continue to make significant investment in research and development activities. We are subject to risks if products are not developed in a timely manner, due to rapidly changing customer requirements and competitive threats from other companies and technologies. Our success primarily depends on our products being designed into new generations of equipment for the semiconductor industry. We develop products that are technologically advanced so that they are positioned to be chosen for use in each successive generation of semiconductor capital equipment. If our products are not chosen to be designed into our customers’ products, our net sales may be reduced during the lifespan of those products.

     Selling, general and administrative expenses decreased $0.5 million for the three months ended September 30, 2007 due to a $2.9 million net decrease in compensation costs resulting from lower incentive compensation partially offset by higher headcount and $0.9 million in favorable foreign exchange fluctuations as there were gains of $0.5 million in 2007 and losses of $0.4 in 2006. These reductions were partially offset by $2.9 million of additional costs related to our ongoing enterprise resource planning (“ERP”) system implementation and general IT infrastructure.

     Selling, general and administrative expenses increased $9.9 million for the nine months ended September 30, 2007 due to $7.6 million of additional costs related to our ongoing ERP system implementation and general IT infrastructure, and $2.7 million in foreign exchange rate gains primarily occurring in 2006 that did not occur in 2007, offset by a $2.1 million net decrease in compensation costs resulting from lower incentive compensation and benefit costs, partially offset by increased headcount.

     Amortization expense for the nine months ended September 30, 2007 decreased $1.3 million primarily as a result of certain acquired intangible assets that were fully amortized during the first quarter of 2006.

     Interest income, net increased $1.8 million and $5.3 million during the three and nine month periods ended September 30, 2007, respectively, mainly as a result of higher average cash and cash equivalent balances and higher average rates in 2007.

     Our effective tax rate for the three and nine month periods ended September 30, 2007 was 21.0% and 27.0%, respectively. The effective tax rate is less than the statutory tax rate primarily due to the profits of our international subsidiaries being taxed at rates lower than the U.S. statutory tax rate and the benefit from U.S. research and development credits.

     During the quarter ended September 30, 2007, we amended prior federal tax returns to reflect revised estimates for qualifying research and development that allowed for us to claim additional research tax credits. As a result of this claim, we recorded a discrete benefit to income tax expense of $1.85 million.

     During the quarter ended September 30, 2006, we received a notification letter from the Israeli Ministry of Industry Trade and Labor (“MITL”) indicating that our Israeli operations were in compliance with requirements relating to the tax holiday granted to our manufacturing operations in Israel in 2001. This tax holiday is anticipated to expire in 2011 and is subject to meeting continued investment, employment and other requirements under the guidelines of the MITL. Additionally, we recorded the impact of both a change in German tax rules allowing interest deductions on certain loans and an adjustment relating to transfer pricing. As a result of these items we recorded a net benefit to income tax expense of $1.6 million.

     Our effective tax rate for the three and nine month periods ended September 30, 2006 was 26.2% and 30.6%, respectively. The effective tax rate is less than the statutory tax rate primarily due to a net benefit of $1.6 million attributable to discrete tax matters related to our international operations, as described above, and the profits of our international subsidiaries being taxed at rates lower than the U.S. statutory rates.

     We have adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), as of January 1, 2007. As a result of the implementation of FIN 48, we did not recognize an adjustment in the liability for unrecognized income tax benefits. At the adoption date of January 1, 2007, the total amount of gross unrecognized tax benefits, which excludes interest and penalties discussed below, was $10.5 million. If these benefits were recognized in a future period, the timing of which is not estimable, the net unrecognized tax benefit of $10.1 million would impact our effective tax rate. The total amount of gross unrecognized tax benefits at September 30, 2007 was approximately $13.4 million. The increase from January 1, 2007 was primarily attributable to our tax positions taken during the current year.

     MKS and its subsidiaries are subject to U.S. federal income tax as well as the income tax of multiple state and foreign jurisdictions. We have concluded all U.S. federal income tax matters for years through 2002. The 2003 Federal tax year remains open to the extent of the loss carryforward to 2004 and 2005. As of September 30, 2007, there were ongoing audits in various other tax jurisdictions.

     Over the next 12 months it is reasonably possible that we may recognize $3.5 million to $4.0 million of previously unrecognized tax benefits related to various federal, state and foreign tax positions as a result of the conclusion of various audits and the expiration of the statute of limitations. The following tax years, in the major tax jurisdictions noted, are open for assessment or refund: U.S. Federal: 2003 to 2006, Germany: 2002 to 2006, Korea: 2005 and 2006, Japan: 2001 to 2006, and the United Kingdom: 2005 and 2006.

     We will accrue interest and, if applicable, penalties, for any uncertain tax positions. This interest and penalty expense will be a component of income tax expense. At the date of adoption of FIN 48 and at September 30, 2007, we had $0.7 million and $1.3 million, respectively, accrued for interest on unrecognized tax benefits.

     The U.S. Research and Development Tax Credit expired at the end of 2005 and was not reinstated until late in the fourth quarter of 2006. As a result, we did not take any benefit for this credit in the three and nine month periods ending September 30, 2006 and recorded a retroactive adjustment for fiscal 2006 in the fourth quarter. The benefits taken in the three and nine month periods ending September 30, 2007 for this credit were approximately $0.9 million and $1.7 million, respectively.

     Cash, cash equivalents and short-term investments totaled $359.8 million at September 30, 2007 compared to $290.0 million at December 31, 2006. The primary source of funds for the first nine months of fiscal 2007 was cash provided by operating activities of $85.1 million.

     Net cash provided by operating activities of $85.1 million for the nine months ended September 30, 2007, resulted mainly from net income of $71.2 million, non-cash charges of $22.8 million for depreciation and amortization and $11.3 million for stock-based compensation and related tax benefits, offset by an increase in net operating assets of $2.9 million and a $12.1 million decrease in net operating liabilities. The $2.9 million increase in net operating assets consisted primarily of a $7.7 million increase in inventory, to support our increased revenues and to support the increased inventory levels required for our China facility relocation, which we expect to complete in the fourth quarter of 2007, and a $5.2 million increase in other current assets, primarily related to prepaid taxes, offset by a $10.0 million decrease in accounts receivable. The decrease in net operating liabilities of $12.1 million is mainly caused by a $9.5 million decrease in accounts payable and a decrease of $3.7 million in accrued expenses and other current liabilities. Net cash provided by operating activities of $55.9 million for the nine months ended September 30, 2006, resulted mainly from net income of $67.7 million, a $26.3 million increase in operating liabilities and non-cash charges of $23.7 million for depreciation and amortization and $11.0 million for stock-based compensation and related tax benefits, offset by an increase in net operating assets of $71.8 million. The net increase in operating liabilities is mainly caused by an increase of $19.1 million in accrued expenses and other current liabilities, primarily as a result of higher accrued compensation and warranty costs and an increase of $5.8 million in accounts payable, primarily as a result of inventory procurement activities. The $71.8 million increase in operating assets consisted primarily of a $37.1 million increase in accounts receivable as a result of higher revenue and a $30.1 million increase in inventory as a result of increased product demand.

     Net cash used in investing activities of $66.1 million for the nine months ended September 30, 2007, resulted primarily from net purchases of $55.6 million of available for sale investments. Net cash used in investing activities of $80.2 million for the nine months ended September 30, 2006, resulted primarily from the purchase of two technology companies for $96.7 million, offset by the net maturities of $24.0 million of available for sale investments.

     Net cash used in financing activities of $5.0 million for the nine months ended September 30, 2007, consisted primarily of $49.0 million in repurchases of common stock, offset by $43.3 million in proceeds from the exercise of stock options and purchases under our employee stock purchase plan. Net cash provided by financing activities of $24.7 million for the nine months ended September 30, 2006, consisted primarily of $18.7 million in proceeds from the exercise of stock options and purchases under our employee stock purchase plan and $5.2 million in net proceeds from short-term borrowings.

     On February 12, 2007, our Board of Directors approved a share repurchase program (the “Program”) for the repurchase of up to $300 million of our outstanding stock over two years. The repurchases may be made from time to time on the open market or through privately negotiated transactions. The timing and amount of any shares repurchased under the Program will depend on a variety of factors, including price, corporate and regulatory requirements, capital availability, and other market conditions. The Program may be discontinued at any time at the discretion of the Company and our Board of Directors. During the nine months ended September 30, 2007, we repurchased 1.9 million shares of common stock for $49.0 million for an average price of $25.13.

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

     To the extent permitted by Massachusetts law, our Restated Articles of Organization, as amended, require us to indemnify any of our current or former officers or directors or any person who has served or is serving in any capacity with respect to any of our employee benefit plans. Because no claim for indemnification has been pursued by any person covered by the relevant provisions of our Restated Articles of Organization, we believe that the estimated exposure for these indemnification obligations is currently minimal. Accordingly, we have no liabilities recorded for these requirements as of September 30, 2007.

     We also enter into agreements in the ordinary course of business which include indemnification provisions. Pursuant to these agreements, we indemnify, hold harmless and agree to reimburse the indemnified party, generally our customers, for losses suffered or incurred by the indemnified party in connection with certain patent or other intellectual property infringement claims, and, in some instances, other claims, by any third party with respect to our products. The terms of these indemnification obligations are generally perpetual after execution of the agreements. The maximum potential amount of future payments we could be required to make under these indemnification agreements is, in some instances, not contractually limited. We have never incurred costs to defend lawsuits or settle claims related to these

indemnification obligations. As a result, we believe the estimated fair value of these obligations is minimal. Accordingly, we have no liabilities recorded for these obligations as of September 30, 2007.

     When, as part of an acquisition, we acquire all of the stock or all of the assets and liabilities of another company, we assume liability for certain events or occurrences that took place prior to the date of acquisition. The maximum potential amount of future payments we could be required to make for such obligations is undeterminable at this time. Other than obligations recorded as liabilities at the time of the acquisitions, historically we have not made significant payments for these indemnifications. Accordingly, no liabilities have been recorded for these obligations as of September 30, 2007.

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

     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 for 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.

     In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS 157 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted. We are in the process of evaluating any potential impact of SFAS 157.

     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Liabilities” (“SFAS 159”). SFAS 159 permits companies to choose to measure certain financial instruments and certain other items at fair value and requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007, although early adoption is permitted. We are in the process of evaluating any potential impact of SFAS 159.

     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 for the year ended December 31, 2006 filed with the Securities and Exchange Commission on February 28, 2007. There were no material changes in our exposure to market risk from December 31, 2006.

     ITEM 4. CONTROLS AND PROCEDURES.

     MKS’ management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2007. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“the Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2007, our chief executive officer and chief financial officer concluded that, as of such date, MKS’ disclosure controls and procedures were effective at the reasonable assurance level.

     There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended September 30, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

     ITEM 1. LEGAL PROCEEDINGS.

     We are subject to various legal proceedings and claims, which have arisen in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our results of operations, financial condition or cash flows.

     ITEM 1A. RISK FACTORS.

     Information regarding risk factors affecting the Company’s business are discussed in the Company’s Annual Report of Form 10-K for the year ended December 31, 2006, filed with the Securities and Exchange Commission on February 28, 2007, in the section entitled “Item 1A. Risk Factors.” As of September 30, 2007, there have been no material changes from those risk factors.

     ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

     The following table provides information about purchases by MKS during the quarter ended September 30, 2007, of equity securities that are registered by MKS pursuant to Section 12 of the Exchange Act:

     ITEM 6. EXHIBITS.

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.