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Table of Contents
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
FORM
10-Q
 
(MARK ONE)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the quarterly period ended
June 30, 2019
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 of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
     
2 Tech Drive, Suite 201
,
Andover
, Massachusetts
 
01810
(Address of principal executive offices)
 
(Zip Code)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Registrant’s telephone number, including area code (
978
)
645-5500
 
Securities registered pursuant to Section 12(b) of the Act:
         
Title of each class
 
Trading
Symbol(s)
 
Name of each exchange
on which registered
Common Stock
, no par value
 
MKSI
 
Nasdaq Global Select Market
 
 
 
 
 
 
 
 
 
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
  
    No  
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation
S-T
(§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    
Yes
  
    No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated
filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule
12b-2
of the Exchange Act:
             
Large accelerated filer
 
 
Accelerated filer
 
             
Non-accelerated filer
 
 
Smaller reporting company
 
             
 
 
Emerging growth company
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 
Indicate by check mark whether the registrant is a shell company (as defined in Rule
12b-2
of the Exchange Act).    Yes  
    No  
As of July 31, 2019, the registrant had
54,484,896
shares of common stock outstanding.
 
 
 
 
 
 
 
 
Table of Contents
  
MKS INSTRUMENTS, INC.
FORM 10-Q
INDEX
             
 
       
          ITEM 1.
   
             
     
3
 
             
     
4
 
             
     
5
 
             
     
6
 
             
     
7
 
             
          ITEM 2.
     
35
 
             
          ITEM 3.
     
46
 
             
          ITEM 4.
     
46
 
   
 
             
          ITEM 1.
     
46
 
             
          ITEM 1A.
     
47
 
             
          ITEM 6.
     
48
 
         
   
49
 
 
 
 
 
 
2
 
 
 
Table of Contents
 
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MKS INSTRUMENTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
(Unaudited)
 
June 30, 2019
   
December 31, 2018
 
ASSETS
   
     
 
Current assets:
   
     
 
Cash and cash equivalents
  $
366,935
    $
644,345
 
Short-term investments
   
92,985
     
73,826
 
Trade accounts receivable, net of allowance for doubtful accounts of $4,460 and $5,243 at June 30, 2019 and December 31, 2018, respectively
   
313,530
     
295,454
 
Inventories
   
479,497
     
384,689
 
Other current assets
   
80,303
     
65,790
 
Assets classified as held for sale
   
36,750
     
—  
 
                 
Total current assets
   
1,370,000
     
1,464,104
 
                 
Property, plant and equipment, net
   
230,649
     
194,367
 
Right-of-use
asset
   
68,631
     
—  
 
Goodwill
   
1,058,667
     
586,996
 
Intangible assets, net
   
599,372
     
319,807
 
Long-term investments
   
10,401
     
10,290
 
Other assets
   
44,228
     
38,682
 
                 
Total assets
  $
3,381,948
    $
2,614,246
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
   
     
 
Current liabilities:
   
     
 
Short-term debt
  $
10,931
    $
3,986
 
Accounts payable
   
88,046
     
83,825
 
Accrued compensation
   
64,415
     
82,350
 
Income taxes payable
   
12,811
     
16,358
 
Lease liability
   
20,670
     
—  
 
Deferred revenue and customer advances
   
26,597
     
14,246
 
Other current liabilities
   
61,686
     
62,520
 
                 
Total current liabilities
   
285,156
     
263,285
 
Long-term debt, net
   
926,879
     
343,842
 
Non-current
deferred taxes
   
76,042
     
48,223
 
Non-current
accrued compensation
   
62,947
     
55,598
 
Non-current
lease liability
   
51,141
     
—  
 
Other liabilities
   
34,296
     
30,111
 
                 
Total liabilities
   
1,436,461
     
741,059
 
                 
Commitments and contingencies (Note 19)
 
 
 
 
 
 
 
Stockholders’ equity:
   
     
 
Preferred Stock, $0.01 par value per share, 2,000,000 shares authorized;
none
issued and outstanding
   
     
—  
 
Common Stock,
no
par value, 200,000,000 shares authorized; 54,479,692 and 54,039,554 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively
   
113
     
113
 
Additional
paid-in
capital
   
849,585
     
793,932
 
Retained earnings
   
1,113,036
     
1,084,797
 
Accumulated other comprehensive loss
   
(17,247
)    
(5,655
)
                 
Total stockholders’ equity
   
1,945,487
     
1,873,187
 
                 
Total liabilities and stockholders’ equity
  $
3,381,948
    $
2,614,246
 
                 
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
 
3
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(in thousands, except per share data)
(Unaudited)
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
 
2019
   
2018
   
2019
   
2018
 
Net revenues:
   
     
     
     
 
Products
  $
401,326
    $
509,999
    $
798,689
    $
1,006,676
 
Services
   
72,784
     
63,141
     
138,982
     
120,739
 
                                 
Total net revenues
   
474,110
     
573,140
     
937,671
     
1,127,415
 
Cost of revenues:
   
     
     
     
 
Cost of products
   
226,213
     
266,890
     
455,923
     
528,211
 
Cost of services
   
36,870
     
31,373
     
72,603
     
61,472
 
                                 
Total cost of revenues (exclusive of amortization shown separately below)
   
263,083
     
298,263
     
528,526
     
589,683
 
Gross profit
   
211,027
     
274,877
     
409,145
     
537,732
 
Research and development
   
41,855
     
36,504
     
80,788
     
71,361
 
Selling, general and administrative
   
83,236
     
76,181
     
165,691
     
159,130
 
Fees and expenses related to term loan
   
     
378
     
5,847
     
378
 
Acquisition and integration costs
   
3,240
     
(1,168
)    
33,407
     
(1,168
)
Restructuring and other
   
1,242
     
790
     
3,165
     
3,010
 
Amortization of intangible assets
   
17,552
     
10,901
     
33,279
     
22,091
 
                                 
Income from operations
   
63,902
     
151,291
     
86,968
     
282,930
 
Interest income
   
1,423
     
1,456
     
3,137
     
2,561
 
Interest expense
   
12,674
     
3,922
     
21,793
     
9,352
 
Other expense, net
   
788
     
281
     
1,113
     
853
 
                                 
Income before income taxes
   
51,863
     
148,544
     
67,199
     
275,286
 
Provision for income taxes
   
14,124
     
25,682
     
17,005
     
47,303
 
                                 
Net income
  $
37,739
    $
122,862
    $
50,194
    $
227,983
 
                                 
Other comprehensive income:
   
     
     
     
 
Changes in value of financial instruments designated as cash flow hedges, net of tax (benefit) expense
(1)
  $
(739
)   $
7,712
    $
(687
)   $
7,890
 
Foreign currency translation adjustments, net of tax of $
0
   
593
     
(18,508
)    
(3,675
)    
(7,737
)
Unrecognized pension gain (loss), net of tax (benefit) expense
(2)
   
2
     
48
     
1
     
(37
)
Unrealized loss on investments, net of tax benefit
(3)
   
(96
)    
(266
)    
(146
)    
(325
)
                                 
Total comprehensive income
  $
37,499
    $
111,848
    $
45,687
    $
227,774
 
                                 
Net income per share:
   
     
     
     
 
Basic
  $
0.69
    $
2.25
    $
0.92
    $
4.18
 
                                 
Diluted
  $
0.69
    $
2.22
    $
0.91
    $
4.12
 
                                 
Weighted average common shares outstanding:
   
     
     
     
 
Basic
   
54,815
     
54,719
     
54,481
     
54,571
 
                                 
Diluted
   
55,089
     
55,274
     
54,966
     
55,280
 
                                 
 
(1)
Tax (benefit) expense was $
(227)
and $
2,367
for the three months ended June 30, 2019 and 2018, respectively. Tax (benefit) expense was $
(212)
and $
2,255
for the six months ended June 30, 2019 and 2018, respectively
(2)
Tax (benefit) expense was $
(1)
and $
12
for the three months ended June 30, 2019 and 2018, respectively. Tax expense (benefit) was $
20
and $
(24)
for the six months ended June 30, 2019 and 2018, respectively
(3)
Tax benefit was $
(30)
and $
(22)
for the three months ended June 30, 2019 and 2018, respectively. Tax benefit was $
(46)
and $
(39)
for the six months ended June 30, 2019 and 2018, respectively.
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
  
4
  
 
Table of Contents
 
MKS INSTRUMENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except per share data)
(Unaudited)
                                                 
 
Common Stock
   
Additional
Paid-In
   
Retained
   
Accumulated
Other
Comprehensive
   
Total
Stockholders’
 
 
Shares
   
Amount
   
Capital
   
Earnings
   
Income/(Loss)
   
Equity
 
Balance at December 31, 2018
   
54,039,554
    $
113
    $
793,932
    $
1,084,797
    $
(5,655
)   $
1,873,187
 
Net issuance under stock-based plans
   
192,218
     
     
22,491
     
     
     
22,491
 
Stock-based compensation
           
     
27,838
     
     
     
27,838
 
Cash dividend ($
0.20
per common share)
           
     
     
(10,843
)    
     
(10,843
)
Comprehensive income (net of tax):
           
     
     
     
     
 
Net income
           
     
     
12,455
     
     
12,455
 
Other comprehensive loss
           
     
     
     
(4,267
)    
(4,267
)
                                                 
Balance at March 31, 2019
   
54,231,772
     
113
     
844,261
     
1,086,409
     
(9,922
)    
1,920,861
 
Net issuance under stock-based plans
   
247,920
     
     
(2,113
)    
     
     
(2,113
)
Stock-based compensation
           
     
7,205
     
     
     
7,205
 
Cash dividend ($
0.20
per common share)
           
     
     
(10,880
)    
     
(10,880
)
Stock dividends accrued
           
     
232
     
(232
)    
     
 
Comprehensive income (net of tax):
           
     
     
     
     
 
Net income
           
     
     
37,739
     
     
37,739
 
Other comprehensive loss
           
     
     
     
(7,325
)    
(7,325
)
                                                 
Balance at June 30, 2019
   
54,479,692
    $
113
    $
849,585
    $
1,113,036
    $
(17,247
)   $
1,945,487
 
                                                 
                               
 
Common Stock
   
Additional
Paid-In
   
Retained
   
Accumulated
Other
Comprehensive
   
Total
Stockholders’
 
 
Shares
   
Amount
   
Capital
   
Earnings
   
Income/(Loss)
   
Equity
 
Balance at December 31, 2017
   
54,355,535
    $
113
    $
789,644
    $
795,698
    $
3,452
    $
1,588,907
 
Net issuance under stock-based plans
   
136,568
     
     
(8,920
)    
     
     
(8,920
)
Stock-based compensation
   
     
     
10,426
     
     
     
10,426
 
Cash dividend ($
0.18
per common share)
   
     
     
     
(9,808
)    
     
(9,808
)
Accounting Standards Codification Topic 606 adjustment
   
     
     
     
1,809
     
     
1,809
 
Comprehensive income (net of tax):
   
     
     
     
     
     
 
Net income
   
     
     
     
105,121
     
     
105,121
 
Other comprehensive gain
   
     
     
     
     
10,805
     
10,805
 
                                                 
Balance at March 31, 2018
   
54,492,103
     
113
     
791,150
     
892,820
     
14,257
     
1,698,340
 
Net issuance under stock-based plans
   
295,050
     
     
(4,132
)    
     
     
(4,132
)
Stock-based compensation
   
     
     
6,366
     
     
     
6,366
 
Cash dividend ($
0.20
per common share)
   
     
     
     
(10,942
)    
     
(10,942
)
Accounting Standards Codification Topic 606 adjustment
   
     
     
     
(42
)    
     
(42
)
Comprehensive income (net of tax):
   
     
     
     
     
     
 
Net income
   
     
     
     
122,862
     
     
122,862
 
Other comprehensive loss
   
     
     
     
     
(11,014
)    
(11,014
)
                                                 
Balance at June 30, 2018
   
54,787,153
    $
113
    $
793,384
    $
1,004,698
    $
3,243
    $
1,801,438
 
                                                 
 
 
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
 
5
 

Table of Contents
 
MKS INSTRUMENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
                 
 
Six Months Ended June 30,
 
 
2019
   
2018
 
Cash flows provided by operating activities:
   
     
 
Net income
  $
50,194
    $
227,983
 
Adjustments to reconcile net income to net cash provided by operating activities:
   
     
 
Depreciation and amortization
   
52,655
     
40,377
 
Amortization of inventory
step-up
adjustment to fair value
   
7,624
     
—  
 
Amortization of debt issuance costs, original issue discount, and soft call premium
   
2,953
     
2,887
 
Stock-based compensation
   
34,767
     
16,792
 
Provision for excess and obsolete inventory
   
12,053
     
10,292
 
(Recovery) provision for doubtful accounts
   
(691
)    
596
 
Deferred income taxes
   
(2,625
)    
1,170
 
Other
   
917
     
460
 
Changes in operating assets and liabilities, net of business acquired:
   
     
 
Trade accounts receivable
   
27,163
     
(42,511
)
Inventories
   
(30,821
)    
(59,529
)
Income taxes
   
(3,941
)    
(11,416
)
Other current and
non-current
assets
   
(897
)    
(4,317
)
Accrued compensation
   
(17,808
)    
(15,933
)
Other current and
non-current
liabilities
   
(273
)    
9,912
 
Accounts payable
   
(24,666
)    
5,604
 
                 
Net cash provided by operating activities
   
106,604
     
182,367
 
                 
Cash flows used in investing activities:
   
     
 
Acquisition of business, net of cash acquired
   
(988,599
)    
—  
 
Purchases of investments
   
(117,919
)    
(148,816
)
Maturities of investments
   
40,386
     
90,734
 
Sales of investments
   
157,710
     
63,363
 
Proceeds from sale of assets
   
35
     
—  
 
Purchases of property, plant and equipment
   
(28,254
)    
(21,818
)
                 
Net cash used in investing activities
   
(936,641
)    
(16,537
)
                 
Cash flows provided by (used in) financing activities:
   
     
 
Net proceeds from short and long-term borrowings
   
640,939
     
36,989
 
Payments on short-term borrowings
   
(1,926
)    
(28,059
)
Payments on long-term borrowings
   
(51,625
)    
(50,000
)
Net payments related to employee stock awards
   
(11,012
)    
(13,052
)
Dividend payments to common stockholders
   
(21,723
)    
(20,750
)
                 
Net cash provided by (used in) financing activities
   
554,653
     
(74,872
)
                 
Effect of exchange rate changes on cash and cash equivalents
   
(2,026
)    
2,586
 
                 
(Decrease) Increase in cash and cash equivalents and restricted cash
   
(277,410
)    
93,544
 
Cash and cash equivalents at beginning of period
   
644,345
     
333,887
 
                 
Cash and cash equivalents at end of period
  $
366,935
    $
427,431
 
                 
 
 
 
 
 
 
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
 
6
  
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
1)    
Basis of Presentation
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The terms “MKS” and the “Company” refer to MKS Instruments, Inc. and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The interim financial data as of June 30, 2019, and for the three and six months ended June 30, 2019 are unaudited; however, in the opinion of MKS, the interim data includes all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results for the interim periods. The condensed consolidated balance sheet presented as of December 31, 2018 has been derived from the consolidated audited financial statements as of that date. The unaudited condensed 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 United States generally accepted accounting principles (“U.S. GAAP”). The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the MKS Annual Report on Form
10-K
for the year ended December 31, 2018 filed with the Securities and Exchange Commission on February 26, 2019.
The preparation of these unaudited condensed 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 unaudited condensed 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, stock-based compensation, inventory, intangible assets, goodwill and other long-lived assets, warranty liabilities, pension liabilities, acquisition expenses, income taxes and investments. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
2)
Recently Issued Accounting Pronouncements
In October 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
2018-16,
“Derivatives and Hedging (Topic 815).” This standard permits the use of the Overnight Index Swap Rate (“OIS”) based on the Secured Overnight Financing Rate as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815 in addition to the interest rates on direct treasury obligations of the U.S. government, the London Interbank Offered Rate (“LIBOR”) swap rate, the OIS rate based on the Federal Funds Effective Rate and the Securities Industry and Financial Markets Association Municipal Swap Rate. This standard is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. The Company adopted this ASU during the first quarter of 2019 and the adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
In August 2018, the FASB issued ASU
2018-15,
“Intangibles-Goodwill and
Other-Internal-Use
Software (Subtopic
350-40):
Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract.” This standard aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain
internal-use
software (and hosting arrangements that include an
internal-use
software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments to this update. This standard is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the requirements of this ASU and adoption could have a material impact on the Company’s consolidated financial statements.
In August 2017, the FASB issued ASU
2017-12,
“Derivatives and Hedging (Topic 815).” This standard better aligns an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The provisions of this ASU are effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. The Company adopted this ASU during the first quarter of 2019 and the adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, “Leases”. This standard requires the recognition of lease assets and liabilities for all leases, with certain exceptions, on the balance sheet. This ASU is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. The Company adopted ASU 2016-02 on January 1, 2019, and used the effective date as its date of initial application. As such, the Company did not adjust prior period amounts. The Company also elected to adopt the package of practical expedients upon transition, which permits companies to not reassess lease identification, classification, and initial direct costs for leases that commenced prior to the effective date.
 
7
 
 
 
Table of Contents
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
The Company implemented internal controls and a lease accounting information system to enable preparation on adoption. Upon adoption, the Company recorded a cumulative effect of initially applying this new standard, resulting in the addition of $71,042 of
right-of-use
assets and $20,192 and $54,147 of short-term and long-term lease liabilities, respectively. The
right-of-use
asset is net of the deferred rent liability, prepaid rent and a net favorable lease asset which were
re-classified
to the
right-of-use
asset upon adoption of the standard. For additional information on the required disclosures related to the impact of adopting this standard, see Note 3 to the Consolidated Condensed Financial Statements.
3)
Leases
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The Company has various operating leases for real estate and non-real estate items. The non-real estate leases are mainly comprised of automobiles but also include copiers, printers and other lower-valued items. The Company does not have any finance leases.
The Company has lease arrangements with lease and non-lease components, has elected to account for the lease and non-lease components as a single lease component, and has allocated all of the contract consideration to the lease component only. The Company has existing net leases in which the non-lease components (e.g. common area maintenance, maintenance, consumables, etc.) are paid separately from rent based on actual costs incurred. Therefore, non-lease components are not included in the right-of-use asset and lease liability and are reflected as expenses in the periods incurred.
The Company has existing leases that include variable lease and non-lease components that are not included in the right-of-use asset and lease liability, and are reflected as expenses in the periods incurred. Such payments primarily include common area maintenance charges and increases in rent payments that are driven by factors such as future changes in an index (e.g., the Consumer Price Index).
A
right-of-use
asset of $68,631, short-term lease liability of $20,670 and long-term lease liability of $51,141 were reflected on the balance sheet as of June 30, 2019.
The elements of lease expense were as follows:
                 
 
Three Months Ended
June 30, 2019
 
 
Six Months Ended
 

June 30, 2019
 
Lease Cost:
   
 
 
 
 
 
Operating lease cost
  $
6,004
 
 
$
11,381
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The weighted average discount rate and the weighted average remaining lease term were 
3.8
% and
5.1
years, respectively, for the period ended June 30, 2019. Operating cash flows used for operating leases for the six months ended June 30, 2019 was $
11,515
.
Future lease payments under
non-cancelable
leases as of June 30, 2019 are detailed as follows:
         
 
 
Amount
 
Year Ending December 31,
 
 
 
2019 (remaining)
  $
11,607
 
2020
   
20,951
 
2021
   
13,899
 
2022
   
8,324
 
2023
   
7,061
 
Thereafter
   
17,301
 
         
Total lease payments
 
 
79,143
 
Less: imputed interest
 
 
7,332
  
         
Total operating lease liabilities
  $
71,811
 
         
 
 
 
 
 
 
 
8
  
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
Minimum lease payments under operating leases prior to adoption of ASU
2016-02
were as follows:
         
 
 
Operating Leases
 
Year Ending December 31,
 
 
 
 
2019
  $
20,106
 
2020
   
17,142
 
2021
   
10,325
 
2022
   
5,573
 
2023
   
4,411
 
Thereafter
   
8,739
 
         
Total minimum lease payments
  $
66,296
 
         
 
 
 
4)
Revenue from Contracts with Customers
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contract assets 
as of June 30, 2019 and December 31, 2018 were $
2,883
and $
3,624
, respectively, and included in other current assets.
A rollforward of the Company’s deferred revenue and customer advances is as follows:
         
 
Six Months Ended
June 30, 2019
 
Beginning balance, January 1
(1)
  $
17,474
 
Deferred revenue and customer advances assumed in ESI Merger
   
4,629
 
Additions to deferred revenue and customer advances
   
34,772
 
Amount of deferred revenue and customer advances recognized in income
   
(27,407
)
         
Ending balance, June 30
(2)
  $
29,468
 
         
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
Beginning deferred revenue and customer advances as of January 1, 2019 included $
8,134
of current deferred revenue, $
3,228
of long-term deferred revenue and $
6,112
of current customer advances.
 
 
 
 
 
 
 
 
 
 
 
 
 
(2)
Ending deferred revenue as of June 30, 2019 included $
17,968
of current deferred revenue, $
2,871
of long-term deferred revenue and $
8,629
of current customer advances.
 
 
 
 
 
 
 
 
 
 
 
 
 
Disaggregation of Revenue
The following table summarizes revenue from contracts with customers:
                                 
 
Three Months Ended June 30, 2019
 
 
Vacuum &
Analysis
   
Light &
Motion
   
Equipment &
Solutions
   
Total
 
Net revenues:
   
     
     
     
 
Products
  $
191,760
    $
167,363
    $
42,203
    $
401,326
 
Services
   
43,895
     
15,216
     
13,673
     
72,784
 
                                 
Total net revenues
  $
235,655
    $
182,579
    $
55,876
    $
474,110
 
                                 
       
 
Three Months Ended June 30, 2018
 
 
Vacuum &
Analysis
   
Light &
Motion
   
Equipment &
Solutions
   
Total
 
Net revenues:
   
     
     
     
 
Products
  $
321,454
    $
188,545
    $
—  
    $
509,999
 
Services
   
46,874
     
16,267
     
—  
     
63,141
 
                                 
Total net revenues
  $
368,328
    $
204,812
    $
—  
    $
573,140
 
                                 
 
 
 
 
 
 
9
 
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
  
                                 
 
Six Months Ended June 30, 2019
 
 
Vacuum &
Analysis
   
Light &
Motion
   
Equipment &
Solutions
   
Total
 
Net revenues:
   
     
     
     
 
Products
  $
384,408
    $
346,060
    $
68,221
    $
798,689
 
Services
   
85,602
     
30,507
     
22,873
     
138,982
 
                                 
Total net revenues
  $
470,010
    $
376,567
    $
91,094
    $
937,671
 
                                 
       
 
Six Months Ended June 30, 2018
 
 
Vacuum &
Analysis
   
Light &
Motion
   
Equipment &
Solutions
   
Total
 
Net revenues:
   
     
     
     
 
Products
  $
625,790
     
380,886
    $
—  
    $
1,006,676
 
Services
   
90,882
     
29,857
     
—  
     
120,739
 
                                 
Total net revenues
  $
716,672
    $
410,743
    $
—  
    $
1,127,415
 
                                 
 
 
 
 
 
Product revenue, excluding revenue from certain custom products, is recorded at a point in time, while the majority of the service revenue and revenue from certain custom products is recorded over time.
Refer to Note 17 for revenue by reportable segment, geography and groupings of similar products.
5)
Investments
The fair value of investments classified as short-term consists of the following:
                 
 
June 30, 2019
   
December 31, 2018
 
Available-for-sale
investments:
   
     
 
Time deposits and certificates of deposit
  $
5,262
    $
102
 
Bankers’ acceptance drafts
   
3,833
     
989
 
Asset-backed securities
   
     
9,113
 
Commercial paper
   
60,154
     
19,359
 
Corporate obligations
   
8,219
     
9,352
 
U.S. treasury obligations
   
     
13,298
 
U.S. agency obligations
   
15,517
     
21,613
 
                 
  $
92,985
    $
73,826
 
                 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments classified as long-term consist of the following:
                 
 
June 30, 2019
   
December 31, 2018
 
Available-for-sale
investments:
   
     
 
Group insurance contracts
  $
6,001
    $
5,890
 
Cost method investments:
   
     
 
Minority interest in a private company
   
4,400
     
4,400
 
                 
  $
10,401
    $
10,290
 
                 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
10
  
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
The following tables show the gross unrealized gains and (losses) aggregated by investment category for
available-for-sale
investments:
                                 
As of June 30, 2019:
 
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
(Losses)
   
Estimated
Fair Value
 
Short-term investments:
   
     
     
     
 
Available-for-sale
investments:
   
     
     
     
 
Time deposits and certificates of deposit
  $
5,261
    $
1
    $
    $
5,262
 
Bankers’ acceptance drafts
   
3,833
     
     
     
3,833
 
Commercial paper
   
60,526
     
     
(372
)    
60,154
 
Corporate obligations
   
8,218
     
1
     
     
8,219
 
U.S. agency obligations
   
15,512
     
6
     
(1
)    
15,517
 
                                 
  $
93,350
    $
8
    $
(373
)   $
92,985
 
                                 
 
 
 
 
 
 
 
 
 
                                 
As of June 30, 2019:
 
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
(Losses)
   
Estimated
Fair Value
 
Long-term investments:
   
     
     
     
 
Available-for-sale
investments:
   
     
     
     
 
Group insurance contracts
  $
5,567
    $
434
    $
    $
6,001
 
                                 
 
 
 
 
 
 
 
 
 
                                 
As of December 31, 2018:
 
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
(Losses)
   
Estimated
Fair Value
 
Short-term investments:
   
     
     
     
 
Available-for-sale
investments:
   
     
     
     
 
Time deposits and certificates of deposit
  $
102
    $
—  
    $
—  
    $
102
 
Bankers’ acceptance drafts
   
989
     
—  
     
—  
     
989
 
Asset-backed securities
   
9,121
     
1
     
(9
)    
9,113
 
Commercial paper
   
19,504
     
—  
     
(145
)    
19,359
 
Corporate obligations
   
9,367
     
—  
     
(15
)    
9,352
 
U.S. treasury obligations
   
13,294
     
4
     
—  
     
13,298
 
U.S. agency obligations
   
21,617
     
2
     
(6
)    
21,613
 
                                 
  $
73,994
    $
7
    $
(175
)   $
73,826
 
                                 
 
 
 
 
 
 
 
 
 
                                 
As of December 31, 2018:
 
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
(Losses)
   
Estimated 
Fair Value
 
Long-term investments:
   
     
     
     
 
Available-for-sale
investments:
   
     
     
     
 
Group insurance contracts
  $
5,546
    $
344
    $
 —  
    $
5,890
 
                                 
 
 
 
 
 
 
 
 
 
The tables above, which show the gross unrealized gains and (losses) aggregated by investment category for
available-for-sale
investments as of June 30, 2019 and December 31, 2018, reflect the inclusion within short-term investments of investments with contractual maturities greater than one year from the date of purchase. Management has the ability, if necessary, to liquidate any of its investments in order to meet the Company’s liquidity needs in the next 12 months. Accordingly, those investments with contractual maturities greater than one year from the date of purchase are classified as short-term on the accompanying balance sheets.
The Company reviews and evaluates its investments for any indication of possible impairment. Based on this review, the Company has determined that the unrealized losses related to these investments at June 30, 2019 and December 31, 2018 were temporary.
Interest income is accrued as earned. Dividend income is recognized as income on the date the stock trades
“ex-dividend.”
The cost of marketable securities sold is determined by the specific identification method. Realized gains or losses are reflected in income and were not material for the six months ended June 30, 2019 and 2018. 
 
11
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
6)       
Fair Value Measurements
  In accordance with the provisions of fair value accounting, a fair value measurement assumes that the transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability and defines fair value based upon an exit price model.
 
The fair value measurement guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:
  Level 1 Quoted prices in active markets for identical assets or liabilities assessed as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
 
 
 
  Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments or securities or derivative contracts that are valued using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.
 
 
 
  Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
 
 
 
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the Company categorizes such assets and liabilities based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
 
12
 
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
Assets and liabilities of the Company are measured at fair value on a recurring basis as of June 30, 2019 and are summarized as follows:
                                 
 
   
Fair Value Measurements at Reporting Date Using
 
Description
 
June 30, 2019
   
Quoted Prices in
Active Markets for
Identical Assets or
Liabilities
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Assets:
   
     
     
     
 
Cash equivalents:
   
     
     
     
 
Money market funds
  $
104
    $
104
    $
    $
 
Time deposits and certificates of deposit
   
3,396
     
     
3,396
     
 
Commercial paper
   
36,968
     
     
36,968
     
 
U.S. agency obligations
   
22,632
     
     
22,632
     
 
Restricted cash – money market funds
   
322
     
322
     
     
 
Available-for-sale
investments:
   
     
     
     
 
Time deposits and certificates of deposit
   
5,262
     
 
     
5,262
     
 
Bankers’ acceptance drafts
   
3,833
     
     
3,833
     
 
Commercial paper
   
60,154
     
     
60,154
     
 
Corporate obligations
   
8,219
     
     
8,219
     
 
U.S. agency obligations
 
 
15,517
 
 
 
 
 
 
15,517
 
 
 
 
Group insurance contracts
   
6,001
     
     
6,001
     
 
Derivatives – currency forward contracts
   
2,920
     
     
2,920
     
 
Funds in investments and other assets:
   
     
     
     
 
Israeli pension assets
   
15,744
     
     
15,744
     
 
Deferred compensation plan assets:
   
     
     
     
 
Mutual funds and exchange traded funds
   
2,001
     
     
2,001
     
 
Money market securities
   
288
     
     
288
     
 
                                 
Total assets
  $
183,361
    $
426
    $
182,935
    $
 
                                 
Liabilities:
   
     
     
     
 
Derivatives – currency forward contracts
  $
1,023
    $
    $
1,023
    $
 
Derivatives – interest rate hedge – non-current
 
 
4,633
 
 
 
 
 
 
4,633
 
 
 
 
Total liabilities
 
$
5,656
 
 
$
 
 
$
5,656
 
 
$
 
Reported as follows:
   
     
     
     
 
Assets:
   
     
     
     
 
Cash and cash equivalents, including restricted cash
(1)
  $
63,422
    $
426
    $
62,996
    $
 
Short-term investments
   
92,985
     
     
92,985
     
 
Other current assets
   
2,920
     
     
2,920
     
 
                                 
Total current assets
  $
159,327
    $
426
    $
158,901
    $
 
                                 
Long-term investments
(2)
  $
6,001
    $
    $
6,001
    $
 
Other assets
   
18,033
     
     
18,033
     
 
                                 
Total long-term assets
  $
24,034
    $
    $
24,034
    $
 
                                 
Liabilities:
   
     
     
     
 
Other current liabilities
  $
1,023
    $
    $
1,023
    $
 
                                 
Other liabilities
 
$
4,633
 
 
$
 
 
$
4,633
 
 
$
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
The cash and cash equivalent amounts presented in the table above do not include cash of $
303,513
as of June 30, 2019.
 
 
 
 
 
 
 
 
 
 
 
 
 
(2)
The long-term investments presented in the table above do not include the Company’s minority interest investment in a private company, which is accounted for under the cost method.
 
 
 
13
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
Assets and liabilities of the Company are measured at fair value on a recurring basis as of December 31, 2018 and are summarized as follows:
                                 
 
   
Fair Value Measurements at Reporting Date Using
 
Description
 
December 31,
2018
   
Quoted Prices in
Active Markets for
Identical Assets or
Liabilities
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Assets:
   
     
     
     
 
Cash equivalents:
   
     
     
     
 
Money market funds
  $
180,340
    $
180,340
    $
—  
    $
—  
 
Time deposits and certificates of deposit
   
850
     
—  
     
850
     
—  
 
Commercial paper
   
2,687
     
—  
     
2,687
     
—  
 
U.S. agency obligations
   
3,418
     
—  
     
3,418
     
—  
 
Restricted cash – money market funds
   
110
     
110
     
—  
     
—  
 
Available-for-sale
investments:
   
     
     
     
 
Time deposits and certificates of deposit
   
102
     
—  
     
102
     
—  
 
Bankers’ acceptance drafts
   
989
     
—  
     
989
     
—  
 
Asset-backed securities
   
9,113
     
—  
     
9,113
     
—  
 
Commercial paper
   
19,359
     
—  
     
19,359
     
—  
 
Corporate obligations
   
9,352
     
—  
     
9,352
     
—  
 
U.S. treasury obligations
   
13,298
     
—  
     
13,298
     
—  
 
U.S. agency obligations
   
21,613
     
—  
     
21,613
     
—  
 
Group insurance contracts
   
5,890
     
—  
     
5,890
     
—  
 
Derivatives – currency forward contracts
   
2,485
     
—  
     
2,485
     
—  
 
Funds in investments and other assets:
   
     
     
     
 
Israeli pension assets
   
14,408
     
—  
     
14,408
     
—  
 
Derivatives – interest rate hedge –
non-current
   
6,083
     
—  
     
6,083
     
—  
 
                                 
Total assets
  $
290,097
    $
180,450
    $
109,647
    $
—  
 
                                 
Liabilities:
   
     
     
     
 
Derivatives – currency forward contracts
  $
1,168
    $
—  
    $
1,168
    $
—  
 
                                 
Reported as follows:
   
     
     
     
 
Assets:
   
     
     
     
 
Cash and cash equivalents, including restricted cash
(1)
  $
187,405
    $
180,450
    $
6,955
    $
—  
 
Short-term investments
   
73,826
     
—  
     
73,826
     
—  
 
Other current assets
   
2,485
     
—  
     
2,485
     
—  
 
                                 
Total current assets
  $
263,716
    $
180,450
    $
83,266
    $
—  
 
                                 
Long-term investments
(2)
  $
5,890
    $
—  
    $
5,890
    $
—  
 
Other assets
   
20,491
     
—  
     
20,491
     
—  
 
                                 
Total long-term assets
  $
26,381
    $
—  
    $
26,381
    $
—  
 
                                 
Liabilities:
   
     
     
     
 
Other current liabilities
  $
1,168
    $
—  
    $
1,168
    $
—  
 
                                 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
The cash and cash equivalent amounts presented in the table above do not include cash of $
456,940
as of December 31, 2018.
 
 
 
 
 
 
 
 
 
 
 
 
 
(2)
The long-term investments presented in the table above do not include the Company’s minority interest investment in a private company, which is accounted for under the cost method.
 
 
 
14
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
Money Market Funds
Money market funds are cash and cash equivalents and are classified within Level 1 of the fair value hierarchy.
Available-For-Sale Investments
Available-for-sale
investments consisted of time deposits, certificates of deposit, bankers’ acceptance drafts, asset-backed securities (which include auto loans, credit card receivables and equipment trust receivables), commercial paper, corporate obligations, U.S. treasury obligations, U.S. agency obligations and group insurance contracts.
The Company measures its debt and equity investments at fair value. The Company’s
available-for-sale
investments are classified within Level 2 of the fair value hierarchy.
Israeli Pension Assets
Israeli pension assets represent investments in mutual funds, government securities and other time deposits. These investments are set aside for the retirement benefit of the employees at the Company’s Israeli subsidiaries. These funds are classified within Level 2 of the fair value hierarchy.
Derivatives
As a result of the Company’s global operating activities, the Company is exposed to market risks from changes in foreign currency exchange rates and variable interest rates, which may adversely affect its operating results and financial position. When deemed appropriate, the Company minimizes its risks from foreign currency exchange rate and interest rate fluctuations through the use of derivative financial instruments. The principal market in which the Company executes its foreign currency contracts and interest rate swaps is the institutional market in an over-the-counter environment with a relatively high level of price transparency. The market participants usually are large commercial banks. The forward foreign currency exchange contracts and interest rate hedge are valued using broker quotations or market transactions and are classified within Level 2 of the fair value hierarchy.
7)
Derivatives
The Company enters into derivative instruments for risk management purposes only, including derivatives designated as hedging instruments and those utilized as economic hedges. The Company operates internationally and, in the normal course of business, is exposed to fluctuations in interest rates and foreign exchange rates. These fluctuations can increase the costs of financing, investing and operating the business. The Company has used derivative instruments, such as forward foreign currency exchange contracts, to manage certain foreign currency exposure, and interest rate swaps to manage interest rate exposure.
By nature, all financial instruments involve market and credit risks. The Company enters into derivative instruments with major investment grade financial institutions, for which no collateral is required. The Company has policies to monitor the credit risk of these counterparties. While there can be no assurance, the Company does not anticipate any material
non-performance
by any of these counterparties.
Interest Rate Swap Agreements
On September 30, 2016, the Company entered into an interest rate swap agreement to fix the rate on approximately
50
% of its then-outstanding balance under the Credit Agreement, as described further in Note 11. This hedge fixes the interest rate paid on the hedged debt at
1.198
% per annum plus the applicable credit spread, which was
2.0
% as of June 30, 2019, through
September 30, 2020
.
At June 30, 2019, the notional amount of this transaction was
$290,000
and had a fair value asset of
$2,055.
At December 31, 2018, the notional amount of this transaction was
$290,000 and had a fair value asset of $6,083.
On April 3, 2019, the Company entered into an interest rate swap agreement, which has a maturity date of March 31, 2023, to fix the rate on $
300,000
of the then-outstanding balance of the 2019 Incremental Term Loan Facility, as described further in Note 11. The rate is fixed at
2.309
% per annum plus the applicable credit spread, which was
2.25
% at June 30, 2019. At June 30, 2019, the notional amount of this transaction was $
300,000
and had a fair value liability of $
6,688
.
 
15
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
The interest rate swaps are recorded at fair value on the balance sheet and changes in the fair value are recognized in other comprehensive income (loss) (“OCI”). To the extent that these arrangements are no longer an effective hedge, any ineffectiveness measured in the hedging relationships is recorded currently in earnings in the period it occurs.
Foreign Exchange Contracts
The Company hedges a portion of its forecasted foreign currency-denominated intercompany sales of inventory, over a maximum period of
eighteen months
, using forward foreign exchange contracts accounted for as cash-flow hedges related to Japanese, South Korean, British, Euro and Taiwanese currencies. To the extent these derivatives are effective in off-setting the variability of the hedged cash flows, and otherwise meet the hedge accounting criteria, changes in the derivatives’ fair value are not included in current earnings but are included in OCI in stockholders’ equity. These changes in fair value will subsequently be reclassified into earnings, as applicable, when the forecasted transaction occurs. To the extent that a previously designated hedging transaction is no longer an effective hedge, any ineffectiveness measured in the hedging relationship is recorded currently in earnings in the period it occurs. The cash flows resulting from forward exchange contracts are classified in the consolidated statements of cash flows as part of cash flows from operating activities. The Company does not enter into derivative instruments for trading or speculative purposes.
As of June 30, 2019 and December 31, 2018, the Company had outstanding forward foreign exchange contracts with gross notional values of $
161,278
and $
159,394
, respectively.
The following tables provide a summary of the primary net hedging positions and corresponding fair values held as of June 30, 2019 and December 31, 2018:
 
June 30, 2019
 
Currency Hedged (Buy/Sell)
 
Gross Notional
Value
   
Fair Value
(1)
 
U.S. Dollar/Japanese Yen
  $
46,933
    $
(508
)
U.S. Dollar/South Korean Won
   
52,484
     
1,523
 
U.S. Dollar/Euro
   
31,603
     
306
 
U.S. Dollar/U.K. Pound Sterling
   
10,208
     
276
 
U.S. Dollar/Taiwan Dollar
   
20,050
     
300
 
                 
Total
  $
161,278
    $
1,897
 
                 
 
December 31, 2018
 
Currency Hedged (Buy/Sell)
 
Gross Notional
Value
   
Fair Value
(1)
 
U.S. Dollar/Japanese Yen
  $
43,770
    $
(478
)
U.S. Dollar/South Korean Won
   
59,149
     
570
 
U.S. Dollar/Euro
   
23,515
     
688
 
U.S. Dollar/U.K. Pound Sterling
   
11,827
     
323
 
U.S. Dollar/Taiwan Dollar
   
21,133
     
214
 
                 
Total
  $
159,394
    $
1,317
 
                 
 
(1)
Represents the receivable (payable) amount included in the consolidated balance sheet.
The following table provides a summary of the fair value amounts of the Company’s derivative instruments:
 
 
June 30, 2019
   
December 31, 2018
 
Derivative assets:
   
     
 
Foreign exchange contracts
(1)
  $
2,920
    $
2,485
 
Interest rate hedge
(2)
   
     
6,083
 
Derivative liabilities:
   
     
 
Foreign exchange contracts
(1)
   
(1,023
)    
(1,168
)
Interest rate hedge
(2)
 
 
(4,633
)
 
 
—  
 
                 
Total net derivative (liability) asset designated as hedging instruments
  $
(2,736
)   $
7,400
 
                 
 
(1)
The derivative assets of $
2,920
and $
2,485
as of June 30, 2019 and December 31, 2018, respectively, related to foreign exchange contracts and are classified in other current assets in the consolidated balance sheet. The derivative liabilities of $
1,023
and $
1,168
as of June 30, 2019 and December 31, 2018, respectively, are classified in other current liabilities in the consolidated balance sheet. These foreign exchange contracts are subject to a master netting agreement with one financial institution. However, the Company has elected to record these contracts on a gross basis in the balance sheet.
(2)
The interest rate hedge liability of $
4,633
as of June 30, 2019 is classified in other liabilities in the consolidated balance sheet. The interest rate hedge asset of $
6,083
as of December 31, 2018 is classified in other assets in the consolidated balance sheet.
 
16
  
 
 
Table of Contents
  
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
The net amount of existing gains as of June 30, 2019 that the Company expects to reclassify from OCI into earnings within the next
twelve months
is immaterial.
The following table provides a summary of the gains (losses) on derivatives designated as cash flow hedging instruments:
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
Derivatives Designated as Cash Flow Hedging Instruments
 
2019
   
2018
   
2019
   
2018
 
Forward exchange contracts:
   
     
     
     
 
Net gain (loss) recognized in OCI
(1)
  $
(10,232
)   $
10,079
    $
(10,165
)   $
10,145
 
Net gain (loss) reclassified from accumulated OCI into income
(2)
  $
1,128
    $
(2,648
)   $
2,077
    $
(5,188
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
Net change in the fair value of the effective portion classified in OCI.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(2)
Effective portion classified in cost of products for the three and six months ended June 30, 2019 and 2018. The tax effect of the gains or losses reclassified from accumulated OCI into income is immaterial.
 
 
 
 
 
 
The following table provides a summary of the gain (loss) on derivatives not designated as hedging instruments:
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
Derivatives Not Designated as Hedging Instruments
 
2019
   
2018
   
2019
   
2018
 
Forward exchange contracts:
   
     
     
     
 
Net gain (loss) recognized in income
(1)
  $
(305
)   $
1,375
    $
(248
)   $
122
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
The Company enters into foreign exchange contracts to hedge against changes in the balance sheet for certain subsidiaries to mitigate the risk associated with certain foreign currency transactions in the ordinary course of business. These derivatives are not designated as hedging instruments and gains or losses from these derivatives are recorded immediately in other (expense) income.
 
 
 
 
 
 
 
8)
Inventories
Inventories consist of the following:
                 
 
June 30, 2019
   
December 31, 2018
 
Raw materials
  $
300,484
    $
235,593
 
Work-in-process
   
82,661
     
61,908
 
Finished goods
   
96,352
     
87,188
 
                 
  $
479,497
    $
384,689
 
                 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
9)
Acquisitions
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Electro Scientific Industries, Inc.
On February 1, 2019, the Company completed its acquisition of Electro Scientific Industries, Inc. (“ESI”) pursuant to an Agreement and Plan of Merger, dated as of October 29, 2018 (the “Merger Agreement”), by and among the Company, EAS Equipment, Inc., formerly a Delaware corporation and a wholly-owned subsidiary of the Company, and ESI (the “ESI Merger”). At the effective time of the ESI Merger and pursuant to the terms and conditions of the Merger Agreement, each share of ESI’s common stock that was issued and outstanding immediately prior to the effective time of the ESI Merger was converted into the right to receive $30.00 in cash, without interest and subject to deduction of any required withholding tax.
The aggregate consideration was $1,032,671, which excludes related transaction fees and expenses, and non-cash consideration related to the exchange of share-based awards of $30,630, for a total purchase consideration of $1,063,301. The Company funded the payment of the aggregate consideration with a combination of the Company’s available cash on hand and the proceeds from the Company’s senior secured term loan facility described in Note 11.
 
17
  
 
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MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
ESI provides laser-based manufacturing solutions for the micro-machining industry that enable customers to optimize production. It’s market is composed primarily of flexible and rigid PCB processing/fabrication, semiconductor wafer processing and passive component manufacturing and testing. ESI solutions incorporate specialized laser technology and proprietary control software to efficiently process the materials and components that are an integral part of electronic devices and systems.
The purchase price of ESI consisted of the following:
         
Cash paid for outstanding shares
(1)
  $
1,032,671
 
Settlement of share-based compensation awards
(2)
   
30,630
 
         
Total purchase price
   
1,063,301
 
Less: Cash and cash equivalents acquired
   
(44,072
)
         
Total purchase price, net of cash and cash equivalents acquired
  $
1,019,229
 
         
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
Represents cash paid of $30.00 per share for 34,422,361 shares of ESI common stock, without interest and subject to a deduction for any required withholding tax.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(2)
Represents the vested but not issued portion of ESI share-based compensation awards as of the acquisition date of February 1, 2019.
 
 
 
 
 
 
 
 
 
Under the acquisition method of accounting, the total estimated acquisition consideration is allocated to the acquired tangible and intangible assets and assumed liabilities of ESI based on their fair values as of the acquisition date. Any excess of the acquisition consideration over the fair value of assets acquired and liabilities assumed is allocated to goodwill. The Company expects that none of such goodwill and intangible assets will be deductible for tax purposes.
The following table summarizes the allocation of the preliminary purchase price to the fair values assigned to assets acquired and liabilities assumed at the date of the ESI Merger:
         
Current assets (excluding inventory)
  $
208,009
 
Inventory
   
83,036
 
Intangible assets
   
316,200
 
Goodwill
   
472,695
 
Property, plant and equipment
   
65,489
 
Long-term assets
   
9,633
 
         
Total assets acquired
   
1,155,062
 
Current liabilities
   
51,479
 
Non-current
deferred taxes
   
33,123
 
Other long-term liabilities
   
7,159
 
         
Total liabilities assumed
   
91,761
 
         
Fair value of assets acquired and liabilities assumed
   
1,063,301
 
         
Less: Cash and cash equivalents acquired
   
(44,072
)
         
Total purchase price, net of cash and cash equivalents acquired
  $
1,019,229
 
         
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
During the three months ended June 30, 2019, the Company recorded an increase in fair value of approximately $12,600 to property, plant and equipment, based upon the final valuation for land and three ESI facilities located in Portland, Oregon. The Company also recorded a reduction in fair value of approximately $9,800 to inventories relating to three product lines. These adjustments also resulted in an adjustment to intangible assets of $2,400 and goodwill of $1,300 and the related impact to the deferred tax line items.
 
18
 
 
 
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MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
The fair value write-up of acquired finished goods inventory was $7,624, the amount of which will be expensed over the period during which the acquired inventory is sold. Accordingly, for the three and six months ended June 30, 2019, the Company recorded $2,484 and $7,624, respectively, of incremental cost of sales charges associated with the fair value write-up of inventory acquired in the ESI Merger.
The fair value write-up of acquired property, plant and equipment of $39,267 will be amortized over the estimated useful life of the applicable assets, excluding the fair value write-up in the value of land. Property, plant and equipment is valued at its value-in-use, unless there was a known plan to dispose of the asset.
The acquired intangible assets are being amortized on a straight-line basis, which approximates the economic use of the asset.
 
The following table reflects the allocation of the acquired intangible assets and related estimate of useful lives:
         
Completed technology - Laser
  $
255,700
 
Completed technology -
Non-Laser
   
18,300
 
Trademarks and trade names
   
14,400
 
Customer relationships
   
25,400
 
Backlog
   
2,400
 
         
  $
316,200
 
         
 
 
 
 
 
 
 
 
 
 
The net fair value of the acquired intangibles was determined using the income approach. In performing these valuations, the key underlying probability-adjusted assumptions of the discounted cash flows were projected revenues, gross margin expectations and operating cost estimates. The valuations were based on the information that was available as of the acquisition date and expectations and assumptions that have been deemed reasonable by the Company’s management. There are inherent uncertainties and management judgment required in these determinations. This acquisition resulted in a purchase price that exceeded the estimated fair value of tangible and intangible assets, the excess amount of which was allocated to goodwill.
While the Company uses its best estimates and assumptions as part of the purchase price allocation process to value the assets acquired and liabilities assumed on the acquisition date, its estimates and assumptions are subject to refinement. Fair value estimates are based on a complex series of judgments about future events and uncertainties and rely heavily on estimates and assumptions. The judgments used to determine the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially impact the Company’s results of operations. The finalization of the purchase accounting assessment will result in a change in the valuation of assets acquired and liabilities assumed and may have a material impact on the Company’s results of operations and financial position. As a result, during the measurement period, which may be up to one year from the acquisition date, the Company records adjustments to the assets acquired and liabilities assumed with a corresponding offset to goodwill to reflect additional information received about facts and circumstances which existed at the date of acquisition. The Company records adjustments to the assets acquired and liabilities assumed subsequent to the purchase price allocation period in the Company’s operating results in the period in which the adjustments are determined. The size and breadth of the ESI Merger will necessitate the use of this measurement period to adequately analyze and assess a number of the factors used in establishing the fair value of certain tangible and intangible assets acquired and liabilities assumed as of the acquisition date and the related tax impacts of any changes made. Any potential adjustments made could be material in relation to the preliminary values presented above.
The Company believes the amount of goodwill relative to identifiable intangible assets relates to several factors, including broadening its position in key industrial end markets to complementary solutions, and leveraging component and systems expertise to provide robust solutions to meet customer evolving technology needs.
The results of this acquisition were included in the Company’s consolidated statement of operations beginning on February 1, 2019. ESI constitutes the Company’s Equipment & Solutions reportable segment (see Note 17).
Certain executives from ESI had severance provisions in their respective ESI employment agreements. The agreements included terms that were accounted for as dual-trigger arrangements. Through the Company’s acquisition accounting, the expense relating to these benefits was recognized in the combined entity’s financial statements. The Company recorded costs of $2,701 and $14,023  in acquisition and integration costs as compensation expense and stock-based compensation expense, respectively, for the six months ended June 30, 2019 associated with these severance provisions. The restricted stock units and stock appreciation rights that were eligible for accelerated vesting if the executive exercised his or her rights but were not issued as of each reporting period-end, were excluded from the computation of basic earnings per share and included in the computation of diluted earnings per share for such reporting period.
 
19
 
 
 
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MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
The Company’s consolidated net revenue and earnings for the three and six months ended June 30, 2019 include the following amounts of revenue and earnings of ESI since the acquisition date:
                 
 
Three Months Ended
June 30, 2019
   
Six Months Ended
June 30, 2019
 
Total net revenues
  $
55,877
    $
91,096
 
                 
Net loss
  $
(3,129
)   $
(34,844
)
                 
Net loss per share:
   
     
 
Basic
  $
(0.06
)   $
(0.64
)
                 
Diluted
  $
(0.06
)   $
(0.63
)
                 
 
 
 
 
 
 
 
 
 
 
Pro Forma Results
The following unaudited pro forma financial information presents the combined results of operations of the Company as if the ESI Merger had occurred on January 1, 2018. The unaudited pro forma financial information is not necessarily indicative of what the Company’s condensed consolidated results of operations actually would have been had the acquisition occurred at the beginning of each year. In addition, the unaudited pro forma financial information does not attempt to project the future results of operations of the combined Company.
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
 
2019
   
2018
   
2019
   
2018
 
Total net revenues
  $
474,110
    $ 683,764     $
952,179
    $
1,344,409
 
                                 
Net income
  $
47,464
    $
132,601
    $
89,871
    $
230,765
 
                                 
Net income per share:
   
             
     
 
Basic
  $
0.87
    $
2.42
    $
1.65
    $
4.23
 
                                 
Diluted
  $
0.86
    $
2.40
    $
1.64
    $
4.17
 
                                 
 
 
 
 
 
 
 
 
 
 
The unaudited pro forma financial information above gives effect primarily to the following:
  (1) Incremental amortization and depreciation expense related to the estimated fair value of identifiable intangible assets and property, plant and equipment, respectively, from the purchase price allocation.
 
 
 
 
 
 
 
 
 
 
  (2) Revenue and cost of goods sold adjustments as a result of the reduction in deferred revenue and the cost related to their estimated fair value.
 
 
 
 
 
 
 
 
 
 
  (3) Incremental interest expense related to the Company’s 2019 Incremental Term Loan Facility, as defined and discussed in Note 11.
 
 
 
 
 
 
 
 
 
 
  (4) The exclusion of acquisition costs and inventory
step-up
amortization from the three and six month period ended June 30, 2019 and the addition of these items to the three and six month period ended June 30, 2018.
 
 
 
 
 
 
 
 
 
 
  (5) The exclusion of debt issuance costs due to the modification of the 2019 Incremental Term Loan Facility from the three and six month period ended June 30, 2019 and the addition of this item to the three and six month period ended June 30, 2018.
 
 
 
 
 
 
 
 
 
 
  (6) The estimated tax impact of the above adjustments.
 
 
 
 
 
 
10)
Goodwill and Intangible Assets
 
 
 
 
 
 
 
 
 
 
Goodwill
The Company’s methodology for allocating the purchase price relating to purchase acquisitions is determined through established and generally accepted valuation techniques. Goodwill is measured as the excess of the cost of the acquisition over the sum of the amounts assigned to tangible and identifiable intangible assets acquired less liabilities assumed. The Company assigns assets acquired (including goodwill) and liabilities assumed to one or more reporting units as of the date of acquisition. Typically acquisitions relate to a single reporting unit and thus do not require the allocation of goodwill to multiple reporting units. If the products obtained in an acquisition are assigned to multiple reporting units, the goodwill is distributed to the respective reporting units as part of the purchase price allocation process.
 
20
 
 
 
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MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
Goodwill and purchased intangible assets with indefinite useful lives are not amortized, but are reviewed for impairment annually during the fourth quarter of each fiscal year and whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The process of evaluating the potential impairment of goodwill and intangible assets requires significant judgment. The Company regularly monitors current business conditions and other factors including, but not limited to, adverse industry or economic trends, restructuring actions and lower projections of profitability that may impact future operating results.
Effective July 1, 2018, the Company reassigned goodwill to certain reporting units within the Light & Motion reportable segment resulting from a reorganization of the composition of goodwill reporting units. The goodwill was reassigned to the reporting units affected using the relative fair value approach. In conjunction with this goodwill reassignment, the Company performed an interim quantitative impairment test as of July 1, 2018 for all of its reporting units and concluded that the fair values of each reporting unit exceeded their respective carrying values.
Effective January 1, 2019, the Company reassigned goodwill to certain reporting units within the Light & Motion reportable segment resulting from a reorganization of the composition of goodwill reporting units. The goodwill was reassigned to the reporting units affected using the relative fair value approach. The Company also concluded that the fair value of each reporting unit exceeded its respective carrying value.
The changes in the carrying amount of goodwill and accumulated impairment loss during the six months ended June 30, 2019 and year ended December 31, 2018 were as follows:
 
Six Months Ended June 30, 2019
   
Twelve Months Ended December 31, 2018
 
 
Gross
Carrying
Amount
   
Accumulated
Impairment
Loss
   
Net
   
Gross
Carrying
Amount
   
Accumulated
Impairment
Loss
   
Net
 
Beginning balance at January 1
  $
731,272
    $
(144,276
)   $
586,996
    $
735,323
    $
(144,276
)   $
591,047
 
Acquired goodwill
(1)
   
472,695
     
     
472,695
     
  
     
  
     
—  
 
Foreign currency translation
   
(1,024
)    
     
(1,024
)    
(4,051
)    
  
     
(4,051
)
                                                 
Ending balance at June 30, 2019 and December 31, 2018
  $
1,202,943
    $
(144,276
)   $
1,058,667
    $
731,272
    $
(144,276
)   $
586,996
 
                                                 
 
(1)
During the six months ended June 30, 2019, the Company recorded $472,695 of goodwill related to the ESI Merger.
Intangible Assets
Components of the Company’s intangible assets are comprised of the following:
As of June 30, 2019:
 
Gross
   
Accumulated
Impairment
Charges
   
Accumulated
Amortization
   
Foreign
Currency
Translation
   
Net
 
Completed technology
(1)
  $
446,431
    $
(105
)   $
(157,407
)   $
(156
)   $
288,763
 
Customer relationships
(1)
   
308,144
     
(1,406
)    
(73,888
)    
(677
)    
232,173
 
Patents, trademarks, trade names and other
(1)
   
120,895
     
     
(42,567
)    
108
     
78,436
 
                                         
  $
875,470
    $
(1,511
)   $
(273,862
)   $
(725
)   $
599,372
 
                                         
 
(1)
During the six months ended June 30, 2019, the Company recorded $316,200 of separately identified intangible assets related to the ESI Merger, of which $274,000 was completed technology, $25,400 was customer relationships and $16,800 was trademarks, trade names and backlog. Separately, on January 1, 2019, the Company reclassified $6,428 of gross favorable lease assets and $3,445 of related accumulated amortization from patents, trademarks, trade names and other to the
right-of-use
asset line in the balance sheet.
  
21
 
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
  
As of December 31, 2018:
 
Gross
   
Accumulated
Impairment
Charges
   
Accumulated
Amortization
   
Foreign
Currency
Translation
   
Net
 
Completed technology
  $
172,431
    $
(105
)   $
(137,283
)   $
(73
)   $
34,970
 
Customer relationships
   
282,744
     
(1,406
)    
(63,788
)    
(269
)    
217,281
 
Patents, trademarks, trade names and other
   
110,523
     
  
     
(42,954
)    
(13
)    
67,556
 
                                         
  $
565,698
    $
(1,511
)   $
(244,025
)   $
(355
)   $
319,807
 
                                         
Aggregate amortization expense related to acquired intangibles for the six months ended June 30, 2019 and 2018 was $33,279 and $22,091, respectively. The net amortization expense from favorable lease commitments for the six months ended June 30, 2019 and 2018 was net of $0 and $277, respectively. Aggregate net amortization expense related to acquired intangible assets for future years is as follows:
Year
 
Amount
 
2019 (remaining)
  $
34,538
 
2020
   
55,565
 
2021
   
47,765
 
2022
   
45,294
 
2023
   
44,942
 
2024
   
44,024
 
Thereafter
   
271,344
 
11)
Debt
Term Loan Credit Agreement
In connection with the completion of the acquisition of Newport Corporation (
Newport
) in 2016 (the “Newport Merger”), the Company entered into a term loan credit agreement (the “Credit Agreement”) with Barclays Bank PLC, as administrative agent and collateral agent, and the lenders from time to time party thereto (the “Lenders”), that provided senior secured financing in the original principal amount of $780,000
(the “2016 Term Loan Facility”), subject to increase at the Company’s option and subject to receipt of lender commitments in accordance with the Credit Agreement (the 2016 Term Loan Facility, together with the 2019 Incremental Term Loan Facility (as defined below), the “Term Loan Facility”). The 2016 Term Loan Facility matures on April 29, 2023. Borrowings under the Term Loan Facility​​​​​​​ bear interest per annum at one of the following rates selected by the Company: (a) a base rate determined by reference to the highest of (1) the federal funds effective rate plus 0.50%, (2) the “prime rate” quoted in
The Wall Street Journal,
(3) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month adjusted for certain additional costs, plus 1.00%, and (4) a floor of 1.75%, plus, in each case, an applicable margin; or (b) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, subject to a LIBOR rate floor of 0.75%, plus an applicable margin. The Company has elected the interest rate as described in clause (b). The Credit Agreement provides that, unless an alternate rate of interest is agreed, all loans will be determined by reference to the Base Rate if the LIBOR rate cannot be ascertained, if regulators impose material restrictions on the authority of a lender to make LIBOR rate loans, or for other reasons. The 2016 Term Loan Facility was issued with original issue discount of 1.00​​​​​​​% of the principal amount thereof.
The Company subsequently entered into four separate repricing amendments to the 2016 Term Loan Facility, which decreased the applicable margin for LIBOR borrowings from 4.0% to 1.75%, with a LIBOR rate floor of 0.75%. As a consequence of the pricing of the 2019 Incremental Term Loan Facility (defined below), the applicable margin for the 2016 Term Loan Facility was increased to 2.00% (from 1.75%) with respect to LIBOR borrowings and 1.00% (from 0.75%) with respect to base rate borrowings. The interest rate on the 2016 Term Loan Facility as of June 30, 2019 was 4.4%.
On September 30, 2016, the Company entered into an interest rate​​​​​​​ swap agreement, which has a maturity date of September 30, 2020, to fix the rate on $335,000 of the then-outstanding balance of the 2016 Term Loan Facility. The rate is fixed at 1.198% per annum plus the applicable credit spread, which was 2.0% at June 30, 2019. At June 30, 2019, the notional amount of this transaction was $290,000 and had a fair value asset of $2,055.
As of June 30, 2019, after total principal prepayments of $475,000 (which includes a $
50,000
prepayment made during the three months ended June 30, 2019) and regularly scheduled principal payments of $6,536, the total outstanding principal balance of the 2016 Term Loan Facility was $298,464. As a result of making these prepayments, the Company is no longer required to make any regularly scheduled principal payments on the 2016 Term Loan Facility until the maturity date of the loan.
 
22
 
 
 
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MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
The Company incurred $28,747 of deferred finance fees, original issue discount and repricing fees related to the term loans under the 2016 Term Loan Facility, which are included in long-term debt in the accompanying consolidated balance sheets and are being amortized to interest expense over the estimated life of the term loans using the effective interest method. A portion of these fees have been accelerated in connection with the various debt prepayments during 2016, 2017 and 2018. As of June 30, 2019, the remaining balance of the deferred finance fees, original issue discount and repricing fees related to the 2016 Term Loan Facility was $2,648.
On February 1, 2019, in connection with the completion of the ESI Merger, the Company entered into an amendment (“Amendment No. 5”) to the Credit Agreement. Amendment No. 5 provided an additional tranche
B-5
term loan commitment in the principal amount of $650,000 (the “2019 Incremental Term Loan Facility”), all of which was drawn down in connection with the closing of the ESI Merger. Pursuant to Amendment No. 5, the Company also effectuated certain amendments to the Credit Agreement which make certain of the negative covenants and other provisions less restrictive. The 2019 Incremental Term Loan Facility matures on February 1, 2026 and bears interest at a rate per annum equal to, at the Company’s option, a base rate or LIBOR rate (as described above) plus, in each case, an applicable margin equal to 1.25% with respect to base rate borrowings and 2.25% with respect to LIBOR borrowings. The 2019 Incremental Term Loan Facility was issued with original issue discount of 1.00% of the principal amount thereof.
On April 3, 2019, the Company entered into an interest rate swap agreement, which has a maturity date of March 31, 2023, to fix the rate on $300,000 of the then-outstanding balance of the 2019 Incremental Term Loan Facility. The rate is fixed at 2.309% per annum plus the applicable credit spread, which was 2.25% at June 30, 2019. At June 30, 2019, the notional amount of this transaction was $300,000 and had a fair value liability of $6,688.
The Company incurred $11,362 of deferred finance fees and original issue discount fees related to the term loans under the 2019 Incremental Term Loan Facility, which are included in long-term debt in the accompanying consolidated balance sheets and are being amortized to interest expense over the estimated life of the term loans using the effective interest method. As of June 30, 2019, the remaining balance of the deferred finance fees and original issue discount related to the 2019 Incremental Term Loan Facility was $10,895.
The Company is required to make scheduled quarterly payments each equal to 0.25% of the original principal amount of the 2019 Incremental Term Loan Facility, with the balance due on February 1, 2026. If, on or prior to the date that is six months after the closing date of Amendment No. 5, the Company prepays any loans under the 2019 Incremental Term Loan Facility in connection with a repricing transaction, the Company must pay a prepayment premium of 1.00% of the aggregate principal amount of the loans so prepaid.
At June 30, 2019, after regularly scheduled principal payments of $1,625, the total balance outstanding of the 2019 Incremental Term Loan Facility was 
$
648,375
and the interest rate was
4.7
%.
Under the Credit Agreement, the Company is required to prepay outstanding term loans under the 2016 Term Loan Facility and the 2019 Incremental Term Loan Facility, subject to certain exceptions, with portions of its annual excess cash flow as well as with the net cash proceeds of certain asset sales, certain casualty and condemnation events and the incurrence or issuance of certain debt. As a result of the Company’s Total Leverage Ratio, it was not required to make a prepayment of excess cash flow for the fiscal year ended December 31, 2018.
All obligations under the Term Loan Facility are guaranteed by certain of the Company’s domestic subsidiaries, and are collateralized by substantially all of the Company’s assets and the assets of such subsidiaries, subject to certain exceptions and exclusions.
The Credit Agreement contains customary representations and warranties, affirmative and negative covenants and provisions relating to events of default. If an event of default occurs, the Lenders under the Term Loan Facility will be entitled to take various actions, including the acceleration of amounts due under the Term Loan Facility and all actions generally permitted to be taken by a secured creditor. At June 30, 2019, the Company was in compliance with all covenants under the Credit Agreement.
Senior Secured Asset-Based Revolving Credit Facility
On February 1, 2019, in connection with the completion of the ESI Merger, the Company
entered into an asset-based credit agreement with Barclays Bank PLC, as administrative agent and collateral agent, the other borrowers from time to time party thereto, and the lenders and letters of credit issuers from time to time party thereto (the “ABL Credit Agreement”), that provides senior secured revolving credit financing of up to $100,000, subject to a borrowing base limitation (the “ABL Facility”).
On April 26, 2019, the Company entered into a First Amendment to the 
 
23
 
 
 
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MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
ABL Credit Agreement which amended the borrowing base calculation for eligible inventory prior to an initial field examination and appraisal requirements. The borrowing base for the ABL Facility at any time equals the 
sum of: (a) 
85
% of certain eligible accounts; plus (b) prior to certain notice and field examination and appraisal requirements, the lesser of (i)
20
% of net book value of eligible inventory in the United States and (ii)
30
% of the borrowing base, and after the satisfaction of such requirements, the lesser of (i) the lesser of (A) 
65
% of the lower of cost or market value of certain eligible inventory and (B) 
85
% of the net orderly liquidation value of certain eligible inventory and (ii) 
30
% of the borrowing base; minus (c) reserves established by the administrative agent
, in each case, subject to additional limitations and examination requirements for eligible accounts and eligible inventory acquired in an acquisition after February 1, 2019
. The ABL Facility includes borrowing capacity in the form of letters of credit up to $
25,000
.
Borrowings under the ABL Facility bear interest at a rate per annum equal to, at the Company’s option, any of the following, plus, in each case, an applicable margin: (a) a base rate determined by reference to the highest of (1) the federal funds effective rate plus 0.50%, (2) the “prime rate” quoted in
The Wall Street Journal,
(3) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month adjusted for certain additional costs, plus 1.00% and (4) a floor of 0.00%; and (b) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, with a floor of 0.00%. The initial applicable margin for borrowings under the ABL Facility is 0.50% with respect to base rate borrowings and 1.50% with respect to LIBOR borrowings.
Commencing with the completion of the first fiscal quarter ending after the closing of the ABL Facility, the applicable margin for borrowings thereunder is subject to upward or downward adjustment each fiscal quarter, based on the average historical excess availability during the preceding quarter.
In addition to paying interest on any outstanding principal under the ABL Facility, the Company is required to pay a commitment fee in respect of the unutilized commitments thereunder equal to 0.25% per annum. The Company must also pay customary letter of credit fees and agency fees.
The Company incurred $785 of costs in connection with the ABL Facility, which were capitalized and included in other assets in the accompanying consolidated balance sheet and are being amortized to interest expense over the contractual term of five years of the ABL Facility. As a result of a prior asset-based facility being
terminated concurrently with our entry into the ABL Facility, the Company wrote off
$216 of previously capitalized debt issuance costs. 
The ABL Credit Agreement also contains customary representations and warranties, affirmative covenants and provisions relating to events of default. If an event of default occurs, the lenders under the ABL Facility will be entitled to take various actions, including the acceleration of amounts due under the ABL Facility and all actions permitted to be taken by a secured creditor. The Company has not borrowed against this ABL Facility to date.
Lines of Credit and Short-Term Borrowing Arrangements
One of the Company’s Japanese subsidiaries has lines of credit and short-term borrowing arrangements with two financial institutions, which arrangements generally expire and are renewed at three-month intervals. The lines of credit provided for aggregate borrowings as of June 30, 2019 of up to an equivalent of $21,312. One of the borrowing arrangements has an interest rate based on the Tokyo Interbank Offer Rate at the time of borrowing and the other has an interest rate based on the Japanese Short-Term Prime Lending Rate. There were no borrowings outstanding under these arrangements at June 30, 2019 and December 31, 2018, respectively.
The Company has various revolving lines of credit and a financing facility. These revolving lines of credit and financing facility have no expiration date and as of June 30, 2019, provided for aggregate borrowings of up to an equivalent of $11,583. These lines of credit have a base interest rate of 1.25% plus a Japanese Yen overnight LIBOR rate. Total borrowings outstanding under these arrangements were $4,431 and $3,389 at June 30, 2019 and December 31, 2018, respectively.
                 
 
June 30, 2019
   
December 31, 2018
 
Short-term debt:
   
     
 
Japanese lines of credit
  $
3,701
    $
2,724
 
Japanese receivables financing facility
   
730
     
665
 
Other debt
   
     
597
 
Term Loan Facility
   
6,500
     
  
 
                 
  $
10,931
    $
3,986
 
                 
 
 
 
 
 
 
 
 
 
 
 
 
24
 
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
                 
 
June 30, 2019
   
December 31, 2018
 
Long-term debt:
   
     
 
Other debt
  $
84
    $
86
 
Term Loan Facility, net
(1)
   
926,795
     
343,756
 
                 
  $
926,879
    $
343,842
 
                 
 
 
 
 
(1)
Net of deferred financing fees, original issuance discount and repricing fee of $
13,543
and $
4,708
as of June 30, 2019 and December 31, 2018, respectively.
 
 
The Company recognized interest expense of $
21,793
and $
9,352
for the six months ended June 30, 2019 and 2018, respectively.
Contractual maturities of the Company’s debt obligations as of June 30, 2019 are as follows:
         
Year
 
Amount
 
2019 (remaining)
  $
7,681
 
2020
   
6,571
 
2021
   
6,512
 
2022
   
6,500
 
2023
   
304,964
 
2024
   
6,500
 
Thereafter
   
612,625
 
 
 
 
12)
Product Warranties
 
 
 
 
 
 
 
 
The Company records 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 shipment volume, product failure rates, utilization levels, material usage, and supplier warranties on parts delivered to the Company. Should actual product failure rates, utilization levels, material usage, or supplier warranties on parts differ from the Company’s estimates, revisions to the estimated warranty liability would be required.
Product warranty activities were as follows:
                 
 
Six Months Ended June 30,
 
 
2019
   
2018
 
Beginning of period
  $
10,399
    $
10,104
 
Assumed product warranty liability from ESI Merger
   
7,177
     
—  
 
Provision for product warranties
   
12,891
     
8,484
 
Direct and other charges to warranty liability
   
(14,418
)    
(7,328
)
                 
End of period
(1)
  $
16,049
    $
11,260
 
                 
 
 
 
 
 
 
 
 
 
(1)
As of June 30, 2019, short-term product warranty of $12,845 and long-term product warranty of $3,204 were included within other current liabilities and other liabilities, respectively, within the accompanying condensed consolidated balance sheet. As of June 30, 2018, short-term product warranty of $10,846 and long-term product warranty of $414 were included within other current liabilities and other liabilities, respectively, within the accompanying condensed consolidated balance sheet.
 
 
 
 
 
 
 
 
13)
Income Taxes
 
 
 
 
 
 
 
 
The Company’s effective tax rates for the three and six months ended June 30, 2019 were 27.2% and 25.3%, respectively. The effective tax rates for the three and six months ended June 30, 2019 and related income tax expense, were higher than the U.S. statutory tax rate primarily due to a correction of an out of period error with respect to deferred tax assets related to limitations on the deduction of executive compensation in the amount of $5,023. This correction, which should have been recorded during the three months ended September 30, 2018, increased the Company’s effective tax rates in the three and six months ended June 30, 2019 by
9.8
% and
7.5
%, respectively. The prior period error and subsequent correction were not material to prior or current interim and annual financial statements. The effective tax rates for these periods were also higher than the U.S. statutory tax rate due to tax effects of the global intangible low taxed income inclusion offset by the deduction for foreign derived intangible income, the benefit from the reinstatement of a capital loss and the utilization of various tax credits.
 
25
 
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
The Company’s effective tax rates for the three and six months ended June 30, 2018 were
17.3
% and
17.2
%, respectively. The effective tax rates for the three and six months ended June 30, 2018, and related income tax expense, were lower than the U.S. statutory tax rate mainly due to the geographic mix of income earned by the Company’s international subsidiaries being taxed at rates lower than the U.S. statutory tax rate, windfall benefits of stock compensation, and the deduction for foreign derived intangible income offset by the tax effects of the global intangible low taxed income inclusion and state income taxes.
As of June 30, 2019, the total amount of gross unrecognized tax benefits, which excludes interest and penalties, was approximately
$40,766.
At December 31, 2018, the total amount of gross unrecognized tax benefits, which excludes interest and penalties, was approximately
$32,684.
The net increase was primarily attributable to the addition of historical gross unrecognized tax benefits for ESI as a result of the ESI Merger during the quarter ended March 31, 2019. As of June 30, 2019, if these benefits were recognized in a future period, the timing of which is not estimable, the net unrecognized tax benefit of $33,069, excluding interest and penalties, would impact the Company’s effective tax rate. The Company accrues interest expense, and if applicable, penalties, for any uncertain tax positions. Interest and penalties are classified as a component of income tax expense. As of June 30, 2019 and December 31, 2018, the Company had accrued interest on unrecognized tax benefits of approximately 
$
560
and $
568, respectively.
Over the next 12 months it is reasonably possible that the Company may recognize approximately 
$
1,175
of previously net unrecognized tax benefits, excluding interest and penalties, related to various U.S. federal, state and foreign tax positions primarily as a result of the expiration of certain statutes of limitations. The Company and its subsidiaries are subject to examination by U.S. federal, state and foreign tax authorities. The U.S. Internal Revenue Service commenced an examination of the Company’s U.S. federal income tax filings for tax years 2015 and 2016 during the quarter ended September 30, 2017. This audit was effectively settled during the quarter ended March 31, 2018, and the impact was not material. Also during the quarter ended March 31, 2018 the Company received notification from the U.S. Internal Revenue Service of their intent to audit its U.S. subsidiary, Newport, for tax year 2015. This audit commenced during the quarter ended June 30, 2018 and was effectively settled during the quarter ended June 30, 2019 with a no change result. The U.S. statute of limitations remains open for tax years 2016 through present. The statute of limitations for the Company’s tax filings in other jurisdictions varies between fiscal years 2013 through present. The Company also has certain federal credit carry-forwards and state tax loss and credit carry-forwards that are open to examination for tax years 2000 through the present.
14)
Net Income Per Share
The following table sets forth the computation of basic and diluted net income per share:
                                 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
2019
   
2018
   
2019
   
2018
 
Numerator:
   
     
     
     
 
Net income
  $
37,739
    $
122,862
    $
50,194
    $
227,983
 
                                 
Denominator:
   
     
     
     
 
Shares used in net income per common share – basic
   
54,815,000
     
54,719,000
     
54,481,000
     
54,571,000
 
Effect of dilutive securities:
   
     
     
     
 
Restricted stock units, stock appreciation rights and shares issued under employee stock purchase plan
   
274,000
     
555,000
     
485,000
     
709,000
 
                                 
Shares used in net income per common share – diluted
   
55,089,000
     
55,274,000
     
54,966,000
     
55,280,000
 
                                 
Net income per common share:
   
     
     
     
 
Basic
  $
0.69
    $
2.25
    $
0.92
    $
4.18
 
Diluted
  $
0.69
    $
2.22
    $
0.91
    $
4.12
 
 
 
 
 
 
 
 
 
Basic earnings per share (“EPS”) is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding during the period. The computation of diluted EPS is similar to the computation of basic
 
26
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding (using the treasury stock method) if securities containing potentially dilutive common shares (restricted stock units (“RSUs”) and stock appreciation rights (“SARs”)) had been converted to such common shares, and if such assumed conversion is dilutive.
For the three and six months ended June 30, 2019, there were approximately 206,000 and 166,000 weighted-average RSUs, respectively, that would have had an anti-dilutive effect on EPS, and would thus need to be excluded from the computation of diluted weighted-average shares.
For the three and six months ended June 30, 2018, there were approximately 99,000 and 49,000 weighted-average RSUs, respectively, that would have had an anti-dilutive effect on EPS, and would thus need to be excluded from the computation of diluted weighted-average shares.
15)
Stock-Based Compensation
 
 
 
 
 
 
 
 
 
 
 
 
The Company grants RSUs to employees and directors under the 2014 Stock Incentive Plan (the “2014 Plan”). The 2014 Plan is administered by the Compensation Committee of the Company’s Board of Directors. The 2014 Plan is intended to attract and retain employees and directors, and to provide an incentive for these individuals to assist the Company to achieve long-range performance goals and to enable these individuals to participate in the long-term growth of the Company.
In connection with the completion of the ESI Merger, the Company assumed:
  all RSUs that vest based solely on the satisfaction of service conditions, granted under any ESI equity plan, arrangement or agreement (“ESI Plan”) that were outstanding immediately prior to the effective time of the ESI Merger, and as to which shares of ESI common stock were not fully distributed in connection with the closing of the ESI Merger,
 
 
 
 
 
 
 
 
 
 
 
 
  all RSUs that were granted subject to vesting based on both the achievement of performance goals and the satisfaction of service conditions granted under any ESI Plan that were outstanding immediately prior to the effective time of the ESI Merger, and
 
 
 
 
 
 
 
 
 
 
 
 
  all SARs granted under any ESI Plan, whether vested or unvested, that were outstanding immediately prior to the effective time of the ESI Merger and held by an individual who was a service provider of ESI as of the date on which the effective time of the ESI Merger occurred.
 
 
 
 
 
 
 
 
 
 
 
 
As of the effective time of the ESI Merger, based on a formula in the Merger Agreement, (a) such RSUs were converted automatically into RSUs with respect to 736,133 shares of the Company’s common stock (the “Assumed RSUs”), and (b) such SARs were converted automatically into SARs with respect to 12,787 shares of the Company’s common stock (the “Assumed SARs”).
Included in the total number of assumed RSUs are 326,283 shares of the Company’s common stock for employees and outside directors that are part of the ESI Deferred Compensation plan
 
(the “ESI DC Plan”). 
These shares will not become issued shares until their respective release dates.
The shares of the Company’s common stock that are subject to the Assumed SARs and the Assumed RSUs are issuable pursuant to the Company’s 2014 Plan.
The 748,920 shares of the Company’s common stock that are issuable pursuant to the Assumed RSUs and the Assumed SARs under the Company’s 2014 Plan were registered under the Securities Act of 1933 on the Registration Statement on Form
S-8.
These shares are in addition to the 18,000,000 shares of the Company’s common stock reserved for issuance under the Company’s 2014 Plan and previously registered under the Securities Act of 1933 on the Registration Statement on Form
S-8.
During the six months ended June 30, 2019, the Company granted 396,192 RSUs with a weighted average grant date fair value of $86.54. During the six months ended June 30, 2018, the Company granted 259,597 RSUs with a weighted average grant date fair value of $112.56. There were
no
SARs granted during the six months ended June 30, 2019 or 2018.
 
27
 
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
The total stock-based compensation expense included in the Company’s consolidated statements of income and comprehensive income was as follows:
                                 
 
Three Months Ended 
June 30,
   
Six Months Ended 
June 30,
 
 
2019
   
2018
   
2019
   
2018
 
Cost of revenues
  $
636
    $
1,489
    $
1,058
    $
2,494
 
Research and development expense
   
1,061
     
819
     
1,871
     
1,541
 
Selling, general and administrative expense
   
4,206
     
4,058
     
12,244
     
12,757
 
                                 
Acquisition and integration related expense
   
1,026
     
—  
     
19,594
     
—  
 
                                 
Total
pre-tax
stock-based compensation expense
  $
6,929
    $
6,366
    $
34,767
    $
16,792
 
                                 
 
 
 
 
 
 
 
 
 
 
 
 
At June 30, 2019, the total compensation expense related to unvested stock-based awards granted to employees and directors under the 2014 Plan that had not been recognized was $38,497, net of estimated forfeitures. The future compensation expense for time-based awards is recognized on a straight-line basis and the future compensation expense for performance-based awards is recognized using the accelerated graded vesting method, both of which expense over the requisite service period, net of estimated forfeitures, except for retirement eligible employees, in which case the Company expenses the fair value of the grant in the period the grant is issued. The Company considers many factors when estimating expected forfeitures, including types of awards and historical experience. Actual results and future changes in estimates may differ substantially from the Company’s current estimates.
The following table presents the activity for RSUs under the Plan:
                 
 
Six Months Ended June 30, 2019
 
 
Outstanding RSUs
   
Weighted Average
Grant Date
Fair Value
 
RSUs – beginning of period
   
647,394
    $
74.04
 
Assumed shares from ESI Merger
   
736,133
    $
84.10
 
Accrued dividend shares
   
3,084
    $
76.13
 
Granted
   
396,192
    $
86.54
 
Vested
   
(513,370
)   $
68.66
 
Forfeited
   
(87,666
)   $
90.98
 
                 
RSUs – end of period
   
1,181,767
    $
85.59
 
                 
 
 
 
 
 
 
 
 
 
 
 
 
The following table presents the activity for SARs under the Plan:
                 
 
Six Months Ended June 30, 2019
 
 
Outstanding SARs
   
Weighted Average
Grant Date
Fair Value
 
SARs – beginning of period
   
177,538
    $
28.52
 
Assumed SARs from ESI Merger
   
12,787
    $
17.38
 
Exercised
   
(38,999
)   $
26.80
 
Forfeited or expired
   
(3,857
)   $
23.02
 
                 
SARs Outstanding – end of period
   
147,469
    $
28.19
 
                 
 
 
 
 
 
 
 
 
 
 
 
 
16)
Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
Share Repurchase Program
On July 25, 2011, the Company’s Board of Directors approved a share repurchase program for the repurchase of up to an aggregate of $200,000 of its outstanding common stock from time to time in open market purchases, privately negotiated transactions or through other appropriate means. The timing and quantity of any shares repurchased will depend upon a variety of factors, including business conditions, stock market conditions and business development activities, including, but not limited to, merger and acquisition opportunities. These repurchases may be
 
28
 
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
commenced, suspended or discontinued at any time without prior notice. The Company has repurchased approximately
2,588,000
shares of common stock for approximately $
127,000
pursuant to the program since its adoption. During the three and six months ended June 30, 2019 and 2018, there were no repurchases of common stock.
Cash Dividends
Holders of the Company’s common stock are entitled to receive dividends when they are declared by the Company’s Board of Directors. In addition, the Company accrues dividend equivalents on the RSUs the Company assumed in the ESI Merger described in Note 15 above when dividends are declared by the Company’s Board of Directors. The Company’s Board of Directors declared a cash dividend of $
0.20
 
per share during each of the first and second quarters of 2019, which totaled 
$
21,723
or $
0.40
per share. The Company’s Board of Directors declared a cash dividend of 
$
0.18
per share during the first quarter of 2018 and
$
0.20
per share during the second quarter of 2018, which totaled
$
20,750
or $
0.38
per share.
On
July 29, 2019
, the Company’s Board of Directors declared a quarterly cash dividend of $0.20 per share to be paid on
September 6, 2019
to shareholders of record as of
August 26, 2019
. Future dividend declarations, if any, as well as the record and payment dates for such dividends, are subject to the final determination of the Company’s Board of Directors. In addition, under the terms of the Term Loan Facility and its ABL Facility, the Company may be restricted from paying dividends under certain circumstances.
17)
Business Segment, Geographic Area, Product and Significant Customer Information
The Company is a global provider of instruments, subsystems and process control solutions that measure, monitor, deliver, analyze, power and control critical parameters of advanced manufacturing processes to improve process performance and productivity for its customers. The Company’s products are derived from its core competencies in pressure measurement and control, flow measurement and control, gas and vapor delivery, gas composition analysis, residual gas analysis, leak detection, control technology, ozone generation and delivery, power, reactive gas generation, vacuum technology, lasers, photonics,
sub-micron
positioning, vibration control, optics and laser-based manufacturing solutions. The Company also provides services relating to the maintenance and repair of its products, installation services and training. The Company’s primary served markets include semiconductor, industrial technologies, life and health sciences, and research and defense.
The Company’s Chief Operating Decision Maker (“CODM”) utilizes financial information to make decisions about allocating resources and assessing performance for the entire Company, which is used in the decision making process to assess performance. Effective February 1, 2019, in conjunction with its acquisition of ESI, the Company created a third reportable segment known as the Equipment & Solutions segment in addition to its
two 
then-existing reportable segments: the Vacuum & Analysis segment and the Light & Motion segment.
The Vacuum & Analysis segment provides a broad range of instruments, components and subsystems which are derived from the Company’s core competencies in pressure measurement and control, flow measurement and control, gas and vapor delivery, gas composition analysis, residual gas analysis, leak detection, control technology, ozone generation and delivery, RF & DC power, reactive gas generation and vacuum technology.
The Light & Motion segment provides a broad range of instruments, components and subsystems which are derived from the Company’s core competencies in lasers, photonics,
sub-micron
positioning, vibration control, and optics.
The Equipment & Solutions segment provides laser-based manufacturing solutions for the micro-machining industry that enable customers to optimize production. The segment’s market is composed primarily of flexible and rigid PCB processing/fabrication, semiconductor wafer processing and passive component manufacturing & test. Equipment & Solutions incorporate specialized laser technology and proprietary control software to efficiently process the materials and components that are an integral part of electronic devices and systems.
The Company derives its segment results directly from the manner in which results are reported in its management reporting system. The accounting policies that the Company uses to derive reportable segment results are substantially the same as those used for external reporting purposes. The Company does not disclose external or intersegment revenues separately by reportable segment as this information is not presented to the CODM for decision making purposes.
 
29
 
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
The following table sets forth net revenues by reportable segment:
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
2019
   
2018
   
2019
   
2018
 
Vacuum & Analysis
  $
235,655
    $
368,328
    $
470,010
    $
716,672
 
Light & Motion
   
182,579
     
204,812
     
376,567
     
410,743
 
Equipment & Solutions
   
55,876
     
—  
     
91,094
     
—  
 
                                 
  $
474,110
    $
573,140
    $
937,671
    $
1,127,415
 
                                 
The following table sets forth a reconciliation of segment gross profit to consolidated net income:
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
2019
   
2018
   
2019
   
2018
 
Gross profit by reportable segment:
   
     
     
     
 
Vacuum & Analysis
  $
102,095
    $
171,082
    $
200,234
    $
329,582
 
Light & Motion
   
84,948
     
103,795
     
177,689
     
208,150
 
Equipment & Solutions
   
23,984
     
—  
     
31,222
     
 
                                 
Total gross profit by reportable segment
   
211,027
     
274,877
     
409,145
     
537,732
 
Operating expenses:
   
     
     
     
 
Research and development
   
41,855
     
36,504
     
80,788
     
71,361
 
Selling, general and administrative
   
83,236
     
76,181
     
165,691
     
159,130
 
Fees and expenses related to term loan
   
     
378
     
5,847
     
378
 
Acquisition and integration costs
   
3,240
     
(1,168
)    
33,407
     
(1,168
)
Restructuring and other
   
1,242
     
790
     
3,165
     
3,010
 
Amortization of intangible assets
   
17,552
     
10,901
     
33,279
     
22,091
 
                                 
Income from operations
   
63,902
     
151,291
     
86,968
     
282,930
 
Interest and other expense, net
   
12,039
     
2,747
     
19,769
     
7,644
 
                                 
Income before income taxes
   
51,863
     
148,544
     
67,199
     
275,286
 
Provision for income taxes
   
14,124
     
25,682
     
17,005
     
47,303
 
                                 
Net income
  $
37,739
    $
122,862
    $
50,194
    $
227,983
 
                                 
The following table sets forth capital expenditures by reportable segment for the three and six months ended June 30, 2019 and 2018:
 
Vacuum & Analysis
   
Light & Motion
   
Equipment &
Solutions
   
Total
 
Three Months Ended June 30, 2019:
   
     
     
     
 
Capital expenditures
  $
6,700
    $
4,938
    $
2,087
    $
13,725
 
                                 
Six Months Ended June 30, 2019:
   
     
     
     
 
Capital expenditures
  $
14,188
    $
10,092
    $
3,974
    $
28,254
 
                                 
Three Months Ended June 30, 2018:
   
     
     
     
 
Capital expenditures
  $
6,972
    $
5,456
    $
—  
    $
12,428
 
                                 
Six Months Ended June 30, 2018:
   
     
     
     
 
Capital expenditures
  $
13,169
    $
8,649
    $
—  
    $
21,818
 
                                 
 
30
 
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
The following table sets forth depreciation and amortization by reportable segment for the three and six months ended June 30, 2019 and 2018:
                                 
 
Vacuum & Analysis
   
Light & Motion
   
Equipment &
Solutions
   
Total
 
Three Months Ended June 30, 2019:
   
     
     
     
 
Depreciation and amortization
  $
3,941
    $
13,292
    $
10,211
    $
27,444
 
                                 
Six Months Ended June 30, 2019
   
     
     
     
 
Depreciation and amortization
  $
7,986
    $
27,432
    $
17,237
    $
52,655
 
                                 
Three Months Ended June 30, 2018:
   
     
     
     
 
Depreciation and amortization
  $
4,968
    $
14,917
    $
—  
    $
19,885
 
                                 
Six Months Ended June 30, 2018:
   
     
     
     
 
Depreciation and amortization
  $
10,097
    $
30,280
    $
—  
    $
40,377
 
                                 
 
 
 
 
 
 
 
 
 
 
Total income tax expense is not presented by reportable segment because the necessary information is not available or used by the CODM.
The following table sets forth segment assets by reportable segment:
                                         
June 30, 2019:
 
Vacuum & Analysis
   
Light & Motion
   
Equipment 
& Solutions
   
Corporate,
Eliminations & Other
   
Total
 
Segment assets:
   
     
     
     
     
 
Trade accounts receivable
  $
141,551
    $
155,452
    $
46,322
    $
(29,795
)   $
313,530
 
Inventories 
   
232,595
     
174,124
     
72,918
     
(140
)    
479,497
 
                                         
Total segment assets
  $
374,146
    $
329,576
    $
119,240
    $
(29,935
)   $
793,027
 
                                         
 
 
 
 
 
 
 
 
 
 
                                         
December 31, 2018:
 
Vacuum & Analysis
   
Light & Motion
   
Equipment 
&
Solutions
   
Corporate,
Eliminations & Other
   
Total
 
Segment assets:
   
     
     
     
     
 
Trade accounts receivable
  $
171,604
    $
140,658
    $
—  
    $
(16,808
)   $
295,454
 
Inventories 
   
222,965
     
161,658
     
—  
     
66
     
384,689
 
                                         
Total segment assets
  $
394,569
    $
302,316
    $
—  
    $
(16,742
)   $
680,143
 
                                         
 
 
 
 
 
 
 
 
 
 
The following is a reconciliation of segment assets to consolidated total assets:
                 
 
June 30, 2019
   
December 31, 2018
 
Total segment assets
  $
793,027
    $
680,143
 
Cash and cash equivalents and investments
   
470,321
     
728,461
 
Other current assets
   
80,303
     
65,790
 
Assets classified as held for sale
 
 
36,750
 
 
 
—  
 
Property, plant and equipment, net
   
230,649
     
194,367
 
Right-of-use
asset
   
68,631
     
—  
 
Goodwill and intangible assets, net
   
1,658,039
     
906,803
 
Other assets
   
44,228
     
38,682
 
                 
Consolidated total assets
  $
3,381,948
    $
2,614,246
 
                 
 
 
 
 
 
 
 
 
 
  
 
31
 
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
Geographic
Information about the Company’s operations in different geographic regions is presented in the tables below. Net revenues to unaffiliated customers are based on the location in which the sale originated. Transfers between geographic areas are at tax transfer prices and have been eliminated from consolidated net revenues.
 
                                 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
2019
   
2018
   
2019
   
2018
 
Net revenues:
   
     
     
     
 
United States
  $
217,549
    $
281,818
    $
441,896
    $
558,538
 
China
 
 
56,002
 
 
 
32,005
 
 
 
93,750
 
 
 
63,077
 
Korea
   
38,896
     
66,983
     
74,698
     
120,994
 
Japan
   
30,995
     
54,087
     
73,097
     
112,361
 
Other Asia 
   
72,426
     
75,188
     
136,005
     
145,500
 
Europe
   
58,242
     
63,059
     
118,225
     
126,945
 
                                 
  $
474,110
    $
573,140
    $
937,671
    $
1,127,415
 
                                 
 
 
 
 
 
 
 
 
 
 
                 
 
June 30, 2019
   
December 31, 2018
 
Long-lived assets:
(1)
   
     
 
United States
  $
171,324
    $
146,687
 
Europe
   
30,514
     
26,794
 
Asia
   
60,072
     
50,572
 
                 
  $
261,910
    $
224,053
 
                 
 
 
 
 
 
 
 
 
 
 
 
(1)
Long-lived assets include property, plant and equipment, net and certain other long-term assets, excluding long-term tax related accounts.
 
 
 
 
Goodwill associated with each of the Company’s reportable segments is as follows:
                 
 
June 30, 2019
   
December 31, 2018
 
Reportable segment:
   
     
 
Vacuum & Analysis
  $
196,777
    $
197,126
 
Light & Motion
   
389,539
     
389,870
 
Equipment & Solutions
   
472,351
     
—  
 
                 
Total goodwill
  $
1,058,667
    $
586,996
 
                 
 
 
 
 
 
 
 
 
 
 
Worldwide Product Information
The Company groups its product offerings into
three
groups based upon the similarity of product function as follows:
                                 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
2019
   
2018
   
2019
   
2018
 
Advanced Manufacturing Components
  $
359,123
    $
509,999
    $
730,468
    $
1,006,676
 
Global Service
   
72,784
     
63,141
     
138,982
     
120,739
 
Advanced Manufacturing Systems
   
42,203
     
—  
     
68,221
     
—  
 
                                 
  $
474,110
    $
573,140
    $
937,671
    $
1,127,415
 
                                 
 
 
 
 
 
 
 
Advanced manufacturing components are comprised of product revenues from the Company’s Vacuum & Analysis and Light & Motion segments. Global service is comprised of total service revenues for all three of the Company’s reportable segments. Advanced manufacturing systems is comprised of product revenues for the Company’s Equipment & Solutions segment.
 
32
 
 
 
Table of Contents
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
18)
Restructuring and Other
 
 
 
 
 
 
 
Restructuring
The Company recorded restructuring charges of $1,242 and $1,465 during the three and six months ended June 30, 2019, respectively, primarily related to severance costs as a result of an organization-wide reduction in workforce, the consolidation 
of service functions in Asia and the movement of certain products to low cost regions. The Company recorded restructuring charges of $
790
and 
$
2,010
during the three and six months ended June 30, 2018, respectively, primarily related to severance costs as a result of streamlining and consolidating certain administrative functions.
Restructuring activities were as follows:
                 
 
Six Months Ended June 30,
 
 
2019
   
2018
 
Beginning of period restructuring accrual
  $
2,632
    $
3,244
 
Charged to expense
   
1,465
     
2,010
 
Payments and adjustments
   
(1,445
)    
(2,727
)
                 
End of period restructuring accrual
  $
2,652
    $
2,527
 
                 
 
 
 
 
 
 
 
Other
We recorded a charge of $
1,700
during the six months ended June 30, 2019 related to a contractual obligation we acquired as part of our acquisition of Newport in April 2016.
We recorded $1,000 of environmental costs during the six months ended June 30, 2018 related to a U.S. Environmental Protection Agency-designated Superfund site acquired as part of the Newport Merger.
 
19)
Commitments and Contingencies
 
 
 
 
 
 
 
 
 
Newport Litigation
In 2016, two putative class actions lawsuit captioned Dixon Chung v. Newport Corp., et al., Case No. A-16-733154-C, and Hubert C. Pincon v. Newport Corp., et al., Case No. A-16-734039-B, were filed in the District Court, Clark County, Nevada on behalf of a putative class of stockholders of Newport for claims related to the merger agreement (“Newport Merger Agreement”) between the Company, Newport, and a wholly-owned subsidiary of the Company (“Merger Sub”). The lawsuits named as defendants the Company, Newport, Merger Sub, and certain then current and former members of Newport’s board of directors. Both complaints alleged that Newport directors breached their fiduciary duties to Newport’s stockholders by agreeing to sell Newport through an inadequate and unfair process, which led to inadequate and unfair consideration, by agreeing to unfair deal protection devices and by omitting material information from the proxy statement. The complaints also alleged that the Company, Newport and Merger Sub aided and abetted the directors’ alleged breaches of their fiduciary duties. The Court consolidated the actions, and plaintiffs later filed an amended complaint captioned In re Newport Corporation Shareholder Litigation, Case No. A-16-733154-B, in the District Court, Clark County, Nevada, on behalf of a putative class of Newport’s stockholders for claims related to the Newport Merger Agreement. The amended complaint alleged Newport’s former board of directors breached their fiduciary duties to Newport’s stockholders and that the Company, Newport and Merger Sub had aided and abetted those breaches. It sought monetary damages, including pre- and post-judgment interest. In June 2017, the Court granted defendants’ motion to dismiss and dismissed the amended complaint against all defendants but granted plaintiffs leave to amend.
On July 27, 2017, plaintiffs filed a second amended complaint containing substantially similar allegations but naming only Newport’s former directors as defendants. On August 8, 2017, the Court dismissed the Company and Newport from the action. The second amended complaint seeks monetary damages, including pre- and post-judgment interest. The Court granted a motion for class certification on September 27, 2018, appointing Mr. Pincon and Locals 302 and 612 of the International Union of Operating Engineers - Employers Construction Industry Retirement Trust as class representatives. On June 11, 2018, plaintiff Dixon Chung was voluntarily dismissed from the litigation. On May 1, 2019, the Court granted the defendants’ motion to strike plaintiffs’ jury demand and determined that the case will be tried by the Court, and not a jury. A bench trial is scheduled for the first quarter of 2020. Fact discovery in the action is complete, and expert discovery is ongoing.
The Company is 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.
 
33
 
 
 
Table of Contents
  
 
MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
20)
Assets Classified as Held for Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
During the three months ended June 30, 2019, the Company re-classified $36,750 of certain assets from property, plant and equipment to current assets as held for sale, as these assets met the criteria for classification as held for sale. These assets relate to the expected sale of three buildings and land in Portland, Oregon related to our Equipment & Solutions segment as well as two buildings and land in Boulder, Colorado related to our Vacuum & Analysis segment. The Company will be consolidating into one leased facility at each location and anticipates closing on both of these sales during the third quarter of 2019.
 
34
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Table of Contents
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
 
 
 
 
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 of 1934, as amended (the “Exchange Act”). When used herein, the words “believes,” “anticipates,” “plans,” “expects,” “estimates,” “would,” “will,” “intends” 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. While we may elect to update forward looking statements in the future, we specifically disclaim any obligation to do so even if our estimates or expectations change. Risks and uncertainties include, but are not limited to those discussed in our Annual Report on Form
10-K
for the year ended December 31, 2018 and in the section entitled “Risk Factors” as referenced in Part II, Item 1A “Risk Factors” of this Quarterly Report on Form
10-Q.
Overview
We are a global provider of instruments, subsystems and process control solutions that measure, monitor, deliver, analyze, power and control critical parameters of advanced manufacturing processes to improve process performance and productivity for our customers. Our products are derived from our core competencies in pressure measurement and control, flow measurement and control, gas and vapor delivery, gas composition analysis, residual gas analysis, leak detection, control technology, ozone generation and delivery, power, reactive gas generation, vacuum technology, lasers, photonics,
sub-micron
positioning, vibration control, optics and laser-based manufacturing solutions. We also provide services relating to the maintenance and repair of our products, installation services and training. Our primary served markets include semiconductor, industrial technologies, life and health sciences, research and defense.
Acquisition of Electro Scientific Industries, Inc.
On February 1, 2019, we completed our acquisition of Electro Scientific Industries, Inc. (“ESI”) pursuant to an Agreement and Plan of Merger, dated as of October 29, 2018 (the “ESI Merger”). At the effective time of the ESI Merger and pursuant to the terms and conditions of the merger agreement, each share of ESI’s common stock that was issued and outstanding immediately prior to the effective time of the ESI Merger was converted into the right to receive $30.00 in cash, without interest and subject to deduction of any required withholding tax. We paid the former ESI stockholders aggregate consideration of approximately $1.033 billion, excluding related transaction fees and expenses, and
non-cash
consideration related to the exchange of share-based awards of approximately $31 million for a total purchase consideration of approximately $1.063 billion. We funded the payment of the aggregate consideration with a combination of our available cash on hand and the proceeds from our senior secured term loan facility as described below.
Segments and Markets
Effective February 1, 2019, in conjunction with our acquisition of ESI, we created a third reportable segment known as the Equipment & Solutions segment in addition to our two then-existing reportable segments: the Vacuum & Analysis segment and the Light & Motion segment. ESI provides laser-based manufacturing solutions for the micro-machining industry that enable customers to optimize production. ESI’s primary served markets include flexible and rigid PCB processing/fabrication, semiconductor wafer processing and passive component manufacturing and testing. ESI solutions incorporate specialized laser technology and proprietary control software to efficiently process the materials and components that are an integral part of electronic devices and systems.
The Vacuum & Analysis segment provides a broad range of instruments, components and subsystems which are derived from our core competencies in pressure measurement and control, flow measurement and control, gas and vapor delivery, gas composition analysis, residual gas analysis, leak detection, control technology, ozone generation and delivery, RF & DC power, reactive gas generation and vacuum technology.
The Light & Motion segment provides a broad range of instruments, components and subsystems which are derived from our core competencies in lasers, photonics,
sub-micron
positioning, vibration control, and optics.
We have a diverse base of customers. Approximately 54% and 42% of our net revenues for the six months ended June 30, 2019 and 2018, respectively, were from advanced manufacturing applications. These include, but are not limited to, industrial technologies, life and health sciences, and research and defense.
Approximately 46% and 58% of our net revenues for the six months ended June 30, 2019 and 2018, respectively, were from sales to semiconductor capital equipment manufacturers and semiconductor device manufacturers.
Net revenues from customers in our advanced markets increased by $23.4 million, or 10%, for the three months ended June 30, 2019, compared to the same period in the prior year, primarily due to an increase of $52.2 million from our Equipment & Solutions segment as a result of the ESI Merger. This increase was offset by a decrease of $16.8 million and $12.0 million in revenue from customers in our advanced markets in our Light & Motion and Vacuum & Analysis segments, respectively.
 
35
 
 
Table of Contents
 
Net revenues from customers in our advanced markets increased by $25.8 million, or 5%, for the six months ended June 30, 2019, compared to the same period in the prior year, primarily due to an increase of $80.8 million from our Equipment & Solutions segment as a result of the ESI Merger, which included five months of revenue from customers in our advanced markets for the six months ended June 30, 2019. This increase was offset by a decrease of $27.8 million and $27.2 million in revenue from customers in our advanced markets in our Light & Motion and Vacuum & Analysis segments, respectively.
Net revenues from semiconductor capital equipment manufacture and semiconductor device manufacture customers decreased by $122.4 million, or 36%, for the three months ended June 30, 2019, compared to the same period in the prior year. This decrease was comprised of a decrease in net semiconductor revenues of $120.7 million and $5.4 million in the Vacuum & Analysis and Light & Motion segments, respectively, offset by an increase of $3.7 million from our Equipment & Solutions segment as a result of the ESI Merger.
Net revenues from semiconductor capital equipment manufacture and semiconductor device manufacture customers decreased by $215.6 million, or 33%, for the six months ended June 30, 2019, compared to the same period in the prior year. This decrease was comprised of a decrease in net semiconductor revenues of $219.5 million and $6.4 million in the Vacuum & Analysis and Light & Motion segments, respectively, offset by an increase of $10.3 million from our Equipment & Solutions segment as a result of the ESI Merger, which included five months of revenue from semiconductor customers for the six months ended June 30, 2019.
The semiconductor capital equipment industry has been experiencing a moderation in capital spending in the near term and we have seen a similar effect on our semiconductor revenue in the first and second quarters and expect that to continue into the third quarter. The semiconductor capital equipment industry is subject to rapid demand shifts, which are difficult to predict, and we cannot be certain as to the timing or extent of future demand or any future weakness in the semiconductor capital equipment industry.
A significant portion of our net revenues is from sales to customers in international markets. For the six months ended June 30, 2019 and 2018, international net revenues accounted for approximately 53% and 50% of our total net revenues. A significant portion of our international net revenues was from China, Germany, South Korea, Japan and Israel. We expect that international net revenues will continue to represent a significant percentage of our total net revenues. Long-lived assets located in the United States were $175.9 million and $146.7 million, as of June 30, 2019 and December 31, 2018, respectively, excluding goodwill and intangibles, and long-term
tax-related
accounts. Long-lived assets located outside of the United States were $90.6 million and $77.4 million, as of June 30, 2019 and December 31, 2018, respectively, excluding goodwill and intangibles, and long-term
tax-related
accounts.
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 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, 2018, other than the adoption of ASC 842 as outlined below.
Leases
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”), Leases, (“ASU
2016-02”),
to enhance the transparency and comparability of financial reporting related to leasing arrangements. We adopted ASU
2016-02
on January 1, 2019, or the effective date, and used the effective date as our date of initial application.
At the inception of an arrangement, we determine whether the arrangement is or contains a lease based on the facts and circumstances present. Most leases with a term greater than one year are recognized on the balance sheet as
right-of-use
assets, short-term lease liabilities and long-term lease liabilities. We have elected not to recognize on the balance sheet leases with terms of one year or less. Operating lease liabilities and their corresponding
right-of-use
assets are recorded based on the present value of lease payments over the expected remaining fixed lease term. Certain adjustments to the
right-of-use
asset may be required for items such as incentives received. In calculating the present value of future lease payments, we utilize our incremental borrowing rates, which are the rates incurred to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. We have elected to utilize a single blended interest rate based on currencies, geographies and lease terms that comprise the lease portfolio.
Although separation of lease and
non-lease
components is required, certain practical expedients are available. Entities may elect the practical expedient to not separate lease and
non-lease
components. We have elected to account for the lease and
non-lease
components of each of our operating leases as a single lease component and allocate all of the contract consideration to the lease component only. The lease component results in an operating
right-of-use
asset being recorded on the balance sheet and amortized on a straight-line basis as lease expense.
Many of our leases contain options to renew and extend lease terms, and options to terminate leases early. We do not recognize the
right-of-use
asset or lease liability for renewal or termination periods unless we are reasonably certain to exercise the option at lease inception.
For further information about our critical accounting policies, including our revenue recognition policy, please see the discussion of critical accounting policies in our Annual Report on Form
10-K
for the year ended December 31, 2018 in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates.”
 
36
  
 
Table of Contents
 
Results of Operations
The following table sets forth for the periods indicated the percentage of total net revenues of certain line items included in our consolidated statements of operations and comprehensive income data.
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
 
2019
   
2018
   
2019
   
2018
 
Net revenues:
   
     
     
     
 
Product
   
84.7
%    
89.0
%    
85.2
%    
89.3
%
Services
   
15.3
     
11.0
     
14.8
     
10.7
 
                                 
Total net revenues
   
100.0
     
100.0
     
100.0
     
100.0
 
Cost of revenues:
   
     
     
     
 
Cost of product revenues
   
47.7
     
46.5
     
48.6
     
46.8
 
Cost of service revenues
   
7.8
     
5.5
     
7.8
     
5.5
 
                                 
Total cost of revenues (exclusive of amortization shown separately below)
   
55.5
     
52.0
     
56.4
     
52.3
 
Gross profit
   
44.5
     
48.0
     
43.6
     
47.7
 
Research and development
   
8.8
     
6.4
     
8.6
     
6.3
 
Selling, general and administrative
   
17.6
     
13.4
     
17.7
     
14.1
 
Fees and expenses related to term loan
   
     
—  
     
0.6
     
—  
 
Acquisition and integration costs
   
0.7
     
(0.2
)    
3.5
     
(0.1
)
Restructuring and other
   
0.2
     
0.1
     
0.3
     
0.3
 
Amortization of intangible assets
   
3.7
     
1.9
     
3.6
     
2.0
 
                                 
Income from operations
   
13.5
     
26.4
     
9.3
     
25.1
 
Interest income
   
0.3
     
0.3
     
0.3
     
0.2
 
Interest expense
   
2.7
     
0.7
     
2.3
     
0.8
 
Other expense, net
   
0.1
     
0.1
     
0.1
     
0.1
 
                                 
Income from operations before income taxes
   
11.0
     
25.9
     
7.2
     
24.4
 
Provision for income taxes
   
3.0
     
4.5
     
1.8
     
4.2
 
                                 
Net income
   
8.0
%    
21.4
%    
5.4
%    
20.2
%
                                 
 
 
 
 
 
Net Revenues
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(dollars in millions)
 
2019
   
2018
   
2019
   
2018
 
Product
  $
401.3
    $
510.0
    $
798.7
    $
1,006.7
 
Service
   
72.8
     
63.1
     
139.0
     
120.7
 
                                 
Total net revenues
  $
474.1
    $
573.1
    $
937.7
    $
1,127.4
 
                                 
 
 
 
 
 
Product revenues decreased $108.7 million and $208.0 million during the three and six months ended June 30, 2019, respectively, compared to the same periods in the prior year. These decreases were primarily attributed to a decrease in net product revenues from our semiconductor customers, primarily due to lower volume, of $120.7 million and $213.2 million, respectively, for the same periods, partially offset by an increase in net product revenues from customers in our advanced markets of $12.0 million and $5.2 million. The decreases in product revenues from semiconductor customers for the MKS business, excluding the impact of the ESI Merger (the “legacy MKS business”), for the three and six months ended June 30, 2019, were $124.4 million and $223.5 million, respectively, offset by increases in product revenues from our semiconductor customers of $3.7 million and $10.3 million, respectively, for the same periods, from the Equipment & Solutions segment as a result of the ESI Merger, which included five months of product revenue for the six months ended June 30, 2019. The decreases in product revenues from customers in advanced markets for the legacy MKS business for the three and six month periods ended June 30, 2019 were $26.5 million and $52.7 million, respectively, mainly due to decreases in the industrial technologies market, which we believe has been negatively impacted by the general trade tensions between the U.S. and China as a result of increasing tariffs and other trade restrictions. These decreases were offset by increases in product revenues from customers in our advanced markets of $38.5 million and $57.9 million, for the three and six months ended June 30, 2019, respectively, for the same periods, from the Equipment & Solutions segment as a result of the ESI Merger.
 
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Service revenues consisted mainly of fees for services related to the maintenance and repair of our products, sales of spare parts, and installation and training. Service revenues increased $9.7 million and $18.3 million during the three and six month periods ended June 30, 2019, respectively, compared to the same periods in the prior year. These increases were primarily attributed to increases in service revenues from customers in our advanced markets of $11.4 million and $20.6 million for the three and six months ended June 30, 2019, respectively, from the Equipment & Solutions segment as a result of the ESI Merger.
Total international net revenues, including product and service, were $256.6 million and $495.8 million for the three and six months ended June 30, 2019, respectively, compared to $291.3 million and $568.9 million for the three and six months ended June 30, 2018, respectively. The decreases of $34.7 million and $73.1 million for the three and six months ended June 30, 2019 were primarily due to decreases in net revenues in Japan and South Korea.
The following table sets forth our net revenues by reportable segment:
                                 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
(dollars in millions)
 
2019
   
2018
   
2019
   
2018
 
Net revenues:
   
     
     
     
 
Vacuum & Analysis
  $
235.6
    $
368.3
    $
470.0
    $
716.7
 
Light & Motion
   
182.6
     
204.8
     
376.6
     
410.7
 
Equipment & Solutions
   
55.9
     
—  
     
91.1
     
—  
 
                                 
Total net revenues
  $
474.1
    $
573.1
    $
937.7
    $
1,127.4
 
                                 
 
 
 
 
 
 
 
Net revenues from our Vacuum & Analysis segment decreased $132.7 million and $246.7 million for the three and six months ended June 30, 2019, respectively, compared to the same periods in the prior year, due to decreases in net revenues from semiconductor customers of $120.7 million and $219.5 million for the three and six months ended June 30, 2019, respectively, and decreases in net revenues from customers in our advanced markets of $12.0 million and $27.2 million for the three and six months ended June 30, 2019, respectively, primarily from customers in our industrial technologies market.
Net revenues from our Light & Motion segment decreased $22.2 million and $34.1 million for the three and six months ended June 30, 2019, respectively, compared to the same periods in the prior year. The decreases were primarily attributed to decreases in net revenues from customers in our advanced markets of $16.8 million and $27.8 million for the three and six months ended June 30, 2019, respectively, primarily from customers in our industrial technologies market. The remainder of the decreases were attributed to decreases in net revenues from semiconductor customers of $5.4 million and $6.3 million for the three and six months ended June 30, 2019, respectively.
Gross Profit
                                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
 
2019
   
2018
   
% Points
Change
   
2019
   
2018
   
% Points
Change
 
Gross profit as a percentage of net revenues:
   
     
     
     
     
     
 
Product
   
43.6
%    
47.7
%    
(4.1
)%    
42.9
%    
47.5
%    
(4.6
)%
Service
   
49.3
     
50.3
     
(1.0
)    
47.8
     
49.1
     
(1.3
)
                                                 
Total gross profit
   
44.5
%    
48.0
%    
(3.5
)%    
43.6
%    
47.7
%    
(4.1
)%
                                                 
 
 
 
 
 
 
 
Gross profit as a percentage of net product revenues decreased by 4.1 and 4.6 percentage points for the three and six months ended June 30, 2019, respectively, compared to the same periods in the prior year, primarily due lower revenue volumes and lower factory utilization, partially offset by favorable product mix.
Gross profit as a percentage of net service revenues decreased by 1.0 percentage point for the three months ended June 30, 2019, compared to the same period in the prior year, primarily due to higher material costs and higher excess and obsolete inventory charges, offset by favorable absorption. Gross profit as a percentage of net service revenues decreased by 1.3 percentage points for the six months ended June 30, 2019, primarily due to unfavorable mix and higher material costs, offset by favorable absorption.
 
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The following table sets forth gross profit as a percentage of net revenues by reportable segment:
                                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
 
2019
   
2018
   
% Points
Change
   
2019
   
2018
   
% Points
Change
 
Gross profit as a percentage of net revenues:
   
     
     
     
     
     
 
Vacuum & Analysis
   
43.3
%    
46.4
%    
(3.1
)%    
42.5
%    
46.0
%    
(3.5
)%
Light & Motion
   
45.7
     
50.7
     
(5.0
)    
46.8
     
50.7
     
(3.9
)
Equipment & Solutions
   
44.5
     
—  
     
100.0
     
35.3
     
—  
     
100.0
 
                                                 
Total gross profit
   
44.5
%    
48.0
%    
(3.5
)%    
43.6
%    
47.7
%    
(4.1
)%
                                                 
 
 
 
 
 
 
 
Gross profit for our Vacuum & Analysis segment decreased by 3.1 and 3.5 percentage points for the three and six months ended June 30, 2019, respectively, compared to the same periods in the prior year, primarily due to lower revenue volumes.
Gross profit for our Light & Motion segment decreased by 5.0 and 3.9 percentage points for the three and six months ended June 30, 2019, respectively, compared to the same periods in the prior year, primarily due to unfavorable product mix, lower factory utilization and lower revenue volumes.
Gross profit for our Equipment & Solutions segment of 44.5% and 35.3% for the three and six months ended June 30, 2019, respectively, includes the inventory
step-up
adjustment to fair value from purchase accounting of $2.5 million and $5.1 million, respectively. Excluding these adjustments, the gross margins would have been 49.0% and 43.6%, respectively, for these periods.
Research and Development
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(dollars in millions)
 
2019
   
2018
   
2019
   
2018
 
Research and development expenses
  $
41.9
    $
36.5
    $
80.8
    $
71.4
 
 
 
 
 
 
 
 
Research and development expenses increased $5.4 million for the three months ended June 30, 2019, compared to the same period in the prior year, primarily due to the ESI Merger, which included $5.2 million of compensation-related expenses, $0.8 million of depreciation expense and $0.6 million of project materials. These increases were offset by a decrease of $1.5 million of compensation-related expenses relating to the legacy MKS business.
Research and development expenses increased $9.4 million for the six months ended June 30, 2019, compared to the same period in the prior year, primarily due to the ESI Merger, which included $7.7 million of compensation-related expenses, $1.3 million of depreciation expense, $1.2 million of project materials and $0.6 million of occupancy costs. These increases were offset by a decrease of $2.4 million of compensation-related expenses related to the legacy MKS business.
Our research and development efforts are primarily focused on developing and improving our instruments, components, subsystems and process control solutions to improve process performance and productivity.
We have thousands 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 durations of 3 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 smaller integrated circuit geometries and in the flat panel display and solar markets to larger substrate sizes, 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. We expect to continue to make significant investment in research and development activities. We are subject to risks from products not being developed in a timely manner, as well as from 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 and advanced technology markets. 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 revenues may be reduced during the lifespan of those products.
 
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Selling, General and Administrative
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(dollars in millions)
 
2019
   
2018
   
2019
   
2018
 
Selling, general and administrative expenses
  $
83.2
    $
76.2
    $
165.7
    $
159.1
 
 
 
 
 
 
 
 
Selling, general and administrative expenses increased by $7.0 million for the three months ended June 30, 2019, compared to the same period in the prior year. This increase was primarily attributed to the ESI Merger, which included $7.4 million of compensation-related expense, $1.1 million of depreciation expense, $1.0 million of consulting and professional fees and $0.6 million of travel and entertainment expense. The increase was also attributed to an increase of $0.6 million of commissions expense and an increase of $0.5 million of information technology related expenses, offset by a decrease of $5.3 million of compensation-related expense related to the legacy MKS business.
Selling, general and administrative expenses increased by $6.6 million for the six months ended June 30, 2019, compared to the same period in the prior year. This increase was primarily attributed to the ESI Merger, which included $11.5 million of compensation-related expense, $2.1 million of depreciation expense, $1.5 million of consulting and professional fees, $1.0 million of travel and entertainment expense and $0.6 million of commission expense. The increase was also attributed to an increase of $0.7 million of information technology related expenses, offset by a decrease of $11.2 million of compensation-related expense related to the legacy MKS business.
Fees and Expenses Related to Incremental Term Loan Facility
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(dollars in millions)
 
2019
   
2018
   
2019
   
2018
 
Fees and expenses related to term loan
  $
    $
0.4
    $
5.8
    $
0.4
 
 
 
 
 
 
 
 
We recorded fees and expenses related to Amendment No. 5 to our senior secured term loan facility, as described below, which related to the ESI Merger, during the six months ended June 30, 2019. We recorded fees and expenses during the three and six months ended June 30, 2018 related to the fourth repricing of our Term Loan Credit Agreement.
Acquisition and Integration Costs
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(dollars in millions)
 
2019
   
2018
   
2019
   
2018
 
Acquisition and integration costs
  $
3.2
    $
(1.2
)   $
33.4
    $
(1.2
)
 
 
 
 
 
 
 
We recorded acquisition and integration costs related to the ESI Merger, which closed on February 1, 2019, during the three and six months ended June 30, 2019. These costs consisted primarily of compensation costs for certain executives from ESI who had change in control provisions in their respective ESI employment agreements that were accounted for as dual-trigger arrangements and other stock vesting accelerations, as well as consulting and professional fees associated with the ESI Merger.
During the three and six months ended June 30, 2018, we reversed a portion of acquisition and integration costs recognized during previous periods related to the acquisition of Newport Corporation in April 2016 (the “Newport Merger”), related to severance agreement provisions that were not met.
Restructuring and Other
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(dollars in millions)
 
2019
   
2018
   
2019
   
2018
 
Restructuring and other
  $
1.2
    $
0.8
    $
3.2
    $
3.0
 
 
 
 
 
 
 
 
 
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We recorded restructuring costs of $1.2 million and $1.5 million during the three and six months ended June 30, 2019, respectively, which consisted primarily of severance costs related to an organization-wide reduction in workforce, the consolidation of service functions in Asia and the movement of certain products to low cost regions. We recorded restructuring costs of $0.8 million and $2.0 million during the three and six months ended June 30, 2018, respectively, which consisted primarily of severance costs related to streamlining and consolidating certain administrative functions.
We recorded a charge of $1.7 million during the six months ended June 30, 2019 related to a contractual obligation we acquired as part of the Newport Merger.
We recorded $1.0 million of environmental costs during the six months ended June 30, 2018 related to a U.S. Environmental Protection Agency-designated Superfund site acquired as part of the Newport Merger.
Amortization of Intangible Assets
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(dollars in millions)
 
2019
   
2018
   
2019
   
2018
 
Amortization of intangible assets
  $
17.6
    $
10.9
    $
33.3
    $
22.1
 
 
 
 
 
 
 
 
Amortization of intangible assets increased by $6.7 million and $11.2 million during the three and six months ended June 30, 2019, respectively, compared to the same periods in the prior year, primarily due to the amortization of intangible assets acquired as part of the ESI Merger.
Interest Expense, Net
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(dollars in millions)
 
2019
   
2018
   
2019
   
2018
 
Interest expense, net
  $
11.3
    $
2.5
    $
18.7
    $
6.8
 
 
 
 
 
 
 
 
Interest expense, net, increased by $8.8 million and $11.9 million for the three and six months ended June 30, 2019, respectively, primarily due to interest expense related to Amendment No. 5 to our senior secured term loan facility, as described below.
Other Expense, Net
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(dollars in millions)
 
2019
   
2018
   
2019
   
2018
 
Other expense, net
  $
0.8
    $
0.3
    $
1.1
    $
0.9
 
 
 
 
 
 
 
 
The changes in other expense, net, for the three and six months ended June 30, 2019, respectively, primarily related to changes in foreign exchange rates.
Provision for Income Taxes
                                 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
(dollars in millions)
 
2019
   
2018
   
2019
   
2018
 
Provision for income taxes
  $
14.1
    $
25.7
    $
17.0
    $
47.3
 
 
 
 
 
 
 
 
Our effective tax rates for the three and six months ended June 30, 2019 were 27.2% and 25.3%, respectively. Our effective tax rates for the three and six months ended June 30, 2019, and related income tax expense, were higher than the U.S. statutory tax rate primarily due to a correction of an out of period error with respect to deferred tax assets related to limitations on the deduction of executive compensation in the amount of $5.0 million. This correction, which should have been recorded during the three months ended September 30, 2018, increased our effective tax rates in the three and six months ended June 30, 2019 by 9.8% and 7.5% respectively. The prior period error and subsequent correction were not material to prior or current interim and annual financial statements. Our effective tax rates for these periods were also higher than the U.S. statutory tax rate due to the tax effect of the global intangible low taxed income inclusion offset by the deduction for foreign derived intangible income, the benefit from the reinstatement of a capital loss, and the utilization of various tax credits.
 
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Our effective tax rates for the three and six months ended June 30, 2018 were 17.3% and 17.2%, respectively. Our effective tax rates for the three and six months ended June 30, 2018, and related income tax expense, were lower than the U.S. statutory rate due to foreign earnings taxed at lower rates, windfall benefits of stock compensation and the deduction for foreign derived intangible income offset by the tax effect of the provision for global intangible low taxed income inclusion and state income taxes.
As of June 30, 2019, the total amount of gross unrecognized tax benefits, which excludes interest and penalties, was approximately $40.8 million. At December 31, 2018, the total amount of gross unrecognized tax benefits, which excludes interest and penalties, was approximately $32.7 million. The net increase is primarily attributable to the addition of historical gross unrecognized tax benefits for ESI as a result of the ESI Merger during the quarter ended March 31, 2019. As of June 30, 2019, excluding interest and penalties, there were approximately $33.1 million of net unrecognized tax benefits that, if recognized, would impact our annual effective tax rate. We accrue interest and, if applicable, penalties for any uncertain tax positions. Interest and penalties are classified as a component of income tax expense. As of June 30, 2019 and December 31, 2018, we had accrued interest on unrecognized tax benefits of approximately $0.6 million and $0.6 million, respectively.
Over the next 12 months it is reasonably possible that we may recognize approximately $1.2 million of previously net unrecognized tax benefits, excluding interest and penalties, related to federal, state and foreign tax positions as a result of the expiration of statutes of limitation. The U.S. statute of limitations remains open for tax years 2016 through present. The statute of limitations for our tax filings in other jurisdictions varies between fiscal years 2013 through the present. We also have certain federal credit carry-forwards and state tax loss and credit carry-forwards that are open to examination for tax years 2000 through the present.
We are subject to examination by U.S. federal, state and foreign tax authorities. The U.S. Internal Revenue Service commenced an examination of our U.S. federal income tax filings for tax years 2015 and 2016 during the quarter ended September 30, 2017. This audit was effectively settled during the quarter ended March 31, 2018, and the impact was not material. Also during the quarter ended March 31, 2018 we received notification from the U.S. Internal Revenue Service of their intent to audit our U.S. subsidiary, Newport Corporation, for tax year 2015. This audit commenced during the quarter ended June 30, 2018 and was effectively settled during the quarter ended June 30, 2019 with a no change result.
On a quarterly basis, we evaluate both positive and negative evidence that affects the realizability of net deferred tax assets and assess the need for a valuation allowance. The future benefit to be derived from our deferred tax assets is dependent upon our ability to generate sufficient future taxable income in each jurisdiction of the right type to realize the assets.
Our future effective tax rate depends on various factors, including further interpretations and guidance from U.S. federal and state governments on the impact of the enactment of the Tax Cuts and Jobs Act, the adoption of the proposed regulations on the foreign derived intangible income and the global intangible
low-taxed
income provision, as well as the geographic composition of our
pre-tax
income, and changes in income tax reserves for unrecognized tax benefits. We monitor these factors and timely adjust our estimates of the effective tax rate accordingly. We expect that the geographic mix of
pre-tax
income will continue to have a favorable impact on our effective tax rate, however the geographic mix of
pre-tax
income can change based on multiple factors resulting in changes to the effective tax rate in future periods. While we believe we have adequately provided for all tax positions, amounts asserted by taxing authorities could materially differ from our accrued positions as a result of uncertain and complex application of tax law and regulations. Additionally, the recognition and measurement of certain tax benefits include estimates and judgment by management. Accordingly, we could record additional provisions or benefits for U.S. federal, state, and foreign tax matters in future periods as new information becomes available.
Liquidity and Capital Resources
Cash and cash equivalents and short-term marketable investments totaled $459.9 million at June 30, 2019, compared to $718.2 million at December 31, 2018. This decrease primarily related to the use of $406.0 million of cash to fund the payment of a portion of the purchase price for ESI on February 1, 2019.
Net cash provided by operating activities was $106.6 million for the six months ended June 30, 2019 and resulted from net income of $50.2 million, which included
non-cash
charges of $107.6 million, offset by a net increase in working capital of $51.2 million. The net increase in working capital was due to an increase in inventories of $30.8 million, a decrease in accounts payable of $24.6 million, a decrease in accrued compensation of $17.8 million, a decrease in income taxes of $3.9 million, an increase in other-current and
non-current
assets of $0.9 million, and a decrease in other current and
non-current
liabilities of $0.3 million, offset by a decrease in trade accounts receivable of $27.1 million.
Net cash provided by operating activities was $182.4 million for the six months ended June 30, 2018 and resulted from net income of $228.0 million, which included
non-cash
charges of $72.6 million, offset by a net increase in working capital of $118.2 million. The net increase in working capital was primarily due to an increase in inventories of $59.5 million and an increase in accounts receivable of $42.5 million, related to an
 
42
  
 
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increase in business activities, a decrease in accrued compensation of $15.9 million, as
year-end
bonuses were paid during the first quarter of 2018, a decrease in income taxes of $11.4 million and an increase in other current and
non-current
assets of $4.3 million. This increase in working capital was offset by an increase in other current and
non-current
liabilities of $9.9 million and an increase in accounts payable of $5.6 million.
Net cash used in investing activities was $936.6 million for the six months ended June 30, 2019 and was primarily due to the payment of a portion of the purchase price for the ESI Merger of $988.6 million and purchases of production-related equipment of $28.2 million, partially offset by net sales and maturities of short-term investments of $80.2 million. Net cash used in investing activities was $16.5 million for the six months ended June 30, 2018 due to purchases of production-related equipment of $21.8 million, offset by net sales and maturities of short-term investments of $5.3 million.
Net cash provided by financing activities was $554.6 million for the six months ended June 30, 2019 and was primarily from net proceeds of $587.4 million, mainly from our 2019 Incremental Term Loan Facility, as described below, used to finance the ESI Merger, partially offset by net payments related to tax payments for employee stock awards of $11.0 million and dividend payments made to common stockholders of $21.7 million. Net cash used in financing activities was $74.9 million for the six months ended June 30, 2018 and resulted from partial repayment of the Term Loan Facility, as described below, of $50.0 million, dividend payments made to common stockholders of $20.8 million and net payments related to tax payments for employee stock awards of $13.0 million, partially offset by net borrowings relating to our lines of credit of $8.9 million.
On July 25, 2011, our Board of Directors approved a share repurchase program for the repurchase of up to an aggregate of $200 million of our outstanding common stock from time to time in open market purchases, privately negotiated transactions or through other appropriate means. The timing and quantity of any shares repurchased depends upon a variety of factors, including business conditions, stock market conditions and business development activities, including but not limited to merger and acquisition opportunities. These repurchases may be commenced, suspended or discontinued at any time without prior notice. We have repurchased approximately 2,588,000 shares of common stock for approximately $127.0 million pursuant to the program since its adoption. During the six months ended June 30, 2019 and 2018, there were no repurchases of common stock.
Holders of our common stock are entitled to receive dividends when and if they are declared by our Board of Directors. In addition, we accrue dividend equivalents on the restricted stock units we assumed in the ESI Merger when dividends are declared by our Board of Directors. Our Board of Directors declared a cash dividend of $0.20 per share during each of the first and second quarters of 2019, respectively, which totaled $21.7 million, or $0.40 per share. Our Board of Directors declared a cash dividend of $0.18 per share during the first quarter of 2018 and $0.20 per share during the second quarter of 2018, which totaled $20.8 million, or $0.38 per share.
On July 29, 2019, our Board of Directors declared a quarterly cash dividend of $0.20 per share to be paid on September 6, 2019 to shareholders of record as of August 26, 2019. Future dividend declarations, if any, as well as the record and payment dates for such dividends, are subject to the final determination of our Board of Directors. In addition, under the terms of our senior secured Term Loan Facility and our senior secured asset-based revolving credit facility, we may be restricted from paying dividends under certain circumstances.
Term Loan Credit Agreement
In connection with the completion of the Newport Merger, we entered into a term loan credit agreement (the “Credit Agreement”) with Barclays Bank PLC, as administrative agent and collateral agent, and the lenders from time to time party thereto (the “Lenders”), that provided senior secured financing in the original principal amount of $780.0 million (the “2016 Term Loan Facility”), subject to increase at our option and subject to the receipt of lender commitments in accordance with the Credit Agreement (the 2016 Term Loan Facility, together with the 2019 Incremental Term Loan Facility (as defined below), the “Term Loan Facility”). The 2016 Term Loan Facility matures on April 29, 2023. Borrowings under the Term Loan Facility bear interest per annum at one of the following rates selected by the Company: (a) a base rate determined by reference to the highest of (1) the federal funds effective rate plus 0.50%, (2) the “prime rate” quoted in
The Wall Street Journal
, (3) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month adjusted for certain additional costs, plus 1.00%, and (4) a floor of 1.75%, plus, in each case, an applicable margin; or (b) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, subject to a LIBOR rate floor of 0.75%, plus an applicable margin. We have elected the interest rate as described in clause (b). The Credit Agreement provides that, unless an alternate rate of interest is agreed, all loans will be determined by reference to the Base Rate if the LIBOR rate cannot be ascertained, if regulators impose material restrictions on the authority of a lender to make LIBOR rate loans, or for other reasons. The 2016 Term Loan Facility was issued with original issue discount of 1.00% of the principal amount thereof.
We subsequently entered into four separate repricing amendments to the 2016 Term Loan Facility, which decreased the applicable margin for LIBOR borrowings from 4.0% to 1.75%, with a LIBOR rate floor of 0.75%. As a consequence of the pricing of the 2019 Incremental Term Loan Facility (defined below), the applicable margin for the 2016 Term Loan Facility was increased to 2.00% (from 1.75%) with respect to LIBOR borrowings and 1.00% (from 0.75%) with respect to base rate borrowings. The interest rate on the 2016 Term Loan Facility as of June 30, 2019 was 4.4%.
 
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In September 2016, we entered into an interest rate swap agreement, which has a maturity date of September 30, 2020, to fix the rate on $335.0 million of the then-outstanding balance under the 2016 Term Loan Facility. The rate is fixed at 1.198% per annum plus the applicable credit spread, which was 2.0% at June 30, 2019. The notional amount of the interest rate swap agreement was $290.0 million and had a fair value asset of $2.1 million at June 30, 2019.
As of June 30, 2019, after total principal prepayments of $475.0 million (which includes a $50.0 million prepayment made during the three months ended June 30, 2019) and regularly scheduled principal payments of $6.5 million, the total outstanding principal balance of the 2016 Term Loan Facility was $298.5 million. As a result of making these prepayments, we are no longer required to make any regularly scheduled principal payments on the 2016 Term Loan Facility until the maturity date of the loan.
We incurred $28.7 million of deferred finance fees, original issue discount and repricing fees related to the term loans under the 2016 Term Loan Facility, which are included in long-term debt in the accompanying consolidated balance sheets and are being amortized to interest expense over the estimated life of the term loans using the effective interest method. A portion of these fees have been accelerated in connection with the various debt prepayments during 2016, 2017 and 2018. As of June 30, 2019, the remaining balance of the deferred finance fees, original issue discount and repricing fees related to the 2016 Term Loan Facility was $2.6 million.
On February 1, 2019, in connection with the completion of the ESI Merger, we entered into an amendment (“Amendment No. 5”) to the Credit Agreement. Amendment No. 5 provided an additional tranche
B-5
term loan commitment in the principal amount of $650.0 million (the “2019 Incremental Term Loan Facility”), all of which was drawn down in connection with the closing of the ESI Merger. Pursuant to Amendment No. 5, we also effectuated certain amendments to the Credit Agreement which make certain of the negative covenants and other provisions less restrictive. The 2019 Incremental Term Loan Facility matures on February 1, 2026 and bears interest at a rate per annum equal to, at our option, a base rate or LIBOR rate (as described above) plus, in each case, an applicable margin equal to 1.25% with respect to base rate borrowings and 2.25% with respect to LIBOR borrowings. The 2019 Incremental Term Loan Facility was issued with original issue discount of 1.00% of the principal amount thereof.
On April 3, 2019, we entered into an interest rate swap agreement, which has a maturity date of March 31, 2023, to fix the rate on $300.0 million of the outstanding balance of the 2019 Incremental Term Loan Facility. The rate is fixed at 2.309% per annum plus the applicable credit spread, which was 2.25% at June 30, 2019. At June 30, 2019, the notional amount of this transaction was $300.0 million and had a fair value liability of $6.7 million.
We incurred $11.4 million of deferred finance fees and original issue discount fees related to the term loans under the 2019 Incremental Term Loan Facility, which are included in long-term debt in the accompanying consolidated balance sheets and are being amortized to interest expense over the estimated life of the term loans using the effective interest method. As of June 30, 2019, the remaining balance of the deferred finance fees and original issue discount related to the 2019 Incremental Term Loan Facility was $10.9 million.
We are required to make scheduled quarterly payments each equal to 0.25% of the original principal amount of the 2019 Incremental Term Loan Facility, with the balance due on February 1, 2026. If, on or prior to the date that is six months after the closing date of Amendment No. 5, we prepay any loans under the 2019 Incremental Term Loan Facility in connection with a repricing transaction, we must pay a prepayment premium of 1.00% of the aggregate principal amount of the loans so prepaid. At June 30, 2019, after regularly scheduled principal payments of $1.6 million, the total balance outstanding of the 2019 Incremental Term Loan Facility was $648.4 million, and the interest rate was 4.7%.
Under the Credit Agreement, we are required to prepay outstanding term loans under the 2016 Term Loan Facility and the 2019 Incremental Term Loan Facility, subject to certain exceptions, with portions of our annual excess cash flow as well as with the net cash proceeds of certain asset sales, certain casualty and condemnation events and the incurrence or issuance of certain debt. As a result of our Total Leverage Ratio, we were not required to make a prepayment of excess cash flow for the fiscal year ended December 31, 2018.
All obligations under the Term Loan Facility are guaranteed by certain of our domestic subsidiaries, and are collateralized by substantially all of our assets and the assets of such subsidiaries, subject to certain exceptions and exclusions.
The Credit Agreement contains customary representations and warranties, affirmative and negative covenants and provisions relating to events of default. If an event of default occurs, the Lenders under the Term Loan Facility will be entitled to take various actions, including the acceleration of amounts due under the Term Loan Facility and all actions generally permitted to be taken by a secured creditor. At June 30, 2019, we were in compliance with all covenants under the Credit Agreement.
Senior Secured Asset-Based Revolving Credit Facility
On February 1, 2019, in connection with the completion of the ESI Merger, we entered into an asset-based credit agreement with Barclays Bank PLC, as administrative agent and collateral agent, the other borrowers from time to time party thereto, and the lenders and letters of credit issuers from time to time party thereto (the “ABL Credit Agreement”), that provides senior secured revolving credit financing of up to $100.0 million, subject
 
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to a borrowing base limitation (the “ABL Facility”). On April 26, 2019, we entered into a First Amendment to the ABL Credit Agreement which amended the borrowing base calculation for eligible inventory prior to an initial field examination and appraisal requirements. The borrowing base for the ABL Facility at any time equals the sum of: (a) 85% of certain eligible accounts; plus (b) prior to certain notice and field examination and appraisal requirements, the lesser of (i) 20% of net book value of eligible inventory in the United States and (ii) 30% of the borrowing base, and after the satisfaction of such requirements, the lesser of (i) the lesser of (A) 65% of the lower of cost or market value of certain eligible inventory and (B) 85% of the net orderly liquidation value of certain eligible inventory and (ii) 30% of the borrowing base; minus (c) reserves established by the administrative agent, in each case, subject to additional limitations and examination requirements for eligible accounts and eligible inventory acquired in an acquisition after February 1, 2019. The ABL Facility includes borrowing capacity in the form of letters of credit up to $25.0 million.
Borrowings under the ABL Facility bear interest at a rate per annum equal to, at our option, any of the following, plus, in each case, an applicable margin: (a) a base rate determined by reference to the highest of (1) the federal funds effective rate plus 0.50%, (2) the “prime rate” quoted in
The Wall Street Journal
, (3) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month adjusted for certain additional costs, plus 1.00% and (4) a floor of 0.00%; and (b) a LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, with a floor of 0.00%. The initial applicable margin for borrowings under the ABL Facility is 0.50% with respect to base rate borrowings and 1.50% with respect to LIBOR borrowings. Commencing with the completion of the first fiscal quarter ending after the closing of the ABL Facility, the applicable margin for borrowings thereunder is subject to upward or downward adjustment each fiscal quarter, based on the average historical excess availability during the preceding quarter.
In addition to paying interest on any outstanding principal under the ABL Facility, we are required to pay a commitment fee in respect of the unutilized commitments thereunder equal to 0.25% per annum. We must also pay customary letter of credit fees and agency fees.
We incurred $0.8 million of costs in connection with the ABL Facility, which were capitalized and included in other assets in the accompanying consolidated balance sheet and are being amortized to interest expense over the contractual term of five years of the ABL Facility. As a result of a prior asset-based facility being terminated concurrently with our entry into the ABL Facility, we wrote off $0.2 million of previously capitalized debt issuance costs. 
The ABL Credit Agreement also contains customary representations and warranties, affirmative covenants and provisions relating to events of default. If an event of default occurs, the lenders under the ABL Facility will be entitled to take various actions, including the acceleration of amounts due under the ABL Facility and all actions permitted to be taken by a secured creditor. We have not borrowed against this ABL Facility to date.
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 for other contractually narrow or limited purposes. Accordingly, we have no
off-balance
sheet arrangements that have or are reasonably expected to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
Contractual Obligations
Other than the 2019 Incremental Term Loan Facility for $650.0 million described above, there have been no other changes outside the ordinary course of business to our contractual obligations as disclosed in our Annual Report on Form
10-K
for the year ended December 31, 2018.
Recently Issued Accounting Pronouncements
In August 2018, the FASB issued ASU
2018-15,
“Intangibles-Goodwill and
Other-Internal-Use
Software (Subtopic
350-40):
Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract.” This standard aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain
internal-use
software (and hosting arrangements that include an
internal-use
software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments to this update. This standard is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. We are currently evaluating the requirements of this ASU and adoption could have a material impact on our consolidated financial statements.
 
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
 
 
 
 
 
 
 
Information concerning market risk is contained in the section entitled “Quantitative and Qualitative Disclosures About Market Risk” contained in our Annual Report on Form
10-K
for the year ended December 31, 2018 filed with the Securities and Exchange Commission on February 26, 2019. As of June 30, 2019, there were no material changes in our exposure to market risk from December 31, 2018.
ITEM 4. CONTROLS AND PROCEDURES.
 
 
 
 
 
 
 
 
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2019. 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 an issuer that are designed to ensure that information required to be disclosed by the issuer 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 Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions 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 June 30, 2019, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
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) during the quarter ended June 30, 2019, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
 
 
 
 
 
 
 
 
Newport Litigation
In 2016, two putative class actions lawsuit captioned Dixon Chung v. Newport Corp., et al., Case No.
 A-16-733154-C,
 and Hubert C. Pincon v. Newport Corp., et al., Case No.
 A-16-734039-B,
 were filed in the District Court, Clark County, Nevada on behalf of a putative class of stockholders of Newport Corporation (“Newport”) for claims related to the merger agreement (“Newport Merger Agreement”) between the Company, Newport, and a wholly-owned subsidiary of the Company (“Merger Sub”). The lawsuits named as defendants the Company, Newport, Merger Sub, and certain then current and former members of Newport’s board of directors. Both complaints alleged that Newport directors breached their fiduciary duties to Newport’s stockholders by agreeing to sell Newport through an inadequate and unfair process, which led to inadequate and unfair consideration, by agreeing to unfair deal protection devices and by omitting material information from the proxy statement. The complaints also alleged that the Company, Newport and Merger Sub aided and abetted the directors’ alleged breaches of their fiduciary duties. The Court consolidated the actions, and plaintiffs later filed an amended complaint captioned In re Newport Corporation Shareholder Litigation, Case No.
 A-16-733154-B,
 in the District Court, Clark County, Nevada, on behalf of a putative class of Newport’s stockholders for claims related to the Newport Merger Agreement. The amended complaint alleged Newport’s former board of directors breached their fiduciary duties to Newport’s stockholders and that the Company, Newport and Merger Sub had aided and abetted these breaches. It sought monetary damages, including
 pre-
 and post-judgment interest. In June 2017, the Court granted defendants’ motion to dismiss and dismissed the amended complaint against all defendants but granted plaintiffs leave to amend.
On July 27, 2017, plaintiffs filed a second amended complaint containing substantially similar allegations but naming only Newport’s former directors as defendants. On August 8, 2017, the Court dismissed the Company and Newport from the action. The second amended complaint seeks monetary damages, including
 pre-
 and post-judgment interest. The Court granted a motion for class certification on September 27, 2018, appointing Mr. Pincon
 
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and Locals 302 and 612 of the International Union of Operating
Engineers - Employers Construction Industry Retirement Trust as class representatives. On June 11, 2018, plaintiff Dixon Chung was voluntarily dismissed from the litigation. On May 1, 2019, the Court granted the defendants’ motion to strike plaintiffs’ jury demand and determined that the case will be tried by the Court, and not a jury. A bench trial is scheduled for the first quarter of 2020. Fact discovery in the action is complete, and expert discovery is ongoing.
The Company is 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 on Form
10-K
for the year ended December 31, 2018 in the section entitled “Risk Factors.” There have been no material changes to the risk factors as described in Part I, Item 1A, “Risk Factors,” in our Annual Report on Form
10-K
for the year ended December 31, 2018 other than the supplemental risk factor added below.
If significant tariffs or other trade restrictions on our products or components that are imported from or exported to China continue or are increased, our business, financial condition and results of operations may be materially harmed.
General trade tensions between the U.S. and China have been escalating throughout 2018 and 2019, with one round of U.S. tariffs on Chinese goods taking effect in July 2018, a second round in August 2018 and a third round in September 2018. In response to each of these rounds of U.S. tariffs, China imposed retaliatory tariffs in July 2018, August 2018 and September 2018 on certain products made in the U.S. and shipped to China. The Trump Administration subsequently increased its third round of U.S. tariffs on Chinese goods in May 2019 from 10% to 25% and China responded with retaliatory increases to its third round of tariffs on certain U.S. goods in June 2019. These tariffs currently affect some of our products made in China and some of the components that we or our suppliers source from China, and some of our products and components we export to China. The U.S. and China tariffs have negatively impacted our business, financial condition and results of operations. We are exploring and will continue to explore all of our options to reduce the impact of these tariffs on our business, including but not limited to, seeking alternative sources for our components, modifying other business practices, raising our prices, and shifting production outside of China.
In May 2019, the U.S. Department of Commerce’s Bureau of Industry and Security (“BIS”) added Chinese-based Huawei Technologies Co. Ltd. and 68 of its affiliates onto the BIS Entity List, thereby prohibiting the sale of U.S. goods to Huawei, without a license from BIS. Accordingly, the Company has had to suspend outstanding orders from Huawei, and has been negatively impacted by the cancellation of orders from customers who are providers to Huawei. In addition, China’s Ministry of Commerce announced in May 2019 that China will introduce an “unreliable entity list” under which non-Chinese entities that cut off suppliers to Chinese companies may be subject to government action.
On August 1, 2019, the Trump Administration proposed a fourth round of U.S. tariffs on thousands of categories of goods, including electronics, of 10%. In addition, the Trump Administration has continued to signal that it may alter trade agreements and terms between China and the United States, including limiting trade with China. It is possible that additional restrictions on trade will be imposed, that further tariffs will be imposed, including the tariffs proposed on August 1, 2019, and that existing tariffs will be increased on imports of our products or the components used in our products, or that our business will be impacted by additional retaliatory tariffs or restrictions imposed and/or increased by China or other countries in response to existing or future tariffs, causing us to lose sales revenue, incur increased costs and lower margins, seek alternative suppliers, raise prices or make changes to our operations, any of which could materially harm our business, financial condition and results of operations.
Further, the geopolitical and economic uncertainty between the U.S. and China caused by the tariffs and trade bans have caused, and may continue to cause, decreased demand for our products, directly and indirectly, which could materially harm our business, financial condition and results of operations. This trade uncertainty has caused, and may continue to cause, customers to delay or cancel orders as they limit expenditures that could be affected by future actions and evaluate ways to mitigate their own tariff and cost exposure. Such delays and cancellations could have a material impact on our business, financial condition and results of operations.
 
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Table of Contents
 
ITEM 6. EXHIBITS.
 
         
Exhibit 
      No.      
   
Exhibit Description
         
 
  +3.1(1)
   
         
 
  +3.2(2)
   
         
 
  +3.3(3)
   
         
 
  +3.4(4)
   
         
 
  10.1
   
         
 
*10.2
   
         
 
  31.1
   
         
 
  31.2
   
         
 
  32.1
   
         
 
101.INS
   
XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags
are embedded within the Inline XBRL document
         
 
101.SCH
   
XBRL Taxonomy Extension Schema Document
         
 
101.CAL
   
XBRL Taxonomy Extension Calculation Linkbase Document
         
 
101.LAB
   
XBRL Taxonomy Extension Label Linkbase Document
         
 
101.PRE
   
XBRL Taxonomy Extension Presentation Linkbase Document
         
 
101.DEF
   
XBRL Taxonomy Extension Definition Linkbase Document
 
 
+ Previously filed
 
* Management contract or compensatory plan arrangement
 
(1) Incorporated by reference to the Registration Statement on Form
 
S-4
 
(File No.
 333-49738),
 
filed with the Securities and Exchange Commission on November 13, 2000.
 
(2) Incorporated by reference to the Registrant’s Quarterly Report on Form
 
10-Q
 
for the quarter ended June 30, 2001 (File No.
 000-23621),
 
filed with the Securities and Exchange Commission on August 14, 2001.
 
(3) Incorporated by reference to the Registrant’s Quarterly Report on Form
 
10-Q
 
for the quarter ended June 30, 2002 (File No.
 000-23621),
 
filed with the Securities and Exchange Commission on August 13, 2002.
 
(4) Incorporated by reference to the Registrant’s Current Report on Form
 
8-K
 
(File No.
 000-23621),
 
filed with the Securities and Exchange Commission on May 6, 2014.
 
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SIGNATURES
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.
             
Date: August 7, 2019
 
 
By:
 
/s/ Seth H. Bagshaw
 
 
 
Seth H. Bagshaw
 
 
 
Senior Vice President, Chief Financial Officer and Treasurer
 
 
 
(Principal Financial Officer)
 
 
 
 
 
 
 
 
 
 
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