MKS INSTRUMENTS INC - Quarter Report: 2011 June (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(MARK ONE)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-23621

MKS INSTRUMENTS, INC.

Massachusetts		04-2277512
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		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

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 þ No o

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

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     As of July 29, 2011 the registrant had 52,460,897 shares of common stock outstanding.

 

 

MKS INSTRUMENTS, INC.
FORM 10-Q
INDEX

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
Consolidated Balance Sheets — June 30, 2011 and December 31, 2010			3
Consolidated Statements of Operations — Three and six months ended June 30, 2011 and 2010			4
Consolidated Statements of Cash Flows — Six months ended June 30, 2011 and 2010			5
Notes to Unaudited Consolidated Financial Statements			6
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			24
ITEM 4. CONTROLS AND PROCEDURES			25
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS			25
ITEM 1A. RISK FACTORS			25
ITEM 6. EXHIBITS			25
SIGNATURES
EXHIBIT INDEX
EX-31.1
EX-31.2
EX-32.1
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

PART I. FINANCIAL INFORMATION

ITEM 1.		FINANCIAL STATEMENTS.

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

		June 30, 2011				December 31, 2010
ASSETS
Current assets:
Cash and cash equivalents		$	226,538			$	162,476
Short-term investments			269,749				269,457
Trade accounts receivable, net			150,980				138,181
Inventories			164,450				156,429
Deferred income taxes			13,872				13,775
Other current assets			24,120				12,577
Total current assets			849,709				752,895
Property, plant and equipment, net			69,653				68,976
Long-term marketable securities			5,277				—
Goodwill			140,020				140,020
Intangible assets, net			1,243				1,743
Other assets			14,713				18,779
Total assets		$	1,080,615			$	982,413
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Short-term borrowings		$	619			$	—
Accounts payable			33,754				36,427
Accrued compensation			29,201				29,944
Income taxes payable			490				5,347
Other current liabilities			37,919				37,968
Total current liabilities			101,983				109,686
Other liabilities			29,666				25,688
Commitments and contingencies (Note 15)
Stockholders’ equity:
Preferred Stock, $0.01 par value, 2,000,000 shares authorized; none issued and outstanding			—				—
Common Stock, no par value, 200,000,000 shares authorized; 52,439,231 and 50,648,601 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively			113				113
Additional paid-in capital			699,458				663,792
Retained earnings			232,372				171,356
Accumulated other comprehensive income			17,023				11,778
Total stockholders’ equity			948,966				847,039
Total liabilities and stockholders’ equity		$	1,080,615			$	982,413

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

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

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Net revenues
Products		$	198,737			$	198,930			$	406,184			$	370,001
Services			25,750				21,717				50,154				42,812
Total net revenues			224,487				220,647				456,338				412,813
Cost of revenues
Cost of products			105,086				111,117				216,301				205,256
Cost of services			14,413				12,211				28,688				24,743
Total cost of revenues			119,499				123,328				244,989				229,999
Gross profit			104,988				97,319				211,349				182,814
Research and development			15,582				16,154				32,478				31,829
Selling, general and administrative			31,851				30,902				64,558				58,714
Amortization of intangible assets			250				314				500				783
Gain on sale of asset			—				—				—				(682	)
Income from operations			57,305				49,949				113,813				92,170
Interest income			309				284				585				631
Interest expense			—				30				5				52
Income from continuing operations before income taxes			57,614				50,203				114,393				92,749
Provision for income taxes			19,013				17,059				37,749				30,607
Income from continuing operations			38,601				33,144				76,644				62,142
Income from discontinued operations, net of taxes			—				5,633				—				5,860
Net income		$	38,601			$	38,777			$	76,644			$	68,002
Basic income per share:
Continuing operations		$	0.74			$	0.66			$	1.48			$	1.24
Discontinued operations			—				0.11				—				0.12
Net income		$	0.74			$	0.77			$	1.48			$	1.36
Diluted income per share:
Continuing operations		$	0.73			$	0.65			$	1.46			$	1.22
Discontinued operations			—				0.11				—				0.12
Net income		$	0.73			$	0.76			$	1.46			$	1.34
Cash dividends per common share		$	0.15			$	—			$	0.30			$	—
Weighted average common shares outstanding:
Basic			52,346				50,067				51,877				49,834
Diluted			52,906				50,870				52,646				50,735

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

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

		Six Months Ended
		June 30,
		2011				2010
Cash flows from operating activities:
Net income		$	76,644			$	68,002
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			6,374				7,037
Stock-based compensation			6,048				4,310
Provision for excess and obsolete inventory			6,458				4,926
Gain on disposal of discontinued operations			—				(4,228	)
Deferred income taxes			2,485				2,280
Excess tax benefits from stock-based compensation			(5,218	)			(640	)
Other			299				(722	)
Changes in operating assets and liabilities:
Trade accounts receivable			(10,953	)			(57,994	)
Inventories			(12,880	)			(28,280	)
Income taxes			(365	)			3,519
Other current assets			(9,885	)			(696	)
Accrued expenses and other current liabilities			2,614				27,700
Accounts payable			(2,897	)			13,959
Net cash provided by operating activities			58,724				39,173
Cash flows from investing activities:
Purchases of short-term and long-term available-for-sale investments			(197,574	)			(111,767	)
Maturities, sales and settlements of short-term and long-term available-for-sale investments			192,944				104,544
Purchases of property, plant and equipment			(6,265	)			(6,627	)
Proceeds from sale of assets			4				2,113
Net proceeds from sales of discontinued operations			—				15,097
Other			(170	)			(1,438	)
Net cash (used in) provided by investing activities			(11,061	)			1,922
Cash flows from financing activities:
Proceeds from short-term borrowings			13,404				71,795
Payments on short-term borrowings			(12,791	)			(72,319	)
Net proceeds related to employee stock-based compensation			24,662				2,265
Dividend payments to common stockholders			(15,628	)			—
Excess tax benefits from stock-based compensation			5,218				640
Net cash provided by financing activities			14,865				2,381
Effect of exchange rate changes on cash and cash equivalents			1,534				(2,963	)
Increase in cash and cash equivalents			64,062				40,513
Cash and cash equivalents at beginning of period			162,476				111,009
Cash and cash equivalents at end of period		$	226,538			$	151,522

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

MKS INSTRUMENTS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Tables 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. The interim financial data as of June 30, 2011 and for the three and six months ended June 30, 2011 and 2010 are unaudited; however, in the opinion of MKS, the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the results for the interim periods. The consolidated balance sheet presented as of December 31, 2010 has been derived from the audited consolidated financial statements as of that date. The unaudited consolidated financial statements presented herein have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and note disclosures required by United States generally accepted accounting principles (“U.S. GAAP”). The 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, 2010 filed with the Securities and Exchange Commission on February 25, 2011.

The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to revenue recognition, stock-based compensation, inventory, intangible assets, goodwill and other long-lived assets, 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 June 2011, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”) which eliminates the option to present the components of other comprehensive income as part of the statement of equity and requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments are effective retrospectively for fiscal years, and interim periods within those years, beginning after December 15, 2011. The ASU requires changes in presentation only and the Company does not expect it will have a material effect on its consolidated financial statements.

In May 2011, the FASB issued an ASU which applies to all reporting entities that are required or permitted to measure or disclose the fair value of an asset, a liability, or an instrument classified in a reporting entity’s shareholders’ equity in the financial statements. The amendments do not extend the use of fair value accounting, but provide guidance on how it should be applied where its use is already required or permitted by other standards within U.S. GAAP. The amendments change the wording used to describe many requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. Additionally, the ASU clarifies the FASB’s intent about the application of existing fair value measurements. The amendments in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Company does not expect the new ASU to have a material effect on its financial position, results of operations or cash flows.

In October 2009, the FASB issued an ASU that established new accounting and reporting provisions for arrangements including multiple revenue-generating activities. This ASU provides amendments to the criteria for separating deliverables, measuring and allocating arrangement consideration to one or more units of accounting. The amendments in this ASU also established a selling price hierarchy for determining the selling price of a deliverable. Significantly enhanced disclosures are also required to provide information about a vendor’s multiple-deliverable revenue arrangements, including information about the nature and terms, significant deliverables, and its performance within arrangements. The amendments also require providing information about the significant judgments made and changes to those judgments and about how the application of the relative selling-price method affects the timing or amount of revenue recognition. The amendments in this ASU were effective prospectively for revenue arrangements entered into or materially modified in the fiscal years beginning on or after June 15, 2010. The Company adopted the new ASU in the first quarter of 2011, and the adoption did not have a material impact on the Company’s financial position, results of operations or cash flows.

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

In October 2009, the FASB issued an ASU that changed the accounting model for revenue arrangements that include both tangible products and software elements that are “essential to the functionality,” and scoped these products out of current software revenue guidance. The new ASU includes factors to help companies determine what software elements are considered “essential to the functionality.” The amendments now subject software-enabled products to other revenue guidance and disclosure requirements, such as guidance surrounding revenue arrangements with multiple-deliverables. The amendments in this ASU were effective prospectively for revenue arrangements entered into or materially modified in the fiscal years beginning on or after June 15, 2010. The Company adopted the new ASU in the first quarter of 2011, and the adoption did not have a material impact on the Company’s financial position, results of operations or cash flows.

3)

Cash and Cash Equivalents and Investments

The fair value of short-term available-for-sale investments with maturities or estimated lives of less than one year consists of the following:

		June 30, 2011				December 31, 2010
Time deposits and drafts		$	1,597			$	15,716
Equity mutual funds			517				491
U.S. treasury and agency obligations			267,635				253,250
		$	269,749			$	269,457

The fair value of long-term available-for-sale investments with maturities or estimated lives of more than one year consists of the following:

		June 30, 2011				December 31, 2010
U.S. treasury and agency obligations		$	5,277			$	—

The following table shows the gross unrealized gains and (losses) aggregated by investment category:

						Gross				Gross
						Unrealized				Unrealized
		Cost				Gains				(Losses)				Estimated Fair Value
As of June 30, 2011:
Money market funds		$	16,792			$	—			$	—			$	16,792
Time deposits and drafts			31,053				—				—				31,053
Equity mutual funds			659				—				(142	)			517
U.S. treasury and agency obligations			347,865				60				(15	)			347,910
		$	396,369			$	60			$	(157	)		$	396,272
Reported as follows:
Cash and cash equivalents (1)		$	121,245			$	1			$	—			$	121,246
Short-term investments			269,846				58				(155	)			269,749
Long-term marketable securities			5,278				1				(2	)			5,277
		$	396,369			$	60			$	(157	)		$	396,272

						Gross				Gross
						Unrealized				Unrealized
		Cost				Gains				(Losses)				Estimated Fair Value
As of December 31, 2010:
Money market funds		$	7,032			$	—			$	—			$	7,032
Time deposits and drafts			18,554				—				—				18,554
Equity mutual funds			659				—				(168	)			491
U.S. treasury and agency obligations			298,034				42				(35	)			298,041
		$	324,279			$	42			$	(203	)		$	324,118
Reported as follows:
Cash and cash equivalents (1)		$	54,664			$	—			$	(3	)		$	54,661
Short-term investments			269,615				42				(200	)			269,457
		$	324,279			$	42			$	(203	)		$	324,118

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

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 and realized gains or losses are reflected in income and were not material for the three and six months ended June 30, 2011 and 2010.

4)

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 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 1 assets and liabilities include money market funds and debt and equity securities.
	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 and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain time deposits, time drafts and non-exchange traded derivative contracts.
	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.

The following tables provide a summary of assets and liabilities of the Company measured at fair value on a recurring basis as of June 30, 2011 and December 31, 2010:

						Fair Value Measurements at Reporting Date Using
						Quoted Prices in								Significant
						Active Markets for				Significant Other				Unobservable
						Identical Assets				Observable Inputs				Inputs
Description		June 30, 2011				(Level 1)				(Level 2)				(Level 3)
Assets:
Available-for-sale securities:
Money market funds		$	16,792			$	16,792			$	—			$	—
Time deposits and drafts			31,053				—				31,053				—
Equity mutual funds			517				517				—				—
U.S. treasury and agency obligations			347,910				347,910				—				—
Derivatives — currency forward contracts			74				—				74				—
Total assets		$	396,346			$	365,219			$	31,127			$	—
Liabilities:
Derivatives — currency forward contracts		$	3,301			$	—			$	3,301			$	—

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

						Fair Value Measurements at Reporting Date Using
						Quoted Prices in								Significant
						Active Markets for				Significant Other				Unobservable
						Identical Assets				Observable Inputs				Inputs
Description		June 30, 2011				(Level 1)				(Level 2)				(Level 3)
Reported as follows:
Assets:
Cash and cash equivalents		$	121,246			$	91,790			$	29,456			$	—
Short-term investments			269,749				268,152				1,597				—
Long-term marketable securities			5,277				5,277				—				—
Other current assets			74				—				74				—
		$	396,346			$	365,219			$	31,127			$	—
Liabilities:
Other current liabilities		$	3,301			$	—			$	3,301			$	—

						Fair Value Measurements at Reporting Date Using
						Quoted Prices in				Significant Other				Significant
						Active Markets for				Observable				Unobservable
						Identical Assets				Inputs				Inputs
Description		December 31, 2010				(Level 1)				(Level 2)				(Level 3)
Assets:
Available-for-sale securities:
Money market funds		$	7,032			$	7,032			$	—			$	—
Time deposits and drafts			18,554				—				18,554				—
Equity mutual funds			491				491				—				—
U.S. treasury and agency obligations			298,041				298,041				—				—
Derivatives — currency forward contracts			369				—				369				—
Total assets		$	324,487			$	305,564			$	18,923			$	—
Liabilities:
Derivatives — currency forward contracts		$	3,463			$	—			$	3,463			$	—
Reported as follows:
Assets:
Cash and cash equivalents		$	54,661			$	51,823			$	2,838			$	—
Short-term investments			269,457				253,741				15,716				—
Other current assets			369				—				369				—
		$	324,487			$	305,564			$	18,923			$	—
Liabilities:
Other current liabilities		$	3,463			$	—			$	3,463			$	—

Money market funds

As of June 30, 2011 and December 31, 2010, this asset class consisted mainly of a money market portfolio that comprises Federal government agency and U.S. treasury securities. The asset class is classified within Level 1 of the fair value hierarchy because its underlying investments are valued using quoted market prices in active markets for identical assets.

Time deposits and drafts

As of June 30, 2011, this asset class consisted primarily of time deposits denominated in the Euro currency and time drafts guaranteed by a financial institution. As of December 31, 2010, this asset class consisted of time deposits denominated in the Euro currency. The asset class is valued using other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities and are classified within Level 2 of the fair value hierarchy.

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

Equity mutual funds

As of June 30, 2011 and December 31, 2010, this asset class consisted of certain U.S. and international equity mutual funds, classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices in an active market for identical assets. The equity mutual funds are associated with the Company’s supplemental defined contribution retirement obligations.

U.S. treasury and agency obligations

As of June 30, 2011 and December 31, 2010, this asset class consisted of U.S. treasury and agency obligations classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices in an active market for identical assets.

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, which may adversely affect its operating results and financial position. When deemed appropriate, the Company minimizes its risks from foreign currency exchange rate fluctuations through the use of derivative financial instruments. The principal market in which the Company executes its foreign currency contracts 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 are valued using broker quotations, or market transactions and are classified within Level 2 of the fair value hierarchy.

5)

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 contracts, to manage certain foreign currency exposure.

By nature, all financial instruments involve market and credit risks. The Company enters into derivative instruments with major investment grade financial institutions and 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.

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 and European 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 other comprehensive income (“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.

To the extent the hedge accounting criteria is not met, the related foreign currency forward contracts are considered as economic hedges and changes in the fair value of these contracts are recorded immediately in earnings in the period in which they occur. These include hedges that are used to reduce exchange rate risks arising from the change in fair value of certain foreign currency denominated assets and liabilities (i.e., payables, receivables) and other economic hedges where the hedge accounting criteria were not met.

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

As of June 30, 2011 and December 31, 2010, the Company had outstanding forward foreign exchange contracts with gross notional values of $70,244,000 and $87,666,000, respectively. The following tables provide a summary of the primary net hedging positions and corresponding fair values held as of June 30, 2011 and December 31, 2010:

		June 30, 2011
		Gross Notional
Currency Hedged (Buy/Sell)		Value				Fair Value (1)
U.S. Dollar/Japanese Yen		$	33,626			$	(1,632	)
U.S. Dollar/South Korean Won			21,123				(1,296	)
U.S. Dollar/Euro			9,462				(294	)
U.S. Dollar/U.K. Pound Sterling			6,033				(5	)
Total		$	70,244			$	(3,227	)

		December 31, 2010
		Gross Notional
Currency Hedged (Buy/Sell)		Value				Fair Value (1)
U.S. Dollar/Japanese Yen		$	50,104			$	(2,876	)
U.S. Dollar/South Korean Won			27,574				(563	)
U.S. Dollar/Euro			6,934				305
U.S. Dollar/U.K. Pound Sterling			3,054				40
Total		$	87,666			$	(3,094	)

The following table provides a summary of the fair value amounts of the Company’s derivative instruments:

Derivatives Designated as Hedging Instruments		June 30, 2011				December 31, 2010
Derivative assets:
Forward exchange contracts		$	74			$	369
Derivative liabilities:
Forward exchange contracts			(3,301	)			(3,463	)
Total net derivative liability designated as hedging instruments (1)		$	(3,227	)		$	(3,094	)

The following table provides a summary of the gains (losses) on derivatives designated as hedging instruments:

Derivatives Designated as Cash Flow Hedging Relationships		Three Months Ended								Six Months Ended
		June 30,				June 30,				June 30,				June 30,
Forward exchange contracts:		2011				2010				2011				2010
Net (loss) recognized in OCI (1)		$	(157	)		$	(1,097	)		$	(319	)		$	(741	)
Net (loss) gain reclassified from OCI into income (2)			(949	)			371				(1,475	)			384

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

6)

Inventories

Inventories consist of the following:

		June 30, 2011				December 31, 2010
Raw materials		$	81,967			$	82,012
Work-in-process			22,606				21,891
Finished goods			59,877				52,526
		$	164,450			$	156,429

7)

Goodwill and Intangible Assets

Goodwill

The Company tests goodwill for impairment on an annual basis, which has been determined to be as of October 31 of each fiscal year. The Company also tests goodwill between annual tests if an event occurs or circumstances change that indicate that the fair value of a reporting unit may be below its carrying value.

Goodwill impairment is determined using a two-step process. The first step involves a comparison of the estimated fair value of a reporting unit to its carrying amount, including goodwill. In performing the first step, the Company determines the fair value of a reporting unit using a discounted cash flow (“DCF”) analysis. Determining fair value requires the exercise of significant judgment, including judgments about appropriate discount rates, perpetual growth rates, and the amount and timing of expected future cash flows. Discount rates are based on a weighted average cost of capital (“WACC”), which represents the average rate a business must pay its providers of debt and equity. The WACC used to test goodwill was derived from a group of comparable companies. The cash flows employed in the DCF analysis were derived from internal earnings and forecasts and external market forecasts. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired and the second step of the impairment test is not necessary. If the carrying amount of a reporting unit exceeds its estimated fair value, then the second step of the goodwill impairment test must be performed.

The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with its carrying amount of goodwill to measure the amount of impairment loss, if any. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination, whereby the estimated fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

As of October 31, 2010, the Company performed its annual impairment assessment of goodwill and determined that no impairment charges were required, as the fair value of each reporting unit exceeded its book value.

The changes in the carrying amount of goodwill and accumulated impairment losses during the six months ended June 30, 2011 and twelve months ended December 31, 2010 were as follows:

		2011												2010
		Gross				Accumulated								Gross				Accumulated
		Carrying				Impairment								Carrying				Impairment
		Amount				Loss				Net				Amount				Loss				Net
Beginning balance at January 1		$	279,434			$	(139,414	)		$	140,020			$	337,765			$	(193,254	)		$	144,511
Acquired goodwill (1)			—				—				—				2,292				—				2,292
Sale of discontinued operations (2)			—				—				—				(60,623	)			53,840				(6,783	)
Ending balance at June 30, 2011 and December 31, 2010		$	279,434			$	(139,414	)		$	140,020			$	279,434			$	(139,414	)		$	140,020

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

 

Intangible Assets

Components of the Company’s intangible assets are comprised of the following:

						Accumulated
		Gross				Amortization				Net
As of June 30, 2011:
Completed technology		$	76,829			$	(76,536	)		$	293
Customer relationships			8,940				(8,228	)			712
Patents, trademarks, trade names and other			24,638				(24,400	)			238
		$	110,407			$	(109,164	)		$	1,243

						Accumulated
		Gross				Amortization				Net
As of December 31, 2010
Completed technology		$	76,829			$	(76,230	)		$	599
Customer relationships			8,940				(8,083	)			857
Patents, trademarks, trade names and other			24,638				(24,351	)			287
		$	110,407			$	(108,664	)		$	1,743

Aggregate amortization expense related to intangible assets for the three and six months ended June 30, 2011 was $250,000 and $500,000, respectively. Aggregate amortization expense related to intangible assets for the three and six months ended June 30, 2010 was $314,000 and $783,000, respectively. Estimated amortization expense for each of the three remaining fiscal years is as follows:

Year		Amount
2011 (remaining)		$	488
2012			389
2013			366

8)

Debt

The Company’s Japanese subsidiary has lines of credit and short-term borrowing arrangements with two financial institutions which provide for aggregate borrowings as of June 30, 2011 of up to an equivalent of $30,941,000 U.S. dollars, which generally expire and are renewed at three month intervals. At June 30, 2011 total borrowings outstanding under these arrangements were $619,000 at an interest rate of 0.68%. There were no borrowings outstanding at December 31, 2010.

9)

Product Warranties

The Company provides for the estimated costs to fulfill customer warranty obligations upon the recognition of the related revenue. While the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers, the Company’s warranty obligation is affected by 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. The product warranty liability is included in other current liabilities in the consolidated balance sheets.

Product warranty activities were as follows:

		Six Months Ended June 30,
		2011				2010
Balance at January 1		$	9,865			$	6,560
Provision for product warranties			3,638				4,731
Direct charges to warranty liability			(3,832	)			(2,309	)
Balance at June 30		$	9,671			$	8,982

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

10)

Income Taxes

The Company’s effective tax rate for both the three and six months ended June 30, 2011 was 33.0%. The Company’s effective tax rate for the three and six months ended June 30, 2010 was 34.0% and 33.0%, respectively. The effective tax rates for the six months ended June 30, 2011 and 2010, and the related income tax provisions were lower than the U.S. statutory tax rate primarily due to the geographic mix of income and profits earned by the Company’s international subsidiaries being taxed at rates lower than the U.S. statutory rate.

At June 30, 2011, the total amount of gross unrecognized tax benefits, which excludes interest and penalties, was approximately $16,749,000. At December 31, 2010, the total amount of gross unrecognized tax benefits, which excludes interest and penalties, was approximately $15,270,000. The net increase from December 31, 2010 was primarily attributable to an increase in reserves for existing uncertain tax positions. If these benefits were recognized in a future period, the timing of which is not estimable, the net unrecognized tax benefit of $12,789,000, 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. At June 30, 2011 and December 31, 2010, the Company had accrued interest on unrecognized tax benefits of approximately $1,253,000 and $986,000, respectively.

The Company and its subsidiaries are subject to examination by federal, state and foreign tax authorities. The statute of limitations for the Company’s tax filings varies by tax jurisdiction between fiscal years 2001 through present.

While the Company believes it has adequately provided for all tax positions, amounts asserted by taxing authorities could materially differ from the Company’s accrued positions as a result of uncertain and complex application of tax regulations. Additionally, the recognition and measurement of certain tax benefits include estimates and judgment by management and inherently includes subjectivity. Accordingly, the Company could record additional provisions or benefits due to U.S. federal, state, and foreign tax-related matters in the future as it revises estimates or settles or otherwise resolves the underlying matters.

11)

Discontinued Operations

During the second quarter of 2010, the Company committed to a plan to divest two product lines, as their growth potential no longer met the Company’s long-term strategic objectives. The Company completed the sale of Ion on May 17, 2010 for $15,097,000 of net cash proceeds after expenses and recorded a pre-tax gain on the sale of $4,228,000. As a result of committing to a plan to divest a second product line and, therefore, meeting the asset held for sale criteria, during the second quarter of 2010, the Company performed a fair value analysis of its YDI business in order to measure it at the lower of its carrying value or fair value less cost to dispose. Based on the analysis, the Company determined that the carrying value was less than the fair value, less costs to dispose, and therefore, no impairment charge was required. The YDI business was considered held for sale of June 30, 2010. The Company completed the sale of the assets of its YDI business on August 11, 2010 for $490,000 of net cash proceeds after expenses and recorded a pre-tax gain on the sale of $224,000.

The two product lines have been accounted for as discontinued operations. Accordingly, their results of operations have been reclassified to discontinued operations in the consolidated statements of operations for all periods presented. The assets and liabilities of these discontinued businesses have not been reclassified or segregated in the consolidated balance sheets or consolidated statements of cash flows due to their immaterial amounts. Net revenues and income from discontinued operations for the three and six months ended June 30, 2011 and 2010 are below:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Net revenues		$	—			$	3,881			$	—			$	9,784
Income from discontinued operations before income taxes		$	—			$	786			$	—			$	1,219
Gain from disposal of discontinued operations before income taxes			—				4,228				—				4,228
Income tax benefit			—				(619	)			—				(413	)
Income from discontinued operations		$	—			$	5,633			$	—			$	5,860

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

12)

Net Income Per Share

The following table sets forth the computation of basic and diluted net income per share:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Numerator:
Income from continuing operations		$	38,601			$	33,144			$	76,644			$	62,142
Income from discontinued operations, net of tax			—				5,633				—				5,860
Net income		$	38,601			$	38,777			$	76,644			$	68,002
Denominator:
Shares used in net income per common share — basic			52,346,000				50,067,000				51,877,000				49,834,000
Effect of dilutive securities:
Stock options, restricted stock and employee stock purchase plan			560,000				803,000				769,000				901,000
Shares used in net income per common share — diluted			52,906,000				50,870,000				52,646,000				50,735,000
Basic income per common share:
Continuing operations		$	0.74			$	0.66			$	1.48			$	1.24
Discontinued operations			—				0.11				—				0.12
Net income		$	0.74			$	0.77			$	1.48			$	1.36
Diluted income per common share:
Continuing operations		$	0.73			$	0.65			$	1.46			$	1.22
Discontinued operations			—				0.11				—				0.12
Net income		$	0.73			$	0.76			$	1.46			$	1.34

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 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 (stock options and restricted stock units) had been converted to such common shares, and if such assumed conversion is dilutive.

As of June 30, 2011, stock options and restricted stock units relating to an aggregate of approximately 1,638,000 shares were outstanding. For the three and six months ended June 30, 2011, the potential dilutive effect of 331,000 and 256,000 weighted-average shares, respectively, of restricted stock units and stock options were excluded from the computation of diluted weighted-average shares outstanding as the shares would have an anti-dilutive effect on EPS.

As of June 30, 2010, stock options and restricted stock units relating to an aggregate of approximately 3,637,000 shares were outstanding. For the three and six months ended June 30, 2010, the potential dilutive effect of 1,201,000 and 1,295,000 weighted-average shares, respectively, of restricted stock units and stock options were excluded from the computation of diluted weighted-average shares outstanding as the shares would have an anti-dilutive effect on EPS.

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

13)

Comprehensive Income

Components of comprehensive income were as follows:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Net income		$	38,601			$	38,777			$	76,644			$	68,002
Other comprehensive income (loss):
Changes in value of financial instruments designated as cash flow hedges (net of tax)			(517	)			(905	)			(123	)			(690	)
Foreign currency translation adjustments			2,207				(2,953	)			5,331				(4,921	)
Unrealized (loss) gain on investments (net of tax)			(8	)			(40	)			37				(74	)
Other comprehensive income (loss)			1,682				(3,898	)			5,245				(5,685	)
Total comprehensive income		$	40,283			$	34,879			$	81,889			$	62,317

14)

Geographic, Product and Significant Customer Information

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

Information about the Company’s operations in different geographic regions is presented in the tables below. Net revenues to unaffiliated customers are based on the location in which the sale originated. Transfers between geographic areas are at negotiated transfer prices and have been eliminated from consolidated net revenues.

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Geographic net revenues:
United States		$	110,412			$	128,011			$	221,015			$	240,813
Japan			27,551				30,704				52,190				61,300
Europe			30,852				22,423				60,556				42,719
Asia (excluding Japan)			55,672				39,509				122,577				67,981
		$	224,487			$	220,647			$	456,338			$	412,813

		June 30, 2011				December 31, 2010
Long-lived assets (1):
United States		$	53,891			$	54,840
Japan			4,073				4,273
Europe			5,404				4,970
Asia (excluding Japan)			8,385				8,597
		$	71,753			$	72,680

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

The Company groups its products into three product groups. Net product and service revenues for these product groups are as follows:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Instruments and Control Systems		$	119,553			$	114,249			$	231,689			$	203,345
Power and Reactive Gas Products			83,523				87,693				180,005				173,464
Vacuum Products			21,411				18,705				44,644				36,004
		$	224,487			$	220,647			$	456,338			$	412,813

15)

Commitments and Contingencies

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 the Company’s results of operations, financial condition or cash flows.

The Company reviewed its contractual obligations and commercial commitments as of June 30, 2011 and determined that there were no significant changes from the ones set forth in the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

16)

Subsequent Events

Stock Repurchase Program

On July 25, 2011, MKS’ Board of Directors approved a share repurchase program for the repurchase of up to an aggregate of $200,000,000 of its 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 commenced, suspended or discontinued at any time without prior notice.

Cash Dividend

On July 25, 2011, MKS’ Board of Directors authorized a quarterly cash dividend of $0.15 per share, payable on September 16, 2011 to shareholders of record as of September 1, 2011. Future dividend declarations, as well as the record and payment dates for such dividends, are subject to the final determination of the Company’s Board of Directors.

MKS INSTRUMENTS, INC.

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. 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 at some point 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, 2010 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 leading global provider of instruments, subsystems and process control solutions that measure, control, power, monitor and analyze critical parameters of advanced manufacturing processes to improve process performance and productivity. We also provide services relating to the maintenance and repair of our products, software maintenance, installation services and training.

     Our products are used in diverse markets, applications and processes. The primary markets we serve are manufacturers of capital equipment for semiconductor devices and for other thin film applications including flat panel displays, light emitting diodes (“LEDs”), solar cells, data storage media and other advanced coatings. We also leverage our technology into other markets with advanced manufacturing applications including medical equipment, pharmaceutical manufacturing, energy generation and environmental monitoring.

     We are managed as one operating segment. We group our products into three product groups: Instruments and Control Systems, Power and Reactive Gas Products and Vacuum Products. Our products are derived from our core competencies in pressure measurement and control, materials delivery, gas composition analysis, control and information technology, power and reactive gas generation and vacuum technology.

     We have a diverse base of customers that includes manufacturers of semiconductor capital equipment and semiconductor devices, thin film capital equipment used in the manufacture of flat panel displays, LEDs, solar cells, data storage media, and other coating applications; and industrial, medical, pharmaceutical manufacturing, energy generation, environmental monitoring and other advanced manufacturing companies, as well as university, government and industrial research laboratories. For the six months ended June 30, 2011 and the full year ended December 31, 2010, we estimate that 62% and 64% of our net sales, respectively, were to semiconductor capital equipment manufacturers and semiconductor device manufacturers. We expect that sales to semiconductor capital equipment manufacturers and semiconductor device manufacturers will continue to account for a substantial portion of our sales.

     Through the second quarter of 2011, we saw an improvement in the global economy, which contributed to an increase in our business, financial condition and results of operations for the six months ended June 30, 2011 compared to the same period for the prior year. As a result of the improved global economy, our net revenues to semiconductor capital equipment manufacturers and semiconductor device manufacturers increased 7% for the six months ended June 30, 2011 compared to the same period for the prior year. Although our business levels increased for the six months ended June 30, 2011 compared to the same period for the prior year, the semiconductor capital equipment industry is subject to rapid demand shifts, which are difficult to predict, and we are uncertain as to the timing or extent of future demand or any future weakness in the semiconductor capital equipment industry. As we recently reported, we have recently begun to see a moderation in our semiconductor capital equipment manufacture and semiconductor devise manufacture customers’ order rates.

     Our net revenues sold to other advanced markets, which exclude semiconductor capital equipment and semiconductor device product applications, increased 18% for the six months ended June 30, 2011 compared to the same period for the prior year. The increase was mainly due to product revenues from a thin film solar customer in China during the first quarter of 2011. These advanced and growing markets include LED, medical, biopharm, environmental, thin films, solar and other markets and we anticipate that these markets will continue to grow and will represent a larger portion of our revenue.

     A significant portion of our net sales is to customers in international markets. International net sales include sales by our foreign subsidiaries, but exclude direct export sales. For the six months ended June 30, 2011 and the year ended December 31, 2010, international net sales accounted for approximately 52% and 43% of our net sales, respectively. A significant portion of our international net sales were in Japan and China. We expect that international net sales will continue to represent a significant percentage of our total net sales.

Critical Accounting Policies and Estimates

     The preparation of our consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect the amounts reported. There have been no material changes in our critical accounting policies since December 31, 2010. For further information, please see the discussion of critical accounting policies in our Annual Report on Form 10-K for the year ended December 31, 2010 in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates.”

Results of Operations

     The following table sets forth, for the periods indicated, the percentage of total net revenues of certain line items included in MKS’ consolidated statements of operations data.

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Net revenues:
Product			88.5	%			90.2	%			89.0	%			89.6	%
Services			11.5				9.8				11.0				10.4
Total net revenues			100.0				100.0				100.0				100.0
Cost of revenues:
Cost of product revenues			46.8				50.4				47.4				49.7
Cost of service revenues			6.4				5.5				6.3				6.0
Total cost of revenues			53.2				55.9				53.7				55.7
Gross profit			46.8				44.1				46.3				44.3
Research and development			6.9				7.3				7.1				7.7
Selling, general and administrative			14.2				14.0				14.1				14.2
Amortization of intangible assets			0.1				0.2				0.1				0.2
Gain on sale of asset			—				—				—				(0.2	)
Income from operations			25.5				22.6				25.0				22.4
Interest income, net			0.1				0.1				0.1				0.1
Income from continuing operations before income taxes			25.7				22.7				25.1				22.5
Provision for income taxes			8.5				7.7				8.3				7.4
Income from continuing operations			17.2				15.0				16.8				15.1
Income from discontinued operations, net of taxes			—				2.6				—				1.4
Net income			17.2	%			17.6	%			16.8	%			16.5	%

Net Revenues (dollars in millions)

		Three Months Ended June 30,												Six Months Ended June 30,
		2011				2010				% Change				2011				2010				% Change
Net Revenues:
Product		$	198.7			$	198.9				(0.1	)%		$	406.2			$	370.0				9.8	%
Service			25.8				21.7				18.6				50.1				42.8				17.1
Total net revenues		$	224.5			$	220.6				1.7	%		$	456.3			$	412.8				10.5	%

     Product revenues decreased $0.2 million and increased $36.2 million during the three and six months ended June 30, 2011, respectively, compared to the same periods for the prior year. For the three months ended June 30, 2011 our product revenues related to our semiconductor capital equipment manufacturer and semiconductor device manufacturer customers increased by $2.9 million, or 2.3%. Although we have seen a recovery in the global economy since late 2009, which has contributed to an increase in demand for our products in many of the markets we serve, we have recently seen a moderation in our semiconductor capital equipment manufacturer and semiconductor device manufacturer customers’ order rates. Our product revenues sold to other advanced markets, which exclude semiconductor capital equipment and semiconductor device product applications decreased $3.1 million, or 4.3%, during the three months ended June 30, 2011 compared to the same period for the prior year primarily due to a reduction in product sales to the solar market.

     For the six months ended June 30, 2011 our product revenues related to our semiconductor capital equipment manufacturer and semiconductor device manufacturer customers increased by $17.3 million, or 7.4%. Our product revenues sold to other advanced markets, which exclude semiconductor capital equipment and semiconductor device product applications increased $18.9 million, or 13.8% during the

six months ended June 30, 2011 compared to the same period for the prior year. The increase in demand in our other markets included the LED, biopharm, environmental, thin films, solar and other markets. A significant portion of this increase was due to product revenues from a thin film solar customer in China during the first quarter of 2011.

     Service revenues consisted mainly of fees for services relating to the maintenance and repair of our products, software maintenance, installation services and training. Service revenues increased $4.1 million, or 18.6%, and $7.3 million, or 17.1%, during the three and six months ended June 30, 2011, respectively, compared to the same periods for the prior year, as a result of the improvement in the global economy, increase in product sales and due to our investment to grow our service business in Asia.

     Total international net revenues, including product and service, were $114.1 million, and $235.3 million, or 50.8% and 51.6% of net revenues for the three and six months ended June 30, 2011, respectively. Total international net revenues, including product and service, were $92.6 million, and $172.0 million, or 42.0% and 41.7% of net revenues, for the three and six months ended June 30, 2010, respectively. The increases are due to a general increase in worldwide demand from many of the markets we serve as a result of improvement in the global economy. A significant portion of the increase in international net revenues for the six months ended June 30, 2011 was due to product revenues from a thin film solar customer in China during the first quarter of 2011.

Gross Profit

		Three Months Ended June 30,												Six Months Ended June 30,
		2011				2010				% Points Change				2011				2010				% Points Change
Gross profit as percentage of net revenues:
Product			47.1	%			44.1	%			3.0	%			46.8	%			44.5	%			2.3	%
Service			44.0				43.8				0.2				42.8				42.2				0.6
Total gross profit percentage			46.8	%			44.1	%			2.7	%			46.3	%			44.3	%			2.0	%

     Gross profit on product revenues increased by 3.0 percentage points for the three months ended June 30, 2011, compared to the same period for the prior year. The increase is due to an increase of 4.8 percentage points due to favorable product mix and an increase of 1.0 percentage points from favorable foreign exchange fluctuations. These increases were partially offset by 1.8 percentage points due to higher overhead and 1.4 percentage points related to higher excess and obsolete inventory related net charges. The higher overhead spending is due to higher salary and fringe related costs for additional personnel due to the higher business levels and an increase in incentive compensation.

     Gross profit on product revenues increased by 2.3 percentage points for the six months ended June 30, 2011, compared to the same period for the prior year. The increase is due to an increase of 4.4 percentage points due to favorable product mix, and an increase of 0.9 percentage points from favorable foreign exchange fluctuations. These increases were partially offset by 1.9 percentage points due to higher overhead and 1.0 percentage points related to higher excess and obsolete inventory related net charges. The higher overhead spending is due to higher salary and fringe related costs for additional personnel due to the higher business levels and an increase in incentive compensation.

     Cost of service revenues consists primarily of costs of providing services for repair and training which includes salaries and related expenses and other fixed costs. Service gross profit increased by 0.2 percentage points and 0.6 percentage points for the three and six months ended June 30, 2011, respectively, compared to the same periods for the prior year. The increase is mainly a result of higher service revenues since a majority of our overhead costs are fixed.

Research and Development (dollars in millions)

		Three Months Ended June 30,												Six Months Ended June 30,
		2011				2010				% Change				2011				2010				% Change
Research and development expenses		$	15.6			$	16.2				(3.5	)%		$	32.5			$	31.8				2.0	%

     Research and development expense decreased $0.6 million during the three months ended June 30, 2011, compared to the same period for the prior year. The decrease includes a $0.4 million decrease in spending on project materials due to changes in the timeline of certain projects and a $0.2 million decrease in patent and other legal related costs.

     Research and development expense increased $0.7 million during the six months ended June 30, 2011, compared to the same period for the prior year. The increase includes a $1.2 million increase in compensation expense and a $0.2 million increase in patent and other legal related costs offset by a $0.9 million decrease in spending on project materials. The increase in compensation expense is due to higher salary costs for additional personnel and an increase in stock-based compensation costs. In addition, compensation costs increased as fringe related costs were higher as a result of increased taxes related to an incentive compensation payment and the restoration in the second quarter of 2010 of the employer match portion of the 401(k) profit-sharing plan and employee stock purchase plans.

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

     We have 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 a duration 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 as well as legal costs associated with maintaining and defending our intellectual property.

     We believe that the continued investment in research and development and ongoing development of new products are essential to the expansion of our markets, and we expect to continue to make significant investment in research and development activities. We are subject to risks if products are not developed in a timely manner, due to rapidly changing customer requirements and competitive threats from other companies and technologies. Our success primarily depends on our products being designed into new generations of equipment for the semiconductor industry and other 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.

Selling, General and Administrative (dollars in millions)

		Three Months Ended June 30,												Six Months Ended June 30,
		2011				2010				% Change				2011				2010				% Change
Selling, general and administrative expenses		$	31.9			$	30.9				3.1	%		$	64.6			$	58.7				10.0	%