Summary of MKS INSTRUMENTS INC

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
We believe that this Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, 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 the section of this Quarterly Report on Form 10-Q entitled "Risk Factors" and our Annual Report on Form 10-K for the year ended December 31, 2007 in the section entitled "Risk Factors." Overview
We are a leading worldwide provider of instruments, components, subsystems and process control solutions that measure, control, power, monitor and analyze critical parameters of semiconductor and other advanced manufacturing processes.
We are managed as one operating segment which is organized around three product groups: Instruments and Control Systems, Power and Reactive Gas Products and Vacuum Products. Our products are derived from our core competencies in pressure measurement and control, materials delivery, gas composition analysis, electrostatic charge management, control and information technology, power and reactive gas generation and vacuum technology. Our products are used in diverse markets, applications and processes. Our primary served markets are manufacturers of capital equipment for semiconductor devices, and for other thin film applications including flat panel displays, solar cells, data storage media and other advanced coatings. We also leverage our technology in other markets with advanced manufacturing applications including medical equipment, pharmaceutical manufacturing, energy generation and environmental monitoring.
Our customers include manufacturers of semiconductor capital equipment and semiconductor devices; thin film capital equipment used in the manufacture of flat panel displays, solar cells, data storage media, and other coating applications; other industrial, medical and manufacturing companies; and university, government and industrial research laboratories. For the nine months ended September 30, 2008 and the full year ended December 31, 2007, we estimate that approximately 58% and 68% of our net revenues, respectively, were to semiconductor capital equipment manufacturers and semiconductor device manufacturers. We expect that revenues to the semiconductor capital equipment manufacturers and semiconductor device manufacturers will continue to account for a majority of our revenues.
During 2007 and 2008, quarterly revenues ranged from $157.4 million to $211.4 million. Net revenues have declined each quarter in 2008 as a result of both the semiconductor industry cyclical downturn as well as from the weakness in the overall economic environment. For the fourth quarter of 2008, we expect that our net revenues could be below this range. However, the semiconductor capital equipment industry is subject to rapid demand shifts, which are difficult to predict, and we are uncertain how long revenue levels may be maintained or the timing or extent of any future downturn or upturn in the semiconductor capital equipment industry.
A portion of our net revenues is to operations in international markets. For the nine months ended September 30, 2008 and full year ended December 31, 2007, international revenues accounted for approximately 41% and 39% of net revenues, respectively.
Critical Accounting Policies and Estimates The preparation of our consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect the amounts reported. There have been no material changes in our critical accounting policies since December 31, 2007. 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, 2007 in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates."

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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         Nine Months Ended
                                                  September 30,              September 30,
                                                 2008         2007         2008         2007
Net revenues
Product                                           86.4 %       91.0 %        87.3 %      91.2 %
Services                                          13.6          9.0          12.7         8.8

Total net revenues                               100.0        100.0         100.0       100.0
Cost of revenues
Cost of product revenues                          51.5         51.8          50.6        51.5
Cost of service revenues                           8.5          5.9           8.1         5.7

Total cost of revenues                            60.0         57.7          58.7        57.2

Gross profit                                      40.0         42.3          41.3        42.8
Research and development                          12.4          9.5          11.4         9.0
Selling, general and administrative               21.3         18.0          19.2        17.3
Amortization of acquired intangible assets         1.2          2.1           1.4         2.0

Income from operations                             5.1         12.7           9.3        14.5
Interest income, net                               0.8          2.2           1.0         1.8
Gain (net impairment) of investments               0.3            -          (0.2 )         -

Income before income taxes                         6.2         14.9          10.1        16.3
Provision for income taxes                         1.9          3.1           3.2         4.4

Net income                                         4.3 %       11.8 %         6.9 %      11.9 %

Net Revenue (dollars in millions)

                               Three Months Ended                         Nine Month Ended
                                 September 30,                             September 30,
                        2008        2007        % Change          2008        2007        % Change

  Net revenues
  Product              $ 135.9     $ 164.7          (17.5 )%     $ 455.7     $ 544.2          (16.3 )%
  Service                 21.5        16.3           31.6 %         66.1        52.2           26.5 %

  Total net revenues   $ 157.4     $ 181.0          (13.1 )%     $ 521.8     $ 596.4          (12.5 )%

Product revenues decreased $28.8 million during the three months ended September 30, 2008 mainly due to a decrease in worldwide demand from our semiconductor capital equipment manufacturer and semiconductor device manufacturer customers, which resulted in a decrease in revenues of $36.6 million or 30.4% compared to the same period for the prior year. This decrease was partially offset by a $12.9 million or 21.2% increase in revenues related to other markets, mainly solar.
Product revenues decreased $88.4 million during the nine months ended September 30, 2008 mainly due to a decrease in worldwide demand from our semiconductor capital equipment manufacturer and semiconductor device manufacturer customers, which resulted in a decrease in revenues of $106.3 million or 25.9% compared to the same period for the prior year. This decrease was partially offset by a $31.7 million or 17.1% increase in revenues related to other markets, mainly solar.
Service revenues consist mainly of fees for services relating to the maintenance and repair of our products, software maintenance, installation services and training. Service revenue increased $5.2 million and $13.8 million during the three and nine month periods ended September 30, 2008, respectively, mainly due to a higher installed base of products and increased software maintenance fees.
Total international net revenues, including product and service, were $72.2 million and $215.8 million for the three and nine months ended September 30, 2008 or 46% and 41% of net revenues, respectively, compared to $68.4 million and $226.0 million for the three and nine months ended September 30, 2007 or 37.8% and 37.9% of net revenues, respectively.

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Gross Profit

                                         Three Months Ended                             Nine Months Ended
                                           September 30,                                  September 30,
                                                              % Points                                       % Points
                                2008            2007           Change          2008            2007           Change

Gross profit as
percentage of net
revenues
Product                         40.4 %          43.1 %          (2.7 )%        42.0 %          43.6 %          (1.6 )%
Service                         37.6 %          34.1 %           3.5 %         36.2 %          34.8 %           1.4 %

Total gross profit
percentage                      40.0 %          42.3 %          (2.3 )%        41.3 %          42.8 %          (1.5 )%

Gross profit on product revenues decreased 2.7 percentage points for the three months ended September 30, 2008 compared to the three months ended September 30, 2007. Our margin was negatively impacted by approximately 2.5 percentage points from lower revenue volumes since a portion of our overhead costs are fixed, 1.2 percentage points from unfavorable foreign currency fluctuations, 0.6 percentage points due to increased overhead costs, partially offset by 1.8 percentage points from favorable product mix.
Gross profit on product revenues decreased by 1.6 percentage points during the nine months ended September 30, 2008 consisting of approximately 2.3 lower percentage points from decreased revenue volumes, 0.6 percentage points from unfavorable foreign currency fluctuations, offset by 1.2 percentage points from lower overhead spending due to lower sales volumes.
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 3.5 and 1.4 percentage points for the three and nine month periods ended September 30, 2008, respectively, compared to the corresponding periods of the prior year, primarily as a result of increased revenue volumes partly related to our acquisition of Yield Dynamics, Inc. ("Yield acquisition") in the fourth quarter of 2007. Research and Development (dollars in millions)

                                          Three Months Ended                               Nine Months Ended
                                            September 30,                                    September 30,
                                2008            2007           % Change          2008            2007           % Change

Research and
development expenses          $ 19.5          $ 17.2              13.8 %       $ 59.3          $ 53.8              10.1 %

Research and development expense increased $2.3 million during the three months ended September 30, 2008. The increase includes $0.9 million in expenses related to the Yield acquisition, increased compensation expense of $0.5 million, as a result of higher staffing levels and $0.9 million in other research and development costs, primarily consisting of patent and other legal related costs.
Research and development expense increased $5.5 million during the nine months ended September 30, 2008 mainly due to $3.0 million in expenses related to the Yield acquisition, $1.0 million of higher consultant costs, and $1.8 million in other research and development costs, primarily consisting of patent and other legal related costs.
Our research and development is primarily focused on developing and improving our instruments, components, subsystems and process control solutions to improve process performance and productivity.
We have hundreds of products and our research and development efforts primarily consist of a large number of projects focused on developing and improving our instruments, components, subsystems and process control solutions to improve process performance and productivity, none of which is individually material to us. Current projects typically have a duration of 12 to 30 months depending upon whether the product is an enhancement of existing technology or a new product. Our current initiatives include projects to enhance the performance characteristics of older products, to develop new products and to integrate various technologies into subsystems. These projects support in large part the transition in the semiconductor industry to larger wafer sizes and smaller integrated circuit geometries, which require more advanced process control technology. Research and development expenses consist primarily of salaries and related expenses for personnel engaged in research and development, fees paid to consultants, material costs for prototypes and other expenses related to the design, development, testing and enhancement of our products.
We believe that the continued investment in research and development and ongoing development of new products are essential to the expansion of our markets, and expect to continue to make significant investment in research and development activities. We are subject to risks if products are not developed in a timely manner, due to rapidly changing customer requirements and competitive threats from other companies and technologies. Our success primarily depends on our products being designed into new generations of equipment for the semiconductor industry. We develop products that are technologically advanced so that they are positioned to be chosen for use in each successive generation of semiconductor capital equipment. If our products are not chosen to be designed into our customers' products, our net revenues may be reduced during the lifespan of those products.

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Selling, General and Administrative (dollars in millions)

                                         Three Months Ended                               Nine Months Ended
                                            September 30,                                   September 30,
                                2008            2007          % Change          2008             2007           % Change

Selling, general and
administrative expenses       $ 33.5          $ 32.5              3.0 %       $ 100.3          $ 103.0            (2.6 )%

Selling, general and administrative expenses increased $1.0 million for the three months ended September 30, 2008. The increase includes a $1.6 million increase in compensation expense, primarily due to increased fringe benefit costs, a $1.1 million increase in foreign exchange costs and a $0.9 million increase related to the Yield acquisition, partially offset by a $2.3 million decrease in consulting and professional fees. Decreased consulting fees were due to lower IT infrastructure spending.
Selling, general and administrative expenses decreased $2.7 million for the nine months ended September 30, 2008. The decrease includes a $6.3 million decrease in consulting and professional fees, a $1.1 million decrease in foreign exchange costs partially offset by a $2.6 million increase related to the Yield acquisition, a $1.1 million increase in compensation expense and a $0.6 million increase in facilities costs related to the relocated corporate headquarters. Increased compensation expense is primarily due to higher salary and fringe benefit costs. The decrease in consulting and professional fees were primarily due to lower IT infrastructure spending. The foreign exchange gains in 2008 were primarily attributable to the settlement of cash and intercompany loans at different foreign exchange rates in connection with a legal entity consolidation in the first quarter of 2008 between some of our foreign subsidiaries. Amortization of Acquired Intangible Assets (dollars in millions)

                                        Three Months Ended                             Nine Months Ended
                                           September 30,                                 September 30,
                               2008           2007          % Change         2008            2007          % Change

Amortization of
acquired intangible
assets                        $ 2.0          $ 3.9            (49.4 )%      $ 7.1          $ 12.1            (41.7 )%

Amortization expense for the three and nine months ended September 30, 2008 decreased $1.9 million and $5.0 million, respectively, as certain acquired intangible assets became fully amortized during 2007 and 2008. Interest Income, Net (dollars in millions)

                                     Three Months Ended                  Nine Months Ended
                                       September 30,                       September 30,
                                2008      2007      % Change       2008       2007      % Change

        Interest income, net   $ 1.3     $ 4.0       (66.9 )%     $ 5.1     $ 10.9       (52.8 )%

Interest income, net decreased $2.7 million and $5.8 million during the three and nine months ended September 30, 2008, respectively, mainly as a result of lower average cash and cash equivalent balances and lower interest rates in 2008. The lower outstanding cash balances are primarily a result of our stock repurchase program.
Gain (Impairment) of Investments (dollars in millions)

                                        Three Months Ended                             Nine Months Ended
                                           September 30,                                 September 30,
                                2008           2007         % Change          2008            2007         % Change

Gain (net impairment)
of investments                $  0.5          $  -               -          $  (0.9 )        $  -               -

During the fourth quarter of 2007, we determined that declines in the fair value of our investments in certain commercial paper were other-than-temporary. This commercial paper was issued by two structured investment vehicles (SIVs) that entered into receivership during the fourth quarter of 2007 and failed to make payments at maturity. Due to the mortgage-related assets these issuers held, they were exposed to the adverse market conditions that affected the value of their collateral and their ability to access short-term funding. These investments were not currently trading on active markets, and therefore, had no readily determinable market value. As a result of our assessment as of December 31, 2007, we recorded a $1.5 million impairment charge to earnings, based upon the Company receiving contemporaneous quotes from established third-party pricing services.

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During the six months ended June 30, 2008, we recorded additional impairment charges of $1.4 million on these two SIV investments due to further declines in value. In addition, we received a $0.5 million principal payment from one of these investments. This resulted in a new cost basis for these securities of $2.4 million at June 30, 2008.
During the three months ended September 30, 2008, we liquidated our position in these two impaired investments, one by sale and the other by a structured payment, for a combined total of $2.9 million and as a result, we recorded a gain from the liquidation of $0.5 million. For the nine months ended September 30, 2008, we recorded net impairment charges of $0.9 million related to these two investments. The liquidation of these two impaired investments leaves the remaining portfolio consisting of direct U.S. Government and Agency obligations and high quality, liquid, short term corporate debt obligations. Provision for Income Taxes (dollars in millions)

Three Months Ended Nine Months Ended September 30, September 30,

2008 2007 2008 2007

Provision for income taxes $ 3.0 $ 5.7 $ 16.6 $ 26.3

Our effective tax rate for the three and nine months ended September 30, 2008 was 30.9% and 31.3%, respectively. The effective tax rate for the three and nine months ended September 30, 2008, is less than the statutory tax rate primarily due to the profits of our international subsidiaries being taxed at rates lower than the U.S. statutory tax rate. SFAS No. 109, "Accounting for Income Taxes," requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized. On a quarterly basis, we evaluate both the positive and negative evidence bearing upon the realizability of its deferred tax assets. We consider future taxable income, ongoing prudent and feasible tax planning strategies, and the ability to utilize tax losses and credits in assessing the need for a valuation allowance. A valuation allowance of $2.7 million related to certain state tax credit carryforwards has been recorded during the three months ended September 30, 2008 because we have concluded that it is more likely than not that these credits will not be utilized since it is expected that the annual amount of state credits generated will exceed the amount of credits that can be used. We recorded a benefit of $1.8 million on the closing of both a statute of limitation and an income tax audit.
Our effective tax rate for the three and nine months ended September 30, 2007 was 21.0% and 27.0%, respectively. The effective tax rate is less than the statutory tax rate primarily due to the profits of our international subsidiaries being taxed at rates lower than the U.S. statutory tax rate and the benefit from U.S. research and development credits.
We adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes ("FIN 48") in 2007. At December 31, 2007, the total amount of gross unrecognized tax benefits, which excludes interest and penalties discussed below, was approximately $16.1 million. If these benefits were recognized in a future period, the timing of which is not estimable, the net unrecognized tax benefit of approximately $13.2 million would impact our effective tax rate. The total amount of gross unrecognized tax benefits at September 30, 2008 was approximately $15.4 million. The net decrease from January 1, 2008 was primarily attributable to the close of the statute of limitation on the 2004 tax year.
MKS and its subsidiaries are subject to U.S. federal income tax as well as the income tax of multiple state and foreign jurisdictions. We have concluded all U.S. federal income tax matters for years through 2002. While the U.S. 2004 federal tax year is closed, the 2003 federal tax year remains open to the extent of the loss carryforward to 2005. Currently, we are under a federal audit for the 2005 tax year. As of September 30, 2008, there were ongoing audits in various other tax jurisdictions.
Within the next 12 months, it is reasonably possible that we may recognize $4.5 million to $5.0 million of previously unrecognized tax benefits related to various federal, state, and foreign tax positions as a result of the conclusion of various audits and the expiration of the statute of limitations. The following tax years, in the major tax jurisdictions noted, are open for assessment or refund: U.S. Federal: 2003, 2005 to 2007, Germany: 2001 to 2007, Korea: 2004 to 2007, Japan: 2001 to 2007, and the United Kingdom: 2006 and 2007. We do not expect any material changes to the returns as filed to result from these open audits.
We accrue interest and, if applicable, penalties, for any uncertain tax positions. This interest and penalty expense is a component of income tax expense. At September 30, 2008 and December 31, 2007, we had $1.6 million and $1.5 million, respectively, accrued for interest on unrecognized tax benefits.
On October 3, 2008, the U.S. Research and Development Tax Credit was extended retroactively to amounts paid or incurred in 2008 and through December 31, 2009. As a result, we estimated a tax benefit of approximately $2.5 million for the year ended December 31, 2008. This fiscal year benefit will be recorded entirely in the fourth quarter of 2008. Therefore, we did not take any benefit for this credit in the three and nine month periods ending September 30, 2008. The benefits taken in the three and nine months ended September 30, 2007 for this credit were approximately $0.9 million and $1.7 million, respectively.

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Liquidity and Capital Resources
Cash, cash equivalents and short-term investments totaled $257.2 million at September 30, 2008 compared to $323.8 million at December 31, 2007. This decrease was attributable to our share repurchase program through which we repurchased $115.7 million of our common stock during the first nine months of fiscal 2008. The primary source of funds for the first nine months of fiscal 2008 was cash provided by operating activities of $61.3 million.
Net cash provided by operating activities of $61.3 million for the nine months ended September 30, 2008, resulted mainly from net income of $36.4 million, non-cash charges of $17.8 million for depreciation and amortization, $9.5 million for stock-based compensation and related tax benefits, $1.7 million for decreases in deferred income taxes and by an increase in net operating assets of $0.7 million. The net increase in operating assets is primarily due to a $6.1 million decrease in inventory and $1.0 million in trade accounts receivable, offset by an increase in other current assets of $6.4 million. The increase in other current assets of $6.4 million related to the timing of value-added tax payments and the increase in our net receivable for unrealized gains and losses on foreign exchange forward contracts. These increases were offset by a decrease in net operating liabilities of $6.0 million, mainly caused by a decrease of $3.0 million in accounts payable and $3.2 million in income taxes payable. Net cash provided by operating activities of $85.1 million for the nine months ended September 30, 2007, resulted mainly from net income of $71.2 million, non-cash charges of $22.8 million for depreciation and amortization and $11.3 million for stock-based compensation and related tax benefits, offset by an increase in net operating assets of $2.9 million and a $12.1 million decrease in net operating . . .