MKS Inc: Form 10-Q for the period ended Sep 30, 2024

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 of 1933 and Section 21E of the Securities Exchange Act of 1934 regarding the future financial performance, business prospects and growth of MKS Instruments, Inc. (“MKS,” the “Company,” “our,” or “we”). These statements are only predictions based on current assumptions and expectations. Any statements that are not statements of historical fact (including statements containing the words “will,” “projects,” “intends,” “believes,” “plans,” “anticipates,” “expects,” “estimates,” “forecasts,” “continues” and similar expressions) should be considered forward-looking statements. Actual events or results may differ materially from those in the forward-looking statements set forth herein.

Among the important factors that could cause actual events to differ materially from those in the forward-looking statements that we make are the level and terms of our substantial indebtedness and our ability to service such debt; our entry into the chemicals technology business through our acquisition of Atotech Limited (“Atotech”) in August 2022 (the “Atotech Acquisition”) which may expose us to significant additional liabilities; the risk that we are unable to integrate Atotech successfully or realize the anticipated synergies, cost savings and other benefits of the Atotech Acquisition; legal, reputational, financial and contractual risks resulting from the ransomware event we identified in February 2023, and other risks related to cybersecurity, data privacy and intellectual property; competition from larger, more advanced or more established companies in our markets; the ability to successfully grow our business, including through growth of the Atotech business and growth of the Electro Scientific Industries, Inc. business, which we acquired in February 2019, and financial risks associated with those and potential future acquisitions, including goodwill and intangible asset impairments; manufacturing and sourcing risks, including those associated with limited and sole source suppliers and the impact and duration of supply chain disruptions, component shortages, and price increases; changes in global demand; the impact of a pandemic or other widespread health crisis; risks associated with doing business internationally, including geopolitical conflicts, such as the conflict in the Middle East, trade compliance, regulatory restrictions on our products, components or markets, particularly the semiconductor market, and unfavorable currency exchange and tax rate fluctuations, which risks become more significant as we grow our business internationally and in China specifically; conditions affecting the markets in which we operate, including fluctuations in capital spending in the semiconductor, electronics manufacturing and automotive industries, and fluctuations in sales to our major customers; disruptions or delays from third-party service providers upon which our operations may rely; the ability to anticipate and meet customer demand; the challenges, risks and costs involved with integrating or transitioning global operations of the companies we have acquired; risks associated with the attraction and retention of key personnel; potential fluctuations in quarterly results; dependence on new product development; rapid technological and market change; acquisition strategy; volatility of stock price; risks associated with chemical manufacturing and environmental regulation compliance; risks related to defective products; financial and legal risk management; and the other important factors described under the heading “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2023 filed with the U.S. Securities and Exchange Commission on February 27, 2024 (“Annual Report”) and any subsequent Quarterly Reports on Form 10-Q. We are under no obligation to, and expressly disclaim any obligation to, update or alter these forward-looking statements, whether as a result of new information, future events or otherwise, even if subsequent events cause our views to change.

The Management’s Discussion and Analysis of Financial Condition and Results of Operations describes principal factors affecting the results of operations, financial condition, cash flows and liquidity, as well as our critical accounting policies and estimates that require significant judgment and thus have the most significant potential impact on our condensed consolidated financial statements, and is intended to better allow investors to view the Company from management’s perspective. This section focuses on material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be necessarily indicative of our future operating results or our future financial condition. This section provides an analysis of our financial results for the three months ended September 30, 2024 compared to the three months ended June 30, 2024, and the nine months ended September 30, 2024 compared to the nine months ended September 30, 2023. As a result of rounding, there may be immaterial differences in amounts presented and certain calculations may not sum to the total number expressed in each category or tie to a corresponding schedule.

Overview

We enable technologies that transform our world. We deliver foundational technology solutions to leading edge semiconductor manufacturing, electronics and packaging, and specialty industrial applications. We apply our broad science and engineering capabilities to create instruments, subsystems, systems, process control solutions and specialty chemicals technology that improve process performance, optimize productivity and enable unique innovations for many of the world’s leading technology and industrial companies. Our solutions are critical to addressing the challenges of miniaturization and complexity in advanced device manufacturing by enabling increased power, speed, feature enhancement and optimized connectivity. Our solutions are also critical to addressing ever-increasing performance requirements across a wide array of specialty industrial applications.

Segments

We have three divisions which are our reportable segments, Vacuum Solutions Division (“VSD”), Photonics Solutions Division (“PSD”) and Materials Solutions Division (“MSD”).

VSD delivers foundational technology solutions to leading edge semiconductor manufacturing, electronics and packaging and specialty industrial applications. VSD products are derived from our core competencies in pressure measurement and control, flow measurement and control, gas and vapor delivery, gas composition analysis, electronic control technology, reactive gas generation and delivery, power generation and delivery, temperature sensing and vacuum technology.

PSD provides a full range of solutions including lasers, beam measurement and profiling, precision motion control, vibration isolation systems, photonics instruments, opto-mechanical components, optical elements, laser-based systems for flexible printed circuit board (“PCB”) processing, and laser-based systems for high density interconnect PCB and package substrate manufacturing. During the quarter ended March 31, 2024, we moved our Optical Sensing Products (“OSP”) product line from the PSD segment to the VSD segment. The purpose of this realignment was to better align the OSP products with semiconductor related products within the VSD segment. Prior periods have been recast to reflect this change.

MSD develops leading process and manufacturing technologies for advanced surface modification, electroless and electrolytic plating, and surface finishing. Applying a comprehensive systems-and-solutions approach, MSD’s portfolio includes chemistry, equipment and services for innovative and high-technology applications in a wide variety of end markets.

Markets

Net Revenues by End Market

(dollars in millions)

Semiconductor Market

MKS is a critical solutions provider for semiconductor manufacturing. Our products are used in major semiconductor processing steps, such as deposition, etching, cleaning, lithography, metrology, and inspection. The semiconductor industry continually faces new challenges, as products become smaller, more powerful and highly mobile. Ultra-thin layers, smaller critical dimensions, new materials, 3D structures, and the ongoing need for higher yield and productivity drive the need for tighter process measurement and control, all of which MKS supports. We believe we are the broadest critical subsystem provider in the wafer fabrication equipment (“WFE”) ecosystem and address over 85% of the market. We characterize our broad and unique offering as Surround the Wafer® to reflect the technology enablement we provide across almost every major process in semiconductor manufacturing today.

The semiconductor market is subject to rapid demand shifts, which are difficult to predict, and we cannot be certain as to the timing or extent of future demand or any future softening in the semiconductor capital equipment industry. In addition to these rapid demand shifts, the semiconductor capital equipment industry is subject to significant trade restrictions, especially in China.

For the three months ended September 30, 2024, net revenues in our semiconductor market increased by $9 million, or 3%, compared to the prior quarter primarily due to strong in-quarter demand conversion within VSD.

For the nine months ended September 30, 2024, net revenues in our semiconductor market decreased by $19 million, or 2%, compared to the same period in the prior year. This decrease was mainly due to continued softened demand for semiconductor capital equipment related to deposition and etching, partially offset by an increase in sales of our lithography, metrology and inspection products.

Electronics and Packaging Market

MKS is a foundational solutions provider for the electronics and packaging market. Our portfolio includes photonics components, laser drilling systems, electronics chemistries and plating equipment that are critical for the manufacturing of PCBs and package substrates, and critical to wafer level packaging (“WLP”) applications. Similar to the semiconductor industry, the PCB, package substrate and WLP industries demand smaller features, greater density, and better performance. In addition, the electronics and packaging market also includes sales of our vacuum and photonics solutions for display manufacturing applications. We characterize our complementary offering of laser systems and chemistry solutions as Optimize the Interconnect®, to reflect the unique technology enablement we provide at the Interconnect level within PCBs, package substrates and WLPs.

For the three months ended September 30, 2024, net revenues in our electronics and packaging market increased by $2 million, or 1%, compared to the prior quarter primarily due to an increase in chemistry sales within MSD.

For the nine months ended September 30, 2024, net revenues in our electronics and packaging market decreased by $22 million, or 3%, compared to the same period in the prior year. This decrease was primarily due to lower revenue within MSD mainly as a result of lower palladium prices that are passed through to our customers, which were partially offset by volume growth in chemistry sales.

Specialty Industrial Market

MKS’ strategy in the specialty industrial market is to leverage our domain expertise and proprietary technologies across a broad array of applications in industrial technologies, life and health sciences, and research and defense markets.

Industrial Technologies

Industrial technologies encompasses a wide range of diverse applications, including chemistries for functional coatings, surface finishing and wear resistance in the automobile industry, vacuum solutions for synthetic diamond manufacturing and photonics for solar manufacturing. Other applications include vacuum and photonics solutions for light emitting diode and laser diode manufacturing.

Life and Health Sciences

Our products for life and health sciences are used in a diverse array of applications, including bioimaging, medical instrument sterilization, medical device manufacturing, analytical, diagnostic and surgical instrumentation, consumable medical supply manufacturing and pharmaceutical production.

Research and Defense

Our products for research and defense are sold to government, university and industrial laboratories for applications involving research and development in materials science, physical chemistry, photonics, optics and electronics materials. Our products are also sold for monitoring and defense applications, including surveillance, imaging and infrastructure protection.

For the three months ended September 30, 2024, net revenues in our specialty industrial market decreased by $2 million, or 1%, compared to the prior quarter mainly due to lower revenue in our material processing and defense markets within PSD.

For the nine months ended September 30, 2024, net revenues in our specialty industrial market decreased by $37 million, or 4%, compared to the same period in the prior year. This decrease was mainly due to lower revenue in general industrial and solar markets within VSD.

International Markets

Starting in the second quarter of 2024, we changed our basis of reporting geographical net revenues from the location in which the sale originated to the shipped-to location of the end customer. Prior periods have been recast to reflect this change, which was made to better align with how management reviews geographic net revenues.

A significant portion of our net revenues is from sales to customers in international markets. For the nine months ended September 30, 2024 and 2023, international net revenues accounted for approximately 77% and 75%, respectively, of our total net revenues. A significant portion of our international net revenues was generated from sales to customers in China, South Korea, Japan, Taiwan and Singapore. We expect international net revenues will continue to account for a significant percentage of total net revenues for the foreseeable future.

Long-lived assets located outside of the United States accounted for approximately 61% and 58% of our total long-lived assets as of September 30, 2024 and December 31, 2023. Long-lived assets include property, plant and equipment, net, right-of-use assets, net and certain other assets.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported. There have been no material changes in our critical accounting policies since December 31, 2023.

For further information about our critical accounting policies, please see the discussion of critical accounting policies in our Annual Report 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 our condensed consolidated statements of operations and comprehensive income (loss) data:

Net revenues

(dollars in millions)

For the three months ended September 30, 2024, net product revenues increased $6 million compared to the prior quarter primarily due to higher volume of sales at VSD.

For the nine months ended September 30, 2024, net product revenues decreased $115 million compared to the same period in the prior year as a result of decreases in sales in all three of our end markets. The decrease in product revenues in the semiconductor market was mainly due to volume decreases related to continued softened demand for semiconductor capital equipment related to deposition and etching products at VSD, partially offset by volume increases in sales of our lithography, metrology and inspection products at PSD. The decrease in product revenues in our electronics and packaging market was mainly due to lower equipment sales at MSD. The decrease in product revenues in our specialty industrial market was mainly due to lower solar and general industrial sales at VSD.

Net service revenues consisted mainly of fees for services related to the maintenance and repair of our products, sales of spare parts, and installation and training. For the three months ended September 30, 2024, net service revenues increased $3 million compared to the prior quarter mainly in our semiconductor market.

For the nine months ended September 30, 2024, net service revenues increased $37 million compared to the same period in the prior year primarily due to an increase in net service revenues in our semiconductor market, mainly at VSD, and an increase of net service revenues in our electronics and packaging market, mainly at MSD.

The following table sets forth our net revenues by reportable segment:

(dollars in millions)

For the three months ended September 30, 2024, net revenues from VSD increased $10 million compared to the prior quarter mainly due to volume increases in the semiconductor market. For the nine months ended September 30, 2024, net revenues from VSD decreased $80 million compared to the same period in the prior year mainly due to a decrease in revenues from customers in the semiconductor market as a result of continued softened demand for semiconductor capital equipment in the deposition and etching tool markets.

For the three months ended September 30, 2024, net revenues from PSD decreased $3 million compared to the prior quarter. For the nine months ended September 30, 2024, net revenues from PSD increased $35 million compared to the same period in the prior year, primarily as a result of an increase in sales of our lithography, metrology and inspection products in our semiconductor market, and an increase in sales of our data communications and research and defense products in our specialty industrial market.

For the three months ended September 30, 2024, net revenues from MSD increased $2 million compared to the prior quarter. For the nine months ended September 30, 2024, revenues from MSD decreased $33 million compared to the same period in the prior year primarily due to lower equipment revenue as customers postponed certain investment decisions, and a small decrease in chemistry sales, primarily due to lower palladium prices, which are passed on to our customers, offset by an increase in chemistry volumes.

Gross margin

Gross margin for our products increased for the three months ended September 30, 2024 compared to the prior quarter, mainly as a result of lower warranty and scrap costs as well as better absorption on higher revenue volumes.

Gross margin for our products increased for the nine months ended September 30, 2024 compared to the same period in the prior year primarily due to favorable product mix, higher factory utilization and lower excess and obsolete inventory charges, partially offset by higher warranty costs and lower revenue volumes.

Gross margin for our services increased for the three months ended September 30, 2024 compared to the prior quarter mainly as a result of favorable product mix partially offset by higher excess and obsolete inventory charges and warranty costs for service parts.

Gross margin for our services increased for the nine months ended September 30, 2024 compared to the same period in the prior year primarily due to favorable product mix, better absorption on higher revenue volumes and lower direct labor and overhead costs.

The following table sets forth gross margin as a percentage of net revenues by reportable segment:

Gross margin for VSD increased for the three months ended September 30, 2024 compared to the prior quarter primarily due to lower material costs, favorable product mix and higher revenue volumes, partially offset by higher variable compensation costs. Gross margin for VSD increased for the nine months ended September 30, 2024 compared to the same period in the prior year primarily due to higher factory utilization and lower material costs, partially offset by lower revenue volumes, unfavorable product mix and higher warranty costs.

Gross margin for PSD increased for the three months ended September 30, 2024 compared to the prior quarter primarily due to favorable product mix and lower material costs, partially offset by unfavorable factory utilization. Gross margin for PSD increased for the nine months ended September 30, 2024 compared to the same period in the prior year primarily due to higher revenue volumes, lower freight and duty costs and lower excess and obsolete inventory charges, partially offset by unfavorable product mix and lower factory utilization.

Gross margin for MSD increased for the three months ended September 30, 2024 compared to the prior quarter primarily due to favorable product mix and lower warranty costs, partially offset by higher excess and obsolete charges. Gross margin for MSD increased for the nine months ended September 30, 2024 compared to the same period in the prior year primarily due to lower palladium prices and favorable product mix, partially offset by higher warranty costs.

Research and development

(dollars in millions)

For the three months ended September 30, 2024, research and development expenses increased $4 million compared to the prior quarter, primarily due to an increase of $4 million in compensation-related costs, including salaries, fringe and variable compensation expenses. Research and development expenses decreased $12 million for the nine months ended September 30, 2024 compared to the same period in the prior year, mainly due to decreases of $7 million in compensation-related costs, including salaries, fringe and variable compensation expenses, $3 million in test equipment and $1 million in project material costs.

Our research and development efforts are primarily focused on developing and improving our instruments, components, chemistry, subsystems, systems 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. Projects typically have a duration of three to thirty-six months but may be extended for development of new products.

We continue to make product advancements designed to meet our customers’ evolving needs. We have developed, and continue to develop, new products designed to address industry trends, such as the rising demand for more complex hardware architecture related to increasing investments in artificial intelligence, the shrinking of integrated circuit critical dimensions and technology inflections, and, in the flat panel display and solar markets, the transition to larger substrate sizes, which require more advanced processing and process control technology, the continuing drive toward more complex and accurate components and devices within the handset and tablet market, the transition to 5G for both devices and infrastructure, the growth in units and via counts in the high density interconnect PCB drilling market, and the transition from internal combustion to electric vehicles. In addition, we have developed, and continue to develop, products that support the migration to new classes of materials, ultra-thin layers, and 3D structures that are used in small geometry manufacturing. In our chemistry and equipment plating businesses, a majority of our research and development investment supports existing customers’ product improvement needs and their short-term research and development goals, which enables us to pioneer new high-value solutions while limiting commercial risk. Research and development expenses consist primarily of salaries and related expenses for personnel engaged in research and development, fees paid to consultants, material costs for prototypes and other expenses related to the design, development, testing and enhancement of our products.

We believe that the continued investment in research and development and ongoing development of new products are essential to the expansion of our markets. We expect to continue to make significant investment in research and development activities. We are subject to risks from products not being developed in a timely manner, as well as from rapidly changing customer requirements and competitive threats from other companies and technologies. Our success primarily depends on our products being designed into new generations of equipment for the semiconductor, electronics and packaging, and specialty industrial markets. We seek to develop products that are technologically advanced so that they are positioned to be chosen for use in each successive generation of semiconductor capital equipment and advanced markets applications. 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)

For the three months ended September 30, 2024, selling, general and administrative expenses increased $6 million, compared to the prior quarter, primarily due to an increase of $6 million in compensation-related costs mainly related to variable compensation.

For the nine months ended September 30, 2024, selling, general and administrative expenses decreased $16 million compared to the same period in the prior year primarily as a result of decreases of $21 million in compensation-related costs, mainly related to salaries, fringe and variable compensation and $13 million in net costs incurred in the 2023 period as a result of the ransomware event in February 2023, partially offset by increases of $9 million in information technology investments, $6 million in software maintenance and $2 million in consulting and professional fees.

Acquisition and integration costs

(dollars in millions)

Acquisition and integration costs incurred during the three and nine months ended September 30, 2024 and 2023 were related to consulting and professional fees related to the Atotech Acquisition.

Restructuring and other

(dollars in millions)

Restructuring and other charges during the three and nine months ended September 30, 2024 and three months ended June 30, 2024, primarily related to severance costs as a result of a global cost-saving initiative implemented in the fourth quarter of 2023. Restructuring and other charges during the nine months ended September 30, 2023 primarily related to severance costs as a result of a global cost-saving initiative implemented in each of the first and second quarters of 2023.

Fees and expenses related to amendments to the Term Loan Facility

(dollars in millions)

During the three months ended September 30, 2024, we recorded fees and expenses related to the Fourth Amendment to Credit Agreement, dated as of July 23, 2024, by and among us as parent borrower, the other loan parties party thereto, JPMorgan Chase Bank, N.A., as administrative agent, and each lender party thereto (the “Fourth Amendment”). During the nine months ended September 30, 2024, we recorded fees and expenses related to the Fourth Amendment and the Second Amendment to Credit Agreement, dated as of January 22, 2024, by and among us as parent borrower, the other loan parties party thereto, JPMorgan Chase Bank, N.A., as administrative agent, and each lender party thereto (the “Second Amendment”).

Amortization of intangible assets

(dollars in millions)

For the three months ended September 30, 2024, amortization of intangible assets was flat compared to the prior quarter. For the nine months ended September 30, 2024, amortization of intangible assets decreased by $41 million compared to the same period in the prior year primarily due to the backlog intangible asset related to MSD being fully amortized in the three months ended December 31, 2023, and the write-off of completed technology at our equipment solutions business (“ESB”) reporting unit of PSD in the second quarter of 2023.

Goodwill and intangible asset impairments

(dollars in millions)

During the nine months ended September 30, 2023, as a result of softer industry demand, particularly in the personal computer and smartphone markets, we concluded there was a triggering event in the three months ended June 30, 2023 at our electronics (“EL”) and general metal finishing (“GMF”) reporting units, which together constitute MSD, and the ESB reporting unit of PSD.

For the EL, GMF and ESB reporting units, we performed a quantitative assessment of goodwill using a combination of market approach and the income approach. Fair value estimates are based on a complex set of judgments about future events and uncertainties and rely heavily on estimates and assumptions that have been deemed reasonable by our management. There are inherent uncertainties and management judgment required in these determinations.

This quantitative assessment resulted in a non-cash goodwill impairment of $826 million for the EL reporting unit, $428 million for the GMF reporting unit and $372 million for the ESB reporting unit. In addition, we recorded a $49 million impairment of in-process research and development allocated to the EL reporting unit and a $152 million impairment related to completed technology allocated to the ESB reporting unit.

We will continue to monitor and evaluate the carrying value of goodwill and intangible assets. If market and economic conditions or business performance deteriorate, the likelihood that we would record an impairment charge would increase, which could materially and adversely affect our financial condition and operating results.

We have concluded there were no triggering events across our reporting units through the nine months ended September 30, 2024.

Interest expense, net

(dollars in millions)

For the three months ended September 30, 2024, interest expense, net decreased $16 million compared to the prior quarter primarily as a result of our entering into the Fourth Amendment, which decreased the applicable margin for both the USD Tranche B loan and the EUR Tranche B loan (each as defined and described further below under “Credit Facilities”) by 0.25%. In addition, in July 2024, we made a voluntary prepayment of $110 million aggregate principal amount of the Term Loan Facility (as defined and described further below under “Credit Facilities”) consisting of $69 million principal amount of the USD Tranche B loan and €38 million principal amount of the Euro Tranche B loan (the “July 2024 Prepayment”).

For the nine months ended September 30, 2024, interest expense, net decreased by $43 million compared to the same period in the prior year. In addition to the impact of the Fourth Amendment and the July 2024 Prepayment, in May 2024, we issued $1.4 billion of Convertible Notes (as defined and described further below under “Convertible Notes,”) at a coupon rate of

1.25% and used $1.2 billion of the proceeds to pay down our loans under the Term Loan Facility, which had an interest rate of approximately 7.8%. In addition to the foregoing, interest expense, net for the nine months ended September 30, 2024, was lower as compared to the same period in the prior year as a result of the voluntary prepayments of $100 million in October 2023, $50 million in February 2024 and $50 million in April 2024 on loans under the Term Loan Facility.

Loss on extinguishment of debt

(dollars in millions)

For the three months ended September 30, 2024, in connection with the July 2024 Prepayment and the Fourth Amendment, we recorded a loss on extinguishment of debt as a result of the acceleration of deferred financing and original issue discounts associated with our loans under the Term Loan Facility. For the three months ended June 30, 2024, in connection with the issuance of the Convertible Notes in May 2024, we recorded a loss on extinguishment of debt as a result of the acceleration of deferred financing and original issue discount costs associated with our loans under the Term Loan Facility.

For the nine months ended September 30, 2024, in addition to the loss on extinguishment of debt related to the Fourth Amendment and the July 2024 Prepayment, and the issuance of the Convertible Notes in May 2024, we recorded a loss on extinguishment of debt as a result of the acceleration of deferred financing costs associated with the extinguishment of our senior secured tranche A term loan using proceeds from borrowing additional USD Tranche B and additional Euro Tranche B loans pursuant to the Second Amendment.

Other expense (income), net

(dollars in millions)

Other expense (income), net, for the three and nine months ended September 30, 2024, three months ended June 30, 2024 and nine months ended September 30, 2023, consisted primarily of net foreign exchange and fair value gains and losses.

(Benefit) provision for income taxes

(dollars in millions)

Our effective tax rates for the three months ended September 30, 2024 and June 30, 2024 were (4.0)% and (3.6%), respectively. Our effective tax rates for the three months ended September 30, 2024 and June 30, 2024 were lower than the U.S. statutory tax rate primarily due to the tax benefit related to the earnings mix, an increase in the U.S. deduction for foreign derived intangibles income (“FDII”) and a one-time increase in research and development credits due to the filing of prior year amended returns for 2020 and 2021, partially offset by an expected increase in foreign withholding taxes and a waiver of deductions related to U.S. base erosion payments.

Our effective tax rates for the nine months ended September 30, 2024 and 2023 were 1.2% and 4.1%, respectively. Our effective tax rate for the nine months ended September 30, 2024 was lower than the U.S. statutory tax rate primarily due to the tax benefit related to the earnings mix, increase in the U.S. deduction for FDII and a one-time increase in research and development credits due to filing of prior year amended returns for years 2020 and 2021, partially offset by an expected increase in foreign withholding taxes and a waiver of deductions related to U.S. base erosion payments. Our effective tax rate for the nine months ended September 30, 2023 was lower than the U.S. statutory tax rate primarily due to the tax benefit related to the impairment of intangible assets and various tax credits.

On a quarterly basis, we evaluate both positive and negative evidence that affects the realizability of net deferred tax assets and assess the need for a valuation allowance. The future benefit to be derived from our deferred tax assets is dependent upon our ability to generate sufficient future taxable income in each jurisdiction of the right type to realize the assets.

Our future effective tax rate depends on various factors, including the impact of tax legislation, further interpretations and guidance from U.S. federal and state governments on the impact of proposed regulations issued by the Internal Revenue Service, further interpretations and guidance from foreign governments, the geographic composition of our pre-tax income, and changes in income tax reserves for unrecognized tax benefits. We monitor these factors and timely adjust our estimates of the effective tax rate accordingly. We expect the Atotech Acquisition will continue to have an unfavorable impact on our effective tax rate as MSD operates primarily in jurisdictions with tax rates higher than the U.S. statutory tax rate. However, the geographic mix of pre-tax income can change based on multiple factors, resulting in changes to the effective tax rate in future periods. While we believe we have adequately provided for all tax positions, amounts asserted by taxing authorities could materially differ from our accrued positions as a result of uncertain and complex application of tax law and regulations. Additionally, the recognition and measurement of certain tax benefits includes estimates and requires judgment by management. Accordingly, we may record additional provisions or benefits for U.S. federal, state, and foreign tax matters in future periods as new information becomes available.

Many countries in which we operate have implemented or are implementing legislation and other tax changes to align their tax systems with the Organisation for Economic Co-operation and Development global minimum tax rate known as Pillar Two of the Global Anti-Base Erosion (“GloBE”) rules. The GloBE rules provide a framework for a coordinated multi-country system of taxation intended to ensure large multinational enterprise groups pay a minimum level of tax on the income arising in each of the jurisdictions where they operate. Many jurisdictions, including many EU countries, have enacted certain provisions of the GloBE rules effective as of January 1, 2024. The Company does not expect the GloBE rules to have a material impact on its consolidated financial statements.

Liquidity and Capital Resources

Cash and cash equivalents at September 30, 2024 and December 31, 2023 totaled $861 million and $875 million, respectively. The primary driver in our current and anticipated future cash flows is, and we expect will continue to be, cash generated from operations, consisting primarily of our net income (loss), excluding non-cash charges and changes in operating assets and liabilities. In periods when our sales are growing, higher sales to customers will result in increased trade receivables, and inventories will generally increase as we build products for future sales. This may result in lower cash generated from operations. Conversely, in periods when our sales are declining, our accounts receivable and inventory balances will generally decrease, resulting in increased cash from operations. We believe that our current cash and investments position and available borrowing capacity, together with the cash anticipated to be generated from our future operations, will be sufficient to satisfy our estimated working capital, planned capital expenditure requirements, payments of debt, and any future cash dividends declared by our Board of Directors or share repurchases through at least the next 12 months and the foreseeable future.

Net cash provided by operating activities was $352 million for the nine months ended September 30, 2024, resulting from net income of $99 million, which included non-cash charges of $254 million, mainly the result of $262 million of depreciation and amortization expense and $52 million of loss on extinguishment of debt, partially offset by $168 million in deferred income taxes and a net increase in working capital of $1 million. The net increase in working capital was primarily due to a decrease in accrued compensation of $26 million, a decrease in accounts payable of $21 million and a decrease in other current and non-current liabilities of $28 million. This net increase in working capital was partially offset by increases in income taxes payable of $53 million, other current and non-current assets of $17 million and inventory of $11 million.

Net cash used in investing activities was $66 million for the nine months ended September 30, 2024, and consisted primarily of $67 million in capital expenditures.

Net cash used in financing activities was $303 million for the nine months ended September 30, 2024, primarily due to net proceeds from the issuance of Convertible Notes of $1.4 billion and incremental loans under the Term Loan Facility in an aggregate principal amount of $761 million. The proceeds of the incremental loans under the Term Loan Facility were used in part to prepay the USD Tranche A term loans outstanding under the Amended Credit Agreement (as defined and described further below under “Credit Facilities”) in full in an aggregate principal amount of $744 million and the proceeds of the Convertible Notes were used in part to prepay a portion of the USD Tranche B loans in an aggregate principal amount of $1.2 billion. In addition, there were normal quarterly debt payments and voluntary prepayments that totaled $248 million. We also made payments of $167 million to purchase a capped call option related to the Convertible Notes, $33 million for debt financing costs and $44 million for dividends.

Holders of our common stock are entitled to receive dividends when they are declared by our Board of Directors. During each of the first three quarters of 2024 and 2023, our Board of Directors declared a cash dividend of $0.22 per share. The cash dividends totaled $44 million for both the nine months ended September 30, 2024 and 2023. On November 4, 2024, our Board of Directors declared a quarterly cash dividend of $0.22 per share to be paid on December 6, 2024 to stockholders of record as of November 25, 2024. Future dividend declarations, if any, as well as the record and payment dates for such dividends, are subject to the final determination of our Board of Directors.

Credit Facilities

In connection with the completion of the Atotech Acquisition, on August 17, 2022 (the “Effective Date”) we entered into a credit agreement with JPMorgan Chase Bank, N.A., as administrative agent and collateral agent, Barclays Bank PLC, and the lenders from time to time party thereto, which we have amended several times since (as amended, the “Amended Credit Agreement”). As of September 30, 2024, the Amended Credit Agreement provided for (i) a senior secured term loan facility comprised of two tranches: a $2.6 billion loan (the “USD Tranche B”) and a €800 million loan (the “Euro Tranche B” and together with the USD Tranche B, the “Term Loan Facility”) and (ii) a senior secured revolving credit facility of $675 million (the “Revolving Facility” and, together with the Term Loan Facility, the “Credit Facilities”), with the commitments under each of the foregoing facilities subject to increase from time to time subject to certain conditions.

As of September 30, 2024, borrowings under the Credit Facilities bore interest at a rate per annum equal to, at our option, any of the following, plus, in each case, an applicable margin: (a) with respect to the USD Tranche B and the Revolving Facility, (x) a base rate determined by reference to the highest of (1) the federal funds effective rate plus 0.50%, (2) the prime rate quoted in The Wall Street Journal, or (3) a forward-looking term rate based on the variable secured overnight financing rate (“Term SOFR”) (plus an applicable credit spread adjustment) for an interest period of one month, plus 1.00%, and (y) a Term SOFR rate (plus an applicable credit spread adjustment) for the interest period relevant to such borrowing, subject to a rate floor of (I) with respect to the USD Tranche B, 0.50% and (II) with respect to the Revolving Facility, 0.0%; and (b) with respect to the Euro Tranche B, a Euro Interbank Offered Rate (“EURIBOR”) rate determined by reference to the costs of funds for Euro deposits for the interest period relevant to such borrowing adjusted for certain additional costs, subject to a EURIBOR rate floor of 0.0%. As of September 30, 2024, the applicable margins for borrowings under the Credit Facilities were (i) under the USD Tranche B and the Revolving Facility, 1.25% with respect to base rate borrowings and 2.25% with respect to Term SOFR borrowings and (ii) under the Euro Tranche B, 2.75%.

In addition to paying interest on outstanding principal under the Credit Facilities, we are required to pay a commitment fee in respect of the unutilized commitments under the Revolving Facility. The commitment fee is subject to adjustment based on our first lien net leverage ratio as of the end of the preceding fiscal quarter. We must also pay customary letter of credit fees and agency fees. As of September 30, 2024, the commitment fee was 0.25% per annum representing a downward adjustment from 0.375% as of June 30, 2024.

As of September 30, 2024, the weighted average interest rate of the Term Loan Facility was 6.9%. The Revolving Facility has a maturity date in August 2027 while the USD Tranche B and Euro Tranche B have a maturity date in August 2029. As of September 30, 2024, there were no borrowings under the Revolving Facility.

We are required to make scheduled quarterly principal payments equal to approximately $10 million with respect to the USD Tranche B and approximately €2 million with respect to the Euro Tranche B, in each case with the balance due thereunder on the seventh anniversary of the Effective Date. There is no scheduled amortization under the Revolving Facility. Any principal amount outstanding under the Revolving Facility is due and payable in full on the fifth anniversary of the Effective Date.

Under the Amended Credit Agreement, we are required to prepay outstanding term loans, subject to certain exceptions, with portions of our annual excess cash flow as well as with the net cash proceeds of certain of its asset sales, certain casualty and condemnation events and the incurrence or issuances of certain debt. If at any time the aggregate amount of outstanding loans, unreimbursed letter of credit drawings and undrawn letters of credit under the Revolving Facility exceeds the aggregate commitments under the Revolving Facility, we are required to repay outstanding loans and/or cash collateralize letters of credit, with no reduction of the commitment amount.

We may voluntarily prepay, and have voluntarily repaid, outstanding loans under the Credit Facilities from time to time, subject to certain conditions, without premium or penalty other than customary “breakage” costs with respect to Term SOFR or EURIBOR loans and any prepayment premium that might be applicable to repayments we make prior to January 23, 2025. Additionally, we may voluntarily reduce the unutilized portion of the commitment amount under the Revolving Facility.

On October 23, 2024, we made a voluntary prepayment of €200 million principal amount, which equates to $216 million, to our Euro Tranche B loan under the Term Loan Facility.

All obligations under the Credit Facilities are guaranteed by certain of our wholly-owned domestic subsidiaries and are required to be guaranteed by certain of our future wholly-owned domestic subsidiaries, and are secured by substantially all of our assets and the assets of such subsidiaries, subject to certain exceptions and exclusions.

Under the Amended Credit Agreement, we have the ability to incur additional incremental debt facilities in an amount up to (x) the greater of (1) $1,011 million and (2) 75% of consolidated last twelve months earnings before interest, taxes, depreciation, and amortization, plus (y) an amount equal to the sum of all voluntary prepayments of term loans under the Term Loan Facility, plus (z) an additional unlimited amount subject to pro forma compliance with certain leverage ratio tests (based on the security and priority of such incremental debt).

The Amended Credit Agreement contains customary representations and warranties, covenants and provisions relating to events of default. As of September 30, 2024, we were in compliance with all covenants under the Amended Credit Agreement. The USD Tranche B and the Euro Tranche B are not subject to financial maintenance covenants.

On May 16, 2024, we completed a private offering of Convertible Notes. A significant portion of the net proceeds from the offering was used to repay approximately $1.2 billion of the USD Tranche B. As a result of the repayment, we recorded a $38 million loss on extinguishment of debt.

Convertible Notes

On May 16, 2024, we completed a private offering of $1.4 billion aggregate principal amount of convertible senior notes due 2030 (the “Convertible Notes”). The Convertible Notes were sold in a private placement under a purchase agreement, dated as of May 13, 2024, entered into by and among us and Morgan Stanley & Co. LLC, J.P. Morgan Securities LLC, BofA Securities, Inc. and Mizuho Securities USA LLC, as representatives of the several initial purchasers named therein, for resale to persons reasonably believed to be qualified institutional buyers in reliance on Rule 144A under the Securities Act of 1933, as amended.

The net proceeds from the offering were approximately $1.4 billion after deducting the initial purchasers’ discounts and commissions and estimated offering expenses paid by us. We used approximately $167 million of the net proceeds from the offering to pay the cost of the capped call transactions described below. We used the remaining net proceeds from the offering to repay approximately $1.2 billion in borrowings outstanding under the USD Tranche B, together with accrued interest, as well as for general corporate purposes.

Indenture and the Convertible Notes

On May 16, 2024, we entered into an indenture (the “Indenture”) with respect to the Convertible Notes with U.S. Bank Trust Company, National Association, as trustee. Under the Indenture, the Convertible Notes are senior unsecured obligations of ours and bear interest at a coupon rate of 1.25% per annum, with interest payable semiannually in arrears on June 1 and December 1 of each year, beginning on December 1, 2024. The Convertible Notes will mature on June 1, 2030, unless earlier converted, redeemed or repurchased in accordance with their terms.

Subject to certain conditions, on or after June 5, 2027, we may redeem for cash all or any portion of the Convertible Notes at a redemption price equal to 100% of the principal amount of the Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date, if the last reported sale price of our common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on, and including, the trading day immediately preceding the date the notice of redemption is sent.

The conversion rate for the Convertible Notes is initially 6.4799 shares of our common stock per one thousand dollars principal amount of Notes, which is equivalent to an initial conversion price of approximately $154.32 per share. The conversion rate is subject to adjustment upon the occurrence of certain events.

Upon conversion, we will pay cash up to the aggregate principal amount of the Convertible Notes to be converted and pay or deliver, as the case may be, cash, shares of common stock or a combination of cash and shares of common stock, at our election, in respect of the remainder, if any, of our conversion obligation in excess of the aggregate principal amount of the Convertible Notes being converted. Prior to March 1, 2030, noteholders may convert all or any portion of their Convertible Notes only upon the occurrence of certain events and during certain periods, and thereafter, at any time until the second scheduled trading day immediately preceding the maturity date.

If we undergo a fundamental change (as defined in the Indenture) prior to the maturity date of the Convertible Notes, holders may require us to repurchase for cash all or any portion of their Convertible Notes at a fundamental change repurchase price equal to 100% of the principal amount of the Convertible Notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date.

The Indenture contains customary terms and covenants, including that upon certain events of default that are occurring and continuing, either the trustee or the holders of at least 25% in aggregate principal amount of the outstanding Convertible Notes may declare 100% of the principal of, and accrued and unpaid interest, if any, on, all the Convertible Notes to be due and payable.

As of September 30, 2024, the Convertible Notes are classified as a long-term liability, net of issuances costs, on the condensed consolidated balance sheet. The Convertible Notes were issued at par and costs associated with the issuance of the Convertible Notes are amortized to interest expense over the contractual term of the Convertible Notes. As of September 30, 2024, the effective interest rate of the Convertible Notes was 1.56%.

Capped Call Transactions

On May 13, 2024, in connection with the pricing of the Convertible Notes, and on May 14, 2024, in connection with the exercise in full by the initial purchasers of their option to purchase additional Convertible Notes, we entered into privately negotiated capped call transactions with certain of the initial purchasers of the Convertible Notes or their respective affiliates and other financial institutions. The capped call transactions are expected generally to reduce the potential dilution to our common stock upon conversion of any Convertible Notes and/or offset any cash payments that we are required to make in excess of the principal amount of any converted Convertible Notes, as the case may be, with such reduction and/or offset subject to a cap initially equal to $237.42 per share (which represents a premium of 100% over the last reported sale price of $118.71 per share of our common stock on The Nasdaq Global Select Market on May 13, 2024), and is subject to customary adjustments under the terms of the capped call transactions.

Lines of Credit and Borrowing Arrangements

Certain of our Japanese subsidiaries have lines of credit and a financing facility with various financial institutions, many of which generally expire and are renewed at three-month intervals with the remaining having no expiration date. These lines of credit and financing facility provided for aggregate borrowings as of September 30, 2024 and December 31, 2023 of up to an equivalent of $21 million and $14 million, respectively. There were no borrowings under these arrangements at September 30, 2024 and December 31, 2023.

Derivatives

We enter into derivative instruments for risk management purposes only, including derivatives designated as hedging instruments and those utilized as economic hedges. We operate internationally, and in the normal course of business, are exposed to fluctuations in interest rates and foreign exchange rates. These fluctuations can increase the costs of financing, investing and operating the business. We have used derivative instruments, such as foreign exchange forward contracts and options, to manage certain foreign currency exposure, and interest rate swaps and caps to manage interest rate exposure.

By nature, all financial instruments involve market and credit risks. We enter into derivative instruments with major investment grade financial institutions and no collateral is required. We have policies to monitor the credit risk of these counterparties. While there can be no assurance, we do not anticipate any material non-performance by any of these counterparties.

Interest Rate Agreements

We have various interest rate swap agreements as described further in Note 5 to the Notes to the condensed consolidated financial statements. These interest rate swap agreements exchange the variable Term SOFR rate to a fixed rate in order to manage the exposure to interest rate fluctuations associated with the variable Term SOFR rate paid on the outstanding balance of the Term Loan Facility.

Contractual Obligations

There have been no changes outside the ordinary course of business to our contractual obligations as disclosed in our Annual Report.

Recent Accounting Pronouncements

Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures

In November 2023, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures (“ASU 2023-07”), which requires a public entity to disclose significant segment expenses and other segment items on an annual and interim basis and provide in interim periods all disclosures about a reportable segment’s profit or loss and assets that are currently required annually. Additionally, it requires a public entity to disclose the title and position of the Chief Operating Decision Maker. The ASU does not change how a public entity identifies its operating segments, aggregates them, or applies the quantitative thresholds to determine its reportable segments. The new standard is effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024, with early adoption permitted. A public entity should apply the amendments in this ASU retrospectively to all prior periods presented in the financial statements. We do not expect the additional disclosure requirements under ASU 2023-07 to have a material impact on our consolidated financial statements.

Income Taxes (Topic 740): Improvements to Income Tax Disclosures

In December 2023, the FASB issued ASU No. 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures, which focuses on the rate reconciliation and income taxes paid. ASU No. 2023-09 requires a public business entity (“PBE”) to disclose, on an annual basis, a tabular rate reconciliation using both percentages and currency amounts, broken out into specified categories with certain reconciling items further broken out by nature and jurisdiction to the extent those items exceed a specified threshold. In addition, all entities are required to disclose income taxes paid, net of refunds received disaggregated by federal, state/local and foreign and by jurisdiction if the amount is at least 5% of total income tax payments, net of refunds received. For PBEs, the new standard is effective for annual periods beginning after December 15, 2024, with early adoption permitted. An entity may apply the amendments in this ASU prospectively by providing the revised disclosures for the period ending December 31, 2025 and continuing to provide the pre-ASU disclosures for the prior periods, or may apply the amendments retrospectively by providing the revised disclosures for all periods presented. We are currently evaluating the impact of this ASU on our consolidated financial statements and related disclosures.

Income Statement—Reporting Comprehensive Income—Expense Disaggregation Disclosures (Subtopic 220-40): Disaggregation of Income Statement Expenses

In November 2024, the FASB issued ASU No. 2024-03, Income Statement—Reporting Comprehensive Income—Expense Disaggregation Disclosures (Subtopic 220-40): Disaggregation of Income Statement Expenses, which requires public companies to disclose, in interim and annual reporting periods, additional information about certain expenses in the notes to financial statements. The amendments in this ASU are effective for annual reporting periods beginning after December 15, 2026, and interim reporting periods beginning after December 15, 2027, with early adoption permitted. We are currently evaluating the impact of this ASU on our consolidated financial statements and related disclosures.

Information concerning market risk is contained in the section entitled “Quantitative and Qualitative Disclosures About Market Risk” contained in our Annual Report. As of September 30, 2024, there were no material changes in our exposure to market risk from December 31, 2023.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer (who served as both our principal executive officer and principal financial officer for the three months ended September 30, 2024), evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2024. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on that evaluation, our Chief Executive Officer concluded that, as of September 30, 2024, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to our management, including our Chief Executive Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2024 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Information regarding risk factors affecting our business is discussed in the section entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2023 filed with the U.S. Securities and Exchange Commission on February 27, 2024 and the section entitled “Risk Factors” in our Quarterly Report on Form 10-Q for the period ended June 30, 2024 filed with the U.S. Securities and Exchange Commission on August 8, 2024, which section is incorporated herein by reference.