MKS Instruments, Inc. — Q3 2019 Form 10-Q
Period: Three and nine months ended September 30, 2019. Unaudited financial statements; amounts below are in U.S. dollars. MKS supplies instruments, subsystems, process-control solutions and related services to semiconductor, industrial, life-sciences, research and defense markets.
Business context and reporting period
MKS acquired Electro Scientific Industries (ESI) on February 1, 2019, adding the Equipment & Solutions segment and laser-based manufacturing systems. The acquisition was funded with cash and term-loan proceeds; total purchase consideration was approximately $1.063 billion. Results include ESI from the acquisition date, limiting direct comparison with 2018.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $462.5 million | $487.2 million | $1,400.1 million | $1,614.6 million |
| Gross profit / margin | $205.0 million / 44.3% | $231.9 million / 47.6% | $614.1 million / 43.9% | $769.6 million / 47.7% |
| Operating income / margin | $66.8 million / 14.4% | $117.0 million / 24.1% | $153.8 million / 11.0% | $400.0 million / 24.9% |
| Net income | $47.4 million | $93.3 million | $97.6 million | $321.3 million |
| Diluted EPS | $0.86 | $1.70 | $1.77 | $5.82 |
| Operating cash flow | Not separately presented for quarter | Not separately presented for quarter | $167.3 million | $278.3 million |
| Capital expenditures | Not separately presented for quarter | Not separately presented for quarter | $44.8 million | $36.9 million |
At September 30, 2019, cash and cash equivalents were $386.3 million and short-term investments were $88.8 million, totaling $475.1 million. Total current assets were $1.360 billion versus current liabilities of $310.7 million. Reported short- and long-term debt totaled approximately $886.1 million; term-loan principal outstanding was $894.6 million. The company also had an unused $100 million asset-based revolving facility.
Material changes versus prior comparable periods
- Q3 revenue decreased 5.1%; nine-month revenue decreased 13.3%. Lower semiconductor-related volumes were the main pressure on legacy MKS, partly offset by ESI and higher service revenue.
- Semiconductor customer revenue fell 14% in Q3 and 28% year to date. Management attributed this to reduced semiconductor capital-equipment spending. Advanced-market revenue increased 5% in both periods, primarily reflecting ESI contributions.
- Gross margin fell 3.3 percentage points in Q3 and 3.8 points year to date, mainly from lower factory utilization and product volumes. Product gross margin declined 4.5 points year to date; service gross margin rose 0.8 points.
- Net income and diluted EPS declined substantially. Higher interest expense, amortization, acquisition-related costs and lower operating income contributed. Interest expense was $13.5 million in Q3 and $35.3 million for nine months, versus $3.7 million and $13.1 million, respectively.
- ESI contributed $49.3 million of Q3 revenue and a $5.8 million net loss; for the period since acquisition, it contributed $140.4 million of revenue and a $40.7 million net loss.
Outlook, management commentary, risks and unusual items
- Management said semiconductor capital spending had moderated over the prior 12 months and the timing of a full recovery remained uncertain, while market conditions were improving. The filing provides no specific financial guidance.
- Cash from operations was lower year over year, and cash declined primarily due to the ESI acquisition. Investing cash outflow included $988.6 million for the acquisition. Management attributed operating cash flow to net income and non-cash charges, partly offset by working-capital needs, including higher inventory and lower payables.
- On September 27, MKS refinanced its term loans into a facility maturing February 2026. The stated interest rate at September 30 was 3.59%; $300 million of the new borrowing was interest-rate swapped. The company reported compliance with debt covenants. Debt is secured by substantially all company and certain subsidiary assets.
- In August, MKS sold buildings in Boulder and Portland, receiving $41.2 million net proceeds and recording a $6.8 million gain; it leased the buildings back for periods extending into 2020 and 2021.
- Nine-month acquisition and integration costs were $35.5 million. The ESI purchase accounting included a $7.6 million inventory fair-value step-up expensed as inventory was sold. ESI goodwill and identifiable intangible assets were preliminary and could be adjusted during the measurement period.
- A $5.0 million out-of-period deferred-tax correction was recorded in Q2 2019; the filing says it was not material to prior or current interim and annual statements. Nine-month effective tax rate was 20.4%.
- A Newport shareholder lawsuit remained pending against former Newport directors; MKS and Newport had been dismissed as defendants. A bench trial was scheduled for January 2020. Management said other ordinary-course legal matters were not expected to have a material adverse effect.
- Management cited exposure to semiconductor demand shifts, international markets and currency movements, as well as product-development, customer-design-win and competitive risks. No material changes to previously disclosed risk factors were reported. Disclosure controls were deemed effective.
Important facts for investors to verify
- Whether semiconductor demand and factory utilization recover, and how that affects legacy segment revenue and margins.
- ESI’s integration progress, ongoing profitability, and any material revisions to preliminary purchase accounting or goodwill/intangible valuations.
- Debt repayment capacity, floating-rate exposure, covenant headroom and the effect of acquisition financing on interest expense and liquidity.
- Cash conversion and working-capital trends, particularly inventory and accounts payable.
- Timing and outcome of the Newport litigation and any developments in tax exposures or unrecognized tax benefits.